ESG investing does not warrant any exemption or exception from established fiduciary principles and law. It does raise the issue of whether a trustee of a private trust, who is required by the duty of loyalty to act only in the sole interests of the beneficiary without regard to the interests of anyone else, including the fiduciary, should make an ESG investment serving the “social good.” Restated, is it possible for a trustee to consider ESG investments relating to unrelated social issues that have benefits to others, in addition to their financial return for the trust beneficiary? There is thought leadership in support of the proposition that ESG investing is permissible for a trustee of a trust under American fiduciary law (consistent with the duty of loyalty and prudent investor rule) if (1) the trustee reasonably concludes the ESG investment will benefit the beneficiary directly by improving risk-adjusted return and (2) the trustee’s exclusive motive for adopting the ESG investment program is to obtain that direct benefit. See Max M. Schanzenbach & Robert H. Sitkoff, Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee, 72 Stan. L. Rev. 381 (2020). Relevant in that analysis are the trustee’s compliance with the prudent investor rule (due diligence and process in exercise of discretion; the trustee’s application of an overall investment strategy with risk and return objectives reasonably suited to the trust, and conclusion that the ESG investment strategy would provide better returns and the same or less risk than other options, continued monitoring to address changes in circumstances, and adequate contemporaneous documentation).
Unlike a private trust for the benefit of designated ascertainable beneficiaries, a charitable trust is established for the benefit of a charitable purpose, and its trustee must act solely in furtherance of that charitable purpose. See Restatement of Charitable Nonprofit Organizations §§ 1.01(a)–(b), 1.02 cmt. b (Am. L. Inst., Tentative Draft No. 1 (2016)); 3 Restatement (Third) of Trusts § 78(1) (Am. L. Inst. 2007). Investing assets of a charitable endowment to obtain third-party benefits is permissible if those benefits fall within the charitable purpose. If a charity acquires an ESG asset with a dual purpose (as an investment for return and as a vehicle to carry out its mission), then the charity is complying with its duty of loyalty even if the acquisition does not generate as much return as another. IRS Notice 2015-62 (applicable to private foundations) was issued in response to questions about mission-related investing. See I.R.S. Notice 2015-62, 2015-39 I.R.B. 411 (Sept. 28, 2015). It provides that an investment made to both further charity purposes and produce financial returns is not a breach of fiduciary duty, even if investment returns are lower than expected.
Determining whether ESG investing is a wise and appropriate option from a fiduciary standpoint in executing a fiduciary investment strategy may involve a consideration of several factors, including but not limited to the following:
- Whether there is an existing trust (drafted before the existence of the ESG investing concept) or a newly drafted trust with specific language of settlor or donor intent, and purposes authorizing ESG investing. An existing trust may (or may not) have powers and purposes language giving the fiduciary sufficiently broad powers to allow for ESG investing consistent with trust purposes. Judicial document construction may be necessary if trust language is unclear or ambiguous, or if there is disagreement on interpretation. “Family legacy” positions addressed in settlor intent or trust language (legacy positions such as heirloom stock, interests in oil companies, fossil fuels) may also influence whether ESG investing is possible. If the trust’s purpose is to financially support generations of family, any ESG investment considered should generate sufficient financial returns to do so (in addition to having more subjective benefits). The trustee in the exercise of discretion should honor and implement grantor intent and trust purposes as they are stated in the trust instrument plain language. Fiduciary prudence is about thoughtful, documented process in exercise of discretion, not just investment results.
- Whether applicable state law allows ESG investing in the context of trust administration. The fiduciary duties of prudence, impartiality, and loyalty in assessing potential ESG investment (as with any other investment) must be observed.
- Beneficiary interests and preferences. Under the UPIA § 6 (Impartiality) adopted by most states, if a trust has two or more beneficiaries, the trustee shall act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries. The best interests of a beneficiary may not be the same as what the beneficiary wants.
- Trustee process and protocol (independent, contemporaneous, well-documented, careful due diligence, consistent monitoring, vetting, and exercise of fiduciary discretion in trust administration over time to implement settlor intent and trust purposes in compliance with fiduciary duty).
Trustee options and tools to address ESG issues may include the following:
- Court orders and consent orders (e.g., trust modification or equitable deviation to allow ESG investing, if the existing trust language does not provide for it; declaratory judgment to determine legal rights of various parties (such as whether a beneficiary has rights to invade trustee powers to determine how trust assets are invested); guidance or instruction to trustee on specific issues; document construction) may assist in providing protection and certainty to trustees and beneficiaries.
- Beneficiary consent, release, and ratification of trust ESG investment. Under well-established trust law, a beneficiary may consent to in advance or subsequently ratify or release trustee conduct that would otherwise constitute a breach of trust (neutralizing trustee liability exposure). See 4 Restatement (Third) of Trusts § 97 (Am. L. Inst. 2012).
- Division of trust for multiple beneficiaries into separate trusts for each beneficiary (allowing for investment strategy customized for each beneficiary). ESG investing would not necessarily be the sole reason for this option.
- Nonjudicial settlement agreements (be careful; they provide less certainty than a court order).
- Facilitated meeting between trustee and beneficiaries. Mediator obtains beneficiary input and reminds them of trust terms. This is useful to defuse intergenerational beneficiary disputes over ESG issues and remind beneficiaries of trust purposes and settlor intent, that the trustee is neutral, etc.
- Family values statement. This is a tool to define beneficiary values and priorities re: ESG issues. This is more an expression of principle than an enforceable agreement and may require updates as beneficiary positions change over time. Family values statements do not alter the terms of a trust or the trustee’s duties or powers.
All that taken into consideration, issues such as ESG investing powers are best addressed in the estate planning stage, in consultation with the expected trustee, who will likely have preferred language to suggest. The strategic decision of whether to draft broadly with respect to grantor intent and fiduciary powers (which may encompass the ESG investing trend and those after it)—or to draft with a more specific approach—is nothing new.
There is recent indication that the general ESG investing trend may be losing popularity. In 2022, multiple state attorneys general warned BlackRock CEO Laurence Fink that ESG polices violate the sole interest rule, which requires fiduciaries to maximize financial returns rather than promote social or political objectives. Others warned state pension boards that ESG investing is likely a violation of fiduciary duty. In 2023, certain large-asset management firms scaled back their support of ESG initiatives and 14 states passed anti-ESG legislation restricting investors from considering ESG factors when investing public funds. Economic headwinds in 2024 and geopolitical conflict also have made ESG less appealing in comparison to more traditional options. See Jon Solorzano, Sarah Morgan & Matt Dobbins, ESG Is Over—as We Know It, 39 Westlaw J. Corp. Officers & Dir. Liab., no. 14, Jan. 11, 2024. ESG-related enforcement has also increased. See Madison Guerinot, How Will an Increased Focus on ESG by the SEC and Investors Impact Transactions?, 61 Hous. Law., no. 6, May/June 2023, at 18. The Securities and Exchange Commission launched the Climate and ESG Task Force in 2021 with respect to ESG reporting. In 2022, the SEC charged BNY Mellon Investment Advisor, Inc., for misstatements and omissions about ESG considerations (including lack of ESG quality review scores at the time of investment) in making investment decisions for certain mutual funds it managed, resulting in a $1.5 million penalty. In September 2023, the SEC adopted changes to the “Name Rule,” including changes designed to discourage greenwashing and other deceptive or misleading marketing practices by US investment funds. See Douglas Gillison & Michelle Price, US Cracks Down on Funds “Greenwashing” with New Investment Requirement, Reuters, Sept. 20, 2023. The existing rule required investments with names suggesting a focus on a particular type of investment to have 80 percent of the assets invested in accordance with the suggestion of the name. The new rule extends that 80 percent requirement to funds with names suggesting a focus on investments with “particular characteristics” (an undefined term) and used ESG as an example of a term that would trigger the new requirement. Funds with names such as “ESG” or “sustainable” must consistently invest in appropriate assets or risk a “materially deceptive” or “misleading” finding. Perhaps such enforcement may result in a more accurate and reliable due diligence and vetting process for fiduciaries considering potential ESG investing.