Robo-voting: An Overview
With the focus of government, business, and the media all centered on the singular issue of coronavirus, attention toward the upcoming proxy shareholder voting season has been moved to the back burner. Over the next few months, shareholders of publicly traded companies will be voting on various resolutions, including who sits on boards of directors and what critical investment decisions will be made. In the run-up to this voting season, IPFI is committed to making sure that investors, shareholders, and especially pension beneficiaries are informed of the nuances and realities behind this process. More importantly, we hope to shed light on the more detrimental aspects of the industry that we believe have compromised the fiduciary integrity of public pension funds.
The current economic crisis is causing many companies, investors, and pension fund managers to make tough decisions. While it is likely that major changes to pension management will not be made until after this pandemic has subsided, we hope that the new financial realities facing many fund managers will impress upon them the need for reform.
In the past, we have been critical of the outsized role played by proxy advisory firms in investment decisions, and specifically the “robo-voting” process through which their influence is actualized. In this post, we will expand upon the concept of robo-voting in order to provide the average shareholder or pension fund beneficiary some insight into how their money is being managed – or, in many cases, mismanaged.
How did we get here?
As the intricacies of the financial industry and investment decisions have grown more and more complicated over the past several decades, a growing number of institutional investors have come to rely on the advice and analysis of proxy advisory firms in their decision-making process. While the rise in prominence of these outside consultants may have originally come about as a market reaction to the nature of the financial industry, their current standing does not reflect the realities of an open and free market. Only two firms – ISS and Glass Lewis – control 97% of the proxy advisory industry, creating an effective duopoly and preventing investors from doing any actual comparison shopping for a firm that might best meet their needs. The limited number of proxy firms (and employees who work for them) compared to the vast array of investors seeking their assistance has hindered responsiveness and limited the ability of investors to critically evaluate the advice they receive. Furthermore, questions have arisen over potential conflicts of interest among proxy advisory firms, calling into doubt their fiduciary obligations to their clients.
What is Robo-voting?
Robo-voting, also known as “automatic voting” or “proxy voting,” is the process by which asset managers, pension fund managers, and other investors automatically vote in line with the recommendations provided to them by proxy advisory firms. In a previous article, IPFI President Christopher Burnham compared the use of robo-voting to robocalls, and in a sense the reasoning behind the two is similar – by automating the process, robo-voting allows fund managers to save time and money. While many major institutional investors do spend considerable resources evaluating proposals from management and shareholders, this is certainly not the case overall. An overwhelming number of fund managers have outsourced the oversight and decision-making process to proxy advisors.
While proxy advisory firms have repeatedly stated that their role is simply to provide advice and guidance to investors, who can then use it as they see fit, the ultimate decisions made by investors demonstrate just how much ISS and Glass Lewis are calling the shots. How widespread is the trend of automatically following the advice and voting guidance of these firms? According to data released by the American Council for Capital Formation, 175 entities and investors, representing over $5 trillion in assets, vote in line with proxy firm recommendations at least 95% of the time. Of these, about half vote in line 99% of the time.
Analysis from a Harvard Law School report notes that the level of influence of ISS alone may be as high as 25% of all voting outcomes.
Among the investment funds which have followed in lock-step with proxy advice are several public pensions. The same ACCF report notes that several pensions have followed proxy voting recommendations at least 99% of the time: the Virginia Retirement System, Los Angeles County Employees Retirement Association, Kentucky Teachers’ Retirement System, Pensionskasse SBB, and Alameda County Employees Retirement Association. For retired public employees who have entrusted their retirement to these funds managers, this would seem to be a major abdication of responsibility.
Why is this a problem?
When undertaken in a responsible manner, proxy voting is considered to be a key aspect in the effectiveness of capital markets – the SEC itself has said as much in the past. However, this is not the case when the reach and influence of proxy advisory firms has extended far beyond their stated role as straightforward providers of data and analysis. The duopoly of ISS and Glass Lewis wields enormous influence over the direction of publicly traded companies in the United States. Despite their influence, they are, unlike fund managers, under no obligation to uphold a fiduciary duty to the clients they represent, or to provide insight into whether their decisions are made based on the desire to maximize value for shareholders. Flawed recommendations are prevalent, and transparency into the decision-making process is lacking.
At the end of the day, these firms are for-profit entities, and are therefore incentivized to make decisions that will improve their own standing and develop a wide-reaching market for their services. This may even entail the pursuit of certain political priorities in investment decisions, over which the ultimate beneficiaries have little say. Given their broad reach and impact, the potential for conflicts of interest could have grave ramifications for pensions and investment funds.
Where do we go from here?
The prevalence of robo-voting is in itself not something that has come about through the pressure of proxy advisors, but rather as a function of the needs of investors looking to find efficiencies in the face of numerous shareholder proposals and the complexities of the financial industry. This is especially true among smaller investment firms and pension funds who may not have the resources at their disposal to conduct a comprehensive critique of proxy recommendations.
Fortunately, growing awareness of the practice of robo-voting and the undue influence of proxy advisory firms has spurred calls for regulation. The SEC is in the process of considering new rules that would boost transparency requirements for these firms – unfortunately, deliberation and implementation has been delayed by the outbreak of the coronavirus. In the meantime, it is the responsibility of pension fund beneficiaries to demand that their fund managers take a critical approach to the use of proxy advice in their investment decisions.