DOL and SEC Weigh New Proxy Voting Standards

Both the Department of Labor and the Securities and Exchange Commission are revisiting their proxy voting rules, creating an opportunity for greater regulatory alignment.

The U.S. Securities and Exchange Commission (SEC) will be meeting on November 5, 2019, for an open meeting, at which the regulator is expected to vote on a proposal for new rules that could limit the role of proxy advisers and impact investors’ ability to engage with companies on environmental, social and governance (ESG) matters.

The meeting comes several months after the Commission issued a separate proxy voting rule interpretation which established that advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules. With the interpretation, the SEC has taken the stance that proxy advisory firms are, by providing their advice, not simply delivering objective information to a third party but are, in fact, appealing to the client to vote in a certain way. This in turn means the proxy voting firm must meet a set of specific responsibilities in terms of the accuracy, delivery and intention of its recommendations.

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Sara Crovitz, a partner at Stradley Ronon who formerly served as Deputy Chief Counsel and Associate Director in Investment Management at the SEC, says retirement plan advisers and wealth managers should be paying close attention to these developments.

“During my time at the SEC, there was certainly some debate and evolution in terms of interpreting what a ‘solicitation’ means in the proxy voting context,” she explains. “Put simply, the core goal of the solicitation rule is to make sure someone isn’t trying to control your shares via proxy voting advice. However, the question about whether someone is giving advice or a solicitation to control your shares is a subtle one.”

By way of background, Crovitz recalls, the SEC created its main proxy voting standards framework back in 2003.

“When the SEC put out its rules in this area, it was actually in large part a response to a specific news event,” Crovitz says. “Your readers may recall the Hewlett Packard-Compact merger. In that case, an asset manager was found to have changed its proxy vote at the last minute, basically because HP said that if they wouldn’t vote to approve the merger, HP would not have its people do business with that asset manager in the future. So, the solicitation rule was definitely created at a time when there was some distrust and a certain tone hanging over this whole discussion about proxy voting.”

In a phrase, the presumption from the perspective of the SEC is that fiduciary advisers with the ability to exercise shareholder rights on behalf of clients should be engaged and should be casting votes. If the adviser is not going to vote, the SEC expects the adviser to have run a cost-benefit analysis demonstrating that it is not in the clients’ best interest to be voting on a particular matter.

“Under the Trump Administration, the SEC now seems to be suggesting that it is okay not to vote in various circumstances,” Crovitz says. “In my view, this is almost a meeting in the middle of the Department of Labor [DOL] and the SEC on this issue. The DOL’s stance is different, in that you have to do a cost-benefit analysis to prove that it is worth voting. The outlooks are really almost opposite, and for that reason it will be very interesting to track this issue as it unfolds across regulators in the coming years.”

George Michael Gerstein, partner and co-chair of the fiduciary governance team at Stradley Ronon, agrees with that characterization. He also says he expects the DOL could issue new guidance on this topic within the next few weeks. This expectation is based on the fact that, back in April, the White House issued an executive order stipulating that the Secretary of Labor should, within 180 days of the date of the order, “complete a review of existing DOL guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.”

“Technically there was no requirement in the order for new guidance to be issued, but we are nonetheless on the lookout,” Gerstein says. “From the perspective of the DOL, the real question is, how granular does the regulator expect any cost-benefit analysis of shareholder engagement activities to be? Republican and Democratic administrations have gone back and forth on this over the years.”

In his view, Gerstein says, the Bush Administration’s guidance in this area was too onerous. It required very careful and detailed analysis proving that shareholder activism would be beneficial to plan participants.

“Many parties thought the DOL’s stance was that a cost-benefit analysis was required on a vote-by-vote basis,” Gerstein says. “Then, under the Obama Administration, the step was taken to ‘clarify’ that it really didn’t have to be on a vote-by-vote basis. Plan fiduciaries could run a general analysis of the costs and benefits of shareholder engagement.”

Moving forward, Gerstein says, the DOL could go in a few different directions.

“I am concerned they could require a far deeper analysis of the calculation of the costs of exercising shareholder rights—going back to something similar to the Bush-era guidance,” Gerstein says. “That would prove particularly problematic in the context of the expanding use of ESG investing, in my view. If the DOL tightens the screws so much, it could potentially spook some fiduciaries into thinking they have to show some immediate benefit to the plan from any shareholder engagement activity they engage in.  I think the DOL understands the opposite side of the coin from engagement is divestment, to be frank. So, the executive order’s original goal of energy infrastructure promotion could actually backfire if the DOL is too strict about shareholder engagement under ERISA. You could even see plan fiduciaries choosing to divest from energy companies rather than engage with those companies to help improve their long-term viability.”

*Editor’s note: PLANADVISER Magazine is owned by Institutional Shareholder Services (ISS). ISS has filed a lawsuit seeking to halt the implementation of the new proxy voting rules. 

Recordkeeping Fees Under the Microscope

Retirement plans of all sizes are seeing their recordkeeping fee schedules questioned, especially when those fees are expressed as a percentage of assets.

Responding to PLANADVISER’s coverage of the recently revealed fiduciary breach lawsuit settlement entered into by the Massachusetts Institute of Technology (MIT), a reader sent the following query: “I noticed in the MIT lawsuit you reported that one of the non-monetary provisions was that fees paid to the recordkeeper for basic recordkeeping services will not be determined on a percentage-of-plan-assets basis. I assume MITs plan’s size [approximately $3.8 billion] was the reason that this was objectionable?”

The question sounds straightforward, but it actually keys into a complicated debate that is unfolding in the retirement plan industry about the appropriate way to pay for recordkeeping under the Employee Retirement Income Secuirty Act (ERISA). ERISA demands, among many other things, that fiduciary retirement plan sponsors carefully evaluate and monitor the reasonableness of fees being paid by their participants. The law does not stipulate, however, that one specific type of fee structure is superior in itself, nor does it suggest all prudent plan fiduciaries must run their plans the same way.

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Taking a step back, the reader is right in that the general wisdom in the retirement plan industry was for a long time that small plans could reasonably pay for recordkeeping on a percentage-of-assets basis. Because 401(k) plans and accounts generally start out quite small, this approach makes for a good deal for new plans/participants, at least at first. Down the line, growing plans or those starting out with substantial assets can negotiate for per participant fees. But historically, even many large plans have long paid for defined contribution (DC) plan recordkeeping on an asset-based schedule.

Today, the landscape is rapidly shifting, and it definitely seems to be the case that per-participant recordkeeping fees are becoming the expected best practice, no matter what size the plan. Plaintiffs’ attorneys and progressive plan sponsors are driving this trend. Their argument is simply that, with today’s digital recordkeeping technology, it is no more work for the plan provider to administer an account with $1,000,000 versus an account with $100. Thus, the argument goes, it is not reasonable under ERISA for the fee to grow while the service being provided remains the same.

ERISA experts say the issue of what constitutes fair and reasonable recordkeeping fees is actually quite complex. One cannot simply say in isolation of other crucial details that one method of payment is better. In fact, some observers argue that asset-based fees are actually in a sense fairer and more progressive, in that participants with small balances pay less in fees relative to those people who have large accounts and presumably are wealthier. In the end, as explained by ERISA attorneys and judges ruling in ERISA cases, most important is that plan sponsors deliberate carefully and document their decisions—that a prudent process is followed in creating and then monitoring whatever fee structure is ultimately used.

Per Participant Fees Can Still Be Excessive

Theory aside, plaintiffs in ERISA lawsuits are having success arguing in favor of per-participant fees. Especially when cases have settled, as in the MIT affair, fiduciary plan sponsors are agreeing to engage in request for proposal (RFP) processes that will specifically demand recordkeeping fee schedules organized on a per-participant basis.

One pending proposed class action lawsuit, filed in August against TriHealth Inc.’s DC retirement plan, shows that per-participant fees can also be excessive—at least in the eyes of participants and their attorneys. The ERISA lawsuit suggests that the administrative fees charged to plan participants at TriHealth “are greater than 90% of its peer plans’ fees, when fees are calculated as cost-per-participant or when fees are calculated as a percent of total assets.”

The complaint shows that in 2017, for example, TriHealth’s plan carried a cost of 86 basis points per participant. This compares with the mean of 44 bps across 27 peer plans, plaintiffs argue. As a total of plan assets, in 2017, TriHealth’s plan cost 86 bps compared with a mean of 41 bps. For context, TriHealth’s plan was benchmarked against peer plans with an asset range of $250 million to $500 million.

“The total difference from 2013 to 2017 between TriHealth’ fees and the average of its comparators based on total number of participants is $7,001,443,” the complaint states. “The total difference from 2013 to 2017 between TriHealth’s fees and the average of its comparators based on plan asset size is $7,210,002.”

When the wave of excessive fee cases began against retirement plan sponsors, most targeted large or mega plans, based on assets. More recently, a number of cases have been filed against so-called “small” plans. For example, the Greystar 401(k) Plan, with less than $250 million in assets, was the target of a complaint filed earlier this year. Similarly, fiduciaries of the approximately $500 million 401(k) program offered by Pioneer Natural Resources USA settled a lawsuit that was filed in 2018.

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