IPFIUSA

Institute for Pension Fund Integrity advisory board members and former pension fund officials have submitted comment letters on a proposed regulation by the Department of Labor concerning the role of proxy advisory firms in ERISA pension investment. If it is put into place, the rule would have a significant impact on the reach of proxy voting, the power that proxy advisory firms have on pension investment decisions, and the extent to which politicized decision making has undermined the fiduciary obligations of pension fund managers.

Coming in the wake of the Department’s recent proposed rule on environmental, social, and governance (ESG) investments, as well as guidance from the Securities and Exchange Commission, this new rule reinforces the principle that fiduciaries can consider proxy decisions based only on economic considerations and not on “unrelated objectives.” The proposal rightly also takes aim at the costs of the proxy advisory decision process – costs that are ultimately borne by the ERISA pension beneficiaries.

IPFI President and former Connecticut State Treasurer Christopher Burnham states in his letter that “One of the most significant aspects of the proposed rule is the fact that plan fiduciaries will no longer have to vote on all proxy matters – specifically, that ‘fiduciaries must not vote in circumstances where plan assets would be expended on shareholder engagement activities that do not have an economic impact on the plan.’ … For pension beneficiaries, especially those in smaller plans who may lack the resources to pour into evaluating every proxy firm recommendation, the added convenience and lower costs stemming from this reform cannot be underestimated.”

IPFI Advisory Board member and former Ohio State Treasurer Ken Blackwell notes that “The proposed rule seeks to address the outsized roles that proxy advisory firms have in investment decisions and examine whether their recommendations are always economically beneficial to pensioners. The proxy system has long been taken advantage of by those without fiduciary responsibilities, preventing sound advice from reaching the nation’s pension and investment funds and retail shareholders.”

Beyond the scope of the proposed rule, IPFI believes that more action should be taken to address the outstanding issue of robo-voting and the negative impact that it has had for pension beneficiaries – the process by which asset managers and other investors automatically vote in line with the recommendations provided to them by proxy advisory firms. While many major institutional investors do spend considerable resources evaluating proposals from management and shareholders, this is certainly not the case overall. An overwhelming number of fund managers have outsourced the oversight and decision-making process to proxy advisors. Specifically, IPFI’s board members recommended that the Department of Labor prohibit robo-voting in controversial and contested matters or for ESG-related shareholders proposals that do not prioritize pecuniary objectives for pension beneficiaries.

Board member and former New York State AFL CIO Board Vice President Richard Brower notes that “one powerful option could be to place stronger limits on robo-voting in instances where there is a contested proxy firm recommendation…If there is no contestation, proxy voting may go forward unimpeded. Ultimately, the goal should be to provide pension beneficiaries with all of the insight they need into how their money is managed, while simultaneously finding avenues for cost-savings when available.”

The Institute for Pension Fund Integrity believes that ERISA standards must be modernized in order to set in stone the underlying fiduciary principles that have been the cornerstone of responsible pension management. While individual investors, endowments, and corporations should be free to pursue whatever investment strategy they see fit based on their needs, the unique nature of pension funds requires that fund managers steer clear of any political agenda.

The Department of Labor should be applauded for taking this necessary step toward clarifying and correcting guidance on the fiduciary obligations of pension fund managers as far as their relationship with proxy advisory firms is concerned, and it is our hope that leaders in business, finance, and public policy will voice their support for this initiative.

Click here to read the comment letter by IPFI President and former Connecticut State Treasurer Christopher Burnham.

Click here to read the comment letter by IPFI Advisory Board member and former Ohio State Treasurer Ken Blackwell.

Click here to read the comment letter by IPFI Advisory Board member and former New York State AFL CIO Board Vice President Richard Brower.

This article originally appeared in Bloomberg Law on September 25, 2020.

Companies looking to tap into the $12 trillion market for sustainable and socially responsible investments face myriad challenges—including moving targets and shifting political winds.

That’s where the lawyers come in. The boom in investors looking to bankroll companies advancing certain environmental, social, and governance priorities has ramped up demand for law firms that can help businesses live up to the wide array of expectations.

“There’s no uniform body of criteria or objectives” for gauging a company’s commitment to ESG principles, said Heather Palmer, a partner at Sidley Austin LLP. There are plenty of acronym-heavy organizations that recognize companies for voluntary ESG commitments, but no “coalescence around a specific standard,” she said.

Nimble law firms are responding by creating specialized legal teams across practice areas to demystify current ESG standards, from diversity and executive compensation obligations to global pollution initiatives. They’re also helping prepare for new U.S. restrictions on ESG investing from President Donald Trump’s administration.

ESG-related assets topped $12 trillion in 2018—an 18-fold increase from the $639 billion in play two decades ago—according to the Forum for Sustainable and Responsible Investment, which has been tracking ethically motivated investing since 1995.

BlackRock Inc. CEO Larry Fink declared sustainable investing the “strongest foundation for client portfolios going forward,” in a January letter.

“We’ve really reached sort of a tipping point,” Melissa Bender, an asset management partner at Ropes & Gray, told Bloomberg Law. “ESG integration is here to stay.”

New Kids on the Block

Some firms are treating ESG as “the next new thing,” Ropes & Gray strategic transactions partner Michael Littenberg said. But the principles have been steering financial decisions for decades, he said.

Whether they’ve been parsing ESG for a few weeks now or grappling with the underlying issues since the Watergate era, the number of Big Law firms assembling one-stop shops to quell fears about the multifaceted investment strategy keeps growing.

Winston & Strawn LLP joined the fray in August, unveiling a new ESG advisory team dedicated to making sense of it all. Partners Mike Blankenship and Eric Johnson tapped nearly a dozen attorneys who’ve made careers out of troubleshooting issues like shareholder activism, regulatory compliance, and crisis management.

The new team is the “culmination of issues around human capital that we’ve seen for many, many years,” employment litigator Cardelle Spangler said. She said diversity and inclusion initiatives, as well as campaigns to bolster equality are increasingly part of ESG analysis.

In a pandemic-ravaged world where money is already tight and politically motivated investors vote with their wallets every chance they get, Blankenship urged companies to embrace ESG or risk irrelevance.

A recent McKinsey & Company report polling nearly 600 C-suite executives and investment professionals supports Blankenship’s theory.

ESG programs “will contribute more shareholder value in five years than today,” 80% of respondents said. And 83% said they’d pay a premium—up to 10% more—to acquire a company with a positive ESG record over one with failing marks.

The Trump administration, however, is throwing cold water on ESG investing.

A proposed Labor Department rule aims to curb ESG investing by forcing fiduciaries to justify including the popular funds in work-sponsored retirement plans. The department said federal law requires fiduciaries to put financial security above “non-pecuniary” goals like combating climate change, human rights, or shunning weapons manufacturers.

Littenberg said Ropes & Gray is currently working with more than 200 clients, ranging from asset managers to influential trade groups, on ESG-related issues. Latham & Watkins LLP also has an ESG task force that features attorneys with various specializations around the world.

Watchdog Soup

Meanwhile, stakeholders keep moving the goalposts—on a constantly shifting playing field.

The United Nations Principles for Responsible Investment, for instance, asks individuals to consider ESG factors as part of their decision-making process, while the Global Reporting Initiative urges companies to report the social and environmental impact of their operations around the world.

The nonprofit Institute for Pension Fund Integrity called for clarity about ESG-centric business dealings in its Aug. 27 brief. “Companies should take the extra step to convey how they define ESG and how it impacts their investment strategies,” the group wrote.

If only it were that simple.

Stacey Mitchell, a partner at Akin Gump Strauss Hauer & Feld LLP, said bringing companies up to speed on ESG often involves highlighting “potentially overlapping, or at times, conflicting legal obligations” they hadn’t considered. Taking a holistic approach is critical, she said, because ESG considerations stretch far beyond corporate boardrooms.

Mitchell called middle management the “front-line workers when it comes to ESG issues,” mapping out scenarios where environmental compliance managers at mining companies and HR leaders at technology firms make judgment calls that have ripple effects throughout the supply chain.

Recent moves by the Trump administration also throw plan retirement administrators into the mix. The proposed Labor Department rule would impose significant new reporting requirements on retirement plan administrators that consider ESG in investments.

Josh Lichtenstein, a Ropes & Gray partner, said the additional reporting requirements could ensnare “funds that just include ESG considerations as part of their risk evaluation framework” rather than the activist entities the administration appears to want sidelined.

“If all funds that consider ESG factors at all in investing are caught up by the rule then almost every fund would be subject to it,” Lichtenstein said.

That could mean new litigation risks for plan sponsors.

“Any time you require fiduciaries to take additional steps you run the risk of plaintiffs saying they didn’t do that additional work,” even if they have an excellent investment process,” Lichtenstein said.

Winston & Strawn benefits lawyer Mike Melbinger said he’s been monitoring another ESG crackdown, from the Securities and Exchange Commission. That agency, along with the Labor Department, is moving to regulate proxy voting power by ESG investors.

The new regulations are unlikely to put a dent in ESG investing, according to Melbinger.

“The real world has kind of moved on and is doing this,” he said.

This op-ed originally appeared in TownHall and affiliated outlets on September 15, 2020.

For pension beneficiaries across the country, the recent proposals by the Department of Labor are a positive step towards ensuring that accountability and fiscal responsibility take precedence over any other considerations.

Two new rules are currently being weighed. The first, for which the department is currently in the process of sorting through public comment, concerns the role of environmental, social, and governance (ESG) investments in ERISA-backed pension funds. The second takes aim at “proxy voting,” examining the outsized roles that proxy advisory firms have in investment decisions and examining whether their recommendations are always economically beneficial to pensioners.

These rules rightly reaffirm a fiduciary’s obligation to prioritize financial returns over alternative investment strategies in the management of ERISA-managed pension fund assets. As a former Treasurer of the State of Ohio and Mayor of Cincinnati, I have had firsthand experience overseeing a pension system and I take seriously the responsibility of a fund’s management team to provide financial security to the men and women who rely on their pension or 401K for a secure retirement.

Last November, SEC Chairman Jay Clayton remarked that a chief complaint “was the concern that [shareholders’] financial investments—including their retirement funds—were being steered by third parties to promote individual agendas, rather than to further their primary goals of being able to have enough money to lessen the fear of ‘running out’ in retirement or to leave money to their children or grandchildren.” In putting forth these two regulations, the Department of Labor is taking clear steps to also address this concern.

In the case of the first rule, fiduciary duty obliges pension fund managers to only consider ESG investments when they add value to a fund. When such investments will not improve the financial performance of the fund, or the decision to invest in them is based on political motives, they should be forgone. According to a study by the Pacific Research Institute, ESG funds were “43.9 percent smaller compared to an investment in a broader, S&P 500 index fund,” after 10 years. As ESG strategies become more fashionable, there is cause for concern that financial returns will be replaced by politics at the top of asset managers’ considerations.

The question of pensioner’s financial interests is further addressed in the recent proposed rule by the DOL. The proxy system has long been taken advantage of by outside actors without fiduciary responsibilities, preventing sound advice from reaching the nation’s pension and investment funds and retail shareholders. There is currently a duopoly in the system, in which two companies, Institutional Shareholder Services (ISS) and Glass Lewis, control the overwhelming majority of the proxy advisory market. These firms are not obligated to adhere to fiduciary duty like ERISA plan managers, and abdicating authority over proxy voting in such a way violates fund managers obligation to plan participants.

The proposed rule is a good step in the right direction by the Department of Labor, but more should be done around proxy advisors’ role in a process called automatic or robo-voting. Some fund managers allow proxy advisors to vote their proxies, often without the ability or impulse to consider the recommendation. In other words, fund managers blindly vote the recommendation without consideration of the impact to the fun. Such a practice disenfranchises pensioners and should be curbed. The Securities and Exchange Commission issued guidance on this front to asset managers in June of this year, and DOL should adopt this guidance as a part of the rule.

Pensions should be, and once were, apolitical entities. At the Institute for Pension Fund Integrity, where I sit on the board, we are singularly focused on that objective—getting politics out of pensions and protecting the financial security of America’s workforce. I applaud the Department of Labor’s efforts to further codify the most basic tenet of fiduciary duty: investment decisions should be governed by considering risk and returns, not the political agenda of a third party. As I have previously noted, “public pension funds are already underfunded and underperforming.” Let us not exacerbate the issue by appeasing the special interest groups to the detriment of private sector labor workers and retirees across the country.

Pension fund managers need to be reminded that they are charged with acting on behalf of individuals who sacrificed a portion of their wages every payday with the expectation that their money would be handled with care, not used to promote the interests of political actors. The proposed rule changes are an important step towards fulfilling these obligations.

Ken Blackwell served as Treasurer of State of Ohio and as a member of the U.S. Department of Labor Advisory Council on Employee Welfare and Pension Benefit Plans. He is a trustee of the Institute for Pension Fund Integrity.

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.”