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In this current outlook we review: (1) DOL’s proposed change to ERISA proxy voting rules to provide for consideration of Economically Targeted Investments (ETI) and Environmental, Social, and Governance (ESG) factors; (2) the Ninth Circuit’s ruling in Tibble allowing plaintiffs to proceed with their failure-to-monitor claim; (3) the current status of Oregon’s mandatory private employer auto-IRA; and (4) IRS’s proposal to allow the use of forfeitures to fund QMACs and QNECs.
There is some difference of views about the value of proxy voting. Some advocate the “Wall Street Rule” – that if an investor is dissatisfied with the management of a company in which it holds shares, it should simply sell those shares. Others argue that in some cases large investors are, in effect, forced to invest in large companies and that the only way they can improve management is through shareholder activism. A related issue is the extent to which ERISA fiduciaries may consider “non-financial” issues (e.g., a corporation’s environmental policies) in voting proxies.
In a series of Interpretive Bulletins, the DOL, under different Administrations, has zigged and zagged on what are ERISA’s requirements as to proxy voting.
In 1994, the Clinton DOL published IB 94-2 – an “Interpretive bulletin relating to written statements of investment policy, including proxy voting policy or guidelines.” IB 94-2 generally provided:
(1) That the trustee, or where an investment manager has been appointed, the investment manager, generally has authority to vote proxies. That “fiduciary obligations of prudence and loyalty to plan participants and beneficiaries require the responsible fiduciary to vote proxies on issues that may affect the value of the plan’s investment.” But that “a fiduciary should consider whether the plan’s vote, either by itself or together with the votes of other shareholders, is expected to have an effect on the value of the plan’s investment that will outweigh the cost of voting.”
(2) That where, e.g., a fiduciary responsible for voting proxies is subject to instructions or to proxy voting principles in an investment policy, the fiduciary must generally follow those instructions/principles “insofar as the policy directives or guidelines are consistent with … ERISA.”
(3) With respect to shareholder activism:
An investment policy that contemplates activities intended to monitor or influence the management of corporations in which the plan owns stock is consistent with a fiduciary’s obligations under ERISA where the responsible fiduciary concludes that there is a reasonable expectation that such monitoring or communication with management, by the plan alone or together with other shareholders, is likely to enhance the value of the plan’s investment in the corporation, after taking into account the costs involved. Such a reasonable expectation may exist in various circumstances, for example, where plan investments in corporate stock are held as long-term investments or where a plan may not be able to easily dispose such an investment. Active monitoring and communication activities would generally concern such issues as the independence and expertise of candidates for the corporation’s board of directors and assuring that the board has sufficient information to carry out its responsibility to monitor management. Other issues may include such matters as consideration of the appropriateness of executive compensation, the corporation’s policy regarding mergers and acquisitions, the extent of debt financing and capitalization, the nature of long-term business plans, the corporation’s investment in training to develop its work force, other workplace practices and financial and non-financial measures of corporate performance.
In 2008, the Bush DOL issued IB 2008-2, which superseded IB 94-1. While IB 2008-2 reiterated many of the principles of IB 94-1, it emphasized that plan fiduciaries voting proxies “need to take into account costs when deciding whether and how to exercise their shareholder rights.” And it added a new section on “Socially-Directed Proxy Voting, Investment Policies and Shareholder Activism,” that cautioned fiduciaries that they “risk violating the exclusive purpose rule when they exercise their fiduciary authority in an attempt to further legislative, regulatory or public policy issues through the proxy process.”
In December 2016, the Obama DOL withdrew IB 2008-2 and replaced it with a new IB 2016-1. The new IB reiterates many of the non-controversial provisions of IBs 94-1 and 2008-2. It then goes on to discount the concerns expressed in IB 2008-2 about cost, stating that: “In most cases, proxy voting and other shareholder engagement does not involve a significant expenditure of funds by individual plan investors because the activities are engaged in by institutional investment managers ….”
Even more significant, IB 2016-1 drops (entirely) IB 2008-2’s section on social investing and instead argues that:
[T]he ETI [Economically Targeted Investment] market which considers ESG [environmental, social and governance] factors [has] grown internationally as new tools and measures were developed leaving investors better equipped to evaluate the question of whether a given investment could both benefit the plan in financial terms and advance environmental, social or corporate governance goals. In fact, the new tools and measures have revealed that environmental, social and governance impacts can be intrinsic to the market value of an investment.
IB 2016-1 then supplements IB 94-1’s list (independence and expertise of directors, appropriateness of executive compensation, policy regarding mergers and acquisitions, etc.) of appropriate subjects for shareholder activism by adding to it “certain updates to the examples of areas where monitoring or communication with management is likely to enhance the value of the plan’s investment in the corporation.” Those additional areas where shareholder activism by an ERISA fiduciary may (as of 2016) be appropriate include:
[P]lans on climate change preparedness and sustainability, governance and compliance policies and practices for avoiding criminal liability and ensuring employees comply with applicable laws and regulations, the corporation’s workforce practices (e.g., investment in training to develop its work force, diversity, equal employment opportunity), policies and practices to address environmental or social factors that have an impact on shareholder value, and other financial and nonfinancial measures of corporate performance.
It’s hard to know what to make of these changes in policy. Four questions: First, does DOL’s determination that in most cases the costs of proxy voting will be insignificant establish a new rule requiring (“in most cases”) proxy voting?
Second, the new IB reads as if DOL has made a determination that, e.g., corporate “plans on climate change preparedness and sustainability” are good corporate policy. If an ERISA fiduciary votes against such policies – or even simply abstains with respect to them – does that somehow violate ERISA? Or at least open the fiduciary to a lawsuit claiming that she has violated ERISA?
Third, how long will DOL’s new proxy voting policy last? These rules seem to change with every change of Administration. Will the Trump Administration simply “withdraw” IB 2016-1 and reinstate IB 2008-2? The process for doing so isn’t complicated – it doesn’t require notice-and-comment.
Finally, it’s clear from IB 2016-1 that (for the moment) DOL thinks that some sorts of shareholder social activism are permitted under ERISA (with respect to climate change, diversity, the environment, etc.). Might it be possible for the new, Trump DOL to come in and authorize a whole new set of approved proxy voting “public policy issues” – like, for instance, opposition to re-locating plants to Mexico?
Tibble v. Edison has been a key 401(k) fee case. Oversimplifying somewhat: In the first round of Tibble litigation, the lower court found that defendant fiduciaries breached their ERISA duties of loyalty and prudence by including in the plan’s fund menu the higher-fee retail share classes of six mutual funds, rather than lower-fee institutional share classes. Three of those six funds were, however, selected for inclusion in the fund menu in 1999, and the lower court held that claims with respect to those funds were barred by ERISA’s six-year statute of limitations.
The statute of limitations issue went all the way to the Supreme Court. The Supreme Court, reversing the lower court decision, held that “a fiduciary is required to conduct a regular review of its investment” and, with respect to the 1999 funds, that ongoing duty to regularly review investments provided a basis for a fiduciary lawsuit that wasn’t barred by the statute of limitations.
When, after the Supreme Court decision, the case was reconsidered by the Ninth Circuit, a three-judge panel dismissed plaintiffs’ case on a “technicality,” holding that plaintiffs had forfeited their right to assert that defendant fiduciaries had an obligation to review, on an ongoing basis, the prudence of the inclusion of a fund in a plan’s fund menu. In December 2016, the Ninth Circuit, hearing the case en banc (that is, before the full court) reversed the three-judge panel and “remanded on an open record for trial on the claim that, regardless of whether there was a significant change in circumstances, defendants should have switched from retail class fund shares to institutional-class fund shares to fulfill their continuing duty to monitor the appropriateness of the trust investments.”
Bottom line: unless this case is settled (which at this point seems unlikely), we are, after a trial, going to get a decision on the extent of a fiduciary’s obligation “to conduct a regular review” of funds in a plan’s fund menu. That decision may provide plan fiduciaries with some guidance on their duties in this regard.
On January 17, 2017 the Oregon Retirement Savings Board (ORSB) reviewed a proposed launch schedule that envisions a pilot program for 10 small employers beginning in May (registration) and August (first contributions) of 2017. Contributions by larger employers (100 employees and over) would begin January 2018.
The ORSB is also currently considering a set of proposed regulations providing rules for the implementation of the Oregon program. Of greatest interest to current plan sponsors, the proposal provides that Oregon employers must either register (and implement an auto-IRA arrangement) or file a “Certificate of Exemption.” Generally, an employer may only file a Certificate of Exemption if “the Employer offers a Qualified Plan to all of its Employees.” (Emphasis added.)
It appears that if employees are excluded because of, e.g., age or service requirements, the employer can only file a “conditional Certificate of Exemption,” which is only good for three years. Thus – while it is very un-clear – it appears that Oregon may still be considering requiring employers who offer a plan but exclude some employees to cover those excluded employees under the new Oregon auto-IRA.
Qualified matching contributions (QMACs) and qualified nonelective contributions (QNECs) are nonforfeitable matching and employer contributions that can be used to satisfy Tax Code section 401(k)/(m) nondiscrimination tests. Current 401(k)/(m) regulations require that, in order to qualify as a QMAC or QNEC, the contribution must (among other things) be nonforfeitble when contributed. Because of this rule, forfeitures cannot be used as QMACs or QNECs.
IRS is now proposing to change this rule to only require that a QMAC or QNEC be nonforfeitable “when they are allocated to participants’ accounts.”
If this change is finalized, then, e.g., when a participant forfeits matching contributions, those matching contributions can be used to fund QMACs or QNECs so long as, when they are allocated as a QMAC or QNEC, they are nonforfeitable.
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We will continue to follow these issues.