In recent months there has been a lot of focus on how the U.S. Department of Labor (DOL)'s 2022 final rule on fiduciary investment duties (the so called "ESG rule") impacts investment selection and ESG considerations for ERISA-covered retirement plans (see our prior Alert and podcast). As we approach the fall, it is critical for managers of plan asset funds or commingled vehicles that include the assets of multiple ERISA plans to also focus on the upcoming proxy voting requirements of the final rule and to determine what concrete steps they will take to comply with a rapidly approaching December 1, 2023 deadline that applies to certain of those requirements. Managers of commingled funds that are subject to ERISA and that have not already obtained consent to their proxy voting polices must have their plan investors accept certain proxy voting policies by this December 1 to avoid compliance risks when those funds vote proxies.
December 1 Proxy Requirement
The final rule requires the investment manager of a pooled investment vehicle that holds ERISA plan assets of more than one employee benefit plan to reconcile differences in investment policy statements (IPS) and proxy voting practices for each investing plan. In the case of proxy voting, to the extent permitted by applicable law, the rule requires the manager to vote (or abstain from voting) the relevant proxies to reflect such policies in proportion to each plan's economic interest in the pooled investment vehicle. This is an unwieldy process that may require significant investments of additional time and resources to implement. The final rule permits a manager to avoid this unwieldy process by taking the following steps:
- Develop its own IPS/proxy voting policy consistent with ERISA; and
- Require each of the participating plans to accept this policy, including any proxy voting policy, before the plans are allowed to invest.
If a manager chooses this alternative approach and seeks the investing plans' approval, the plan fiduciaries must assess whether the manager's IPS and proxy voting policy are consistent with ERISA before deciding to retain the investment manager.
Note, this provision was not a new component of the final rule—the DOL's 2021 re-proposal included it, and while commenters requested the language be removed, the DOL was ultimately unpersuaded, based on the view that the final rule is similar to guidance relating to pooled investment vehicles that has been consistently part of the DOL's prior sub-regulatory guidance since 1994. Note that this requirement does not apply to separately managed accounts, but the DOL confirmed in the preamble to the final rule that there is nothing in ERISA that precludes an investment manager from requiring a plan fiduciary to accept the manager's proxy voting policies before agreeing to become a plan investment manager.
Implementation Challenges
Although the DOL was clear in the final rule that proxy voting polices must be accepted by December 1, there are a number of unanswered questions on how the acceptance process must work. First, the rule refers to manager's IPS, but the IPS is a plan sponsor document, so it is unlikely that a manager would already have one in place. In addition, managers may not have obtained formal acceptance of their proxy voting policies from existing investors. Instead of expressly permitting negative consent to satisfy these requirements, the DOL responded to requests to permit acceptance via negative consent by referring to the extended December 1 compliance date. The result is an uncertain landscape where the clearest path to compliance is obtaining explicit, affirmative acceptance by each plan of an IPS and proxy voting policy.
Practically speaking, most managers are not going to be positioned to reconcile the different policies of their investing plans in proportion to each plan's economic interest in the respective vehicle, so managers that oversee ERISA plan asset funds will likely have to determine what documents or policies they require and obtain their investing plans' acceptance by December 1, 2023. Managers must also determine and implement communications strategies and determine how to address non-responding plans, including whether to redeem them from funds or otherwise get comfortable that these plans will not impose extra proxy policy reconciliation requirements. Since these requirements were already given a delayed applicability date (most of the other provisions of the DOL's final rule took effect on January 30, 2023), there is no additional grace period for compliance. Therefore, managers need to determine how they intend to comply with these requirements and formulate their communication strategy with their investing plans now.
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