This week the White House issued an executive order on the evolving topic of proxy voting and environmental, social and governance investing programs being put into practice by retirement plans subject to the Employee Retirement Income Security Act (ERISA).
In the order, the Trump Administration says its intent is to “promote energy infrastructure and economic growth.” To this end, the order covers 10 sections that describe the Administration’s vision for greater exploitation of natural resources as a driver of economic growth.
For the retirement plan industry, Section 5 of the executive order is probably most significant. As this section details, the majority of financing in the United States is conducted through its capital markets.
“The United States capital markets are the deepest and most liquid in the world,” the order states. “They benefit from decades of sound regulation grounded in disclosure of information that, under an objective standard, is material to investors and owners seeking to make sound investment decisions or to understand current and projected business.”
Here the order cites the Supreme Court’s 1976 decision in TSC Industries Inc. vs. Northway, which determined that environmental, social and governance (ESG) information is “material” to investment decisions of fiduciaries if “there is a substantial likelihood that a reasonable shareholder would consider it important.”
According to the executive order, the United States capital markets have “thrived under the principle that companies owe a fiduciary duty to their shareholders to strive to maximize shareholder return, consistent with the long-term growth of a company.”
After laying this out, the order gets prescriptive: “To advance the principles of objective materiality and fiduciary duty, and to achieve the policies set forth in subsections 2(c), (d), and (f) of this order, the Secretary of Labor shall, within 180 days of the date of this order, complete a review of available data filed with the Department of Labor by retirement plans subject to the Employee Retirement Income Security Act of 1974 in order to identify whether there are discernible trends with respect to such plans’ investments in the energy sector.”
Furthermore, within 180 days of the date of this order, the Secretary “shall provide an update to the Assistant to the President for Economic Policy on any discernable trends in energy investments by such plans. The Secretary of Labor shall also, within 180 days of the date of this order, complete a review of existing Department of Labor 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.”
Experts Anticipate Order Impact Could Be Muted
In written commentary discussing the new executive order, George Michael Gerstein, co-chair of the fiduciary governance group at Stradley Ronon, suggests the impact of the executive order is likely to be more symbolic than substantive when it comes to the real-world activities of retirement plan fiduciaries and investment managers.
“Less than one year ago, the DOL released Field Assistance Bulletin 2018-1, in which the DOL clarified its views on how shareholder engagement could be conducted in a manner consist with ERISA’s fiduciary duties,” Gerstein observes. “Proxy voting and other forms of engagement are fiduciary functions under ERISA.”
According to Gerstein, the application of ERISA’s fiduciary duties in this context is “ultimately a function of materiality and cost, each positively related to the other, so that as the perceived materiality of an issue on investment performance that is the subject of engagement increases, a fiduciary has more rope to incur costs on its meetings with the board, etc. The converse is also true.”
With this in mind, should the DOL respond to this executive order by implementing a narrower interpretation of what ESG risks are material to a company’s performance, this could in theory drive less engagement on those risks by retirement plan fiduciaries.
“A more probable result, however, is that fiduciaries already evaluating ESG risks will continue parsing whatever ad hoc disclosures are volunteered by the companies, and may point to statements made by prominent individuals and institutions on the materiality of these risks,” Gerstein says.
Shifting Perspective on ESG and Proxy Voting in ERISA Plans
Earlier commentary shared by David Levine, principal with Groom Law Group, provides some helpful context for understanding the potential impact of the new executive order.
As Levine explains, the DOL’s Field Assistance Bulletin 2018-01 (issued under the Trump Administration) puts a new spin on the earlier and more legally significant Interpretive Bulletin 2016-01, in which the Obama Administration directed the DOL to operate under the assumption that proxy voting and shareholder engagement can be consistent with a fiduciary’s obligation under ERISA.
The new Trump-inspired spin, in essence, says that the DOL primarily characterized proxy voting and shareholder activism activities as permissible under ERISA because they typically do not involve a significant expenditure of funds, Levine explains. In other words, with President Trump in charge, the DOL now operates under the assumption that it is not always appropriate for retirement plan fiduciaries to routinely incur significant expenses and to engage in direct negotiations with the board or management of publicly held companies with respect to which the plan is just one of many investors.
Similarly, according to Levine, FAB 2018-01 states that another Obama-era Interpretive Bulletin (IB 2015-01) was not meant to imply that plan fiduciaries, including appointed investment managers, should routinely incur significant plan expenses to, for example, “fund advocacy, press, or mailing campaigns on shareholder resolutions, call special shareholder meetings, or initiate or actively sponsor proxy fights on environmental or social issues relating to such companies.”
Finally, Levine says, FAB 2018-01 uniquely cautions fiduciaries who believe there are special circumstances that warrant “routine or substantial” shareholder engagement expenditures to document an “analysis of the cost of the shareholder activity compared to the expected economic benefit (gain) over an appropriate investment horizon.”
“Thus, DOL has signaled that, as a matter of enforcement, it will require additional documentation regarding significant expenditures of plan assets for shareholder proxy voting activities,” Levine says.