Nearly a year after it held a roundtable on the topic, the Securities and Exchange Commission on Aug. 21 issued “an interpretation that proxy voting advice provided by proxy advisory firms generally constitutes a ‘solicitation’ under the federal proxy rules.”
This is a big deal. Proxy advisers have become the most powerful players in corporate governance. The field is dominated by just two firms, Institutional Shareholder Services (ISS) and Glass Lewis. They provide recommendations to funds on how to vote on proxy questions that come before them as owners (on behalf of their investors) of shares of thousands of different companies. Those proxy questions include electing board members and engaging accounting firms but, more and more, funds are called on to vote on environmental, social and governance issues that are subsumed under the shorthand acronym “ESG.”
The advisers have been criticized for making decisions — especially in the ESG arena — using ideological rather than strictly financial criteria. They have also been accused of making factual errors and not correcting them quickly, of using one-size-fits-all approaches to questions rather than considering the needs and strengths of individual companies, and of conflicts of interest.
And they’ve been criticized for forcing a practice often called “robo voting.” Specifically, “robo-voting” takes place when pension fund managers and other fund managers automatically vote in alignment with proxy advisory firm recommendations. This practice undermines the First Amendment rights of public pensioners and retail investors since their voice has been disenfranchised in the shareholder resolution votes by fund managers. This practice is most problematic if the resolutions advance a political agenda instead of prioritizing financial returns. J.W. Verret on the SEC Investor Advisory Committee and George Mason Law School called attention to this issue in a recent Financial Times op-ed when he wrote, “This kind of automatic voting in line with unregulated third parties’ guidance is undermining the fiduciary duty that advisers owe to investors.”
While the SEC’s “interpretation” or “guidance” is not a rule-making or a regulation, it “could have significant impacts on how proxy firms and investment advisers conduct business,” wrote Peter Rasmussen on BloombergLaw.com. Nor is the SEC finished with the matter. Great oversight may be coming.
The SEC made it clear that the recommendations of proxy advisers are subject to legal anti-fraud provisions under the SEC’s Rule 14a-9. Previous SEC actions had given the investment community the distinct impression that proxy advisers had special protections and that investment funds, including public pension plans, could shift responsibility for making proxy-voting choices onto the advisers without either group assuming the sort of responsibility that traditionally extends to advice giving and receiving in the securities world.
The SEC warned that Rule 14a-9 “prohibits any solicitation from containing any statement which … is false or misleading with respect to any material fact.” And the commission stated that proxy advisers would have to disclose information which “extends to opinions, recommendations, or beliefs” in order to avoid a potential violation.
It appears that proxy advisers will have to justify their voting recommendations much more rigorously than they do now. If so, millions of Americans will benefit.
We cannot expect to safeguard the retirements of the 14 million-plus public servants contributing to pension plans if the SEC fails to assign proper accountability to the firms that are responsible for more and more pension-fund decisions. A Manhattan Institute study has shown that a portfolio of ESG investments performs more poorly than the market as a whole, and the recent returns of the largest public-employee pension fund CalPERS, which is a prominent practitioner of ESG investing, have been especially dismal. For the fiscal year ending June 30, returns of the public equity portfolio of CalPERS’s portfolio were just 6.1 percent while S&P 500 index funds returned 9.7 percent.
This emphasis on ESG, driven by proxy advisers, poses disastrous consequences for our nation’s already-suffering public pensions. Americans deserve better. After sacrificing a portion of every hard-won paycheck in order to secure financial stability for their families’ futures, plan members need to receive what was promised to them in retirement.
According to the SEC’s own language, its mission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” There’s nothing fair about a market skewed by trending political causes advanced by vocal minorities.
On Aug. 21, the SEC took a good first step at reviving the principles of fiduciary responsibility. Lack of transparency and accountability both enable the practices that can lead to recommendations that harm the performance both of corporation and pension funds.
Public pension funds are already underfunded and underperforming. The SEC is in a unique position to address a serious problem. Now is the time for leading officials to ensure that investments are based, in the SEC’s own words, on “timely, comprehensive, and accurate information,” not on blanket recommendations steeped in ideology.
• Ken Blackwell has served as treasurer and as secretary of State of Ohio, as well as mayor of Cincinnati. He serves on the Advisory Board of the Institute for Pension Fund Integrity.