By Prateek Patel April 29, 2020
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Many Americans are finding it challenging to watch carefully planned retirement investments adjust daily as a result of the coronavirus emergency and uncertainty in the current economic environment. For public-sector employees, like policemen, firefighters, or teachers, their priorities lie with serving their communities, many of which are now operating from home. But the need for security, safety and education remains quarantine-proof.
Like many public-sector employees, their retirement savings are managed by pension funds that operate as fiduciaries to make investment decisions to maximize long-term growth on behalf of pensioners. But there is a concern that public pension fund managers are skipping steps in their due diligence processes by executing votes on shareholder resolutions using a system known as automatic voting or “robo-voting.”
The proxy voting process is designed to facilitate communication between public companies and investors and provides a platform for shareholders to submit proposals for consideration by the board of directors and other shareholders. This process is intended to promote practices that preserve the long-term value for the business, which shareholders stand to benefit from. However, in some cases the process has been hijacked by politically motivated shareholders who in some cases prefer the business to become more “woke” even at the cost of reducing shareholder value. As a result, politically motivated shareholders have directly impacted public markets by encouraging more companies to remain private, thereby reducing the ability of Main Street investors to invest in healthy businesses.
When it comes to voting on resolutions, many public pension funds rely completely on the voting recommendations of proxy advisory firms. Currently, two firms make up the majority of the proxy voting recommendations industry: Institutional Shareholder Services and Glass Lewis, which control 97 percent of the advisory market. Both firms have significant influence over every aspect of the proxy voting process and provide voting recommendations to clients and market participants on which proposals to support or vote against, oftentimes based solely on their own metrics. However, the two firms have failed investors and pension funds in the past by providing incomplete and inaccurate recommendations that ultimately lead to bad decisions.
A 2018 report from the American Council on Capital Formation found that proxy advisory firms had made significant errors at least 139 times over the three previous proxy seasons. Several companies, ranging from Carmike Cinemas to Motorcar Parts of America, cited serious disputes with proxy recommendations.
A separate Penn Law study suggests that recommendations from proxy advisory firms like ISS can shift up to 10 percent of the vote at companies. Alternatively, a negative recommendation against a shareholder proposal can harm proposal prospects, especially when firms are using their own broad metrics comparing the smallest businesses against the largest in a specific industry. For example, a Harvard Law study notes that a negative recommendation from ISS can lead to a 25 percent reduction in shareholder support.
Inaccuracies in recommendations and little scrutiny from pension funds can have a massive impact on shareholder voting, especially when pensions exercise robo-voting and vote their pensioner’s shares as soon as recommendations are issued. Three pension funds — Virginia Retirement System, Los Angeles County Employee Retirement Associations and Swiss Railways pension fund Pensionskasse SBB — voted identically with proxy recommendations, approximately 99 percent of the time. Pension fund managers — along with mutual funds and other asset managers — abdicate their fiduciary responsibility when they match proxy advisory recommendations vote by vote without further analyzing the recommendations, especially if the recommendations contain errors.
Concerningly, current rules also allow mutual funds and other asset managers to pre-populate their voting instructions to vote with proxy advisors, which worsens the problem. In other words, the robo-voting problem goes beyond just pension funds and implicates a number of entities that are regulated by the Securities and Exchange Commission.
The 2018 ACCF study also found that 29.5 percent of the vote at public companies were robo-voted automatically in line with either ISS or Glass Lewis, only 72 hours after the recommendation was issued.
When the SEC first began reviewing the proxy process, then-Commissioner Dan Gallagher correctly raised concerns about this process in 2013 when he said “the last thing we should want is for investment advisers to adopt a mindset that leads to them blindly cast their clients’ votes in line with a proxy advisor’s recommendations.”
A pending rulemaking provides an opportunity for the SEC to mitigate the practice of robo-voting by examining a policy of disabling pre-populated voting instructions on contested proxy matters. This would ensure that fiduciaries under the SEC’s purview actually take the time to examine particular issues and cast votes in the best interest of their shareholders, rather than blindly relying on proxy advisory firms.
Pension funds and other institutional investors should be held responsible for blindly robo-voting shares based on proxy advisor recommendations without also exercising due diligence of reviewing recommendations for accuracy. The SEC should take this opportunity to protect the long-term interests of all retirement savers and pensioners.
Prateek Patel is a federal policy associate with the Shareholder Advocacy Forum, a project of Americans for Tax Reform.