George Michael Gerstein, co-chair of the fiduciary governance group at Stradley Ronon, commonly provides analysis to PLANADVISER Magazine on complex issues pertaining to the Employee Retirement Income Security Act (ERISA) and the many regulations promulgated and policed thereunder by the Department of Labor (DOL).
Gerstein’s latest comments, which are also summarized in detail in a post published to Stradley Ronon’s Fiduciary Governance Blog, are about the DOL’s recently published proxy voting rule proposal. Like many other retirement industry stakeholders, Gerstein is voicing concern that the proposal risks seriously chilling proxy voting activities and other forms of shareholder engagement executed by investment managers and other parties on behalf of retirement plan investors.
“If adopted without modification, fiduciaries of plans, who include investment managers subject to ERISA, may shy away from voting proxies and participating in shareholder engagement on matters that do not demonstrably improve the value of the plan’s holding in the short-term,” Gerstein says. “Thus, the exercise of shareholder rights on environmental, social and governance [ESG] issues, the benefits of which may be long-term in nature, may indeed be squeezed out of proxy voting policies of ERISA plan fiduciaries.”
Gerstein is far from the only ERISA expert making this argument and wondering why the DOL, under the direction of President Donald Trump, is seeking new restrictions on shareholder engagement on behalf of retirement plan investors. The U.S. Securities and Exchange Commission (SEC) is also seeking to create restrictions around the use of proxy voting advisers by certain institutional investors. In fact, the SEC has already finalized newly restrictive rules in this area.
Now that he has had some time to review the DOL’s proposed approach, Gerstein says it represents the continuation of a game of political football that has been playing out for many years. He recalls how, starting with the Clinton administration in the mid-1990s, each presidential administration has taken a slightly different approach on this topic.
“Ultimately, the administrations have gone back and forth as to whether a weighing of the costs and benefits associated with proxy voting is necessary for each such vote or whether such an analysis is reserved for unusually expensive votes or engagements,” Gerstein says.
In guidance published in 2016—during the very last days of the Obama administration—the DOL pointed out that proxy voting rarely entails a significant expenditure of plan assets, and, because the value of the vote or engagement may be long-term in nature, there was rarely an issue where the costs outweighed the benefits, Gerstein says. Moreover, the DOL’s 2016 guidance stated that, because many plans’ investments track indices, it is often necessary to engage issuer boards rather than to divest the plan’s exposure in that company.
“And so, as the DOL reasoned in Interpretive Bulletin 2016-01, the general rule was that proxy voting and shareholder engagement was permissible in most instances,” Gerstein says.
This state of affairs now appears set to change again, thanks to the efforts from the DOL and the SEC. As Gerstein explains, the DOL’s new proposal provides that a responsible plan fiduciary “must vote a proxy where the fiduciary prudently determined that the matter being voted upon would have an economic impact on the plan after taking costs into account.” Conversely, and more significantly, however, the plan fiduciary “must not vote any proxy unless the fiduciary determines that the matter being voted upon would have an economic impact on the plan after taking costs into account.”
“This begs the following questions,” Gerstein says. “How much evidence must the fiduciary marshal to demonstrate that a particular vote would have an economic impact on the plan’s investment? Does the benefit of engagement by a group of shareholders count? What exactly are the ‘costs’ that need to be considered? Successive administrations have largely fought over how often the ERISA fiduciary must undertake this cost-benefit analysis with respect to proxy voting and other shareholder rights.”
Gerstein says the new proposal is a significant development in that it appears to demand that an ERISA fiduciary evaluate on a vote-by-vote basis whether the plan will receive some economic benefit as a result of the shareholder activity. Considering the fact that a given retirement plan may, through its indexed investments and actively managed funds, hold investments in hundreds or thousands of companies each calling for shareholder votes on many complex issues, this would be a tremendous amount of required analysis.
“The DOL, to its credit, recognized that a vote-by-vote analysis would be costly and onerous,” Gerstein says. “Thus, the proposal introduces the concept of ‘permitted practices,’ which, while not safe harbors, are examples of voting policies the DOL thinks the fiduciaries can efficiently rely upon to satisfy their compliance requirements under the proposal.”
Gerstein’s blog post includes a number of specific examples of such voting policies, noting that the DOL has solicited further feedback on whether other examples should be provided in a final rulemaking. One example policy states that “voting resources will focus only on particular types of proposals that the fiduciary has prudently determined are substantially related to the corporation’s business activities or likely to have a significant impact on the value of the plan’s investment, such as mergers, dissolutions, buy-backs, etc.”
Gerstein also points to a negatively structured but permissible voting policy, detailed as follows: “A policy of refraining from voting on proposals when the plan’s holding in a single issuer relative to the plan’s total investment assets is below a quantitative threshold that the fiduciary prudently determines, considering its percentage ownership of the issuer and other relevant factors, is sufficiently small that the outcome of the vote is unlikely to have a material impact on the investment performance of the plan’s portfolio or investment performance of assets under management in the case of an investment manager.”
The proposal has a 30-day comment period, meaning comments are due by early October.