Issues & Insights

Don’t Let Coronavirus Stop Long Overdue Proxy Reform

Due to a number of factors, including the coronavirus outbreak and a steep decline in commodity prices, people’s investment portfolios have suffered substantial losses.

While these factors are beyond most everyone’s control, protection of everyday investors through proxy advisor reform by the SEC must continue. The practice by many investment firms of blindly following advice based on political and social motivations while disregarding their fiduciary responsibility is irresponsible, if not reckless.

Large investment managers face a complex, time-consuming, task in voting proxies. Mutual fund companies and pension funds own shares of thousands of companies, each requiring multiple decisions on electing directors and approving important corporate policies. 

The virus outbreak makes allocating time to accomplish this work more difficult. It will increase pressure to outsource even more of this task to less qualified, third parties, and to increase uninformed and thoughtless automated voting.

In writing the new Rule, the main problem the SEC faced was that proxy voting came to be dominated by two powerful firms that often make recommendations based not on what’s best for investors, but on their own values.

What fund managers who vote on investors’ behalf need is accurate, transparent, materially complete, and fair information and analysis. Unfortunately, the process by which proxy advisors determine their voting recommendations is opaque, conflicts of interest abound, and companies are given little or no time to review proxy advisors’ judgments for factual errors.

The SEC’s new approach, as outlined in guidance issued last August, is to consider proxy advisors’ recommendations as “solicitations,” subjecting them to stricter rules to ensure investors’ interests are protected. For their part, investment managers would be required to exercise more diligence in vetting proxy advisors. 

As the SEC put it, managers have to determine “whether the proxy advisory firm has the capacity and competency to adequately analyze the matters for which the investment adviser is responsible for voting.”

The Coronavirus outbreak probably will increase pressure on fund managers to use more proxy voting services, but under the rule simply handing over this task to others would not relieve fund managers of their fiduciary obligation to shareholders.

The two main proxy advisers, Institutional Shareholder Services (ISS) and Glass Lewis, have a duopoly with a market share of well over 90%. They have evolved into de facto regulators. A 2016 study found that 25% of all proxy voting outcomes are determined by their recommendations, and a Stanford University survey found that portfolio managers, who know listed companies best, are involved in only 10% of voting decisions at large investment firms.

Proxy advisors have become arbiters of public-company disclosure requirements, executive pay, and, of course, adherence to ideologically tinged environmental, social, and governance (ESG) principles.

According to a recent NASDAQ/U.S. Chamber of Commerce survey, 19% of companies identified significant conflicts of interest among proxy advisors. Conflicts include advocating for board candidates who represent proxy advisory clients and making voting recommendations on proxy proposals when the sponsor is a client. 

The conflicts at ISS are particularly egregious because the firm sells consulting services to companies to help them get the proxy recommendations that ISS provides to the voting institutions. Prohibiting proxy advisory firms from engaging in such conflicts should be self-evident.

It’s also obvious that companies should be given the opportunity to engage with advisors and correct factual errors before recommendations are disseminated. The SEC can rectify the problem by mandating that advisors have to contact issuers three to five days before issuing opinions. 

Many fund managers use pre-populated ballots (so-called “robo-voting”) to justify their own laziness or lack of interest. The managers just automatically vote as the proxy advisors recommend.

2018 American Council for Capital Formation study found that institutions with assets totaling more than $5 trillion in assets are voting with proxy-advisor robo-recommendations at least 95% of the time. Given the virus outbreak, the incentive for fund managers to use more prepopulated ballots is large. The new Rule would push back against this harmful incentive.

The Coronavirus outbreak may encourage fund managers to be even less engaged with proxy voting issues and this should be resisted. Proxy voting advisers were intended to be third-party researchers assisting investment advisers with their work. They were not intended to supersede an investment adviser’s responsibility to its customers, the ultimate investor. 

Reform of the proxy advisory business is not an unnecessary interference; it is a long-overdue corrective by the SEC to a process that has increasingly lost sight of the shareholders’ own need for strong, unsullied returns. 

Jonathan Chanis manages New Tide Asset Management, LLC, a company investing in listed equity. He formerly taught at Columbia University and worked at several financial firms, including Citigroup and Goldman Sachs. He recently filed a comment letter with the SEC’s public docket on the SEC’s proposed rule on proxy voting advice.

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