Proposed DOL Regulation Sets Guidelines for Fiduciaries on Proxy Voting

The DOL has proposed amending its investment duties regulation to include standards for determining whether and how to exercise shareholder rights, including the right to vote proxies. Such rights have been the subject of multiple DOL interpretive bulletins and other guidance since 1988 (see our Checkpoint article). According to the DOL, that guidance has sown persistent confusion over whether fiduciaries must always vote proxies, which has resulted in increased plan expenses from unnecessary or inappropriate voting. In particular, the DOL expressed concern about the use of plan assets “to support or pursue proxy proposals for environmental, social, or public policy [ESG] agendas that have no connection to increasing the value of investments used for the payment of benefits or plan administrative expenses.” To address these issues, the DOL has proposed amending its regulation on plan fiduciaries’ investment duties to articulate its standards for the exercise of shareholder rights, including when plan fiduciaries must and must not vote proxies. Here are highlights:

• General Standards. After summarizing the relevant principles under ERISA, the proposal lists certain fiduciary standards and specific actions that must be taken by responsible fiduciaries. The standards require that shareholder rights be exercised solely in accordance with the economic interest of the plan based only on factors affecting the investment’s value, and prohibit subordinating the financial interests of participants and beneficiaries to any non-pecuniary objective. When considering an exercise of shareholder rights, fiduciaries must (a) consider factors such as the portion of the plan invested, the portion of the issuer owned, and the cost of acting; (b) investigate the material facts supporting a proxy vote or other action; and (c) maintain records sufficient to demonstrate the basis for any exercise of shareholder rights. If a fiduciary seeks advice about exercising shareholder rights, the fiduciary must exercise prudence and diligence in selecting and monitoring the advisor, and must not rely on an advisor without appropriate supervision.
• When to Vote Proxies. The proposal clearly states the DOL’s position that fiduciaries are not obligated to vote all proxies. In fact, fiduciaries would be barred from voting if the matter being voted on would not have an economic impact based on the factors noted above.
• Proxy Voting Policies. The proposal affirms that plans may adopt proxy voting policies setting parameters that serve the plan’s economic interest. These policies, the DOL observes, may help address the fact that it may be difficult to know whether a proxy vote will affect the plan’s economic interest without investigation and analysis, so simply deciding whether to vote may burden a plan “out of proportion to any benefit.” To diminish that burden, the proposal outlines three “permitted practices” that may be included in a proxy voting policy. First, a plan could adopt a policy of voting in accordance with management’s recommendation on matters that are “unlikely to have a significant impact.” Second, a plan’s proxy policy could focus voting resources on certain types of proposals. Third, a policy could call for refraining from voting if the plan’s investment is below a quantitative threshold that makes it unlikely the outcome of a vote will have a material impact on the plan. (The preamble asks for comment on a 5% threshold.) Proxy policies would have to be reviewed every two years. The permitted practices would not preclude voting when the plan fiduciary concludes voting would be prudent based on the economic impact after considering the costs.
• Responsibility and Delegation. The proposal affirms that the responsibility for exercising shareholder rights rests exclusively with a plan’s trustee, unless the trustee is directed by a named fiduciary or has properly delegated that responsibility. Investment managers with the authority to manage plan assets are authorized to exercise shareholder rights unless the plan, trust, or management agreement establish otherwise. If the authority to vote proxies is delegated to an investment manager, or the fiduciary obtains voting-related advice, the responsible plan fiduciary must require that the rationale for voting or the voting advice be sufficiently documented.
• Pooled Investment Vehicles. Investment managers of pooled investment vehicles generally must reconcile conflicting proxy policies. This may require proportional voting. Alternatively, investment managers may require investors to accept a single proxy policy before investing.
• Comments and Effect. The preamble invites comments, which are due no later than 30 days after the proposal is published in the Federal Register. Once the final regulation is issued and takes effect, Interpretive Bulletin 2016-01 (see our Checkpoint article)—which no longer represents the views of the DOL—will be removed.

EBIA Comment: Most 401(k) plan assets are held in mutual funds or other investment vehicles that are managed by institutional investors responsible for voting proxies and exercising other shareholder rights. (According to the DOL, the percentage of ERISA plan assets—of any type—invested in individual corporate securities fell to about 11% in 2017.) And some of the investments in individual securities are employer stock for which all or a portion of the shareholder rights must be passed through to participants. As a result, many 401(k) plans will not be directly affected by this proposal. For plans that are affected, however, the DOL’s basic message could not be clearer: Fiduciaries must vote proxies “only where it is financially in the interest of the plan to do so.” If voting is not expected to have an economic impact on a plan, fiduciaries should refrain from voting (unless the vote simply follows management’s recommendation, as permitted under one of the proposal’s “permitted practices”). While this message is characterized, in part, as a response to persistent confusion over the DOL’s standard, it is also clearly designed to stop shareholder activism that does not serve the plan’s financial interest. In this, the regulation resembles the DOL’s recently proposed regulation on ESG investments, which would also amend the investment duties regulation to prevent fiduciaries from using plan assets to promote nonfinancial interests (see our Checkpoint article). 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.H.8 (“Proxy Voting and Shareholder Engagement”).

Contributing Editors: EBIA Staff.