UK - The Highland Council has been warned that attempts to exclude investments from the £801.7m (€897.8m) pension scheme on ethical grounds would be unlawful and could lead to the council being forced to make up any shortfall to the scheme.

The council was presented with a report in March on the pension fund's investments in tobacco stocks, which equated to around £27.2m at the end of December 2008, after concerns were raised about the investments on ethical grounds.

Councillors decided to defer a decision on whether investments, including tobacco, could be excluded from the fund until the next meeting to allow them to examine the implications of negative screening as opposed to its current approach of positive engagement.

At present, the council's statement of investment principles recognises the importance of social, environmental and ethical considerations when selecting investments, and instructs managers to "take into account the key principles of socially responsible investment primarily through a policy of engagement with companies that fail to demonstrate appropriate observance of these principles".

However, legal advice provided to the Highland Council on whether it was lawful for the council to instruct certain investments to be excluded from the fund stated the move would require a change in legislation. 

Philip Simpson, an advocate, told the council "they are not entitled to exclude investments on ethical grounds as the law currently stands", and warned if an instruction was given the decision "would be susceptible to challenge by way of judicial review".

The Highland Council was also advised that in the event of trying to exclude tobacco, or other investments, the council would be "legally obliged to make up for any shortfall in investment".

Investments by the pension fund in tobacco stocks reached £27.2m in December 2008, while details from the scheme's annual report for 2007/08 showed its sixth-largest equity holding was in British American Tobacco, with an investment equivalent to 1.52% of the fund's assets.

The update at the council meeting, earlier this week, also revealed the existing investment managers all agree that although tobacco investments can be "controversial", these companies have strong cash flow and balance sheets providing "relatively high, stable and predictable returns".

It was claimed, for example, that over the last seven years a restriction on tobacco stocks would have cost the pension fund more than "10 basis points per annum in absolute performance".

Councillors were meanwhile warned that if they voted in favour of exclusion they could be "liable to penalties available following an audit, namely censure, suspension and disqualification", and if they were aware the decision was unlawful at the time of voting individual councillors could also be personally liable for any loss to the pension scheme.

The council was therefore recommended to note "in terms of the legal advice they are not entitled to exclude investments on ethical grounds as the law currently stands".

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