Subject: File No. S7-23-19
From: Logsn Albright
Affiliation: Capital Policy Analytics

February 2, 2020

I am a professional economist working in Washington, DC, and have studied and written about the issue of proxy voting fairly extensively.

It is my view that proxy advisers as they currently operate, and as they are utilized by hedge fund managers, represent a significant problem for investors. The SECs efforts to highlight this problem and increase transparency among fund managers is laudable, as it will enable investors to make better-informed decisions how their money is used.

Investors care about their return on investment. In an effort to maximize returns while minimizing risk, they frequently give charge of their money to investment fund managers, public pensions, 401ks, and mutual funds, whose expertise, education, and experience ostensibly gives them insights into financial markets unavailable to the average citizen. In short, investors trust the judgment of fund managers more than they trust their own, and they expect that trust to be rewarded with cold, hard cash.

However, research indicates that many fund managers may not be using their own judgment at all, and in some situations and are merely blindly following the lead of third party firms. Proxy adviser firms provide information services to institutional investors, fund managers, and anyone who might be in charge of investing a significant sum of money. In exchange for a fee, these firms provide recommendations on how votes should be cast at shareholder meetings for public companies, as well as other aspects of the financial industry. For investors or their agents who are unable to attend shareholder meetings, this can be a valuable service, with so-called proxy-votes being cast in absentia, but the increasing reliance by major investment firms on these services has given rise to concerns over conflicts of interest and too much power being placed in the hands of too few advisers.

A study released by the American Council for Capital Formation (ACCF) found that, between 2012 and 2018, numerous major investment firms, such as Blackstone and the Virginia Retirement System, have been automatically following proxy recommendations without performing their own due diligence. ACCF was able to identify 175 entities managing a total of $5 trillion in assets that voted in line with proxy firm recommendations at least 95 percent of the time.

This has several worrying implications for individual investors. First, fund managers who market themselves to investors as financially savvy are being misleading. It takes no particular skill or training to automatically comply with the recommendations of a proxy firm. The fees investors pay fund managers for their expertise could just as easily be paid directly to proxy firms, cutting out the middle man.

Whats more, following proxy advisers is not necessarily a good way to represent the interests of investors, which should be the sole responsibility of fund managers. An earlier report by ACCF reported that not only are proxy advisory firms regularly issuing inaccurate guidance, but the business community rarely has sufficient time to correct the data when they do. Additionally, when a proxy firm acts based on an error in its analysis, rather than being caught and corrected by independent analysts, the error is instead propagated by fund managers voting in line with the mistaken recommendation. One example of a proxy firm acting improperly came 2013, when Institutional Shareholder Services (ISS), the largest proxy firm in the country, was fined $300,000 by the Securities and Exchange Commission in 2013 for revealing confidential proxy voting information.

This issue with robo-voting is acknowledged by the proposed rule, but as of yet no steps have been taken to correct it. While an outright ban on robo-voting would not, in my opinion, be appropriate, increased transparency requirements for when and how robo-voting is taking place, as well as the suggested limits on prepopulated forms would potentially be effective in reducing dangerous impact of robo-voting.

Finally, proxy firms have an outsized ability to influence the market, as well as public companies, as a whole. A single recommendation by a firm like ISS can have the power to swing a shareholder vote in one direction or another, as dozens of complying fund managers fall in line. To give one small example, a sufficiently influential proxy firm could be able to unilaterally select the Chairman of the Board of Directors for a major company, by simply issuing a recommendation that will be followed by the countrys public pension and mutual fund managers. Given that the proxy firms themselves dont necessarily have a stake in the companies for which they are effectively voting, its easy to see why this might be dangerous. As the ACCF report points out, fund managers automatically voting in line with proxy advisers recommendations can also have lasting implications for capital allocation decisions and has resulted in ISS and Glass Lewis playing the role of quasi-regulator, whereby boards feel compelled to make decisions in line with proxy advisors policies due to their impact on voting.

Without oversight, any number of conflicts of interest could emerge leading to proxy advisers making recommendations that benefit themselves rather than the investors who follow their recommendations. The proposed rule does contain enhanced requirement for conflict of interest disclosure as part of the SECs exemption criteria from proxy rules, which is an improvement on the status quo. It is possible that these requirements could be extended further than just as exemption criteria to ensure that advisory firms are working in the best interests of their clients as opposed to their individual members.

The proxy advisers maintain that they are only filling a need in the market by supplying useful information to investors and fund managers, which they are free to act or not act on as they choose. Technically, thats true, and it is easy to see why fund managers would rationally choose to employ these services. They may believe that the recommendations serve the best interests of their clients, or they may simply find it easier than conducting independent research on investment and voting strategies. Nevertheless, relying solely on these recommendations without engaging in the due diligence proper for the handlers of other peoples money is an abdication of responsibility and a disservice to their clients.

The bottom line for investors is that the proxy firms ultimately have no fiduciary duty to serve their interests. In other words, if you are invested in a pension system, a 401k, or a mutual fund, the proxies making decisions about your money dont have any obligation or incentive to look out for you. ACCFs research should serve as a wakeup call, not only to individual investors, who can largely be forgiven for trusting their assets to the experts, but also to the fund managers, who have knowingly acted irresponsibly with respect to their clients.

Its important to shine a bright light on these practices and urge investors to demand a more hands-on approach from their fund managers, or else take their assets elsewhere. In this respect, any efforts to make fund managers reliance on proxy advisor firms more transparent would be a step in the right direction.