Tomorrow’s Company Briefing on…

Fiduciary Duty

March 2009

“The governance challenge is to make sure that the resolution of conflicts is an open and fair process between entities that are informed, motivated and empowered.  That challenge is primarily addressed by laws, most significantly the imposition of the highest standard of procedural and substantive performance ever developed under our legal system, the fiduciary standard.”

Monks and Minow, Corporate Governance 4^th Edition, p94

The concept of fiduciary duty underpins the operation of the modern capitalist system.  A fiduciary is someone who has undertaken to act for and on behalf of another in a particular manner in circumstances which give rise to a relationship of trust and confidence.[i]   Directors have a fiduciary duty in respect of the companies they run and pension fund trustees owe their duty to the fund’s beneficiaries.  Investment managers and consultants are obliged to take account of the fiduciary obligations of their clients. 

A fiduciary is expected to exercise due care and be extremely loyal to the person to whom he owes the duty, must not put his personal interests before the duty and must not profit from the position: “[t]he distinguishing or overriding duty of a fiduciary is the obligation of undivided loyalty.”[ii]  

Directors’ Duties

Building from the work of the original RSA Tomorrow’s Company inquiry, a UK director’s fiduciary duty was restated in the Companies Act 2006 as a duty to promote the company’s success.  Directors have to act in good faith and advance the company’s interests, defined as the benefit of its members as a whole.  The new wording for the duty explicitly enables directors to have regard to the environmental and social impacts of their company’s business[iii] and has been held to give “a more readily understood definition of the scope of the duty” that has been in place for some time.[iv] 

Directors’ duties vary from country to country.  In Germany the duty is to stakeholders, rather than to the company[v], while in the US, a director’s duty is to run the business in the interests of shareholders, although state legislation can allow directors to consider the impact of their decisions on any affected party.  To complicate the picture in the US, the 1933 Securities Act and the 1934 Securities Exchange Act place a higher duty of care by the board on SEC-enforced reporting requirements than on running the business itself and that duty of care is related to a derived perception of value – the share price – rather than the actual value in efficiently utilising and protecting the assets of the company itself.[vi]

The Duty on Pension Funds and Their Agents

In the UK and US, the conventional interpretation of the duty by investors has been to seek to maximise financial returns from the investments made.  However, Freshfields have argued that the prudent investor rule in the US and Cowan v. Scargill in the UK, the usual authorities for this approach, do not support the single-minded pursuit of profit maximisation.  Instead, the prudent investor rule can be interpreted as requiring decision-makers to have regard (at some level) to environmental, social and governance (ESG) considerations in every decision they make, while Cowan v. Scargill merely confirms that trustees must exercise their powers for the purpose for which they were granted.[vii]

Freshfields note that conventional investment analysis focuses on value, in the sense of financial performance, and that the links between ESG factors and financial performance are increasingly being recognised.  Consequently, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.[viii]

A Dynamic Concept

Fiduciary duties evolve over time according to changes in social norms and the values of society and, to a degree, technological and market changes.  For example, paying equal wages to men and women and subsidising public transport were held as breaches of fiduciary duty in the past, but would not be considered so now.[ix] 

Directors’ duties in the UK have recently been revised to take account of environmental and social issues, while for investors, the debate centres on the integration of ESG factors into decision-making.  The body of research into ESG factors is growing and large institutional investors are being seen as universal owners, with interests in the well-being of the economy as a whole.  As financial transactions and investment vehicles become more specialised and complex, some argue that our interpretation of fiduciary duty must expand to encompass our greater knowledge and understanding of the long-term social and environmental costs and risks.[x]