On December 29, 2016, the Department of Labor (DOL) issued Interpretive Bulletin 2016-01 (the “Bulletin”) relating to the exercise of shareholder rights by fiduciaries of employee benefit plans, including the voting of mutual fund proxies under 401(k) and similar retirement savings plans.
What is the Obligation?
Generally, the Bulletin provides that fiduciaries that manage employee benefit plan assets have a fiduciary obligation to exercise shareholder rights for securities (including mutual funds) held by such plans. Thus, plan fiduciaries may not simply ignore their voting rights.
To fulfill such obligations, fiduciaries must exercise their voting rights with respect to the proxies of securities held by benefit plans. In addition, the Bulletin provides that fiduciaries may need to review:
- the independence and expertise of candidates for the corporation’s board of directors;
- executive compensation and merger and acquisition activity;
- the extent of debt financing, the nature of long-term business plans, and the corporation’s investment in training to develop the workforce;
- other financial and non-financial measures of corporate performance; and
- environmental, social, and governance factors.
The Bulletin provides that these obligations exist to ensure that fiduciaries consider factors that may affect the value of the plan’s investments and to not subordinate the interests of participants and beneficiaries.
Who has the Obligation?
The Bulletin provides that generally, the plan trustee has the obligation to exercise such shareholder rights. However, the plan document or the trust document can alter this obligation. For example, if the assets are held by a non-discretionary trustee (i.e., a directed trustee) or passive custodian, then the employer would be the fiduciary with the obligation to exercise shareholder rights. Alternatively, the plan sponsor could delegate such obligation to an ERISA section 3(38) investment manager, who would then have the obligation to direct the trustee as to the exercise of shareholder rights.
The Bulletin provides that if the plan has utilized an investment manager and the plan document or the investment management agreement does not specifically preclude the investment manager from exercising shareholder rights, the investment manager has the exclusive responsibility for exercising shareholder rights.
Prior to the Bulletin, the DOL had issued Interpretive Bulletins 94-2 and 2008-2. The DOL believed that the 2008 guidance had been misunderstood and had discouraged plan fiduciaries from exercising shareholder rights. The DOL was concerned that fiduciaries thought the 2008 guidance prohibited them from exercising shareholder rights unless a cost-benefit analysis was performed.
Because exercising shareholder rights does not generally involve a significant expenditure of funds, and because fiduciaries typically engage investment managers or advisors, the DOL withdrew the 2008 guidance and supplemented the 1994 guidance with the new Bulletin.
First, the plan document, trust document, investment management agreement, and any other relevant document should be reviewed or renegotiated to determine who has expressly taken on the obligation of exercising shareholder rights. If these documents are silent, then generally the trustee would have such obligation, unless the trustee is a directed trustee, or the plan uses a passive custodian.
If the plan is a participant-directed defined contribution plan that provide participants the ability to direct their investments (i.e., a self-directed account), then the shareholder rights may be passed through to participants. However, the terms of the plan should provide and related vendor service agreements must be consistent with pass through voting. In addition, if the plan is designed to satisfy ERISA section 404(c) (which alleviates fiduciary liability for participant directed investments if certain conditions are satisfied), the plan should be sure to comply with all of the requirements of ERISA section 404(c) specifically with respect to proxy voting. This would include, for example, a requirement that participants receive notice of their proxy voting and other rights, there is no employer influence on the voting, and confidentiality requirements are satisfied. The plan fiduciary should retain records of providing this information to participants.
Plans will generally have an investment policy statement, which sets forth guidelines for plan investments. Included in this statement should be guidelines for exercising shareholder rights and voting proxies. If the plan sponsor or plan committee will retain all voting rights, these guidelines should be discussed and analyzed before documenting the guidelines.
If a third-party will be exercising the shareholder rights, the Bulletin provides that the determination of the terms of an investment policy statement, which should include a statement on exercising shareholder rights, is a fiduciary act. Thus, the plan sponsor should review the third-party’s policy statements and conclude on its own that the statement is in the best interest of the plan participants.
Although the obligation to exercise shareholder rights may be delegated to third parties, the plan sponsor still has the ultimate responsibility of reviewing and monitoring retain an ongoing obligation to review and monitor other fiduciaries. The plan sponsor should be reviewing the shareholder rights that have been exercised by such third-parties and the decision making process of those third-parties. If the third-party is not providing such information, or is exercising shareholder rights that are inconsistent with the stated guidelines, it is possible that the plan sponsor could be viewed as not be fulfilling its fiduciary obligations. The plan sponsor should ensure that it has the right under an agreement with the third-party to review the voting records and voting process.
With regard to mutual funds, the mutual fund itself should be exercising the shareholder rights with respect to securities held by the fund. In that case, the investment manager or advisor should be reviewing and monitoring the rights that have been exercised by the funds. Accordingly, the plan sponsor should be reviewing the investment manager or advisor to ensure they are reviewing the exercise of shareholder rights by the mutual funds. The Bulletin provides that an investment manager of a pooled investment vehicle may be subject to different proxy voting policies for different plans. In such case, the investment manager may have different votes based on the different voting policies. A review of the investment manager should ensure the investment manager is taking into account the plan’s specific policy.
What This Means for You
The exercise of shareholder rights and voting proxies is not a new obligation for fiduciaries. However, the Bulletin reiterates the obligations of plan fiduciaries and provides some guidance for factors that have become increasingly important to some, such as environmental and social issues.
Plan fiduciaries should be sure to understand who has these obligations and review and monitor the activities to ensure that such fiduciary obligations are fulfilled and to provide a defense should a fiduciary be challenged.