We need to go back to basics when it comes to proxy adviser reform
The Securities and Exchange Commission has recently undertaken reforms to its oversight of proxy advisers, releasing guidance about how institutional investors can rely on these advisers to determine how to vote shares in corporate elections, mergers and issue proposals. The commission took this guidance a step further and voted to move forward on proposed rules on proxy advisers and the shareholder proposal process. These proposed rules are now out for public comment.
The SEC’s actions acknowledge that proxy advisers are powerful intermediaries that can influence the outcomes of corporate votes. Convincing a proxy adviser to support your campaign can be an effective way for conflicted and political pension funds to convince other institutional investors to vote in favor of their campaigns, on issues like climate change, gun rights, or the minimum wage.
While institutional investors have been vocal in their concerns about conflicts of interest in the auditing, investment analysis and credit rating agency professions, they have been noticeably silent on conflicts of interest for proxy advisers. This may be because proxy advisers serve as a useful ally to their issue campaigns.
The SEC’s oversight of these conflicted intermediaries is a welcome first step; proxy advisers are plagued by conflicts of interest and make recommendations that lack empirical support. Additionally, while direct oversight of the proxy advisory industry may alleviate some of the problems posed by their conflicts of interest, that alone will not be enough. So long as investment advisers are permitted to meet their fiduciary duties to retail investors without even reviewing proxy advisor recommendations, problems will persist.
While attention to proxy advisers is appropriate, the SEC is right to also propose tightening requirements for submitting shareholder proposals on the corporate proxy. Corporate elections are not merely about board elections; they also involve thousands of votes every year on proposals addressing a wide range of issues related to corporate governance.
Shareholders have the right under federal law to put proposals on the corporate proxy and have the company pay the costs of a vote on the proposal. Currently, shareholders with only $2,000 in company shares can make recommendations that are then subsidized by the company and the company’s other shareholders.
When the federal rules providing a subsidy for shareholder proposals were first adopted, participating shareholders were overwhelmingly retail shareholders — mom-and-pop investors holding a direct interest in the corporation. One could understand why the SEC may have felt the need to subsidize those retail shareholders and provide them with more of a voice in corporate votes.
Over the past number of decades, however, pension funds and other institutional investors have become holders of the majority of outstanding stock. With institutional investors voting over 90 percent of their shares, and retail shareholders voting less than 30 percent, the shareholder proposal process has become less about retail shareholders and more of a subsidy for large institutional investors.
Keep in mind, any future restrictions on a shareholder’s ability to place recommendations on the corporate proxy will not in any way limit their ability to fund their own campaigns for a shareholder vote in support of their recommendation. Pension funds can afford to fund their own proxy solicitations for their shareholder proposals, especially considering the topics being voted on in these subsidized votes. Public pension funds often push politicized issue proposals regarding climate change or minimum wage which are being subsidized in corporate elections by large groups of retail shareholders who do not typically vote on these issues.
The SEC should stand by its proposed changes to holding requirements for shareholder proposals and further constrain the range of proposals subsidized by the company and its other shareholders. Prior SEC interpretations significantly increased demand for proxy advisors who are more likely to support social issue campaigns. These interpretations of the federal proxy rules should be curtailed to limit shareholder proposals to bylaw or charter amendments under state law. Items with no link to shareholder value, such as social issues, should be prohibited.
Finally, the SEC must consider the broader universe of rules it has adopted that have driven demand for proxy advisory services. The reforms suggested in this article would limit the demand for proxy advisory services by eliminating the range of votes about which proxy advisers have been making dubious recommendations at the behest of their politically motivated clients. A back-to-basics approach of ensuring transparency and accuracy in the proxy adviser space is a good building block.
J.W. Verret is an associate professor of law at George Mason University’s Antonin Scalia Law School, and a member of the SEC Investor Advisory Committee. Follow him @JWVerret.