New Guidance Restores 1994 ERISA Proxy Voting Interpretation
The DOL bulletin also clarifies the ability to consider ESG factors in proxy voting and shareholder engagement.
On December 29, 2016, the Department of Labor (DOL) issued Interpretive Bulletin 2016-1 (IB 2016-1), addressing how the Employee Retirement Income Security Act’s (ERISA’s) fiduciary responsibility rules apply to proxy voting, maintenance and compliance with investment policy statements, and active engagement with corporate management by plan fiduciaries, as well as other legal rights of shareholders.
This bulletin withdraws Interpretive Bulletin 2008-2 (IB 2008-2), issued at the end of the Bush administration, and returns in several respects to the positions described in the predecessor to IB 2008-2—Interpretive Bulletin 94-2 (IB 94-2) from the Clinton administration—with some notable modifications.
The DOL explains that, in its view, IB 2008-2 has been misunderstood in a way that has discouraged ERISA plan fiduciaries from voting proxies and engaging in other prudent exercises of shareholder rights, through its statement that plan fiduciaries need to take into account the costs of exercising such rights. According to the DOL, this statement has been read by some to require as a general rule that the plan perform a cost-benefit analysis and be able to conclude, in each instance, that a proxy vote or exercise of shareholder rights is more likely than not to increase the economic value of the plan’s investment.
IB 2016-1 addresses these concerns by explaining that the dual obligations of prudence and loyalty require the responsible fiduciary to vote proxies on issues that may affect the plan’s investments, while recognizing that some cases, such as voting proxies on shares of foreign corporations, may involve unusual requirements. In such special circumstances, a discrete analysis of the cost of the shareholder activity versus the economic benefit associated with the outcome of the activity is warranted. But the DOL notes that this type of analysis does not need to be done in most cases, as it is the DOL’s understanding that many proxy votes involve very little, if any, additional expense to the individual plan shareholders to arrive at a prudent result.
IB 94-2 had raised the concern that the DOL viewed fiduciaries as responsible for voting proxies regardless of the cost of doing so, and IB 2008-2’s changes were intended to make clear that cost is a relevant consideration. One of the areas of concern had been index funds, whose holdings are dictated by the underlying index and the cost of voting all of a fund’s different holdings can be a material consideration, especially for a fund tracking a large index. Any additional costs associated with managing an index fund can introduce “tracking error” that diverges from the performance of the index, so the goal is to minimize expenses. However, the current guidance appears to take a different perspective. The preamble to IB 2016-1 notes that the pervasiveness of US publicly traded stock in ERISA plan investment portfolios, such as index funds, is a factor contributing to the importance of proxy voting and shareholder engagement.
IB 2016-1 further provides, as in IB 94-2, that a statement of proxy voting policy is an important part of a comprehensive statement of investment policy, adding that a statement of investment policy can include policies concerning economically targeted investments or incorporating environmental, social, or governance (ESG) factors. ESG considerations have also been added as issues that could be an appropriate subject for shareholder engagement activities. Despite addressing ESG factors in IB 2015‑1, the DOL believed that statements in IB 2008-2 caused confusion as to whether or how a plan fiduciary may consider ESG issues in connection with proxy voting or other shareholder activities.
The DOL cites the growing number of institutional investors that are engaging companies on ESG issues as proof that there are financial benefits associated with shareholder engagement, and highlights the merits of shareholders taking a more engaged role with the companies. Thus, IB 2016-1 states that if a fiduciary concludes that there is a reasonable expectation that shareholder engagement on ESG issues is likely to enhance shareholder value, after taking the costs involved into account, a fiduciary can, consistent with under ERISA, take into account ESG impacts in proxy voting and shareholder engagement. Making clear that ESG considerations can be taken into account when making investment decisions should permit plan fiduciaries more flexibility in determining a prudent course of action.
The DOL also sought to lower the threshold for shareholder engagement activities, by changing the standard from the plan fiduciary having a reasonable expectation that such activities “will enhance the economic value of the plan’s investment” to “is likely to enhance the value of the plan’s investment,” restoring the original language of IB 94-2. The DOL indicated its concern that the language of IB 2008-2 suggested a “more likely than not” standard that could be read as “discouraging fiduciaries from recognizing the long-term financial benefits that, although difficult to quantify, can result from thoughtful shareholder engagement.”
Given the history of each administration revising its predecessor’s positions on proxy voting and shareholder activism, it is conceivable that this guidance may be subject to further consideration by the next administration. But, if so, this may not be a high priority. Thus, until further notice, plan fiduciaries and investment managers for ERISA plans should assess how the most recent changes impact their oversight and implementation of proxy voting for the plan assets they manage and their approach to shareholder activism. It may also be a good time to review and update proxy voting policies to ensure they are consistent with current practices.