Seyfarth Synopsis: On the heels of the Department of Labor’s June proposed regulation throwing cold water on plan fiduciaries’ selecting investments in the environment, social and governance (ESG) space, the agency has now offered their viewpoint on a fiduciary’s obligation — nay, ability — to vote proxies for its plan’s holdings. See here for our prior post on ESG investments.

Background

The DOL’s prior subregulatory guidance can be found in Interpretive Bulletin 2008-02 (published under the Bush administration), Interpretive Bulletin 2016-01 (published under the Obama administration), and Field Assistance Bulletin 2018-01 (published under the Trump administration). In April 2019, President Trump issued a directive to the DOL to study their guidance in this area. The Executive Order said the DOL should review their “existing guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.” This item then appeared on the DOL’s Fall 2019 regulatory agenda, and culminated in the proposed regulations issued August 31, 2020.

Prior to this latest guidance, it had been generally accepted that a fiduciary’s responsibility to manage plan assets included exercising shareholder rights associated with the plan’s investments — e.g., proxy voting — unless it would result in the expenses of plan assets out of proportion to the matter at hand. It is common for the plan’s investment policy to address proxy voting. Often this responsibility is delegated to investment managers.

Given the magnitude of assets invested by ERISA-governed retirement plans ($2.1 trillion in 2017 according to the DOL), through the new proposed regulations the current administration continues to express its concern with shareholder activism by plan fiduciaries. Previous attempts to address that issue focused on an admonition by the DOL that fiduciaries must be able “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 2008-02.

The proposed rule, issued on August 31, 2020, would revoke the DOL’s prior guidance and amend a regulation dated back to 1979. The proposal is very reminiscent of the DOL’s proposal concerning a fiduciary’s investment duties, which would amend the same regulations from 1979. The new proposal would create a bifurcated approach under which the fiduciary faces an affirmative obligation on one hand, and a prohibition on the other. Under the new guidance, when confronted with a proxy matter, the plan fiduciary must consider the cost involved with voting and whether the matter being voted on would have an economic impact on the plan’s investment. If it does, the fiduciary must vote the proxy. The new guidance provides that the plan fiduciary is actually barred from voting the proxy unless the plan fiduciary determines that the matter would have an economic impact on the plan.

The DOL justifies this position by stating that the new rule is actually protecting plan assets because it “would reduce plan expenses by giving fiduciaries clear directions to refrain from spending workers’ retirement savings to research and vote on matters that are not expected to have an economic impact on the plan.” Ironically, this split obligation/prohibition creates real problems for the plan fiduciary who analyze every proxy presented, or risk violating their fiduciary duties.

Proposed Rule

The proposed rule sets forth specific standards requiring fiduciaries to:

(A) act solely in accordance with the economic interest of the plan considering only factors that they prudently determine will impact the economic value of the plan’s investment based on a determination of risk and return over an appropriate investment horizon consistent with the plan’s objectives and funding policy;

(B) consider the likely impact on the plan’s investment performance based on such factors as the size of the plan’s holdings in the issuer relative to the total plan assets, the plan’s percentage ownership of the issuer, and the costs involved with voting;

(C) not subordinate the financial interests of the participants to any non-pecuniary objective, or sacrifice investment return or take additional investment risk to promote goals unrelated to those financial interests;

(D) investigate material facts that form the basis for any vote;

(E) maintain records on proxy voting activities, including the basis for particular votes; and

(F) exercise prudence and diligence in selecting and monitoring persons selected to advise on or assist with such voting rights.

The DOL states that where the authority to vote proxies has been delegated to an investment manager or other entity, in order to properly monitor such delegate to ensure these standards are satisfied the plan fiduciary must require documentation of “the rationale for proxy voting decisions … sufficient to demonstrate that the decision … was based on the expected economic benefit to the plan, and that the decision … was based solely on the interests of participants and beneficiaries in obtaining financial benefits under the plan.”

The rule then requires fiduciaries to vote the proxy where the matter could have an economic impact on the plan after considering the above standards. On the other hand, if the fiduciary concludes that the proxy matter would not have an economic impact on the plan, than the fiduciary must not vote the proxy at all.

In an acknowledgement it may be difficult to always know whether a proxy matter would affect the plan’s economic interest without conducting an expensive study, the DOL says that plan fiduciaries can develop proxy voting policies. The proxy voting policy could incorporate three permitted practices:

  1. A policy of ordinarily voting in accordance with management’s recommendation on matters that are “unlikely to have a significant impact.”
  2. A policy focused on voting only on certain types of proposals likely to have a significant impact on the plan’s investment, such as corporate transactions, share buy-back plans, issuance of additional dilutive shares, and contested elections for directors.
  3. A policy refraining from voting if the plan’s investment is below a quantitative threshold that makes it unlikely the outcome of a vote will have a material impact on the plan.

The DOL proposal specifically provides that a fiduciary is prohibited from following recommendations of a proxy advisory firm or other service provider without determining that the provider’s proxy voting guidelines are consistent with the plan’s economic interest.

Plan fiduciaries should note that if the obligation to vote proxies has been delegated to an investment manager, it is typical for the manager’s agreement to provide that it will vote proxies according to the manager’s underlying proxy voting guidelines, which may not align with the proposed fiduciary guidance. As a result, plan fiduciaries may have to revisit that delegation or the incorporated proxy voting policy to bring the practice into alignment with the new rules.

The proposal would require that plan fiduciaries review any proxy voting policies every two years, which the DOL notes is its understanding of the industry standard for reviewing investment policy statements. Interestingly, the DOL states — “To facilitate transparency, the Department also reminds fiduciaries that proxy voting guidelines must be made available to plan participants, either as a separate document or by including them in the plan’s existing investment policy statement.”