Department of Labor Issues Final Rule on Proxy Voting

On December 11, 2020, the Department of Labor ("DOL") issued its final rule addressing plan fiduciaries' investment duties with regard to proxy voting and shareholder rights ("Final Rule" or "Rule"). The DOL previously published its proposed rule on September 4, 2020 ("Proposed Rule").

The most significant departure from the highly prescriptive Proposed Rule is an emphasis on a more principles-based design that eliminates the potentially burdensome cost-benefits analysis and documentation requirements for proxy voting. The Final Rule requires, among other things, that plan fiduciaries act solely with the economic interest of the plan and its participants and beneficiaries in mind when managing plan assets. This Final Rule is consistent with themes from the DOL’s recent environmental, social, and governance ("ESG") final regulations ("Investment Duties Rule"), discussed in our prior alert.

Background

The Employee Retirement Income Security Act of 1974, as amended ("ERISA"), requires that plan fiduciaries act prudently and solely in the interests of plan participants and beneficiaries ("P&Bs"). The DOL was concerned that its prior sub-regulatory guidance caused confusion regarding the exercise of shareholder rights and the consideration of non-pecuniary or non-financial factors in proxy voting. Further, the DOL was concerned that prior guidance resulted in a “misplaced belief” that fiduciaries must always and in every situation vote proxies (with minor exceptions) to fulfill their fiduciary obligations. In this Final Rule, the DOL was able to provide more clarity in this area with new binding guidance.

The Final Rule supersedes the DOL’s prior guidance and amends the "Investment Duties" regulation at 29 C.F.R. 2550.404a-1 to address the duties of prudence and loyalty by plan fiduciaries in the context of proxy voting and other shareholder rights.

The Final Rule states that the general fiduciary standard applies to proxy voting and other shareholder rights. Specifically, fiduciaries must carry out these duties prudently and solely in the interests of P&Bs and for the exclusive purpose of providing benefits to P&Bs and defraying the reasonable expenses of administering the plan. In the preamble to the Final Rule, the DOL cautions that using plan assets to further policy-related or political issues, including ESG issues, would violate the prudence and exclusive purpose requirements of ERISA, unless doing so is exclusively for the economic interests of the plan and the P&Bs.
   
Final Rule

The Final Rule applies the requirement of non-pecuniary objectives to proxy voting and the exercise of shareholder rights from the Investment Duties Rule.

Shareholder Rights and Fiduciary Duties

The Final Rule specifically provides that the fiduciary duty to manage plan assets that are shares of stock includes the management of "shareholder rights appurtenant" to those shares, such as the right to vote proxies. The Final Rule also clarifies that the fiduciary duty to manage shareholder rights does not mean fiduciaries must always vote proxies to fulfill their fiduciary obligations. Further, the responsibility for exercising shareholder rights remains with the plan trustee unless: (i) the trustee is required to follow the directions of a named fiduciary, or (ii) an investment manager has been appointed to manage the assets.
   
Six General Requirements of Fiduciary Obligations

The Final Rule imposes six general requirements on plan fiduciaries who are deciding whether to exercise shareholder rights. These fiduciaries must:

1. Act solely in accordance with the economic interest of the plan and its P&Bs;
2. Consider any costs involved;
3. Not subordinate the interests of P&Bs in their retirement income or financial benefits under the plan to any non-pecuniary objective, or promote non-pecuniary benefits or goals unrelated to those financial interests of the plan's P&Bs;
4. Evaluate material facts that form the basis for any particular proxy vote or other exercise of shareholder rights;
5. Maintain records on proxy voting activities and other exercises of shareholder rights; and
6. Exercise prudence and diligence in the selection and monitoring of third parties, if any, selected to advise or otherwise assist with exercises of shareholder rights (such as providing research and analysis, recommendations regarding proxy votes, administrative services with voting proxies, and recordkeeping and reporting services).

 
Monitoring Delegates

Fiduciaries often delegate authority to investment managers, proxy voting firms, or other persons, to vote proxies and exercise shareholder rights on behalf of the P&Bs. The Final Rule requires that fiduciaries prudently monitor the proxy voting activities of such delegates and determine whether their activities are consistent with their fiduciary obligations, the six requirements listed above, and the safe harbor provisions for proxy voting described below.
 
Mutual Funds

The DOL confirmed that the Final Rule does not apply to the exercise of shareholder rights on securities owned or held by mutual funds because ERISA does not govern the management of mutual fund assets.

Proxy Voting Rules

Following Advice of Proxy Advisory Firms

Fiduciaries often follow the recommendations of proxy advisory firms or other service providers. The Final Rule requires fiduciaries to determine that such firm or other service provider's proxy voting guidelines are consistent with the fiduciary obligations in 1-5 described above.

Safe Harbors for Implementing Proxy Voting Policies

The Proposed Rule would have (i) required fiduciaries to vote any proxy where the fiduciary prudently determined that the matter being voted upon would have an economic impact on the plan, and (ii) prohibited fiduciaries from voting any proxy unless the fiduciary prudently determined that the matter being voted upon would have an economic impact on the plan. Commentators characterized these proposed requirements as a "high risk compliance dilemma." The Final Rule omits both of these requirements.
The Final Rule also provides two safe harbors for fiduciaries to satisfy their duties of prudence and loyalty in determining whether (but not how) to vote a proxy. Fiduciaries may adopt either, or both, of the following proxy voting policies:
 

1. One type of policy limits voting to proposals that are substantially related to the issuer’s business or are expected to materially affect the value of the investment. 
2. The other type of policy is to refrain from voting when the plan’s ownership of a single issuer of stock is relatively small, relative to the plan’s total assets, so that voting on a particular matter is not expected to materially affect the investment performance of the plan’s portfolio (or the portion of a plan’s portfolio managed by an investment manager). 

Periodic Review

Under the Final Rule, fiduciaries must “periodically review” their proxy voting policies adopted under the safe harbor provisions (the Proposed Rule would have required at least once every two years).
   
Clarified Proxy Voting Rights Passed Through to Participants

The Proposed Rule did not address proxy rights passed through to plan participants. However, the Final Rule adds a provision clarifying that these amendments to the Investment Duties regulation does not apply to voting, tender, and similar rights passed through to participants and beneficiaries.

Reconciliation of Conflicting Policies for Pooled Investment Vehicles

Typically, an investment manager of pooled investment vehicles holds the assets of more than one plan. These plans might have conflicting investment policy statements. The Final Rule requires investment managers to reconcile, to the extent possible, any conflicting policies. In the case of proxy voting, investment managers are required to vote (or abstain from voting) the relevant proxies to reflect the different policies in proportion to each plan's economic interest in the pooled investment vehicle.

Alternatively, the investment manager may develop its own investment policy statement consistent with the Final Rule and require participating plans to accept it, including any proxy voting policy, before they are permitted to invest. Plan fiduciaries are also required to assess whether the new investment policy statement and/or proxy voting policy are consistent with ERISA and the Investment Duties regulation before retaining the investment manager.

Effective Date

The Final Rule applies 30 days after its publication in the Federal Register. However, the DOL provided later effective dates for certain portions of the Final Rule. Specifically, fiduciaries other than investment advisers have until January 31, 2022 to comply with requirements 4 and 5 above to: (i) evaluate material facts that form the basis for an exercise of shareholder rights, and (ii) to maintain records on proxy voting activities and other exercises of shareholder rights. This delayed effective date does not apply to fiduciaries who are registered investment advisers. 

All fiduciaries have until January 31, 2022 to comply with: (i) the requirement to review service provider proxy voting guidelines and (ii) the requirement to reconcile conflicting investment policies applicable to investment managers of pooled investment vehicles holding the assets of multiple benefit plans.

The actual effective date will likely be prior to President-elect Biden’s inauguration, which means that the incoming Biden administration will not be able to easily delay (and later withdraw) the rule because it will have already taken effect. Any changes by the new administration would require notice-and-comment rulemaking, which could easily take three to six months. 

For more information about the Final Proxy Rule and related securities matters, please contact Gary Blachman, Erik Hansen, Melissa Proffitt, Matt Fornshell, Ian Minkin, Austin Anderson, or the Ice Miller LLP attorney with whom you work.
 
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.