In a new article, I discuss how investment advisers like Blackrock, State Street, and Vanguard, can become adequately informed prior to voting their proxies without having to read massive amounts of information about the hundreds or thousands of companies they manage for their clients. The issue has major significance for corporate governance because investment advisers to mutual funds, exchange-traded funds, and professional money managers of separately managed accounts are typically delegated the authority to vote their clients’ securities. Most commonly, these voting rights are associated with a company’s common stock. Investment advisers 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 resolving 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. One way to achieve this maximization is to make sure that the voting recommendations provided by proxy advisors are truly informed. This leads to my recommendation that the proxy advisor should be held to the standard of an information trader. Such a standard is equivalent to performing at the level of a professional security analyst. Moreover, if a proxy advisor cannot attest to the use of that standard when generating a voting recommendation, then the proxy advisor must abstain from making that recommendation to its clients. Making a recommendation that does not meet this standard would be a breach of a proxy advisor’s fiduciary duty under the Investment Advisers Act of 1940.
Another way to achieve this maximization is for the Securities and Exchange Commission to recognize the value of board voting recommendations. As I argued in my October 12, 2018 comment letter to the SEC, the most precise voting recommendations are not provided by a proxy advisor but by the board of directors. Moreover, shareholders can easily identify them, without charge, in a public company’s proxy statement.
The recognition of the value of board voting recommendations would have significant policy implications. For example, it would change a long-standing SEC policy where the value of proxy advisor recommendations is recognized but the value of board voting recommendations is not. Such a paradigm shift will allow investment advisers to be less inhibited in using these informed and precise voting recommendations as a means to meet their fiduciary voting obligations. One way to implement this new policy is for the SEC to provide investment advisers with a liability safe harbor under the Advisers Act when using board voting recommendations in voting their proxies as long as their clients do not prohibit their use and no significant business relationship exists between the investment adviser and the company whose shares are being voted.
A ready argument against this recommendation is that shareholders would be giving up their role of keeping the board accountable if they simply followed the voting recommendations of the board. But this argument ignores the fact that shareholder voting cannot be looked at as simply another tool of accountability such as when shareholders file a direct or derivative lawsuit. When shareholders vote, they are also participating, alongside the board, in corporate decision making. That is, they are temporarily transformed into a locus of authority that rivals the authority of the board. As co-decision makers, it is critical that shareholders, like investment advisers, have at their disposal informed and sufficiently precise voting recommendations, no matter the source, including the board of directors. If shareholders feel that the board can provide them with the most precise voting recommendations, then that is what they should use.
A primary argument found in my article is that a proxy advisor provides uninformed recommendations because it is resource constrained and so may economize on the use of its resources by simply accepting a board’s voting recommendations as its own. This may explain why proxy advisors vote in support of management’s recommendations about 89 percent of the time. While this is not necessarily an undesirable approach, especially if you believe in the value of board recommendations, it needs to be disclosed. Otherwise, an investment adviser will be misled into believing that the proxy advisor is providing an independent source of voting recommendations. Given such disclosure, the client may want to go somewhere else for an independent third-party recommendation.
In sum, my article encourages a greater use of board voting recommendations versus the current predominance of recommendations provided by proxy advisors. The voting recommendations provided by the board are simply more informed and therefore much more precise. Yes, significant bias may exist in some board recommendations, reducing their precision, either because of agency costs or a too narrow a focus, but voting recommendations have no value if they are not informed. As argued here, that is the major problem with the voting recommendations provided by proxy advisors.
This post comes to us from Bernard S. Sharfman, chairman of the Main Street Investors Coalition Advisory Council, an associate fellow of the R Street Institute, and a member of the Journal of Corporation Law’s editorial advisory board. It is based on his recent paper, “Enhancing the Value of Shareholder Voting Recommendations,” available here. The opinions expressed here are the author’s and do not represent the official position of the coalition or any other organization with which he is affiliated.