Testimony at the Subcommittee on Capital Markets Hearing: “Reforming the Proxy Process to Safeguard Investor Interests”

Capital markets, ESG, Institutional Investors, Oversight, Proxy advisors, SEC enforcement, shareholder resolutions
More from: Nell Minow, ValueEdge Advisors

Nell Minow is Vice Chair of ValueEdge Advisors. This post is based on her testimony.

I am very grateful for the opportunity to share my thoughts on the proxy process and shareholder resolutions. I welcome your questions and will submit supplemental materials as necessary following this session and the related hearings on ESG and proxy advisors. I am particularly grateful for the opportunity to remind my fellow panelists about the essential elements of transparency and accountability that are the foundation of capitalism and the reason the markets of this country are the strongest, the most robust, and the greatest creators of wealth for investors and employees in the world. I am always disappointed to see the lengths corporate insiders and their service providers will go to insulate themselves from minimal transparency and feedback.

I have worked on behalf of shareholders since 1986 in a series of companies co-founded with Robert A.G. Monks and Rick Bennett, starting with Institutional Shareholder Services, all previous companies profitably sold and doing well. I met Bob Monks when I was at OMB and he was on the staff of then-Vice President George H.W. Bush on President Reagan’s Task Force on Regulatory Relief, where we worked with the late Boyden Gray, who was an exemplar of free market economics.

I would like to state for the record that I have included my firm purely for identification. No one is paying me to be here and neither I nor our clients have any financial interest in any legislation or regulatory activity on these matters. I emphasize this because my experience with those who comment on these issues is that they often disguise their financial interest in the policies being discussed. [1]

The appendices to this testimony include my recent comment to OMB listing some of the Orwellian names of the fake, dark money front groups that are distorting the legislative and regulatory processes on these issues.

The sole and only reason capitalism works is the ability of investors, the providers of capital, to have some oversight to minimize what economists call agency costs and lawyers like me call conflicts of interest. We would not have capitalism if businesses took money from investors and just said, “Trust me.” Markets do not run on money; they run on trust, and in the words of Ronald Reagan, “trust but verify.” This is why the US has the most meaningful disclosure requirements in the world, but disclosure is not worth much if shareholders cannot respond to it.

That essential oversight is grounded in shareholder rights, including the ability to buy and sell, limited liability, shareholder litigation, and proxy voting, including votes on management proposals to elect directors, appoint auditors, and approve executive compensation, and advisory proposals from other shareholders on matters that fall within the very narrow requirements of the SEC’s rules. For example, that means they cannot pertain to what is classified as “ordinary business,” the daily decisions about products and operations. Yet they do have to be relevant, within the control of the company’s board and managers. You can submit a shareholder resolution asking a software company to sell brownies, but the SEC will keep it off the proxy card. So the proposal has to be significant enough to be relevant but not central enough to constitute ordinary business. The proponent is limited to 500 words for discussion of the issue, while the company has no limits in its response and full access to the company treasury to fight it.

I am certain I do not need to explain to Members of Congress why it is important to allow affected parties to vote on important issues.

Four key points about shareholder proposals.

Only a small percentage of companies receive proposals from shareholders each year. The household name companies get several, and many companies get one or two, but most companies get none. The majority of public companies do not receive any shareholder proposals. On average, 13 percent of Russell 3000 companies received a shareholder proposal in a particular year between 2004 and 2017.2 In other words, the average Russell 3000 company can expect to receive a shareholder proposal once every 7.7 years. For companies that receive a shareholder proposal, the median number is one per year. Many of these proposals are withdrawn after conversations with the company. Self-reported, undocumented claims about the costs of reviewing and responding to shareholder proposals are wildly inflated and should be reviewed with skepticism as self-serving.
Even a 100 percent vote in favor of a shareholder proposal is advisory only [2]. Company executives can and do ignore significant, even majority votes. I am not objecting to keeping shareholder proposals non-binding, which is in any event a matter of state law and outside the jurisdiction of Congress. But I emphasize that therefore, any downside risk from a shareholder vote on any topic is negligible, even non-existent. And the benefit of knowing what investors think is enormous; if management disagrees with the vote, at least they will learn that they are not communicating effectively and can do better. Limiting shareholder proposals is killing the messenger. It would be like telling customers they could not complain about products or services. Proposals are one of the very few ways insulated insiders hear honest feedback.
While a small number of people are responsible for a large percentage of shareholder proposals, the far more significant number is the level of support those proposals receive. We already have a system in place to keep proposals that do not get minimum levels of support off the proxy card, and indeed that was the fate of most of the anti-ESG proposals voted on this year. But it does not matter who files the proposals; what matters is whether they get widespread support from a variety of shareholders. If there are votes in favor from large and small funds and individuals, index funds and managed funds, pension funds and foundations, that is the best possible market test, and market tests are what keep companies and the economy strong.
No one is required to purchase the services of a proxy advisory firm. Many institutional investors do not. Those who do are not obligated to follow their recommendations. Indeed, the data show that while they do follow the advice on routine matters like re-electing directors and approving auditors (over 90 percent of proxy advisor recommendations are to vote with management), their clients review their analyses and then make their own decisions on the more complex and controversial issues like business combinations. ProxyInsight produced a study [3] proving that only 21 percent of investors use the proxy voting policy of a Proxy Voting Advisor and of the 1,086 investors surveyed 70.9 percent vote proxies based on their own policies with a further 8.5 percent delegating to a sub advisor or other asset manager.

These services are purchased by the most sophisticated financial professionals in the world. Those that choose to work with a proxy advisor can pick a registered investment advisor, one that is a registered NRSRO, or one who is not, one that offers consulting services to corporations or one that does not. Or more than one, to compare their analyses, as some do. While there have been claims over the past few years that there is a “duopoly,” that is clearly not the case as anti-ESG fund manager and Presidential candidate Vivek Ramaswamy created an anti-ESG proxy advisory firm [4] this year and it already has at least one major institutional investor client. [5]

This is exactly how markets are supposed to work and it would be a catastrophic intrusion of the nanny state to interfere with a product that is purchased voluntarily by highly expert customers, just as they purchase many other independent research services to help them with investment decisions.

Further on the subject of proxy advisory firms: Up to 1986, there were no firms providing comprehensive proxy advisory services, just some specialty firms covering what today we would call social issues. In fact, ISS was not created to sell proxy advisory services. But when Bob Monks tried to sell the products we originally planned, no one wanted them. Instead, our prospective clients told us what they did want was independent advice on proxy proposals, which had suddenly become complex and controversial after decades of routine votes to re-elect the board and approve the audit firm.

That was the era of the hostile takeover, made possible by the invention of junk bonds that could finance even the largest acquisitions. And so, it was the era of abuse of investors by both raiders (as we called them in those days) and entrenched management (as we still call them). It was also the era of the rise of the institutional investor, pension funds and mutual funds, for example. And so, two powerful forces collided. For the first time there were widespread attacks on shareholder value and for the first time there were shareholders big enough to act, smart enough to know when it was necessary, and, as fiduciaries, obligated to do so when it was in the best interests of the beneficial holders.

There were some scandals, particularly the “Avon letter” matter, when the Department of Labor stepped in because CEOs were directing their pension funds to vote in favor of poison pills (rather, against shareholder proposals challenging poison pills), not because they were in the interests of the employee pension plan participants for whom the CEOs were acting as fiduciaries, but because they were in the interests of the CEOs themselves. This is the opposite of fiduciary obligation, and that is what the “Avon letter,” dated February 23, 1988, addressed. Key points on ESG:

5. There are no documented cases of ESG-based institutional investor decisions for any reason other than financial returns. But there are many documented cases of institutional investor decisions that favor corporate insiders due to commercial conflicts of interest with portfolio companies. Big corporations, especially fossil fuel companies, have spent massive amounts of money to fight the E in ESG, with a lot of claims that ESG in general and E in particular leads to investment decisions, including proxy votes, that are not based exclusively on financial returns. And yet, in the many comments filed with the SEC and Labor Department, these commentors have been unable to come up with a single example of a buy-sell-hold or voting decision that is not based, to use the language of ERISA, on “the exclusive benefit” – meaning financial benefit – of the ultimate customer, whether a pension plan participant or mutual fund investor.

There are many documented cases of decisions by fund managers that are contrary to the interests of beneficial holders. But these are not made for political or “woke” reasons; they are made for business reasons. As Vanguard founder John Bogle wrote many times over many years and as has been documented by studies going back to the 1980s, fund managers will vote proxies on, for example, CEO pay, contrary to the interests of beneficial holders if the portfolio company is a current or potential client of the firm. [6] In one widely reported case, Deutsche Bank switched its vote on a business combination after a side payment from Hewlett Packard, resulting in an enforcement action by the SEC and the promulgation of the rules now requiring that votes be disclosed. [7]

6. The Executive Branch and Independent Commissions at the federal level and state authorities for state and local funds already have not just the authority but the obligation to identify and bring enforcement actions if any institutional investors make any decisions for other than strictly financial returns, again, “for the exclusive benefit” of the beneficial holders. That applies to all decisions relating to share ownership including buy-sell-hold, voting, or exercise of other share ownership rights including submitting shareholder proposals, nominating board members, and participating in shareholder litigation. As the “Avon letter” and Deutsche Bank examples cited above show, the government can and does enforce the obligation to act as fiduciaries. There is no evidence that further authority is required, though a reminder, with particular attention to the commercial conflicts issue, may be worth considering.

7. There is no evidence that ESG-based investment decisions are based on nonfinancial criteria. On the contrary, ESG is a reflection of the inadequacy of traditional indicators in assessing investment risk and return. It is not investors, either individual or institutional, who are proposing the weakening of financial measures of performance. The Business Roundtable announced in 2019 that their member corporations had agreed to work for vague “stakeholder”-oriented goals instead of shareholder value. [8]

We have even seen admissions from corporations themselves that they object to ESG because they are looking for subsidies, not market-based investments. For example, a comment letter filed with the Labor Department by a trade association, The Western Energy Alliance first claimed that they support ESG, which one might think would lead them to conclude that they should be able to attract ESG-oriented investors. On the contrary, though, they then went on to say that they understand what ESG means better than pension fund fiduciaries, among the most sophisticated financial professionals in the world and subject to the strictest standards of care and loyalty our legal system imposes. Again, they failed to come up with a single example of a “wrong” or “non-pecuniary” or “political” investment decision by a pension fiduciary. Here is their real issue: “We have observed how ESG advocacy has negatively affected the industry’s access to capital over the last few years.” What the industry is saying here is that they want pension funds to subsidize otherwise market-unworthy investments. If ERISA directed plan fiduciaries to act for the exclusive benefit of corporate insiders, that might be worth considering. But an institutional investor fund manager’s duty is to protect beneficial owners, and that is the opposite of what the Western Energy Alliance and the other critics of ESG are asking for.

In conclusion:

Shareholder proposals are a very modest way to raise concerns at low cost to investors and to companies. They are submitted to a small fraction of companies but play an essential role in signaling concerns. If they are limited, the only options for shareholders will be far more disruptive and expensive.
Proxy advisor services are not mandatory and are purchased by sophisticated financial experts. There are no barriers to entry as shown by the new “anti-woke” proxy advisory service, they are not unduly influential (as shown by the votes contrary to proxy advisor recommendations), and they are already adequately regulated.
ESG indicators are a supplement to traditional financial disclosures, the ones that have repeatedly proven inadequate. Again, no one has to use them and they are purely market-driven. The only participants in these issues who have been driven by nonfinancial indicators are major corporations (the Business Roundtable’s “stakeholder” pledge) and institutional investors (voting proxies to benefit portfolio companies who are clients instead of beneficial holders).