Commentary: The SEC’s New Rules For Proxy Advisory Firms Are A Key Step Toward Accountability

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.

Robo-Voting: An Overview

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.


In Case You Missed It: IPFI Has Been Busy Fighting For Public Pensions

See below for a round-up of the latest material from IPFI:
SEC Rulemaking and What It Means for Proxy Advisory Firms
  • “The SEC recently announced proposed rules aimed at addressing the outsized influence of proxy advisory firms, restoring much-needed protections to the proxy voting process and those who bear the financial consequences of the decisions made throughout. The proposed rules stand to correct a number of issues related to proxy advisory firms that compromise the shareholder voting process, company performance, and financial returns on public pension investments.” Read the full report here.
CalSTRS Need to Focus More on Investment Performance, Less on Proxy Advisory Firms
  • “CalSTRS’ management – by voting automatically with proxy advisory firms’ recommendations – is silencing the voice of everyday pensioners who are the main beneficiaries of the pension fund. Reforming this automatic voting status will create greater transparency for all CalSTRS pensioners.” Read more here.
LACERS Must Stand Up Against Divestment Pressure
  • “As the new year begins, fiduciaries must remain vigilant against misguided abuse of our nation’s pensions. Those in charge of California’s retirees have a duty to manage the Los Angeles City Employees’ Retirement System (LACERS) with the sole objective of increasing returns. Forced divestment and politically-motivated financial decisions have been shown to compromise that outcome.” Read more here.
The Misguided Movement to Divest
  • “The head of the world’s largest money manager should know that selling stock is an ineffective vehicle for change. Instead, it provides an opportunity for major oil and gas companies to buy back their stock. In the end, it’s the pension plan members who have committed a portion of every paycheck to funds that invest in these industries that wind up suffering.” Read more here.
Bucking the Trend to Rescue New Jersey’s Pension
  • “As three of New York City’s five pension funds move to divest from fossil fuels, one state government in the neighborhood is bucking the trend to move away from corporations operating in the carbon-based fuel industry. Governor Phil Murphy of New Jersey has warned against the impulse to sever ties completely with industries or companies when one does not agree with their practices.” Read more here.
Fallout from COVID-19 Demonstrated Rose-Colored Perspective on Pension Returns
  • “While an economic disruption of this magnitude may not have been on the radar of investors and public officials, it demonstrates the unrealistic optimism that states have held for pension fund returns on investment.” Read more here.
Latest Commentary 
The SEC Is Right To Force More Transparency Into Proxy Voting
  • IPFI President Christopher Burnham lends his support to the SEC’s efforts to codify overdue regulations limiting the influence of proxy advisory firms on the shareholder voting process. “The Securities and Exchange Commission is about to take an important first step in bringing accountability and transparency to the proxy voting world. For far too long pension funds have off-loaded their fiduciary duty to their beneficiaries to proxy advisory firms by outsourcing to them, the review of proxy proposals. These firms, in turn, then make recommendations to plan sponsors but without any oversight and very little transparency.” Read the article here.
ESG Versus Impact Investing
  • “ESG is used around the world as a way to help both large and small companies increase shareholder value by good governance, being good stewards of the environment and taking care of their employees. ESG is not about forcing pension funds, or banks, to stop funding soda companies, coal companies, private prison companies, defense industry companies or anything else that offends politicians, activists, elitists or scared bank CEOs seeking to impose their supercilious arrogance over fiduciary responsibility.” Read the full article here.
What the SEC’s Proposed Rule Means for Investors
  • IPFI Advisory Board member Chris Cummiskey details how investors can navigate the new SEC rules relating to proxy advisory firms. “As the SEC’s recently proposed rule S7-22-19 […] makes its way through the public comment period, investors must understand how this rule will bring long-overdue accountability to the proxy voting process, and what that means for bottom-line dollars.” Read the full article here.
In the coming months, IPFI will continue to assert its four core principles:
  •  Adherence to fiduciary responsibility
  •  Balanced economic, social and governance (ESG) factor investment
  •  Long term pension fund returns
  •  Data driven investment

Fallout from COVID-19 Demonstrated Rose-Colored Perspective on Pension Returns

As of the writing of this article, global markets have experienced the largest drop since the Great Depression as a result of fallout from the COVID-19 virus, erasing all gains from the economic upswing of the last two years. It is likely that with a global quarantine in effect, markets will continue to reel in the weeks and months to come. The global economy will face a daunting recovery, and although we can rest assured that this crisis will pass, it will take years for certain sectors to regain their footing. Fallout and a change in mindsets and habits after the virus may cause some industries to disappear entirely.


In the face of all this, public pensions and the returns that they are supposed to guarantee to retired public servants will undoubtedly face a funding crisis. While an economic disruption of this magnitude may not have been on the radar of investors and public officials, it demonstrates the unrealistic optimism that states have held for pension fund returns on investment. In an effort to compensate for mounting unfunded liabilities, many state officials have pegged future investment growth to a rosy rate-of-return that assumes annual market growth upwards of 8%, which does not account a recession, now likely approaching. For pensions to meet their mark, this would entail a booming economy for years to come. Even a minor economic downturn that slowed growth by a percentage point would cause pensions to drastically miss their targets, possibly increasing liabilities nationwide by as much as $500 billion. What will they look like now in the face of global economic collapse?


This is not the first time that we have seen such fallout. In the wake of strong economic growth throughout the 1990’s (coupled with the Dot Com boom), many state pension funds were in a stable and financially sound position as investments poured in. Unfortunately, many public officials were reluctant to use this increased revenue to take action to shore up pension funds in the long run or establish “rainy-day” measures, instead opting to boost their political standing by increasing pension fund payouts. One major example of this was in California, where in 1999 the state legislature passed SB 400 which increased pension benefits on the basis of an estimated $17.6 billion in state pension surplus. Soon after the benefits were granted, the economic fallout from the 9/11 attacks dragged the pension fund deep into the red – a fund that was now obliged to make larger payouts to beneficiaries. Given that recessions impact government revenue streams across the board, the infusion of additional public money into the pension fund in an effort to shore up losses becomes much more difficult in lean times. One would think that this failure to account for economic fluctuation in the long term would have been a lesson for public pension fund managers, but given our current situation, this does not appear to be the case.


Unfunded liabilities in public pension plans are a problem that has a tendency to compound upon itself. In order to make up losses and ensure that the fund will be stable in the future, fund managers and public officials are faced with several options: increase contributions from workers, reduce expected benefits, or adjust their investment strategy in an effort to boost returns. Because the first two options are politically detrimental to elected officials who will then face the scorn of public employees, the third choice is usually first on the table. Unfortunately, seeking out investments with a higher rate of return by their very nature increase the risk of the fund and makes it much more susceptible to economic volatility. This is a tradeoff that many states have been willing to make, especially coming off of the last decade of strong economic growth. We are now seeing how these decisions can backfire.


What policy changes could be implemented to prevent such pension funding crisis in the future? First, public officials should begin to move toward realistic actuarial assumptions when calculating future pension fund growth and the contribution levels that will be necessary to correct unfunded liabilities. Fortunately, many states and localities have begun to move in this direction in the wake of the record-low interest rates we have seen since the financial crisis of 2008. This trend needs to expand on a more profound scale. Second, when the COVID-19 crisis passes (and it will) and the economy returns to a positive level of growth, public officials must avoid the immediate political gains of using surpluses to fund larger pension payments and must instead think long-term. If history teaches us anything, the next economic downturn is right around the corner.


Ultimately, the failure to realistically project pension rates of return and to adequately re-invest surplus comes down to a failure in political leadership. No governor wants to tell their constituents that a realistic re-assessment of pension investment returns means that their unfunded liability problem is much worse than before. However, the hard-working public employees who have dedicated their careers to public service in anticipation of stable retirement benefits deserve the truth. Our leaders need to get real. Economic disruptions happen. Recessions happen. And yes, major crisis like pandemics, war, and terrorist attacks happen. To simply ignore this reality when evaluating rates of return in an attempt to cover up underlying problems is a dereliction of the duty that public servants swear to uphold. Hopefully, this pandemic will finally bring about some frank conversations and hard decisions to ensure the stability of public pensions for generations to come.

Bucking the Trend to Rescue New Jersey’s Pension

As three of New York City’s five pension funds move to divest from fossil fuels, one state government in the neighborhood is bucking the trend to move away from corporations operating in the carbon-based fuel industry. Governor Phil Murphy of New Jersey has warned against the impulse to sever ties completely with industries or companies when one does not agree with their practices. A spokesman for New Jersey’s investment division laid out the state’s reasoning for staying in the game. Divestment means forfeiting shareholder voice, the New Jersey official said, meaning that they would no longer be able to move the company in a direction more in line with their views. Murphy, a former senior director at Goldman Sachs, understands how the market and corporations actually work, and therefore the negligible impact of divestment.

Further showing the ignorance of the divestment movement, it is major energy companies that have made important breakthroughs in clean energy science since the beginning. Given the kind of change climate activists are seeking, they should be doing everything they can to have a say when Exxon and BP are deciding where to put their money. Nature Conservancy, the nation’s largest environmental nonprofit, has been partnered with Royal Dutch Shell for over a decade.

In the face of criticism, Governor Murphy is taking the right steps to improve one of the country’s worst funded pension systems. His budget proposal includes more than $500 million in increased pension funding in addition to his support of returns-focused investing. Struggling funds cannot afford to play futile political games with average Americans’ financial security. Meanwhile, the three New York City funds are moving a combined $3 billion to appease activists. Mayor Bill de Blasio claims that this move shows that “New York City is taking action,” but really it is the opposite. Taking action means doing something to effect change. Mayor de Blasio is giving up his seat at the table and leaving retirees out to dry in the process.

What the SEC’s Proposed Rule Means for Investors

This article originally appeared on Morning Consult on March 5, 2020.

In the new year, we often make many promises. This time, we must resolve to protect the interests of retail and institutional investors from the meddling of proxy advisory firms. I have always argued for clear and navigable investment voting processes, and this moment is particularly critical. As the SEC’s recently proposed rule S7-22-19, Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice makes its way through the public comment period, investors must understand how this rule will bring long-overdue accountability to the proxy voting process, and what that means for bottom-line dollars.

Proxy advisory firms amassed their influence through a series of unintended consequences and a prevailing lack of oversight. Until the SEC issued Staff Legal Bulletin No. 20 in 2014 clarifying that investors were not required to vote every proxy, the misconception that they were prompted institutional investors to disproportionately rely on proxy advisory firms to carry out their voting duties.

During that time, a duopoly flourished. Glass Lewis and International Shareholder Services (ISS) dominate 97 percent of the market, which affords them the ability to dictate the rules of the game with little competition. Proxy advisory firms position themselves as third-party “allies” to investors while wielding enormous power to sway voting outcomes and determine where and how fiduciaries invest others’ money. And that’s cause for concern. 

For one, proxy advisory firms are rife with conflicts of interest. Consider that ISS bases its voting recommendations, in part, on an analysis of a company’s governance performance demonstrated by an ISS Governance Score. ISS also offers a service to companies on how to improve their ISS Governance Score. Hence, ISS collects payment on opposite sides of the same mechanism. 

ISS also sells voting services to investors as well as consulting services to companies considering management-proposed resolutions. This introduces the risk of the proxy firm recommending that investors vote in favor of management when it’s a consulting client. The Ohio Public Employees Retirement System (OPERS) understood the danger this posed to its pension plan members’ long-term financial security and swiftly ended its contract with ISS in the mid-2000s.

Conflicts of interest become even more troubling given the preponderance of automatic voting. On average, investors vote following proxy recommendations 80 percent of the time. A single negative ISS recommendation on say-on-pay leads to a 25 percentage point reduction in support.

As a fiduciary, an investment adviser owes each of its clients a duty of care with respect to services undertaken on the client’s behalf. However, proxy advisory firms provide several different voting guidelines that obfuscate fiduciary duty and skew investments toward subjective goals, including faith-based and sustainability guidelines. By relying on shadow reports, proxy firms offer investors the best of both worlds: the ability to vote how they please while simultaneously recusing themselves of any responsibility by supposedly following the unbiased advice of a third party.

As it turns out, everyday investors are becoming increasingly aware of the many flaws in the existing proxy advisory process. A recent survey found over 80 percent of investors in support of the SEC’s proposed rule at the end of the survey. Additionally, the survey found that the more asset managers and investors learn about proxy firms, their business and what drives their recommendations, the more they support responsible regulation.

Currently, proxy advisory firms provide recommendations based on inaccessible, private data unavailable for public review. S7-22-19 would require proxy firms to ensure their recommendations include dissenting opinions and also allow companies the opportunity to correct inaccuracies in proxy advisory reports.

Proxy voting functions, fundamentally, as an “information production process”. These firms are modern-day factories; their product is information. A proxy firm survives only by maintaining a constant rate of production. By creating reports, data and analyses that tailor to specific political and financial agendas in secret, proxy firms are capable of re-defining public opinion among investors and manipulating large swaths of capital, almost single-handedly.

Though charged with helping investors generate revenue, it seems that proxy advisory firms are only concerned with one bottom-line: their own. The proposed rule rightfully addresses the many transgressions inherent in the proxy advisory process. With the help of the SEC, I believe that we can shift the balance back in favor of investors.

ESG Versus Impact Investing

This article originally appeared in Forbes on February 28, 2020.

There is absolutely nothing wrong with senior management and directors of companies across America reviewing, analyzing, measuring and integrating into company operations, a focus on environmental, social, and governance (“ESG”) considerations. Nor is it a new concept. As one general counsel of a Fortune 200 company told me last summer, “We’ve been integrating ESG into our operations for the past 40 years.”

The reason is, of course, that embracing ESG adds value to companies. This is especially true in the emerging markets, where independent directors, outside audits and anti-nepotism policies all indicate a company’s embrace of good governance. On environmental issues, look no farther than BP or Brazilian-based Vale S.A. to see the damage of what reckless neglect of sound environmental policies can do to the value of a company—BP lost 54% of its value after the oil spill disaster in the Gulf of Mexico, and Vale has plunged in value after the dam holding back mine tailings failed last year, and also faces criminal and murder charges for the more than 250 deaths that happened as a result of the dam failure.

The “S” of ESG speaks for itself. Taking care of your employees, including offering those aspects of 21st century benefits—such as maternal and parental leave, or allowing employees to work remotely, are now essential elements of attracting and retaining good workers. Ten years ago, the consulting world warned us of the impending “war for talent.” That struggle is only intensifying as a new generation is not just embracing but redefining “work-life balance.” Even Goldman Sachs, long known for its brutal work schedule, changed their rules after the suicide of one of their young telecom analysts in 2015. Simply stated, embracing ESG adds value to a company.

Impact Investing on the other hand, does not add value. Impact investing is a nice way to re-label “political investing”—investing with a specific political agenda—be it against the companies that supply our military, coal companies, gun companies and many others. Impact Investing is the antithesis of the utilitarian principles on which, the United States was founded—the greatest good for the greatest number of people—and instead is based on “investing to force change based on my personal political agenda”, and “I certainly know more than you so I will impose my will upon you.”

The absolute worst example of this is allowing politics to undermine fiduciary duty in the management of our public pension funds. From California to New York City, governors and mayors have tried to pad their liberal credentials by forcing public pension trustees to abdicate fiduciary duty to their political whims. However, in the case of California, state employees and retirees pushed back last October when they voted to toss the sitting CALPERS board president in favor of Jason Perez, a Corona, CA police officer who ran on removing politics from the management of California’s public employee pension fund.

In 2001, California stripped tobacco companies from the CALPERS portfolio thereby leaving almost $4 billion of performance (alpha) on the table. More recent proposals have targeted oil companies and private prison companies. One has to assume, that should Mike Bloomberg be elected president, his crusade as mayor of New York against sugar and soda companies will continue. But play politics in the legislature not in our public pension plans.

Now banks and money managers, seeking to appease their own activist clients and shareholders, are trying to put lipstick on the hog by advocating for ESG when what they are doing is advocating for a political agenda. We must not, however, allow them to advance political investing by calling it “ESG.” Again, ESG is used around the world as a way to help both large and small companies increase shareholder value by good governance, being good stewards of the environment and taking care of their employees. ESG is not about forcing pension funds, or banks, to stop funding soda companies, coal companies, private prison companies, defense industry companies or anything else that offends politicians, activists, elitists or scared bank CEOs seeking to impose their supercilious arrogance over fiduciary responsibility.

The Misguided Movement to Divest

At the World Economic Forum in Davos, Switzerland, Greta Thunberg demanded an end to all investments in fossil fuels. While Ms. Thunberg may have good intentions, her demands are indicative of the economic ignorance found in today’s activists. Unfortunately, BlackRock CEO Larry Fink has fallen victim to the same flawed reasoning. Just ahead of the Davos summit, Fink announced that his company would divest entirely from fossil fuels. The head of the world’s largest money manager should know that selling stock is an ineffective vehicle for change. Instead, it provides an opportunity for major oil and gas companies to buy back their stock. In the end, it’s the pension plan members who have committed a portion of every paycheck to funds that invest in these industries that wind up suffering. 

Public servants who hope to one day collect a livable retirement expect that their dollars will be invested based on proven, traditional strategies that yield maximum returns. But many of the industries that can deliver on this expectation now face widespread attacks. The fact is divestment doesn’t work. The large-scale selling of a company’s stock only brings the price down briefly. This makes it more attractive to investors less concerned with the political implications of a particular company. Divestment has little impact on the actual operations of a business. Even AIG CEO Brian Duperreault, who supports impact investing, stated during a Davos conference that AIG is not prepared to cancel business with “low ESG score” companies.  

The dangerous trend of ESG activism compromises returns on the pensions of over 14 million Americans. Divestment movements have become a favored tactic of activists who are unable to effect change in the legislature. In turn, they attempt to circumnavigate democracy by wielding the funds at their disposal in a manner they believe will help their cause, all while attacking investors who employ investment strategies geared toward maximizing returns, their fundamental obligation as a fiduciary. ESG investing, on the other hand, is incompatible with maximum returns.  A recent study by Pacific Research Institute found that ESG funds underperform standard S&P 500 index funds by 43.9 percent over 10 years.  To advocate in favor of an investment strategy that so profoundly limits returns is irresponsible and a violation of an asset manager’s fiduciary duty, and America’s pension funds would be the victims.

Pension funds and other financial assets are amoral entities. They are best served by considering all investment options, not just the ones that fit into a third party’s political agenda. 

The SEC Is Right To Force More Transparency Into Proxy Voting

This article originally appeared in Forbes on January 31, 2020. 

The Securities and Exchange Commission is about to take an important first step in bringing accountability and transparency to the proxy voting world. For far too long pension funds have off-loaded their fiduciary duty to their beneficiaries to proxy advisory firms by outsourcing to them, the review of proxy proposals. These firms, in turn, then make recommendations to plan sponsors but without any oversight and very little transparency. A key point to remember is that fund managers and plan sponsors vote as recommended by the proxy advisory firms almost 100% of the time.

Under SEC Chairman Jay Clayton, the Commission is now trying to “improve [the] accuracy and transparency of proxy voting advice” received from these firms, by focusing on two key areas. If the rule changes are implemented, advisory firms will have to send their recommendations to issuers before they send them to clients. This will allow issuers to review for accuracy, as well as bring a welcomed transparency to the process. Secondly, the SEC is proposing to eliminate frivolous proxy proposals by raising the bar that activist, and those seeking to impose their political view on other shareholders, must reach to force a proxy vote.

What Chairman Clayton is advocating for is not new; the Investment Advisors Act of 1940 required investment advisors to adopt policies and procedures that required them to vote only in the best interest of their clients. What we face today, instead, is an epidemic of supercilious activists who believe they, alone, know what is best for mom and pop investors, and particularly our public pension retirees.

The slippery slope of injecting politics into proxy voting is a clear violation of fiduciary duty. Over the past few decades activists have tried to strip out companies involved in the Vietnam War (almost all of the S&P 500 companies in 1969 sold something to the US Armed Forces) to late last year when the  Charlottesville, VA City Council voted to strip out shares in Northrup Grumman, General Dynamics, and any other company producing systems that protect our country, and maybe, might just bring our children home safely. It can include, cigarettes, energy, guns, sugar and sugary drinks, nuclear energy, and dozens more, depending on your proclivity and personal bias.

In 1995, as the Treasurer of Connecticut, I indexed 75% of the State’s teacher and state employees pension portfolio, which for the previous ten years had been the worse preforming state pension fund in the United States—dead last.  Within six months of indexing, we skyrocketed to the top 10 states in the nation in terms of performance, thereby earning a much higher return for our retirees while decreasing costs at the fund. I also shut down our activist office at the Treasury saving over $1 million a year for the pension fund.

In the past ten years, only six states have outperformed a simple index fund of 60% indexed to the S&P 500 and 40% indexed to the Bloomberg-Barclay’s Bond Index. This means that 44 states waste millions of dollars hiring active and activist managers trying to beat the index, when if they only indexed the portfolio they would beat 88% of the other states. This is pathetic.

In a recent letter to his investors, as quoted in the Financial Times about the new proposed SEC rules, activist hedge fund manager, Dan Loeb, wrote, “Someone has been rigging the public debate and trying to mislead the commission…These endorsements were actually part of a false letter-writing campaign that had been bought and paid for by corporations. This is the ‘swamp’ at its worst.”

No Dan, the real swamp are those politicians who seek to impose their personal political agenda on the retirement accounts of our hard working public employees and teachers. Our fiduciary duty is to ensure the highest return at a reasonable risk, not the highest return after playing politics.

The SEC is about to restore transparency and accountability back into proxy voting and Chairman Clayton should be congratulated for standing up for strict adherence to fiduciary duty.

Case for Proxy Reform Glaringly Evident After Latest Debate

On January 27, the Bipartisan Policy Center hosted a discussion on the SEC’s proposed reforms to the proxy voting process. Tom Quaadman, Executive Vice President of the U.S. Chamber Center for Capital Markets Competitiveness and Pat McGurn, Special Counsel and Head of Strategic Research and Analysis at Institutional Shareholder Services examined the key elements of the proposed reforms and debated their ramifications before an audience that IPFI was privileged to be a part of. 

Mr. Quaadman spoke to how the proposed rule addressed widespread concerns around accuracy, conflicts of interest, and the need for more transparency. Specifically, he cited the 2.5% error rate in proxy reports on companies, which he partially attributes to a lack of communication between proxy advisory firms and companies. Since the 2014 SEC-issued guidance on proxy advisory firms, an annual survey revealed that the level of company-initiated interactions with proxy advisory firms has been steadily declining due to the inability to correct factual errors promptly.  Quaadman added, “A financial analyst who doesn’t interact with the company and just makes industry-wide pronouncements isn’t going to last five minutes on Wall Street.” 

The discussion later turned to automatic voting, or robo-voting as it is commonly known. Quaadman referred to the observation that at least a third of the vote coming in within the first 48 hours, with 95% of those votes following the proxy advisory recommendations. McGurn swiftly noted that the majority of ISS’ client recommendations are based on custom reports tailored to that client. But, by ISS protocol, the term ‘custom’ may indicate a configuration as simple as, “vote in-line with ISS on everything except X.” Unquestioningly following recommendations save for one factor is an insufficient deployment of fiduciary duty. 

Finally, the two keynote speakers explored how conflicts of interest may arise. Mr. McGurn argued the SEC’s reforms compromised the integrity of the firewall between consulting and proxy voting firms. Calling this firewall “leaky” Quuadman pointed to the fact that many companies who receive poor recommendations from proxy advisors are soon after contacted by their colleagues on the consulting side of the business. In other words, their proxy recommendations in some cases can be confused as business development. Quaadman also reminded the audience that proxy firms do not publicly disclose if shareholder or director slate proponents are clients.

ISS clients cast 8.5 million ballots and 3.8 trillion shares annually. Under the current arrangement, rife with factual errors, robo-voting, and conflicts of interest, ISS and Glass Lewis operate as “de-facto standard setter[s] in corporate governance.” The prevailing argument against SEC regulation maintains that it’s simply not necessary. 

McGurn failed to provide any examples to alleviate concerns raised about ISS’ violation of fiduciary duty, need for greater transparency, and their clear conflicts of interest. The discussion summarized here demonstrates that the proposed rules are not only necessary but integral to the performance of our markets and the safeguarding of America’s public servants’ future retirements.