The Biden Administration can address global warming by encouraging fiduciary input on ESG matters.
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.
