Whether—and How—to Vote Proxies

Art by Tim Bower

On September 4, the Department of Labor (DOL) published a proposed regulation regarding the fiduciary duties under the Employee Retirement Income Security Act (ERISA) that apply when a fiduciary exercises proxy voting rights. The proposal, if finalized in its current form, could have a substantial impact on how investment managers approach the voting of proxies. The DOL’s proposal comes on the heels of the final proxy voting regulations adopted by the Securities and Exchange Commission (SEC) on July 22.

Background

The DOL has held the position that the fiduciary act of managing ERISA-covered plan assets includes the management of voting rights, and shareholder rights, appurtenant to shares of stock. A fiduciary must exercise such duties prudently and solely for the “economic benefit” of participants and beneficiaries. In many cases, a plan’s named fiduciary will delegate its management authority, including that of exercising proxy voting rights, to a registered investment adviser (RIA) or other financial institution that manages plan assets on a discretionary basis. That manager, in turn, will often engage a third-party proxy voting advice business to, among other things, exercise proxy rights or provide advice as to how the manager should do so. In other cases, the plan’s named fiduciary will retain the authority to vote by proxy, but may engage a proxy voting advice business as well.

The Proposal

In the proposal, the DOL emphasizes its view that plan fiduciaries fail to understand that ERISA’s fiduciary rules don’t require a fiduciary to vote each and every proxy. It expressed concern that plan fiduciaries may be imposing costs on the plan that exceed the economic benefits it receives from voting the proxies. Further, the department is of the view that many plan fiduciaries rely on third parties such as investment managers or proxy voting advice businesses to exercise a plan’s proxy rights or to provide recommendations without taking steps to confirm that the voting advice is rigorous, impartial and consistent with the plan’s economic goals.

To address its concerns, the DOL proposes to impose specific requirements on the party responsible for exercising proxy rights. These requirements must be met for purposes of determining whether the plan should exercise its proxy rights in the first place and, if so, how to do so. The responsible fiduciary must, among other things, act solely in accordance with the economic interests of the plan and not subordinate those to any non-pecuniary objectives, or sacrifice investment risk or return to promote nonfinancial interests. To conduct its analysis, the fiduciary must investigate material facts concerning the vote. Further, the fiduciary must consider the proxy’s “likely impact on the investment performance of the plan based on such factors as the size of the plan’s holdings in the issuer relative to the total investment assets of the plan, the plan’s percentage ownership of the issuer, and the costs involved.” The DOL appears to be stating that a fiduciary should not vote a proxy if its interest in the issuer is insufficient to influence the outcome of the vote.

The proposed regulation also imposes substantial requirements on the fiduciary who delegates proxy voting authority to a manager or who engages a proxy advisory business. Such fiduciary would have to ensure the manager or advisory firm has policies and procedures in place designed to assure compliance with the regulatory requirements. Additionally, in the case of a pooled “plan asset” vehicle, the fiduciary would have to confirm the vehicle’s manager has procedures in place to make sure it properly voted proxies with regard to each plan investor. The proposal also appears to require the fiduciary to engage in a process whereby it reviews each of the proxy decisions. Traditionally, fiduciaries who have delegated investment management functions have not been required to perform this level of oversight over the delegate.

Sponsor Implications

One may read the proposal as suggesting that the DOL believes that managers who exercise proxy rights on behalf of ERISA plans do so when the economic benefits to the plan are so small that they are outweighed by the costs of exercising the proxy rights, including whether to exercise the rights in the first place. Additionally, some fiduciaries apparently make decisions based upon non-pecuniary factors that are not solely for protecting the economic interests of the plan—e.g., to promote social or policy causes. As a result, if the DOL adopts the regulation, named fiduciaries, managers of employee benefit plan assets and proxy advisory businesses likely will have to make substantial changes to their proxy voting policies and procedures.

David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers.