The current proxy advisory system — in which proxy advisors make recommendations to investors and asset managers on how they should vote on shareholder proposals — has evolved into a deeply perverse mess. This has yielded adverse outcomes for investors, retirees, and firms, and for the economy as a whole, as a result of inefficient investment and an aggregate capital stock less productive than otherwise would be the case.
This state of affairs has come to pass because of a series of regulatory decisions and politicized interpretations of the relevant statutes over many years. One would think that those offering advice to business firms and investment fund managers would be required to serve the fiduciary interests of those to whom such advice is given. One would be wrong: The pursuit of political power through financial regulation — that is, the ability to use other people’s money to achieve preferred policy outcomes — has resulted in a duopoly of two firms in the provision of proxy advisory services. These are Institutional Shareholder Services and Glass Lewis.
These proxy advisors have no fiduciary responsibilities to investors or fund participants. Accordingly, they have strong incentives to use proxy advice to further their own political and policy preferences. The result has been a wave of proxy proposals promoting ESG or “environmental, social, and governance” objectives, the central examples of which are various greenhouse gas-climate proposals, discrimination against fossil fuel investments, the pursuit of racial and gender quotas for corporate boards, and other such politicized objectives.
Moreover, again because of regulatory decisions, the asset managers to whom the proxy advice is given are in a position in which failure to adhere to the proxy advisors’ recommendations carries significant legal liability.
The financial results of this self-serving system have not proven salutary for investors, retirees and firms. Accordingly, serious pushback has emerged in various forms. Litigation is an important tool with which to defend the fiduciary interests at risk; in particular, various states have threatened litigation and disinvestment over the promotion of ESG objectives and discrimination against important local industries.
Congress has also begun to pay attention to the perversities of the proxy advisory system. The House Financial Services Committee last month held a subcommittee hearing that addressed directly the perverse economic results of the ESG preferences of the proxy advisors.
But congressional action is slow and uncertain, and the litigation process consumes years and significant costs. This environment means that other elected officials can take action to constrain the proxy advisors.
Of particular interest is the recent increase in attention from state attorneys general: More than two dozen AGs sent a letter last summer to 25 major asset managers that had voted at least 75 percent of the time in line with proxy advice from Institutional Shareholder Services on leftist environmentalist proposals.
Noting that the AGs “enforce our states’ civil laws against unfair and deceptive acts and practices, state securities laws, and state common law to protect our residents and the integrity of the marketplace,” the letter asked some hard questions. In particular: “Whether the Asset Managers’ disproportionate support for Institutional Shareholder Services recommendations was consistent with their fiduciary duties.” The letter notes that “Company management opposed all the identified proposals, and many of them are harmful to shareholder value on their face.”
The perverse economic effects of the proxy advisors’ ability to pursue political objectives with other people’s money, combined with increased attention and pushback from policymakers, are beginning to have favorable impacts.
Following the conclusion of this year’s shareholder voting season, every major asset management firm — BlackRock, State Street, and Vanguard — showed another significant drop in overall support for ESG proposals after facing years-long criticism over their previous support for these leftist proposals.
State Street reported that it had only supported 6 to 7 percent of environmental proposals. BlackRock’s support also fell to a record low, at only 4 percent of these same proposals, an 18-point drop from two years ago. This is likely one effect of the firm’s decision in June to add Egan Jones as a more conservative, fiduciary-focused proxy advisor option for its clients, thus loosening the stranglehold Institutional Shareholder Services and Glass Lewis have on our capital markets.
Impressively, Vanguard announced that it supported zero of 400 ESG shareholder proposals, as it analyzed its voting for the 2023-2024 shareholder season.
The current chairman of the Securities and Exchange Commission, Gary Gensler, has little interest in protecting investors and the efficiency of capital markets; he is a politician pursuing a political agenda. That Congress, however slowly and uncertainly, is paying attention to the machinations of an executive branch agency can impose constraints on the ability of future regulators to ignore their statutory responsibilities as he has.
But that is a slow process. The involvement and pushback by the state attorneys general is a welcome development, with possible investigations of the proxy advisory firms. In the larger context — at a crucial but more subtle level — this ongoing process of reform is an illustration of the supreme virtues of the separation of powers and federalism.
Benjamin Zycher is a senior fellow at the American Enterprise Institute.