Final Regulations Substantially Alter DOL’s Proxy Voting Guidance

The DOL has issued final regulations establishing standards for determining whether and how to exercise shareholder rights, including the right to vote proxies, for stock held by ERISA-covered plans (including 401(k) plans). Such rights have been the subject of multiple DOL interpretive bulletins and other guidance since 1988 (see our Checkpoint article). In August, the DOL proposed amending its regulations on plan fiduciaries’ investment duties to articulate the standards for exercising shareholder rights, including when plan fiduciaries must and must not vote proxies (see our Checkpoint article). The proposal prompted considerable public comment (despite a short comment period), which has resulted in substantial changes to these final regulations, including the adoption of a “principles-based” approach that deletes specific obligations commenters perceived as particularly burdensome. But they retain the basic idea that fiduciaries do not have a fiduciary obligation to vote all proxies and must satisfy certain basic obligations when deciding whether to vote proxies or exercise other shareholder rights. Here are highlights of the changes:

• Economic Impact Test. The final regulations eliminate provisions that would have compelled fiduciaries to vote proxies on matters that would have an economic impact on the plan and refrain from voting on matters that would not have an economic impact. Those provisions, the DOL acknowledged, raised concerns about increased costs, liability exposure, the difficulty of determining economic impacts, and the possibility that some risks created by not voting might not have an economic impact.
• Pass-Through Rights. The regulations do not apply to voting, tender, and similar rights that are passed through to participants and beneficiaries pursuant to the terms of an individual account plan.
• Required Considerations. Fiduciaries deciding whether to exercise shareholder rights must satisfy a list of obligations that has been substantially revised under the final regulations’ less prescriptive approach. Concerns about compliance costs and the difficulty of quantifying economic value prompted the DOL to eliminate the obligation to consider only factors affecting “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.” Also removed is the express requirement to consider the impact on investment performance of factors such as the size of the plan’s holdings in the issuer relative to the total investment assets of the plan, and the plan’s percentage ownership of the issuer. (These factors may be relevant, but they cannot be considered in some circumstances—e.g., where a portfolio is managed by different managers.) The final rule prohibiting the promotion of nonpecuniary benefits omits references to sacrificing investment return and taking on additional investment risk. According to the DOL, this is to avoid suggesting that a fiduciary may exercise proxy voting and other shareholder rights with the goal of advancing non-pecuniary goals so long as it does not increase costs or reduce the investment’s value.
• Records. The general obligation to maintain records on proxy voting has been retained, but the express requirement to maintain records that demonstrate the basis for particular proxy votes and exercises of shareholder rights has been deleted to avoid its implications for monitoring investment managers. Also deleted is the provision obligating fiduciaries to require proxy advisors and investment managers to document that their recommendations or decisions were based on economic benefits to the plan and solely on the financial interests of participants and beneficiaries.
• Proxy Voting Guidelines. The regulations retain the framework for adopting proxy voting policies, but the provisions with optional means for deciding whether to vote are framed as safe harbors, not minimum requirements. The proposed rule that would have allowed fiduciaries to vote with management on proposals unlikely to have a significant impact has been eliminated, as has the requirement to review proxy policies at least every two years.
• Applicability Date. The final regulations generally will be effective January 15, 2021. Certain obligations, however, are delayed until January 31, 2022.
• Prior Guidance. Interpretive Bulletin 2016-01 (see our Checkpoint article), which no longer represents the views of the DOL, has been withdrawn, and FAB 2018-01 will no longer be considered current guidance (see our Checkpoint article).

EBIA Comment: The principles-based approach of the final regulations will allow the rules to adapt to the circumstances and avoid substantial burdens and risks raised by the original proposal. The modifications to the regulations are well-chronicled in the preamble, which is extraordinary for its description of some commenters’ strong opposition to the proposal and the DOL’s willingness to articulate (and in many cases respond to) those concerns. The final product may, for some, be sufficiently close to current practice that compliance by the applicability date should not be difficult. For others, however, the holiday season just got busier. For more information, see EBIA’s 401(k) Plans manual at Sections XXV.C.2 (“Establish and Maintain a Statement of Investment Policy”) and XXV.L (“Proxy Voting and Shareholder Rights”).

Contributing Editors: EBIA Staff.