On Dec. 31, Index Universe published a helpful survey of funds based on environmental, social and governance (ESG)-screened indexes. Lorne Abramson, a California-based adviser and manager, compares the strategies, costs, and performance of a number of exchange-traded and separately-managed index funds.

"Investing Responsibly" addresses two persistent misconceptions about ESG investing:

1) ESG screens limit returns by imposing sector bias on portfolios.

2) ESG investing is a "boutique" approach that conflicts with conventional investment strategies.

Mr. Abramson argues that ESG can play a complementary role in portfolio construction:

"The focus of this survey is ultimately from the standpoint of ESG as an 'overlay' component, building upon the fundamental investment principles of global asset class diversification, frictional cost minimization and tax efficiency. In other words, it assumes ESG is not a separate asset class, but a means of investing in existing, traditional asset classes."

Unbalanced Indexes Can Still Outperform

Mr. Abramson acknowledges that ESG screening does introduce sector bias to some indexes. This may be deliberate, as part of a "green" strategy focusing on clean-tech firms, for example. Other funds, such as the recently launched FaithShares ETFs, may avoid those businesses, like gambling or alcohol production, that conflict with certain religious teachings.

The world's longest-running ESG-screened index, the FTSE KLD 400 Social Index (KLD400), is tracked by an iShares exchange-traded fund (listed as DSI). Historically, the KLD400 has been somewhat underweight in energy and basic materials, and overweight in financial and technology stocks. This sector bias helps explain why the KLD400 outperformed the market in the late 1990s, during the "tech bubble."

For the record, since inception, the KLD400 has outperformed the S&P 500, delivering annualized returns of 9.51%, versus 8.66%, as of 12/31/09. It has also outperformed at the 1-, 3- and 5-year marks. (The KLD400 lagged at the 10-year mark, at the end of the "tech bubble.")

Select Social Index Seeks Sector Neutrality

Mr. Abramson also mentions the iShares ETF based on the FTSE KLD Select Social Index (SSI). The SSI seeks to closely track the sector composition of its benchmark, the large-cap FTSE All-World US Index. This index includes strong ESG performers from sectors like energy and basic materials. As explained by the SSI's methodology:

"The FTSE KLD Select Social Index (SSI) is optimized to maximize exposure to positive environmental, social, and governance factors while exhibiting risk and return characteristics similar to those of the FTSE US 500 Index. The Index is sector-diversified, holding companies with the highest social and environmental scores from each sector."

Click here to see SSI performance data. Since inception, the SSI has delivered annualized returns of 2.41%, versus 2.26% for its unscreened benchmark. Like the KLD400, the SSI has outpaced its benchmark over 1-, 3-, and 5-year periods.

Other Options in an Expanding Marketplace

"Investing Responsibly" discusses other passive-strategy ESG funds, and considers the industry trend towards globalization. For example, Pax World and Northern Trust have launched ESG products based on KLD global benchmark indexes.

While he notes that "there are still noticeable asset class gaps" in the marketplace, Mr. Abramson foresees "growth and innovation continuing in both the ESG and indexing arenas." By enabling investors to use ESG criteria as a complementary tool, he believes that passive funds will make it easier "to incorporate one's values into a broadly diversified, cost- and tax-efficient asset allocation plan."

For another perspective on passive ESG strategies, see Marla Brill's "Sustainability Indexes: Pros and Cons" at FA Green.

The trials and tribulations of former plaintiff's lawyer Steven Eugene ("Gene" a/k/a "Geno") Cauley have received a fair amount of ink over the last year, but there is a new twist.

Readers may recall that Cauley was one of the lead counsel in the BISYS securities litigation that settled in 2006 for $65.8 million. Cauley was the sole signatory of the escrow fund in the BISYS litigation, and revealed in April that he was unable to produce the $9.3 million in remaining settlement funds from the BISYS litigation.

Following this disclosure, Cauley resigned from his firm, surrendered his law license, and agreed to plead guilty to one count each of wire fraud and criminal contempt for "failing to safely hold" the settlement funds. His sentencing is scheduled for next week.

Last month, one of Cauley's creditors, Centennial Bank, sued Cauley's former law firm (n/k/a Carney Williams Bates Bozeman & Pulliam, PLLC) and his former partners. According to an article in the Arkansas Business Journal, Centennial is operating under a power of attorney, in the name of Cauley.

According to the article, the firm's defense to the suit is essentially that Cauley forfeited his contingency fee rights when he surrendered his law license in May. The firm's lawyer, Skip Henry, notes that "[b]ecause he is no longer a lawyer, we cannot pay him any contingency fees."

A follow up article from the Arkansas Business Journal also notes that Cauley is a former director of Centennial Bank's holding company, Home BancShares, Inc. (NASDAQ - HOMB) and that Cauley and his various entities (listed here) owe Centennial more $41 million.

More bad news for Cauley - his Gulfstream G450 was repossessed by Wachovia in June.

RiskMetrics has published a summary of its 2009 Postseason Report, which has extensive analysis of investor and issuer responses to the key corporate governance issues from this season. To access the report, please visit here.

RiskMetrics will also offer commentary on the report through its upcoming webcast, 2009 Postseason Review, which will be held on Tuesday, October 20 at 1 p.m. Eastern. Pat McGurn, Ted Allen, Valerie Ho and Sean Quinn will examine trends for the U.S. proxy season 2009 and what's ahead for 2010. To register for the webcast, please visit here.

Also, the next step in our transparent policy formulation process is our annual open comment period, which provides all market participants an opportunity to comment on proposed updates to our benchmark proxy voting policies. The comment period officially opens on October 21. Stay tuned for more details.

The Securities and Exchange Commission plans to delay a final vote on proxy access until 2010, Bloomberg News reported today.

The SEC was planning take a final vote on its proposed proxy access rule in November, but the commission wanted to give its staff more time to review more than 500 comments that have been submitted by companies, investors, and academics, according to Bloomberg News.

Investor advocates weren't discouraged by this news, agreeing that the SEC needs to be careful while crafting a rule on the controversial issue of proxy access. The commission previously tried to address the issue in 2007 and 2003.

"We agree that the commission should take the time it needs to deliberate so the strongest possible rule can be created that stands up to the test of time and any immediate legal challenges," said Richard Ferlauto, director of corporate governance at the American Federation of State, County, and Municipal Employees, and a long-time advocate for proxy access.

"Not having proxy access in place in time for the start of the 2010 proxy season is disappointing, but shareowners have waited years," Amy Borrus, deputy director of the Council of Institutional Investors, told Bloomberg News. "A few more months won't be the end of the world."

David Lynn, a former SEC lawyer who is a partner with the law firm of Morrison & Foerster, said the commission should take its time on proxy access. "The last thing we need is a rush job on this," Lynn said.

The SEC's two-part access rule includes a new Rule 14a-11, which would set minimum marketwide standards to permit investor groups to nominate directors to appear on management proxy statements. The draft rule would impose a sliding ownership threshold (of 1, 3, or 5 percent) based on market capitalization (or net assets in the case of investment companies). The draft rule calls for a minimum holding period of one year, but SEC chair Mary Schapiro indicated last month that the commission may extend the required holding period, a change that labor investors and some companies have called for.

Corporate advocates and the SEC's two Republican commissioners oppose the proposed Rule 14a-11, arguing that companies and investors should be able to design their own provisions with stricter access rules. The SEC also proposes to amend Rule 14a-8(i)(8) to permit investors to resume filing access bylaw proposals at companies, provided that the resolutions don't conflict with the draft Rule 14a-11 or applicable state laws.

Corporate advocates have argued that any marketwide rule should be delayed until 2011 to give companies more time to cope with other regulatory developments, including a New York Stock Exchange rule change that would bar broker votes from uncontested board elections and a proposed set of SEC disclosure rules.

It appears likely that the Rule 14a-11 portion of the access rule-making would face a corporate legal challenge. James Cox, a securities law professor at Duke University, said he believes that a marketwide access mandate would be "highly vulnerable" to a lawsuit that asserts such a rule is beyond the agency's authority to regulate corporate proxy disclosures. Senator Charles Schumer has introduced legislation, which Schapiro has welcomed, that would confirm that the SEC has the authority to issue a director election rule, but his bill's chances for passage are uncertain at this point.

Though not as prevalent as they once were, shareholder rights plans, commonly referred to as "poison pills," remain a fixture of the corporate governance landscape. As the global economic crisis took a toll across U.S. and international capital markets over the past year, companies continued to adopt pills, albeit with more shareholder-friendly provisions. Indeed, an analysis of regulatory filings, proxy voting trends, and other data finds that companies are incorporating more shareholder-friendly provisions into their pills; moreover, companies are putting such plans to a shareholder vote in greater numbers than ever before.

Perhaps as a consequence of increased management votes to ratify or adopt pills, shareholder activism, as measured by filings of shareholder proposals to terminate or allow shareholders to vote on pills, has declined. However, those shareholder proposals appearing on ballots generally received high levels of support in 2009.

Amid the recent economic turmoil, 2009 has also seen the emergence of NOL poison pills, which are meant to protect companies' tax assets rather than to deter acquisition offers. It was an NOL pill, in fact, that became the subject of controversy in Selectica v. Versata, pending in Delaware Chancery Court, which may significantly affect future uses of poison pills by Delaware companies.

Select key findings from the report include:

* Newly Enacted Pills: Thirty-three S&P 1,500 Index companies enacted pills between July 1, 2008, and July 1, 2009. Their average term was 7.6 years, and 10 were for terms of three years or less. Four of those were enacted for a period of 12 months or less.

* Pill Usage Among S&P 1,500 Companies Declines for Third Straight Year: The number of S&P 1,500 companies that maintained a poison pill declined for the third straight year in 2009, from 34.5 percent in 2008 to 27.5 percent in 2009. In 2007, 42.5 percent maintained a pill.

* Poison Pill Trigger Thresholds: In 2009, 69.2 percent of the S&P 1,500 companies that maintained a pill employed a 15 percent trigger. Another 19.6 percent employed a 20 percent trigger, and 7.9 percent employed a 10 percent trigger.

RiskMetrics' clients can contact their account managers to learn how to obtain a copy of 2009 Corporate Governance Background Report – Poison Pills. To purchase a copy, please visit our online bookstore.

Institutional investors may have a fiduciary duty to consider environmental, social, and governance (ESG) factors, according to a new study from the United Nations Environment Programme Finance Initiative (UNEP FI). In reporting on "Fiduciary Responsibility," Social Funds' Robert Kropp expressed the uncertainty that still surrounds the question of ESG-related fiduciary responsibilities:

"The report argues that consultants may well have a legal duty to proactively raise ESG issues with their clients. The report also recommends that ESG issues be embedded into legal contracts between asset owners and asset managers."

As the case for managers' ESG-related obligations under securities and trust law is still open, UNEP FI says, ESG proponents should encourage clients to demand integration from their advisors. For now, asset owners, not courts, must drive ESG integration – though lawmakers may yet embed responsible investing into managers' obligations.

"We need to live off the interest"

In his introduction to the 101-page report, Achim Steiner of UNEP FI says that the economic crisis "requires us to review the economic models this century has inherited from the last one." He places particular emphasis on the environment, declaring that "we are living off the Earth's capital – we need to live off the interest."

Towards this end, "Fiduciary Responsibility" describes how some shareholders have begun to consider the ESG performance of the companies they invest in. While the report does not prove that ESG integration is a fiduciary duty, it does offer practical reforms that would help create such duties. For example, UNEP FI calls out signatories of the Principles for Responsible Investment (PRI): "…In order to maintain their membership, all asset manager and asset owner signatories [should be required to] embed ESG issues in their legal contracts."

UNEP FI also says that government should redefine the work of fiduciaries:

"Global capital market policymakers should also make it clear that advisors to institutional investors have a duty to proactively raise ESG issues within the advice that they provide, and that a responsible investment option should be the default position. "Furthermore, policymakers should ensure prudential regulatory frameworks that enable greater transparency and disclosure from institutional investors and their agents on the integration of ESG issues into their investment."

Commentary on ESG and Fiduciary Duty

"Fiduciary Responsibility" is the sequel to a 2005 UNEP FI study, called the "Freshfields report" after the consultants who prepared it, that helped spur the creation of the PRI. The new report includes a literature review of "practical developments" in ESG integration; the results of a survey of how major investment managers approach the topic; and commentary from UK and US experts in fiduciary law.

Quayle Watchman Consulting describes how attitudes and laws have changed since 2005. In the UK, the law now impels corporate directors to consider the broader effects of their decisions:

"Under current United Kingdom company law legislation, the Companies Act 2006 (the '2006 Act') imposes duties on company directors to report on the environmental and social impacts of their business activities. "[Guidance] on the duty of directors to promote the success of the company under section 172 of the 2006 Act, which is the principal replacement duty for the common law fiduciary duties of company directors, also adds that 'success' is to be judged in terms of long-term increase in the value of the company rather than short-term gains."

The obligations of directors have changed, but Quayle Watchman notes that "the government declined to introduce amending legislation to clarify the position of pension fund trustees." While trustees may consider ESG factors in their investment decisions, there is no legal imperative to do so. Quayle Watchman considers the roots of trustees' "short-termism":

"There appears to be resistors to responsible investing which relate to deeply-rooted characteristics of the investment decision-making system including: the mandates that pension funds and their investment consultants set; the systems for measuring and rewarding performance (which focus on peer comparison and beating benchmarks rather than on fulfilling the long-term liabilities of pension funds); and the competencies of service providers (e.g. sell-side analysts). "The effect of this resulting short-termism is that less attention is paid to responsible investment matters than is appropriate–these issues are too long-term in nature to affect the day-to-day behavior of fund managers."

Asset Owners Must Lead Their Managers

Quayle Watchman explains how investors, "in the absence of government legislation or regulations, codes of practice or guidance," can build a long-term perspective into capital markets. They note the impact of the PRI program, which has attracted more than 550 signatories, representing approximately $18 trillion in assets under management.

Responsible investment, conducted at this scale, has helped shift the financial sector's priorities. "Fiduciary Responsibility" cites Bloomberg's placement of carbon emissions data on its terminals as evidence that sustainability is now a mainstream concern.

In the aftermath of the global financial crisis, fiduciary duties may undergo a broader philosophical shift. According to Quayle Watchman:

"The courts accept, despite the widespread use of mathematical modeling, that investment is an art rather than a science, and that there is a wide spectrum of opinion on investment which may be held by advisers without an adviser acting negligently."

The Canadian Coalition for Good Governance (CCGG), which represents pension funds and other institutional investors, is urging companies to move away from stock awards and to place a greater emphasis on "pay for performance."

So far, the group has met with the compensation committees at 11 large issuers, including most of Canada's major banks. Coalition members plan to meet with directors at 25 more companies in the coming year, including those in energy sector.

In June, the coalition released a set of six principles that it wants boards to consider when devising compensation packages. The principles, which supplement the CCGG's 2005 compensation guidelines, include:

* "pay for performance" should be a large component of executive compensation;

* "performance" should be based on measurable risk adjusted criteria, matched to the time horizon needed to ensure the criteria have been met; compensation should be simplified to focus on key measures of corporate performance;

* executives should build equity in their company to align their interests with shareholders;

* companies should limit pensions, benefits, and severance and change of control entitlements; and

* effective succession planning reduces paying for retention.

Meanwhile, 13 issuers have agreed to start holding annual advisory votes on compensation in 2010 after shareholder "say on pay" proposals received unexpectedly broad support at Canada's major banks this year. Unlike the Obama administration, Canada's federal government has not called for legislation to mandate advisory votes, so investors likely will continue their efforts to seek voluntary "say on pay" votes.

According to Debra Sisti, head of Canadian Research at RiskMetrics, the CCGG is working with the "say on pay" target companies, the shareholder proponents who submitted the resolutions, legal counsel, and other relevant industry consultants in an inclusive process to draft wording for Canada's first management advisory vote proposal. The exercise aims to result in a version that will be acceptable to all issuers and investors.

Shareholders likely will be asked to vote on a proposal much like the more general version seen in the U.S. this year that asks for approval of the report of the compensation committee, the compensation discussion and analysis, and/or the accompanying tabular disclosures. Under advisory votes, there is an expectation that boards will take ownership of this disclosure to ensure its completeness and accuracy, Sisti said.

Even good directors can find themselves in the untenable position of having to capitulate on compensation issues with a strong corporate leader who, in their opinion, could not easily be replaced. For this reason, some corporate directors they have expressed the view that advisory votes will be a positive tool with which they can press more successfully for pay tied to performance, and if necessary, compensation restraint, Sisti noted.

Securities Docket will host a webcast on Tuesday, July 21 at 11 a.m. EDT on the securities litigation issues facing institutional investors. The webcast will include securities litigation experts and academics who will examine the fiduciary duties of institutional investors.

Significant topics to be covered, include:

-Monitoring the portfolio: When and why you would want to be a lead plaintiff

-Don't leave money on the table: Filing claim forms in settled cases to recover losses

-Opting in: Navigating the waters of non-US securities litigation

-Opting out: When does it make sense to leave the safety of the class action and pursue an individual case

Bruce Carton of Securities Docket will moderate the webcast, and panelists include Adam Savett, Director of RiskMetrics' Securities Class Action Services; Salvatore J Graziano, Partner, Berstein Litowitz Berger & Grossmann, LLP; and Wayne Schneider, General Counsel of the New York State Teachers' Retirement System.

To register for the webcast, please visit here.

Judge Denny Chin today sentenced disgraced financier Bernard Madoff to the maximum possible sentence - 150 years.

Reuters has a story here, the Associated Press here, and Bloomberg, here.

It is interesting to note that none of the individual crimes to which Madoff pleaded guilty carries a sentence greater than 20 years. The 150 years is derived from having the sentences run in consecutive terms rather than the more common method of concurrent terms. As noted over on the WSJ Law Blog last week:

In most federal cases in which there are multiple charges, the judge sentences a defendant to serve a prison term on the most serious count, and then the others are served concurrently with that one. It is rare that a judge sentences a person to the maximum for every count, but that's what the government advises here

As noted in the Saturday edition of the WSJ (sub. req'd), Madoff is not eligible for a minimum security prison camp, and thus is likely to be sent to one of the low- or medium-security prisons near New York City like Fort Dix, N.J., Otisville, N.Y., or Allenwood, Pa.

The Madoff Madness and the Banking Crisis: At one extreme, trustees must dodge sociopathic fraudsters; on the other, they must avoid the hubris of "the smartest guys in the room."

Modern Portfolio Theory and the legal thinking it's influenced address the problem by means of risk analysis and diversification. This approach has limits, as Investments & Pensions Europe reported recently: "Dutch pension funds have lost €166m to the Ponzi scheme run by Bernard Madoff, Wouter Bos, the Dutch finance minister has claimed."

The Age Before the "Prudent Man"

In other times, courts have taken different views of how a trustee should deal with risk.

Harvard College v. Amory, 9 Pick. (26 Mass.) 446, 461 (Mass. 1830) was the case that first stated the Prudent Man Rule. The Massachusetts Supreme Judicial Court said that trustees should model their stewardship "on how men of prudence, discretion, and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested."

The Court rejected Harvard's argument that the trustees should have invested in an annuity which would have been less risky than common stocks, but would have provided the beneficiary a much lower income. Harvard's position seems ludicrous today. It wasn't in 1830.

In rejecting Harvard's position, the Court quoted critically an English case (Trafford v. Boehm, 3 Atk. 440, 444, 26 Eng. Rep. 1054, 1056) decided 86 years earlier:

"Neither South-sea stock nor Bank stock[s] are considered as a good security, because it depends upon the management of the governors and directors, and [both] are subject to losses; for instance, it is in the power of the South-sea company to trade away their whole stock while they keep within the terms of their charter…. "But South-sea annuities and Bank annuities are of a different consideration; the directors have nothing to do with the principal, and are only to pay the dividends and interest till such time as the government pay off the capital, and it is not in their power to bring any loss upon them, and therefore are only and properly good securities."

Two things one should note here. First, the court held that annuities backed by government debt were appropriate trust investments. But stock shares issued by the same entities that sponsored the annuities weren't. It's this very limited scope of trust investing the Prudent Man Rule overturns.

The Lessons of the 18th Century's Bubble Economy

Second, note how the court contrasts the relative investment merits of "South-sea stock" and "South-sea annuities." Here one sees the aftershocks of probably the greatest financial and political crisis in Anglo-American history between the English Civil Wars and today.

The collapse of the South Sea Company in 1720 shook the British state to its core. The South Sea Bubble combined a completely fraudulent investment scheme with political intrigue and mad speculation in everything from real estate to trading voyages. (See generally Malcolm Balen, The Secret History of the South Sea Bubble (New York: Fourth Estate, 2002) and James Macdonald, A Free Nation Deep in Debt (New York: Farrar, Straus & Giroux, 2003), pp. 206-219, 223-29.)

It would be hard to identify an area of commercial law or of political and social history that the Bubble did not affect. Trust law certainly changed.

In 1723 the South Sea Company shareholders began receiving perpetual annuities backed by government debt (the Company's only asset) in exchange for their devalued shares. The "Bank" mentioned in Trafford is the Bank of England, then still a private institution but, from the South Sea Bubble onward, the unquestioned central bank for the Empire. It too issued annuities backed by government debt. But even its stock, the Trafford court held, was not a proper trust investment.

I can't imagine a swing in the law back to Trafford. But the devastation of pensions and other trusts, such as the Harvard University endowment (see Richard Bradley, "Drew Gilpin Faust and the Incredible Shrinking Harvard", Boston Magazine, June 2009) – whether caused by fraud, hubris or faith in failing models – will lead to changes in trustees' fiduciary duties.