Finalized DOL Regulation Raises Commingled Funds Proxy Voting Issue

The US Department of Labor’s final regulation on the investment duties of ERISA fiduciaries contains a special rule on proxy voting by ERISA pooled investment vehicles, which requires action by December 1, 2023.

Despite requests to do so, the Department of Labor (DOL) in its final rule did not remove this provision, which imposes an additional burden on investment managers of Employee Retirement Income Security Act of 1974 (ERISA)-governed pooled investment vehicles holding assets of multiple ERISA plans. According to this provision (which the DOL notes reflects its longstanding position, although it has not previously been codified in regulation), the commingled fund’s investment manager would be required to reconcile, insofar as possible, any conflicting investment policy statements of the individual investing plans, including with respect to proxy voting, thereby potentially being required to vote (or abstain from voting) proxies in a manner that reflects those differing policies in proportion to each plan’s economic interest in the pooled fund.

Recognizing the difficulties this would present, the regulation provides an alternative approach, whereby the manager may require investing plans to accept the manager’s/fund’s investment policy statement, including any proxy voting policy, as a condition to the plan’s investment in the fund.

Recognizing that fund sponsors/managers will need time to come into compliance, this provision is not effective until December 1, 2023.

While this provision is applicable solely to ERISA pooled investment vehicles, managers of single-plan accounts or separately managed accounts (SMAs) subject to ERISA may also want to ensure that their documents clearly identify whose proxy voting policy governs the account. Accordingly, investment managers would be advised to review their existing fund/account documentation to see how proxy voting is currently handled.

If there are no provisions, or the provisions are unclear, the manager will want to:

• revise its documents going forward to add appropriate language to make clear whose voting polices control, and
• clarify existing fund documents and investment management agreements in this regard.

As to how to handle existing documentation, the DOL, in response to requests to permit managers to use a “negative consent” procedure for adoption of a manager’s proxy voting policy by plans with current investments in a pooled fund, stated it believes that the later effective date for this provision “should alleviate commenters’ concerns.” The implication is that the DOL does not believe ERISA would prevent using a “negative consent” approach to make such a change, assuming this approach is acceptable under the applicable fund documents and other governing law.

Assuming that the fund/account intends to rely on the manager’s proxy voting policy, the proxy voting language—which can be in a fund’s subscription agreement, participation agreement, investment management agreement, or similar document executed by the plan fiduciary on behalf of the investing plan—should ideally specifically authorize and direct the manager to vote proxies in accordance with its proxy voting policy. Below is an example:

The [Trustee/Investment Manager/Investment Adviser] shall vote, or refrain from voting, all proxies with respect to securities held in the [Fund/Account] in accordance with its proxy voting policies, guidelines, and procedures in effect from time to time. The Plan Fiduciary acknowledges receipt of a current copy of the [Trustee’s/Investment Manager’s/Investment Adviser’s] proxy voting policies, guidelines, and procedures, and the [Trustee/Investment Manager/Investment Adviser] agrees to provide a current copy to the Plan Fiduciary upon request.

The reason for providing a copy of the manager’s proxy voting policy is to address the statement in the regulation that the investing plan fiduciaries will be responsible to assess whether the manager’s proxy voting policy is consistent with Title I of ERISA. By analogy to similar conditions in DOL regulations and exemptions, it may be acceptable to provide a summary rather than the full policy, depending on how much detail is contained in the summary.

While the DOL regulation also raises the same issue with respect to an ERISA-governed fund’s overall investment policy, this has generated less concern, because an investing plan can generally be viewed as accepting a fund’s investment guidelines by making an investment in the fund under the terms of the fund documents. Fund documents (as well as SMA documents) typically authorize the manager to invest in accordance with the fund’s (or SMA’s) specific investment objectives and guidelines that are included as part of the documentation delivered to each investor. However, managers may also want to confirm that their documents are clear on this point and, if not, consider whether to make any changes.

HOW WE CAN HELP

While the compliance deadline is still nine months away, affected parties should begin planning now to allow adequate time to obtain any necessary consents. Morgan Lewis is available to provide assistance in review of ERISA fund and SMA documents to assess compliance with this newly formalized DOL requirement.