Shareholder Rights, ESG Rules Begin Friday

Part of a Department of Labor rule regarding the selection of plan investment and shareholder rights—often called the ESG rule—will be fully in effect on Friday, December 1.

Part of the Final Rule on Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights has been in effect since January 30, which includes permitting plans governed by the Employee Retirement Income Security Act to use environmental, social and governance factors in investment selection, including as their qualified default investment alternative. It also permits plans to use a relaxed “tiebreaker” rule which allows them to use non-financial criteria to decide between two investment options that would both equally serve the interests of the plan.

The second half of the rule, which speaks to shareholder rights and proxy voting, takes effect in December. The DOL removed language from old rules that the department believed incentivized abstentions on shareholder proposals, an excision that will remove a safe harbor voting policy that limited “voting resources to 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.”

Ruth E. Delaney, a partner in K&L Gates LLP, says the rule reiterates the principle that a fiduciary’s duty to manage plan assets includes the management of shareholder rights, including the right to vote proxies.

In the context of pooled investment vehicles, where multiple plans may be subject to proxy voting policies that conflict with the policies of other plans, the manager would be required, to the extent possible, to reconcile conflicting policies and vote proxies proportionately in accordance with each plan’s interest in the vehicle.  However, consistent with longstanding guidance, a manager may, instead, require investors to accept the manager’s own proxy voting policy as a condition of a plan’s investing in such vehicle. 

However, Delaney explains that existing investors are not grandfathered in explicitly by the rule, and managers may need to take steps to get consent from their investors to follow the manager’s proxy voting policy. Delaney says some managers have drafted negative consent forms: Investors already in those funds are assumed to have consented by saying nothing. The DOL declined to explicitly approve of or forbid this approach, according to Delaney.

Fiduciary managers have until Friday to avoid compliance issues by obtaining consent.

Delaney says the rule also permits fiduciaries to use ESG considerations when voting on shareholder proposals and when making recommendations on those votes.

Delaney adds that the rule “codifies longstanding principles” that already existed, such as the notion that fiduciary duty requires the prudent exercise of shareholder rights. Abstentions are permitted in cases where it would be prudent, such as when the voting process would be costly to the plan.

Under the rule, fiduciaries are required to “prudently select and monitor a service provider,” but this does not require them to “monitor in real time every vote.” Instead, the fiduciary must follow a prudent process in picking service providers and must ensure their activities align with their investment policy, Delaney says.