BlackRock, an investment adviser that primarily markets and manages index funds to millions of passive investors around the globe, has become a leading shareholder activist. Based on the extremely large amount of assets it has under management ($7.3 trillion), its importance as a shareholder activist cannot be overstated. BlackRock’s shareholder activism is reflected in its rhetoric disclosing the objectives of its activism, shareholder voting, and engagement (direct or indirect communication) with portfolio companies.
The issue that I address in a recent paper is whether the fiduciary duties of a manager of an “employee pension benefit plan” under the Employee Retirement Income Security Act of 1974 (“ERISA”) extend to BlackRock’s delegated voting authority and the shareholder activism that it empowers. The issue has been little examined in the academic literature, but the concentration of shareholder voting power in the hands of a small number of investment advisers makes it ripe for study.
BlackRock, like its major index-fund rivals Vanguard and State Street Global Advisors (the “Big Three”), has enormous proxy voting power but no underlying economic interest in the shares that it votes. This relatively new development is a result of both the large movement of assets into the index funds of a relatively small number of investment advisers and the industry practice of mutual funds and electronically traded funds (“ETFs”) to delegate voting authority to their respective investment advisers.
BlackRock has centralized this voting authority in an investment stewardship team of relatively few professionals. BlackRock has approximately 45 professionals globally, with only 21 based in the U.S., who are, on an annual basis, responsible for voting tens of thousands of proxies and engaging in various matters with the management of hundreds of publicly traded companies. Therefore, at many public companies, BlackRock’s investment stewardship team may now control the fate of a shareholder or management proposal, whether a nominated director receives a required majority of votes to remain on the board of directors, whether a proxy contest succeeds or fails, or even, through engagement with a company’s management, how that company conducts its business.
In BlackRock CEO Larry Fink’s 2019 letter to CEOs, he explained that BlackRock’s shareholder activism was primarily a way to market its investment products to millennials, a group that it believes sees the primary objective of business as the improvement of society rather than the generation of profits.
In Fink’s 2020 letter to CEOs and in a companion letter to clients, he announced how BlackRock will implement its millennial marketing strategy. First, BlackRock will dictate what a public company’s stakeholder relationships should be by requiring its portfolio companies (virtually every public company) to disclose data on “how each company serves its full set of stakeholders.” Moreover, noncompliance is not acceptable. According to Fink, “we will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.” Second, he announced the launch of a large number of new ESG funds and a refocusing of shareholder engagement to put a greater emphasis on stakeholders who are affected by climate change and gender equality.
BlackRock’s rhetoric would mean nothing if it were not backed up by shareholder voting and engagement. Voting is the stick that allows BlackRock to pressure companies to adopt its activist agenda. Based on its second-quarter 2020 Global Quarterly Stewardship Report, it is now clear that BlackRock’s investment stewardship team has ramped up its shareholder activism so that it matches its rhetoric. For example, it reported a 22 percent increase in total company engagements (974), compared with the second quarter of 2019. Moreover, it identified 244 companies that it believed were making insufficient progress integrating climate risk into their business models or disclosures. Of these companies, it took voting action against 53, or 22 percent, and placed the remaining 191 companies “on watch.” Those companies that do not make significant progress on integrating climate risk into their business models or disclosures risk voting action against management in 2021.
External pressure has also added fuel to BlackRock’s activism. In November 2019, Boston Trust Walden and Mercy Investment Services submitted a shareholder proposal to BlackRock demanding that it provide a review explaining why its climate-change rhetoric does not correspond with how it actually votes at shareholder meetings. The proposal was reportedly withdrawn after BlackRock agreed to give more consideration to shareholder proposals on climate change and join Climate Action 100, an investor group that targets its shareholder activism at fossil fuel producers and greenhouse gas emitters.
My paper takes the position that a plan manager has a fiduciary duty, the duty of prudence, to investigate BlackRock’s shareholder activism. This duty applies not only to the BlackRock mutual funds or ETFs that an ERISA plan invests in but also to those BlackRock fund selections that it makes available to its participants and beneficiaries in self-directed accounts. The fiduciary objective in this investigation is to ensure that BlackRock is utilizing shareholder activism consistent with a plan manager’s duty of loyalty under ERISA; that is, “solely in the interest of the participants and beneficiaries” and for the exclusive purpose of providing financial benefits to them. If that is not happening, these funds should be excluded from an ERISA plan.
Given this fiduciary duty of investigation, my paper also argues that if a plan manager were to investigate BlackRock’s shareholder activism, it would find this use to be in conflict with the plan manager’s fiduciary duties. For example, BlackRock’s first objective is to increase the marketing of its investment products to millennials. Its second objective is to appease shareholder activists who threaten to attack the business decisions, procedures, and objectives of its own corporate management. In both cases, shareholder voting and engagement are not being executed solely in the interest of its beneficial investors, including those beneficial investors who are participants and beneficiaries of an ERISA plan. As a result, those BlackRock-managed funds where its investment stewardship team has been delegated voting and engagement authority should not be allowed to become part of an ERISA plan until remedial action is taken.
Moreover, in order for BlackRock to attract millennial investors, its shareholder activism must focus on “improving society” for various stakeholders and not just “generating profit” for its shareholders. This commingling of strategies can be understood as implementing a voting and engagement approach that is at least partially targeting non-pecuniary objectives. That is, this activism is not being done for the exclusive purpose of providing financial benefits to plan participants and beneficiaries. Therefore, a plan manager, after complying with its duty of prudence to investigate and identify this mix of strategies, would be required to exclude those BlackRock funds that were associated with this kind of activity.
For the funds to once again become eligible for inclusion, it would appear that BlackRock needs to create a firewall between funds that are to be included in ERISA plans and those that are not. The former would somehow not be associated with the activism implemented by its investment stewardship team. Or BlackRock could simply shut down its shareholder activism until it could implement a strategy of shareholder activism that would not violate an ERISA plan manager’s fiduciary duties.
While the focus of my paper is on BlackRock’s delegated voting authority and associated shareholder activism, it is meant to apply to any investment advisers who attempt to leverage their delegated voting authority for purposes of engaging in shareholder activism. In addition, the Department of Labor should provide guidance to plan managers on when to exclude the investment products of investment advisers with delegated voting authority.
This post comes to us from Bernard S. Sharfman, a senior corporate governance fellow at RealClearFoundation. It is based on his recent paper, “The Conflict between Blackrock’s Shareholder Activism and ERISA’s Fiduciary Duties,” available here. The opinions expressed in this post are his alone and do not represent the official position of RealClearFoundation or any other organization with which he is affiliated.