Pension & Benefits News EBSA proposed rules on proxy voting would severely restrict plan ESG investments 
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Monday, September 28, 2020

EBSA proposed rules on proxy voting would severely restrict plan ESG investments 

By Pension and Benefits Editorial Staff

 EBSA has released proposed regulations that, while stressing that fiduciaries are under no mandate to vote proxies appurtenant to shares of stock, expressly state that fiduciaries may not vote proxies in circumstances where plan assets would be expended on shareholder engagement activities that do not have an “economic” impact on the plan. The proposed regulations would expressly remove Interpretive Bulletin 2016-01 and emphasize the current DOL perspective that plan assets may not be used to support or pursue any proxy proposal for environmental, social or governmental (ESG) or public policy agendas that have no connection to increasing the value of investments used for the payment of benefits or plan administrative expenses. In implementing the revised DOL policy, the proposed regulations would specify standards that fiduciaries must meet in exercising shareholder rights and stipulate “Permitted Practices” that would guide the adoption of proxy voting policies designed to serve a plan’s economic interests. 

Fiduciary responsibility in proxy voting. Fiduciaries, under ERISA Sec. 404(a)(1), are required to discharge their duties solely in the interests of and for the exclusive purpose of providing benefits to participants and beneficiaries. The DOL has, further, long held that the fiduciary act of managing plan assets that are shares of corporate stock includes the voting of proxies attributable to those shares. The power to vote a proxy, according to the DOL, is a plan asset and, in managing plan assets that include shares of company stock, a fiduciary is subject to the fiduciary responsibility rules in voting proxies attributable to those shares. Accordingly, a plan trustee or other fiduciary will be liable for losses that are attributable to the proxy vote. 

The prudent exercise of voting rights solely for the benefit of participants and beneficiaries has been the subject of conflicting guidance from the DOL that primarily reflects the ideology of the political party controlling the White House. Of particular concern has been whether a fiduciary must exercise a proxy. 

In Interpretive Bulletin (IB) 94-2, the DOL recognized that fiduciaries may engage in shareholder activities intended to monitor or influence corporate management in situations where the responsible fiduciary concludes that, after taking into account the costs involved, there is a reasonable expectation that such shareholder activities (by the plan alone or together with other shareholders) will enhance the value of the plan’s investment in the corporation. However, IB 94-2 also stressed that ERISA does not permit fiduciaries, in voting proxies or exercising other shareholder rights, to subordinate the economic interests of participants and beneficiaries to unrelated objectives. 

Subsequently, IB 2008-02 modified and superseded the earlier rule, primarily by conditioning the exercise of proxy voting on the economic benefits of the action for plan participants and beneficiaries. IB 2008-02 further explained that fiduciaries’ responsibility for managing proxies includes both deciding to vote or not to vote. Moreover, the DOL stressed that the duties of prudence and loyalty under ERISA Sec. 404(a) require that, in voting proxies, the responsible fiduciary may consider only those factors that relate to the economic value of the plan’s investment and shall not subordinate the interests of the participants and beneficiaries in their retirement income to unrelated objectives. Thus, votes may only be cast in accordance with a plan’s economic interests. Accordingly, if the responsible fiduciary reasonably determines that the cost of voting is likely to exceed the expected economic benefits of voting, the fiduciary has an obligation to refrain from voting. As a final point, IB 2008-02 clarified the thinking of the time by cautioning that any use of plan assets by a plan fiduciary to further political or social causes “that have no connection to enhancing the economic value of the plan’s investment” through proxy voting or shareholder activism is a violation of ERISA’s exclusive purpose and prudence requirements. 

In IB 2016-01, the DOL reversed course, conceding that the guidance under IB 2008-02 had been “out of step” with domestic and international trends in investment management and had the potential to dissuade fiduciaries from exercising shareholder rights, including the voting of proxies, in areas that are increasingly being recognized as important to long-term shareholder value. In withdrawing IB 2008-02 and reinstating IB 94-2, however, the DOL still cautioned that, in voting proxies, a responsible fiduciary is required to “consider the factors that may affect the value of the plan’s investment and not subordinate the interests of participants and beneficiaries in their retirement income to unrelated objectives.” 

In further addressing the issue of whether a fiduciary must vote proxies, the DOL in IB 2016-01 stated that a responsible fiduciary is required to vote proxies on “issues that affect the value of the plan’s investment.” DOL did acknowledge that voting proxies may, in special cases (e.g., voting proxies on shares of foreign corporations) involve out of the ordinary costs or unusual requirements. Under such circumstances, fiduciaries were advised to consider whether the plan’s vote, either by itself or together with the votes of other shareholders, is expected to have an effect on the value of the plan’s investment that warrants the additional cost of voting. 

Persistent misunderstanding” regarding obligation to vote proxies. In the current guidance, EBSA, stressing that fiduciaries need not vote all proxies, explains that a fiduciary’s duty is only to vote those proxies that are prudently determined to have an economic impact on the plan after the costs of research and voting are taken into account. However, EBSA concedes the existence of a “persistent misunderstanding” that fiduciaries must research and vote all proxies. Accordingly, in order to clarify any misunderstanding, the proposed rules expressly state that fiduciaries must not vote in circumstances where plan assets would be expended on shareholder engagement activities that do not have an economic impact on the plan, whether by themselves or after the costs of engagement are taken into account. As IB 2016-01 does not reflect the current DOL view, it will be removed from the Code of Federal Regulations in the event the final rule is adopted. 

Fiduciary standards in exercising shareholder rights . Under ERISA Proposed Reg. 2550.404a-1(e)(2)(i), fiduciaries, when deciding whether to exercise shareholder rights and when exercising such rights, including the voting of proxies, must carry out their duties prudently and solely in the interests of the participants and beneficiaries and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying the reasonable expenses of administering the plan. Proposed Reg. 2550.404a-1(e)(2)(ii) sets forth specific standards that fiduciaries must meet when deciding whether to exercise shareholder rights and when exercising those rights. 

Specifically, a fiduciary would be required to: 

  1. act solely in accordance with the economic interest of the plan and its participants and beneficiaries considering only factors that they prudently determine will affect 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 investment objectives and the funding policy of the plan; 
  2. consider the likely impact on the investment performance of the plan based on such factors as the size of the plan’s holdings in the issuer relative to the total investment assets of the plan, the plan’s percentage ownership of the issuer, and the costs involved; 
  3. not subordinate the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan to any non-pecuniary objective, or sacrifice investment return or take on additional investment risk to promote goals unrelated to those financial interests of the plan’s participants and beneficiaries or the purposes of the plan; 
  4. investigate material facts that form the basis for any particular proxy vote or other exercise of shareholder rights. Note: A fiduciary would not be allowed to adopt a practice of following the recommendations of a proxy advisory firm or other service provider without appropriate supervision and a determination that the service provider’s proxy voting guidelines are consistent with the economic interests of the plan and its participants and beneficiaries; 
  5. maintain records on proxy voting activities and other exercises of shareholder rights, including records that demonstrate the basis for particular proxy votes and exercises of shareholder rights; and 
  6. exercise prudence and diligence in the selection and monitoring of persons, if any, selected to advise or otherwise assist with exercises of shareholder rights, such as providing research and analysis, recommendations regarding proxy votes, administrative services with voting proxies, and recordkeeping and reporting services. 

Reasonable investigations. Fiduciaries would be required, when making voting decisions, to perform “reasonable investigations.” Information that will better enable fiduciaries to determine whether or how to vote proxies on particular matters, EBSA advises, includes the cost of voting, including opportunity costs; the type of proposal (e.g., those relating to social or public policy agendas versus those dealing with issues that have a direct economic impact on the investment); voting recommendations of management; and an analysis of the particular shareholder proponents. EBSA further stress that fiduciaries must be prepared to articulate the anticipated economic benefit of proxy-vote decisions in the event they decide to vote. 

Delegation of proxy voting authority. Fiduciaries may reasonably delegate proxy voting authority to investment managers. However, EBSA cautions that fiduciaries must monitor proxy voting decisions made by their investment managers to ensure such entities are voting, or refraining from voting, in a manner that maximizes investment returns and does not sacrifice economic benefits for non-pecuniary objectives. Therefore, consistent with the duty to monitor, fiduciaries, under ERISA Proposed Reg. 2550.404a-1(e) (2)(iii), would need to require an investment manager or proxy advisory firm to document the rationale for proxy voting decisions or recommendations sufficient to demonstrate that the decision or recommendation was based on the expected economic benefit to the plan, and that the decision or recommendation was based solely on the interests of participants and beneficiaries in obtaining financial benefits under the plan. A plan fiduciary, EBSA further counsels, must also assess and monitor an investment manager’s use of any proxy advisory firm, including any review by the manager of the advisory firm’s policies and procedures for identifying and addressing conflicts of interest. 

Obligation to vote proxy. Directly addressing the “misunderstanding” that fiduciaries are required to vote all proxies, the proposed regulations make a fiduciary’s proxy vote dependent on whether the vote will affect the economic value of the plan’s investments. Specifically, under Proposed Reg. 2550.404a-1(e)(3), a plan fiduciary would be required to vote any proxy where it prudently determines that the matter being voted upon would have an economic impact on the plan. By contrast, a plan fiduciary would be prohibited from voting any proxy unless it prudently determines that the matter being voted upon would have an economic impact on the plan. 

Permitted practices. In order to address the concern that the costs incurred by a fiduciary in determining whether to exercise proxy voting rights could exceed the potential economic benefits to the plan, Proposed Reg 2550.404a-1(e)(3)(iii) provides “Permitted Practices,” that are intended to reduce the need for fiduciaries to consider proxy votes that are unlikely to have an economic impact on the plan. As envisioned by EBSA, a fiduciary would adopt proxy voting policies that encompass permitted practices and then apply the proxy voting policies to proxy votes. The development and adoption of such policies would help fiduciaries comply with their obligations under the proposed regulations but would be subject to the fiduciary duties of prudence and loyalty. 

Examples of proxy voting policies. The proposed regulations provide the following examples of proxy voting policies that are prudently designed to serve a plan’s economic interests. 

  1. A policy of voting proxies in accordance with the voting recommendations of management of the issuer on proposals or particular types of proposals that the fiduciary has prudently determined are unlikely to have a significant impact on the value of the plan’s investment, subject to any conditions determined by the fiduciary as requiring additional analysis because the matter being voted upon may present heightened management conflicts of interest or is likely to have a significant economic impact on the value of the plan’s investment. 
  2. A policy that voting resources will focus only on particular types of proposals that the fiduciary has prudently determined are substantially related to the corporation’s business activities or likely to have a significant impact on the value of the plan’s investment, such as proposals relating to corporate events (mergers and acquisitions transactions, dissolutions, conversions, or consolidations), corporate repurchases of shares (buy-backs), issuances of additional securities with dilutive effects on shareholders, or contested elections for directors. 
  3. A policy of refraining from voting on proposals or particular types of proposals when the plan’s holding in a single issuer relative to the plan’s total investment assets is below a “quantitative threshold” that the fiduciary prudently determines, considering its percentage ownership of the issuer and other relevant factors, is sufficiently small that the outcome of the vote is unlikely to have a material impact on the investment performance of the plan’s portfolio (or investment performance of assets under management in the case of an investment manager). 

 Note: EBSA is soliciting comments as to whether a specific quantitative upper limit (“cap”) should be defined (e.g., 5 percent cap or some other percentage amount of plan assets). 

Review of proxy voting policies. Plan fiduciaries would be required to review proxy voting policies at least once every two years. 

Conflicting investment policy statements . The investment manager of a pooled investment vehicle that holds assets of more than one employee benefit plan may be subject to an investment policy statement that conflicts with the policy of another plan. Under such circumstances, the investment manager is required under ERISA Sec. 404(d) to reconcile the conflicting policies. In addition, with respect to proxy voting, the investment manager would be required under Proposed Reg. 2550.404a-1(e)(4)(ii) to vote (or abstain from voting) the relevant proxies to reflect such policies in proportion to each plan’s economic interest in the pooled investment vehicle. The investment manager would be allowed to develop an investment policy statement and require participating plans to accept the investment manager’s investment policy, including any proxy voting policy, before they are allowed to invest. However, a fiduciary would need to assess whether the investment manager’s investment policy statement and proxy voting policy are consistent with ERISA Title I and the proposed rules before deciding to retain the investment manager. 

Effective date .  The proposed regulations would be effective 30 days after the date of the publication of the final rules. 

Source: 85 FR 55219. 

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