Proxy Proposal Angers Institutions

This article by Brian Croce originally appeared in Pensions & Investments on September 7, 2020.

A Department of Labor proposal requiring ERISA-governed fiduciaries to cast proxy votes only when there is an economic impact on the retirement plan is misguided, sources say, but stakeholders from the business community have applauded the initiative.

“It’s just a reflection of the fact that institutional investors have become more aware of corporate governance as an element of shareholder value and corporations don’t like that,” said Nell Minow, Washington-based vice chairwoman of ValueEdge Advisors, which advises institutional investors on corporate governance issues. “The DOL is trying to give a great big fat giveaway to the very last people they should be concerned about to the detriment of (participants).”

Will Hansen, executive director of the Plan Sponsor Council of America and chief government affairs officer at the American Retirement Association in Washington, said the PSCA is concerned that the proposal is a step too far in regulating the activities of plan sponsors.

“While plan sponsors appreciate the ability to have guidance on when they do not need to exercise their proxy rights, some plan sponsors still seek the ability to always exercise their proxy rights,” Mr. Hansen said. “In addition, PSCA is unaware of any evidence that there is a significant problem with the use of plan assets in proxy activities.”

In continuing its recent flurry of rule-making proposals — which includes an effort unveiled in June stipulating that ERISA plan fiduciaries cannot invest in ESG vehicles that sacrifice investment returns or take on additional risk — the Labor Department on Aug. 31 proposed a rule to ensure that ERISA plan fiduciaries “keep their eyes properly focused on the interests of ERISA plan participants,” a senior official said on a call with reporters.

What to consider

The proposal would apply to the fiduciary who is ultimately responsible for a plan’s proxy voting and shareholder engagement efforts, whether internally or externally managed. It outlines specific steps fiduciaries must take when deciding whether to exercise shareholder rights and voting proxies, including a requirement to consider the likely impact on the investment performance of the plan; investigate the material facts that form the basis for any particular proxy vote or other exercise of shareholder rights; and maintain records on proxy voting activities and other exercises of shareholder rights.

“The plan fiduciary must never subordinate the interests of participants and beneficiaries in their retirement income or other benefits to unrelated objectives, including promoting non-pecuniary goals,” the senior Labor Department official said.

The U.S. Chamber of Commerce, which has long advocated for regulations curtailing what it calls “nuisance” shareholder resolutions and the outsized influence of proxy advisory firms, welcomed the Labor Department’s initiative.

“This proposal will strengthen investor protection and promote the interests of retirees,” said Thomas Quaadman, executive vice president of the Chamber’s Center for Capital Markets Competitiveness in Washington, in a statement. Along with recent actions taken by the Securities and Exchange Commission, the “DOL proposal will ensure that proxy voting is directly tied to the economic return for retirees and follows a transparent and unconflicted process,” Mr. Quaadman added.

In July, SEC commissioners approved sweeping changes to the rules governing proxy advisory firms, including a requirement for those firms to disclose conflicts of interests to clients and allow companies that are the subject of voting advice to be able to access that advice before or at the same time as the advice is disseminated to clients.

Proponents of additional proxy regulation have said that automatic, or “robo” voting, when a proxy ballot is prepopulated with an advisory firms’ recommendation and submitted before client review, is a problem in need of reform, a claim disputed by the institutional investor community throughout the SEC rule-making process.

“This ‘automatic voting’ prohibits pension beneficiaries from having full transparency on the proxy votes that affect them,” said Christopher Burnham, president of the Washington-based Institute for Pension Fund Integrity, in a statement. “The SEC rightfully issued guidance to restrict this mismanaged practice and the Labor Department should similarly issue new oversight to this end. A process for review and rectifying flaws in the research and recommendations by proxy voters better legitimizes the proxy process and ensures that shareholders are voting with accurate information.”

The Labor Department also outlined the “permitted practices” that a fiduciary could adopt in order to comply with the proposal, including voting proxies in accordance with the voting recommendations of a corporation’s management on proposals that the fiduciary has prudently determined are unlikely to have a significant impact on the value of the retirement plan’s investment.

George Michael Gerstein, co-chairman of the fiduciary governance group at Stradley Ronon Stevens & Young LLP in Washington, called that permitted practice a “nudge toward following management’s recommendations.”

Moreover, defining an economic benefit for a plan might be difficult, Mr. Gerstein added. “The way the proposal is currently drafted, I think there’s a real question as to whether long-term benefits that are not easily quantifiable in the here and now will pass muster under the proposal,” he said. “That has a significant consequence because any engagement takes a long time to materialize. If you’re engaging a company board on an ESG issue, it could take months or years to get to the point where there’s greater disclosure or they amend certain practices.”

That outstanding question and whether there’s a true economic consideration for a plan in voting a given proxy are going to present litigation risks, and “it’s going to be incumbent upon fiduciaries to show that they considered these issues,” Mr. Gerstein said.

Comment period

Like its other recent rule proposals, the Labor Department is soliciting comments for 30 days, as opposed to 60 or 90 days, which are more typical.

Mr. Gerstein said the quick comment period indicates the Labor Department’s intent to move fast on this issue and others, which is not uncommon at this point in the legislative calendar. “I think it’s typical for an administration to see that the first term is winding down and they want to get stuff out,” he said, adding that no administration assumes it will be re-elected.

Ms. Minow said the Labor Department is “trying to get all the horses out of the barn before the door closes.”

Maureen O’Brien, Chicago-based vice president and corporate governance director at Segal Marco Advisors, said the 30-day comment period is an “aggressive window in which to solicit comment particularly given the complex and highly impactful nature of the proposal. The apparent goal of the draft rule is a stark departure from how the department has viewed proxy voting for more than three decades.”

After looking over the proposal, Mr. Gerstein said the Labor Department expressed skepticism that proxy voting is in fact beneficial to ERISA plans. “That is a premise they’re starting from,” he said. “So in terms of how the industry thinks about responding in a short comment period, the DOL is going to need some convincing that the voting and the engagement is worth it to plans as long-term investors.”

If implemented, the rule will likely be treated as “an insignificant compliance issue,” because the value and impact of proxy votes is already well established, Ms. Minow said. “Nevertheless, this rule is an atrocity,” she added. “There’s no way that it could withstand a challenge in court, and we’ll do everything we can to make that clear during this idiotically truncated comment period.”