The Department of Labor’s regulatory agenda includes a “deregulatory” project on ERISA rules for proxy voting. In this article we review current DOL rules on proxy voting and consider some of the issues that may come up under this (de)regulation project.
Background – April 2019 Executive Order
In April 2019 President Trump issued an “Executive Order on Promoting Energy Infrastructure and Economic Growth” that included a separate section on “Environment, Social, and Governance Issues; Proxy Firms; and Financing Energy Projects Through the United States Capital Markets,” instructing the Department of Labor to (among other things) review current ERISA guidance with respect to proxy voting and shareholder engagement.
The EO stated that “[i]t is the policy of the United States to promote private investment in the Nation’s energy infrastructure” through (among other things): “timely action on infrastructure projects that advance America’s interests and ability to participate in global energy markets; increased regulatory certainty regarding the development of new energy infrastructure; … and support for American ingenuity, the free market, and capitalism.”
In order to “advance the principles of objective materiality and fiduciary duty, and to achieve the policies”identified above, the EO instructed the Secretary of Labor to 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[DOL] guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.”
DOL regulatory project
Included in the Department of Labor’s Fall 2019 regulatory agenda is an item “Proxy Voting Update,”described as follows:
This deregulatory action would modernize fiduciary practices related to the voting rights associated with ERISA plan investments and harmonize those regulations with the requirements of other regulators. The goal of this proposal would be to protect the interests of participants and beneficiaries by: (1) addressing practices that could present conflicts of interest associated with proxy advisory firm recommendations; (2) ensuring that proxy voting decisions are based on best information; and (3) ensuring that proxy voting decisions are solely in the interest of, and for the exclusive purpose of providing plan benefits to, participants and beneficiaries.
Proxy voting – current fiduciary rules
DOL has, in interpretive bulletins and other sub-regulatory guidance, identified the following principles as applicable to plan fiduciary decisions with respect to proxy voting:
The fiduciary act of managing plan corporate stock investments includes voting proxies with respect to that stock.
This responsibility generally “flows” with (that is, is part of the package including) investment management responsibility, although it may be reserved for/delegated to another fiduciary.
This responsibility may be subject to guidelines in an investment policy statement, which the fiduciary voting the proxy generally must follow except to the extent that doing so would violate ERISA, e.g., where doing so would be imprudent.
In voting proxies, the fiduciary is required to “consider those factors that may affect the value of the plan’s investment and not subordinate the interests of the participants and beneficiaries in their retirement income to unrelated objectives.” (Quoting Interpretive Bulletin 2016-01.)
Shareholder activism by plan fiduciaries should be subjected to a cost-benefit analysis: “The fiduciary obligations of prudence and loyalty … require the responsible fiduciary to vote proxies on issues that may affect the economic value of the plan’s investment. However, fiduciaries also need to take into account costs …. Such costs include, but are not limited to, expenditures related to developing proxy resolutions, proxy voting services and the analysis of the likely net effect of a particular issue on the economic value of the plan’s investment. Fiduciaries must take all of these factors into account in determining whether the exercise of such rights (e.g., the voting of a proxy), independently or in conjunction with other shareholders, is expected to have an effect on the economic value of the plan’s investment that will outweigh the cost of exercising such rights.” (Quoting Interpretive Bulletin 2008-02.)
Proxies, shareholder activism, and ESG
Certainly, one of the key issues presented by these rules is the use of proxies to influence corporate policy on issues that some argue are not directly related to “economic value,” including with respect to environmental, social, and governance (ESG) issues.
In this regard, there has to some extent been a different “Republican Administration” and “Democratic Administration” position at DOL.
Thus, IB 2008-02, published by the Bush DOL, stated:
Because of the heightened potential for abuse in such cases [where fiduciaries exercise their authority “in an attempt to further legislative, regulatory or public policy issues through the proxy process”], the fiduciaries must be prepared to articulate a clear basis for concluding that the proxy vote, the investment policy, or the activity intended to monitor or influence the management of the corporation is more likely than not to enhance the economic value of the plan’s investment before expending plan assets.
IB 2016-01, published by the Obama DOL, criticized this framing of the issue, and sought to provide more latitude to fiduciaries.
[S]tatements in IB 2008-2 may cause confusion as to whether or how a plan fiduciary may consider ESG issues in connection with proxy voting or undertaking other shareholder engagement activities. … [B]y focusing on a “cost-benefit analysis” demonstrating a “more likely than not” enhancement in the economic value of the investment, the Department believes that IB 2008-2 may be read as discouraging fiduciaries from recognizing the long-term financial benefits that, although difficult to quantify, can result from thoughtful shareholder engagement when voting proxies, establishing a proxy voting policy, or otherwise exercising rights as shareholders.
In Field Assistance Bulletin (FAB) 2018-01, the Trump DOL once again revisited this issue, stating:
All that language in [IB 2016-01] should be read in the context of the Department’s observation that proxy voting and other shareholder engagement typically does not involve a significant expenditure of funds by individual plan investors because the activities are generally undertaken by institutional investment managers that are appointed as the responsible plan fiduciary …. The IB was not intended to signal that it is appropriate for an individual plan investor to routinely incur significant expenses to engage in direct negotiations with the board or management of publicly held companies with respect to which the plan is just one of many investors. Similarly, the IB was not meant to imply that plan fiduciaries, including appointed investment managers, should routinely incur significant plan expenses to, for example, fund advocacy, press, or mailing campaigns on shareholder resolutions, call special shareholder meetings, or initiate or actively sponsor proxy fights on environmental or social issues relating to such companies.
Finally, while the language of the April 2019 Executive Order is somewhat obscure, this issue may be what was being targeted by the instruction to DOL to review current guidance “to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.”
Shareholder activism vs. the “Wall Street Rule”
We note that the Office of Management and Budget has headlined the current DOL ERISA proxy voting project as “deregulatory.” DOL has (see above) from the beginning regarded proxy voting, and corporate governance through proxy voting, as a fundamental ERISA fiduciary issue. There is, however, a counter-theory that a simpler (and less costly) way to address questions of corporate governance is for the shareholder to simply sell its shares in a company that it views as badly managed, or (for that matter) that is addressing environmental issues in (what the shareholder views as) the “wrong way.” This has been called the “Wall Street Rule” or the “Wall Street Walk.”
It is arguable, under a robust version of the cost-benefit analysis of IB 2008-02, that selling-rather-than-voting may be more prudent, because less costly, in a number of circumstances. Indeed, one way to look at ESG investing is as a way to implement this approach in the ESG context: rather than pressure firms to change, e.g., their environmental practice, the less costly solution is simply to invest in those that do change their environmental practice.
In IB 2016-01 DOL addressed this counter-argument at length:
The pervasiveness of US publicly-traded stock in ERISA plan investment portfolios, both direct holdings and through pooled investment funds, including index funds, is another factor that contributes to the importance of proxy voting and shareholder engagement practices. If there is a problem identified with a portfolio company’s management, selling the stock and finding a replacement investment may not be a prudent solution for a plan fiduciary. As Vanguard founder John Bogle put it in the context of index funds, “the only weapon [index funds] have, if we don’t like the management, is to get a new management or to force the management to reform.”
Differences between DB and DC
Finally, we note a set of issues that was highlighted in the FAB 2018-01. In a defined benefit plan, the plan investment manager is, in effect, exercising rights with respect to “other people’s money.” That is, the beneficiary of the stock owned by the plan (and the appurtenant voting rights) is not the fiduciary but plan participants.
In, e.g., an ERISA section 404(c) defined contribution plan, where participants are choosing investments from a fund menu – conceivably, where there is a brokerage window, including thousands of funds – the issue is more complicated. With respect to ESG investing, FAB 2018-01 stated that “where an investment platform … allows participants … an opportunity to choose from a broad range of investment alternatives … a prudently selected, well managed, and properly diversified ESG-themed investment alternative could be added to the available investment options on a 401(k) plan platform without requiring the plan to forgo adding other non-ESG-themed investment options to the platform.”
If whoever is in charge of investment management is also (generally) in charge of proxy voting, should the ERISA proxy voting rules applicable to these sorts of “participant choice” plans – where the ultimate asset allocation decision is made by the participant – be re-thought? It is conceivable that this issue may also come up for review in DOL’s regulation project.
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We will continue to follow this issue.