Synopsis: Fiduciaries investing charitable assets have a duty to carry out the charity’s purposes, but they may be uncertain about what that means for the investment portfolio. Increasingly, charities want to align investments with mission but wonder whether legal constraints prevent that. This Article explains the legal framework that governs the invest-ment of charitable assets and elucidates the legal rules that permit and even encourage charities to align investments with mission. The Article analyzes application of the rules to sustainable investing and ESG investing, concluding that all fiduciaries can use ESG information for both extra-financial and financial reasons if the fiduciaries seek non-concessionary returns, that charities may engage in mission-aligned investing even if the returns are concessionary (though they need not be), and that charities themselves can figure out how best to use their investment assets to further their purposes.
From political posturing to green-washing, from divestment to proxy voting, environmental, social, and governance (ESG) investing has gotten the attention of financial analysts, the media, and the public. Although some of the attention is political, a good deal of it derives from an aware-ness that ESG factors affect the long-term financial health of companies and that companies’ externalities affect the world in which we live and work.
As ESG investing grows exponentially, fiduciaries worry about their responsibilities. To understand how they can or should use ESG investing strategies, fiduciaries need an explanation of the framework of legal rules that apply to fiduciary investing. The history of those rules and the evolv-ing ways in which the standards have been interpreted and applied can offer insights into what is allowed and what is not, what is hyperbole and what is misinformation.
For fiduciaries investing charitable assets, the decision-making process is particularly complicated. Fiduciaries of charities have a duty to carry out the purposes of the charity but uncertainties as to what that means in terms of the investment portfolio make decision making difficult. Increasingly, charities want to align investments with mission, but they (or their legal advisors) may wonder whether they can. Against this backdrop, fiduciaries need a clear explication of the legal framework that governs the investment of charitable assets and an analysis of the legal rules that permit and even encourage charitable fiduciaries to align investments with mission. This Article speaks to those needs.
Part II of this Article begins with a look at fiduciary investing in general and then analyzes the fiduciary duties as they apply to charities. Part III turns to sustainable investing by fiduciaries, considering challenges to a fiduciary’s use of different types of sustainable investing and the ways the prudence standard has evolved to include the use of ESG information. Part III then discusses a charity’s use of sustainable investing, considering whether a charity can or should align investments with mission. This discussion includes a look at the problems fiduciaries face when pressed to use divestment as a strategy to address a social or environ-mental problem. Before leaving the topic, the Article considers arguments that UPMIFA requires universities to divest from fossil fuels. Part III closes with a look at the effect a charity’s investment policy may have on its ability to attract donations. The Article concludes with a recognition that fiduciaries of charities may engage in mission-aligned investing and that charities themselves can figure out how best to use their investment assets to further their purposes.
Fiduciary duties—how a trustee, director, or other fiduciary of a charity should manage and invest charitable assets—form the core of the legal framework governing the investment of charitable assets. Under state law, in all states, the trustees or directors who manage charities must invest the charitable funds as prudent investors, holding and investing the property for the organization’s charitable purposes. The duty comes from the prudent investor standard, codified in most states using the Uniform Prudent Investor Act (UPIA) for a charitable trust and the Uniform Prudent Management of Institutional Funds Act (UPMIFA) for a charity organized as a nonprofit corporation. The prudent investor standard is the same for all charities because UPMIFA adopted its prudent investor guidance from UPIA. Thus, all fiduciaries of charities must invest under a prudence standard, considering a list of factors that include things specific to the charity as well as more general economic conditions. The fiduciary duties of loyalty and impartiality also affect investment decision making, and fiduciaries should invest the charity’s assets in a way that will support the charity’s purposes over the duration of the charity.
When a fiduciary invests assets, the fiduciary is not investing for the fiduciary’s own account but instead is investing for someone else. In a private trust, the fiduciary invests for the trust’s beneficiaries, in a pension the fiduciary invests for the plan participants and their beneficia-ries, and in a charity the fiduciary invests for the charitable purposes of the charity. An individual might choose to invest the individual’s own money in a risky venture or invest everything in one company, without diversification, but a fiduciary investor must act as a prudent investor. The fiduciary investor must follow the norms of what a prudent investor would do and not follow the fiduciary’s own whims. The norms for prudent investing have evolved and continue to evolve, so this Part provides a brief history of the prudent investor standard.
An understanding of fiduciary investing begins with trust law, and every story about fiduciary investing begins with Harvard College v. Amory. In this 1830 case, the court said that trustees should “observe how men of prudence . . . manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.” Despite this auspicious start, which was a great improvement over the legal lists of approved investments that had been in use at that time, cases interpreting the standard restricted it. Courts focused on the “safety of the capital” language and concluded that trustees must avoid risk. Over time, states went back to legal lists, and trustees became increasingly risk-averse. Protection of the principal became the goal of fiduciary investing, and fiduciaries analyzed investments on an asset-by-asset basis. Fiduciary investing became increasingly conser-vative.
In the second half of the twentieth century, theories of investment were changing. Roger Ibbotson and Rex Sinquefield published a study showing that the inflation-adjusted returns for stocks far exceeded those of bonds. Economists developed the theory of efficient markets and modern portfolio theory, which Jonathan Macey explained in his influential book, An Introduction to Modern Financial Theory. Financial analysts de-veloped investment strategies using modern portfolio theory to increase returns without increasing risk. With these developments, commentators began raising concerns about the need to update the prudent “man” rule. The American Law Institute included the prudent investor rule as part of the Restatement (Third) of Trusts, adopting the rule in 1990 and publishing it in 1992. Shortly thereafter, the National Conference of Commissioners on Uniform State Laws (now known as the Uniform Law Commission or ULC) produced UPIA, influenced by the Restatement, and based on modern portfolio theory.
UPIA directs a trustee to determine the appropriate level of risk for the trust, based on the purposes of the trust, and then to manage the risk rather than to try to avoid all risk. UPIA directs the trustee to analyze risk across the portfolio, rather than try to ensure that each investment is without risk. UPIA provides a list of factors the trustee should consider, including factors related to the specific terms of the trust and factors involving general economic conditions. UPIA adds a duty to diversify investments, unless, due to “special circumstances,” the purposes of the trust are better served by not diversifying. UPIA also permits the fiduciary to delegate investment decision making authority, as long as the fiduciary exercises “reasonable care, skill, and caution” in establishing the scope and terms of the delegation and in selecting and monitoring financial advisors. Finally, UPIA directs trustees to consider the purposes of the trust in making investment decisions and to consider an asset’s special relationship or value to the purposes of the trust. Although UPIA applies to trusts, the Prefatory Note states that “the standards of the Act can be expected to inform the investment responsibilities of directors and officers of charitable corporations.”
Under modern portfolio theory and UPIA, a prudent fiduciary would invest trust assets on a total-return basis, without regard to the categori-zation of returns as income or principal. After the adoption of UPIA, the ULC recognized the disconnect between UPIA’s guidance and the prin-cipal and income statutes. The Revised Uniform Principal and Income Act (1997) added a power to adjust, enabling a trustee who invested as a prudent investor using a total-return portfolio strategy to adjust between principal and income to reach an appropriate income amount without sacrificing overall returns.
In the 1960s, fiduciaries who managed charitable endowments struggled with the risk-adverse trust law standard. Uncertainty existed over whether trust law applied to nonprofit corporations, and the managers of many endowments, whether the endowment was held as a charitable trust or a nonprofit corporation, assumed that the restrictive trust law rules applied. Fiduciaries assessed risk on an asset-by-asset basis, rather than using the portfolio approach advocated by modern portfolio theory. The emphasis on risk avoidance led to investments in bonds rather than stocks.
In addition to concerns over risk, investment decisions were made based on the allocation of principal and income under state statutes. Endowments were set up to spend “income,” and in the 1960s, trust law classified receipts of interest and dividends as income and capital gains as principal. Therefore, if an endowment manager wanted to increase spending, the manager would want investments that produced income, which often meant investments in bonds. Over time the value of the endowments was eroding and concern grew over the long-term financial health of the endowments.
A study published in 1969 by Professor William L. Cary and practicing attorney Craig B. Bright examined the legal duties of fiduciaries investing charitable endowments and identified the problems just de-scribed. With the study to support the argument that change was needed, the ULC drafted, and in 1970 promulgated, the Uniform Management of Institutional Funds Act (UMIFA).
UMIFA provided specific investment authority for fiduciaries of charities organized as nonprofit corporations, to clarify that any rules restricting the investment options of trustees did not apply to directors of a nonprofit corporation. UMIFA gave directors the authority to delegate to investment advisors, a power that was unavailable to trustees at that time. A new spending rule addressed the problem faced by endowment funds subject to a restriction to spend only income from the funds. UMIFA permitted the charity to spend the amount of appreciation in an endowment fund that was “prudent” under “the facts and circumstances prevailing at the time of the action or decision” and after considering “long and short term needs of the institution in carrying out its educational, religious, charitable, or other eleemosynary purposes, its present and anticipated financial requirements, expected total return on its invest-ments, price level trends, and general economic conditions.” UMIFA created a concept called “historic dollar value,” defined as the amounts contributed to an endowment fund. This amount did not include appreci-ation or depreciation over time. The charity could spend appreciation above historic dollar value, based on a determination that doing so was prudent. UMIFA also included a provision governing the release of restrictions.
UMIFA was widely adopted, but changes, including the evolution of prudence norms, led to a revision. In 2006 the ULC approved UPMIFA, which incorporated UPIA’s prudent investor standard, modernized the rules governing expenditures from endowments, and added provisions on modification of donor restrictions. Like UMIFA, the revised Act does not apply to funds managed by fiduciaries that are not charities. Thus, UPMIFA applies to nonprofit corporations and to trusts managed by charities, but not to trusts managed by corporate trustees or individuals. Every state except Pennsylvania has adopted UPMIFA.
The adoption of UPIA across the country was one of the drivers behind the ULC’s decision to revise UMIFA. Section 3 of UPMIFA is based on UPIA, with adjustments to the language because UPMIFA applies to charities. Section 3 of UPMIFA also includes language from the Revised Model Nonprofit Corporation Act: a broad statement that the fiduciaries must “manage and invest the fund in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.” The use of the “corporate” formulation is intended to signal that UPMIFA adopts the business judgment rule but with the recognition that the rule is applied to charities. The language from UPIA then provides more specific guidance.
Section 3 of UPMIFA begins with a reminder that the standard is default law and is subject to any written restrictions or directions provided by a donor. Section 3 then emphasizes that fiduciaries “shall consider” the purposes of the charity and of the fund in making investment decisions. The rest of section 3 incorporates guidance adapted from UPIA, including a requirement that fiduciaries consider, if relevant, a list of factors that range from general economic conditions and the expected total return of the investments to charity-specific factors such as the charity’s short-term and long-terms needs for distributions. Like UPIA, UPMIFA requires diversification, unless the charity determines that its purposes are better served without diversification. Fiduciaries should incur only costs that are “appropriate and reasonable in relation to the assets, the purposes of the institution, and the skills available to the institution.” UPMIFA requires the fiduciaries to consider, if relevant, “an asset’s special relationship or special value, if any, to the charitable purposes of the institution.”
Before examining the further evolution of prudence in investment decision making, the next section reviews other fiduciary duties that relate to the fiduciary investing of charitable funds.
Trust law requires a trustee to act in the sole interests of the trust’s beneficiaries, while corporate law requires directors to act in the best interests of the corporation. Some early cases that considered the duty owed by fiduciaries of a charity applied the trust standard even if the charity was organized as a nonprofit corporation. The influential Sibley Hospital case applied the corporate standard to directors of a nonprofit corporation, and following that decision a number of state statutes adopted nonprofit corporation statutes that applied the corporate standard to directors. The Revised Model Nonprofit Corporation Act (RMNCA) did the same, and the Restatement of the Law of Charitable Nonprofit Organizations (the Restatement of Charitable Nonprofits) followed the RMNCA’s articulation of the duty of loyalty.
Section 2.02 of the Restatement of Charitable Nonprofits applies the same standard for the duty of loyalty to all charities, regardless of organi-zational form. The Comment to section 2.02 explains that adoption of the corporate standard recognizes that most charities, including those organized as trusts, operate programs and are similar to corporations in the way they conduct activities. Further, the settlors of many trusts modify the duty of loyalty in the trust instrument to bring it closer to the corporate standard. A general shift toward the corporate standard had been occurring, and the Restatement of Charitable Nonprofits adopts that shift. Although corporate in form, the duty is owed to a charity and that circumstance affects the duty.
A charity typically does not have identifiable beneficiaries, so in a charity the duty of loyalty is owed to the purposes of the charity. This duty contrasts with the duty owed by directors of a for-profit corporation to the corporation itself. In a charity, whether a charitable trust or a nonprofit corporation, the duty is owed not to the charity but to its purposes and to the indefinite beneficiaries of those purposes.
A fiduciary acting in a charity’s best interests must make decisions for the benefit of the charity’s purposes and not for the fiduciary’s personal benefit. Breaches of the duty of loyalty typically involve some form of conflict of interest, but a conflict of interest by itself is not prohibited. The Restatement of Charitable Nonprofits directs a fiduciary to “address reasonably situations that involve the potential for self-dealing” when the interests of the fiduciary may conflict with those of the charity. The fiduciary must manage any conflict of interest for the benefit of the charity and should follow conflict-of-interest procedures that can help ensure fairness for the charity.
A fiduciary also has a duty of impartiality, to treat fairly the various people or purposes for whom the fiduciary makes decisions. For a charity, this duty requires the fiduciary to consider future as well as current beneficiaries of the charity’s purposes. If the charity is created to last in perpetuity, the time horizon for investments is long. Current decisions about investments or spending will affect the financial health of the charity far into the future. If the purposes of the charity are expected to continue for a long time, the duty of impartiality requires consideration of the intended duration in making decisions.
The duty of impartiality is of particular importance for endowments, which are typically intended to last indefinitely. A charity likely wants its endowment to respond to current needs and still be available to respond to needs in the future. Economics Professor James Tobin explains, “[t]he trustees of an endowed institution are the guardians of the future against the claims of the present. Their task [in managing the endowment] is to preserve equity among generations.”
A charity may own assets that are used directly to carry out the charity’s mission. These assets include things like land used for nature education, paintings owned by a museum, or university classrooms and dormitories. These assets have financial value to the charity, but their purpose is not as investment and the charity does not expect to generate financial return from the asset, at least not as the primary purpose for the asset.
UPIA does not specifically exclude program-related investments and therefore impliedly includes them, so a program-related investment held by a charitable trust will be subject to the investment standard of UPIA. Under UPIA a trustee considers the purposes of the trust and the special value of an asset to the trust’s purposes in making investment decisions, so these provisions will guide a trustee of a charitable trust making an investment in a program-related asset.
UPMIFA excludes program-related assets from the definition of institutional fund, so the assets are not directly covered by UPMIFA guidance. UPMIFA defines “program-related asset” as an asset held “primarily to accomplish a charitable purpose of the institution and not primarily for investment.” The definition is not intended to be sy-nonymous with the tax definition, but it is similar. Questions have been raised as to whether an investment asset used to generate income that will then be used to carry out a charitable activity should be excluded from UPMIFA as a program-related asset. The UPMIFA exclusion of program-related assets is not intended to cover an asset held primarily for investment purposes, even if all the income from the asset is used to support the charity’s program. Reading UPMIFA to exclude from UPMIFA an asset held primarily for investment runs counter to UPMIFA’s purpose of providing guidance for investment decision making.
A charity may use a program-related asset both to carry out its program and to produce investment returns. The Comments to section 2 of UPMIFA remind fiduciaries that to the extent there is an investment component to a program-related asset, the fiduciary should establish investment criteria for the asset. The investment criteria will take into consideration the goal of the investment that is related to the charity’s program or mission. UPMIFA does not exclude investments that carry out a charitable purpose but are not held primarily for that purpose. In establishing investment criteria for those investments (mission-related investments), the fiduciary can consider the charity’s purposes and the special relationship the asset has to those purposes.
Fiduciaries managing a charity must follow the prudent investor standard in investing funds held by the charity, must act in the best interests of the purposes of the charity and not for the fiduciary’s own benefit, and must manage the funds for future as well as current beneficiaries of the charity’s mission. These duties interrelate. The effect of the duty of loyalty on investment decision making has been an issue for charities that want to align investing with mission and for fiduciaries that want to use ESG information in making investment decisions for a charity. Part III turns to issues of sustainable investing.
As discussed in Part II, trust law is the source of standards for fiduciary investing in general. This section explores the use of material ESG information in fiduciary investing for noncharitable trusts before turning to investing by charities. As the financial materiality of ESG information becomes more evident, the need to clarify the fiduciary’s responsibility becomes more pressing.
Socially responsible investing (SRI) dates back as far as anti-slavery efforts by the Quakers in the eighteenth century. The idea of SRI in some form got more attention in the 1970s and 1980s when the anti-apartheid movement in the United States began to use divestment as a strategy to draw attention to the problems in South Africa. Anti-apartheid activists urged universities with endowments to divest from companies doing business in South Africa.
In 1980, Professors John Langbein and Richard Posner published an article in which they analyzed SRI as it was then being used and discussed constraints on its use by fiduciaries. The article had a significant impact on advice given to fiduciaries and continued to influence the discussion long after the types of investment strategies being used changed.
Langbein and Posner defined what they called “social investing” as “excluding the securities of certain otherwise attractive companies from an investor’s portfolio because the companies are judged to be socially irresponsible, and including the securities of certain otherwise unattractive companies because they are judged to be behaving in a socially laudable way.” They also described the determination of which companies were to be excluded as follows: “Most of the literature on social investing discusses the portfolio adjustments that must be made by an investment manager who follows the list of exclusions and inclusions recommended by liberal and radical spokesmen. We shall do the same for want of any practical alternative . . . .”
Langbein and Posner analyzed the economics of divestment as an investment strategy and raised two financial concerns. Divestment removes stocks from a portfolio and limits diversification. Langbein and Posner wrote that an anti-apartheid fund could be structured without being “grossly underdiversified” but suggested that a “consistent and principled devotion to the concept of social investing” would likely lead to exclusions of more companies, which would make avoiding under-diversification difficult. Diversification is a key way to reduce risk in a portfolio, so loss of diversification could reduce the risk-adjusted return. Langbein and Posner recognized that a social investor could construct an adequately diversified portfolio, they just doubted that it would happen.
The other financial concern Langbein and Posner raised was the administrative cost of an actively managed fund. Their article emphasized the benefits of passive investing for maximizing financial returns, explaining that “a passive, market-matching fund is likely to outperform a conventional, actively-managed fund in terms of expected return; in addition, it is much more diversified than a conventional fund.” Divestment, by definition, was actively managed and therefore would have higher costs than a passive fund. However, they noted that a social investing fund “need not generate higher administrative costs than an investment strategy that involves research and active trading.” That is, these costs might not be higher than a non-SRI actively-managed fund. Langbein and Posner concluded that “a social-investing portfolio will probably have the same expected return as a standard investment portfolio (of the same systematic risk)” with the caveat that the administrative costs would be higher, so the net expected return would be lower, as compared with a passive fund.
Langbein and Posner also raised a non-financial concern about fiduciary investing and the South African divestment movement. In their view, support for the protests in South Africa was not within the charitable purposes of the universities that were being asked to consider divest-ment. The university could not spend university funds directly on the cause and therefore should not engage in social investing to do so indirectly. The conclusion is based on the assumption, stated earlier in their article, that social investing would involve costs.
In 1980, when Langbein and Posner published their article, most SRI still involved negative screens. In the 1990s, an early SRI fund, Domini Investments was beginning to develop more nuanced strategies, but any SRI fund necessarily involved active investing and administrative costs that exceeded costs of passive investing. Langbein served as the Reporter to UPIA, and when he wrote the comments to UPIA, promulgated in 1994, those comments confirmed the position that the costs incurred to engage in social investing are the problem. The Comments state: “No form of so-called ‘social investing’ is consistent with the duty of loyalty if the investment activity entails sacrificing the interests of trust beneficiaries—for example, by accepting below-market returns—in favor of the interests of the persons supposedly benefitted by pursuing the particular social cause.”
For years, lawyers advising charities pointed to the language in the UPIA Comments as meaning that they should avoid anything that sounded like SRI. The language in the UPIA Comment focused on costs incurred by social investing, and in 1994 little empirical evidence existed comparing SRI and non-SRI funds. But even after studies began to show no necessary cost when actively invested SRI funds were compared with actively invested non-SRI funds, risk-adverse lawyers encouraged their clients to avoid SRI.
A complete history of the development of investment strategies that incorporate ESG factors is beyond the scope of this paper. Early SRI used negative screens. Negative screens are still in use, but many other forms of investing have been developed, including best-in-class, positive screens, and ESG integration. These different investment strategies have been referred to as SRI, responsible investing, sustainable investing, ESG investing, or impact investing. One of the challenges in discussing these investment strategies is that descriptive terms are not used consis-tently, leading to confusion. In this Article, I use “sustainable investing” as the generic, catch-all label when I describe a variety of investment strategies without a specific strategy in focus. I use SRI when I refer to this sort of investing historically, particularly in the 1980s and 1990s. I use ESG investing and impact investing based on the definitions that follow.
ESG investing refers to the use of material environmental, social, and governance information together with traditional financial metrics to improve financial results and to pursue extra-financial goals. This type of ESG investing is also called ESG integration. The ESG information can have financial consequences, and analysts may use the information to improve financial results, without regard to other consequences. The ESG information may also have extra-financial benefits, leading to a double bottom-line for some investors who want to obtain both financial returns and environmental or social returns. Many investors pursue some form of ESG strategy with the goal of obtaining this double bottom-line.
The following explanation of ESG provides a helpful example:
What is ESG?
It’s probably easiest to think of this as a set of considerations that investors are using to try to understand risks and opportunities that aren’t accounted for in traditional financial models.
Climate change is one of the simplest examples: Investors are trying to find out how physical risks from things like rising sea levels and worsening drought could impact a company’s operations. For example, does a company rely on water to operate its factories, or to move goods in places like Europe or China where rivers have dried to a trickle this summer?
Investors also want information about “transition risk”—how companies will fare as governments enact policies aimed at cutting emissions and demand grows for things like renewable energy and batteries.
The term impact investing is sometimes used broadly to cover any type of sustainable investing, but I define impact investing as investing that pursues both financial and extra-financial returns but focuses on the extra-financial returns. Impact investing is more likely than ESG investing to result in concessionary returns because impact investing prioritizes the environmental or social impact of the investment. However, not all impact investing results in concessionary returns.
A 2020 article published by Professors Max Schanzenbach and Robert Sitkoff argues that the duty of loyalty limits a fiduciary’s use of ESG investing as I have defined it. In their view, a trustee of a noncharitable trust can use ESG information only if the sole purpose for using the ESG information is to improve financial returns. If the fiduciary considers extra-financial benefits as well as financial benefits, the fiduciary breaches the duty of loyalty. The authors set up this position by defining ESG investing in a way that excludes many ESG-connected strategies financial managers currently use. Schanzenbach and Sitkoff state:
[W]e clarify the umbrella term “ESG investing” by differentiating it into two categories. We refer to ESG investing for moral or ethical reasons or to benefit a third party, what had been called SRI, as collateral benefits ESG. We refer to ESG investing for risk and return benefits—that is, to improve risk-adjusted returns—as risk-return ESG.
The authors describe collateral benefits ESG as investing that “often operates as a screen on investment activity” or by using shareholder voting or engagement. The authors assert that collateral benefits ESG will result in costs to the investor. Schanzenbach and Sitkoff argue that the trust law duty of loyalty requires that the sole focus of a manager’s attention be on the financial benefit of ESG information. They declare that the “rule does not allow consideration of other interests even if the beneficiary’s interest is not subordinated or there is no concession in returns.”
As Jennifer Goode and Andrea Kushner point out in their 2022 article, the two categories Schanzenbach and Sitkoff created ignore strategies that use ESG information to pursue both financial and collateral benefits. Many different strategies for using ESG information exist, and many of them seek nonconcessionary financial performance while also pursuing ESG-related extra-financial goals. Goode and Kushner call this type of strategy ESG-focused strategy and point out that the pursuit of the extra-financial goals “does not mean that the strategy necessarily elevates its ESG-related mandate above its financial goals.” Goode and Kushner explain that a manager might structure an ESG-focused portfolio by first “selecting an initial pool of investment opportunities based on an ESG-related theme or objective” and then using research to “identify companies within the narrowed opportunity set that are most likely to deliver the desired ESG-related impact without sacrificing return or increasing risk.” An ESG-focused fund is, necessarily, actively managed, but the authors point out that passive ESG funds now exist.
Schanzenbach and Sitkoff conclude that any strategy that considers both financial and extra-financial benefits would be a breach of the duty of loyalty because the motive for the investment strategy was not purely financial. The better view, which Goode and Kushner take, is that trust law does not prohibit a fiduciary from considering collateral benefits, as long as the investment decisions do not result in a financial cost to the beneficiaries or in some other way harm the beneficiaries.
The duty of loyalty is intended to protect the beneficiaries from fiduciary actions that involve self-dealing or a conflict-of-interest transaction with a related party. If neither of these situations apply, the fiduciary must not invest in a way that necessarily causes a cost to the beneficiaries or otherwise harms the beneficiaries. If the transaction is fair financially, the trustee has not breached the duty of loyalty. Thus, the fiduciary can seek a collateral benefit that does not come at the expense of the beneficiaries.
Schanzenbach and Sitkoff point to a statement in the Restatement (Third) of Trusts to support their view that a fiduciary that considers ESG information for its extra-financial benefits breaches the duty of loyalty. They excerpt part of the comments to the Restatement section describing the prudent investor standard:
[T]he trustee must act with undivided loyalty and solely in the interests of the beneficiaries . . . . The prohibition [i.e., the duty of loyalty] . . . applies to investing in a manner that is intended to serve interests other than those of the beneficiaries or the purposes of the settlor . . . . Thus, for example, in managing the investments of a trust, the trustee’s decisions ordinarily must not be motivated by a purpose of advancing or expressing the trustee’s personal views concerning social or political issues or causes.
One of the sentences not included in the excerpt is the first sentence in the paragraph that includes the second sentence in the excerpt. That paragraph starts, “The strict duty of loyalty in the trust law ordinarily prohibits the trustee from investing or managing trust investments in a manner that will give rise to a personal conflict of interest.” The paragraph continues with the sentence quoted above, beginning “The prohibition,” but the focus of the paragraph appears to be on conflict-of-interest situations. Further, a comment to the Restatement section describing the duty of loyalty focuses on self-dealing by a trustee and concludes: “a trustee’s action or decision that is motivated by and taken in the best interest of the beneficiaries does not violate the rule of Subsection (1) or (2) merely because there may be an incidental benefit to the trustee.”
The underlying point of the Restatement (Third) of Trusts comments on both the duty of loyalty and on prudent investment is that the trustees must not put their own interests or anyone else’s interests above the interests of the beneficiaries. It is also helpful to remember that this provision on prudent investment was drafted in the early 1990s, just ahead of the prudent investor rule. The reference to “social or political causes” reflects that era.
If a trustee is not engaged in self-dealing or a conflict-of-interest transaction, the remaining concern with respect to the duty of loyalty is that the trustee cannot engage in an investment strategy that will necessar-ily impose a cost that does not benefit the purposes of the trust. In the early years of SRI, many people assumed that using SRI would result in a cost to the portfolio. Diversification is a key element of modern portfolio theory, and early forms of SRI involved negative screens, which appeared to threaten diversification. The assumption was that the removal of some potential investments from the investable universe would limit diversification and, therefore, reduce returns.
Researchers began to compare the results for SRI and non-SRI funds in an attempt to determine whether the SRI returns were necessarily concessionary. In general, the results showed mostly positive or neutral results for the SRI funds. Funds using negative screens were more likely to show negative or neutral results, and funds using ESG integration were more likely to show positive results. Studies conducted over a longer period of time were more likely to show positive results for ESG integration. The overall conclusion for the studies is that ESG investing, as defined in this article, does not necessarily result in a cost to the portfolio. Thus, a trustee of a trust can engage in ESG investing without causing a per se violation of the trustee’s fiduciary duty of loyalty.
If the use of ESG information does not impose a cost on a portfolio, other than the costs of active management, then the prudent investor rule applies to determine whether an investment strategy using ESG informa-tion is prudent. A charity may choose to use a passive investment strategy to avoid the administrative costs associated with active manage-ment, and such a decision may be prudent for a charity, if the charity considers the factors that go into prudent investing. This Part considers a decision to use active management and to use some form of ESG investing rather than a strategy that does not incorporate ESG information. If the charity decides to use active management, the research and skill of the manager will affect the overall return. The trustee must choose an investment advisor carefully and continue to monitor the advisor’s performance.
Material ESG information can help identify risk or opportunity in an investment. For example, climate-related financial risk may come in the form of increased regulatory actions or climate litigation, as well as the direct effects of climate-related fires, flooding, or other natural disasters on a company’s infrastructure or supply chains. Climate-related opportu-nities can include investing in green businesses or innovative ways to reduce emissions or sequester carbon. ESG investing has gotten attention in part due to recognition that incorporating ESG information into an investment strategy may improve financial returns on a risk-adjusted basis.
Given that one aspect of prudent investing is to minimize risk, the risks identified through analysis of material ESG information are very much within the scope of what a prudent investor should consider. The studies showing financial benefits from the use of ESG information tend to be studies conducted over a longer timeframe. A concern with modern portfolio theory is that its emphasis on alpha (specific risk and return) has led to an emphasis on short-term results. Long-term value depends in part on systemic risks such as climate change, political instability, income inequality, and global financial crisis. Systems level investment strat-egies consider resources that are held in common and are used to produce long-term value. Investors seeking long-term returns depend on the stability of environmental, social, and financial systems, so decisions that improve these systems will minimize risk and create value for the investors. A shift to long-term analysis will benefit the companies but also benefit investors. ESG factors are part of that long-term analysis.
A November 2023 announcement by CalPERS provides an example of a fiduciary’s plan to use of ESG information to improve returns and reduce risk. CalPERS, California’s public pension plan, described its strategy to use climate-related information to manage financial risk and identify opportunities to increase long-term value in the plan. The Sustainable Investments 2030 Strategy includes as objectives generating outperformance by investing in climate solutions and increasing resilience through climate risk analysis. CalPERS’s Chief Executive Officer Marcie Frost described the strategy as “the next step in CalPERS’ efforts to improve our long-term investment returns while also making meaning-ful progress in the fight against climate change.” Addressing climate change might be considered an extra-financial goal, but CalPERS’s announcement does not suggest a willingness to take concessionary returns. Results are prospective and depend on many factors, but CalPERS’ strategy is based on the idea that the climate-related efforts will improve long-term returns on a risk-adjusted basis.
In addition to the need to consider systemic risk to improve long-term returns, attention to systemic risk may also allow investors to improve profit maximization at the portfolio level through investor climate actions at the company level. Madison Condon has argued that institutional investors have increased climate change activism because they view the benefits as accruing across the portfolio, even if the effect of the activism is to reduce profits at the individual company level. Condon examined large institutional investors, which, in line with modern portfolio theory, have broadly diversified portfolios that mirror the economy.
Condon explains that large institutional investors hold portfolios in which their holdings in the oil and gas industry operate in ways that created significant risk for other holdings in their portfolios. She reports that six shareholders hold approximately a quarter of the shares of Exxon Mobil and Chevron and hold similarly large stakes in PepsiCo and General Mills. The former contribute significantly to global emissions, while the latter are “highly exposed to the negative impacts of climate change: temperature rise, extreme weather events, drought, and decreased labor productivity, to name a few.” The climate risks are undiversifiable systemic risk, but the institutional holders are in the position of being able to engage in shareholder actions involving the oil and gas companies to address the climate risks. The actions they push might reduce profits at the individual company level (for the fossil fuel companies) but improve returns for the overall portfolio. As Condon states, “Institutional investors have the economic incentive to function as ‘surrogate regulators,’ sacrificing individual firm profits for the benefit of the broader portfolio.”
Individual companies are more likely to respond to a coalition of shareholders, so in 2017 a group of institutional investors founded Climate Action 100+. By 2019 the coalition had grown to 360 investors, and it included institutional investors from the U.S. and around the world. In December 2018, Royal Dutch Shell announced, in a joint statement in partnership with Climate Action 100+, that it would reduce total emissions 20% by 2023 and 50% by 2050. The announcement indicated that Shell would link executive compensation to attainment of these goals. Following that announcement, Climate Action 100+ members and other investors filed shareholder actions with ExxonMobil, BP, Chevron, and Equinor requesting emissions targets aligned with the Paris Climate Agreement. A few months after the BP proposal passed, BP announced that it would “sell off some oil projects and slow down the development of others in order to meet shareholder demands to align BP’s business plan with the Paris Agreement.”
The changes at Shell and BP reflect the power large institutional investors hold, and the changes also demonstrate the ability of a coalition of shareholders to influence corporate behavior. Condon argues that the investor activism described serves “the purpose of maximizing long-term portfolio returns, to the detriment of firm-specific returns.” The actions against fossil fuel companies in their portfolios reflects the institutional investors’ recognition of the financial benefit to the portfolios of reductions in greenhouse gas emissions.
Five states have amended their prudent investor statutes in response to increasing interest in ESG investing. Illinois authorizes the trustee to consider ESG information, identifying this information as related to investments. The other statutes take a different approach, permitting the trustee to consider the personal values of beneficiaries (Delaware and Georgia), of the settlor as well as of beneficiaries (Oregon), and of “interested persons” (New Hampshire). The intention behind these statutes may be to protect trustees faced with pressure from beneficiaries to engage in values-based investing. The statutes do not remove the duty to act as a prudent investor, but the interests of the beneficiaries are broadened to include more than financial returns. A trustee will not be in violation of the prudent investor standard if the trustee takes concessionary returns in aligning investments with the beneficiaries’ values.
These amendments to the prudent investor statutes relate to the duty to act in the sole or best interests of the beneficiaries. The trustee of a trust is tasked with managing and investing the property held in the trust, so lawyers have assumed that the interests subject to this duty are solely financial interests. Nothing in the Restatement of Trusts or the Uniform Trust Code limits interests to financial interests, and UPIA indicates that a trustee may consider “an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.” The comments explain that this subsection allows the trustee to consider “any preferences of the beneficiaries respecting heirlooms or other prized assets.” Although the intention of this subsection may have been to permit retention of specific family assets, the subsection reflects an understanding that for some beneficiaries or settlors, financial return is not the only interest the trustee should protect. The amendments to the prudent investor statutes expand the interests a fiduciary may consider.
The amendments to the prudent investor statutes address the values of beneficiaries and relate primarily to private trusts. Another type of legislation has focused on preventing fiduciaries managing state pensions and other state funds from using ESG information to inform their invest-ment decisions. The politicians promoting this legislation appear to be doing so for political reasons. A problem is that the term ESG investing has been used by investors as a convenient shorthand without differentiat-ing different investment strategies. Indeed, the term has been described as “an ambiguous concept that encompasses several different investment and analytical strategies that are evolving at a rapid pace.” As Part III.A.3 of this article described, even scholars writing about ESG disagree on interpretations of the term. Politicians have used their own definitions to make political points.
In 2022, former Vice President Mike Pence wrote that “ESG is a pernicious strategy” based on his view that “ESG empowers an unelected cabal of bureaucrats, regulators and activist investors to rate companies based on their adherence to left-wing values.” Florida Governor Ron DeSantis announced in 2023 that he and Republican leaders in Florida had developed legislation “to protect Floridians from the woke ESG financial scam.” Republican legislators in Florida and other states have introduced bills to limit the ability of fiduciaries investing state pensions or other government funds to consider ESG information. As of April 2023, at least 14 states have adopted some form of limit on ESG investing.
Investment advisors have expressed concerns that these bills will hurt investment portfolios. State officials in Indiana provided legislators with an analysis showing that enactment of a bill considered there would result in a drop in the value of pensions in that state over the next decade. Analysis in Kansas showed a similar drop in returns. In response to the anti-ESG legislation, and in an attempt to let fiduciaries operate without legal uncertainty, Senator Tina Smith introduced the Freedom to Invest in a Sustainable Future Act in February 2023. She explained that the bill “would codify a neutral, free-market approach,” which had been threatened by attacks on Department of Labor guidance and by state legislation.
Investment managers see the problem as one of communication and better understanding of “ESG.” Eugenia Unanyants-Jackson, global head of ESG at PGIM explains:
‘At PGIM, we set out very clearly from the beginning that we do not see ESG as an investment philosophy, investment style or an investment product . . . . What we are saying is ESG is a tool, and we can use that toolkit that we have to identify material risks arising from ESG factors and potentially the opportunities that are arising from large societal trends,’ such as decarbonization and gender equality.
Marina Severinovsky, head of sustainability-North America at Schroders, agrees, saying, “We maintain our fundamental belief that the investment discipline of considering sustainability factors, in terms of understanding the risks and opportunities to companies from the social and environ-mental changes taking place over the longer time horizon, is additive to portfolio outcomes.”
In the face of conflicting meanings and political posturing, fiduciaries must focus on their duties of loyalty, prudence, obedience, and impartiality. A charity’s fiduciaries should create and follow a process that considers financially material information, and they may choose in addition to incorporate alignment with the charity’s mission into the investment analysis. The charity should monitor investment decision making carefully, emphasizing its investment policy when delegating to an external investment advisor. By taking a thoughtful approach to investment decision making, a charity’s fiduciaries should be able to comply with the prudence standard and their other fiduciary duties.
Despite common assumptions that SRI would result in costs to the portfolio, some charities realized decades ago that they could align their investment portfolio with their mission without a financial penalty. The Jessie Smith Noyes Foundation began in the 1980s to do just that. Their website explains: “We started with negative screens to divest from companies that were profiting from harm (e.g., tobacco and weapons manufacturers), expanded to proactively investing in companies that are building the better world we envision, and broadened further into shareholder activism and direct impact investments.”
The Noyes Foundation website also explains that they engage in this investment strategy without sacrificing returns. They have sought market-rate returns while making social and environmental impacts since the early days of taking this approach. When I visited their website in 2015, I found information stating that they monitored fund managers against non-screened benchmarks as part of a rigorous review process for fund managers. At that time, they sought a 6% annual payout while preserving the inflation-adjusted value of the assets over the long term. In a September 2022 announcement, they posted:
We are deepening our commitment to this area of work in part because mission-aligned investment strategies work. It is possible to align all assets for positive impact and get competitive returns. For example, within the past five years we have seen an annualized positive return of between 7–13%. Even with fluctuations in return, we are financially positioned for the long-term while contributing to a more sustainable, better future.
Charities like the Noyes Foundation choose to engage in mission-related investing—investing that aligns with the mission of the charity—while still earning market-rate returns. Some charities may prefer to use their investment funds to carry out the mission more aggressively, and they may be willing to take concessionary returns to do so. If returns are below market benchmarks, these investments call into question the duty of loyalty, as discussed in Part III.A. For a charity, so long as the investment carries out the charity’s purposes, the investment will not breach the duty of loyalty. The fiduciary must monitor the investment to ensure that benefits relate to the charity’s purpose.
Both UPMIFA and the Restatement (Third) of Trusts support the idea that a charity can use its investment assets to carry out its purposes. UPMIFA provides that a manager “shall consider the charitable purposes” of the charity and fund being invested. This language does not require mission-related investing, but it supports the view that a charity’s investments can be guided by its purposes and not just by the goal of increasing revenue to carry out those purposes. Another UPMIFA provision permits consideration of an asset’s special relationship to the charitable purposes of the organization.
A comment in the prudent investment section of the Restatement (Third) of Trusts also makes the point that a charity’s mission can be considered under the prudent investor standard:
[S]ocial considerations may be taken into account in investing the funds of charitable trusts to the extent the charitable purposes would justify an expenditure of trust funds for the social issue or cause in question or to the extent the investment decision can be justified on grounds of advancing, financially or operationally, a charitable activity conducted by the trust.
Together, UPMIFA and the Restatement (Third) of Trusts support the conclusion that a charity can invest in a way that furthers the charity’s mission, even if the investment’s financial returns are less than the charity might earn in other investments with equivalent risk.
Although fiduciary duties derive from state law, an Internal Revenue Code (IRC) provision on program-related investing (PRIs) and a Treasury Notice on mission-related investing (MRIs) support the view that both are acceptable for charities. The IRC penalizes a private foundation and its manager if the foundation’s funds are invested in a way that jeopardizes any of the exempt purposes of the foundation. The regulations explain that an investment is a jeopardizing investment if the managers failed to exercise “ordinary business care and prudence” in making the invest-ment. There are few cases or rulings regarding this restriction on “jeopardizing investments,” so the actual parameters are uncertain. To permit a charity to enter into an investment related to the charity’s purpose, the IRC includes an exception for “program-related investments” (PRIs). A PRI is an investment made primarily to carry out the charity’s purposes, if no “significant purpose” is the “production of income or the appreciation of property.”
Some charities have developed PRI programs, but the idea has been underutilized. In addition to worrying about whether a particular investment will qualify as a PRI, a foundation may want to be able to invest in a way that carries out its mission while still generating a reasonable return on the investment. Although the PRI rules do not prohibit market-rate returns, the purpose behind the investment must be “primarily” for non-investment reasons and no significant purpose can be generating a financial return. The lack of clarity makes lawyers and the foundations they advise nervous.
As foundations (and other charities) became more interested in mission-related investing, the IRS was asked whether a mission-related investment made with production of financial return as a significant purpose would be a jeopardizing investment. That is, could a foundation make a mission-related investment that did not qualify as a PRI without having the investment treated as a jeopardizing investment. The IRS issued Treasury Notice 2015-62 in response. This notice refers to the guidance in the regulations that protects managers who exercise ordinary business care and prudence. The notice then points out that many factors go into an analysis of ordinary business care and prudence, and one factor the managers may consider is the relationship between an investment and the foundation’s charitable purposes. The notice goes on to say that the managers need not
select only investments that offer the highest rates of return, the lowest risks, or the greatest liquidity so long as the foundation managers exercise the requisite ordinary business care and prudence under the facts and circumstances prevailing at the time of the investment in making investment decisions that support, and do not jeopardize, the furtherance of the private foundation’s charitable purposes.
The Treasury Notice applies to private foundations, but the notice says that it is consistent with state laws on investment decision making by charities and makes specific reference to UPMIFA.
Related to the question of whether a charity may engage in mission-related investing is the question of whether a charity’s fiduciaries should apply their duty of obedience to purpose across all of the decisions they make on behalf of the charity. Traditionally, the duty of obedience to a charity’s purpose, part of the duty of loyalty, has been viewed as it relates to the actions the charity takes in furtherance of that purpose, either making grants to support the purpose, or actively carrying out the purpose. Investment assets have been treated purely as a source of revenue that can be used to carry out the purpose. But perhaps a better view is that the charity’s duty of obedience to its purpose applies to everything it does—its administrative decisions, its investment decisions, and its charitable activities.
The Surdna Foundation takes this approach, explaining that they “are bridging the separation that often exists between endowment investing and grantmaking.” They started exploring MRIs and PRIs in 2014 and ultimately allocated about 10% of their endowment to MRIs and PRIs. They also decided to “apply a robust variety of other impact investing strategies across our endowment.” The foundation issued a report with the goal of helping “others in the philanthropic community who choose to explore impact investing tailored to their mission and goals.”
Given that fiduciaries of a charity owe a duty of loyalty to the purpose of the charity, application of that duty to the investment assets makes sense. A determination of how to invest assets in a way that supports the purpose will not, in most cases, be easy. As the Surdna Foundation fiduciaries found, aligning a charity’s investment policy with its purpose takes effort. For some charities, the effort seems insurmountable. When an investigative journalist reported in 2007 that the Gates Foundation investments were not aligned with its charitable purposes, the Chief Operating Officer released a statement explaining that “[d]ivesting from companies cited as having significant problems in social-responsibility rankings . . . would rule out almost half the largest U.S. corporations.” Divestment may not be the best way to align investments with mission, but other investment strategies provide options. A determination of how investments can help or hurt a charity’s mission is difficult, but the Surdna Foundation found that the “learning and decision-making process was well worth the journey.”
The Nature Conservancy (TNC) provides a good example of a shift in thinking of a large public charity. TNC was incorporated in 1951, although its roots go back to a research organization, the Ecological Society of America, established in 1915. TNC is known for protecting environ-mentally significant land, and it also has a substantial research arm with over 400 scientists. TNC has a large endowment, which it uses to provide financial support for its environmental work. About 10 years ago, TNC began to think about how it could align its investments with its mission. Initially, the organization divested from “the most polluting companies in the portfolio” and “started to invest in some funds aligned with its mission.” Then in 2020 Bolu Olusanya became vice president and chief investment officer and started building an internal investment management team. That team began investing in climate tech funds and then added direct investment in a few climate-tech startups. TNC was able to leverage its expertise, using its scientists to vet each startup before making a decision to invest. Olusanya sought companies that would “have gigaton scale from a decarbonization standpoint, but also outsized expected return.” The goal continues to be the generation of financial resources for the work of TNC but doing so while promoting TNC’s mission through a portion of its investments.
If a charity can invest for mission, then the next obvious question is how to determine the scope of a charity’s mission and whether an invest-ment relates to that mission. For some charities, the mission-investment connection is easy. For example, if a charity’s mission is to support attempts to address climate change, an investment in green energy or investments taking into consideration companies’ efforts to reduce their carbon footprint would align with that mission. For some charities, however, tying investments to mission is more complicated. As long as the investments meet the prudent investor standard in terms of the risk-and-return goals for that charity, the investments will not breach the duty of loyalty, even if the connection between investments and mission is unclear. But managers may feel more comfortable with investments that align with mission, so consideration of that alignment is appropriate.
For universities and university endowments the question of mission is a tricky one. Ever since the anti-apartheid campaigns, universities have been pressured by student groups and others to invest their endowments in ways that support public purposes pushed by the groups. Divestment campaigns have targeted oil, coal, and gas projects, private prisons, companies supporting “the occupation of Palestine,” and companies doing business with the government of Sudan. Universities have been reluctant to use the “d” word for two reasons: it opens them up to the next campaign, and divestment is not a strategy that a prudent investor would use. The use of material ESG information together with other financial metrics is one thing, but a decision not to invest in certain companies or fields based on a list is another. In 2021, the Harvard President, Lawrence Bacow, issued a letter to the Harvard community about climate change and the Harvard endowment. The letter described climate change as “the most consequential threat facing humanity” and stated that Harvard “must . . . address this crisis on as many fronts as we have at our disposal.” The letter then explained the investment strategy the Harvard Management Company had been taking with respect to fossil fuels—no direct investments and a phase-out, over time, of a small amount of indirect investment.
President Bacow’s statement is noteworthy in two respects. First, the President did not describe the steps taken as “divestment,” despite pressure from students and others to divest from fossil fuels. Second, the investment strategies are described as part of the university’s work “as an institution” to address climate change. After stating that the Harvard Management Company will make no future investments in companies that explore for or develop reserves of fossil fuels, the letter says, “Given the need to decarbonize the economy and our responsibility as fiduciaries to make long-term investment decisions that support our teaching and research mission, we do not believe such investments are prudent.” The letter also describes the research and teaching work Harvard will be doing around climate change and sustainability. In presenting the investment information in this way, President Bacow seems to be linking the investment decisions about climate and fossil fuels to Harvard’s mission to work, through research and teaching, to address climate change. Even if the decisions around investments in fossil fuels are related to mission, President Bacow’s statement does not suggest that the endowment will take concessionary returns. Indeed, the statement emphasizes that given the long-term time horizon for Harvard’s investments, investments in companies that develop reserves of fossil fuels are no longer financially prudent.
A statement issued by New York University’s fiduciary board chair regarding NYU’s investments in fossil fuels similarly avoids the word divestment. The statement, issued by William R. Berkley, chair of NYU’s board of trustees, commended the student group Sunrise NYU for engaging productively with the board’s investment committee to discuss adjustments to the portfolio that could help address climate change. The statement affirmed that NYU “currently has no direct ownership” in a company “whose primary business is the exploration or extraction of fossil fuels,” commits to avoid any direct investments in such companies, commits “not to renew or seek out any dedicated private funds whose primary aim is to invest in the exploration or extraction of fossil fuels,” and commits “to seek out investments in commingled funds that would reduce the endowment’s indirect exposure” to those companies, “while maintaining the financial health of the endowment.” The letter addressed the students’ concerns while confirming that the board will act as prudent investors with respect to the endowment. Although the letter carefully avoids the word divestment, Sunrise NYU and press reports regarding the letter describe the letter as a “divestment announcement.”
Divestment represents an easy-to-understand goal, so groups push for divestment and claim victory, as they did in the Harvard and NYU cases, when a university reduces its direct investments in fossil fuels and works to reduce its indirect investments in a prudent manner. University fiduciaries must balance the need to be responsive to students and others while continuing to act as prudent investors. That balance is attainable but requires careful work. The difficulty for anyone trying to understand whether universities (or other charities) have “divested” is that some universities use the word divestment when they agree to end direct investments even if they will continue to hold indirect investments, while other universities refuse to use the word even when they have ended direct investments and significantly reduced indirect investments.
A difficulty with divestment from fossil fuels as a strategy is that even if someone concludes that investment actions to address climate change are appropriately aligned with a university’s mission, divestment is both underinclusive and overinclusive. As Felix Mormann and Felicia Mormann point out, some fossil fuel companies have comprehensive plans for greenhouse gas reduction and strong commitments to renewables. The divestment movement is overinclusive because it would lump these companies together with companies that continue to develop new oil and gas wells. The movement is underinclusive because it fails to consider emission-intensive companies that are not fossil fuel companies. For example, a manufacturer that uses coal-fired electricity emits significantly more greenhouse gases than another company that uses alternative sources of energy. An investor using an ESG strategy might use this sort of information to identify companies making efforts to address environ-mental externalities and then analyze those companies’ financial metrics before choosing which to include in a portfolio.
Some investors, like Wellcome Trust, prefer engagement to divest-ment. As a fiduciary investor, CalPERS has taken a number of steps to address climate change but opposes divestment. CalPERS joined with other investors in Climate Action 100+ to push fossil fuel companies to reduce their emissions and expand into other energy sources. CalPERS announced in 2023 its intention to invest $100 billion in climate solutions by 2030. The announcement emphasized its view that to assure long-term financial results for its plan participants and their beneficiaries, it needed to address the risks climate change is causing to financial markets and companies and to find investment opportunities in clean energy and other elements of shifts in the economy in response to climate change. CalPERS’s transition plan was hailed as “strategic” and “a bold step tailored to meet the existential challenges and colossal financial risks of a warming climate and harness the massive opportunities of the shift to a new clean economy.” Despite these efforts to address climate change, CalPERS opposed legislation that would require divestment from fossil fuel companies by 2030. CalPERS worried that divestment would result in a significant transaction cost. CalPERS also worried that divestment would not yield climate improvements and that they would lose the ability to influence behavior in the companies divested.
For a university, defining mission to include addressing climate issues, which Harvard President Bacow has done, can be based on the need to protect the university’s ability to continue to develop, disseminate, and preserve knowledge. A university might face the effects of climate change through fires or flooding that affect its campus directly, the need to rebuild campus infrastructure in the face of higher temperatures, higher insurance premiums, destruction in locations away from campus where scholars or students need to do field work, or more broadly through the societal upheaval that may come with climate refugees and the loss of wealth and wealth creation opportunities. These potential consequences may affect the university’s ability to carry out its mission, now or in the future, making decisions to use endowment assets as one tool to address climate change self-interested.
In 2021 “[c]oncerned students, faculty, alumni, financial and political leaders, scientists, civic groups, and community members” filed a complaint with the Massachusetts Attorney General, asking the Attorney General to investigate the Harvard Corporation for breaches of fiduciary duties in connection with investments in fossil fuels. The complaint argued that investments in fossil fuels violated UPMIFA and that Harvard had breached the duties of loyalty and care and the duty to act in good faith. After the complaint was filed, Harvard President Bacow issued the statement described in the prior section of this Article, addressing the investment issues raised in the complaint. Whether the Attorney General would have acted on the complaint is unknown, but if the goal of the complaint was to push Harvard to reduce investments in fossil fuels, the complaint was successful.
Although the Attorney General did not address the complaint, it is interesting to examine the UPMIFA arguments. The complaint points out that UPMIFA requires a fiduciary manager to consider the charitable purposes of the institution for which assets are invested. The complaint then states:
As stewards of the Harvard endowment, the Corporation is required to act in good faith and with loyalty, taking care that its investments further the purposes of the university. The Corporation may not simply seek profit at any cost: the privileges that Harvard enjoys as a non-profit institution come with the responsibility to ensure that its resources are put to socially beneficial ends.
This statement goes beyond what UPMIFA requires and beyond what the duties of loyalty and care require. UPMIFA directs the managers to consider the purposes of the institution, but UPMIFA does not direct a particular outcome of that consideration. UPMIFA does not require that the investments further the purposes (other than by generating revenue) or that the investments “are put to socially beneficial ends.”
The complaint is on firmer legal ground when it discusses the duty to act as a prudent investor, arguing that investments in fossil fuels have become “excessively risky thanks to increased government regulation and the fossil fuel industry’s own failure to diversify its operations and to avoid capital-intensive extraction.” Certainly, a prudent investor should consider financial risks associated with any investments, but a determi-nation not to invest in a particular fossil fuel company should be made based on an analysis of that company and not a decision to divest from an entire sector.
To support its arguments that Harvard knew that it had a “duty to divest” the complaint notes that Harvard decided in 1986 to divest from companies doing business in South Africa, in 1990 to divest from the tobacco industry, and in 2006 to divest from “certain companies doing business in Darfur.” The complaint then states that these prior divestments serve as “acknowledgements that its investment activity must comport with Harvard’s missions and values.” Concern about future divestment campaigns may explain why President Bacow refused to describe the decision to reduce investments in fossil fuels as divestment.
Contrary to what was argued in the complaint, the law does not require that Harvard, or any charity, ensure that its investments do not promote “environmental degradation and social injustice.” A hallmark of the U.S. charitable sector is its multiplicity of views, purposes, and goals. Trust law, UPMIFA, and tax law all permit a wide variety of purposes that can be considered charitable. A charity cannot pursue a purpose that is illegal or against public policy, but few restrictions have been imposed on a charity’s actions based on a public policy argument. Public policy is inherently subjective, which makes legal requirements for charities based on public policy problematic. If public policy were broadly defined to prevent a charity from acting in a manner that promoted social injustice, for example, differing views on what that meant and different applications of the policy by multiple charitable regulators could lead to inequities and might have a chilling effect on all charities. The better approach is to argue that a charity’s mission can be defined broadly. A university’s mission can include protection of the environment and the promotion of social justice, and then the university itself can determine what that means.
Even if arguments based on UPMIFA and public policy are shaky, the result sought by the complaint seeking an investigation of Harvard’s investment decisions was accomplished. Harvard agreed to further reduce its investments in fossil fuels, and the students claimed victory. Student groups and other organizations have filed similar complaints against other universities, including University of Wisconsin, University of New Mexico, Marquette University, Johns Hopkins University, Massachusetts Institute of Technology, Stanford University, Yale University, Princeton University, Vanderbilt University, Santa Clara University, and Duke University. From a legal standpoint, the argument should be that universities can address climate change as part of their mission, through a variety of means, including research, scholarship, teaching, the way the university operates its physical plant, and the way the endowment is invested.
With growing interest in ESG factors—climate change, social justice, and other issues—charities may want to use ESG-focused investing to encourage more donations. Potential donors may want to see that investments in a charity’s endowment are aligned with the charity’s purposes and may be more inclined to contribute to the endowment if they see a double benefit of doing so. A charity might want to promote its endowment based on its investment strategies. If it does so in writing, the descriptions will be considered a “gift instrument” under UPMIFA and will be treated as donor restrictions on the endowment.
Some donors may take the lead in encouraging charities to engage in ESG-focused investing. A donor might include restrictions on investments in connection with their donations, or a donor might instead authorize a charity to engage in ESG-focused investing or mission investing. Although a charity can engage in mission-related investing without donor authorization, donor authorization may reassure a charity’s fiduciaries as they restructure their investment policy. A charity that chooses to accept donations with donor restrictions must then comply with those restrictions.
A charity may face pressure to align investments with mission and suffer reputational harm for not doing so. In January 2007, the Los Angeles Times reported that the Gates Foundation held investments in companies that caused illness and disease in countries where the Gates Foundation had programs to address health issues. The investigation reported that “hundreds of Gates Foundation investments—totaling at least $8.7 billion, or 41% of its assets, not including U.S. and foreign government securities—have been in companies that countered the foundation’s charitable goals or socially concerned philosophy.” The report attracted attention, and the Gates Foundation quickly announced that it would review its investments. A statement posted on the foundation’s website downplayed the issue, stating that investment managers voted proxies “to encourage good corporate governance” and that the foundation would continue to review its investments. A week later the foundation announced that it would “keep its current approach to investing its endow-ment.” The Gates Foundation now has an impact investing fund, the Strategic Investment Fund, that operates alongside grant-making with a goal of charitable impact rather than financial return.
For organizations dependent on new donations, publicizing the align-ment of mission and investment policy raises difficult issues. While some donors may applaud attention to climate and environmental concerns, other donors may continue to hold the view that investments should be invested for the sole purpose of increasing revenue for the charity. As ESG investing has become politicized, potential donors may not want a charity to take a position on its investments that appears to be political. To manage donor expectations and concerns, a charity needs to communicate clearly about what it is doing and why. A charity with a specific social or environmental focus might attract donors who would want the charity to align investments with mission. However, a charity with a broader social or educational mission, like a university, is more likely to seek donors with different views on investments and different opinions on investment policy. That charity would want to explain clearly the financial reasons for including environmental information in its investment decision making, rather than emphasizing any potential extra-financial benefits. Another possible strategy for some charities is to permit donors to contribute to separate funds with different investing policies.
Whether a charity is organized as a trust or a nonprofit corporation, the charity’s fiduciaries must follow the prudent investor standard in managing the charity’s assets. The fiduciaries should create an investment policy to guide the fiduciaries themselves and any investment managers they use. The fiduciaries may delegate investment responsibil-ities to external investment advisors, but to do so the fiduciaries must act “in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances” to select the investment advisors, establish the scope of the delegation, and monitor the advisors’ actions.
In following the prudent investor standard, the fiduciaries must consider the purposes of the charity, the charity’s needs for the fund being invested, and economic conditions in general. The fiduciaries should consider material financial information, including material ESG infor-mation. As the Restatement (Third) of Trusts explains, prudence is an evolving concept: “[T]he rules must be general and flexible enough to adapt to changes in the financial world and to permit sophisticated, prudent use of any investments and courses of action that are suitable to the purposes and circumstances of the diverse trusts to which the rules will inevitably apply.” As the information investors use to manage risk expands, a prudent investor considers that information.
A charity may use ESG information to reduce risk and improve returns, and for a charity that intends to exist far into the future, ESG information may be particularly relevant. The charity should invest with a long-term horizon, and some ESG factors, particularly information related to a company’s ability to cope with climate change, may identify risk that will affect long-term investing results. A charity may use ESG information with a goal of improving investment outcomes, without regard to mission, or a charity may decide to engage in mission-related investing. A charity that aligns its investments with mission may seek either non-concessionary or concessionary returns, and as long as the investments are mission-related, concessionary returns do not breach the duty of loyalty to the charity.
The prudent investor standard continues to evolve and is not bound by best practices at a particular time. The information considered financially material changes over time, and increasingly prudent investors recognize the materiality of ESG information. Jane Ditelberg explains, “As ESG factors continue to drive investment decisions for non-trustee investors, it is not unreasonable to conclude that this will, now or in the future, be considered a pertinent factor in prudent portfolio construction, applicable to trustees as well as other investors.” In addition, the duty of obedience to purpose, a part of the duty of loyalty, can be viewed as applicable across all decisions a fiduciary makes for a charity. If so, and if the fiduciary can determine how to align investments with mission, the fiduciary may be able to use the investment portfolio to strengthen the charity’s impact.
