Earlier this month the Department of Labor (DOL) proposed a rule that would prohibit ERISA-covered plan fiduciaries from expending plan assets to vote proxies unless doing so adds economic value to the plan.
The proposal comes amid a flurry of other regulatory activity by the DOL, including a revised fiduciary rule and new guidance around including private equity and evaluating environmental, social, and governance (ESG) factors in defined contribution (DC) plans.
Over the years, the DOL has issued guidance regarding the fiduciary act of managing plan assets that are shares of corporate stock. The fiduciary obligations of prudence and loyalty to participants require the fiduciary to vote proxies on issues that may affect the value of the investment. However, the fiduciary is only required to cast a vote when there is an economic impact. Generally the responsibility to vote on proxies is described in the plan document or investment management agreements.
The department’s new proposal dovetails with SEC guidance finalized in 2020 and would create a refined set of circumstances in which plan fiduciaries may engage in proxy voting. The introduction to the proposed rule notes that the DOL “is concerned that the costs for fiduciaries to prudently exercise proxy voting rights often will exceed any potential economic benefits to a plan.” Specifically, the rule would require a fiduciary to determine whether voting would result in clear economic consequences for the plan. If the fiduciary determines that a vote would have a financial impact, voting on the matter would be permitted. However, if the vote would not result in a material financial impact on the plan, the fiduciary would be prohibited from voting.
In addition, the rule would require fiduciaries to document their proxy voting activities and the rationale behind certain voting decisions or, if a separate party was responsible for proxy voting, to monitor the process and decisions made by that party. Moreover, the proposed rule indicates that a fiduciary may adopt proxy voting policies establishing certain “permitted practices” (e.g., quantitative threshold of materiality), and the fiduciary may then apply those policies to proxy votes. The proposed rule would also require that the policies be reviewed every two years.
The business-friendly rule suggests that a fiduciary may adopt a policy of voting proxies in accordance with management’s recommendations on proposals that would not have a significant impact on the value of the plan’s investment. It also suggests that the proposed rule is necessary due to the “recent increase in the number of environmental and social shareholder proposals.” It goes on to note that “many of these proposals have little bearing on share value or other relation to plan interests.”
One possible consequence of the proposal is a chilling effect on proxy voting, particularly in situations where it may be difficult to determine or prove that the subject of a vote would have a clear financial impact on the plan. Just as the DOL’s proposed ESG rule may seemingly create a larger hurdle for ESG adoption in DC plans, the proposed proxy voting rule may make it more difficult for plan fiduciaries to vote on matters tied to non-economic considerations, which may or may not include ESG considerations.
The DOL has opened a 30-day comment period for the proposed rule. Given the more than 8,000 comments submitted in response to the proposed ESG rule (with most opposing it), the proposed proxy rule may also see a flurry of feedback.
Plan sponsors should consider their current proxy voting arrangements and ensure the processes are clearly outlined and documented. In addition, sponsors should continue to monitor the situation and stay abreast of future developments, particularly following the comment period.