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DOL Embraces Pecuniary Principles-Based Proxy Voting Standard in Final Rule

Regulatory Compliance

Once again, the Department of Labor has taken comments on a controversial proposal to heart, and pulled back on the letter, if not the impetus, in its final rule of plan proxy voting.

As had been the case with its recent rulemaking on Environmental Societal & Governance (ESG) investing (more precisely now the “Financial Factors in Selecting Plan Investments”), the Department of Labor released a final rule on Dec. 11 directing that plan fiduciaries must engage in proxy voting decisions and other exercises of shareholder rights only when such a decision could have a financial impact on the retirement plan.[i] In describing the final rule, the Labor Department noted: “the final rule reflects significant modifications to the proposal[ii] based on the public record and commenters’ feedback.”[iii]

The DOL notes that the most significant change from the proposed guidance released Aug. 31 is the adoption of a more principles-based approach. The DOL explains that this change eliminated some of the provisions that may have resulted in significant increases in plan cost and liability exposure for plan fiduciaries. The final rule does, however, retain from the proposal a provision that requires plan fiduciaries—when deciding whether to exercise shareholder rights and when exercising such rights, including the voting of proxies—“to carry out their duties prudently and solely in the interests of the plan participants and beneficiaries and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying the reasonable expenses of administering the plan.”

Pass-through Exception

One element that commenters brought to the attention of the Labor Department: pass-through voting to participants. The Labor Department acknowledges that the proposal was not intended to address this, but to clarify matters the final rule includes an express provision stating that the final rule does not apply to “voting, tender, and similar rights with respect to such securities that are passed through pursuant to the terms of an individual account plan to participants and beneficiaries with accounts holding such securities.” Now, the Labor Department cautions that this exclusion “…should not be read as an indication that plan trustees and other plan fiduciaries do not have fiduciary obligations with respect to such practices.” 

Rather, it notes that prior guidance recognized that in certain circumstances a trustee may follow the instructions of participants in an eligible individual account plan that expressly states that a trustee is subject to the direction of plan participants with respect to certain decisions regarding the management of their account. In such a case—these were quite common in employee stock ownership plans (ESOPs) in the 1980s—the Labor Department notes that “the trustee must follow the direction of participants if those directions are proper, made in accordance with plan terms, and not contrary to ERISA”—though plan trustees and other fiduciaries would continue to have to comply with ERISA’s prudence and loyalty provisions with respect to the pass through of votes to plan participants and beneficiaries, and can continue to rely on the Department’s prior guidance with respect to such participant-directed voting.

The rule does apply to plans with respect to stocks they hold directly, as well as with respect to stocks they hold through ERISA-covered intermediaries, such as common trusts, master trusts, pooled separate accounts, and 103-12 investment entities. 

Six Principles 

The DOL notes that another element—similar to the proposal, but with some modifications in response to public comments—is a list of principles that fiduciaries must comply with when making decisions on exercising shareholder rights, including proxy voting, in order to meet their prudence and loyalty duties. The final rule states that the fiduciary duty to manage shareholder rights does not require the voting of every proxy or the exercise of every shareholder right. When a plan fiduciary decides whether to exercise shareholder rights, including proxy voting, the plan fiduciary must comply with six principles, including to: 

  1. act solely in accordance with the economic interest of the plan and its participants and beneficiaries;
  2. consider any 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 promote non-pecuniary benefits or goals unrelated to those financial interests of the plan’s participants and beneficiaries or the purposes of the plan;
  4. evaluate material facts that form the basis for any particular proxy vote or other exercise of shareholder rights;
  5. maintain records on proxy voting activities and other 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.

Moreover, the rule advises that a responsible plan fiduciary must prudently monitor the proxy voting activities of investment managers or proxy advisory firms selected to assist the fiduciary and determine whether such activities are consistent with the rule’s requirements. A fiduciary may not adopt the practice of following the recommendations of a proxy advisory firm or other service provider without determining that such firm or service provider’s proxy voting guidelines are consistent with the rule’s obligations. 

Safe Harbor 

Under the final rule, a fiduciary may adopt optional means or safe harbors for satisfying the fiduciary responsibilities with respect to decisions on whether to vote proxies. Plan fiduciaries may adopt either or both of the following policies:

  • 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 are expected to have a material effect on the value of the plan’s investment. 
  • A policy of refraining from voting on proposals or types of proposals when the size of the plan’s holdings in the stock subject to the vote are below quantitative thresholds that the fiduciary prudently determines, considering its percentage ownership of the stock and other relevant factors, is sufficiently small that the matter being voted upon is not expected to have a material effect on the investment performance of the plan’s portfolio (or assets under management in the case of an investment manager).

What’s Not in the Final Rule

The proposal included requirements that the Labor Department has decided not to include. Specifically, while the proposal had provided that a plan fiduciary must vote any proxy where the fiduciary prudently determined that the matter being voted upon would have an economic impact on the plan (after considering certain factors and taking into account the costs involved (including the cost of research, if necessary, to determine how to vote). Additionally, the proposal provided that a plan fiduciary must not vote any proxy unless the fiduciary prudently determined that the matter being voted upon would have an economic impact on the plan (also after considering certain factors and taking into account the costs involved). 

In contrast, the final rule does include specific language to make clear that plan fiduciaries do not have an obligation to vote all proxies, as well as a safe harbor provision, modified from the proposal, “pursuant to which plan fiduciaries may adopt proxy voting policies and parameters prudently designed to serve the plan’s economic interest that provide optional means for satisfying their fiduciary responsibilities regarding determining whether to vote under ERISA sections 404(a)(1)(A) and 404(a)(1)(B).”

Recordkeeping Revision

The Labor Department said it was retaining the general recordkeeping requirement, but is removing the requirement to maintain documents that would be necessary to demonstrate the basis for a vote “to avoid any inferences related to responsibilities in monitoring investment managers.” The final rule requires fiduciaries to maintain records on proxy voting activities and other exercises of shareholder rights, but “in general, the extent of the documentation needed to satisfy the monitoring obligation will depend on individual circumstances.” Additionally, the final rule provides that fiduciaries must 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,” though the Labor Department notes that this provision is “essentially a restatement of the general fiduciary obligations that apply to the selection and monitoring of plan service providers.”

Effective Date

The final rule will be effective 30 days after publication in the Federal Register and applies to exercises of shareholder rights after such date. The final rule, however, includes two later compliance dates in response to concerns about the feasibility of complying with certain provisions: 

  • Fiduciaries which are not SEC-registered investment advisers have until Jan. 31, 2022, to comply with the new requirements to evaluate material facts providing the basis for exercising a right and to maintain records on proxy voting activities. 
  • SEC-registered investment advisers must comply as of the 30-day applicability date, however, as these requirements are intended to align with their existing obligations under the Investment Advisers Act. 
  • All fiduciaries have until Jan. 31, 2022, to comply with the requirements that fiduciaries review service provider proxy voting guidelines prior to following their recommendations to determine that the guidelines are consistent with their obligations under the rule, and the requirements pertaining to investment managers of pooled investment vehicles.

Since the overall rule will become effective 30 days after publication, likely making it effective before presumptive President Joe Biden takes office on Jan. 20, 2021, that might make it harder for the Biden administration to pull back at that point.

[i] The Labor Department notes that from 2011 through 2017, shareholders submitted 462 environmental proposals and 841 social shareholder proposals, and resubmitted at least once 41% of environmental and 51% of social proposals, and that it “believes it is likely that many of these proposals have little bearing on share value or other relation to plan financial interests.” 

[ii] For those wondering about the rationale for issuing the rule, the Labor Department had said it was concerned that its 1988 Avon Letter and “subsequent sub-regulatory guidance” had resulted in a “misplaced belief among some stakeholders that fiduciaries must always and in every case vote proxies, subject to limited exceptions, in order to fulfill their obligations under ERISA.”

[iii] The Department invited interested persons to submit comments on the proposed rule, and in response received approximately 300 written comments from a variety of parties, including plan sponsors and fiduciaries, plan service and investment providers (including investment managers and proxy voting firms), and employee benefit plan and participant representatives. The Department also received approximately 6,700 submissions in response to petitions.