Last month, the Department of Labor issued a proposed regulation that promises to check the increasing pressure from activist shareholders, who are enjoying record levels of support for environmental and social shareholder proposals, which are often untethered to shareholder value and should not be supported by private pension fund managers.
Specifically, the proposal directs plan managers to only vote on shareholder proposals that add economic value to their portfolios, a reversal of past interpretations, which prompted plan managers to blindly vote on all proposals to meet their fiduciary obligations.
This new interpretation from the Labor Department is more in line with the intent of its underlying legal authority, the Employee Retirement Income Security Act (ERISA), which sets out strict fiduciary standards for the management of private sector retirement funds to ensure that plan managers’ actions are wholly aligned with the interests of retirees – to maximize the value of their retirement assets.
ERISA plan assets are considerable, estimated by the Federal Reserve at $9.4 trillion in 2019, and holding around 5.5 percent of all US corporate stock. While declining as a proportion of all corporate equity, ERISA plan assets are nevertheless substantial. The impact of the proposal is therefore significant.
The proposed regulation formally repeals more permissive Obama-era sub-regulatory guidance that encouraged fiduciaries to recognize “the long-term financial benefits that, although difficult to quantify, can result from thoughtful shareholder engagement when voting proxies, establishing a proxy voting policy, or otherwise exercising rights as shareholders.” The vagueness of this guidance gave cover to investment managers to acquiesce activists.
The Department also states it issued the proposal to resolve a “persistent misunderstanding” among some quarters that fiduciaries are required to vote all proxies. This pushed investment managers to vote on all proposals to comply with ERISA, instead of evaluating whether their vote would have a positive financial impact of their portfolio.
This misunderstanding pushed investment managers to rely on proxy advisors to fulfill their proxy voting responsibilities. But proxy advisors do not owe retirees a fiduciary duty, had unchecked conflicts of interests, and are more likely to support dubious environmental and social shareholder proposals than asset managers writ large. To make matters worse, some investment managers automatically vote in line with recommendations from proxy advising firms, known colloquially as ‘robo-voting’ without conducting their own due diligence.
There is an increasing body of evidence that demonstrates the prevalence of robo-voting. A recent academic study suggests that the fraction of Institutional Shareholder Services (ISS) customers blindly following its recommendations grew from 5 percent in 2007 to 23 percent in 2017, while another study found that 175 asset managers with more than $5 trillion in assets under managers follow ISS’s recommendations at least 95 percent of the time.
The proposal throws cold water on this practice by requiring plan fiduciaries to, “investigate material facts that form the basis for any particular proxy vote” and states, “…the fiduciary may not adopt a practice of following recommendations of a proxy advisory firm or other service without appropriate supervision...”
The fiduciary responsibilities also extend to selecting and monitoring proxy advisory firms as well as assessing their competence and potential conflicts of interest. In the proposal, the Department points out that, “in certain instances a proxy advisory firm may issue proxy voting recommendations while the company that is the subject of such recommendations is a client of the firm’s consulting business.” Once the proposal is finalized, fiduciaries will need to monitor for potential conflicts of interest and document what specific actions they have taken to do so.
Removing obligations to vote on matters unrelated to plan value will take a significant compliance burden off the shoulders of fiduciaries and deliver cost savings to the benefit of plan participants and remove the need to outsource compliance to unaccountable proxy advisors. More importantly, quarantining plan assets from crusading activists will help safe-guard long-term investment returns.
It speaks to the forces at work in the service of ideological investing that a regulation is needed to ensure that those tasked with investing the retirement savings of millions of American workers prioritize their economic interests and only vote proxies where it is in their financial interests. Those workers can be more confident once the regulation is implemented.
Burchell Wilson is a consulting economist with Freshwater Economics.