The Securities and Exchange Commission (SEC) last month voted on new guidelines that direct fund managers who oversee the retirement funds of millions of pensioners and retail investors, to stop outsourcing their votes on shareholder proposals to unaccountable proxy advisors, and instead take responsibility to ensure their actions are in retirees’ best-interests.
This relatively obscure regulatory action is actually a significant win for America’s senior citizens, who rely on robust returns to fund their retirements. As more and more retirement assets are managed by institutional investors, their votes on shareholder proposals have an ever-greater impact on the governance and ultimately the performance of our public companies.
ValueWalk's Raul Panganiban interviews Joseph Cioffi, Author of Credit Chronometer and Partner at Davis + Gilbert where he is Chair of the Insolvency, Creditor’s Rights & Financial Products Practice Group. In the interview, we discuss the findings of the 3rd Annual report. Q2 2021 hedge fund letters, conferences and more The following is a computer Read More
Specifically, the new guidelines will help protect retirees from the insidious practice of “robo-voting” where certain fund managers automatically vote in lock step with proxy advisors without conducting their own due diligence, adding additional protection against unregulated proxy advisors’ conflicts-of-interest.
In the past, the SEC unintentionally created a system that encouraged fund managers to simply rely on the recommendations of proxy advisors as a way to mitigate conflicts-of-interest when voting on shareholder proposals. The Commission’s rationale was that as a third-party organization, theoretically free of any direct conflict, analysis from proxy advisors is “independent”.
But research has shown that proxy advisors are not independent actors and often mold their recommendations to cater to the interests of their fund manager clients. In effect, proxy advisors acted as an SEC sanctioned trojan horse for fund manager interests all along.
Case in point – many investors and companies alike aren’t aware that the largest proxy advisor, Institutional Shareholder Services (ISS), offers custom voting reports to cater to the needs of their clients. In fact, ISS clients can also choose between three to five specialty policy guideline reports per company in addition to its benchmark report.
Why is this troubling? Depending on the which report they purchase, institutional investors can receive different voting recommendations for the companies in which their clients hold shares, meaning that fund managers could, in effect, select their desired voting recommendations.. Before the new guidelines, they would also receive a safe harbor designation from the SEC. In other words investors get to choose how they vote and still claim to be free of conflicts of interest. Clearly this is a breach of the spirit guiding the SEC’s regulatory approach.
To make matters worse, ISS also has a consulting business for the very same companies they are issuing recommendations on, meaning that companies can also essentially pay for favorable recommendations. In other words, ISS is engaged in what has been described as a pure racket.
Proxy Advisor Glass Lewis conflict of interest?
Meanwhile, Glass Lewis, the second largest proxy advisor, is actually owned by a large fund manager, the Ontario Teachers’ Pension Plan. In one instance, the Ontario Teachers’ Pension Fund publicly announced their opposition to a company’s Board of Directors. The very next day, Glass Lewis issued its voting recommendation for the company. Like its parent company, the voting recommendation was also in opposition of the company’s board—another key indication that advisors are not independent.
Policy guideline reports base their voting recommendations on different factors. One report is generally aligned with Department of Labor fiduciary guidance, while another takes social factors into consideration.
In a recent survey, 91 percent of retail investors, including retirees, stated a preference for wealth maximization over the pursuance of social objectives. However, with these report offerings, a fund manager could choose to follow policy guideline voting recommendations based on social factors, instead of fiduciary guidance, putting retail investor wealth maximization at risk. In the same survey, 84 percent of retail investors indicated having a choice in how their shares are voted is at least slightly important.
Proxy Advisors and Individual Investors
Retail investors, including retirees, also hold value in the guidelines and methodologies used to form recommendations. Over 95 percent of retail investors said recommendations free of conflicts of interest were important to them and 86 percent supported SEC oversight in regards to proxy advisory firm transparency, specifically to address one-size-fits-all practices.
Thankfully, fund managers will now have to take additional steps to show how their reliance on proxy advisors mitigates these serious conflicts-of-interest and ensure they are following recommendations that are in retirees’ best interests. Proxy advisors will also be incentivized to issue recommendations that align with the fiduciary duty of their clients. Both of these conditions serve as a critical first step and the foundation of a forthcoming rulemaking.
The SEC is taking action that considers the five million senior citizens of America, who need proper protection of their retirement assets. These retail investors have trusted that the growth of America’s public market will help them save for their retirement, and these new guidelines will act as critical insurance that investor oversight of these companies is sound.