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Scott Clayton

020 3356 9763


Ethical Investment

Keith J Cutler

Richards Butler
(taken from Issue 10 – January 2000)


The Pensions Act 1995 changed the investment role of the Pension Scheme Trustee. Trustees suddenly had to disclose a Statement of Investment Principles which had to contain, as a minimum, the Trustees’ policy on the kind of investments they would hold, the balance of investments, the level of risk and the expected return.

It is said in some quarters that a high percentage of people want those charged with investing their savings and pension funds to take into account socially responsible issues and avoid investing in companies that adopt unethical practices.  The Government has responded to public opinion and, from next year, Pension Scheme Trustees will have to include in their Statement of Investment Principles their investment approach to the ethical investment debate.

This article will consider the proposed changes, the increase in the exposure of Trustees if their investment policy responds positively to ethical investment and what can be done now, including the following areas –

1        The political debate;

2        What is an ethical investment;

3        The legal position of a Trustee’s duty of care;           and

4        Steps to be taken by Trustees to protect their           position

The Political Debate

The Government acknowledges that higher numbers of people want their “savings” invested ethically and has been moving towards legislation requiring Trustees of Pension Schemes to set out their “stall” on where they stand.

The move towards legislation really started in July 1998, with a speech by John Denham in which he said:

“We are minded to require trustees to disclose to what extent, if any, they have taken account of ethical and social considerations in their investment strategy.”.

This was followed, in December 1998, by a Green Paper, which set out the Government’s view on ethical investment.  It stated that:

“It is important that pension schemes consider in a positive way how their funds are invested.  We believe that trustees should be free to consider moral and social issues in relation to their investments, provided trustees adhere to the obligations placed on them by trust law and always put beneficiaries’ interests first.”.

Despite the concerns of the NAPF and others, the Government published in July The Occupational Pension Schemes (Investment, and Assignment, Forfeiture, Bankruptcy, etc.) Amendment Regulations 1999.  These operate to amend the current Regulations (Occupational Pension Schemes (Investment) Regulations 1996) by requiring Trustees to make an addition to the content of the Statement of Investment Principles, as follows:

“The…other matters on which trustees must state their policy in their statement of investment principles…are –

(a)              the extent (if at all) to which social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments; and

(b)              their policy (if any) in relation to the exercise of the rights (including voting rights) attaching to the investments.”.

This requirement always raises the issue of how this will impact upon the need for Trustees to adhere to their obligations under trust law and their duty of care to obtain the best possible return on their investments.

What is an Ethical Investment

Views on ethics and morals vary widely in any given society.  This causes some difficulty in addressing with any certainty what amounts to an ethical investment.  Any single Pension Scheme is likely to have as many different views represented within its membership as it has members.  It therefore comes as no surprise that the Government does not attempt to offer a definition.

The types of investment which the prudent man of business might consider as unethical are standard.  These include investing in companies which trade in tobacco, alcohol, gambling, arms and also businesses connected with dubious political regimes.

There are also a wide range of other possible areas in which a company may pursue which would be categorised as unethical, which would deter an investment by a group of trustees operating a socially responsible investment policy.  These include use of sweatshop labour and oppressive employment policies generally, testing of products on animals, pornography, the fur trade, nuclear power, potentially polluting products (such as oil or pesticides), tropical hardwoods, ozone-damaging chemicals and the development of genetically modified products, and their use in consumer goods.

The Legal Position of a Trustee’s Duty of Care

The starting point for all Trustees when examining the case law and what their duties are when entertaining the idea of making an ethical investment is the prudent man test with which everyone should be familiar that is to

“take such care as an ordinary prudent man would take if he were minded to make [an investment] for the benefit of other people for whom he felt morally bound to provide.”(Re Whiteley (1886) 33 Ch D 347) 

This area was substantively reviewed in the case of Cowan v Scargill [1985] Ch 270.  The issue here was, as is well known, the desire of one half of the trustee body to exclude from the class of potential investments shares in industries which competed with the Coal Industry and overseas investments as they considered this was contrary to the interests of certain members.  In his judgment, Sir Robert Megarry, Vice Chancellor, produced his now famous list of investment principles that any Trustee must bear in mind:

  • it is a Trustees’ paramount duty to exercise his/her powers in the best interests of the present and future beneficiaries of the trust.  In a pension scheme, the purpose of which is to provide a financial benefit, that will usually be their best financial interests;
  • Trustees must set their own personal interests and views aside when considering investments;
  • the members’ financial benefit may not always be the Trustees’ sole legitimate concern, but cases where other considerations outweigh the financial will be rare, and the burden of proof will be on the trustees;
  • the standard required is the prudent man test, and includes the duty to seek advice;
  • the Trustees must consider the need to diversify investments and their suitability to the trust (see now Pensions Act 1995, section 36(2)(a)); and


  • the same basic investment principles apply to pension funds as do to any form of trust.

These principles have been considered in the Courts on several occasions since 1985, although not always with reference to Pension Schemes.  Cowan v Scargill is still very much the leading case on the exercise of trustees’ investment powers, but there has been some useful guidance on the practical application of these principles in subsequent cases, for example Martin v City of Edinburgh District Council [1989] PLR 10.

A Trustee’s investment decision cannot be delegated.  He can seek advice on the suitability of investments, but the final decision is the Trustee’s.  Therefore a Trustee should only take account of ethical considerations when deciding on adopting an investment if he is satisfied that the above factors are properly discharged.  To do otherwise amounts to exercising a power in conflict with his appointment.

A Trustee is charged with the duty of obtaining the best possible return for their members.  The Trustee has a duty of care to the members and has no place making moral statements in the choice of investment, unless the investment chosen is clearly contrary to the objects of the Trust Deed, for example, the Trustees of a Christian Charity can be exonerated for avoiding investments in weapons as the following case shows.

Bishop of Oxford & Others v. Church Commissioners 

The Church Commissioners for England 1989 investment policy was unsuccessfully challenged by the Bishop of Oxford and others when the latter contended that the policy gave insufficient regard to ethical considerations – Bishop of Oxford & Others v The Church Commissioners for England [1992] 1 W.L.R 1241.

The Commissioners’ investment policy had been set out in their annual report for 1989.  Here are the first few paragraphs as examples of their policy:

“The primary aim in the management of our assets is to produce the best total return, that is capital and income growth combined…..


While financial responsibilities must remain of primary importance (given our position of trustees), as responsible investors we also continue to take account of social, ethical and environmental issues…….  As regards our Stock Exchange holdings this means that we do not invest in companies whose main business is armaments, gambling, alcohol, tobacco and newspapers.  It also means that we must continue to be vigilant in our monitoring of the activities of those companies where we do have a shareholding.”

In his judgment the Vice Chancellor considered that where Trustees or Commissioners held money to further the work of the trust their prime duty was to seek the maximum return on their investment:

“…. investments are held by trustees to aid the work of the charity in a particular way by generating money.  That is the purpose for which they are held.

However, the Vice Chancellor was prepared to absolve the Trustees of a Charity where they were confronted with a particular situation which conflicted with the objects of the Charity, unless there was a chance of serious financial detriment, as to do so would be against the very objects of their appointment.

Therefore if an investment is contrary to the objects of the Charity, it can be excluded but the Trustees of a Pension Scheme have a fundamental objective, namely to ensure the best possible return for their members as they are, as stated above, morally obliged to provide their benefits.

Trustees should not use property held by them for investment purposes as a means for making moral (or political) statements at the expense of others.  For a Pension Scheme Trustee to do so would be seen as not ensuring the best possible return.  Making an investment on ethical grounds is making a moral statement, however small unless the return on the ethical investment could be as good if not better than the other investments.  Trustees should avoid the temptation.

Fraud on the Power to Invest Prudently 

The decision by a Board of Trustees to make an ethical investment in the absence of credible investment data would amount to a breach of their duty to their members in that they would be ignoring their obligation to obtain the best possible return for their members – it would be a fraud on their power to invest.

In the Hillsdown Holding plc v Pensions Ombudsman case the Ombudsman had found that the trustees were in breach of trust in using power to transfer assets from one scheme to another as the primary object was to secure a repayment of surplus to the Employer.  He held that the transfer “constituted maladministration and involved injustice” to the pensioners in that they received a reduction in the security of their benefits and were deprived of the opportunity of further benefit increases and directed that the surplus payments be repaid. [1] (See Hillsdown Holdings plc v Pensions Ombudsman [1997] 1 AIIER 862 at 879 per Knox J.) (emphasis added).  Hillsdown Holdings plc  appealed.

Knox J’s conclusion was that –

“the FMC trustee’s exercise of the power in r 21 constituted a fraud on the power, or in more modern parlance an improper use of the power for a collateral purpose.  The purpose for which it was exercised was the composite one of giving effect to the bargain struck with Hillsdown of which a major element was that a payment of surplus to Hillsdown.  The transfer was well outside the proper ambit of r 21 which was to enable transfers of obligations and assets to other approved funds securing pension rights for members.  In my view the Pensions Ombudsman was right in calling the transfer a fraud on the power.” [1997] 1 A11ER 862 at 893 h.j.

A Trustee of a Pension Scheme has the power to make investments.  His duty is to invest in the best investment for the benefit of his members.  The use of this investment power for a collateral purpose would be a fraud on the power (“fraud” having the Chancery connotation of invalid purpose).  It has been highlighted above that a Pension Scheme Trustee should not be seen to be making a moral statement in making an ethical investment.  To do so would be using the investment power for a collateral purpose.  This would amount to a fraud on the power and the Trustee would be responsible for any loss as a consequence (“loss” in this case is restitutionary, not damages.  Any aggrieved beneficiary could insist the trust fund be restored to what it would have been: he does not need to show he has personally received less as a result).

Steps to be Taken by Trustees to Protect their Position

If Trustees want to make ethical investments without fear of legal redress then their Trust Deed will require amendment to provide within the objects of their Pension Scheme authority for adopting a policy of making investments which conflict with their overriding duty of investing their trust property for the highest possible return.  However, this would change the very basis of the Trust and would undoubtedly require member and employer consent and possibly court ratification.

Alternatively, the Trustees could offer members the opportunity to invest their AVCs on an ethical basis.  This would put this part of the matter firmly within the members’ control and would be a useful barometer as to the views of active members.

The Scheme’s Investment Manager could be consulted on whether or not a socially responsible investment policy could be implemented in practice.  The experience of the Investment Manager could distract an enthusiastic and morally minded board of trustees.  A simple analysis of the financial risks would rarely be disregarded.  The views of the employer, whilst not a determinant in the final decision process, may also be critically important as far as contributions are concerned in a final salary scheme; here the “loss” through investing ethically falls on the employer.  A yield reduction of as little as ¼% has huge funding consequences after 20 years.

However, investing a proportion of the Scheme’s funds in ethically minded investments to be seen to be bearing them in mind, is a dangerous approach.  You are unlikely to receive much sympathy from the Ombudsman or the Courts if your only defence to following this course of action was to gauge performance and membership reaction.

The Effectiveness of an Exclusion Clause 

In Armitage v. Nurse [1998] CH 241 the Court of Appeal held that a clause in a settlement providing that no Trustee should be liable for any loss or damage which might happen to the trust fund unless such loss or damage was caused by his own actual fraud, no matter how indolent, imprudent, lacking in diligence, negligent or wilful he might have been was effective.  It was only if the Trustee could be shown to have acted dishonestly that they would be responsible.

Therefore, a Trustee, adopting an ethically minded investment may find some comfort within the terms of his trust deed protecting him from his actions.  However, there continues to be some academic debate over the ability of such a Trustee avoiding liability where there has been gross negligence.  Lord Justice Millett stated the test as follows (at page 252) namely that –


“Nothing less than conscious and wilful misconduct is sufficient.  The trustee must be –


“conscious that, in doing the act which is complained of or in omitting to do the act which is said sought to be done, he is committing a breach of his duty, or is recklessly careless whether it is a breach of his duty or not.” See Re Vickey [1931] 1 CH 572 at 583 per Maugham.

Therefore, if a Trustee, (in the knowledge that he must achieve the best return for his members) having taken advice compares two investments, one of which is a Socially Responsible Investment with a lower average return than another investment and chooses the Socially Responsible Investment does the Trustee take a conscious decision against achieving the best return for his members?

If the Trustee could show he honestly believed that the risk was one which ought to be taken in the best interests of the beneficiaries, then he would not be guilty of conscious or wilful misconduct.  However, how could the Trustee honestly believe that the investment was in the best interest of the beneficiaries?  His duty is to get the best return and not to exercise a “fraud on the power” of investment and not invest for the best possible return.  In Cowan v. Scargill, an attempt to invest in the best interests of beneficiaries by avoiding investments in oil and gas was correctly criticised.

A Pension Fund Trustee’s obligation is to invest wisely, prudently and profitably.  They are not promoting or protecting any cause, whether moral or political, they are merely investing money to provide a member with a Pension.  Therefore, reliance on an exemption clause may not be available.

Edge v Pensions Ombudsman 1999 4 ALL E.R. 546

This new decision from the Court of Appeal has recently entered the ethical investment debate.  In the Edge case, Mr Edge and his board of trustees had preferred a category of member.  One of the reasons given by the Trustees was to make the scheme more attractive to this category, namely active members, and thus endeavour to guarantee the future of the scheme.  The decisions of the Court of Appeal exonerated the Trustees reasoning and decisions.

The reason this case has entered the ethical debate is that it has been suggested (at a recent Association of Pension Lawyers’ Conference) that the Trustees can be allowed to make ethical investments as this would make the Scheme more attractive to all members and, therefore, guarantee the future of the Scheme.

However, the Trustees in Edge were merely preferring one category of member over another, an approach often taken by Trustees over centuries.  At no point in making their decision were the Trustees taking a decision which could cause the Scheme any loss and the writer considers the arguments to have little weight.

Insurance Cover

A standard insurance contract for Pension Fund Trustees will provide an indemnity for a trustees held responsible for any “Wrongful Act” (as defined in the Insurance policy).

An example of what is known as a Wrongful Act is –

“… any actual or alleged act or omission committed or attempted by the Assured or any matter claimed against the Assured solely by reason of the Assured acting in the capacity of Trustee or carrying out duties for the Trustee or Trust”.

As the insurance market develops the number of Exclusion of Liability clauses is likely to grow.  The standard exclusion is for dishonest and malicious acts.  The same arguments apply to these definition clauses as apply to exclusion clauses.  Any claim against a Trustee will not be for negligence but rather for the mis-application of trust funds in favour of one investment on ethical grounds.  It is suggested that Pension Scheme Trustees keep a watchful eye on any changes in the contents of their Insurance Policies.

Statutory Protection

Commentators invited the Government to include in the legislation a provision absolving Trustees from claims if, in fact, they adopted an ethical policy.  No such protection is offered, which throws light on the Government’s attitude to the attendant risks for Trustees.  


The investment policies of Pension Schemes are now to include social, ethical and environmental considerations.

In order to allow Trustees to make ethically minded investments and risk their members’ benefits, they should call upon the employer and their membership for permission to change the basis of the Trust they have been charged with in order to avoid any conflict of their views with the intention of the Trust Deed.

Until this is done the risk of challenge remains and, therefore, the financial best interest of the Pension Scheme must prevail.  There are few, if any, circumstances that a group of Trustees can ignore this.  To do so would amount to wilful default and the possible voiding of their exclusion clause and insurance policy.

It is the duty of the Pension Fund Trustee to obtain the best return for his members.  It is not his duty to regulate the social, ethical and environmental development of this country even though he had the buying power to do so.

Keith J Cutler


Solicitor in the Pension and Investment Funds Depart­ment at Richards Butler whose associated company, Beaufort Trust Corporation Limited is a Member of TACT