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Asset Managers’, Fiduciary Duties and Proxy Advisors

This post is the second in a series on corporate governance, guest-authored by experts from around the country, and intended to elevate differing perspectives and new ideas. The Bipartisan Policy Center recently launched a corporate governance project which is exploring the role of corporations in today’s ever-evolving society.

Job Title: Associate Dean for Academic Affairs and Robert J. Watkins/Procter & Gamble Professor of Law

Current Employer: The Ohio State University

Bio: Paul Rose is Associate Dean for Academic Affairs; Robert J. Watkins/Procter & Gamble Professor of Law; Director, Law, Finance & Governance at The Ohio State University. He teaches Business Associations, Comparative Corporate Law, Corporate Finance, Investment Management Law, and Securities Regulation. He has written extensively on sovereign wealth funds, corporate governance, and securities regulation, and he has consulted with and provided testimony on these topics to numerous regulators and other agencies, including the U.S. Senate Committee on Banking, Housing and Urban Affairs; the U.S. Securities & Exchange Commission; the Government Accountability Office; and the Congressional Research Service. He is an affiliate with the Sovereign Wealth Fund Initiative, a research project at The Fletcher School at Tufts University, a non-resident fellow of the ESADEgeo-Center for Global Economy and Geopolitics, an affiliate with IE Business School, and an affiliate with the Sovereign Investment Lab, a research project at Università Bocconi.

Prior to joining the faculty at The Ohio State University Moritz College of Law, Professor Rose was a visiting assistant professor in securities and finance at Northwestern University School of Law. Before joining Northwestern, Rose practiced law in the corporate and securities practice group of Covington & Burling LLP’s San Francisco office. He worked as an assistant trader in equity and emerging market derivatives at Citibank, N.A. in New York prior to attending law school.

The 2020 proxy season will ramp up over the coming weeks and—set against the backdrop of economic upheaval caused by the COVID-19 pandemic—it has a very different feel. Nonetheless, the issue of proxy voting and proxy advisors will be in the spotlight again as the majority of U.S. annual meetings, held virtually, consider a raft of shareholder resolutions.

During the first quarter of 2020, responses to the Securities Exchange Commission’s call for comments on its proposed rules for proxy advisors reached a crescendo, with a number of institutional investors arguing that the SEC’s rulemaking was a “solution in search of a problem.” While these arguments may well have been made in good faith, they remain myopic in their evaluation of the proxy advisory system, which continues to suffer from widespread robo- or autovoting.

It is understandable that this is the case as a host of investors, particularly larger ones, use proxy advisors in the way they were intended. These fund managers will often review reports from multiple advisors, conduct their own internal assessments, and only then confirm their votes. Setting aside potential concerns about whether the analysis of proxy advisors is either accurate or truly independent, it seems that these investors meet the high standards of fiduciary duty, by using proxy advisors solely as a third-party source of analysis that serves to inform final comprehensive proxy voting decisions.

However, what some of these investors fail to accept is that there remains clear evidence that many other asset managers vote exclusively—or almost exclusively—in line with proxy advisor recommendations. I have written previously about the potential risks of overreliance on external ratings and recommendations and, more recently, researched the voting alignment of investors with proxy advisors. That research, when supplemented by reviews of proxy voting guidelines of investors, provided compelling evidence of overreliance on proxy advisor recommendations. In the period since the publication of that research in November, there is evidence that those trends continue unabated.

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Investors and Proxy Advisor Alignment

Source: Proxy Insight data based on proprietary methodology.

InvestorResolutions at NovemberISS Alignment at NovemberFurther Resolutions VotedISS Updated Alignment
<strong>AQR Capital Management LLC</strong>282,565100971100
<strong>Arrowstreet Capital</strong>64,51010011,653100
<strong>Texas Education Agency</strong>40,4671001,390100
<strong>QS Investors, LLC</strong>215,083100696100
<strong>Stone Ridge Asset Management</strong>102,554100124100
<strong>Rafferty Asset Management, LLC</strong>68,80510012100
<strong>New Mexico Educational Retirement Board</strong>38,3461009,776100
<strong>Martingale Asset Management</strong>11,2281000100
<strong>Symmetry Partners LLC</strong>9,79210057100
<strong>IndexIQ Advisors LLC </strong>112,815100237100
<strong>ProFund Advisors LLC </strong>179,0711001,360100
<strong>Alpine Woods Capital Investors LLC </strong>44,48610017100
<strong>GlobeFlex Capital, LP</strong>12,21210019100
<strong>RiverFront Investment Group, LLC</strong>17,39510065100
<strong>CoreCommodityManagement, LLC </strong>17,54110059100
<strong>Rampart Investment Management</strong>16,1111000100
<strong>Philadelphia International Advisors, LP </strong>11,0581006100
<strong>NorthCoast Asset Management LLC </strong>5,9191004100
<strong>FFCM LLC </strong>56,9031008100
<strong>GRT Capital Partners</strong>8,5261002100
<strong>Ramsey Quantitative Systems Inc.</strong>7,48510028100
<strong>Elkhorn Investments, LLC </strong>9,6311000100
<strong>NuWave Investment Management, LLC </strong>7,3581000100
<strong>Artio Global Management LLC </strong>6,9161001100
<strong>Madrona Funds </strong>010033,190100
<strong>Total Resolutions</strong>1,596,905-80,045-

Despite the past five months being the quietest part of the year for the holding of AGMs, the investors identified in my November research that had never deviated from an ISS recommendation did so a further 80,000 times. With proxy season on the horizon, those numbers are set to rise considerably once again.

The SEC started to address the issue of investor use of proxy advisors by publishing guidance in August 2019.  That guidance provides that, in certain circumstances, such as “where the investment adviser’s voting policies and procedures do not address how it should vote on a particular matter, or where the matter is highly contested or controversial,” the investment adviser could consider “whether a higher degree of analysis may be necessary or appropriate to assess whether any votes it casts on behalf of its client are cast in the client’s best interest.”

An example of such a circumstance includes when a meeting or a proposal is contested, and the proxy advisory firm and the board’s recommendations are in conflict. The SEC’s upcoming rule should explore such a client-focused solution, which balances the valuable role proxy advisors can play when used appropriately with the need to ensure investment advisers meet the high standards required of them when discharging their fiduciary duties.

Notably, just last week, Japan’s Financial Services Agency started down the same road as the SEC when codifying the second version of its Stewardship Code, stating that investors “should not mechanically depend on the advisors’ recommendations but should exercise their voting rights at their own responsibility and judgment based on the results of the monitoring of the investee companies and dialogue with them.”

While some argue that those investment advisors who outsource their votes to ISS and Glass Lewis are more ‘informed’ than they would be if they had to tackle the mountain of proxy voting without the proxy advisors’ service, those same proponents underestimate the high bar that a fiduciary standard sets for proxy voting. In essence, such an argument aims to maintain the status quo and, in effect, creates islands of immunity for a large number of investment advisors from accusations that they are failing to meet their fiduciary obligations. The case that changes to prevent automatic voting in alignment with proxy advisor recommendations would be excessively ‘disruptive’ also seems weak. ISS and Glass Lewis already have the capability to disable automatic voting. In fact, it is a prominent feature of their research and voting platform and one that is used as a marketing tool, allowing companies to discharge their role as “stewards of capital.” Once a certain recommendation or piece of analysis is issued by the proxy advisor, investor clients receive a flag or an alert dictating that they must go into the proxy advisors’ system and actively confirm the vote.

Simply enshrining an effective mechanism to meet fiduciary duties should not be viewed as contentious or burdensome. In this sense, the SEC would only be building on established best practice in the market and effectively balancing the interests of all stakeholders.

It seems counterintuitive to argue that requiring investors to explicitly confirm that the recommendations of proxy advisors are in line with their clients’ best interests in a limited number of contentious circumstances is bad for corporate governance.

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