July 2, 2018
Shareholders of a company are usually viewed as a responsible check on the company’s management. They are able to vote on matters that can directly impact a company’s success in the form of shareholder resolutions. The amount of voting influence a shareholder possess is directly proportional to the amount of stock they hold in the company. Alarmingly, a practice known as “empty voting” by institutional investors, such as mutual fund managers, is challenging this basic axiom and may be putting retail investors’ capital at risk.
Empty voting occurs when mutual fund advisors vote on shareholder resolutions for retail investors using their delegated voting power. This concentrates voting decisions with the advisers and gives them disproportionate influence over the fate of shareholder resolutions, without requiring them to take on the risk of owning the stocks of the underlying companies. Empty voting drowns out the voices of retail investors and could ultimately lower shareholder value if mutual fund advisors vote in line with their own interests instead of retail interests.
In a recent blog, Main Street Coalition Advisor Bernard Sharfman explains the disproportionality of empty voting:
“It is the consequence of the industry practice of centralizing the voting of mutual funds into the hands of their advisor’s corporate governance department. As a result of this delegation of voting authority, mutual fund advisors have the voting power, but not the economic interest in the shares that they vote.”
The enormous growth of capital invested in mutual funds has exacerbated this issue:
“However, as the mutual fund industry has continued to grow at a rapid pace, especially in the form of index funds, this empty voting has created an enormous concentration of delegated voting power. For example, Blackrock, Vanguard, and State Street Global Advisors (the Big 3) now control, without having any economic interest in the underlying shares, the voting rights associated with trillions of dollars worth of equity securities.”
This immense voting power even allows mutual fund managers to determine whether a shareholder resolution passes or fails. Sharfman explains how this power could lead to scenarios in which mutual fund managers use their power in pursuit of their own personal interest, instead of the interests of the retail investors who purchased the fund:
“For example, an advisor may be tempted to act opportunistically when an advisor is also a company’s retirement plan administrator and is very hesitant to vote against management for fear of losing the company’s business. This is one of the reasons why the SEC implemented its proxy voting rule for investment advisors back in 2003. Or, an advisor may be tempted to support public pension funds in their efforts to remove dual class shares from being listed on stock exchanges if it will lead to bringing more public pension fund assets under management. For the same reason, advisors may support proxy access proposals initiated by public pension funds. Or, advisors may try to avoid confrontation with their own shareholder activists by being more supportive of social responsibility proposals, such as those dealing with climate change, than they would otherwise.”
The negative implications of empty voting on retail investors is another reason why the Main Street Investors Coalition is demanding that fund managers focus on maximizing performance and working to ensure that retail investors who own passive funds have a say in how their shares are voted. These reforms would help balance the disproportionate sway that mutual fund advisors wield over shareholder resolutions today.