September 14, 2018
It’s been a busy week for Main Street Investors. In addition to the Securities and Exchange Commission’s (SEC) exciting move to rein in proxy advisors by rescinding two no action letters that underpinned the outsized power and role of proxy advisors, the SEC Investor Advisory Committee also met to discuss improvements to the proxy process and the implications of the rise in passive investing. Comments at the meeting will inform the upcoming roundtable and explore much needed improvements to the proxy process.
SEC Chairman Jay Clayton opened the meeting with remarks that reaffirmed his commitment to main street investors:
“I hope you will approach these issues as I try to do: with a view to what is best for the long-term interests of America’s Main Street investors. For example, those who are investing monthly in their retirement accounts to fund expenses that may be years away.”
There was a general consensus among members of the advisory committee and the panels that the core of good corporate governance lies with the ability of investors to effectively oversee the management of the companies they are invested in. Retail investor participation in the proxy process is a critical component of good corporate governance because these investors have a direct stake in the financial performance of the companies they are invested in.
Participants in the discussion on how to improve the proxy voting infrastructure generally agreed that increased participation of retail investors in the proxy process is essential. David Katz, a partner at Wachtell, Lipton, Rosen & Katz, noted that the concentration of shareholder power by institutional investors has lowered the overall cost for companies to communicate with shareholders, but has made it harder to communicate with all shareholders. Katz was optimistic that technology could overcome this obstacle and that all investors deserve equal access to information from companies. Deborah Majoras of Proctor and Gamble, agreed that technology as simple as email could facilitate easier and enhanced communication with retail investors and potentially increase participation.
The second half of the discussion focused on the implications of a significant rise in passive investing. More passive investing has led to a greater concentration of power in the hands of large institutional investors, as retail investors have increasingly put their savings into professionally managed funds. Although the growth of passive funds has led to significant returns for retail investors, committee member John Coates noted that if the current trend of passive investing continues, “there could eventually be as few as five institutional investors making decisions about corporate governance for every public company in America.” This is why the Main Street Investors Coalition advocates for ways to return power to retail investors.
Institutional investors who oversee and manage passive funds are responsible for voting on thousands of proxies each year and often rely on proxy advisory firms for recommendations on how to vote. Robert Sharps, the Chief Investment Officer for T. Rowe Price Group, Inc, who actively manages funds, noted that passive institutional investors often “take a top-down approach” to corporate governance issues. Sharps elaborated that there are instances where this approach can be problematic when the issue in question is very specific to a certain company.
The rise of passive investing ,coupled with the rise of “environmental, social, and governance” investing (ESG), compounds the problem for retail investors. New research indicates it’s possible that fund managers who support ESG shareholder initiatives are lowering the financial value of the impacted companies. This goes against the demands of retail investors. When surveyed, 78 percent of people invested in passive funds said they invested because they want low-fees and consistent returns – not to advance social and/or political causes.
Advisory committee members and panels who spoke on ESG also generally agreed that the lack of standardization of ESG is problematic because there are many different meanings to the term. This is in line with what the American Council for Capital Formation found in “Ratings that Don’t Rate: The Subjective World of ESG Ratings Agencies”.
Robert Pozen, a Senior Lecturer at the MIT Sloan School of Management, warned that is it “too early” to definitively state that ESG will lead to increased long term financial performance. He also cautioned that any fund manager who is pursuing an ESG strategy must fully disclose that to investors and must develop a comprehensive approach to ensure that the strategy truly does create long term financial value.
The Investor Advisory Committee meeting demonstrated that both outside experts and the SEC are aware of and considering potential actions on issues raised by the Main Street Investors Coalition. More experts will have the opportunity to weigh in at or ahead of the SEC roundtable this fall. The Main Street Investors Coalition will continue to monitor developments at the SEC to ensure that the voices of retail investors are heard as important changes are considered.