Having my weekly market square fix of Thai green curry, I recently chanced upon a crowd of protestors, pushing for divestment. After Cambridge’s first ever Green Week, the Divestment movement has been reaching new highs, calling for the individual Cambridge college funds (“CF”), and the University-wide Cambridge University Endowment Fund (“CUEF”), to restructure its investments. The Cambridge Zero Carbon Society has strongly asserted that continued investment into “arms, tax havens and the world’s most destructive fossil fuel companies” is  a “national scandal”.1 Beyond the Cambridge bubble, divestments have become a hot topic in other universities and charities as well, as socially responsible investing (“SRI”) has proven to be more than a passing fad.2 From a certain moral view, divestment is a good thing, essentially disowning the activities of potentially destructive, immoral, or unethical industries. It is an exercise of the dollar vote, and people are voting against these industries. 

However, turning to the legal perspective, this issue is not as straightforward. It is noted that investments made by universities and charities, are made as a result of trust duties arising both from statute and common law. As such, divestments from specific sectors of the market, like what Cambridge Zero Carbon Society is calling for, may be in breach of these duties, some of which require the trustees to invest and grow the trust fund in the most profitable way possible. 

This article will explore the law governing trustee investment discretion, and how the law has evolved in a time where ethical investing is playing a bigger role in society. It is argued that the law is lagging behind practice. It is also hoped that a clearer understanding of the legal position of trustees and divestment will allow both sides to engage in more fruitful discussions. 

A Quick Introduction to the Functions of Charities:

Settlors (typically successful and generous benefactors), vest a sum of money in an organisation (normally a charity, in the context of Cambridge), whereby the organisation, becoming a trustee and fiduciary, holds legal title to the sum of money, but are then required to perform several duties, one of which is to use the money towards the purposes that the settlors require. 

An example of how this would work in practice: The Dunlevie Fund in Trinity College, Cambridge was set up after an endowment by Bruce Dunlevie, to help undergraduates do something life-enhancing which they could not otherwise afford while at College. Administrators of the trust (the Dunlevie Fund), have the primary duty and power of selecting candidates every year who fulfil the terms of the trust, that candidates perform ‘life-enhancing activities’ like traveling to cultural centres, watching football games etc., and then disburse some of the money towards these students. Ancillary duties of the trustees include investing the initial sum of money, in order to ensure that the trust can continue assisting students for years to come. This is to protect it from inflation, and to grow the fund.

Investment Duty of Charitable Trusts: 

This duty to invest the trust fund can arise by explicit terms in the trust, i.e. where Bruce Dunlevie requires the trustees in Trinity to invest in the FTSE 500. It is assumed that the CFs, and the CUEF was set-up with just a broad general power of investment, as is the case with most charities, without further details as to what to invest in. The trustees here would then by subject to the duty of care under the Trustee Act 2000, and the common law duties. Alternatively, if the trust was silent as to whether investment was possible, the trustees could still choose to engage in investment, henceforth being subject to the duty of care under the Trustee Act, and the ensuing common law duties. 

The Trustee Act is silent as to whether ethical investing is possible, but section 3 permits the trustee to invest and ‘make any kind of investment that he could make if he were entitled to the assets of the trust’. Under section 4 of the Trustee Act, trusts have duties to ensure the suitability of investments to the trust, and that the investments were properly diversified (Nestle v National Westminster Bank). Here, trustees are "to be judged by the standard of current portfolio theory, which emphasises the risk level of the entire portfolio rather than the risk attaching to each investment taken in isolation".3As Thornton puts it, assets which are individually more hazardous may be offset by other, safer investments to form a portfolio which is balanced and which, when taken as a whole, seems best designed to further the financial needs of the particular trust.4

Additionally, the long-standing common law principles remain unaffected, particularly the principle that: 

The starting point is the duty of trustees to exercise their powers in the best interests of the present and future beneficiaries of the trust... When the purpose of the trust is to provide financial benefits for the beneficiaries, as is usually the case, the best interests of the beneficiaries are normally their best financial interests. In the case of a power of investment... the power must be exercised so as to yield the best return for the beneficiaries, judged in relation to the risks of the investments in question...5

The Central Clash and its Exceptions: 

As such, we now see clash between the moral duty to divest, and trust duties. Even if the CF and CUEF trustees morally agree to the Divestment movement, they are bound by their trustee duties to not take into account the ethical and moral duty of divestment. Trustees risk being in breach of their trust duties and being liable, on these two grounds: 

1. Divesting from certain industries would arguably cause issues with proper diversification of portfolios, especially for the bigger funds. The total exclusion of a sector, for example oil and gas or natural resources, would be in clear breach of the section 4 duty to diversify. This issue is exacerbated by the fact that the controversial industries like mining or oil and gas, often make up a large percentage of economic activity, and occupy a substantial portion of the stock market.
2. There is a duty to obtain the best available ‘price’, and maximisation of value and yield should drive investment decisions. Trustees must not to fetter their own discretion, which makes it compulsory for trustees to ignore ethical or moral considerations where it might stand in the way of obtaining the best price. Divesting, where investments are screened according to disqualifying criteria based on moral, environmental, or ethical concerns, and then divested or prevented from being acquired in a portfolio would limit or determine the selection of investment assets, taking precedence over commercial factors. This would seem to offend the duty above to obtain best price. The CUEF fund managers are mindful of these issues, stating that divesting out of the controversial sectors “would result in significant limitations on the CUEF’s ability to invest as successfully as in the past”.6

However, it is noted that there are certain limited exceptions to the rule as laid out in Thornton (2008): 

1. Where all the sui iuris beneficiaries unanimously consent to a less attractive ethical investment, as noted by Sir Robert Megarry V.C. in Cowan v Scargill, possibly based on an application of Saunders v Vautier. However, it is noted that this is exceedingly rare, and for a trust with as many beneficiaries as that of the CUEF or the colleges endowment trust, almost entirely impossible. 
2. Where the trust was a charitable purpose trust. With charitable trusts, the prima facie rule is the same as that under Cowan v Scargill– that the trustee is not entitled to account his ethical considerations. However, this can be displaced in two situations – (a) where investment in a business would conflict with the charity’s aims, and (b) where investment might hamper a charity’s work (Harries v Church Commissioners for England). For (a): An example may be where the trustees of a charity with objects for the protection of the environment legitimately decided not to invest in business which pollute the environment. Alternatively, where a trustee of a charity concerned with preventing alcoholism can choose not to invest in companies manufacturing alcoholic drinks, given by Sir Donald Nicholls VC. There must be a real practical conflict between the charity’s aims and the activities of the potential recipient of investment. Here, the CFs and CUEF are indeed charities, but instead have the purpose of furthering education. As such, only a clearly anti-education investment will satisfy this requirement, which is highly unlikely. For (b): Another situation is where the investment hampers a charity’s work by making potential beneficiaries unwilling to be helped because of the source of the charity’s funding, or by alienating donors to the charities. For example, donors to a charity for cancer relief would not wish the trustees to invest in tobacco companies., or if cancer patients refuse to undergo treatment with the charity because of its links to tobacco companies. It has been noted by Thornton that “any deterrent effect upon potential service users is liable to be difficult to gauge, and unlikely to be sufficiently disruptive to outweigh hard economic arguments the other way in any but very occasional circumstances”. It is noted that the Charities Act 2011 s292A brings in power for charities to make social investments, for the purposes of furthering the charity’s aim and making a profit. ‘Directly furthering charity’s aim’ here cannot be read to allow for the non-investment of certain sectors, and arguably, s292A does little to change the law on trustee’s investment duties. 

Equally Satisfactory Investments? 

Another apparent exception to the rule in Cowan v Scargill is again contained in Harries, where although the Commissioner’s approach (the trustees) was expressly termed by Sir Donald Nicholls as an ‘ethical’ investment policy, it was still held to be compliant, and not ‘inconsistent with the general principles’ of trustee law. This was despite ruling out completely any investments in arms, gambling, alcohol, tobacco and businesses in South Africa, and effectively excluding approximately 13%, by value, of listed UK companies. However, this seems to go against the rule in Cowan, and it is hard to see how this approach would not have fettered the trustee’s discretion in only finding the most profitable investments. In Martin v City of Edinburgh District Council, it was held that trustees who "fetter their investment discretion by any ab ante decision", or act "for reasons extraneous to the trust purposes" would be in breach of trust duties.7As such, Harriesis of arguably questionable use here. 

Instead, where the investment approach merely involves taking into account Environmental, Social and Governance (ESG) issues perceived to be financially material to investment performance, then such practices are generally lawful8, as contrasted with excluding whole sections of the available market. Examples of ESG criteria used by investors include the company's impact on climate change or carbon emissions, water use or conservation efforts, anti-corruption policies, board member diversity, human rights efforts and community development.9 There seems to be emerging consensus among legal practitioners and investment professionals that the integration of ESG criteria into investment decision-making will become the norm even if not prescribed by the law.10 This is merely an application of the rule in Cowan v Scargillof obtaining the best price. There is mounting evidence that ESG issues can affect the performance of investment portfolios and have implications for a company’s earnings and prospects as well as broader economic functioning. In other words, looking at ESG criteria may correlate to an investment’s profit potential. However, it is noted that this is quite far from the Divestment movement’s call for complete divestment from certain industries.

Dissonance: a Hope for the Future?

There is then an issue of ‘disjointed thinking’11, a cognitive dissonance in the law of equity. As Thornton notes, there a mismatch between practice on one side, and legal and economic theory on the other. Arguably, some trustees do take into account ethical grounds, or other immaterial considerations when investing trust assets, but there is a form of de facto immunity, where “due to the risk and uncertainty  inherent in the making of investment choices, it will be very difficult in practice for aggrieved beneficiaries to prove loss arising from breach of  their trustees' duties in this respect”.12 Leggatt L.J. in Nestle stated that "a breach of duty will not be actionable... if it does not cause loss", and that the claimant "will therefore fail who cannot prove a loss... caused by breach of duty." Hayton agrees with this view: “[T]here is still much scope for trustees quietly to take into account the moral, social and political views of beneficiaries and of themselves, since it will in practice be difficult to prove that at the time a particular investment was made it was not as equally financially meritorious as certain other possible investments”.13

It is argued that Parliament should step in to close this lacuna in the law. For now, there remains no possible solution to reconcile the divestment movement with duties of trustees, no matter how compelling the moral and ethical arguments are. Trustees can only enjoy de facto immunity, but this may entail breaches of trust duties, and for trustees in charge of considerable assets, this may be a highly unpopular position. 

References

1. Chye, Bradbury and Hunter. (2018, November 9). Big Oil and deep sea drilling: The corporations underpinning Cambridge colleges’ investments. Retrieved from Varsity: https://www.varsity.co.uk/news/16518.

2. Richardson, Benjamin J., Fossil Fuels Divestment: Is It Lawful? (November 22, 2016). University of New South Wales Law Journal, Vol. 39, No. 4, 2016. Available at SSRN: https://ssrn.com/abstract=2874660

3. Nestle v Westminster Bank plc [1988] Trust Law International 115

4. R. Thornton (2008), Ethical Investments: A Case of Disjointed Thinking Source: The Cambridge Law Journal, Vol. 67, No. 2 (Jul., 2008), pp. 396-422. Published by Cambridge University Press on behalf of Editorial Committee of the Cambridge Law Journal. Stable URL: https://www.jstor.org/stable/25166411

5. Cowan v Scargill [1985] Ch. 270, at 286-287

6. Mark Gilbert, Bloomberg Opinion. (2018, October 15). Doing Good at Cambridge Means an Unholy Row. Retrieved from Bloomberg: https://www.bloomberg.com/opinion/articles/2018-10-15/cambridge-university-endowment-in-esg-battle 7

7. Martin v City of Edinburgh District Council [1989] PLR 10. Note that this is a Scottish case

8. Law Commission (UK), Fiduciary Duties of Investment Intermediaries: Report No 350 (2014)

9. Chen, J. (2019, February 23). Environmental, Social and Governance (ESG) Criteria. Retrieved from Investopedia: https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp

10. UNEP FI. (2015). Fiduciary Duty in the 21st Century. UNPRI

11. Thorton (2008)

12. Thornton (2008)

13. David Hayton, Paul Matthews and Charles Mitchell, Underbill and Hayton's Law of Trusts and Trustees (17th ed., London 2006), para 53.64