The Need To Diminish The Power Of Proxy Advisory Firms

While most of the attention in Washington D.C. this week will be focused on the Joint Congressional Committee’s continued hearings into the Jan. 6 attack on the Capitol, I will be intently watching the Senate Banking Committee’s hearing on how the managers of stock index funds should vote their proxies.

These days there are trillions of dollars invested in index funds, which are passively managed funds that merely track a broader stock market index. The three biggest index fund managers alone—Black Rock, Vanguard, and State Street—control over $20 trillion between them.

Princeton Professor Burton Malkiel first conceived of such an investment in the 1970s, when he published the epochal book A Random Walk down Wall Street, which has been a staple of introductory finance theory classes in business schools for decades. The idea is that few—if any—investment managers can consistently beat the market, especially after accounting for the fees they charge, so investors are better off having their money passively managed at an extremely low fee in a fund that goes up in lockstep with the overall stock market.

One problem that Malkiel never considered in his book is that index investors could end up controlling a sizable portion of stock in most publicly traded companies: The three big investors above are the largest shareholders for most stocks traded in the S&P 500—for instance, together they own fully one-sixth of all MicrosoftMSFT
stock—and collectively, on behalf of the individual investors who have purchased their funds, wield a modicum of power over these companies, which they wield when it comes to the annual proxy votes of publicly traded companies. Some people are concerned by the fact that that their collective block of proxy votes gives them the potential to influence any number of shareholder initiatives, and in recent years they have been more outspoken in using their power to influence any number of issues, some of which are only tangentially tied to investor returns. These deviations from their fiduciary duty is troublesome.

There have recently been some efforts to reduce the influence of these large pension investors: for instance, last month Alaska Senator Dan Sullivan introduced legislation granting individual investors the ability to control the proxy votes associated with their investments that are being held by the investment company managing their wealth.

However, Sullivan’s bill, if passed, would be far from a panacea, and could create unintended consequences unless the unchecked power of proxy advisory firms is similarly addressed.

The SEC requires all investment managers to vote their proxies, which can be a considerable chore for companies that own stocks in hundreds of different companies. Instead, most of them hire a proxy advisory firm to do that for them.

Currently, just two proxy advisory firms – Institutional Shareholder Services (ISS) and Glass Lewis ⎼ control more than 97 percent of the proxy advisory market. This level of market power has made them key players in capital markets, as they make nearly 38 percent of all shareholder votes.

If the INDEX Act only focuses on the biggest asset managers, the power of proxy advisory firms like ISS and Glass Lewis would increase. Any legislation intended to return voting rights to the actual shareholders of America’s companies should address the role of proxy advisory firms in some way as well.

Vivek Ramaswamy, Executive Chairman of Strive Asset Management, and Riley Moore, West Virginia’s State Treasurer, explain that ISS and Glass Lewis are often the firms in charge of voting the proxies of massive state and employee pension funds, and that they advance their own ideologies by supporting liberal shareholder resolutions on behalf of unsuspecting state employees.

As I’ve written before, ISS and Glass Lewis each have a political bent reflective of the progressive left and are inclined to nudge their clients to vote for proxies that support ESG issues, regardless of their impact on investor returns. Both firms have been accused in the past of having an activist bias that supports all manner of liberal proposals.

Recently, policymakers in Texas have seen this firsthand when ISS was found to have been using the state’s proxy votes to support anti-Fossil Fuel activism – a move that seems counter-intuitive given that Texas is the number one state for energy production in the country.

Last month the Texas Committee on State Affairs unanimously authorized a legislative subpoena to compel ISS – in addition to the big three asset managers – to appear before the committee and answer questions relating to their proxy voting practices on behalf of Texas investors.

This subpoena came after Texas legislators interviewed leaders from two of the state’s largest pension systems – the Employee Retirement System of Texas and the Teachers Retirement System of Texas. Notably, ISS voted in support of four shareholder resolutions restricting business with fossil fuel companies on behalf of the Employment Retirement System.

The actions outraged many state legislators, and State Senator Paul Bettencourt used the hearing as an opportunity to demand that the state fire ISS and the pension fund find another firm who would not use the proxy votes of Texas investors to make “politically woke statements.”

As Texas legislators have found, if other policymakers truly want to return votes to individual investors, these efforts must go hand-in-hand with restricting proxy advisory firms from using Americans’ proxy votes to position themselves as “corporate activists.”

The members of the Senate Banking Committee should use their hearing to not only look at index funds’ behavior in advancing a progressive policy agenda but also that of proxy advisory firms, and hold them accountable for hewing to liberal orthodoxy in their voting recommendations, even when they conflict with the fiduciary interests of the people whose money they invest.