On October 16, 2008, the US Department of Labor (the “DOL”) published two interpretive bulletins that modify and supersede the DOL’s prior guidance regarding the responsibilities of a benefit plan fiduciary in examining, and potentially investing the plan’s assets in, “economically targeted” or “socially responsible” investments, and in exercising the benefit plan’s shareholder rights, including the voting of proxies on securities held in the benefit plan’s portfolio. A central theme of both new bulletins is that under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), the paramount consideration of a plan fiduciary, whether the fiduciary is evaluating a potential plan investment or voting the proxies of securities held by the plan, should be to maximize the economic value of the plan’s assets prudently — all other considerations should remain subordinate to this goal. Although these bulletins draw heavily on earlier published DOL guidance, there are some notable new concepts.
Economically Targeted Investments
The first new bulletin relates to a benefit plan’s investment in economically targeted investments (the “ETI Bulletin”), which the DOL describes as “investments selected for the economic benefits they create apart from their investment return to the employee benefit plan.”1 The ETI Bulletin supersedes the DOL’s 1994 bulletin on the same subject (Interpretive Bulletin 94-1). The core rule — that fiduciaries may not subordinate the economic interests of the plan to unrelated objectives — remains unchanged. The DOL has now clarified, however, the limited circumstances under which a fiduciary may consider factors other than the economic interest of the plan when making investment decisions. These clarifications, and the proxy voting changes discussed below, generally formalize a series of interpretive positions taken by the DOL in individual letters issued in recent years where, for instance, the DOL noted its “grave” concern over the use of plan assets “to promote myriad public policy preferences.”2
Under the 1994 bulletin, the DOL had suggested that benefit plan fiduciaries who were otherwise acting in accordance with ERISA’s prudence requirements would not necessarily violate those requirements by investing in an economically targeted investment (“ETI”). The ETI would not be considered a prudent investment, however, if it were expected to provide the benefit plan with a lower rate of return than other available investment alternatives with commensurate or lower degrees of risk.
The ETI Bulletin retains this rule and clarifies that the circumstances in which fiduciaries will be able to consider factors other than the economic interest of the plan are “very limited.” Before a fiduciary selects an ETI (over another investment), it must first conclude that the investment alternatives under consideration are “economically indistinguishable,” that is, “truly equal, taking into account a quantitative and qualitative analysis of the economic impact on the plan.” This analysis must include consideration of an investment opportunity’s level of diversification, degree of liquidity and potential risk and return as compared to other investments that would fill a similar role in the plan’s portfolio.
Importantly, the ETI Bulletin cautions that any fiduciary who considers factors outside the economic interests of the plan should maintain a contemporaneous written account of the economic analysis concluding that the investment opportunities considered were of equal economic value. Specifically, the DOL notes that fiduciaries “will rarely be able to demonstrate compliance with ERISA” absent such a written record.
The ETI Bulletin provides a number of examples illustrating these concepts.
The second new bulletin relates to the exercise of shareholder rights, including guidance regarding the voting of proxies on securities held in benefit plan portfolios (the “Proxy Bulletin”).3 The Proxy Bulletin, like the ETI Bulletin, supersedes a 1994 bulletin on the same topic (Interpretive Bulletin 94-2). The Proxy Bulletin also discusses the adoption of statements of investment policy and shareholder activism. Again, the core rule remains the same — that in making proxy voting decisions, the fiduciary must consider only those factors that relate to the economic value of the plan and must not subordinate the interests of participants and beneficiaries in their retirement income to unrelated objectives. The Proxy Bulletin generally retains the familiar fiduciary delegation regime, under which the plan’s trustee generally retains the power to vote proxies unless that authority has been delegated to a named fiduciary or investment manager. Similarly, the Proxy Bulletin continues to allow the investment manager of a pooled investment vehicle to require participating investors (i.e., benefit plans in the pooled vehicle) to accept the investment manager’s own investment policy statements and proxy voting policies in order to provide clear voting direction for all the plan investors. (Alternatively, the investment manager would need to reconcile conflicting investor policies or vote shares based on the benefit plans’ pro rata interest in the pooled investment, each of which also continue to be permissible.)
The Proxy Bulletin states explicitly that fiduciaries risk violating their prudence and exclusive purpose responsibilities under ERISA when they exercise their authority by voting the proxies on securities held by a benefit plan in a manner that attempts to further “legislative, regulatory or public policy issues.” The DOL similarly warns that fiduciaries must not use their authority in voting proxies or in designing a benefit plan’s investment policy statement to promote public policy preferences and furthermore, that a fiduciary must be “prepared to articulate a clear basis for concluding that the proxy vote is more likely than not to enhance the economic value of the plan’s investment[.]”
On a related point, the Proxy Bulletin clearly contemplates that there may be situations in which a fiduciary decides that it would be more cost effective (and, therefore, prudent) for the plan not to exercise its proxy voting rights. (Although the 1994 bulletin contained a similar “cost/benefit” concept, that bulletin referred to the concept only in connection with the voting of proxies appurtenant to foreign securities.) The Proxy Bulletin states that a fiduciary’s duties require the fiduciary to vote proxies on issues that may impact the plan’s economic value. However, if a fiduciary determines that the cost of voting (and any costs in determining how to vote on a particular issue) is likely to exceed the expected economic benefits to the plan of voting the shares or if the exercise of voting results in the imposition of unwarranted trading or other restrictions, the fiduciary has an affirmative obligation to refrain from voting. In making this determination, the fiduciary should consider the costs of researching how to vote, developing proxy resolutions, and engaging proxy voting services, as well as the likely net effect of a particular issue on the economic value of the plan’s investment. The fiduciary may not consider, however, economic effects unrelated to the plan’s economic interests.
In the shareholder activism context, the Proxy Bulletin similarly provides that fiduciaries should not engage in an activist campaign unless there is a “reasonable expectation” that it “will” enhance the “economic value” of the plan’s investment in the corporation, after taking into account the cost involved. (Under the 1994 bulletin, these activities were merely required to be “likely” to enhance the “value” of a plan’s investment.)