SOCIALLY RESPONSIBLE INVESTING PETER G. PAN JEAN KADOOKA MARDFIN Researchers Report No. 6, 2001 Legislative Reference Bureau State Capitol Honolulu, Hawaii 96813 Internet: www.state.hi.us/lrb/ This report has been cataloged as follows: Pan, Peter G. + Mardfin, Jean Kadooka Socially responsible investing. Honolulu, HI: Legislative Reference Bureau, December 2001. 1. Investments - Moral and ethical aspects - United States - States - Hawaii. 2. Social responsibility of business - United States - States - Hawaii. KFH421.5.L35 A25 01-6 FOREWORD This study was undertaken in response to Senate Concurrent Resolution No. 13, S.D. 2, adopted during the Regular Session of 2001. The Resolution resolved that the Legislature "encourages the Chief Investment Officer, administrator, and trustees of the State Employees' Retirement System to apply the principles of SRI [socially responsible investing] in their investment practices and decisions, and encourages other investment counselors and money managers to also apply SRI to their investment portfolios." Apart from its endorsement of "the principles of SRI," the Legislature separately requested the Bureau to "conduct research on SRI by examining the laws and practices in other states, and current reports and studies in the field." This study responds to the Legislature's request of the Bureau to shed light on "the principles of SRI," particularly in light of public policy. Ms. Jean Mardfin was responsible for Chapter 3 dealing with the issue of fiduciary standards. Wendell K. Kimura Acting Director December, 2001 iii EXECUTIVE SUMMARY "Socially responsible investing" (SRI) is a method of investing that is best known for screening stocks for their social or environmental characteristics, as opposed to their financial performance. Thus, an SRI investor can avoid buying – and supporting – companies that are felt to harm whatever social values held dear by the investor. Or, the investor can get rid of those already owned – a process known as divesting. Much less known is another SRI strategy called "shareholder advocacy" or "shareholder activism." This strategy involves leveraging equity in a company to influence its social behavior. An SRI investor may own many shares, or buy only a nominal amount just to be able to introduce shareholder resolutions aimed at changing a company's social or environmental policies and actions. A third SRI strategy is community investing, in which often lower-than-market returns are offered to make funds available to help the "poorest of the poor" in areas such as affordable housing, small business, and community development. This segment of SRI is relatively minuscule. These three strategies have evolved and are often treated as one. However, although the rationale underlying the three strategies share certain commonalities, they are in no way a prepackaged whole which must be embraced as one indivisible unit. For example, an SRI investor may choose only to screen and divest stocks without engaging in shareholder advocacy or community investing. That is, if an SRI investor uses any one strategy, he or she is not obligated to engage in any of the other two strategies. Engaging in SRI, in any of its three expressions, is beyond reproach for any individual investor. In fact, it is an individual right to choose that is not subject to any other person's criticism or control – including the government's. However, the appropriateness of institutional investors engaging in SRI is debatable. Social screening of stocks for ownership is, above all, a political act. Mandating institutions, particularly public or quasi-public retirement trust funds, to adopt SRI strategies would be a radical act. Such a mandate would not only usurp trust fund boards' right to independent action, but would also confer upon them perhaps unintended public policy-making powers that not even legislative nor executive branches may wield. With respect to public retirement trust fund boards, the question of fiduciary duty and responsibility also arises. Money in such trust funds must be used for the ultimate benefit of beneficiaries. Although there are some indications suggesting SRI investment strategies cause no significant harm (nor outperform non-SRI investment significantly), the evidence is far from conclusive. iv Accordingly, the Bureau recommends that the Legislature refrain from mandating the Employees' Retirement System or any other public institution to adopt either social screening or shareholder advocacy as investment strategies. As community investing is already practiced in some form by the ERS, there appears no need to legislatively mandate the ERS to do so. v TABLE OF CONTENTS Page FOREWORD ....................................................................................................................... iii EXECUTIVE SUMMARY................................................................................................. iv 1. INTRODUCTION ...................................................................................................... 1 S.C.R. No. 13, S.D. 2.................................................................................................... 1 Definition of Socially Responsible Investing................................................................ 1 Focus of the Study......................................................................................................... 2 Organization of the Study............................................................................................. 3 2. CONCEPT OF SOCIALLY RESPONSIBLE INVESTING .................................. 4 I. BACKGROUND.................................................................................................. 4 Historical Beginnings........................................................................................... 4 II. ASPECTS OF SOCIALLY RESPONSIBLE INVESTING................................ 6 Three Major Aspects of SRI................................................................................. 6 1. Portfolio Screening............................................................................. 8 2. Shareholder Advocacy....................................................................... 26 3. Community Investing......................................................................... 37 Social Values, Screens, and Indices..................................................................... 45 Council on Economic Priorities .................................................................. 45 Calvert Social Index.................................................................................... 50 Domini 400 Social Index............................................................................. 55 Exclusionary Screen.................................................................................... 57 Qualitative Screen....................................................................................... 58 Citizens Index.............................................................................................. 61 Good Money Averages................................................................................ 64 Global Sullivan Principles........................................................................... 65 MacBride Principles.................................................................................... 67 CERES Principles ....................................................................................... 69 Global Reporting Initiative.......................................................................... 70 3. SOCIALLY RESPONSIBLE INVESTING AND FIDUCIARY STANDARDS.............................................................................................................. 73 A. Introduction.......................................................................................................... 73 B. A Trustee's Duty................................................................................................... 73 C. Early Case Law in Hawaii: Steiner and Dwight ................................................. 74 D. Attorney General Opinions: Nos. 85-26 and 87-2.............................................. 75 vi 1. Attorney General's Opinion on the University of Hawaii's Board of Regents......................................................................................... 75 2. Attorney General's Opinion to the Board of Trustees of the Employees' Retirement System................................................................... 76 E. Changes to Hawaii Statutes Since 1987............................................................... 77 1. Amendments to Section 179-14, HRS Since Steiner.................................. 77 2. Uniform Laws ............................................................................................. 80 F. Other Considerations............................................................................................ 82 1. Legal Lists................................................................................................... 82 2. Liability for Imprudent Investments in Socially Responsible (or Other) Investments ................................................................................ 85 3. Indemnification of Board Members............................................................ 86 G. Impact on Fiduciary Duty if State Law Requires ERS to Invest in SRI.............. 88 H. Conclusion on Fiduciary Standards for Employees' Retirement System Trustees...................................................................................................