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On August 31, 2020, the Department of Labor released a proposed regulation revising DOL’s rules for the voting (or not voting) of proxies by ERISA plan fiduciaries. The new rule requires that fiduciaries apply an economic cost-benefit analysis to decisions about whether or how to vote proxies and/or engage in shareholder activism that is explicitly stricter than current rules.
In this article we review the proposal, beginning with some highlights.
Highlights
The proposed rule –
Requires a cost-benefit analysis for proxy voting/shareholder engagement, in effect prohibiting voting/engagement where it is not justified by the plan participants’ “pecuniary interest.”
Establishes a set of approved general “practices” that would allow plan fiduciaries to limit voting/engagement to (1) situations in which it is likely to significantly affect the plan investment, (2) substantial corporate events/transactions, e.g., mergers and acquisitions, stock repurchases, dilutive share issuances, or contested elections for directors, and/or (3) material plan shareholdings.
Requires fiduciary supervision/scrutiny of the policies, conduct, and possible conflicts of outside proxy advisory firms and investment managers.
Background
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 Democrat 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 new proposed regulation is very much a “zag.” Thus, the proposal’s preamble states 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 … will be removed from the Code of Federal Regulations when a final rule is adopted.”
The new proposal then articulates (among other things) a rule that plan fiduciaries must engage in just such a “cost-benefit analysis” of the utility of proxy voting and shareholder engagement.
Basic ERISA rules for proxy voting and shareholder engagement
The proposed regulation begins with a set of rules that apply generally 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:
The management by a fiduciary of plan assets includes the duty to manage voting and other shareholder rights.
In managing those rights, the fiduciary must act solely in accordance with the economic interest of the plan/plan participants, considering only factors that will affect the economic value of the plan’s investment.
In determining whether and how much effort/cost to expend on proxy voting, the fiduciary should consider the size of the plan’s holding of the relevant stock, relative to total plan assets.
The fiduciary may not “subordinate the interests of the participants … to any non-pecuniary objective, or sacrifice investment return or take on additional investment risk to promote goals unrelated to those financial interests of the plan’s participants.”
The fiduciary must investigate all material facts. In this regard, DOL’s rule prohibits “a practice of following the recommendations of a proxy advisory firm … without appropriate supervision” and requires a determination that the proxy advisory firm’s guidelines are consistent with the economic interests of plan participants. Per the preamble, this would require the plan fiduciary to (among other things) evaluate whether the advisory firm has any potential conflicts. The rule also includes a requirement that the fiduciary exercise prudence in the selection and monitoring of persons to advise on shareholder rights.
Finally, the fiduciary must maintain adequate records, “including records that demonstrate the basis for particular proxy votes and exercises of shareholder rights.” If authority to vote proxies has been delegated to an outside firm, the fiduciary must require that that firm keep records documenting “the rationale for proxy voting decisions or recommendations sufficient to demonstrate that the decision or recommendation was based on the expected economic benefit to the plan, and … solely on the interests of participants.”
Duty to vote or not vote proxies
DOL emphasizes several times (in the preamble) that there is no duty to vote proxies in all circumstances. Instead, the proposal provides that the responsible plan fiduciary must vote proxies where the vote “would have an economic impact on the plan after considering [the factors listed above] and taking into account the costs involved (including the cost of research, if necessary, to determine how to vote).”
On the other hand, the fiduciary may not vote proxies unless it has made such a determination. So that, if voting would not have the required economic impact, then it should not be undertaken.
Thus, DOL is returning to a (fairly) strict cost-benefit analysis requirement for proxy voting and shareholder engagement.
Permitted practices
An innovation in the DOL proposal is a list of “permitted practices” – general approaches to proxy voting that may be adopted without violating ERISA fiduciary rules. As proposed, these would include:
Voting proxies with issuer management on proposals determined to be “unlikely to have a significant impact on the value of the plan’s investment.”
Focusing voting resources only on proposals determined to be “substantially related to the corporation’s business activities or likely to have a significant impact on the value of the plan’s investment, such as proposals relating to corporate events (mergers and acquisitions transactions, dissolutions, conversions, or consolidations), corporate repurchases of shares (buy-backs), issuances of additional securities with dilutive effects on shareholders, or contested elections for directors.”
Not voting where the value of the plan’s holding relative to total plan assets is below a materiality threshold.
These practices must be reviewed at least once every two years.
DOL has asked for comments on whether there are other general practices that should be added to this list.
Who votes proxies? Generally, the plan’s trustee has responsibility for voting proxies, unless either the trustee is subject to instructions from a named fiduciary or an investment manager has been appointed.
Rules for pooled vehicles. 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, except where the investment manager conditions participation in the pooled vehicle on the investing plans’ agreement to accept the investment manager’s own investment policy.
Effective date. The new rule would be effective 30 days after publication of a final rule.
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The proposal is in line with DOL’s proposed regulation on ESG investments, published in June 2020, 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, this proposal 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 proposal, it represents an attempt to stabilize the DOL policy zig-zag on this issue by reducing prior sub-regulatory guidance to a formal regulation.
While the ESG proposal has generated significant controversy, including within the investment community, the issue of proxy voting – notwithstanding that it raises similar (“ESG-style”) political issues – may be less critical for other (non-political) constituencies. Indeed, the tighter limits on ERISA plan shareholder activism is likely to be welcomed by some plan sponsors.
We will continue to follow this issue.