On December 11, 2020, the Department of Labor released a final regulation revising DOL’s rules for the voting (or not voting) of proxies by ERISA plan fiduciaries.
In this article we review the final rule, beginning with some highlights.
The final rule generally follows the proposal but, in a number of places substitutes more general requirements for the proposal’s more detailed ones. Highlights include elimination of the proposal’s:
Requirement that voting/not voting a proxy be justified by a determination as to whether the matter to which the proxy related had “an economic impact on the plan” that outweighed “the costs of research and voting.”
Specific recordkeeping requirements justifying proxy-related decisions.
Requirement that proxy voting practices be reviewed every two years.
It has generally been recognized that the exercise (or non-exercise) of shareholder rights, e.g., voting proxies with respect to shares of stock held by a retirement plan, is an ERISA fiduciary responsibility. Whether and how those rights may be exercised has, however, in some circumstances been controversial and somewhat political.
Thus, like DOL’s rules for Environmental, Social, and Governance (ESG) investments, DOL’s policy with respect to proxy voting (which may itself involve ESG issues) has zig-zagged as control of DOL policy has changed back and forth from Democratic to Republican.
In 2016, the Obama DOL issued Interpretive Bulletin (IB) 2016-01, which began by criticizing the Bush DOL’s IB 2008-02, stating that that IB had “been misunderstood and may have worked to discourage ERISA plan fiduciaries … from voting proxies and engaging in other prudent exercises of shareholder rights. … [and] has been read by some stakeholders to articulate a general rule that broadly prohibits ERISA plans from exercising shareholder rights, including voting of proxies, unless the plan has performed a cost-benefit analysis and concluded that the action [e.g., of voting a proxy] is more likely than not to result in a quantifiable increase in the economic value of the plan’s investment.”
If the Obama DOL’s IB 2016-01 was a “zig,” then the Trump DOL’s final regulation is clearly a “zag.” Thus, the final regulation includes a statement that IB 2016-01 “no longer represents the view of the Department regarding the proper interpretation of ERISA with respect to the exercise of shareholder rights by fiduciaries of ERISA-covered plans” and removes IB 2016-01 from the Code of Federal Regulations.
Basic ERISA rules for proxy voting and shareholder engagement
The new regulation begins with a set of rules that apply when a fiduciary decides whether and how to vote a proxy on (or otherwise exercise shareholder rights with respect to) stock held by the plan.
Generally, the management by a fiduciary of plan assets includes the duty to manage voting and other shareholder rights. This duty, however, “does not require the voting of every proxy or the exercise of every shareholder right.”
Specifically, in managing those rights, the fiduciary:
Must act solely in accordance with the economic interest of the plan/plan participants.
Must consider the costs involved.
May not “subordinate the interests of the participants … to any non-pecuniary objective, or promote non-pecuniary benefits or goals unrelated to those financial interests of the plan’s participants and beneficiaries.”
Must evaluate material facts.
Must maintain records (as generally required by ERISA’s fiduciary rules).
Must exercise prudence and diligence in the selection and monitoring of relevant service providers, e.g., proxy advisory firms.
The final rule eliminates provisions in the proposal that would have required the fiduciary to: (1) make, in effect, a binary decision about whether voting the proxy was or was not prudent ( would/would not “have an economic impact on the plan”); (2) keep (and/or require the proxy advisory firm to keep) detailed records in support of proxy-related decisions; (3) (in the view of some commentators at least) affirmatively investigate the facts with respect to a particular vote.
Instead, the regulation relies on a more general, “principles-based approach” (as described above).
An innovation in the new rule is the creation of a safe harbor for policies with respect to proxy voting that may be adopted without violating ERISA fiduciary rules. These include:
A policy limiting voting resources “to particular types of proposals that the fiduciary has prudently determined are substantially related to the issuer’s business activities or are expected to have a material effect on the value of the investment.”
A policy of not voting on proposals when the plan’s holding is below a prudently determined threshold.
A policy in the proposal that would have allowed voting proxies with issuer management on proposals determined to be “unlikely to have a significant impact on the value of the plan’s investment” was not included in the final rule.
Plan fiduciaries must review proxy voting practices “periodically” (the proposal would have required review at least once every two years).
Who votes proxies?
Generally, the plan’s trustee has responsibility for voting proxies, unless either the trustee is subject to the instructions of a named fiduciary or an investment manager has been appointed.
Where proxy voting has been delegated to an investment manager or proxy voting firm, the plan fiduciary must prudently monitor their activities.
Where a fiduciary generally follows the recommendations of a proxy advisory firm, the fiduciary must make a determination that that firm’s guidelines are consistent with the rules described above (that is, in accordance with the economic interest of the plan/plan participants, considering the costs involved, etc.)
Rules for pooled vehicles
The final rule retains the proposal’s pooled vehicle rule. Investment managers of pooled vehicles that include assets of multiple plans with conflicting investment policies must generally vote/abstain with respect to relevant shares in accordance with those plans’ different policies, in proportion to each plan’s economic interest in the pool. Alternatively, the investment manager may condition participation in the pooled vehicle on the investing plans’ agreement to accept the investment manager’s own investment policy.
The new rule would generally be effective 30 days after publication of a final rule, although its applicability is delayed, until January 31, 2022, with respect to certain requirements.
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The new rule is in line with DOL’s final regulation on ESG investments, in that it is (or at least appears to be) intended to have the effect of reducing “ESG-related” shareholder engagement by holding fiduciaries to a “pecuniary interest of plan participants” standard.
In that regard, the rule may be seen as responding to President Trump’s 2019 Executive Order on Promoting Energy Infrastructure and Economic Growth, which instructed DOL to (among other things) review “existing [DOL] guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.”
And, like the ESG rule, it represents an attempt to stabilize the DOL policy zig-zag on this issue by reducing prior sub-regulatory guidance to a formal regulation.
Like the ESG rule, the new proxy rule has generated significant controversy, and some aspects of it are likely to be generally opposed by Democrats, including members of the incoming Biden Administration. It is, however, likely to be final before the Biden Administration takes office, limiting Democrat’s options.
If the Democrats win control of the Senate (in the Georgia Senate run-off elections), then the new rule could be repealed by Congressional Review Act legislation. If Republicans retain control of the Senate, then changing the rule would probably require an amendment to it, through a formal administrative proceeding.
We will continue to follow this issue.