SEC Proposed Rule: Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice

Summary of Study

Bottom Line: The dangers of automatic voting driven by environmental, social, and governance (ESG) considerations are not consistent with the fiduciary responsibility to maximize returns for investors. The SEC must make an explicit requirement that proxy advice is justified explicitly on value maximization grounds.

Proxy advisors are constrained by fiduciary responsibility considerations only weakly. The personal preferences of proxy advisors, who are often oriented toward specific policy or political goals, can carry substantial weight in terms of decisions on proxy matters. Such matters include executive compensation and corporate policies on a range of social and environmental questions.

The voting recommendations flowing from the proxy advisory services have been shaped by incentives very different from enhancing value for the shareholders and future retirees and pensioners who participate in the funds.

Proxy advisors are not necessarily a cost-saving mechanism. The proxy advisors do not offer their services at a subsidized price. Someone must evaluate the proxy proposals on behalf of fund managers and pay the costs of constructing and operating a more-or-less permanent analytic effort.

Two areas of specific concern are automatic voting and specialty reports.

Automatic Voting

Acceptance of proxy advisory recommendations has evolved into the default option, while the rejection of the recommendations is the exception. This has been confirmed empirically. Three central problems result automatic voting:  

  1. Automatic voting literally outsources the evaluation of proxy proposals to the proxy advisors, an outcome that obviously disenfranchises pensioners in particular and shareholders more generally.
  2. This outsourcing, by inserting an artificial external actor between the fund management and those to whom that management has a fiduciary responsibility, must reduce the transparency of decisions on proxy proposals.
  3. Such systematic deference manifesting itself in automatic voting yields an incentive on the part of the proxy advisors that is tremendously powerful. 

Specialty Reports

Specialty reports by proxy advisors typically are prepared in response to requests from specific investors, and thus are likely to reflect preferences on matters not driven by fiduciary considerations of interest to all investors. ESG considerations are represented heavily among such specialty reports.

This practice allows fund managers facing political pressures from a subset of investors to pay its proxy advisor to ratify voting decisions driven by ESG and other objectives, while maintaining the illusion of an “independent” supporting analysis.

The SEC should require that the preparation and use of such specialty reports be justified specifically in terms of the fiduciary responsibility to maximize returns, and not on any other grounds.

Proxy reform would strengthen the fiduciary responsibility of those making or influencing business decisions to maximize that economic value. It would affect that outcome by minimizing the scope and opportunity for business decisions driven by considerations reflecting the personal preferences of managers, proxy advisors, and others in place of the fiduciary interests of the shareholders.

Read the full comment letter here