This paper reviews the historical legal background to the evolution of fiduciary duty in the UK, with reference to the parallel evolution of the concept in the US.
The concept of fiduciaries was intended to promote social welfare, evolving alongside social norms, but this common law approach causes implementation problems in today’s complex society. Governments have sought to clarify fiduciary duty using regulatory frameworks, but these tend to be reactionary and backward looking and have expanded the scope of fiduciary duty to include governments, plan sponsors and the public as stakeholders in pension fund governance. Clark concludes that investment innovation has been stifled by this regulatory approach, and the concept of fiduciary duty today is inadequate to promote either the best interests of beneficiaries or sustainable investment.
Two historical legal cases define the nature and scope of fiduciary duty as it relates to investment management – Harvard College vs Amory in the US, and Cowan vs Scargill in the UK. Harvard vs Amory in 1830 allowed trustees to act prudently and with discretion to protect both income and capital, a forward-looking approach at the time. However, this was later repealed and the more conservative English interpretation of fiduciary duty imposed, with a prohibition on trading in listed company securities. Only in the mid-20th century did the Prudent Man rule make a reappearance.
Cowan vs Scargill  is often cited as a definitive legal precedent ruling out the inclusion of social and moral matters in investment decisionmaking. However the legal decision in this specific case, which dealt with the issue of whether coal industry pension fund assets should be investing in competing energy companies, did in fact acknowledge that non-financial issues such as political stability could be considered where they may impact the long term strength of the economy.
Clark reminds us that these landmark cases have been stripped of their detail over time to provide broadly applicable codes of fiduciary behaviour, as is the norm with English common law. However the cases dealt with specific issues rather than general concepts, and over time differences in interpretation as well as the growing complexity of both the investment industry and the fiduciary landscape further reduces the applicability of historic interpretations to today’s society. Given the uncertainty surrounding the responsibilities of fiduciaries, Clark suggests that it is not surprising that fiduciaries gravitate towards outdated interpretations that have some legitimacy from previous legal decisions, rather than looking forward and adapting to the changing environment.
In recent years the UK government has attempted to address some of the concerns surrounding pension fund fiduciary services in the UK. The Myners inquiry in 2001 found that typical pension fund trustees lacked adequate skills and resources to make effective decisions, comparing them unfavourably with their counterparts in the US. The report also said that pension funds were focusing too heavily on standardised performance benchmarks instead of making asset allocation decisions tailored to their funds’ liabilities. It led to the establishment of a pensions regulatory body and the introduction of new codes guiding the responsibilities of pension fiduciaries, an outcome that Clark argues expanded the scope of pension fund fiduciary duty to include the UK government (as an underwriter via the establishment of the Pension Protection Fund) and employers (as corporate pension scheme sponsors) as stakeholders.
“Given the uncertainty surrounding the responsibilities of fiduciaries, it is not surprising that fiduciaries gravitate towards outdated interpretations rather than adapting to the changing environment.”
Myners also argued that corporate engagement should be a central component of an expanded definition of fiduciary duty, a view that eventually resulted in the UK’s Stewardship Code in 2010.
Innovation and investment
Advocates of a common law approach to fiduciary duty, as opposed to a ‘rules and regulations’ approach, believe that it should avoid bureaucratic inefficiencies while promoting behaviour consistent with social welfare. However the legislation created by governments to fill in perceived gaps in the fiduciary duty concept, such as the comply or explain codes of practice to promote transparency in the UK and ERISAdefined standards of qualification for pension fund trustees in the US, may be impeding innovation. Clark argues that such legislation drove the near-universal adoption of modern portfolio theory by pension fund trustees, which has proven to be fundamentally flawed in light of the recent financial crises. Clark suggests that the investment industry is now open to innovative new investment decision making tools, such as best practice case studies, collaborative research, international standard setting sponsored by independent professional organisations rather than governments, and a greater emphasis on academic research.
RI Quarterly Vol. 2: Fiduciary duty
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Fiduciary duty and the search for a shared conception of sustainable investment