Sunday, December 20, 2020

Compliance with the DOL's New Proxy Rules May Stump ERISA Fiduciaries

A counter-revolution in ESG Investing?

Author: David Schwartz J.D. CPA

On Friday, December 11, the Department of Labor (DOL) issued its final rules on proxy voting by ERISA fiduciaries. As proposed last August 30, the draft rules drew hundreds of responses by the ESG-directed investing community, many of which criticized the proposal as unworkable. The final version of the rules eliminates the proposal's rigid requirements for plan sponsors to weigh the economic vs. non-economic effects before casting their proxy votes. Yet that softer, principles-based approach may itself create compliance problems for ERISA fiduciaries -- and may not even survive the first hundred days of the Biden administration.

Commenters seem to have persuaded policy-makers at DOL that compliance with the original draft rules would have been too costly and complex to implement. Rather, the Labor Department focused the final rule on "whether a fiduciary has a prudent process for proxy voting and other exercises of shareholder rights" as a more workable framework for achieving the DOL's objectives. 


What is the Purpose of the Rules?

What were the DOL's stated objectives with its new proxy guidelines? The DOL sought to rectify a "persistent misunderstanding" that ERISA fiduciaries must vote all proxies. According to Jeanne Klinefelter Wilson, acting assistant Secretary of Labor for the Employee Benefits Security Administration, these new proxy restrictions are meant to ensure that ERISA fiduciaries are only expending resources researching and voting proxies that have a financial effect on the plan:


"The plan fiduciary must never subordinate the interests of participants and beneficiaries in their retirement income to unrelated objectives, including promoting non-pecuniary goals or benefits."


What do the Rules Require?

The final proxy voting rule makes clear that fiduciaries are not required to vote every proxy. It outlines six points a fiduciary must undertake when making decisions on exercising shareholder rights, like proxy voting:

  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 to any non-pecuniary objective.
  4. Evaluate material facts that form the basis for any particular proxy vote.
  5. Maintain records on proxy voting activities and other exercises of shareholder rights.
  6. Exercise prudence and diligence in the selection and monitoring of proxy advisory firms.[1]


The DOL's new rules have two safe harbor provisions. ERISA fiduciaries adopting at least one of these policies will be considered to have satisfied their responsibilities when deciding whether to vote proxies.  

  1. Adopting a policy that proxy 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."
  2. Refraining from voting on 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.[2]

Fall-out Effects on Fiduciaries

Securities Lending.  Even with the change to a more principles-based regime from the rules as proposed, these new requirements can be a hardship on ERISA fiduciaries and costly to the plans they manage. Outside of the safe harbors, the complex calculus an ERISA fiduciary must now engage in for each and every proxy voting decision just became more time-consuming and expensive. Plus, ERISA plans with securities lending programs may find their previous discretion regarding whether to recall loaned securities to vote their proxies has been all but eliminated. As SIFMA pointed out in their comment letter on the proposal: 


"Moreover, there may be logistical challenges with determining the economic benefits of some proposals. For example, when an institution lends shares under a securities lending program, it cannot generally vote those shares at an upcoming shareholder meeting if the shares are on loan on the record date to identify voting rights. Because the institution may not know what will be on the meeting agenda until after the record date, it would not be able to perform a rigorous "economic analysis" to determine whether the benefits of recalling or objective costs associated with a recall or restriction, the likely outcome is that these shares would not be voted." [3]

Voting ESG Proxy Matters.  Despite numerous mentions in the rule's preamble, the term "ESG" is not mentioned anywhere in the rule text. According to the DOL, The lack of a precise or generally accepted definition of 'ESG,' either collectively or separately as 'E, S, and G,' made ESG terminology not appropriate as a regulatory standard. . . The focus on the final rule is on whether a factor is pecuniary, not whether it's an ESG factor." [4]   Nonetheless, ERISA fiduciaries are going to find it difficult to justify voting proxies for a whole host of issues that are not so clearly tied to a pecuniary benefit to the fund. The DOL counters, however, that voting on ESG-related proxies is still an option. Jeanne Klinefelter Wilson, acting assistant Secretary of Labor for the Employee Benefits Security Administration said of the rules:


"Now, this does not mean that fiduciaries are prohibited from considering such issues as environmental impact and workplace practices when they are relevant to the financial analysis. Because these issues are pecuniary in that instance, and therefore appropriate considerations under the rule."


On the other hand, it is fairly well known that these rules arise out of the perceived skepticism of ESG by the current administration. George Michael Gerstein, co-chairman of the fiduciary governance group at Stradley Ronon Stevens & Young recently said of the rules:


"I think many view as being the impetus for the financial factors rule and this rule and that it was designed to target ESG in some way," Mr. Gerstein said, referencing a Labor Department rule that was finalized in October and requires ERISA plan fiduciaries to select investments based on pecuniary factors. "I think the DOL has at least attempted to allay those concerns but the devil is ultimately going to be in the details, which is whether the rule has enough clarity that it's not going to chill activity that was otherwise commonplace."[5]


During the comment period, ERISA fiduciaries like TIAA urged the DOL to soften its apparent stand against ESG investing. In their comments, TIAA argued that ESG factors do not always have an immediately discernable pecuniary effect, but rather can enhance a company's shareholder value in less tangible ways like risk reduction and reputational value. They also noted that the rules as proposed (and ultimately adopted) make these kinds of considerations more, not less, difficult for ERISA fiduciaries. 


"while not every ESG issue subject to a proxy vote has economic implications, ESG factors are often in direct alignment with a company’s pecuniary considerations – and thus it is often the case that voting proxies on ESG-related issues is in the economic interest of investors."  

"Given the direct link that can exist between a company’s financial performance and its handling of  ESG  factors,  we believe plan fiduciaries are well justified in expending resources to make careful informed proxy voting decisions on  ESG-related items on behalf of plans and plan participants. The Proposed Rule would make it even more expensive and difficult for plan fiduciaries to make these voting decisions."[6]


Will the Rule Survive? 

Successive administrations have fought over how often ERISA fiduciaries must undertake this cost-benefit analysis concerning proxy voting and other shareholder rights, making new rules and moving the goalposts with each new Secretary of Labor. Presumably, President Biden's administration will swing policy back to a more favorable posture to ESG investing and proxy voting by ERISA fiduciaries. Given the outcry against this rulemaking, it would not be at all surprising if the new DOL leadership amends or repeals these burdensome proxy rules. 



[1] DOL Fact Sheet,

[2] Ibid.

[3] SIFMA Comment Letter

[4] DOL Fact Sheet, see note [1] above.


[6] TIAA Comment Letter