The fiduciary duties of institutional investors have become a hot issue for policymakers and courts, with the future financial security of millions of American workers and savers at stake. Unfortunately, many recent policy debates and court opinions on such duties demonstrate only a limited understanding of fiduciary principles.  A more complete appreciation of them is essential for informed policy and court decisions that affect U.S. financial security and economic stability.  In a new article, we offer a guide to essential investment fiduciary concepts.

While policymakers and courts are generally  familiar with the fiduciary duties of loyalty and prudence, they give little attention to related legal principles essential to the application of those duties. Among the overlooked principles are:

• Strictest Duty – The investor fiduciary duty of loyalty is subject to the trust standard, which is known as the strictest of fiduciary duties. For instance, fiduciary duties applicable to corporate directors are generally more lax (g., regarding conflicts of interest).  People who are only familiar with standards applied to other types of fiduciaries or to elected public officials often fail to fully appreciate differences in the rules applicable to investor fiduciaries.
• Trust Fund Standards – Assets held in pension funds, mutual funds, college savings plans, endowments, and similar collective investment vehicles do not, of course belong to the governments, companies, managers or other agents who control them but are held in trust for the fund’s participants or beneficiaries. The agents who manage these trust assets cannot misappropriate or use them to further their own or third party political, personal or policy.
• Duty of Impartiality – Investor fiduciaries have an obligation to identify, consider and make a good faith effort to balance competing interests between different groups of beneficiaries. For example, since younger and older beneficiaries have significantly different risk-tolerance levels and investment horizons, pension fund fiduciaries must manage assets to address both short- and long-term risk and return obligations.
• Duty of Obedience for Charitable Nonprofits – While most investor fiduciaries must use fund assets to meet the financial needs of their beneficiaries exclusively, fiduciaries of charitable nonprofit endowments and foundations also have a duty of obedience to their organization’s goals. This duty obligates charitable nonprofit endowment and foundation fiduciaries to consider the charitable purposes of their sponsoring organization when investing fund assets. In some instances, these purposes may include environmental or social policy goals.  Unfortunately, policymakers and courts often conflate investment practices of religious or other charitable nonprofits with those of different investors. Failure to recognize this distinction can distort the resulting analysis.

Similarly, fiduciary principles that inform interpretation of the duty of prudence have been overlooked:

• Future-Oriented Process – The duty of prudence is process-oriented and forward looking. Investor fiduciaries must evaluate investments in the context of how they fit into the overall circumstances and strategies of their fund.  Specific investments are not evaluated on a standalone basis.  In addition, when exercising the full range of fiduciary duties, this focus on process can result in fiduciaries at different funds with dissimilar characteristics or circumstances using the same basic processes but reaching divergent conclusions and results. Prudence is not an inflexible one-size-fits-all
• Governing Fiduciary Perspective – Governing fiduciaries and investment managers usually play different roles. Governing fiduciaries are responsible for oversight of their entire fund or investment plan, while investment managers usually have a specific mandate for only a portion of it.  This can result in governing fiduciaries and investment managers having different perspectives. However, policymakers and courts have tended to focus only on fiduciary duties from the perspective of individual and more visible investment managers. This can blind them to how each manager fits into the overall fund structure established by the governing fiduciary and produce a skewed result where the total fund context is ignored.
• Duty to Investigate Facts – The prudent standard of care requires that investor fiduciaries investigate facts “relevant” to investment and management decisions. This obligation precludes fiduciaries from jumping to conclusions. The duty contemplates use of a reasonable, good faith process of inquiry to inform decisions.  Scope of this inquiry can be broader than the corporate concept of “materiality,” as it extends to determination of what could be material to each institutional investor. This duty to investigate is central to informed decision making and contemplates creation of documents that show the basis for fiduciary decisions.
• Prudence is Dynamic – Prudence is not a static concept. The prudent standard of care evolves as facts, circumstances, and knowledge evolve. Consequently, resilience and adaptation are necessary for forward-looking investment fiduciaries with long-term liabilities. A newfound appreciation of this concept forced fundamental changes in investment and legal frameworks for investor fiduciaries in the 20^th This evolution occurred after it became evident that, over time, static legal lists of mandated and precluded investments limited adaptability and produced markedly lower returns than a dynamic whole portfolio approach.

The above investor fiduciary principles reflect the impact that market evolution and investor experience has had over centuries on the development of common law.  The failure to recognize this past learning and apply the complete range of current investor fiduciary duty principles has skewed much of the recent policy debate and legal analysis toward a mirage.  Context provided by the actual investor fiduciary duty landscape merits greater attention.

This post comes to us from Susan N. Gary at the University of Oregon School of Law, Keith L. Johnson at Global Investor Collaboration Services LLC, and Nicholas W. Zuiker at Reinhart Boerner Van Deuren s.c. It is based on their recent  article, “Investor Fiduciary Duties in the Crosshairs – Targeting a Mirage,” available here.