Several years ago, at a Goldman Sachs annual meeting, time was set aside for shareholders to ask questions of the CEO. A man approached the microphone and announced that he was a guest, not a shareholder, and wondered if he could ask a question. “No,” he was politely informed, “only shareholders can ask questions.”
It was a telling moment that spoke a significant truth about the corporate system – only shareholders count. For many, a responsible company is defined as a company that takes care of its shareholders. A nod will be given to other “stakeholders,” such as employees and community members affected by corporate activity, but only to the extent that these good relationships help create wealth for shareholders. Shareholders? That’s us. Most of us don’t know much about picking stocks, so we trust a financial advisor or a mutual fund manager to do this for us. Nearly 100 million Americans invest in mutual funds.
When you invest in a mutual fund, your money becomes part of a common pool of assets that the fund manager uses to invest in stocks or bonds or other financial instruments. It’s their job to look out for your best interests. A mutual fund is a profit-seeking vehicle, but it can also become a vehicle for the common good. Your small investment can be leveraged to help produce significant change.
Shareholders have not done a particularly good job monitoring the behavior of the companies they own. In fact, they are often a significant part of the problem. Corporations are some of the largest economic entities in the world, and they are managed with the steady drumbeat of "make me money" in the background. It should come as no surprise when companies cut corners on safety, oppose environmental regulations and outsource production where wages and worker protections are weakest. They do this to satisfy their shareholders. A year before the explosion in the Gulf of Mexico, Tony Hayward, BP’s former CEO, quipped that he pays his shareholders an annual dividend “to keep his job.”
Moral and financial concerns are not independent but interdependent. Corporate success depends on a delicate web of relationships with employees, customers, communities, governments, suppliers, investors, and ecosystems. Companies that treat these stakeholders with dignity and respect can prosper in the long run by avoiding problems and winning the loyalty of their employees and consumers. They can also create tremendous value for society. When oil companies like BP pay insufficient attention to worker health and safety, however, shareholders also suffer. And CEOs, like Mr. Hayward, lose their jobs.
So what does it mean to be a shareholder? A shareholder is a person of influence. Together, we have an opportunity to seek profits and wield that influence for the common good.
Read why Domini chose not to invest in BP, years before the Gulf of Mexico disaster. .
The complexity of our food production systems is astounding, as are its staggering impacts on climate change and human rights. Any given meal or afternoon snack can touch on issues as far-ranging as the survival of the orangutan or a land rights dispute in Africa. Climate change, water scarcity, nutritional content, marketing to children, animal welfare and labor rights are all on the table.
Behind each familiar brand lies a complex set of relationships stretching across the globe. We view these relationships as opportunities for positive impact. As investors, we can create the incentives for companies to simultaneously be more transparent and to dig deeper to ensure their businesses are operating responsibly. Through your investment in the Domini Funds, your money is working to help catalyze this process of transformation.
For example, deforestation is an important driver of climate change, accounting for an estimated 10 percent of greenhouse gas emissions. The Consumer Goods Forum, an industry association, has acknowledged that “the consumer goods industry, through its growing use of soya, palm oil, beef, paper and board, creates many of the economic incentives which drive deforestation.” All 400 members of the Forum, representing all the world’s major consumer goods manufacturers, retailers and service providers, have committed to zero net deforestation by 2020.
Who will hold these companies accountable for these commitments? What do they mean in practice?
The shareholder proposal is an effective tool for encouraging corporate management to come to the table to discuss our concerns. We developed a proposal that we have submitted to several of the largest food companies, asking for public reports assessing each company’s impact on deforestation and its plans to mitigate these risks. We’ve asked these companies to report on their impact by commodity, as each carries its own set of risks and possible solutions. Among these commodities, palm oil has received the most attention because its production is responsible for large-scale forest conversion in the tropics and extensive carbon emissions.
At Domini Social Investments, the research we conduct to understand the dynamics of our food systems is core to the investment process. Whether it is expressed in the avoidance of many manufacturers of agricultural chemicals, in the search for systems that provide safer food for all, or in the proxy votes we cast or the hard questions we ask of corporate managers, we view our social and environmental standards as key to the process of helping both the public and corporations understand what is at stake.
Download our new Annual Report (PDF) to learn more about the ways the Domini Funds are helping to promote better food production around the globe, including our approach to local and organic sourcing, genetically modified organisms, pesticide use and deforestation.
Climate change presents a real and present threat to human civilization. It also presents tremendous risks and opportunities to the corporations in your mutual fund portfolio. How they handle these challenges may make the difference for all of us. Does your mutual fund manager agree with this, or do they deny the seriousness of the issue?
Concerned investors have been submitting shareholder proposals for years, asking corporations to report on their greenhouse gas emissions and take meaningful steps to address climate change. These proposals are put to a vote of all shareholders at each company’s annual meeting. Your mutual fund – in your 401(k), or your IRA, or your personal investment account – uses your money to buy shares in corporations and to vote on your behalf. A recent mutual fund study conducted by Ceres tracked the 39 shareholder proposals on climate change that went to vote in 2013. How did your mutual fund vote?
First, the good news. A handful of large fund managers supported climate resolutions more than 50% of the time. The largest fund managers, however, managing trillions of dollars, voted against these proposals, or sat on the sidelines by abstaining. According to Ceres, one of the largest mutual fund managers in the country has never cast a single vote in support of a climate-related resolution in the 10 years covered by the survey.
Socially responsible funds like the Domini Social Equity Fund are different. We not only vote in favor of these proposals, we also take the lead by drafting and submitting proposals, and by engaging in long-term dialogues with companies in our portfolios on climate change, deforestation and human rights. All of our investment decisions are based on considerations of environmental sustainability and universal human dignity.
In an article titled “The Coming Climate Crash”, Henry Paulson, former US Secretary of the Treasury wrote: “We’re staring down a climate bubble that poses enormous risks to both our environment and economy. The warning signs are clear and growing more urgent as the risks go unchecked.” Perhaps your fund manager believes in the reality of climate change, but doesn’t believe it will impact your investments. Isn’t this also a form of climate denial?
You wouldn’t vote for a climate denier. Why would you allow one to vote for you?
View Domini's Proxy Votes
On May 14, Google Inc. shareholders rejected a proposal sponsored by my firm, seeking the adoption of a responsible code of conduct to guide the company's global tax strategies. I suspect this proposal prompted a quizzical reaction from many investors who assume that minimizing corporate tax payments is good for shareholders. An April 28 Pensions & Investments editorial, “Tax exempt but tax conscious,” wrestled with this issue, ultimately concluding fiduciaries could not ask companies to pay more.
We believe a deeper analysis is required. Corporate tax minimization strategies present serious threats to long-term wealth creation and might pose greater risks than corporate taxation itself. But first, I think it is important to dispel a few myths.
The P&I editorial reports the U.S. has the highest effective tax rate in the industrialized world, at more than 40%. According to the Congressional Research Service, however, the average effective corporate tax rate in the U.S. is 27.1%, compared with 27.7% for the rest of the world. In fact, a number of multinationals pay far less than 27%, and some pay nothing at all. But this is not solely a U.S. problem. According to MSCI research, 21.4% of companies in the MSCI World index paid tax rates substantially below the weighted average tax rate of the countries in which they generate revenues.
Why would a company pay even 20% when it could go to Bermuda and pay nothing? The statutory rate is irrelevant. At issue is the ability of multinationals to pay nothing.
The P&I editorial repeats another common myth: “Corporations don't pay taxes, they collect taxes. They allow Congress to hide the true level of taxes.” This version of the “corporate taxation is double-taxation” rhetoric is also false.
Corporations collect payroll and sales taxes, and also pay real estate and income tax. A portion of corporate profits are taxed twice if they happen to be paid out in the form of dividends. But, of course, companies are not required to pay dividends and they do not pay out all of their profits. Shareholders are taxed on capital gains, based on their cost basis when they sell their shares, and on dividends. These taxes bear no direct relation to annual corporate profits.
Perhaps the biggest myth of all is that fiduciary duty compels us to look the other way. Imagine a legal obligation, based on principles of prudence and loyalty, that compels us to condone behavior that stifles innovation, destroys local and national economies, and shifts heavy financial burdens to our own clients and beneficiaries.
Fortunately, this obligation to minimize tax payments does not exist.
According to a legal opinion issued by the U.K. law firm Farrer & Co., “the idea of a strictly "fiduciary' duty to avoid tax is wholly misconceived” and a duty on corporate directors to maximize profits for the benefit of shareholders is “unknown to English law.” In the U.S., I believe a legal analysis would produce the same conclusion — the business judgment rule protects directors who choose to assess their company's “fair share” of taxes, in light of the reputational and legal risks presented by aggressive tax avoidance measures.
For fiduciaries serving investors, the duties are similarly clear — to diversify assets and pursue long-term risk-adjusted returns on behalf of their clients and beneficiaries. Even if Google itself is somehow shielded from costly liability as a result of its tax strategies, it is necessary and appropriate for fiduciaries to consider how Google's activities affect the portfolio, the broader economy, and participants and beneficiaries “in their retirement income,” to quote the Department of Labor's interpretation of obligations under the Employee Retirement Income Security Act. Trustees of underfunded state pension funds might want to do a bit more than merely consider these things.
Aggressive tax avoidance is not the norm, nor should it be. It is a short-sighted and risky strategy that harms investors and society.
Corporate tax avoidance is a direct threat to government and rule of law, and, at a time of high unemployment and high government debt, tax-avoidance strategies have prompted many countries to fight back, including active work by the G20 group representing major economies and the Organization for Economic Co-Operation and Development. Reliance on aggressive tax strategies targeted for reform could result in financial shocks for investors. Google's effective foreign income tax rate has been in the single digits for more than a decade even though most foreign countries it operates in have corporate tax rates in the mid-20s. Does anybody think this can go on forever? The U.K. House of Commons Public Accounts Committee published a report in June 2013 criticizing Google's U.K. tax-minimization approach. The committee chair referred to these tax arrangements as “highly contrived,” “devious” and “unethical.” The French government just handed Google a tax bill for nearly $1.4 billion. If France is successful in collecting even a portion of this, we will see other aggrieved countries stepping up for their share.
Certain multinationals are weaving intentionally opaque and winding trails in and out of every loophole they can find. This global shell game not only hides taxable revenues from governments, it also hides the true sources of corporate value from investors. What portion of Google's profits are derived from superior products and services, and what portion from creative accounting? I would certainly like to know.
Tax should be viewed as an investment, not a cost. To paraphrase Oliver Wendell Holmes, tax is an investment in civilization. Too often in these debates over the burden of corporate tax, we fail to consider what corporate taxes deliver in the long run. What is our return on investment?
Corporations and investors depend upon government services funded by tax revenues, including law enforcement, market regulation, judicial systems, infrastructure maintenance, public education, poverty alleviation, environmental protection, national defense and scientific research. These indispensable services cannot be funded by corporate philanthropy or a rise in share price.
Economist Joseph Stiglitz warns that corporate tax avoidance threatens the wellspring of “future innovation and growth.” Other economists have documented the critical and visionary role government has played in spurring scientific and technological innovation when private investors were unwilling to take the risk. Google and Apple Inc. might not exist today if it had not been for taxpayer funded research. Larry Page and Sergey Brin's initial research was financed by a taxpayer funded National Science Foundation grant.
Investors should be asking Google and other multinationals to adopt ethical principles to guide their tax strategies, considering their impact on society and brand value. Just as corporations should be expected to follow consistent standards globally regarding bribery, child labor, greenhouse gas emissions and non-discrimination, they should adopt principles to help navigate the complexity of local and national tax systems.
We believe this is what fiduciary duty demands.
For the past twenty years, shareholders of the Domini Funds have used their investments to enable conversations with executives at some of the largest and most influential corporations in the world on a wide range of social and environmental issues. Domini Funds investors can take credit for helping to convince JPMorgan Chase* to hire its first Director of Environmental Affairs and to adopt a comprehensive set of environmental policies. They can take credit for helping to convince Nucor, the largest steel producer in America, to adopt stringent human rights policies to address the risk of slavery and illegal deforestation in its Brazilian supply chain. After a five year campaign, they helped convince Emerson Electric to ban discrimination against its gay and lesbian employees, and after a three year dialogue, Toyota Motor* announced that a major trading partner had ended its joint venture with the Burmese military regime. Domini Funds shareholders have helped convince numerous companies to measure their environmental impacts and to adopt strong protections for vulnerable workers in factories around the world.
Since our first shareholder resolution was submitted in 1993, Domini has filed more than 240 proposals at 95 different corporations. The use of social, environmental and governance standards to select investments, combined with a shareholder activism program to help move companies further in the right direction, has proven to be a powerful vehicle for change.
Archimedes, the ancient Greek scientist, once remarked, “Give me a lever and a place to stand and I will move the earth.” For the past twenty years, Domini has provided “a place to stand” for its mutual fund shareholders, finding as many ways as possible to amplify their voice on some of the most pressing challenges of our time. Over the course of 2014 and beyond, we look forward to sharing more success stories about how Domini Funds investors have helped to create positive change.
For more about Domini’s shareholder activism successes over the past twenty years, read our full essay in the Domini Funds 2014 Semi-Annual Report.
Originally Appeared in Private Sector Opinion 32 from the International Finance Corporation
An old management adage says you get what you measure. That’s why any decent MBA program will ensure that its students graduate with a keen knowledge of both management and financial accounting. The rationale is that every manager should not only know how profit is generated, but also be able to report on it to investors, regulators, and other stakeholders.
Few of us today doubt the significance of the environmental and social pressures the world is under. Nor can we doubt the significance of private sector activity both in generating these difficulties and in helping resolve them. Yet there is still no mandate enforcing either the measurement or the disclosure of sustainability...
Originally appeared in the Journal of Applied Corporate Finance (Vol. 25, No. 3, Summer 2013) from the Simon School of Business at University of Rochester
Responsible investors in increasing numbers are asking corporations to disclose data on their environmental, social, and governance policies and practices. These investors put this data to use in analyzing companies' financial prospects, assessing stakeholder relations (and the potential risks and rewards associated with them), making buy-sell decisions, and, when necessary, engaging with management as owners. Such investors also seek to identify companies where management has invested in credible and effective environmental, social and governance (ESG) initiatives that, broadly speaking, aim to create environmental and societal value.
Who are these investors? What types of ESG initiatives to they expect corporate managers to create, monitor, and report on? Will companies whose managers invest in such initiatives be rewarded in the marketplace? These are the kinds of questions this paper seeks to answer...
Originally appeared in Green Living Journal (Fall 2013)
Rian Fried, one of a handful of people who shaped what is now called “socially responsible investing,” passed away on July 3. A passionate and disciplined man, Rian sought to return capitalism to its initial purpose of helping to create a good life, and he was boundless in his enthusiasm for sustainable investing.
Along with Doug Fleer, Rian founded Clean Yield in 1984. In addition to managing assets, they also began publishing a newsletter by the same name. I have received it ever since and have never ceased to be amazed by the bold voice with which it presents groundbreaking new ideas. Whether seeking alternatives to fossil-fuels or finding ways to capitalize a local organic seed farm, Clean Yield has brought all of us along into its cozy Vermont way of doing things.
During the 1980s, Rian Fried traveled to Boston many times, as a small group of us met to discuss our shared vision of investing and to learn from each other. From these meetings grew a shared commitment to the values of responsible investing that endure today. We determined that we must select investments carefully, with environmental and social standards considered. We determined that we must take our Wall Street voice to another level by directly contacting companies and government agencies to raise issues and to mitigate injustices and harms that ordinary business can create. We determined that we must be ready to support grassroots efforts to expand the economic well-being of more people, through innovative financial institutions and from non-traditional companies alike. I will always be grateful to Rian for his quiet insistence that values come first.
Not every passing of a giant is recorded in the headlines, but we in the field of socially responsible investing know full well that Rian Fried was a cornerstone to our thinking and our work. Our hearts are heavy at his passing.
Originally Appeared in Domini Funds' 2013 Annual Report
On March 25, 1911, a fire swept through the 8th-10th floors of the Asch Building in lower Manhattan, occupied by the Triangle Waist Company garment factory. This tragic event, which killed 146 young immigrant workers, helped spur the growth of unions and set in motion a series of legal reforms to protect U.S. garment workers from such preventable disasters.
More than 100 years later, however, garment workers around the world still face the same risks that led to that tragedy. The recent collapse of the Rana Plaza factory complex in Bangladesh was the worst disaster in the history of the apparel industry. The owners of the eight-story complex had illegally added three floors to the building, and although cracks had been seen in the walls the day before the collapse, the factory owner chose to ignore warnings and protests, and ordered workers into the building.
Unfortunately, Rana Plaza was no anomaly. Factory disasters claim the lives of countless workers around the world every year. In Bangladesh, more than 1,800 workers have been killed during the past eight years, and in the past eight months alone, approximately 130 Bangladeshi workers have lost their lives in factory fires.
Globally we have seen a continuous search for the lowest-cost facilities, but nowhere has this issue become as critical as it is in Bangladesh, where the apparel sector employs more than four million people, mostly women. The minimum wage in the country is $38.50 per month, less than half the wage paid in Cambodia and a quarter of the wage paid in China. According to the World Bank, as of 2010, Bangladesh ranked last in terms of minimum wages for factory workers. This race to the bottom has made Bangladesh the second-largest global apparel exporter, behind China. Adding to the problem is a history of weak labor unions and strong representation of factory owners in government. Roughly ten percent Bangladesh’s parliamentary seats are currently held by garment industry leader. The sector’s political influence has been, predictably, an obstacle to meaningful reform.
In the same way that the Triangle Shirtwaist fire brought attention to these issues in the United States a century ago, Rana Plaza has now brought attention to these issues globally. Below, we discuss several paths that companies have taken to improve worker health and safety, particularly in Bangladesh, where the issue has become most critical.
Factory Monitoring Efforts
When we began reaching out to companies to discuss supply-chain sweatshop issues in the mid-1990s, we heard a common refrain: “we don’t own these factories.” However, as responsible investors, consumer activists, students and other labor rights groups engaged with companies to discuss the advantages of taking on greater accountability, things began to change. Companies in a wide range of industries have since adopted codes of conduct for their suppliers and have instituted factory monitoring programs. Many have supplemented these efforts with training programs to educate workers and managers on factory safety and labor rights. Some companies, like Gap, have recognized that a degree of responsibility also lies back at corporate headquarters, where cost-cutting initiatives and last-minute changes to orders can trigger overtime violations and increased pressures on factory managers to cut corners on safety.
It is clear, however, that these efforts have been insufficient to address systemic problems that persist in factories around the world, including excessive hours, forced labor, child labor and safety problems. Many multinational corporations report that they are serving a regulatory function with factory owners that should be played by government. While several leading companies have partnered with civil society organizations to find more lasting solutions, Rana Plaza has made it abundantly clear that more drastic and immediate action is needed.
Banning Production in Bangladesh
Global brands cannot police factory working conditions if they do not know where their clothes are being made. When a company places an order with a factory that meets its standards, it is not uncommon for that factory to ship the order to another factory without the buyer’s knowledge. This practice of unauthorized subcontracting is endemic in Bangladesh, where it is estimated that half of the nation’s roughly 5,000 factories are subcontractors. Even companies with rigorous monitoring programs risk finding their orders being produced at factories not on their approved list. Such was the case when several boxes of Disney sweatshirts were found at the Tazreen factory after a November fire that killed 112 workers.
Our relationship with the Walt Disney Company dates back to 1996, when we first encouraged the company to take greater responsibility over its supply chain. Since then, we have seen a dramatic evolution in its approach to these issues. In addition to providing feedback over the years on Disney’s code of conduct and audit program, we have also visited factories and participated in a hands-on project with Disney and McDonald’s to find a better path towards sustained factory compliance with labor standards.
Two months before Rana Plaza, Disney executives reached out to obtain our feedback on their plans to withdraw from Bangladesh. Disney permits licensing of its name and characters for production in more than 170 countries. While Bangladesh represented only a very small portion of its global sourcing, Disney believed it presented significant risks. Leaving Bangladesh could help the company reduce risk to its brand and allow it to focus efforts where it could most improve working conditions. Therefore, in March, Disney announced that Bangladesh had been removed from its “Permitted Sourcing Countries” list.
Some have accused Disney of “cutting and running,” a tactic that companies use to avoid accountability for sweatshop conditions, but we disagree with those accusations. Disney’s limited economic activity in Bangladesh would have afforded it little leverage with factory management, but by publicly withdrawing, it was able to exercise its leverage as a global brand to send a clear message. The Bangladeshi government needs to understand that substandard working conditions will have economic consequences if it does not take immediate action.
A Shift in Worker Safety Initiatives
For many companies, however, leaving Bangladesh is not a viable option. These companies instead must take a hands-on approach to reform.
In the wake of the collapse, several significant initiatives have arisen to improve worker safety issues. Most notable is the Accord on Fire and Building Safety (the Accord)—a five-year, multi-stakeholder agreement between retailers, non-governmental organizations, and labor unions to maintain minimum safety standards in the Bangladesh textile industry. We believe that this initiative is the best hope for meaningful reform. As a legally-binding agreement, the Accord represents a significant shift from past practice. Its board of directors, which is chaired by the International Labor Organization (ILO), is split evenly between corporations and labor unions. We believe that this equal representation of trade unions is critical. Domini’s Global Investment Standards have always recognized that:
“Healthy and vital unions play a crucial role in addressing the imbalances in power that often arise between corporate management and workers in their struggle for fair working conditions. Without unions, the possibilities for long-term equal partnerships between management and labor would be vastly diminished.”
One Rana Plaza survivor told Time: “The managers forced us to return to work, and just one hour after we entered the factory the building collapsed…" It was not simply lax regulations, political corruption and greed that led to these deaths—it was also fear. In order for desperately poor workers to stand up for themselves, they need strong labor unions.
To date, the Accord has been signed by more than 80 companies, primarily based in Europe. One of the first to sign was Hennes and Mauritz (H&M, Sweden). Over the past three years, we have seen impressive improvements in H&M’s approach to labor conditions in its supply chain. The company has advocated for increases to the minimum wage and for the adoption of a “living wage” standard, and has pledged to remain in Bangladesh even if wages rise.
Some of the other major global brands that have signed the Accord include Fast Retailing (Uniqlo, Theory), PUMA, Carrefour, Tesco, Next and Marks & Spencer. The decision to sign the Accord by Japan’s Fast Retailing, one of the world’s largest retailers, supplements an already impressive social profile, including its practice of publicly reporting the results of its factory audits and the remedial measures its takes. To date, only a handful of American companies, including PVH (Calvin Klein, Tommy Hilfiger) and American Eagle Outfitters, have signed the Accord.
Domini Helps Lead Investor Response to Rana Plaza
In May, Domini worked with other investors affiliated with the Interfaith Center on Corporate Responsibility (ICCR) to draft a public statement urging global companies sourcing from Bangladesh to sign the Accord on Fire and Building Safety and to strengthen local trade unions, disclose suppliers, and ensure appropriate grievance and remedy mechanisms for workers.
More than 200 institutional investors from around the world, representing more than $3.1 trillion, signed our statement. The first 120 signatories came together in only 48 hours, a strong testament to the seriousness of this issue and the need for systemic reform (Read the investor statement).
Citing legal concerns with the Accord, a group of 20 North American retail companies, including Gap, Wal-Mart, Target, Macy’s, Nordstrom and Costco, announced another initiative—The Alliance for Bangladesh Worker Safety (“the Alliance”). While we favor the Accord over the Alliance because of its legally-binding nature and the role of labor unions in its governance structure, both initiatives represent an important shift in approach to worker safety issues. Both the Accord and the Alliance focus on bottom-line, critical reforms to address urgent fire and safety issues; both recognize the need for competitors to work together toward common solutions, to share the results of their factory inspections with each other, and to enforce common standards; both are committed to a level of public transparency; and both recognize the need for workers to have a voice.
Domini is currently helping to coordinate a global investor coalition focused on factory safety in Bangladesh. In the coming months, as we follow developments with the Accord and the Alliance, we will turn careful attention to those apparel companies that have not signed up for either initiative.
Here are a few additional changes we will continue to push for, both in Bangladesh and around the world:
- A global dialogue is needed about the definition and achievement of a sustainable living wage—sufficient for a worker to support a family and save for the future.
- A social safety net should be provided for the families of workers who are injured or killed in the line of work.
- The New York Times reports that children in Bangladesh can tell the latest fashion trend based on the color of the water in the canal that runs past their schoolhouse. The environmental consequences of global supply chains are significant and must be addressed.
- We would like to see the Accord model, which incorporates cross-company information sharing, an active partnership with unions and a commitment to public transparency, become the norm for global supply chains everywhere.
- While Bangladesh may be the flash point today, similar problems persist in other countries around the globe. It is our hope that the reforms sparked by Rana Plaza will reach beyond Bangladesh.
Rozina Akter, a 21-year-old survivor of the Rana Plaza collapse, told the Wall Street Journal: "I'll go back to work as soon as I get better. Not all buildings will collapse." What other choice does she have?
Like the Triangle Shirtwaist fire of another era, we hope to look back on Rana Plaza as a turning point for Bangladesh, and an end to the global “race to the bottom” that this poor country has come to symbolize. We hope that it will catalyze a new era of labor reforms that will provide young women like Ms. Akter with more acceptable and dignified choices. As investors, we will continue to do our part to bring that hope to fruition.
Fiduciaries are the only class of investor legally obligated to care for other human beings. In recent decades, however, the fiduciary duty of loyalty has been turned on its head and converted into a duty to ignore other human beings. Financial returns are now considered more important than the interests of beneficiaries. This misstatement of the law in the quest for alpha is at the heart of the so-called “mainstream” rejection of social investing, and the opposition to divestment from gun makers in the wake of the horrific shooting in Newtown, Conn.
The opposition to divestment, including a Pensions & Investments editorial on Jan. 21, “Misdirected furor,” is based on several well-worn misconceptions about social investing and fiduciary duty. The foundational myth is the notion that “social” issues are unrelated to financial return and must therefore be ignored by fiduciaries. This myth was put to rest ages ago by the performance of the MSCI KLD 400 Social index, and numerous academic studies, including excellent reports on fiduciary duty from Freshfields Bruckhaus Deringer LLP, a London-based international law firm, and FairPensions, a London-based group that campaigns for responsible investing in the pension industry.
The individual performance of a gun investment is largely beside the point, however. There are many lucrative investment opportunities — a fiduciary must exercise prudence in selecting the most appropriate ones. There are only three small-cap publicly traded gun manufacturers in the United States, and a handful of gun-related private equity investments. Can a diversified portfolio be managed for the long term without these investments, which “externalize” unacceptable harm to participants and beneficiaries? This question is neither asked nor answered byP&I's editors.
First and foremost, fiduciaries must be dedicated to their beneficiaries' financial goals. This requires a deep understanding of risk and opportunity, including those relating to “social issues” that affect consumer demand and the broader economy, or impose legal risks and operational costs (e.g., cleanup costs). The debate has moved on from the artificial, bifurcated view of reality that views the investment portfolio in isolation from the real world. A modern fiduciary must understand how the corporation affects the health of the systems upon which it depends for its long-term survival.
P&I urges pension funds to ignore calls for divestment and to “step up and communicate the value of investments to their portfolios. ... They must stay focused on securing the highest risk-adjusted returns possible for their funds.”
This is roughly half right. As Justice Benjamin N. Cardozo famously wrote, the courts have kept “the level of conduct for fiduciaries ... at a level higher than that trodden by the crowd.” Fiduciaries should not respond to every demand — they need to set a higher standard and stay focused on long-term goals. But where P&I and other critics of divestment would ask fiduciaries to ignore these demands in favor of an exclusive pursuit of profit maximization, Mr. Cardozo had something else in mind: “A trustee is held to something stricter than the morals of the marketplace.”
In the marketplace, everything has a price. The market has no use for irreplaceable things of infinite value. As a result, finance lacks clear imperatives to maximize life and the priceless things that sustain it, such as clean air and water. Finance knows no imperative to safeguard children.
Fiduciaries, however, can check the more damaging aspects of finance through the process of prudent decision-making in conformance with a duty of loyalty — another priceless thing. “Price” is not a fiduciary's sole concern. If fiduciary duty meant “maximize returns,” we'd have no need for fiduciary duty at all. We would merely need to set the incentives right and guard against embezzlement.
Newtown presents a very concrete example of what a violation of the duty of loyalty looks like. If you use my money to make a weapon that kills my child, don't tell me that in 20 years I'll retire with more money as a result. If you claim that decision was made in my best interest, you have no right to call yourself a fiduciary.
On the question of divestment as a tactic, the P&I editors have the question exactly backwards — we should be asking about the impact of the investments, not about the tactic of divestment. Investors are not seeking to enter this debate on guns. They are already knee-deep in it, have been on the wrong side and are now looking for an exit.
Semiautomatic weapons are now widely available, not solely as a function of consumer demand, but also due to the ready availability of investor capital and investor demand for expanding markets. Is there any limit to these demands? The New York Times reports that industry strategies to increase market share now include an aggressive push to get guns into the hands of children. The editor of Junior Shooters magazine noted that if the industry is to survive, gun enthusiasts must embrace all youth shooting activities, including “semiautomatic firearms with magazines holding 30 to 100 rounds.”
This is your return on investment: Children toting semiautomatic weapons. Whether communicated through private or public equity ownership, the message, no doubt, has been the same — make more, and get these weapons into as many hands as possible.
Whether they like it or not, pension funds are, in fact, agents of social change. Freedom Group has used pension fund capital to change the retail gun landscape, with clear social consequences.
When we allocate billions of capital, we are also sketching out the parameters of future societal possibilities. The long-term growth of these companies depends upon Washington's inability to enact meaningful gun control. Trustees should consider whether that outcome is in their participants' best interests.
Divestment can be effective. The mere suggestion of divestment prompted Cerberus Capital Management LP to announce it would sell Freedom Group. For public equities, divestment sends a signal to management about what is and what is not acceptable. If it is done on a wide enough scale, it can certainly have an impact on a company's finances. But on the most basic level, it is an expression of the duty of loyalty.
P&I's editors noted that these divestment activities “reveal shortcomings as fiduciaries in portfolio oversight.” Here, I wholly agree. These funds should never have been invested in gun makers in the first place. But that is a very poor argument for taking no action now.