Socially Responsible Investing

Socially responsible investing (SRI) describes an investment strategy which seeks to balance the pursuit of financial return and social merit. In general, socially responsible investors favor corporates that promote environmental protection, consumer protection, human rights, etc., while avoiding businesses involving in alcohol, tobacco, gambling, weapons, etc. Some investment funds (e.g. Islamic fund) are characterized by SRI, but we seldom hear about incidents of serious breaches of SRI rules.

SEC recently charged New Hampshire-based Pax World Management Corp. with violating investment restrictions in socially responsible mutual funds that investors were told would not contain securities issued by companies involved with producing weapons, alcohol, tobacco or gambling products.

Pax World, the SEC-registered investment adviser to several socially responsible mutual funds, including the Pax World Growth Fund and Pax World High Yield Fund, purchased at least 10 securities that the Funds' SRI restrictions prohibited them from buying — contrary to representations it made to investors and the boards of the Funds. Pax World agreed to settle SEC's charges and was ordered to pay a penalty of US$500,000.

Pax World violated the Funds' SRI restrictions by making purchases in the securities of companies that derived revenue from the manufacture of alcohol or gambling products, derived more than 5% of their revenue from contracts with the U.S. Department of Defense, or failed to satisfy the Funds' environmental or labor standards. Pax World Funds held at least one security that violated their SRI restrictions at all times from 2001 through early 2006. For example:

• In 2003, Pax World purchased for the Growth Fund securities issued by an oil and gas exploration company that had failed its three most recent screens.
• In 2004, Pax World purchased for the High Yield Fund securities issued by a conglomerate primarily engaged in the shipping industry but which derived revenue from gambling and the manufacture of liquor.

Pax World failed to consistently follow its own internal SRI-related policies and procedures that required that all new securities be screened by Pax World's Social Research Department prior to purchase to ensure compliance with the funds' SRI disclosures. Pax World failed to screen 8% of all new security purchases from 2001 to 2005.

SRI funds are surging in Asia and thus SRI compliance monitoring would become a new agenda to the compliance function.