March 8, 2019
Members of the Main Street Investors Coalition are weighing in this week with a number of ideas for the Securities and Exchange Commission (SEC) to implement that could protect retail investors from the undue influence of proxy advisors. The National Association of Manufacturers (NAM) submitted a new comment to the SEC and Bernard Sharfman, academic advisor to the Coalition, published a summary of his paper on enhancing the value of shareholder voting recommendations.
NAM outlined how manufacturing companies push for pro-growth policies to boost the market, which in turn would help retail investors save for retirement:
“Manufacturers often turn to the capital markets to finance pro-growth activities like business expansion and job creation, which in turn set the stage for economic expansion right here in America. At the same time, manufacturing workers – 67 percent of whom participate in a workplace retirement plan – depend on the public market to invest for the future. NAM members and their employees are significantly impacted by the outsized role that proxy advisory firms play in America’s capital markets.”
Meanwhile, Bernard Sharfman outlined the importance of value maximization and what the SEC can do to ensure that institutional investors focus on this obligation while utilizing the services of proxy advisor firms.:
“Investment advisors manage well over 30 percent of all U.S. publicly traded equity securities and have a fiduciary duty to vote their proxies in their clients best interests. A critical step in this issue is maximizing the ability of investment advisers to avail themselves of voting recommendations that are made on an informed basis and with the expectation that they will lead to shareholder wealth maximization.”
As we have said time and time again, retail investors who give their money to institutional investors (or investment advisors) to invest in index funds do so for the purpose of maximizing their returns, often for retirement. Both NAM and Sharfman provide easy ways for the SEC to ensure proxy advisors do not get in the way of institutional investors’ attempts at fulfilling this important mission.
NAM Recommendations to the SEC
One issue with the current regulatory framework is that it encourages institutional investors to rely on proxy advisory firms to mitigate potential conflicts of interest. Unfortunately, this practice has led to new conflicts of interest with recommendations from proxy advisory firms that are currently unregulated. NAM recommends a series of minor changes to rectify some of the unintended consequences that have led to the unregulated dominance of proxy advisors:
- The SEC can require institutional investors who use proxy advisory firms to contractually obligate their advisors to hold themselves to the same legal standards they are held to as investment advisors.
- The SEC can also clarify that to qualify as an “independent” third-party you must avoid conflicts of interests that are relevant to the company you are making recommendations for, disclose any conflicts, and deliver recommendations that are specific to the company, instead of making recommendations based one-sized-fits-all corporate governance principles. Alternatively, the SEC could remove mention of independent third parties to get rid of the impression that proxy advisors are independent.
- Institutional investors could also be required to disclose the policies of their proxy advisory firms to the public so that retail investors can better understand the methodology behind the recommendation.
- The SEC can clarify that investment advisors do not have to vote all their shares and sometimes it may be in their best interest to not vote.
Earlier in the year we applauded the SEC’s move to rescind two no-action letters sent from the SEC in 2004 to ISS and Egan Jones which essentially allowed proxy advisors to operate without disclosing conflicts of interest. Now that the letters have been withdrawn, NAM recommends that the SEC issue guidance to replace them and clarify the duty of investment advisors to ensure that they are responsible for ensuring the analysis of proxy firms they rely on meets the legal standard they owe to their clients.
Finally, NAM notes that the SEC has the authority to require proxy advisors to directly register with the SEC as envisioned in the Corporate Governance Reform and Transparency Act and should consider doing so as a direct option.
To better protect retail investors, Bernie Sharfman recommends that the SEC consider requiring proxy advisors to be held to the same standard as an information trader, which would ensure that their recommendations are truly informed.
In addition, he suggests that the SEC could recognize the true value of board recommendations, since the board of directors are closest to the innerworkings of the companies they oversee, whereas proxy advisors are resource constrained and have to evaluated thousands of companies.
Many Productive Ways Forward for the SEC
These ideas should serve as a roadmap for the SEC as it aims to find a path forward on proxy advisors that is practicable and addresses the concerns of retail investors, while also allowing companies to receive research assistance on corporate governance from the firms. The Main Street Investors Coalition looks forward to reviewing comments from additional stakeholders that offer solutions on how we can better protect retail investors from the conflicted interests of proxy advisors.