Topline & Comment Period Deadline
A new U.S. Department of Labor (DOL) rule proposal would, if adopted, greatly accelerate ERISA fiduciaries’ need to evaluate climate-related financial risk and certain other environmental, social and governance (ESG) considerations during plan investment and proxy voting decision-making. The comment period for the proposal closes on December 13, 2021.1
Who is Affected?
The proposal is directly relevant to all ERISA plan sponsors (both DB and DC), investment managers, and pooled investment funds that hold “plan assets.” Proxy advisory firms and product manufacturers are indirectly affected.
Why the DOL Proposed this Rule
The DOL has long wrestled with ESG, especially when ESG was historically associated with collateral benefits (i.e., non-investment performance reasons). Formalized guidance commenced during the Clinton Administration, with each subsequent administration taking different approaches. It was during the Obama Administration when the DOL first acknowledged that an ESG factor can be material to investment performance.
The Trump Administration reaffirmed the Obama Administration’s stance that an ESG factor can be material to investment performance, but its relevant rulemakings, the Financial Factors rule, and the 2020 proxy voting rule, expressed concern over the putative politicization of ESG investing and skepticism that certain types of ESG investing, particularly screens, was in a plan’s best interest. Many believed the Trump-era rules stigmatized, and, therefore, had a chilling effect on, ESG adoption by ERISA plans.
The DOL under the Biden Administration recognized, and agreed with, the concerns that the Financial Factors and proxy voting rules had a chilling effect on ESG adoption. The DOL, in drafting the proposal, sought to enable ERISA fiduciaries to “better recognize the important role that climate change and other ESG factors can play in the evaluation and management of plan investments, while continuing to uphold fundamental fiduciary obligations.” Also, considering the Administration’s broader policy initiatives to address climate change risk, this new proposal fits into a larger tapestry the White House has weaved as part of its “whole-of-government” approach to climate change and other ESG issues.2
How the Proposal Goes Far Beyond Other DOL Approaches to ESG
As with the Financial Factors rule and Obama-era guidance, the proposal emphatically reaffirms that ESG factors can be material to an investment’s risk-return analysis, and in those situations, a fiduciary should consider them along with any other non-ESG material risks.3 In doing so, the DOL fleshed out various types of ESG risks, and, in considerable detail, the multi-dimensional aspects to an ESG factor. Specifically, the proposal describes the following ESG factors that might be material:
- “Climate change-related factors, such as a corporation’s exposure to the real and potential economic effects of climate change including exposure to the physical and transitional risks4 of climate change and the positive or negative effect of Government regulations and policies to mitigate climate change;5
- Governance factors, such as those involving board composition, executive compensation, and transparency and accountability in corporate decision-making, as well as a corporation’s avoidance of criminal liability and compliance with labor, employment, environmental, tax, and other applicable laws and regulations; and
- Workforce practices, including the corporation’s progress on workforce diversity, inclusion, and other drivers of employee hiring, promotion, and retention; its investment in training to develop its workforce’s skill; equal employment opportunity; and labor relations.”
We think this level of specificity by the DOL reveals an increasingly sophisticated and nuanced understanding of climate change risk. The proposal’s granularity on different ESG risks will likely enhance broader understanding of these risks by fiduciaries, thus aiding adoption.
Beyond that, we think the proposal’s express acknowledgment that government action (whether in policy or in rulemaking) may have a negative or positive material effect on plan investments could be transformational.6 Indeed, there will be winners – and there will be losers – from government policy and rulemakings aimed at a transition to a low-carbon economy (or for some other ESG-related reason), and ERISA fiduciaries would be expected to prepare a plan’s portfolio for these risks and opportunities.
The proposal contemplates a broad scope to government action as a potential material risk or opportunity consideration for ERISA fiduciaries. Consider the following:
- The government action appears to include all government levels, both within the United States (federal and state) and abroad;
- The government action need not be limited to actual regulation – a government policy, as reflected in the Biden Administration’s A Roadmap to Build a Climate-Resilient Economy, would likely be sufficient for the fiduciary’s consideration, if the policy initiative is likely to have a positive or negative effect on a particular industry, for example; and,
- The government action can come from any government agency or body, such as the EPA or the Governor of California, for instance.
A government action that sets things into motion, which would trigger an ERISA fiduciary’s consideration under the proposal, will likely put fiduciaries on high alert and wanting to act quickly in response.
Yet another way in which the proposal could serve as ERISA’s zero-to-one ESG moment is that it appears to create a heavy presumption in favor of ESG adoption. Under the proposed text, a fiduciary must consider the projected return of the portfolio relative to the funding objectives of the plan, “which may often require an evaluation of the economic effects of climate change and other environmental, social, or governance factors on the particular investment….” (emphasis added).7 Though the rule separately lists various ESG factors that may be considered by the fiduciary if material to the risk-return analysis,8 the “which may often require” clause clearly reflects an intention by the DOL that various ESG factors are material, and, therefore, must be considered by a prudent ERISA fiduciary. Further lending credence to the view that the proposal goes beyond simply clarifying that ESG factors may be material, the DOL stated in the preamble, “the proposal makes clear that climate change and other ESG factors are often material and that in many instances fiduciaries  should consider climate change and other ESG factors in the assessment of investment risks and returns.”9
A fourth reason this proposal is significant is the DOL’s acknowledgment that “all ESG is not equal, and when it is not material to the risk/return analysis, ESG still may be a legitimate collateral benefit for consideration….”10 Using ESG for these types “collateral benefits” is not new; in fact, it has been a means by which fiduciaries have incorporated ESG for decades.11 But the proposal, relative to the Financial Factors rule, streamlines and broadens its usage. For example, the proposal would eliminate the special documentation requirement under the Financial Factors rule related to the use of collateral benefits. Moreover, the proposal expands the types of collateral benefits that may be considered.12
Notably, however, where a collateral benefit ESG factor is used in selecting a designated investment alternative for a participant-directed (e.g., 401(k)) plan lineup, the proposal would require that such reason/benefit “be prominently displayed in disclosure materials provided to participants and beneficiaries.”13 The DOL mentioned that this new disclosure could be added to the existing participant disclosures provided under 29 CFR Section 2550.404a-5.
How QDIAs are Affected
There was considerable controversy over the Financial Factors rule’s prohibition against an ERISA fiduciary selecting a “qualified default investment alternative” (QDIA) in a participant-directed plan lineup, if that fund, product or model portfolio’s investment objectives, goals or principal investment strategies referenced an ESG factor that was selected for collateral benefits. The stakes are high because there is a massive amount of plan assets invested in QDIAs. The proposal eliminates this prohibition. The proposal will likely accelerate the use of ESG funds, products and model portfolios as QDIAs.
How Pooled Investment Vehicles are Affected
The proposal retains the ability of a pooled investment fund that holds “plan assets” to require participating plans to accept the fund’s investment policy statement and/or proxy voting policy, to the extent consistent with ERISA, as a condition to subscribe into the fund. This is helpful insofar as fund managers would otherwise have had to ascertain, and avoid violating, each plan investor’s own investment policy statements and proxy voting policies.
How Brokerage Windows and Self-Directed Brokerage Accounts are Affected
As with the Financial Factors rule, the proposal does not extend to investment funds within brokerage windows and self-directed brokerage accounts. Some plan sponsors have enabled participants to access ESG funds through these arrangements, and that practice may persist.
How Proxy Voting and Other Shareholder Rights are Affected
ESG investing and the exercise of shareholder rights (including, but not limited to, proxy voting) often go together, which is likely why the DOL addressed them here at once. Consistent with the DOL’s longstanding position, the proposal reiterates that proxy voting and the exercise of other shareholder rights on behalf of ERISA plans is fiduciary conduct, and, therefore, is subject to the fiduciary duties set forth in ERISA. The current view of the DOL, as reflected in the proposal, is that exercising shareholder rights is important and should not be discouraged. Yet, the DOL was quick to reaffirm its historical view “that proxies should be voted as part of the process of managing the plan’s investment in company stock unless a responsible plan fiduciary determines voting proxies may not be in the plan’s best interest (e.g., if there are significant costs or efforts associated with voting).”14
The proposal also eliminates the requirement in the 2020 proxy voting rule that there be special monitoring where the authority to exercise shareholder rights on behalf of the plan had been delegated to an investment manager or where a proxy advisory firm provides advisory services. The DOL believes that ERISA’s duties of prudence and loyalty already impose a monitoring obligation, and, therefore, no special monitoring obligation with respect to shareholder rights is warranted.
The 2020 rule provided two safe harbors for fiduciaries to satisfy ERISA’s fiduciary duties in determining whether to vote a proxy. Briefly, the two safe harbors were: (A) a policy to limit voting resources to particular types of proposals that the fiduciary has prudently determined are substantially related to the issuer’s business activities or are expected to have a material effect on the value of the investment, and (B) 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 matter being voted upon is not expected to have a material effect on the investment performance of the plan’s portfolio (or investment performance of assets under management in the case of an investment manager).
The DOL, in the preamble to the proposal, noted that, because the safe harbors are likely to be widely adopted, it is vital that they actually safeguard the interests of the plans. The DOL is currently not confident the two safe harbors from the 2020 rule are “necessary or helpful,” and, therefore, did not include them in the proposal. As noted below, however, the DOL solicits comments on whether the safe harbors should be retained.
The proposal eliminates a requirement from the 2020 rule that mandated fiduciaries to maintain records on proxy voting activities and the exercise of other shareholder rights.
The proposal retains a requirement that the fiduciary exercise prudence and diligence in the selection and monitoring of persons hired to provide research and analysis, recommendations regarding proxy votes, proxy voting administrative services, recordkeeping and other services related to shareholder rights. This is why the proposal indirectly affects proxy advisory firms.
Some Questions to Consider
The comment period closes on December 13, 2021. The DOL is interested in feedback and has solicited comments on the proposal, including:
- Should a final rulemaking retain the specific examples of ESG risks that may be material (e.g., climate change, etc.)?
- Is the proposal’s revised language around the tie-breaker test clear and appropriate? Should a final rule provide greater specificity on which collateral benefits may be considered?
- Should a final rule retain the enhanced documentation requirement when a plan investment option is selected for collateral benefits?
- Should the safe harbors in the 2020 proxy voting rule be retained?
- Would the proposal cause plans to modify their holdings, such as in favor of mutual funds and away from individual companies, so as to avoid the proxy voting requirements set forth in the proposal?
- Would the proposal affect how a fiduciary would manage the plan’s mutual fund shares in terms of exercising shareholder rights appurtenant to the mutual fund shares?
- Are the proposal’s requirements regarding the selection and monitoring of proxy advisory firms and other service providers regarding the exercise of shareholder rights necessary and could they be read as creating special duties and requirements beyond those already existing under ERISA?
- Should the DOL retain the specific requirement that a fiduciary may not adopt a practice of following the recommendations of a proxy advisory firm without a determination that such firm’s proxy voting guidelines are consistent with the fiduciary’s duties under ERISA? Do the proposal’s other provisions otherwise address concerns related to fiduciaries’ use of automatic voting mechanisms?
We believe there is more to this proposal than what may initially meet the eye. The DOL is clearly trying to nudge ERISA fiduciaries into considering ESG factors in their investment and proxy voting decision-making. Should the proposal be adopted as-is, it will likely serve as an accelerant to ESG adoption by ERISA plans and plan asset vehicles. Because these consequences would be profound, plan sponsors and other fiduciaries should carefully consider whether to provide feedback and comments to the DOL in response to the proposal.
2 See, e.g., A Roadmap to Build a Climate-Resilient Economy, https://www.whitehouse.gov/wp-content/uploads/2021/10/Climate-Finance-Report.pdf, Executive Order 13990, “Protecting Public Health and the Environment and Restoring Science to Tackle the Climate Crisis,” 86 Fed. Reg. 7037 (Jan. 25, 2021), and Executive Order 14030, “Executive Order on Climate-Related Financial Risk,” 86 Fed. Reg. 27967 (May 25, 2021).
3 Since 2015, the DOL has repeatedly asserted that ESG can be a material risk factor, and, in those situations, should be considered by an ERISA fiduciary as part of a prudent process. This holds true under the Obama, Trump and Biden Administrations. That the DOL, under both Democrats and Republicans, has acknowledged that ESG risks can be material to investment performance, strongly suggest this issue is officially off the table.
4 The preamble to the proposal notes, “[t]ransition risk reflects the risks that carbon-dependent businesses lose profitability and market share as government policies and new technology drive the transition to a carbon-neutral economy.”
5 Per the DOL, the “imminent or proposed regulations…to reduce greenhouse gas emissions in the power sector, and other policies incentivizing a shift from carbon-intensive investments to low-carbon investments, [which] could significantly lower the value of carbon-intensive investments while raising the value of other investments.”
6 See George Michael Gerstein, Climate Change Defines the Fiduciary, Bloomberg Law, Oct. 2, 2017 (“The first major component of climate risk relates to forthcoming changes in policy and law at the international, national and local level.”); see also Mercer, Investing in a Time of Climate Change, 2015, https://www.mercer.com/content/dam/mercer/attachments/global/investments/mercer-climate-change-report-2015.pdf.
12 Cf. 86 Fed. Reg. at 57280 (referencing “corporate ethos” and “esprit de corps of the workforce” as collateral benefits) with 85 Fed. Reg. 72846, 72862 (“responding to participant demand in order to increase retirement plan savings or investments in contribution creating jobs for current or future plan participants may be consistent with the interests of participants and beneficiaries in their retirement income or financial benefits under the plan, while selecting based on which investment would bring greater personal accolades to the chief executive officer of the sponsoring employer, or solely on the basis of a fiduciary’s personal policy preferences, would not.”).
13 The DOL noted in the preamble that, “[t]he essential purpose of this proposed disclosure requirement is to ensure that plan participants are given sufficient information to be aware of the collateral factor or factors that tipped the scale in favor of adding the investment option to the plan menu, as opposed to its economically equivalent peers that were not.”
14 See also 86 Fed. Reg. at 57281 (“Prudent fiduciaries should take steps to ensure that the cost and effort associated with voting a proxy is commensurate with the significance of an issue to the plan’s financial interest.”).
Information contained in this publication should not be construed as legal advice or opinion or as a substitute for the advice of counsel. The articles by these authors may have first appeared in other publications. The content provided is for educational and informational purposes for the use of clients and others who may be interested in the subject matter. We recommend that readers seek specific advice from counsel about particular matters of interest.
Copyright © 2021 Stradley Ronon Stevens & Young, LLP. All rights reserved.
Plan sponsors and financial services firms that act as fiduciaries to ERISA plans and “plan asset” funds should take note of a new rule proposal that the U.S. Department of Labor (DOL) announced today. The proposed rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” would address ERISA fiduciaries’ duties with regard to considering climate change and other environmental, social and governance (ESG) factors when selecting investments and exercising shareholder rights.
This rule, if adopted, would have significant implications for financial services firms that act as ERISA fiduciaries. The comment period will run for 60 days after the rule’s publication in the Federal Register. We will be preparing a detailed analysis in the coming days.
The SEC has scheduled an open meeting for 10 am on Wednesday, September 29, at which the agenda will consist of the following:
Wednesday, September 29, 2021
ITEM 1: Enhanced Reporting of Proxy Votes by Registered Management Investment Companies; Reporting of Executive Compensation Votes by Institutional Investment Managers
OFFICE: Division of Investment Management
STAFF: Sarah ten Siethoff, Brian M. Johnson, Angela Mokodean, Nathan Schuur
The Commission will consider whether to propose form amendments to enhance the information certain registered investment companies report about their proxy votes. The Commission will also consider proposing a new rule and form amendments to require institutional investment managers subject to section 13(f) of the Securities Exchange Act of 1934 to report proxy votes relating to executive compensation matters, as required by section 14A of the Exchange Act.
For further information, please contact Brian M. Johnson and Angela Mokodean, Division of Investment Management, at (202) 551-6792.
The U.S. Department of Labor (DOL) has finalized a rulemaking that pertains to proxy voting and the exercise of other shareholder rights with respect to employee benefit plans subject to the U.S. Employee Retirement Income Security Act of 1974, as amended (ERISA).1 The rule applies to plans directly, as well as to commingled investment funds that hold “plan assets.”2 Plan sponsors, investment advisers registered with the U.S. Securities and Exchange Commission (SEC), and other service providers that either exercise shareholder rights on behalf of plans or who appoint those who do should pay particular attention to this final rule.3
As with the DOL’s recent Financial Factors rulemaking, this rule’s genesis was probably the DOL’s concern over the striking growth of environmental, social & governance (ESG) investing. Engagement with a company’s board, for example, is a popular method used by managers to address ESG concerns. But both rules apply much more broadly, including to those managers and mandates that do not take ESG factors into account. Neither this rule nor the Financial Factors rule, is limited to ESG.
The exercise of shareholder rights, including proxy voting, has long been considered fiduciary conduct under ERISA. This rule retains that characterization and defines the scope of responsibilities. In doing so, the rule supersedes DOL Interpretive Bulletin 2016-01 and the relevant portions in DOL Field Assistance Bulletin 2018-01.
As discussed more fully below, fiduciaries of plans and plan asset vehicles will need to review their proxy voting policies and practices regarding their use of proxy advisors, especially when those advisors offer voting recommendations or their platforms pre-populate votes.4 With this rule, proxy advisory firms continue to face increased scrutiny from U.S. regulators, notably the SEC and DOL, over their practices and influence.
From a substantive standpoint, the rule compels fiduciaries to only exercise shareholder rights, including proxy voting, if they are undertaken solely in accordance with the economic interests of the plan and its participants and beneficiaries. This entails the fiduciary discerning some economic benefit to the plan, beyond the plan merely being a shareholder, resulting from the exercise of shareholder activities by the plan alone or together with other shareholders.5 Fiduciaries may consider the longer-term consequences and potential economic impacts from the exercise of such rights, even if they are not currently readily quantifiable, which should strengthen (or at least not hinder) proxy voting and engagement related to material ESG issues.6 Importantly, a discernible economic benefit to the plan must be initially identified to pass muster under the rule, even if the shareholder activity does not result in a direct or indirect cost to the plan.
In the DOL’s view, for example, a fiduciary may have to vote against a shareholder proposal that would result in the issuer incurring direct or indirect costs if such proposal did not also describe “a demonstrable expected economic return” to the issuer. On the other hand, “the costs incurred by a corporation to delay a shareholder meeting due to lack of a quorum is an example of a factor that can be appropriately considered as affecting the economic interest of the plan.”
The costs of proxy voting and other shareholder rights must also be considered, as they too affect the economic interest of the plan. These costs may include direct costs to the plan, such as expenditures for analyzing portfolio companies and the matters to be voted on, determining how the votes should be cast, and ultimately submitting proxy votes to be counted. Moreover, the DOL notes that “[i]f a plan can reduce the management or advisory fees it pays by reducing the number of proxies it votes on matters that have no economic consequence for the plan that also is a relevant cost consideration.”7 Indirect costs are also relevant. For example, the fiduciary should consider the opportunity costs of the exercise of shareholder rights, such as opportunity costs for the client resulting from restricting the use of securities for lending to preserve the right to vote.8
The rest of the rule is more process-oriented, which speaks to how fiduciaries can satisfy these substantive obligations in practice.
First, fiduciaries need to evaluate material facts that form the basis for any particular proxy vote or other exercise of shareholder rights. Here, fiduciaries should consider material information that is known by, available to, or reasonably should be known by the fiduciary. In this respect, the DOL pointed to the fact that, under recent SEC guidance, clients of proxy advisory firms may become aware of additional information from an issuer that is the subject of a voting recommendation, and that an ERISA fiduciary would be expected to consider the relevance of such additional information if material.
Second, fiduciaries must maintain records on proxy voting activities and other exercises of shareholder rights. For fiduciaries that are SEC-registered investment advisers, the DOL intends that these recordkeeping obligations would be applied in a manner that aligns to similar proxy voting recordkeeping obligations under the U.S. Investment Advisers Act of 1940, as amended (Advisers Act).
Third, and as applicable, fiduciaries must exercise prudence and diligence in the selection and monitoring of (i) investment managers charged with proxy voting and (ii) proxy advisory firms 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. The fiduciary should consider the qualifications of the service provider, the quality of services being offered, and the reasonableness of fees charged in light of the services provided. ERISA fiduciaries should also ensure that, when considering proxy recommendations, they are fully informed of the potential conflicts of interest of proxy advisory firms and the steps such firms have taken to address them (e.g., reviewing proxy advisor conflict of interest disclosures, etc.). Finally, fiduciaries should review the proxy voting policies and/or proxy voting guidelines and the implementing activities of the service provider; this requirement, however, does not require use of custom policies.
Fiduciaries may adopt proxy voting policies pursuant to a safe harbor and, if so, review them periodically for compliance with the rule (e.g., every two years). These policies may not preclude (i) submitting a proxy vote when the fiduciary prudently determines that the matter being voted upon is expected to have a material effect on the value of the investment or the investment performance of the plan’s portfolio (or investment performance of assets under management in the case of an investment manager) after taking into account the costs involved, or, conversely, (ii) refraining from voting when the fiduciary prudently determines that the matter being voted upon is not expected to have such a material effect after taking into account the costs involved. The rule specifically provides two safe harbors, either or both of which may be utilized when deciding whether to vote. The safe harbors are not the exclusive means to satisfy the rule or represent minimum requirements.
- Safe Harbor #1: A policy to limit voting resources to particular types of proposals that the fiduciary has prudently determined are substantially related to the issuer’s business activities or are expected to have a material effect on the value of the investment. The reference to the value of the investment rather than the plan’s total investment is intended to make clear that the evaluation could be at the investment manager level dealing with a pool of investor’s assets or at the aggregate plan level. The DOL expects that proposals relating to corporate events (e.g., mergers and acquisitions, dissolutions, conversions, or consolidations), buybacks, issuances of additional securities with dilutive effects on shareholders, or contested elections for directors, are the types of votes that would materially affect the investment.
- Safe Harbor #2: 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 matter being voted upon is not expected to have a material effect on the investment performance of the plan’s portfolio (or investment performance of assets under management in the case of an investment manager).
In response to concerns raised by some commenters, the safe harbors in the final rule are intended to be flexible enough to clearly enable fiduciaries to vote to establish a quorum of mutual fund shareholders or on other fund matters. On this point, the DOL noted that fiduciaries may also adopt voting policies that consider the detrimental effect on the plan’s investment due to the costs (direct and indirect) incurred related to delaying a shareholders’ meeting. The rule envisions fiduciaries having considerable flexibility in fashioning proxy voting policies and the opportunity to deviate from the policies in certain instances.
Proxy advisors remain top-of-mind for the DOL. The safe harbors are intended to provide fiduciaries the ability to operationalize the rule without having to seek recommendations on a vote-by-vote basis from proxy advisors. The rule prohibits fiduciaries from adopting a practice of following the recommendations of a proxy advisory firm without first determining that such firm or service provider’s proxy voting guidelines are consistent with the fiduciary’s obligations under the rule.9 As with the SEC, the DOL expects fiduciaries, under certain circumstances, to conduct a more particularized voting analysis than what may be conducted under the general guidelines. The DOL acknowledged that some plans rely on proxy advisory firms’ pre-population and automatic submission mechanisms for proxy votes but noted that adopting such a practice for all proxy votes effectively outsources their fiduciary decision-making authority.
The rule continues to recognize and account for the fact that an investment manager of a plan asset pooled investment vehicle may be subject to an investment policy statement that conflicts with the policy of another plan investor. In this case, compliance with ERISA requires the investment manager to reconcile, to the extent possible, the conflicting policies (assuming compliance with each policy would otherwise be consistent with ERISA). In the case of proxy voting, the investment manager generally must vote (or abstain from voting) the relevant proxies to reflect such policies in proportion to each plan’s economic interest in the investment vehicle. Investment managers of pooled funds, however, typically develop an investment policy statement and require participating plans to accept the investment manager’s proxy voting policy as a condition to subscribe, which remains permitted under the rule. The investment manager’s policies would need to comply with this rule, and the fiduciary responsible for the plan’s subscription in the fund would be obligated to assess whether the investment manager’s policies are consistent with this rule before subscribing in the fund.10
As noted above, the rule does not directly apply to investment vehicles that do not hold plan assets, such as mutual funds. The rule, for example, does not require ERISA fiduciaries to scrutinize a mutual fund’s voting practices in which the plan has an investment. The DOL does, however, contemplate that ERISA fiduciaries will consider the mutual fund’s voting policies as part of its overall consideration of the mutual fund as a prudent investment in accordance with the Financial Factors rule. Thus, fiduciaries should consider whether the investment fund’s voting policies are expected to have a material effect on the risk and/or return of an investment.
The rule’s compliance date is Jan. 15, 2021, subject to the following:
- All fiduciaries should begin to review their proxy voting policies and practices in light of the new rule, especially plan investment committees and investment managers of separate accounts.
- Fiduciaries that are investment advisers registered with the SEC must comply by Jan.15, 2021, with respect to the requirements to (i) evaluate material facts that form the basis for any particular proxy vote or other exercise of shareholder right and (ii) maintain records on proxy voting activities and other exercises of shareholder rights. The DOL intends that these requirements align with existing obligations under the Advisers Act, including Rules 204-2 and 206(4)-6 thereunder and the 2019 SEC Guidance and 2020 SEC Supplemental Guidance. Other types of fiduciaries have until Jan. 31, 2022, to comply with these requirements.
- All fiduciaries shall have until Jan. 31, 2022, to comply with the requirements that they not adopt a practice of following the recommendations of a proxy advisory firm or other service provider without a determination that such firm or service provider’s proxy voting guidelines are consistent with the rule. Fiduciaries of pooled investment vehicles also have until that date to confirm the fund’s proxy voting policies with the rule.
1 The rule does not apply to the exercise of shareholder rights on behalf of non-ERISA plans, such as IRAs and governmental plans.
2 Investment companies registered under the U.S. Investment Company Act of 1940, as amended, do not hold plan assets and thus not subject to ERISA or this rule. Hedge funds and other commingled vehicles that fail to satisfy one of the exceptions set forth in the DOL’s plan assets regulation, on the other hand, are subject to ERISA and this rule. Similarly, bank-maintained collective investment trusts are subject to ERISA and this rule.
3 The rule does not apply to proxy voting that is passed through to participants and beneficiaries with accounts holding such securities in an individual account plan.
4 Firms that agree to act as “investment managers,” within the meaning of Section 3(38) of ERISA, should ensure the investment management agreement is clear on who has the responsibility to exercise shareholder rights on behalf of the plan. When the authority to manage plan assets has been delegated to an investment manager, the investment manager has exclusive authority to vote proxies or exercise other shareholder rights, except to the extent the plan, trust document, or investment management agreement expressly provides that the responsible named fiduciary has reserved to itself (or to another named fiduciary so authorized by the plan document) the right to direct a plan trustee regarding the exercise or management of some or all of such shareholder rights.
5 The proposed rule included a requirement that the fiduciary consider 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. The DOL eliminated this condition because of its potential compliance costs and that it may not be apparent that a particular vote will affect the plan’s investment return. A similar revision was made to the final Financial Factors rulemaking; thus, even the DOL admits fiduciaries need not be clairvoyant in evaluating how an investment decision, or the exercise of shareholder rights, on some basis (ESG or not) will materially affect the plan’s return in the future. Instead, fiduciaries should follow a thoughtful, prudent process in reaching the position that an investment, or the exercise of rights appurtenant to such investment, is in the economic interests of the plan.
6 As with the Financial Factors rulemaking, the DOL cautioned fiduciaries against taking too elastic an interpretation of economic benefits that could flow to the plan, by noting that “vague or speculative notions that proxy voting may promote a theoretical benefit to the global economy that might redound, outside the plan, to the benefit of plan participants would not be considered an economic interest under the final rule.”
7 The DOL also noted that it would “not be appropriate for plan fiduciaries, including appointed investment managers, to incur expenses to engage in direct negotiations with the board or management of publicly held companies with respect to which the plan is just one of many investors.” It is questionable whether this assertion is supported by the rule itself.
8 The DOL acknowledged that multiple investment managers may be responsible for managing a plan’s assets, and accordingly revised the rule to permit each investment manager to apply the rule to its specific mandate. The DOL noted, however, that “where the plan’s overall aggregate exposure to a single issuer is known, the relative size of an investment within a plan’s overall portfolio and the plan’s percentage ownership of the issuer, may still be relevant considerations in appropriate cases in deciding whether to vote or exercise other shareholder rights.”
9 The fiduciary selecting and using a proxy advisor, therefore, must review the proxy advisor’s voting guidelines against this rule in addition to separately determining whether a specific recommendation necessitates a particularized analysis. The review of the proxy advisor proxy voting guidelines should be addressed at the outset of the relationship with the proxy advisor and when the proxy advisor updates its guidelines (e.g., annually).
10 Uniform policies utilized by the investment manager across client accounts are still permissible under the rule, provided the policies comply with this rule.