U.S. Department of Labor
Employee Benefits Security Administration
December 11, 2020
On December 11, 2020, the U.S. Department of Labor (Department) released a final rule under the Employee Retirement Income Security Act of 1974 (ERISA) to amend the “Investment Duties” regulation at 29 CFR § 2550.404a-1 addressing the application of ERISA’s fiduciary duties of prudence and loyalty under ERISA sections 404(a)(1)(A) and (B) to the exercise of shareholder rights, including proxy voting, proxy voting polices and guidelines, and the selection and monitoring of proxy advisory firms.
- The Department issued the original “Investment Duties” rule in 1979. The rule addressed the duty of prudence under ERISA section 404(a)(1)(B) as it applies to fiduciary decision-making on plan investments and investment courses of action. However, the 1979 regulation did not specifically address the exercise of shareholder rights or the application of ERISA section 404(a)(1)(A), which requires that a fiduciary act for the exclusive purpose of providing benefits to participants and beneficiaries.
- Rather, sub-regulatory guidance and individual letters issued by the Department over the years affirmed that when plan fiduciaries vote proxies or exercise other shareholder rights, the fiduciaries must consider factors that may affect the value of the plan’s investment and not subordinate the interests of the participants and beneficiaries in their retirement income to unrelated objectives.
- Aspects of this prior guidance, however, may have led to confusion or misunderstandings on the part of plan fiduciaries. For example, some fiduciaries believe that the Department’s guidance requires fiduciaries to vote all proxies presented to them. As the number and types of proxy proposals increase, confusion about prior guidance may also have resulted in plans expending plan assets unnecessarily to research and vote on proxy proposals that are not likely to have a material impact on the value of the plan’s investment.
- On August 31, 2020, the Department issued a press release and posted to its website proposed amendments to the Investment Duties rule to provide specific guidance on the fiduciary duties of prudence and loyalty in the context of proxy voting and other exercises of shareholder rights. The proposed rule also addressed the use of written proxy voting policies and guidelines, and the selection and monitoring of proxy advisory firms.
- In response to the proposal, the Department received approximately 300 written comments representing viewpoints from a variety of stakeholders, including plan sponsors, investment managers, proxy advisory firms, employee benefit plan participants, and other service providers. The Department also received approximately 6,700 submissions (form letters) in response to two petitions. These comments are viewable on the Department’s website.
- The final rule, which reflects revisions based on feedback received by the Department during the public notice-and-comment process, will help the Department ensure that plan fiduciaries execute their ERISA duties when exercising shareholder rights in an appropriate, feasible, and cost-efficient manner.
- In a separate rulemaking, the Federal Register published on November 13, 2020 amendments to the Investment Duties regulation to provide guidance under the prudence and loyalty provisions of ERISA sections 404(a)(1)(A) and (B) for fiduciaries as to the consideration of financial factors in selecting plan investments.1 The Department reserved a section of that amended regulation as a placeholder for the additional guidance in this final rule on the exercise of shareholder rights, including proxy voting.
Overview of the Final Rule
After evaluating the public record developed in response to the proposal, EBSA drafted the final rule, which includes notable modifications from the proposal to address public comments.
- The most significant change from the proposal is the Department’s adoption, in the final rule, of a more principles-based approach, which eliminated some of the proposed provisions many commenters identified as likely to result in potentially significant increases in costs to plans and liability exposure for plan fiduciaries if adopted as part of a final rule.
- The principles-based approach of the final rule is based upon fiduciaries having a process, consistent with their duties of prudence and loyalty, for proxy voting and other exercises of shareholder rights—a process by which fiduciaries carry out their duties prudently and solely in the interests of the plan participants and beneficiaries and for the exclusive purpose of providing benefits to participants and beneficiaries and defraying the reasonable expenses of administering the plan.
- The final rule expressly states that the fiduciary duty to manage shareholder rights does not require the voting of every proxy or the exercise of every shareholder right.
- The final rule details the obligations for ERISA plan fiduciaries when making decisions on exercising shareholder rights, including proxy voting, in order to meet their prudence and loyalty duties under ERISA section 404(a)(1)(A) and (B). Plan fiduciaries must:
- Act solely in accordance with the economic interest of the plan and its participants and beneficiaries;
- Consider any costs involved;
- Not subordinate the interests of the participants and beneficiaries 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 participants and beneficiaries or the purposes of the plan;
- Evaluate material facts that form the basis for any particular proxy vote or other exercise of shareholder rights;
- Maintain records on proxy voting activities and other exercises of shareholder rights; and
- Exercise prudence and diligence in the selection and monitoring of persons, 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.
Policies for Proxy Voting; Safe Harbors
- The final rule allows fiduciaries to adopt optional means (safe harbors) for satisfying their fiduciary responsibilities with respect to decisions on whether to vote proxies. Specifically, plan fiduciaries may adopt either, or both, of the following policies:
- A policy 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 are expected to have a material effect on the value of the plan’s investment;
- A policy of refraining from voting on proposals or types of proposals when the size of the plan’s holdings in the stock subject to the vote are below quantitative thresholds that the fiduciary prudently determines, considering its percentage ownership of the stock and other relevant factors, is sufficiently small that the matter being voted upon is not expected to have a material effect on the investment performance of the plan’s portfolio (or assets under management in the case of an investment manager).
- The final rule provides that plan fiduciaries must periodically review proxy voting policies that are adopted under this rule.
- The Department added a new provision clarifying that the final rule does not apply to voting, and similar rights on shares held in defined contribution plans (including ESOPs) that are passed through to participants and beneficiaries that hold the shares in their individual accounts. Plan fiduciaries would, however, still need to comply with ERISA’s statutory duties of prudence and loyalty when administering pass-through provisions in the plan.
- The final rule also continues to provide guidance on a number of specific issues, such as the role of plan trustees and investment managers, practices of following proxy advisory firm recommendations (robo-voting practices), and the treatment of conflicting plan policies in pooled investment vehicles.
Impact on Prior Guidance
- As part of the final rule, the Department removes Interpretive Bulletin 2016-01, 29 CFR §2509.2016-01, and related sub-regulatory guidance, which may no longer be relied upon as reflecting the Department’s interpretation of the application of ERISA’s fiduciary responsibility provisions to the exercise of shareholder rights and written statements of investment policy, including proxy voting policies or guidelines.
Regulatory Impact Analysis
- The final rule will benefit plans by providing improved guidance regarding how ERISA’s fiduciary duties apply to proxy voting. The final rule clarifies the duties of fiduciaries with respect to proxy voting and the monitoring of proxy advisory firms. Accordingly, plan fiduciaries will be better positioned to improve the frequency with which voting resources are expended on matters that a fiduciary has prudently determined are substantially related to an issuer’s business activities or are expected to have a material effect on the value of the investment. To the extent that the final rule increases the investment return on plan assets, it would enhance participants’ and beneficiaries’ retirement security. Participants covered by plans that were not following the Department’s prior sub-regulatory guidance and must make changes to comply with the final rule could benefit from higher investment returns compounded over many years, which could be considerable.
- In response to public comments, the final rule takes a more principles-based approach that will reduce much of the cost burden associated with the proposed rule. The Department believes that many fiduciaries already are compliant with the final rule, because they are meeting the requirements of the Department’s sub-regulatory guidance and prudently conducting their business operations to satisfy their fiduciary obligations as required by ERISA, but such practices are not universal. Plans may incur costs to review proxy voting policies, particularly plans that choose to adopt the safe harbors. Provisions requiring responsible fiduciaries to monitor and document proxy voting policies and activities would generally be satisfied by current best practices that satisfy earlier Department guidance.
- The final rule will be effective 30 days after its publication in the Federal Register and applies to exercises of shareholder rights after such date. However, the rule includes two later compliance dates, in response to commenters’ concerns about the feasibility of compliance with certain provisions without undue cost and burden:
- Fiduciaries that are not SEC-registered investment advisers have until January 31, 2022 to comply with the new requirements to evaluate material facts providing the basis for exercising a right, and to maintain records on proxy voting activities. SEC-registered investment advisers must comply as of the 30-day applicability date, however, as these requirements are intended to align with their existing obligations under the Investment Advisers Act of 1940.
- All fiduciaries have until January 31, 2022 to comply with the requirements that fiduciaries review service provider proxy voting guidelines prior to following their recommendations to determine that the guidelines are consistent with their obligations under the final rule, and the requirements pertaining to investment managers of pooled investment vehicles.
For questions about this final rule, please contact EBSA’s Office of Regulations and Interpretations at 202-693-8500.
- 85 FR 72846 (Nov. 13, 2020).