A lawsuit waiting to happen: ESG violates fiduciary duty

For decades, the concept of fiduciary duty has been a legal cornerstone of the asset management and investment world, because it basically ensures that fund managers have to act solely in the economic interest of plan beneficiaries, also known as shareholders.

Fiduciary duty, as historically applied and practiced in the U.S., has been primarily concerned with maximizing investment returns on behalf of plan participants. However, with the rise of stakeholder capitalism, and the mass implementation of environmental, social and governance (ESG) investing, a new crop of asset managers is seeking to blur the lines of fiduciary duty to include social justice causes.

This matters because the vast majority of Americans have large sums of money in investment portfolios, including public pension plans, which are controlled by asset management companies currently less concerned with maximizing investment returns for their clients than with pushing social justice initiatives with unwitting clients’ funds.

Due to massive consolidation in the asset management world in recent years, three companies — BlackRock, State Street and Vanguard — control more than $22 trillion in total assets under management. For context, the S&P 500, which encompasses the 500 largest corporations in the United States, has a total value of only about $38 trillion. Obviously, this means that the so-called Big Three have unmatched power over the direction of the U.S. economy, seeing as how they possess outsized power when it comes to shareholder voting.

Put another way, the Big Three have such a large share of assets under management, and the attendant shareholder voting rights, that they can bully corporations into pursuing nebulous social justice causes at the expense of maximizing profits.

This is what has been happening for many years, as BlackRock CEO Larry Fink has laid bare for all to see.

So here is the problem: By engaging in stakeholder capitalism and using ESG to shape how companies operate, regardless of the impact on their bottom line, these institutions are breaching their sacred fiduciary duty.

More importantly, they are violating the law.

According to the U.S. Department of Labor, “The primary responsibility of fiduciaries is to run their plans solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits and paying plan expenses. Fiduciaries must act prudently and must diversify the plan’s investments in order to minimize the risk of large losses.”

In plain language, this means that fiduciaries — whether that be a small-time investment manager or a behemoth asset management company — must, according to the letter of the law, oversee the investments they handle with the sole guiding principle of maximizing shareholder returns.

In fact, this is a well-established principle that has been upheld repeatedly by the courts. As the University of Chicago Business Law Review notes, “The concept of shareholder supremacy was addressed by Delaware Supreme Court Justice Leo Strine when he stated: ‘a clear-eyed look at the law of corporations in Delaware reveals that, within the limits of their discretion, directors must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare.’”

Moreover, this issue has been heard before the Supreme Court on multiple occasions, with the Court ruling in favor of shareholder supremacy repeatedly.

And, it should be noted that ESG investing has historically underperformed its non-ESG counterparts, which violates the “Duty of Care” and “Duty of Loyalty” elements of the fiduciary duty menu of responsibilities.

In sum, as currently constructed, ESG investing violates the fiduciary duty as defined by the U.S. government, which means that any and all fund managers who support ESG investing are vulnerable to civil lawsuits.

Chris Talgo (ctalgo@heartland.org) is editorial director at the Heartland Institute.