Legislative and Judicial Actions
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The SEC Favors Proxy Voting Advice Rule Amendments
The Securities and Exchange Commission, in mid-July, adopted amendments to its rules that govern proxy voting advice. SEC Chair Gary Gensler said, in a statement, that the final amendments aim to prevent, for proxy voting advice businesses, burdens that may impair the timeliness and independence of their advice. The amendments also address misperceptions about liability standards applicable to proxy voting advice, while preserving investors’ confidence in the integrity of such advice, Gensler said.
As outlined in a press release distributed after the vote, the final amendments rescind two rules applicable to proxy voting advice businesses that the commission adopted in 2020. Specifically, the final amendments rescind conditions placed on the availability of two exemptions from the proxy rules’ information and filing requirements on which proxy voting advice businesses often rely.
These conditions require that, first, public companies that are the subject of proxy voting advice have such advice made available to them in a timely manner and, second, that clients of proxy voting advice businesses be provided with a way to be notified of any written responses by those public companies to proxy voting advice. The SEC’s release states that institutional investors and other clients of proxy voting advice businesses have continued to express concerns that these conditions could increase these businesses’ compliance costs and impair the independence and timeliness of their voting advice.
The final amendments also delete the 2020 changes made to the proxy rules’ liability provision. As explained in the SEC’s release, although these changes were intended to clarify the application of the liability provision to proxy voting advice, they instead created a risk of confusion regarding how the provision should be applied, undermining their own goal.
The final amendments address the confusion while affirming that proxy voting advice generally is subject to liability under the proxy rules, the SEC says. Finally, the adopting release rescinds guidance that the commission issued in 2020 to investment advisers regarding their proxy voting obligations.
PBGC’s Final Union Pension Relief Rule
On July 6, the Pension Benefit Guaranty Corporation issued the final rule implementing the American Rescue Plan Act of 2021’s Special Financial Assistance program.
Many retirement industry practitioners had long been lobbying for the program, which is designed to provide financial relief to the most severely underfunded union pension programs across the country. Final acceptance of the rule benefits hundreds of thousands of union pensioners and their families who stood to lose as much as 40% of their promised pension payments.
While the program had been operating on an interim basis, sources agree that the rule’s finalization is a critical step for it and its beneficiaries. Additionally, the final rule includes significant changes compared with the rule that created the interim program, and while the vast majority of stakeholders view the updates favorably, others have raised questions that warrant consideration.
According to the PBGC, there are multiple important policy differences between the interim final rule and the final rule. For example, one change addresses the amount of special financial assistance needed to better achieve the goal of allowing plans to remain solvent until 2051.
Final acceptance of the rule benefits hundreds of thousands of union pensioners and their families who stood to lose as much as 40% of their promised pension payments.
Initially, the interim final rule applied a single rate of return, included in the statute, that is higher than could be expected for SFA funds, given they were required to be invested exclusively in safe, but low-return, investment-grade fixed-income products. The final rule uses two different rates of return for SFA and non-SFA assets, respectively, so the interest rate for SFA assets is more realistic, given the investment limitations on these funds.
Another change in the final rule allows up to 33% of SFA to be invested in return-seeking assets that are projected to allow plans to receive a higher rate of return on their investments than under the interim final rule, subject to certain protections. Namely, this portion of plans’ SFA funds generally must be invested in publicly traded assets on liquid markets to ensure responsible stewardship of federal funds. These return-seeking investments include equities, equity funds and bonds. The other 67% of SFA funds must be invested in investment-grade fixed-income products.
The third major change, the PBGC said, is meant to enable plans to confidently restore both past and future benefits and enter 2051 with rising assets. The agency designed the final rule with the goal of ensuring that no “MPRA plan” was forced to choose between restoring its benefit payments to previous levels and remaining indefinitely solvent; an MPRA plan is a group of fewer than 20 multiemployer plans that remained solvent by cutting benefits pursuant to the Multiemployer Pension Reform Act of 2014. The final rule, instead, aims to ensure that all MPRA plans avoid this dilemma and supports them with enough assistance that they can both restore benefits and be projected to remain indefinitely solvent through at least 2051.
Fidelity Freedom Funds Suit
The 6th U.S. Circuit Court of Appeals has ruled in favor of the defendants in an Employee Retirement Income Security Act lawsuit targeting CommonSpirit Health, a large not-for-profit corporation that provides hospital services across the U.S.
The plaintiffs had appealed the matter out of the U.S. District Court for the Eastern District of Kentucky, after that court ruled in favor of the CommonSpirit defendants. The basic claims in the case are that the defendants provided an inadequate selection of investment options in the CommonSpirit employer-sponsored 401(k) plan and allowed for unreasonable expenses to be charged for investment management services and the plan’s administration.
In particular, the complaint named the Fidelity Freedom Funds, a suite of 13 funds that are actively managed by Fidelity fund managers, as having higher operating costs than Fidelity’s passively managed index funds. The complaint alleged that, while the expense ratio for the passive index suite was as low as 0.08%, the expense ratio for the active suite funds ranged from 0.42% to 0.65% for the K Share class, which the plan used until 2018. The plan has since updated to the K6 share class, with expense ratios ranging from 0.37% to 0.49%.
In its dismissal, the District Court said the plaintiff had failed to “allege facts showing that the recordkeeping fees exceeded those of comparable plans or were excessive in relation to the service provided.” The court also stated that the plaintiff had “failed to identify another recordkeeper that would have been willing to conduct the same service as Fidelity” at a reasonable rate. On the claim that CommonSpirit Health had breached its duty of loyalty, the court found that the complaint did not differentiate between the defendant’s alleged violations of the duties of prudence and loyalty, as required when alleging disloyalty under ERISA. As a result, it also dismissed this claim.
The text of the appellate ruling runs to just 13 pages, and it sides firmly with the District Court’s conclusions.
The ruling states that, just as the kinds of retirement plans available to employees have changed over the past few decades, so have the investment options available to them. In the past, the ruling states, most investment options, whether for defined benefit or defined contribution plans, turned on active management, in which the portfolio manager actively makes investment decisions and initiates buying and selling of securities in an effort to maximize return.
The ruling goes on to note that, in gauging the sufficiency of a complaint, the 6th Circuit has taken “a well-worn trail.”
As the appellate ruling stipulates, the legal demand for plausibility required the plaintiff to plead sufficient facts and law to allow the court to draw the reasonable inference that the defendant was liable for the misconduct alleged. The plausibility of an inference depends, in turn, on a host of considerations, including “common sense and the strength of competing explanations for the defendant’s conduct.”
The ruling concludes that, to the contrary, it is in fact possible that denying employees the option of actively managed funds, especially those individuals eager to undertake more or less risk, would itself be imprudent from a fiduciary perspective.
Reached for comment on the importance of the new 6th Circuit ruling, Daniel Aronowitz, managing principal at the fiduciary insurance firm Euclid Fiduciary, calls it “the best decision ever written in an excessive fee case,” as it effectively rebuts the arguments of fiduciary imprudence asserted in most of these lawsuits in which plaintiffs ask the court to infer fiduciary malpractice based on circumstantial evidence of what participants consider an undesirable outcome.
MEP Fee Lawsuit
A settlement agreement has been filed in an Employee Retirement Income Security Act lawsuit involving the employer organization Nextep Inc., its board of directors and investment committee for a multiple employer plan the organization operates.
The complaint in the case alleged excessive investment and recordkeeping fees, stating that, as a large plan, the MEP had substantial bargaining power regarding the fees and expenses that were charged against participants’ investments. The plaintiffs alleged that the defendants, however, did not try to reduce the plan’s expenses or exercise appropriate judgment to scrutinize investment fees or negotiate better rates for recordkeeping and administration services.
The plaintiffs in the case are represented by the law firm Capozzi Adler, which has been involved in an extensive amount of ERISA litigation over the past several years. The settlement agreement, which includes a financial settlement, stipulates that as much as a third of these funds can go to pay the plaintiffs’ attorneys’ fees, leaving about $680,000, less administrative costs and expenses, to be distributed among the sizable class of plaintiffs.
SEC E-Filing Rules
The Securities and Exchange Commission voted unanimously to adopt amendments that update its e-filing rules, adding to the forms that must be submitted electronically. The purpose of the changes is multifold, says the recently released rule document.
According to the rule, the amendments will modernize the SEC’s records management process, promoting the efficient storage, retrieval and analysis of e-filings, and improve the agency’s ability to track and process them.
The document also says the amendments should increase transparency and operational resiliency by modernizing how information is filed or submitted and disclosed to the public. Publicly filed electronic submissions will be more readily accessible and be available in easily searchable formats, the document says.
The rule document says e-filing capabilities helped address logistical and operational issues raised during the COVID-19 pandemic, and that expanding electronic submission will allow the SEC and filers to more effectively handle disruptive events that may occur in the future.
The rule changes apply to registered investment advisers, institutional investment managers and others who file or submit reports to the SEC’s Electronic Data, Gathering, Analysis and Retrieval system, or its Investment Adviser Registration Depository system. The requirements will affect three types of filings that were previously submitted on paper: confidential treatment requests for Form 13F, applications under the Investment Advisers Act of 1940 and Form ADV-NR. Form 13F and the applications will now be submitted to the EDGAR system, and Form ADV-NR will be submitted to the IARD system. The changes to Form 13F include requiring filers to provide additional identifying information and making technical amendments to improve the quality of the data reported on the form.
The rule document says e-filing capabilities helped address logistical and operational issues raised during the COVID-19 pandemic, and that expanding electronic submissions will allow the SEC and filers to more effectively handle disruptive events that may occur in the future.
Except for the amendments to Form 13F, the new rules and form amendments will be effective 60 days after they are published in the Federal Register. The amendments to Form 13F will be effective January 3, 2023, and the SEC is providing a six-month transition period to give filers time to prepare for the changes.
Private Fund Rule
The original comment period for the Securities and Exchange Commission’s proposed private fund industry regulation technically ended in mid-June. But the agency’s website is still accepting public comments, meaning it is apparently not too late for stakeholders to make their voice heard.
In January, the SEC proposed substantial amendments to Form PF, the confidential reporting form for certain SEC-registered investment advisers to private funds—i.e., funds outside the definition of “investment company” by virtue of the exceptions set forth in Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940. The SEC’s leadership says the proposed amendments are designed to enhance the Financial Stability Oversight Council’s ability to assess systemic risk, as well as to bolster the SEC’s overall regulatory oversight of private fund advisers, and its investor protection efforts, in light of the private fund industry’s growth.
The proposed amendments would provide the two organizations with more timely information to analyze and assess risks to investors and the markets more broadly. The proposal would also, for large private equity advisers, lower the reporting threshold from $2 billion to $1.5 billion in private equity fund assets under management. The SEC’s leadership has argued that taking this action would result in reporting on Form PF that continues to provide robust data on a sizable portion of the private equity industry.
Finally, the proposal would require more information regarding large private equity funds and large liquidity funds to enhance the information used for risk assessment and the SEC’s regulatory programs.
Attorneys say the SEC’s messaging shows that the regulator feels it cannot rely on the private fund industry itself to make adequate disclosures under the current framework. Parts of the proposal seem to demand that certain private fund advisers engage a third party to provide fairness assessments regarding how the fund is constructed and distributed, while other parts would ask that new disclosures be made to all investors in a fund as to any side letters or communications certain other investors are receiving.
Should the proposal follow the typical course for such regulations, a final version of it likely will emerge sometime this year and have a multi-year implementation process.
While most of the proposal would affect advisers who service private funds, the commission’s proposal requiring SEC-registered advisers to document the annual review of their compliance policies and procedures in writing would apply to any registered investment adviser.
Mergers Involving DB Plans
Following the release of the Pension Benefit Guaranty Corporation’s final rule on multiemployer plan special financial assistance, the IRS has weighed in on the rule’s effect on certain plan mergers.
In Revenue Ruling 2022-13, the IRS answers the question: “If a multiemployer defined benefit pension plan that has received special financial assistance from the PBGC is merged into a multiemployer defined benefit pension plan that has not received SFA, and the [latter] is designated as the ongoing plan after the merger, is the ongoing plan deemed to be in critical status under section 432(b)(7) of the Internal Revenue Code solely as a result of the merger?”
The question is important because DB plans in critical status must enter into a rehabilitation plan and are subject to certain benefit restrictions. The IRS says the plan designated as the ongoing plan after merging with a plan that received SFA is not deemed to be in critical status.
The agency notes, however, that, following the merger, the ongoing plan must comply with the restrictions and conditions that applied to the plan that received SFA. For example, the ongoing plan will maintain a separate account for the SFA funds received and invest the assets of that separate account in permissible investments in accordance with the PBGC’s final rule.
Equitable Financial Settles SEC Fraud Charges
The Securities and Exchange Commission announced on July 19 that it has secured a settlement from Equitable Financial Life Insurance Co. related to fraud charges the agency had brought against the firm earlier this year.
The basis of the charges, according to an SEC statement, is that Equitable allegedly provided account statements to about 1.4 million variable annuity investors that included “materially misleading statements and omissions” concerning investor fees. Equitable has agreed to compensate the harmed investors to settle the charges. Most of the clients affected are public school teachers and staff members.
As described in the SEC’s order, since at least 2016, Equitable was giving investors the impression that their quarterly account statements listed all fees paid during the period. The SEC found that the statements listed only certain types of fees that investors infrequently incurred and that the statements often had $0.00 listed in fees. Specifically, the SEC’s order found that Equitable violated the antifraud provisions of the Securities Act of 1933. In agreeing to the settlement, the firm neither admitted nor denied the SEC’s findings.