The global community of investors risks losing trillions of
dollars to the effects of climate change. Understandably, some corporate
shareholders are pushing companies to put environmental sustainability front
and center on their business agenda. But a rule issued by the U.S. Department
of Labor during the Trump Administration’s last month in office mutes some of
those voices by banning retirement plan representatives from casting votes to
encourage companies to factor environmental, social, and governance (ESG)
matters into their business strategies.
The Trump Administration’s ban is misguided. After all,
studies demonstrate a direct connection between a company’s consideration of
ESG factors and their long-term financial performance. Although the Labor Department
recently announced a nonenforcement policy for this rule, simple nonenforcement
of this ban does not go far enough. The Labor Department should replace the
Trump Administration rule with one that actually encourages retirement fund
representatives to participate broadly in shareholder voting on ESG-related
issues.
Shareholder voting normally addresses corporate decision
making on a broad range of important matters, including issuance of securities,
makeup of the board of directors, executive compensation, and corporate
political influence. Questions can also come up for shareholder vote that
address ESG-related issues, including response to climate change, corporate
political influence, and diversity targets.
But these shareholder votes are not always cast by the
shareholders themselves. Tightly regulated representatives—fiduciaries—manage
many employer-sponsored retirement plans, even though the retirement plan is
the ultimate shareholder. These fiduciaries make decisions about the assets and
will often cast shareholder votes on behalf of the plan participants. The Trump
Administration’s regulation—known as the Proxy Voting Rule—interprets these
fiduciaries’ duties in a manner that makes it burdensome for them to vote on
corporate ESG matters.
This Proxy Voting Rule not only creates new barriers to
fiduciary participation in ESG voting, it also marks an about-face from prior
guidance. In 2016, the Obama Labor Department announced its view that federal
retirement plan legislation mandated that fiduciaries vote on all issues that
affect the value of the plan they hold or manage. The Labor Department
explicitly stated that it intended this guidance to encourage fiduciaries to
vote on issues impacting the long-term health of a corporation, including ESG
factors.
The Trump Administration’s late-issued Proxy Voting Rule
repealed the 2016 guidance. Instead of encouraging fiduciaries to vote on as
many issues as possible, the Proxy Voting Rule states that fiduciaries are not
required to vote all proxies. In some cases, they even have a duty to abstain.
Specifically, the rule bans fiduciaries regulated under the Employee Retirement
Income Security Act from voting in a manner that would advance social or
political goals, unless they vote “solely in accordance with the economic
interests of the plan.”
In the rule, the Labor Department concedes that there may be
instances where ESG factors may be relevant to the risks or value of a company.
But it states that fiduciaries should evaluate any ESG factor that is up for
vote to determine “whether it is a pecuniary factor relevant to the exercise of
a shareholder right or to an evaluation of the investment.” The Labor
Department also suggests that plans adopt a policy limiting proxy voting only
to matters that the fiduciary has “prudently” decided are either “substantially
related to the issuer’s business activities or are expected to have a material
effect on the value of the investment.”
This heightened scrutiny of ESG-related proxy votes,
combined with the position that fiduciaries are not required to participate in
a proxy vote, will likely chill fiduciaries’ participation in proxy votes
related to ESG considerations.
The Trump Administration justified the stricter approach to
proxy voting on ESG matters by arguing that it protects plan participants by
ensuring fiduciaries do not give priority to political or other non-financial
interests over the financial interests of retirement plan participants.
This justification depends on at least two assumptions.
First, it assumes that, absent this regulation, fiduciaries would be
subordinating the plan beneficiaries’ interests to their own agendas. Second,
ESG factors are presumed to be both non-financial and not in the best interests
of plan participants, absent certain limited instances when they may be
relevant to risks or corporate valuation.
Both of these assumptions are flawed. First, absent the
Proxy Voting Rule, fiduciaries would not subordinate the interests of the
beneficiaries for their own interests. The 2016 Obama Labor Department’s
guidance also forbade the subordination of plan beneficiaries’ interests to
unrelated objectives. Second, ESG matters do affect a company’s bottom line and
are directly relevant to the financial interests of plan participants. Studies
show a consistent positive correlation between ESG factors and corporate financial
performance. The factors underlying high ESG ratings help to drive a company’s
value by lowering risks of worker safety incidents, litigation, and other
disasters that can damage a company’s brand and valuation.
In response to the Proxy Voting Rule, a coalition of
Democratic lawmakers announced that they would introduce legislation to reverse
the rule, adding to a ballooning list of legislative priorities. But this
legislative action will not be necessary if Biden’s Labor Department ends up
revisiting and reversing this rule.
The Biden Administration will likely support ESG, and
already announced a nonenforcement policy for this Proxy Voting Rule, as well
as another Trump era anti-ESG rule. The Administration should go further than
simply not enforcing these rules and encourage more shareholder participation
on ESG matters by publishing a new rule that explicit supports fiduciary voting
on ESG-related questions.
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