Final ERISA Regulations Describe Fiduciary Duties Related to Plan Proxy Voting
The longstanding view of the Department of Labor (the “DOL”) has been that proxy voting and other shareholder rights held by an ERISA plan are subject to ERISA’s fiduciary duties of prudence and loyalty. Previously, this view was expressed by the DOL in sub-regulatory guidance, such as interpretive and field assistance bulletins. In September of 2020, the DOL published a proposed rule (the “Proposal”) regarding an ERISA fiduciary’s duties with respect to shareholder rights. On December 16, 2020, the Department of Labor published the final regulation (the “Regulation”). Much like the Proposal, the Regulation requires that when a fiduciary decides whether and when to exercise plan shareholder rights, it must act prudently and solely in the interests of participants and beneficiaries and for the exclusive purpose of providing them benefits and defraying the reasonable expenses of administering the plan. However, in the Regulation, the DOL took an approach that is less prescriptive and more principles-based than the Proposal.
The Proposal would have required ERISA fiduciaries to vote all proxies which would have an economic impact on the plan and conversely, not vote any proxies which would not have such an impact. Several comments expressed concern that fiduciaries would need to expend considerable expenses to analyze every proxy proposal to determine whether it would have an economic impact. Others voiced concern that the “economic impact” test would lead fiduciaries to focus solely on short-term outcomes. In response to these, and other concerns, the DOL removed this language from the Regulation. Instead, the Regulation emphasizes that an ERISA fiduciary need not vote every proxy and in fact, should not exercise shareholder rights if the cost of doing so would outweigh the economic benefits of exercising such rights. The Regulation provides general guidance regarding appropriate considerations for a fiduciary when it decides whether and how to exercise a plan’s shareholder rights.
Specifically, a fiduciary is required to:
(1) Act solely in accordance with the economic interests of plan participants and beneficiaries and not subordinate the financial interests of participants and their beneficiaries to any nonpecuniary objective. While the Regulation does not contain the Proposal’s express prohibition on voting a proxy where it would fail to make an “economic impact,” fiduciaries must still base proxy voting decisions on economic factors. The preamble to the Regulation cautions fiduciaries from exercising shareholder rights based on theories that the exercise of such rights would “promote a theoretical benefit to the global economy that might redound outside the plan.” In this way, the Regulation follows the same principles as the DOL’s recent “ESG Rule” which prohibited plan fiduciaries from using non-pecuniary factors to inform their investment decisions.
(2) Consider relevant costs involved in exercising shareholder rights. This includes direct expenses such as organizing proxy materials or analyzing portfolio companies and the relevant issues being voted upon. It also includes opportunity costs, such as foregone earnings from the fiduciary recalling securities on a loan owed to the plan. Due to comments which expressed concern regarding an investment manager’s lack of knowledge regarding a plan’s total portfolio, the Regulation does not explicitly include the Proposal’s requirement that fiduciaries must consider factors such as the plan’s percentage ownership of the relevant issuer or the plan’s holding in the issuer relative to the plan’s total portfolio. However, the Regulation’s preamble notes that the DOL’s view is that when such information is known, such factors may be relevant to a decision as to whether the plan should exercise shareholder rights.
(3) Evaluate material facts that form the basis for the proxy vote or exercise of shareholder rights. This language is changed from the Proposal’s requirement that a fiduciary must “investigate” material facts, to clarify that a fiduciary need not conduct its own independent investigation of material facts (e.g., if a proxy service conducts such an investigation on the fiduciary’s behalf). Instead, fiduciaries are required to evaluate material information that it knows, or should know, regarding the plan’s exercise of shareholder rights.
(4) Maintain records on proxy voting and other shareholder rights. This is more general language than the Proposal, which required a fiduciary to specifically maintain documentation that would demonstrate the basis for its voting decisions. The Regulation’s preamble states that the extent of the documentation will depend on individual circumstances, including the subject of the voting decision and its economic impact on the plan. For fiduciaries that are SEC-registered investment advisors, the DOL intends for this obligation to be aligned with SEC recordkeeping requirements with respect to proxy voting under the Advisers Act.
(5) Exercise prudence and diligence in the selection and monitoring of service providers that assist with the exercise of shareholder rights. This includes firms that provide research and analysis, recommendations regarding proxy votes, administrative services related to proxy voting and recordkeeping services. A fiduciary may not adopt the practice of following the recommendations of a proxy adviser without first determining that the adviser’s voting guidelines are consistent with the fiduciary principles outlined above. If a fiduciary delegates the plan’s authority with respect to its shareholder rights to an investment manager or other party, the fiduciary must prudently monitor the party’s exercise of such rights. Thus, when choosing a proxy advisory firm or related service, a plan fiduciary should assess the provider’s qualifications, qualify of services, reasonableness of fees and any applicable conflicts of interest.
The Regulation allows fiduciaries to establish guidelines to assist in deciding whether to vote on a given proxy proposal, provided that such policies are adopted in accordance with the principles outlined above. The Regulation gives an example of two permitted policies: (1) the plan only votes for the types of proposals that the fiduciary determines are substantially related to the issuer’s business activities or would have a material effect on the value of the plan’s investment and (2) the plan refrains from voting on proposals or certain types of proposals where the value of the investment is below a certain threshold (relative to its total holdings) that the fiduciary prudently determines is unlikely to have a material effect on the plan’s portfolio (and in the case of an investment manager, the relevant assets under management). The Regulation provides that these policies can be used separately, or in conjunction with one another. The Proposal included a third example of a permitted proxy policy whereby the plan would vote in accordance with a corporation’s management regarding certain proposals that the fiduciary determines would be unlikely to have a significant economic impact on the plan’s investment. This was not included in the Regulation due to criticism by several commenters that reliance on company management would be inappropriate or incompatible with ERISA’s fiduciary standards.
While the Proposal required that any such policies be reviewed every two years, the Regulation requires that the policies be reviewed “periodically.” The preamble to the Regulation explains that the DOL’s view is that it expects fiduciaries to conduct such a review “roughly” every two years, but it did not want to create an exact deadline to avoid violations based on technicalities. The Regulation specifies that notwithstanding a plan’s adoption of a proxy voting policy, a fiduciary is able to make an independent determination that a particular exercise of shareholder rights would be in the economic interests of the plan, even if the exercise of shareholder rights in such a situation would go against the plan’s adopted voting policy.
The Regulation also provides (substantially unchanged from the Proposal) that the responsibility for exercising shareholder rights lies with the plan’s trustee unless it is subject to the directions of a named fiduciary or discretion over relevant assets has been properly delegated to an investment manager. When authority over assets has been delegated to an investment manager, the manager has exclusive authority to exercise shareholder rights appurtenant to those assets unless the plan, trust document or investment management agreement expressly provides that another fiduciary has the right to direct the plan trustee regarding the exercise of any such rights. Moreover, when a pooled investment vehicle is subject to ERISA and several ERISA investors in the vehicle have investment policy statements that conflict with one another, the investment manager must attempt to reconcile the different policies (assuming such policies are in compliance with ERISA). With respect to proxy voting, the investment manager must vote proxies in proportion with each relevant plan’s interest in the pooled investment vehicle. Alternatively, an investment manager may require participating plans to review and approve of the investment manager’s proxy voting policy prior to investing, in which case the investing fiduciary must ensure that the investment manager’s policy is consistent with Title I of ERISA and the Regulation.
Finally, the Regulation clarifies that it does not apply to voting, tender and similar rights related to securities that pass through such rights to participants and beneficiaries of an individual account plan. In such a case, the plan trustee would be obligated to follow the direction of participants (assuming the directions are made in accordance with the plan terms and ERISA).
Applicability
The majority of the Regulation will go into effect on January 15, 2021. However, the Regulation provides a delayed effective date of January 31, 2022 for the portions of the Regulation that (1) prohibit a fiduciary from following the recommendations of a proxy advisor without first determining that the adviser’s guidelines are consistent with the Regulation and (2) describe an investment manager’s duties with respect to a pooled investment vehicle subject to ERISA. In addition, the requirement to evaluate material facts that form the basis for exercising shareholder rights and to maintain records on the exercise of such rights is delayed until January 31, 2022 for all fiduciaries except SEC-registered investment advisers. This is due to the DOL’s intention that these requirements be aligned with such adviser’s duties under the Advisers Act.
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