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Republican members of the House Committee on Financial Services have formed an ESG Working Group (Working Group). On June 23, 2023, they published a memorandum on “Key Priorities.” Coming from the Financial Services Committee, the Working Group’s focus is on Securities and Exchange Commission regulatory activity, particularly with respect to proxies. Some of those issues, however, overlap with Department of Labor guidance with respect to proxy voting by retirement plan fiduciaries.
In what follows, we first discuss key points of concern identified by the Working Group with respect to proxy voting that implicate issues for retirement plan sponsors. We then review DOL’s position on those issues and how that position has changed from the Trump Administration to the Biden Administration. Our objective is to provide an idea of the issues policymakers will be arguing about in this area, especially if Republicans re-take the Executive Branch.
We begin with some background.
Background
Our focus in this article is on ERISA rules with respect proxy voting and the exercise of shareholder rights by plans/plan fiduciaries generally, and how concerns about ESG-motivated shareholder activity – that is, environmental, social, and governance shareholder proposals and other shareholder efforts to influence issuer (portfolio company) ESG policy – may affect ERISA rules in the future.
For retirement plans, these issues come up in two different contexts. First, where a plan directly holds, e.g., stock in an issuer, plan fiduciaries (typically the plan trustee) must decide whether and how to vote proxies. Second, where securities are held indirectly, e.g., through a mutual fund, the proxy voting policies of the direct holder (e.g., the mutual fund itself) will affect the overall prudence of the plan’s mutual fund investment. And, with respect to both of these situations, sponsor fiduciaries have an overall duty to monitor the prudence of the policies/conduct of, e.g., the trustee and the mutual fund (as a plan investment).
It's worth noting that the deep problem here is agency. Where an individual holds a proxy directly, she can decide on (literally) any basis how to vote that proxy. Where, as is the case with respect to retirement plans, the proxy is held by an agent (e.g., a trustee), there is a risk that the agent will vote the proxy based on considerations unrelated to those of the ultimate beneficiary, the plan participant. ERISA fiduciary law is intended to address that issue, which is why this is not just an SEC concern.
Two areas of concern identified by the Working Group with implications for retirement plans
With respect to these sorts of issues, the Working Group identified two areas of concern that are particularly relevant to retirement plans (and have come up in discussions of retirement plan proxy voting policy):
Reliance on proxy advisory firms: The Working Group believes proxy advisory firms exercise an “outsized influence … on the proxy voting system … commanding 97 percent of the market.” The Working Group argues that these firms have a “tendency to overlook the economic impact of shareholder proposals,” and that “by prioritizing social and political issues over financial analysis, these firms can undermine the fundamental purpose of the proxy voting system.”
To address what it perceives as a lack of transparency and accountability in the proxy advisory firms’ process, a lack of appreciation of the judgment of portfolio companies’ independent directors, and questions about proxy advisory firms’ conflicts of interest, the Working Group advocates that:
[T]here must be accountability measures for proxy advisors and a greater appreciation for the expertise of independent directors. Proxy advisors should be obligated to disclose their economic analysis and provide financial justifications when they recommend against the judgment of an independent board of directors. This disclosure empowers shareholders to make informed voting decisions based on an analysis of a company’s economic value and long-term prospects, rather than relying solely on the social or political policy preferences of proxy advisors.
Influence of Large Asset Managers: The Working Group found that “Three major asset managers, commonly referred to as the ‘Big Three’ [BlackRock, Vanguard, and SSGA], collectively manage approximately $20 trillion in assets. Their substantial holdings in America’s largest companies, facilitated by the structure of index funds, grant them significant voting power and influence over corporate decisions…. They have a combined voting share of approximately one-quarter at shareholder meetings of most S&P 500 companies.”
The Working Group criticized these asset managers’ use of their proxy voting power “to advance liberal social goals such as ESG and DEI (diversity, equity, and inclusion), which may not align with maximizing investor returns.” To address this problem, the Working Group proposes that “Congress should consider policies that better align the voting behavior of passively managed index funds with retail investors’ best interests.”
Current ERISA rules with respect to proxy voting and the exercise of shareholder rights
ERISA rules with respect to proxy voting/shareholder rights was a particular target of the 2020 Trump Administration re-write of the ESG rules (the 2020 Rule). The Biden Administration/Biden DOL amended that rule in 2022 (the 2022 Rule), eliminating some key provisions with respect to proxy voting.
With respect to the issues raised by the Working Group, the final (2022) rules provide:
Obligation to focus on the interests of participants:When deciding whether to exercise shareholder rights/vote a proxy, the fiduciary must consider the cost of doing so, may not “subordinate the interests of the participants and beneficiaries … to any other objective,” must evaluate relevant facts, and must exercise prudence and diligence in selecting and monitoring, e.g., agents to exercise or advise on the exercise of those rights.
This general guidance touches on a couple issues implicated in the Working Group’s review. First, proxies must be voted in the interests of participants (generally, with a view to improving financial performance). Second, plan fiduciaries must monitor agents, including, e.g., trustees and proxy advisory firms, to make sure that the agents’ decisions align with those participant interests.
Obligation to ensure that proxy advisory firm guidance aligns with ERISA requirements: The fiduciary may not automatically follow a proxy advisory firm’s recommendations without determining that its guidelines meet regulatory requirements.
Plan fiduciaries may set parameters for proxy voting: The fiduciary may adopt “proxy voting policies providing that the authority to vote a proxy shall be exercised pursuant to specific parameters prudently designed to serve the plan’s interests.” The point here is to move agency closer to the beneficiary, so that, e.g., a trustee has guidance as to the views of plan fiduciaries (and by implication, participants) instead of just operating on the more generalized (and less accountable and transparent) views of a proxy advisory firm.
Changes to 2020 Rule
Interestingly, the changes made to the 2020 Rule by the Biden DOL also touch issues raised by the Working Group, help illustrate the (persistent) Democrat vs. Republican divide on these issues, and may foreshadow what will be considered if Republicans take back control of the Executive Branch.
No explicit statement that proxies do not have to be voted: Language in the 2020 Rule stating that ERISA “does not require the voting of every proxy or the exercise of every shareholder right,” was eliminated because of concern that it could be “misread as suggesting that plan fiduciaries should be indifferent to the exercise of their rights … even if the cost is minimal.”
Elimination of “non-voting” safe harbors: The 2022 Rule eliminates the two “proxy non-voting” safe harbors that would have allowed sponsors to adopt an explicit non-voting position with respect to non-business/investment related proposals or where the plan’s investment was “below a quantitative threshold.”
It’s fair to say that at least some Republicans question the ultimate utility of shareholder engagement, especially on issues that are non-material or are not focused on improving the profitability of portfolio companies. Hence, the 2020 Rule’s explicit statement that proxies do not have to be voted in all circumstances and its provision of safe harbors plan fiduciaries could adopt for situations in which they would not vote proxies. The Biden DOL eliminated both of these provisions.
Elimination of an explicit requirement that plan fiduciaries monitor/keep records with respect to investment managers and proxy advisory firms: The 2022 Rule eliminates the 2020 Rule’s special monitoring obligations with respect to investment managers and proxy voting firms and specific records requirements with respect to proxy voting/exercises of shareholder rights. Instead, the general fiduciary duty to monitor applies.
The 2020 Rule would have, to some extent at least, explicitly addressed (with added monitoring and recordkeeping requirements) the Working Group’s concern about the proxy voting policies of proxy advisory firms and large asset managers. The 2022 Rule eliminated those requirements.
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DOL policy with respect to proxy voting has remained contentious – with different administrations taking different positions – for 30 years. While ESG investing has been a more high-profile target, the influence on corporate policy of major financial institutions, trustees, investment managers, and proxy advisory firms, acting (with respect to retirement plans) as agents of plan participants, may ultimately prove the bigger issue.
In this article we have tried to sketch out the policy concerns of those (generally, Republicans) who are critical of current policy. The point being, this is what we will be talking about, if Republicans re-take the Executive Branch.
We will continue to follow these issues.