Is Proxy Voting a Conflict-of-Interest Trap for the ERISA Fiduciary?
If you’ve been watching the usual business shows this past two month, you couldn’t help but notice New York City Comptroller John Liu. Besides Comptrolling New York City, Liu also serves as trustee to the retirement plans of all the cities employees. He seems to be on a crusade of late decrying the sins of the board of a certain very large publicly traded company for allegedly getting involved in a bribery scheme inside a foreign country. Liu has stated several times it’s his “fiduciary duty” to vote against the election of this company’s board of directors. But is it? In fact, could it be the exact opposite?
The issue of proxy voting used to exist only within the cobweb-filled annex of the most boring closet of investment management. Indeed, during the 1980’s, just as the business model of Registered Investment Advisers blossomed, the prevailing wisdom, perhaps handed down from the staid trust departments that spawned so many renegade financial services entrepreneurs, held that RIAs should never vote proxies. Instead, if the RIA felt dissatisfied with the management of a company it invested client’s hard-earned money in, that RIA had a duty to vote in only one way – with its feet.
Things changed dramatically in 2003 when the Securities and Exchange Commission adopted a new rule that said it was an investment adviser’s “fiduciary obligation to its clients” to vote proxies. The new rule required “an investment adviser that exercises voting authority over client proxies to adopt policies and procedures reasonably designed to ensure that the adviser votes proxies in the best interests of clients” among other things.
So there you have it in a nutshell, at least as it pertains to Registered Investment Advisers operating under the Investment Advisers Act of 1940 and regulated by the SEC. RIAs are under a “fiduciary obligation” to vote proxies “in the best interests of clients.” It would appear Liu is acting more than appropriately.
Or is he?
While the SEC regulates investment advisers, it does not regulate bank trust departments or ERISA trustees. Liu serves in a capacity like that of an ERISA trustee. The fiduciary duties of an ERISA trustee have greater similarity with those of bank trust departments than with Registered Investment Advisers. Fortunately, the Department of Labor has helped define the meaning of and duties of an ERISA fiduciary. In its publication Meeting Your Fiduciary Responsibilities, the DOL states the responsibilities of plan fiduciaries. Using the DOL’s own language (in quotes), let’s parse these responsibilities in terms of Liu’s thesis.
- Is Liu “acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them”? Liu would argue that he is, but there are those who believe this is a grey area. (Unfortunately, given the politics of this issue, they prefer not to be quoted.) Clearly in the specific company cited by Liu, the stock price – and therefore the benefit to the plan participants – has not suffered. Indeed, relative to the S&P 500 (an apt comparison given this is a large cap stock), this stock has appreciated more than 10% while the S&P 500 has lost 5% during the period since news of the allegations surfaced and Liu has claimed it’s his “fiduciary duty” to vote against the board. If Liu’s fiduciary duty is limited to “acting solely in the interest of plan participants,” perhaps he should have voted against the board only if they didn’t follow local customs (yes, what some call “bribery” others call respecting local customs, which gives you a sense of the appropriateness of the law this company is accused of violating).
- Is Liu “carrying out his duties prudently”? While this might seem more subjective, the DOL does help when it explains, “The duty to act prudently is one of a fiduciary’s central responsibilities under ERISA. It requires expertise in a variety of areas, such as investments. Lacking that expertise, a fiduciary will want to hire someone with that professional knowledge to carry out the investment and other functions.” According to his Wikipedia biography, Liu has never run a large investment portfolio, nor has he ever run a multi-national retailer with nearly half a trillion dollars in sales. So it would have seemed the prudent thing for Liu to have done was to hire an expert with suitable experience (or at least an attorney – which, unlike most politicians, Liu is not – with experience in this particular law) before laying claim to the moral high ground versus the company’s directors.
- Is Liu “following the plan documents (unless inconsistent with ERISA)”? As search through the New York City Employees’ Retirement System Summary Plan Description finds no match for the word “proxy,” so it’s unclear if the plan documents speak to the matter with Liu is referring.
- Does this stock Liu is complaining about fit within the objective of “diversifying plan investments”? Certainly this stock, which has major institutional ownership, does comply with this duty.
- Is Liu “paying only reasonable plan expenses”? Here we find another grey area. The DOL says, “While the law does not specify a permissible level of fees, it does require that fees charged to a plan be ‘reasonable.’” In this case, the question one must ask is “Who is paying for the costs associated with Liu’s efforts, including his time and the time of his staff to prosecute this issue?” If New York City is footing the billing (as opposed to the plan), then ERISA (and the DOL) has no problem (although the taxpayers of New York City might have a different opinion). If the plan is paying for this shareholder advocacy, then it becomes a question of whether this activity benefits the shareholder.
And therein lies the Catch-22 of the situation, for we are back to our original question. On the face of it, if Liu really thinks these allegations of bribery are true and he believes that fact will hurt the shareholder value of the company (said value being the only concern he should care about), then the prudent act might be to sell the company right now, given that it has risen by 10% since Liu began his public tirade.
Said another way, if Liu was really “acting solely in the interest of plan participants and their beneficiaries and with the exclusive purpose of providing benefits to them,” he would be voting with his feet, not with his TV appearances.
And surely he is only acting in the interests of the plan participants and their beneficiaries, right? It’s not like he’s merely acting like a typical scandal-ridden elected official trying to deflect attention away from investigations into his own alleged misdoings, right?
Still, Liu’s actions do pose a very difficult question: At what point does acting solely for the benefit of the beneficiary cross the line into acting in behalf of one’s self-interest? There’s no question such a line exists. Where it exists, and what specifically triggers it, defines the parameter of this debate.
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