Over the course of the last six months, the Securities and Exchange Commission has twice acted to fix one of the last unregulated areas of the financial system — proxy advisory firms.
In August, the commission published guidance aimed at addressing some of the longstanding issues surrounding the overreliance of investment advisers on proxy advisers. And then in November, Chairman Jay Clayton announced a proposed rule designed to rectify a range of flaws in the proxy adviser industry and to improve the accuracy and transparency of proxy voting advice.
In response, asset managers, pension funds and their representatives have voiced concerns over both the guidance and the proposed rule. Much of that critique has argued that there is no need for regulation and that this is "a solution in search of a problem."
They argue that very few institutional investors have asked for, or agree with, the regulations. Instead, they suggest that proxy advisers provide cost-effective research to help inform voting and the proposed rules would impair the voting process. Why improving accuracy and transparency and allowing companies to communicate their views to investors through reports would impair the process is unclear.
But these arguments miss a more important point.
Announcing the guidance in August, Commissioner Elad Roisman noted he does "not consider asset managers to be the investors that the SEC is charged to protect. Rather, the investors that I believe today's recommendations aim to protect are the ultimate retail investors, who may have their life savings invested in our stock markets."
Put another way, it's not the views of the adviser but of the individual investors whose savings are at stake that the SEC should prioritize.
So what are their views?
On two occasions over the last year I have participated in research with the Spectrem Group to ask retail investors their opinions directly. The findings of both surveys suggest that their voice is often borrowed by institutional intermediaries to promote practices in proxy voting that they do not support.
The survey of more than 5,000 investors in April identified that, in contrast to the asset managers representing them, there was a level of apprehension with how proxy advisers were operating in U.S. financial markets.
The investors have at least $10,000 of assets in any combination of stocks, bonds, mutual funds, and exchange-traded funds held in various types of accounts, such as defined contribution plans, advisory accounts, brokerage accounts, individual retirement accounts and other similar investment accounts.
That level of anxiety solidified in a follow-up survey conducted in November. The most notable change during the following eight months was a growing awareness among retail investors of the issues and flaws of proxy advisers.
In fact, 69% of retail investors supported increased SEC oversight at the start of the survey, with that number rising to 81% by the end. Retail investors also clearly support further measures by the SEC to protect their investments and address robovoting, the alarming process where investment advisers vote automatically with proxy firms, doing none of their own due diligence.
The problems in the current system stem in part from the fact that investors' appetite to conduct independent research has been replaced by outsourcing governance analysis and decision-making to third parties with no stake in the financial performance of firms, and critically, no fiduciary duty to retail investors. As long as investment advisers have a duty of care and loyalty to clients, they must perform it. If they choose to refrain from active voting policies, they should be able to do so provided they disclose that decision. It is when investment advisers publicly maintain active voting policies, but in reality outsource voting decisions, that we have a problem.
By extending the current rule to include disabling prepopulated and automatic voting for those funds that disclose presence of an active voting policy, investors will be free to carry out their own independent evaluations. If that change were made, then investment advisers would have to manually certify they wanted to vote in line with a proxy adviser's recommendation and are more likely to vote based on the specific circumstances of the issue in question rather then just following general guidelines set before the proxy season.
The opposition from money managers to the proposed rule makes sense — those that benefit from the status quo tend to speak out in favor of maintaining it. Turkeys do not, it seems, tend to vote for Thanksgiving. But those same advisers continue to miss the point and are focused on different priorities than those they are supposed to represent — the ultimate beneficial owners, retail investors.
The SEC is charged with protecting the interest of ultimate beneficiaries, not asset managers. The feedback from those individuals is clear: There is material concern regarding the operation of proxy advisers and there is substantive support for the SEC's proposed rules. Without its implementation, the ability of fund managers to override the expectations and desires of the clients whose interests they are supposed to protect, will continue.
J.W. Verret is an associate professor of law at George Mason University's Antonin Scalia Law School, Arlington, Va., and a member of the SEC Investor Advisory Committee. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.