Investors’ ability to manage assets and exercise shareholder voting rights to create value and mitigate risk are again under attack in Washington, D.C., this time by the Department of Labor (“DOL”). Fresh on the heels of the SEC’s July adoption of new proxy advisor rules – not to mention its expected move this week to make it harder to file shareholder proposals – and shortly after the comment period on its widely-panned ESG investing rule closed, the DOL has launched yet another regulatory broadside against the investor community. The topic: proposed rules aimed at reducing corporate accountability by limiting when and how private retirement plans and their asset managers can cast proxy votes.
While the DOL has issued guidance on proxy voting on a number of occasions over the last thirty years, this would be its first regulation on the subject. And it would turn the existing guidance on its head – creating a regulatory scheme that presents ERISA fiduciaries with the Hobson’s choice of either spending plan assets on unnecessarily burdensome cost-benefit analyses of whether and how to vote on each ballot item or adopting a “permitted practice” of either voting with management or not voting on almost all ballot items. Private plans and their asset managers, as well as other stakeholders, should be aware of this latest proposal and weigh in with the DOL by the October 5 comment deadline.
Overview of the Proposed Rules
The new rule would have three primary parts:
- A new requirement that each decision to vote a proxy proposal be justified by what the DOL characterizes as “individual cost/benefit analyses.” Specifically, the new rule would add six factors that must be considered both in “deciding whether to exercise shareholder rights and when exercising shareholder rights.” Among the mandatory considerations, the fiduciary must:
- Consider “only factors that they prudently determine will affect the economic value of the plan’s investment;”
- “Investigate material facts that form the basis for any particular proxy vote;” and
- “Maintain records . . . that demonstrate the basis for particular proxy votes.”
- A new rule that would make each decision whether to cast a proxy vote a potential ERISA violation. Specifically, the rule would say that a plan fiduciary “must not vote any proxy unless the fiduciary prudently determines that the matter being voted upon would have an economic impact on the plan after considering those factors described [in point 1 above] and taking into account the costs involved (including the cost of research, if necessary, to determine how to vote).” Conversely, if the fiduciary can make this determination, they must vote.
- A regulatory safe harbor for voting with management or not voting. Specifically, the rule would establish three “permitted practices” that the DOL “anticipates that most, if not all plans, will” use because they avoid the costs of the analyses required by points 1 and 2 above:
- A policy of voting with management on all or most ballot items;
- A policy of only voting on special situations, such as M&A transactions and contested elections of directors;
- A policy of not voting unless the plan’s holding of the company involved exceeds a threshold (the release suggests 5%) of the plan’s total holdings.
The proposed rule is a blatant attempt to prevent ERISA plans and their asset managers from exercising their rights as shareholders. It threatens these fiduciaries with potential liability based on the outcome of costly, burdensome and uncertain analyses. And, in what amounts to more of a regulatory shove than a nudge, it seeks to coerce them into routinely siding with management or not voting.
Perhaps this just reflects a lack of understanding by the DOL of the importance of shareholder engagement. However, the extreme approach taken in the proposed rules, coupled with the short 30-day comment period, suggests this is more a politically-motivated and misguided effort to benefit the management of certain companies to the detriment of retirement plan participants. After all, the rulemaking grew out of an Executive Order whose purpose was “to promote private investment in the Nation’s energy infrastructure.”
It is still critical for investors and other stakeholders to voice their concerns with the DOL and explain the flaws in its proposal. By law, the DOL has to consider and respond to the comments it receives in any final rule. And an agency must base its rules on evidence and provide a reasoned explanation for its actions. Even if the DOL moves forward, comments could lay the groundwork for a legal challenge or help demonstrate why the rule should be undone – through regulation or legislation – in a future Administration. There are a number of issues to raise.
To begin with, the rule lacks an evidentiary basis. The DOL claims to be concerned about the costs of plans’ proxy voting. But the DOL presents no evidence of excessive costs or plan assets being used imprudently on proxy voting today. As the DOL’s own current guidance recognizes:
In most cases, proxy voting and other shareholder engagement does not involve a significant expenditure of funds by individual plan investors because the activities are engaged in by institutional investment managers . . . . Those investment managers often engage consultants, including proxy advisory firms, in an attempt to further reduce the costs of researching proxy matters and exercising shareholder rights. . . . [M]any proxy votes involve very little, if any, additional expense to the individual plan shareholders to arrive at a prudent result. (emphasis added; footnote omitted)
Ironically, the proposal would actually create the problem the DOL purports to be concerned about. The DOL’s 2016 guidance explicitly reassured fiduciaries that, absent unusual circumstances, they do NOT need to engage in a “cost-benefit analysis” before voting proxies. Now, however, the DOL would mandate that each proxy vote be justified through “individual cost/benefit analyses,” that would include a “determination” that the matter being voted on “would have an economic impact on the plan.” The economic analysis projects that researching and documenting these analyses would take asset managers from 40 minutes (for routine items) to 2-½ hours (for special situations) for each proxy vote, resulting in an aggregate compliance burden to ERISA plan asset managers of some $13 billion a year. (The “illustration” that serves as the proposal’s economic analysis ignores the role of proxy advisors or an asset manager establishing a practice of voting in line with a pre-established investment policy statement.) The DOL, however, does not even acknowledge that this is a change from its own guidance, much less provide a reasoned basis for the change.
Nor does the DOL explain what it would take to demonstrate that a specific proxy vote could be “determine[d]” to have an “economic impact” on the plan, a standard that seems ill-suited to the purpose and role of proxy voting. As one ERISA lawyer explained, the proposed rule “could present real practical challenges in that benefits from shareholder engagement are often long term in nature. So we’ll have to look at the rule carefully in order to see if this is remotely workable in the real world.”
The proposal is also laced with unwarranted and unsupported skepticism about the value of proxy voting. The DOL contends that ERISA fiduciaries are allowing “plan assets to be used to support or pursue proxy proposals for environmental, social, or public policy agendas that have no connection to increasing the value of investments,” and argues that evidence of the benefits of shareholder engagement is “mixed.” But these assertions are thinly (and opportunistically) supported. The DOL’s current guidance recognizes “the long-term financial benefits that, although difficult to quantify, can result from thoughtful shareholder engagement when voting proxies, establishing a proxy voting policy, or otherwise exercising rights as shareholders.” Shareholder votes on the election of directors (which constitute a majority of proxy votes) convey important information about shareholders’ views and can and do affect companies’ decisions about who should serve as corporate directors. The DOL’s stance here also ignores the increasing amount of evidence emerging about the importance of ESG considerations to long-term, enterprise value.
Having saddled ERISA fiduciaries with these burdensome analyses, the proposal would then offer them an easy way out – the “permitted practices” of voting with management or not voting. And, in fact, this is the purported benefit of the proposal: “The Department anticipates that plans would derive savings from the proposal’s ‘permitted practices.’” Here, again, though, the DOL offers no rational basis for steering fiduciaries into these practices.
Shareholders’ voting rights are granted by state corporate law (and, in the case of say-on-pay, federal legislation). The DOL does not offer any good reason to supplant the considered judgment of established and traditional authorities on corporate governance with its own judgment of when shareholders should be voting. The DOL’s primary argument is that ERISA fiduciaries can rely on the recommendations of officers and directors because they have fiduciary duties to the company under state corporate law. But the law imposes these duties because management’s interests differ from those of the company’s shareholders. Moreover, state corporate law requires shareholder votes precisely because managers’ fiduciary duties alone are not adequate to align management’s and shareholders’ interests. Moreover, as Professor Ann Lipton has pointed out, courts often lightly enforce these duties because shareholders have other means to oversee management, such as proxy voting. The DOL offers no rational explanation of why routinely voting for the proposals of someone with divergent interests than plan participants, including on matters like executive pay, would be consistent with a fiduciary’s duties of loyalty and prudence, let alone why ERISA should favor it.
The DOL also defends robo-voting for management because “nearly all management proposals are approved with little opposition.” But this is akin to arguing that a bank doesn’t need a security guard because most days no one tries to rob it. The value of the shareholder franchise comes from the ability to exercise it when needed (even if in a small percentage of cases) and management’s knowledge that any of their proposals could be met with similar disapproval. After all, management may no longer feel constrained to offer proposals that are usually acceptable to their shareholders if federal regulations prevent shareholders from voting on them.
The DOL has offered an unusually short comment period. Given what is at stake, commenting is critically important. Therefore, we strongly encourage the investment community to express its views to the DOL by the comment deadline of October 5.
Comments can be submitted electronically at the Federal eRulemaking Portal.