This article originally appeared in Forbes on April 30, 2020.
In a recent Op-Ed in Barron’s , four current state treasurers argue that the SEC’s proposed rules for proxy advisory firms are a harmful overstep by the agency tasked with protecting investors and promoting the creation of wealth in this country. As the former State Treasurer of Connecticut, I strongly disagree with their position. The proposed regulations by the SEC will correct the unintended consequences of a 2003 SEC rule that required investment advisors to adopt policies and procedures to vote on all proxy proposals as a way of improving the function of the capital markets.
Most pensions systems and money managers immediately outsourced this voting process to proxy advisory firms as a way of dealing with the tens of thousands of proxy votes each year, and to comply with a new SEC requirement that their vote be “based upon the recommendations of an independent third party.” The new proposed rules under SEC Chairman Clayton are meant to clarify and strengthen the 2003 rule, ensuring greater transparency and accountability by holding the two dominant and powerful proxy advisory firms to a much higher standard.
Currently, proxy advisory firms have zero fiduciary responsibility and zero transparency, and they represent a breakdown of the efficient market hypothesis. The proxy advisory world is dominated by two firms; together, they control approximately 95% of the proxy advice market. Their recommendations are all powerful—they alone know how a proxy vote will turn out because nearly all money managers and pension funds abdicate their responsibility for fiduciary oversight to these firms. As Professor David Larcker of the Stanford Graduate School of Business has estimated, these two firms control as much as 30% of any corporate proxy vote.
This duopolistic concentration of power is an absolute erosion of shareholder rights, not an enhancement. The role of a fiduciary, codified for over 1000 years in British and American common law, is to invest for the highest return at a reasonable risk. It is not to apply a personal activist agenda.
The worst manifestation of this unaccountable concentration of power over our public pension funds is so-called “robo-voting.” Robo-voting is the practice of money managers and pension funds to blindly rely on the recommendations of proxy advisors. Even when a company’s management contests the recommendation of the proxy advisory firm, automatic robo-voting continues as the proxy advisory firms provide the voting technology to money managers, which can be programmed to agree and vote in accordance with the proxy firm’s recommendations.
As a board member myself, I understand that boards and management must take into account environmental, social, and governance issues in the running of a company. For decades we called this “responsible leadership.” I do not, however, believe that blind robo-approval of any proposal is anything other than the injection of a political agenda into proxy voting by proxy advisory firms with zero oversight and no transparency.
Our terrific public employees, who are counting on duty, stewardship, and the highest standard of care for the management of their retirement funds, deserve to be protected from individual political agendas, and the return to accountability, transparency, and politics-free management of our public pension funds. Our four state treasurer colleagues are wrong in their injection of politics into pension fund management, and the SEC is correct in their new proposed rules to correct the mistaken interpretation of their 2003 rule.
As former SEC Commissioner, Daniel Gallagher, said in a speech in New York City in October of 2013,
“I have grave concerns as to whether investment advisers are indeed truly fulfilling their fiduciary duties when they rely on and follow recommendations from proxy advisory firms. Rote reliance by investment advisers on advice by proxy advisory firms in lieu of performing their own due diligence with respect to proxy votes hardly seems like an effective way of fulfilling their fiduciary duties and furthering their clients’ interests. The fiduciary duty…must demand more than that. The last thing we should want is for investment advisers to adopt a mindset that leads to them blindly cast their clients’ votes in line with a proxy advisor’s recommendations, especially given that such recommendations are often not tailored to a fund’s unique strategy or investment goals.”
I could not agree more.
Christopher Burnham is the President of the Institute for Pension Fund Integrity and the former State Treasurer of Connecticut.