The DOL proposes rules that would curb proxy voting by plan fiduciaries on shareholder proposals.

By Paul A. Davies, Paul M. Dudek, Ryan J. Maierson, and Kristina S. Wyatt

Continued DOL Antipathy Toward ESG

On August 31, 2020, the US Department of Labor (DOL) issued proposed rules that could induce Employee Retirement Income Security Act (ERISA) plan fiduciaries to either abstain from voting on shareholder proposals related to environmental, social, and governance (ESG) matters or establish policies that would have plans default to voting in favor of management’s recommendations. This latest development comes on the heels of DOL actions designed to limit fiduciaries’ consideration of ESG factors in their investment decisions, as discussed in this blog post.

The proposal expressed the DOL’s concern that ERISA plan fiduciaries and proxy advisory firms “may be acting in ways that unwittingly allow plan assets to be used to support or pursue proxy proposals for environmental, social, or public policy agendas that have no connection to increasing the value of investments used for the payment of benefits.”

Proxy Voting and the Exercise of Shareholder Rights

While the proposal is consistent with prior DOL guidance specifying that the exercise of voting rights is part of the fiduciary mandate under ERISA, it emphasizes that plan fiduciaries are not required to vote all proxies. It also states that a plan fiduciary must not vote a proxy unless the plan fiduciary prudently determines that the matter to be voted on would have an economic impact on the plan.[1] When deciding whether to exercise shareholder rights under the amended rules, plan fiduciaries would be required to consider the vote’s economic impact on the plan, taking into account the size of the plan’s holdings of the issuer in proportion to the plan’s total investments, the plan’s percentage ownership of the outstanding shares of the issuer, and the costs associated with voting the shares — including the costs of researching how to vote.

Safe Ground: Permitted Practices

The proposal articulates some “permitted practices” — proxy voting policies that plan fiduciaries could adopt that specify parameters “reasonably designed to serve the plan’s economic interest.” Based on the principle that corporate directors and officers owe a fiduciary duty to act in the best interests of their company, permitted practices could include a policy to vote proxies in accordance with management’s voting recommendations on proposals or particular types of proposals that are not considered likely to have a significant impact on the value of the plan’s investment in the company. Permitted practices could also include a policy to only expend voting resources on proposals substantially related to the company’s “business activities,” or those likely to significantly impact the value of the plan’s investments — such as those related to mergers and acquisitions, share buy-backs, or additional issuances of securities. Plan fiduciaries would also be permitted to adopt policies to refrain from voting on proposals or particular types of proposals when the plan’s holdings of an issuer are below a specified threshold as a percentage of the plan’s assets.

Recordkeeping on Voting Decisions and Oversight of Proxy Advisory Firms and Investment Advisors

Under the proposal, if a plan fiduciary were to vote a proxy, it would be required to maintain records on its proxy voting activities, including the basis for particular proxy votes or exercises of shareholder rights. Further, plan fiduciaries would be prohibited from following the recommendations of proxy advisory firms or other third-party service providers unless they appropriately supervised such advisors and concluded that the advisors’ proxy voting guidelines were consistent with the economic interests of the plan. Under the proposal, if the authority to vote proxies or exercise shareholder rights is delegated to an investment manager, or a proxy advisory firm advises the plan fiduciary on the voting of proxies, the plan fiduciary must require the investment manager or advisor to document the rationale for such proxy voting decisions in a way that demonstrates that the decision was based solely on the interests of plan participants in obtaining financial benefits.

The costs associated with these recordkeeping and oversight activities presumably would need to be factored in to the plan fiduciary’s determination of the overall economic impact of voting and considered as part of the fiduciary’s determination of whether to vote plan proxies. Given that the proposal provides fiduciaries with safe ground to implement “permitted practices,” and the high hurdle plan fiduciaries would be forced to clear to justify voting, it seems that the proposal would all but shut down plan proxy voting on shareholder proposals — except for votes in agreement with management recommendations.

DOL Skepticism as to the Significance of ESG Factors

The proposal clearly articulates the DOL’s skepticism about the significance of ESG factors in driving investment performance, stating, “The Department’s concerns about plans’ voting costs sometimes exceeding attendant benefits has been amplified by the recent increase in the number of environmental and social shareholder proposals introduced. It is likely that many of these proposals have little bearing on share value or other relation to plan interests.” Moreover, the proposal states that “the Department is concerned that plans may incur substantially larger costs to exercise shareholder rights more vigorously, such as by sponsoring or campaigning for shareholder proposals. Such activities may deliver little or no benefit to plans because they concern issues that have little bearing on share value or other plan interests.”

The DOL’s skepticism as to the importance of ESG factors for investment returns is not universally held. This year rang in with Larry Fink’s seminal letter to BlackRock holdings’ CEOs declaring “our investment conviction is that sustainability- and climate-integrated portfolios can provide better risk-adjusted returns to investors. And with the impact of sustainability on investment returns increasing, we believe that sustainable investing is the strongest foundation for client portfolios going forward.” This sentiment has been echoed by others in the investment community throughout 2020, particularly as social issues have gained equal footing with climate change with regard to many investors’ lists of material investment factors.

The Securities and Exchange Commission (SEC) reflects a similar divide of opinions on the materiality of ESG information. Recent amendments to the SEC’s disclosure rules drew criticism from many in the investor community as well as dissenting statements from SEC Commissioners Allison Herren Lee and Caroline Crenshaw, as discussed in this blog post. In separate statements, Commissioners Lee and Crenshaw proposed that industry participants come together to discuss ESG issues in an effort to bridge the divide.

Latham & Watkins will continue to monitor developments in this area.


[1] The proposal speaks only of “economic impacts” without distinguishing between short-term and long-term economic impacts. It is typically investors with a longer-term time horizon that are most keenly focused on the impact of ESG factors, as noted in this recent EU study on directors’ duties and sustainable corporate governance. Given the long-term horizon of ERISA plans, one might expect that the DOL would be all the more focused on ESG considerations and their financial impact on long-term plan performance.