Commentary: Labor Dept. Right to Put Pensioners’ Interest First

This op-ed originally appeared in the Chief-Leader on Nov. 23, 2020.

 

In 1973, I joined the New York City Fire Department after serving in the U.S. Army in Vietnam. I spent 28 years with the department, rising to the rank of Captain while concurrently serving as the President of the Uniformed Fire Officers Association and the Vice Chairman of the New York City Fire Pension Fund.

Throughout these experiences, I’ve seen first-hand the dedication that these brave men and women have poured into their profession, accepting daily risks and reduced pay with the promise of a secure and stable retirement. In recent years, I have also watched as pension fund managers shirked their fiduciary obligations to beneficiaries, giving priority to outside interests and increasing their reliance on unaccountable proxy advisory firms.

The Department of Labor’s recently finalized rule regarding environmental, social, and governance (ESG) investing practices is a much-needed step toward upholding fiduciary responsibility among ERISA-backed pension-fund managers, ensuring that America’s retirees receive the stable, generous pensions that they were promised for so long.

Highest Returns the Goal

Pension funds should be singularly focused on attaining the highest financial returns, adjusted for risk, and ESG investing strategies are a diversion from this goal. Last year, the Pacific Research Group released a study that found that ESG funds were “43.9% smaller compared to an investment in a broader, S&P 500 index fund,” after 10 years. Understanding the higher cost and lower returns related to ESG investing, how anyone could see this as compliant to fiduciary duty escapes me. Pension beneficiaries have little to no control over the investment of their retirement money–as such, boards of trustees owe it to their beneficiaries to manage these funds with the greatest care and intent to generate the greatest returns, thus ensuring the pension promised.

It has been heartening to see the level of support that this principle has received since the draft rule was first announced several months ago. In a recent editorial, the Wall Street Journal reaffirmed the primacy of financial goals in ERISA pension investments. They noted that “A fiduciary…can’t invest retirement assets only in companies with low carbon emissions or racially diverse workforces when these aren’t linked to financial returns. The Labor rule clarifies that financial factors are those that have a ‘material effect on the return and risk of an investment.'”

ESG as it exists today—specifically when it underperforms—is at best a dilution of fiduciary duty which compromises the integrity of investment strategies. It is my hope that investors and management teams come to this realization before it significantly harms pensions. In the absence of such an epiphany, clarified and improved regulation reaffirming the importance of financial considerations, not political considerations, is necessary for ERISA-managed pension funds. As long as asset managers are using ESG to demand higher fees for lesser returns, pension funds are not safe from irresponsible investing.

Eye Proxy Advisers Warily

Some of the biggest proponents of ESG are proxy advisers. This industry—98 percent of which is controlled by two firms— provides research and recommendations for investment funds, such as pensions, and sometimes even vote their proxies through a process called “automatic voting.” Adherence to fiduciary duty is not required for proxy advisers the way it is for ERISA fiduciaries; therefore their guidance can cause asset managers to violate this bedrock principle. While we should celebrate the Department of Labor’s actions on ESG investing, we should also look ahead to a second pending rule that further addresses the undue influence that these proxy advisers wield in pension investment decisions.

These actions from the Department of Labor are a positive step towards further codifying the responsibilities held by those we trust with our money. I applaud this rule as a part of a greater effort to maintain pension funds’ independence from politics, and hope that it will guide ERISA fiduciaries back to their original purpose: protecting and growing Americans’ retirement.

 

Mr. Brower is a board member of the Institute for Pension Fund Integrity

In Case You Missed It – The Department of Labor has Issued a Finalized Rule on ESG Investing in ERISA Pension Plans

Washington, DC – The Department of Labor has finalized and released a new rule on tax-qualified retirement plans governed by the Employee Retirement Income Security Act (ERISA) in order to codify the extent to which Environmental, Social, and Governance (ESG) considerations factor into investment decisions. As laid out in the rule, ERISA plan fiduciaries may not invest in ESG vehicles when they understand an underlying investment strategy is to subordinate return or increase risk for the purpose of non-pecuniary objectives.
Today, massive unfunded liabilities plague pension plans across the country. Given the incredible financial shortcomings facing retirees, efforts to politicize pension fund investments is not only a divergence from fiduciary responsibility, but also an incredibly irresponsible act. This sentiment was reflected in an editorial by the Wall Street Journal board, where they note that “The reason asset managers largely oppose the new Labor rule is because they want to use worker retirements to promote their own political and financial interests. They want to charge higher fees for managing ESG funds even if they don’t produce better financial returns for beneficiaries. The DOL rule forbids them from doing that. Kudos to Labor Secretary Gene Scalia for standing up to these Wall Street complaints.”
They go on to say that “Asset managers like BlackRock, Fidelity and Vanguard say ESG funds perform better over the long-term, but the evidence is spotty. A Pacific Research Institute study last year found that the S&P 500 outperformed a broad basket of ESG funds over a decade by nearly 44%. One reason is many ESG funds excluded companies like Amazon, Netflix and Mastercard.”
At the Institute for Pension Fund Integrity, we are singularly focused on the objective of getting politics out of pensions and protecting the financial security of America’s workforce. These actions by the Department of Labor further codify the most basic tenet of fiduciary duty: investment decisions should be governed by considering risk and returns, not any outside political agenda.
As Secretary of Labor Scalia noted in a recent op-ed, “More than $10.4 trillion is held by private pension plans covered by ERISA. Those amounts exist for one purpose: to fund retirement benefits for the 139 million American workers covered by the plans.”
In a recent Forbes column, IPFI President Christopher Burnham states “There is a place for making these types of [investment] determinations, but it resides solely with elected officials – not plan fiduciaries. The Department of Labor should be commended for finalizing and implementing this new rule, and it is my hope that in the future our government officials will continue to uphold fiduciary duty as a cornerstone of pension fund management.”
“In the coming months, it is likely that the incoming Biden administration will look for opportunities to use their executive authority to counteract many of the rules and regulations put in place by President Trump’s cabinet. In this instance, the Department of Labor’s work should be embraced as a nonpartisan, forward-thinking effort to secure a stable future for America’s workers and retirees. It is my hope that this rule will be not only enshrined, but built upon.”
We at IPFI applaud the Department of Labor’s efforts to clarify and correct guidance on the fiduciary obligations of pension fund managers. This modernization of ERISA will ensure that pension investment strategies remain focused on fiduciary duty and the best risk adjusted return. It is out hope that in the future our government officials will continue to uphold fiduciary duty as a cornerstone of pension fund management.

Commentary: “Pension Beneficiaries Should Celebrate The DOL’s New Investment Rule To Restore Fiduciary Responsibility”

This article originally appeared in Forbes on November 16, 2020.

Pension funds, whether public or private, are under assault. Politicians, and investment managers kowtowing to politicians, want to inject all kinds of personal political decisions on the management of our retirement money. Twenty-five years ago, the flavor of the day was tobacco. Today it is big oil or gun manufacturers, companies such as Berkshire Hathaway that do not meet “minimum” environmental, social, and governance (ESG) requirements and a myriad of other political criteria.

Keeping politics out of the management of other people’s pension plans is an essential part of our duty of loyalty and our fiduciary obligations. That is why the recent announcement by the Department of Labor of a final rule laying out stringent guidelines for fiduciaries of retirement plans under the Employee Retirement Income Security Act (ERISA) is a welcome and much-needed step in the right direction.

Under the new guidelines, a clear regulatory structure is established which sets out standards for the consideration of investments in ERISA-backed pension plans. Plan fiduciaries are now required to make investment choices based solely on pecuniary factors consistent with the plan’s objectives. The overall goal is to create higher returns for plan beneficiaries, with investments driven by the market. Given the egregious levels of unfunded liabilities facing many pensions throughout the country, it is heartening to see such action take place.

Adherence to fiduciary duty is a cornerstone of pension fund management. To inject political-based decision making into how these retirement funds are invested is a clear violation of the fiduciary obligation that these retirees deserve from fund managers. Unfortunately, in recent years we have seen a divergence from this principle with the injection of social and political factors in investment decisions in the form of ESG factors and the so-called “Principles of Responsible Investment,” as well as numerous pushes for divestment from certain industries.

Although the final version of the Department’s rule makes no direct mention of ESG investment funds, it is clear that even without the use of the specific term, politically focused investing was at the forefront of their minds. In fact, as described in a recent issue brief by the Institute for Pension Fund Integrity, the term ESG itself remains ambiguous, even as it has grown in popularity. Based on the rule’s final language, it would seem that Department’s leadership agrees. If investors cannot even decide on a uniform definition of ESG criteria, how can they be expected to detail its pecuniary benefits to a fund? Under the new guidelines, much more stringent documentation and justification will be needed to include ESG strategies in pension fund investment.

I wholeheartedly embrace ESG as a reasonable tool of management by responsible companies, and of course individuals are free to invest their personal portfolios in companies that elevate whatever values they like. However, fiduciaries have a different obligation. They cannot allow nonpecuniary preferences of any kind to influence investment decisions. In these cases, investments should only be made when they are likely to add value to a fund. When such investments will not improve the financial performance of the fund, or the decision to invest in them is based on political motives, they should be forgone.

This principle of fiduciary duty lies at the heart of ERISA, and since its initial passage in 1979 the Department of Labor has taken steps to update and clarify the law as needed. This latest regulatory effort is therefore a welcome and, in my opinion, long overdue update.

As Secretary of Labor Scalia noted in his recent op-ed in the Tampa Bay Times, “ERISA doesn’t task retirement plan managers with solving the world’s problems…Nor does it ask managers to take on politicians’ job of determining which societal trade-offs are acceptable.”

I couldn’t agree more. There is a place for making these types of determinations, but it resides solely with elected officials – not plan fiduciaries. The Department of Labor should be commended for the finalizing and implementing this new rule, and it is my hope that in the future our government officials will continue to uphold fiduciary duty as a cornerstone of pension fund management.

This sentiment was also reflected in an opinion column by the Wall Street Journal editorial board, where they note that “The reason asset managers largely oppose the new Labor rule is because they want to use worker retirements to promote their own political and financial interests. They want to charge higher fees for managing ESG funds even if they don’t produce better financial returns for beneficiaries. The DOL rule forbids them from doing that. Kudos to Labor Secretary Gene Scalia for standing up to these Wall Street complaints.”

In the coming months, it is likely that the incoming Biden administration will look for opportunities to use their executive authority to counteract many of the rules and regulations put in place by President Trump’s cabinet. In this instance, the Department of Labor’s work should be embraced as a nonpartisan, forward-thinking effort to secure a stable future for America’s workers and retirees. It is my hope that this rule will be not only enshrined, but built upon.

Editorial: “Labor vs. the ESG Racket”

This editorial originally appeared in the Wall Street Journal on November 16, 2020.

One of the stakes in who controls the Senate in 2021 is the fate of the Trump Administration’s deregulation project. A GOP Senate could block Democrats from using of the Congressional Review Act to overturn important rules. A valuable case in point is the new Labor Department rule requiring that retirement plan managers invest in the best financial interest of their beneficiaries.

Last month DOL finalized a rule underlining that the Employee Retirement Income Security Act (Erisa) requires plan fiduciaries to act “solely in the interest” of plan participants “for the exclusive purpose of providing benefits” and “defraying reasonable expenses.” In other words, managers can’t prioritize their own pecuniary or political interests.

This shouldn’t be controversial. The Supreme Court unanimously ruled in Fifth Third Bancorp v. Dudenhoeffer (2014) that Erisa’s reference to benefits signifies “financial” rather than “nonpecuniary” benefits. For example, a fiduciary can’t invest employees’ retirements exclusively in their own employer’s stock if the “financial goals demand the contrary,” Justices explained.

A fiduciary also can’t invest retirement assets only in companies with low carbon emissions or racially diverse workforces when these aren’t linked to financial returns. The Labor rule clarifies that financial factors are those that have a “material effect on the return and risk of an investment.”

Asset managers like BlackRock, Fidelity and Vanguard say ESG funds perform better over the long-term, but the evidence is spotty. A Pacific Research Institute study last year found that the S&P 500 outperformed a broad basket of ESG funds over a decade by nearly 44%. One reason is many ESG funds excluded companies like Amazon, Netflix and Mastercard

BlackRock in a public comment cites a 2015 Harvard Business School study that found firms with strong ratings on material sustainability issues had better future performance than firms with lower ratings. Ok, but if that’s the case, CEO Larry Fink and other asset managers shouldn’t have a problem complying with the new Labor rule

Their problem is that they consider political rather than economic risks—for instance, from a Biden Administration imposing more climate regulation—that they assume financial markets don’t account for in stock prices. Many factors they deem to be “material” risks are also not clearly linked to financial performance.

Take the Sustainability Accounting Standards Board, which is BlackRock’s ESG north star. SASB considers a company’s behavioral advertising, plastic consumption and revenue derived from selling no-added-sugar and artificially sweetened drinks “material.” Is bottled Glaceau Smartwater a material risk to Coca-Cola ? It has zero sugar (good), but, OMG, it’s made with plastic.

Notwithstanding the recent plunge in oil prices, BlackRock’s S&P 500 Growth ETF beat its Clean Energy ETF by an annual average of more than 10 percentage points for the five years ending May 15, according to the Institute for Pension Fund Integrity. BlackRock says ESG funds during the first quarter significantly outperformed broader indexes.

Well, yes. That’s because stock prices of energy companies have plummeted during the pandemic amid lockdowns while those of tech companies (which are weighed heavily in many ESG funds) have soared. But fiduciaries are supposed to consider long-term returns.

The reason asset managers largely oppose the new Labor rule is because they want to use worker retirements to promote their own political and financial interests. They want to charge higher fees for managing ESG funds even if they don’t produce better financial returns for beneficiaries. The DOL rule forbids them from doing that. Kudos to Labor Secretary Gene Scalia for standing up to these Wall Street complaints.

CalPERS Focus Remains on Private Equity After Ben Meng’s Departure

After Ben Meng’s departure from California Public Employee’s Retirement System (CalPERS), the state pension fund is looking to increase its margins by investing more into private equity. Meng worked for over a year at CalPERS where he oversaw a disappointing level of growth, and suddenly left in August 2020 after a private complaint alleged that he had personal financial investments that could possibly be conflicts of interest.

Now CalPERS is focused on reinventing itself—but its continual emphasis on a 7% return rate is harming the opportunity for reflection. CalPERS is a $410 billion fund that has historically run far short of its goals. In just the last few weeks, CalPERS announced its intention to focus more of its investments in private equity as both a response to the low interest rates offered in the bond market and as a result of its unyielding pursuit of high returns to make up for an ever-increasing funding shortfall. Despite this, data on CalPERS current investments in private equity—around $80 billion—show that even they are hitting a low benchmark in terms of returns.

“[Private equity] helps us achieve our 7 percent solution. I know we have to be there. I wish we were 100 percent funded. Then, maybe we wouldn’t,” Theresa Taylor, chair of the CalPERS board investment committee said in a meeting. CalPERS aggressive target of 7% growth has led them to rely more on these types of investments. The fund itself has explicitly noted that private equity and distressed debt are the main ways to make it happen. Meng was hired to increase investments in private equity, and it appears the new Chief Investment Officer will likely be asked to do the same.

Instead of continually raising the rate of expected return to make public pensions look good on paper, CalPERS needs to seriously consider lowering its estimated targets. Estimating such a high rate of return makes it easy to appear like the fund is on track, as well as to foot lower bills to the state and cities. Many economists say that public pensions such as CalPERS should be using return rates more correlated with those of risk free bonds which would provide a more accurate and stable return estimate. 

Using a return rate of 7%, however, is only realistic when the funds are invested in high risk assets like private equity. This becomes troubling when considering public pensions’ role in serving retirees who are owed their pensions. Pensions such as CalPERS need to seriously evaluate how they got into this position in the first place—and be more honest about their expectations for the future of the fund. Only then can they begin to take serious steps to solve the long term problems the fund faces.

Investing in Diversity in Pension Plans

The investment profession is slowly moving away from the stereotype of “pale, male and stale” as newer and smaller money managers take advantage of opportunities. Pension plans are citing various reasons for increasing diversity among their staff, including social responsibility, better returns, appealing to more potential investment partners, and promoting an investment class that “thinks outside the box.” So far, California, Illinois, New York, Ohio, Maryland, Pennsylvania, Texas, and North Carolina have initiatives that are actively increasing diversity. 

The racial justice movement in the U.S. has pushed public pension funds to commit investments to minority controlled funds. It is these public institutions that represent a diverse swath of the U.S., making investment decisions for public servants like teachers, firefighters and municipal officials. One of the U.S.’s largest funds, California Public Employees’ Retirement System (CalPERS), is no stranger to investing in social causes. Calpers divested from South African apartheid in 1986 and quit tobacco stocks in 2000. It also does not invest in coal miners, manufacturers that make guns banned in California and businesses operating in Sudan and Iran. Despite this, CalPERS has had a hard time investing in diverse funds because of proposition 209, which bars public funds from giving preference to race, ethnicity or gender.  

To legally promote diversity, CalPERS started an “emerging manager” program in 1991, that had its budget slashed to $500 million from $3.5 billion in 2019. 

Further east from California, the $52.9 billion Teachers’ Retirement System of Illinois has been investing with minority and women-owned firms through its 15-year-old emerging manager program.  As of June 30, 95% of the $675 million preliminary total of the emerging manager program was managed by 17 minority and women-owned firms.  Illinois Teachers put out that it will be adding $250 million into the managers program, bringing the program’s portfolio up to $1 billion. The goal is to create long term relationships with these managers and then eventually “graduate” emerging managers to larger allocations within the portfolio. Illinois Teachers are considering the launch of an internship program for high school and college students, with the hopes that young people of diverse backgrounds choose to work there. 

“All of the data indicates when you have diverse boards and diverse leadership you have better returns. I would argue you’re actually violating your fiduciary responsibility by not paying attention to the data. Unless you’re only selling to white people, if I was at a firm I would want every point of view represented in the investment process,” says Sue Toigo, co-founder of the Robert Toigo Foundation and chair of Fitzgibbon Toigo & Co.  It is clear that the investment world still has progress to make, but it is comforting to note diversity initiatives are being implemented. In the end, increasing diversity will also increase profits.

How Canada Can Inform America’s Public Pensions

Despite the coronavirus-induced economic downturn, Canadian public pension funds have maintained relative success. In fact, for the last decade Canada’s public pensions have been revered as some of the world’s most successful, owning assets in real estate, infrastructure, and natural resources while maintaining large-scale yet diversified portfolios. Canada’s Pension Plan Investment Board (CPPIB) allocates over 18% of its public pension funds into these real assets and manages its assets in-house, cutting down on expenses. Canada’s public pension system is increasingly competing with sovereign wealth funds and other large assets and has had enormous success attracting larger funds to be co-investors. The CPPIB, unlike many other large wealth funds from countries such as China, has the benefit of being viewed as politically independent and are therefore attractive targets.

Canada’s current strategy was forged in the midst of the Great Recession where the pension made a radical shift from public markets to both global and private markets, providing liquidity to firms strapped for cash. These initial investments laid the roadmap for long term activism in the global sphere, and the CPPIB now owns significant stakes in everything from London’s Heathrow Airport to water treatment plants in the UK and real estate in Manhattan.

Today, Canada is increasingly focused on investing in emerging markets and is targeting India most closely. Currently, the CPPIB plans to invest up to one-third of its funds into emerging markets over the next five years. These investments will span a few different sectors, notably real estate, infrastructure, and public and private equities. The COVID-19 crisis has also caused massive disruptions in global markets, and especially India’s economy, which is where Canada sees an opportunity to invest in these distressed markets and fund long-term stable growth for India’s next economic boom.

There are many lessons the U.S. could learn from Canada to improve its public pension investing system, such as hiring more in house managers rather than contracting outside talent and focusing on making real investments in emerging markets in countries such as India, or other countries in Asia and beyond. Firms are eager to partner with Canada because they perceive its public pensions to be politically neutral and focused on the long term, the exact right combination for investment in something like an infrastructure project. If the U.S. could learn some lessons from Canada, public pensions for American retirees would surely benefit and move toward more long term stability—a desirable goal in the current economic climate.

IPFI Issue Brief: Public Pensions and COVID-19: Confronting a Crisis, and Opportunities for Reform

The outbreak of the coronavirus pandemic over the last several months has caused worldwide economic, social, and political upheaval. After a decade of general growth, economies are now faced with a major contraction as social distancing becomes the norm and entire industries are forced to confront new realities. For public pensions, many of which were already struggling with staggering unfunded liabilities and other problems, this economic downturn presents a major challenge.

In their latest issue brief, “Public Pensions and COVID-19: Confronting a Crisis, and Opportunities for Reform,” the Institute for Pension Fund Integrity seeks to examine the overall impact of the coronavirus on public pension plans across the country and evaluate the implications that it will have for future policy decisions.

The market downturn of the last several months has exacerbated the funding shortfalls facing many public pensions funds across the country, all but wiping out recent gains that had been made as a result of the strong economic growth of the past several years. Mismanagement and an unwillingness to implement reforms for years before this crisis has already put public pensions in a precarious position. Unfortunately, the new challenges that public pension funds will have to confront in the months to come are not a direct result of the fallout from coronavirus, but rather an extension of the problems that they have failed to adequately address up to this point.

In the face of these grave challenges, public pension fund managers are now in a position to implement long-needed reforms to their investment, management, and public policy strategies and re-commit to the principals of fiduciary responsibility in public pension fund investment. This will be especially important for states and localities seeking federal assistance to shore up their pension funds.

Read the latest issue brief ““Public Pensions and COVID-19: Confronting a Crisis, and Opportunities for Reform” here.

Commentary: “The Political Games Proxy Advisors Play With Workers Retirement Security”

This op-ed originally appeared in TownHall and affiliated outlets on October 19, 2020.

Over the next several weeks, the Department of Labor will begin to sift through the public comments on their recently proposed rule “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights,” seeking the best course of action to ensure that pension beneficiaries across this country receive the benefits they deserve. This rule reaffirms the fiduciary obligations that ERISA-backed pension fund managers owe to their beneficiaries, and puts forward much needed reforms in a proxy advisory industry that for too long has neglected to serve the best interest of pensioners.

In this tumultuous election season, where even non-controversial issues have become political, it is reassuring to see the Department take steps to codify the bedrock fiduciary principles that have guided pension fund management for decades. Pension fund investment decisions must remain apolitical, driven solely by the financial benefit they can provide. As a former Treasurer of the State of Ohio, I have had firsthand experience overseeing a pension system and I take seriously the responsibility of a fund’s management team to provide financial security to the men and women who worked hard their entire lives with the promise of a secure retirement. For pension beneficiaries across the country, this proposal by the Department of Labor is a positive step toward ensuring that accountability and fiscal responsibility take precedent. Based on the overwhelming proportion of public comment letters in favor of the proposal, it seems that most people agree.

The proxy system has long been taken advantage of by those without fiduciary responsibilities, preventing sound advice from reaching the nation’s pension and investment funds. There is currently a duopoly in the system, in which two companies, Institutional Shareholder Services (ISS) and Glass Lewis, guide the decisions of the entire proxy advisory market. The limited number of proxy firms compared to the multitude of institutions seeking their assistance has limited responsiveness and the ability of investors to critically evaluate the advice they receive. 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 there is limited transparency into the decision-making process.

Beyond the scope of the current proposal, I believe that more should be done by the Department to counter the unaccountable practice of “robo-voting,” in which some fund managers have simply accepted the voting recommendations of proxy advisors automatically without considering the broader fiduciary impact of the proposals. Unfortunately, this practice has become more and more widespread at the expense of transparency to beneficiaries. Recent research from the Ohio State University notes that 400 of the top institutional investors – including many pension funds – automatically voted in line with the recommendations of ISS and Glass Lewis at least 99.5% of the time. This is a grave divergence from the managerial obligations that fund managers should have toward plan participants and beneficiaries.

The Department of Labor should take additional steps to clarify and codify stronger regulations on the practice of robo-voting within this rule. Several months ago, the Securities and Exchange Commission adopted guidelines on the practice of robo-voting which, among other things, require asset managers to take into consideration information released after proxy advisor vote recommendations are made, as well as providing access to company rebuttals of proxy firm recommendations. Short of banning robo-voting entirely, measures should be implemented which prohibit its use in instances where there is a contested proxy vote recommendation. Pension beneficiaries deserve transparency into the processes impacting their money, and the current widespread prevalence of robo-voting is standing in their way.

At the end of the day, pension fund investment must remain an apolitical decision. At the Institute for Pension Fund Integrity, where I sit on the board, we are focused on that objective in order to protect the financial security of America’s workforce. I applaud the Department of Labor’s efforts to further codify these most basic tenets of fiduciary duty, and as they work toward finalizing this regulatory proposal, they should remain singularly focused on ensuring a generous, stable retirement for those who have paid into the system.

SEC Shareholder Move Angers Institutions

This article, written by Brian Croce, originally appeared in Pensions & Investments on October 5, 2020.

New amendments adopted by the Securities and Exchange Commission to raise the thresholds for submitting and resubmitting shareholder proposals in subsequent years has drawn the ire of investors large and small.

“The amendments weaken the voice of investors and jeopardize faith in the fairness of U.S. public capital markets by making the filing process more complicated, constricting and costly,” said Amy Borrus, executive director of the Council of Institutional Investors in Washington, in a statement. “The result will be fewer shareholder proposals — and that is precisely the goal of the business lobby that pressed the SEC to make these changes. Simply put, CEOs and corporate directors do not like being second-guessed by shareholders on environmental, social and governance matters.”

In a 3-2 vote, with the commission’s two Democrats dissenting, the SEC on Sept. 23 amended Exchange Act Rule 14a-8 by replacing the current ownership threshold to submit a shareholder proposal, which currently requires holding at least $2,000 or 1% of a company’s stock for at least one year.

Under the new rule, shareholders submitting any proposal for an annual or special meeting to be held on or after Jan. 1, 2022, will have to meet one of three alternative thresholds: $2,000 of the company’s stock for at least three years; $15,000 for two years or $25,000 for one year, among other changes.

With the new rule, which would take effect 60 days after publication in the Federal Register, the SEC also raised the vote thresholds a proposal must get to be eligible for resubmission. Under the amendment, proposals must get at least 5% support in the first year, 15% in the second and 25% in the third in order to be resubmitted within a five-year span. That is up from the current thresholds of 3%, 6% and 10%, respectively.

The final amendments will apply to any proposal submitted for an annual or special meeting to be held on or after Jan. 1, 2022.

New York state Comptroller Thomas P. DiNapoli, trustee of the $216.3 billion New York State Common Retirement Fund, Albany, said in a statement that the SEC’s action will “negatively impact investors and make it harder for shareholders to hold corporations accountable. These changes are unwanted by investors and may silence those challenging corporations to address issues like gender and racial pay equity, workplace diversity and racial discrimination.”

Patrick McGurn, special counsel and head of strategic research and analysis at proxy advisory firm Institutional Shareholder Services Inc., Rockville, Md., said the vote “shows that the comment period doesn’t count for much at the SEC anymore because if you look at the comments it was overwhelming from an investor perspective. Most of the changes that were adopted by the commission were not only not welcome, but were thought to be unnecessary by the vast majority of commenters on the investor side.”

The SEC originally proposed modernizing the rules concerning shareholder proposals in November, at the same time it proposed amendments to the rules governing proxy advisory firms that require those firms to disclose conflicts of interests to clients and allow companies that are the subject of voting advice to be able to access that advice prior to or at the same time as the advice is disseminated to clients.

The proxy advisory firm rules were finalized in July. But both of the SEC’s proxy-related initiatives have broadly garnered similar reactions: support from the business community and opposition from the investor community.

Striking a balance

SEC Commissioner Elad L. Roisman, who spearheaded the commission’s efforts on the issue, said at the Sept. 23 meeting that the shareholder proposal amendments aim to strike a better balance by ensuring that a shareholder who submits a proposal to a public company has interests that are more likely to be aligned with the other shareholders.

It was a sentiment struck by other supporters, including SEC Chairman Jay Clayton. “A shareholder proponent should not be able to command the time and attention of the company and other shareholders to review, consider and vote on a proposal if 9 out of 10 votes cast by their fellow shareholders have been against the proposal after it’s been submitted for a vote three or more times in five years,” Mr. Clayton said at the meeting.

Christopher Burnham, president of the Institute for Pension Fund Integrity in Washington and founder of venture capital firm Cambridge Global Capital, who has previously served as Connecticut state treasurer and as a member of the Trump administration’s transition team for the State Department, noted that the resubmission thresholds in place today were adopted more that 60 years ago, which is why he said they must be updated. “The market has changed dramatically since 1954, participation has changed dramatically,” Mr. Burnham said. “We must not allow a small, teeny, activist minority to impose a personal political agenda on the majority.”

Despite getting a lot of comments criticizing the proposal, the SEC largely “stuck to their guns,” said Julie Mediamolle, a Washington-based partner with Alston & Bird LLP. “At the end of the day I think the SEC understands this could deter some proposals but on the opposite side (it’s) trying to encourage more engagement throughout the year, not just in connection with annual meetings,” she said.

At the SEC’s Sept. 23 meeting, Commissioner Allison Herren Lee, a Democrat who opposed the proposal, said the amendments, coupled with the SEC’s rules concerning proxy advisory firms, “collectively put a thumb on the scale for management in the balance of power between companies and their owners.”

Fewer proposals

When looking at the 2020 proxy season, of the 455 shareholder resolutions that made it onto a ballot and for which vote results are available to date, 64% earned at least 25% support, according to data from ISS. However, that figure does not take into consideration the number of times that a proposal has appeared on the ballot nor the number of times that boards may have decided to sit down with proponents to negotiate the possible withdrawal of proposals due to the existing resubmission thresholds, Mr. McGurn noted.

Research from CII found that the SEC’s new thresholds for resubmitting shareholder proposals would have more than doubled the number of excluded governance proposals from 2011-2019. In 2020, CII noted that several governance proposals that would have been eligible for resubmission in 2021 would be blocked by the new resubmission thresholds, including resolutions to require independent board chairs at Facebook Inc., Southwest Airlines Co. and Tenet Healthcare Co.

“Shareholder proposals play an invaluable role by providing a low-cost method for shareholders to talk to management and to each other about the future of their company and important policy issues affecting the company,” said Lisa Woll, CEO of Washington-based US SIF: The Forum for Sustainable and Responsible Investment, in a statement. “The votes on shareholder proposals provide more precise information about shareholders’ views of the given topic. In our view, the commission should not be in the business of reducing these lines of communication. Such reductions will likely be unavoidable now.”

But there is an election looming and depending on the results, there could be more traction on proxy-related issues, sources said. “I would think that if Democrats take over the White House and retake the majority of the SEC that these rules would be revisited fairly quickly,” Mr. McGurn said.

The president gets to nominate an SEC chair; currently the commission has a 3-2 Republican majority with Mr. Clayton at the helm.