Commentary Economy Taxes & Regulations

SEC Should Address Retail Investor Concern Over Proxy Advisors

Like many retail investors I have found low-fee passive investments such as index funds highly attractive. Pioneered by the late Jack Bogle, these products give investors the ability to own a diverse portfolio of stocks at an affordable cost, in the process delivering financial prosperity for millions of Americans.


However, the benefits conferred by index funds are increasingly being exploited by an opaque subsector of Wall Street known as proxy advisory firms.

This trend has gained momentum because retail investors participating in these funds are required to surrender their voting rights to managers, who represent all the members en bloc.

As the number of shareholders investing in funds has exponentially grown in the past decade, fund managers have begun to wield tremendous influence over corporate governance at American public companies, even though these managers do not actually own any stock themselves.

Unfortunately, too many asset managers expend little effort in determining how to properly execute their newfound proxy voting power.

The Rise Of Proxy Advisors

Instead they rely heavily on the advice of proxy advisory firms, outside consultants who not only lack any statutory authority to regulate companies or acknowledge an obligation to issue guidance directed toward maximizing returns, but in some cases do not even admit to having a fiduciary responsibility to fund investors.

As a consequence, proxy firms are vicariously exercising significant influence over whether a shareholder resolution at a given company passes or fails. Research shows that a recommendation by the market leader, ISS, can influence a vote by as much as 25%.

Of more concern to retail investors, proxy advisors have a track record of promoting shareholder resolutions aimed primarily at addressing political issues. Research by law firm Sullivan & Cromwell has shown that ISS supported 74% of social proposals in 2018, including 84% of proposals that would force businesses to comply with extralegal environmental standards that are higher than those set by government regulators.

Although supporting politically motivated resolutions is not inherently problematic, evidence that these proposals materially enhance enterprise value is mixed at best.

No Financial Benefits

According to another study authored by a leading Harvard academic, politically oriented proposals on average create greater costs for publicly traded companies — and therefore, shareholders like me — than financial benefits.

That conclusion is also indirectly corroborated in a study conducted by Broadridge and accounting giant PwC showing that during the 2018 proxy season retail investors who voted shares they hold directly were half as likely as fund managers to support environmental and social proposals.

In other words, when retail investors do vote they rarely use their investments as a means to further social initiatives.

To compound the problem, a study by the U.S. Chamber of Commerce found that proxy firms routinely support ballot proposals that have been resoundingly rejected by a majority of other investors in prior years.

‘Zombie’ Proposals

Support from proxy advisors helps keep these initiatives alive, creating “zombie proposals” that company management is perennially forced to assess, draining capital and resources from other profit seeking activities.

These issues are troubling enough, but they appear to be the tip of the iceberg. Among other failings, proxy firms have also been criticized by public companies and academics for using ‘one size fits all’ methodologies, a lack of transparency in decision-making, conflicts of interests between business units, a track record of incorrect guidance and an inability to correct errors.

As recognition of these intrinsic problems at proxy firms has mounted, BlackRock, the world’s largest fund manager with almost $6.5 trillion under management, is now calling for greater transparency from proxy advisors, suggesting that they must improve the quality and accuracy of their guidance to serve the interests of retail investors.

Thankfully, the Securities and Exchange Commission has taken notice of the growing consensus for reform, a step I feel is long overdue.

I am hopeful the commission will design and enforce a regulatory regime for the proxy advisory industry to ensure it is held to the same fiduciary standards as the rest of the financial services industry, requiring them to adhere to the singular goal of maximizing returns for retail investors.

  • Bauroth is a retail investor and member of the Main Street Investors Coalition Advisory Council.

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