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27 Sep. 2019 | Comments (0)

On Governance is a series of guest blog posts from corporate governance thought leaders. The series, which is curated by the ESG Center research team, is meant to serve to spark discussion on some of the most important corporate governance issues.

In the United States, federal securities laws are primarily administered by the Securities and Exchange Commission (SEC). However, the Department of Labor (DOL), through its administration of the Employee Retirement Income Security Act of 1974 (ERISA), also has an important role to play as a securities regulator, especially in the area of investment management.[1] This importance is evidenced by the over $11 trillion worth of assets[2] held in ERISA employee pension benefit plans. 

Under ERISA, those who manage plan assets or provide investment advice owe the strictest duties of loyalty and care to their beneficiaries and participants. These duties are comparable to what is found under the common law of trusts. Moreover, since the famous Avon letter of 1988, it has been DOL policy that the fiduciary act of managing plan assets also includes managing the voting rights associated with a plan’s equity holdings. 

Given that shareholder voting carries with it fiduciary duties, it is somewhat surprising to find that proxy advisors such as Institutional Shareholder Services (ISS) and Glass Lewis, the primary providers of shareholder voting recommendations to ERISA plan managers, have yet to be designated investment advice fiduciaries under Section 3(21)(A)(ii) of ERISA (being designated as such a fiduciary under ERISA is distinct from being an investment adviser under the Investment Advisers Act of 1940). 

ERISA provides that a person is a fiduciary if he renders investment advice for a fee with respect to the assets held in a plan’s portfolio.  ERISA leaves it to the discretion of the DOL to designate what persons are deemed to be rendering investment advice and therefore fiduciaries under Section 3(21)(A)(ii).    

When a proxy advisor provides shareholder voting recommendations to an ERISA plan manager for a fee, it is rendering investment advice.  If these recommendations are followed by the client and other institutional investors, then the quality of the voting recommendations in terms of both precision and bias can have a significant impact on the value of a stock held in portfolio.  If a voting recommendation is very precise and lacks bias, then, if utilized by shareholders, it may help increase company value and its stock price.  If a recommendation lacks precision and/or was created with significant bias, then, if utilized, it may decrease its value.  The significance of such investment advice justifies the DOL in using its discretionary authority to designate proxy advisors as fiduciaries under ERISA.      

 As argued in my recent article and summarized here, the time is now at hand for the DOL to make such a designation.  In the spring of 2019, the DOL announced that it was in the process of preparing a proposed rule (“forthcoming Proposed Rule 1”) that targets proxy voting with the objectives of “(1)addressing practices that could present conflicts of interest associated with proxy advisory firm recommendations; (2) ensuring that proxy voting decisions are based on best information; and (3) ensuring that proxy voting decisions are solely in the interest of, and for the exclusive purpose of providing plan benefits to, participants and beneficiaries.”[3] 

In addition, the DOL announced a related forthcoming proposed rule specifically targeting investment advice fiduciaries (“forthcoming Proposed Rule 2”).[4] This forthcoming proposed rule will address the defects in the highly criticized and recently vacated 2016 fiduciary rule.[5]  In that final rule, the DOL was found to have overreached in trying to designate almost all finance professionals who deal with ERISA plans as investment advice fiduciaries.  If the forthcoming Proposed Rule 2 is going to continue to pursue the idea of increasing the number and type of investment advice fiduciaries, but with a much more limited focus to make sure that statutory constraints are met, then a major focus should be on proxy advisors. 

The DOL’s forthcoming proposed rule making coincides with similar work going on at the SEC. SEC Chair Jay Clayton has initiated a proxy process review that has as one of its major focuses the conflicts of interests and precision of voting recommendations of proxy advisors.[6] This has already led the SEC to issue new guidance requiring investment advisers to be more diligent in their oversight of proxy advisors.[7] 

Being designated investment advice fiduciaries under ERISA would require proxy advisors, like ERISA plan managers (trustees who retains investment and voting authority or investment managers who receive such authority through delegation by the trustees), to not only be constantly guided by the fiduciary principles of solely in the interest of the participants and beneficiaries, exclusive purpose of providing benefits to them and the prudent man standard in the creation of its voting recommendations for ERISA plans, but also must have, without exception, shareholder wealth maximization (SWM) as their sole objective when creating voting recommendations for ERISA plan managers.  

In regard to SWM as the sole objective, the fiduciary “pursuit of financial benefits for the plan beneficiaries,”[8] can only be achieved if the ERISA fiduciary pursues the highest risk-adjusted return possible for the plan’s beneficiaries and participants.  For the management of equity holdings in an ERISA plan (common stock or any other type of security with company voting rights), the common investor purpose can only be achieved if it is interpreted to mean the pursuit of SWM.  

ERISA’s fiduciary duties require that traditional concerns such as a lack of precision in the voting recommendations of proxy advisors due to a lack of resources and newer concerns such as the rise in the use of Environmental, Social, and Governance (ESG) “objectives” cannot creep into the voting recommendations that are used by ERISA plan managers.  However, this does not mean that ESG “factors” cannot be used in the creation of voting recommendations.  Under ERISA, the use of these factors is acceptable, but only in the context of a risk-return analysis with SWM as the sole objective. That is, the purpose of utilizing ESG factors is “to take into account … financially material risks and opportunities that arise out of environmental, social and governance information; it is not about achieving particular environmental, social or governance goals.”[9]  

The importance of ERISA fiduciaries correctly dealing with ESG objectives and factors cannot be understated. It has been reported that their use by institutional investors has increased dramatically over the last 10 years.[10] It has also been reported that institutional investors managing approximately $83 trillion of assets have signed the United Nation’s Principles for Responsible Investment, an initiative that backs the use of ESG in asset allocation.[11] Moreover, at the end of 2018, it was reported that $1.2 trillion had been invested in funds that followed “non-economic guidelines.”[12]  

No doubt, as a means to satisfy their clients, this puts significant pressure on proxy advisors to utilize ESG objectives and factors as well.  If so, then this adds an additional layer of complexity to the voting recommendation process.  This complexity is enhanced by ESG objectives and factors being extremely subjective and easily conflated, creating additional risk that their use may end up with the wrong result.  

Therefore, making sure that ESG objectives are being excluded while ESG factors are being properly used in the creation of voting recommendations is another reason why the time is now ripe for the DOL to designate proxy advisors as investment advice fiduciaries under ERISA. 

Finally, there are several supplemental recommendations that the DOL must implement to support the primary recommendation of designating of proxy advisors as investment advice fiduciaries: 

  • Proxy advisors must provide voting recommendations for ERISA plans that are exclusively focused on SWM. Any type of customization based on client preferences must also meet this requirement.  If not, then the customization cannot be allowed.  It must always be remembered that the clients of proxy advisors are ERISA plan managers, the agents of beneficiaries and participants, and that ERISA’s fiduciary duties are owed to the beneficiaries and participants, not their agents.

    For ISS, this would require a new SWM specialty report for each ERISA plan client.  Moreover, since Taft-Hartley plans come under the fiduciary duties of ERISA, the ISS Taft-Hartley specialty report, notable for its policy of being in compliance with AFL-CIO guidelines, would need to be withdrawn and replaced with the same SWM specialty report. 
  • While the focus of this post is not on the stewardship teams of large mutual fund families, they also need to be designated investment advice fiduciaries.  Like proxy advisors, stewardship teams provide shareholder voting recommendations. But unlike proxy advisors, they have a much more restricted client base – the mutual fund families that they have created and/or manage. The designation of investment advice fiduciary would be required when an investment adviser with a stewardship team has been appointed the investment manager of an ERISA plan, the trustee has delegated shareholder voting authority to the investment adviser, the investment adviser’s mutual funds are investment options for ERISA beneficiaries and participants, and the stewardship teams are providing voting recommendations to these mutual funds.    
  •  Proxy advisors must abstain from providing ERISA plans with voting recommendations on environmental and social shareholder proposals unless they have a compelling reason to believe the board is uninformed. This is so because in terms of evaluating how such E&S proposals impacts shareholder wealth, the board and executive management have a large comparative advantage. Unlike the proxy advisor, they have access to inside information and the ability and resources to do a thorough financial analysis. Also, and perhaps most importantly, in terms of evaluating such proposals from the perspective of SWM, it can be assumed that the board is not conflicted.
  • To help the DOL monitor a proxy advisor’s compliance with their fiduciary duties, a proxy advisor should periodically provide the following information to the DOL:  
    • A description of “the essential features of the methodologies and models applied.” 
    • Information sources used in the creation of its voting recommendations. 
    • A description of the procedures in place to make sure that the voting recommendations provided ERISA plans meet the prudent man standard. 
    • A description of the procedures in place to make sure that the voting recommendations are exclusively tied to the objective of SWM.
    • A description of the procedures in place to deal with a voting recommendation that is contested by a public company.  These procedures must be consistent with the prudent man standard.  
    • A prompt identification and disclosure to the DOL of “any actual or potential conflict of interest or any business relationship that may influence” the creation of its voting recommendations. 
    • Disclosure of the procedures in place to determine when it will abstain from providing voting recommendations. As a resource constrained institution, there will be times when there are not enough resources available, e.g., expertise on a certain merger, proxy contest, or executive compensation in a certain industry or at a specific company, to make a voting recommendation that meets the prudent man standard. 

In sum, if proxy advisors are designated as investment advice fiduciaries and the substance of these supplemental recommendations are implemented, then the voting recommendations of proxy advisors can be used by an ERISA plan manager to successfully comply with her fiduciary duties when managing the voting rights of the plan’s equity holdings.    


The complete article, which is forthcoming in Stanford Journal of Law, Business & Finance,  can be found here.   

The underlying article was supported by a grant provided by the Main Street Investors Coalition.  The opinions expressed here and in the underlying Article are the author’s alone and do not represent the official position of any organization with which he is affiliated, including the Main Street Investors Coalition. 

The views presented on the ESG Blog are not the official views of The Conference Board or the ESG Center and are not necessarily endorsed by all members, sponsors, advisors, contributors, staff members, others associated with The Conference Board or the ESG Center.


[1] Anita K. Krug, The Other Securities Regulator: A Case Study in Regulatory Damage, 92 Tul. L. Rev. 339 341 (2017).

[2] Marlene Satter, Retirement Assets Hit $29.2T: ICI Report, ThinkAdvisor, (Dec. 27, 2018),

[3] Department of Labor, Proxy Voting Update, RIN: 1210-AB91 (Spring 2019),   

[4] Department of Labor, Fiduciary Rule and Prohibited Transaction Exemptions, RIN: 1210-AB82 (Spring 2019),

[5] Chamber of Commerce of the USA v. United States Department of Labor, No. 17-10238 (5th Cir. 2018) at 31/38,

[6] Chairman Jay Clayton, U.S. Securities and Exchange Commission, Statement Announcing SEC Staff Roundtable on the Proxy Process, (July 30, 2018),

[7] U.S. Securities & Exchange Commission, SEC Clarifies Investment Advisers’ Proxy Voting Responsibilities and Application of Proxy Rules to Voting Advice (Aug. 21, 2019), Press Release,

[8] Max M. Schanzenbach and Robert H. Sitkoff, Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee, forthcoming, 72 Stanford L. Rev. at 15 (forthcoming 2020).

[9] Randy Bauslaugh and Dr. Hendrik Garz, Pension Fund Investment: Managing Environmental, Social and

Governance (ESG) Factor Integration, McCarthy Tétrault,

[10] George Kell, The Remarkable Rise Of ESG, (July 11, 2018), Forbes,

[11] Antony Currie and Neil Unmack, Breakingviews - Breakdown: ESG investing faces sustainability test, Reuters (May 28, 2019),

[12] Id.

  • About the Author:Bernard Sharfman

    Bernard  Sharfman

    Bernard Sharfman is an associate fellow of the R Street Institute, chair of the Advisory Council of the Main Street Investors Coalition, a member of the Journal of Corporation Law’s editorial ad…

    Full Bio | More from Bernard Sharfman


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