Proxy Advisory Firms: Don't Trust Them and Try to Verify Them
The modern world of investing is built on a series of “trust-but-verify” relationships. Most average investors – such as those contributing to pensions or 401ks – must trust that investment managers are making wise choices with their money, but can verify decisions based on required financial statements, realized returns, even regulatory oversight. But another powerful player has emerged in this system, with one essential ingredient missing: there is no verification of trust in sight.
While investors expect institutional managers to do the right thing with their savings, many managers have abdicated a key element of their responsibility to this third-party player, proxy advisory firms. As institutions must vote on every shareholder proposal at the hundreds if not thousands of companies in which they hold positions (through and on behalf of their clients’ investments), many outsource the analysis of those proposals to the two largest proxy advisors, ISS and Glass Lewis.
To better understand this trend, the American Council for Capital Formation looked at historical voting records to see where asset managers lined up with recommendations from ISS, the largest of the U.S. funds. Their finding: while the recommendations of ISS may not be followed by their clients 100% of the time, they are followed nearly 100% of the time by many of the largest fund managers in the country. A review of historical voting records of 175 asset managers with more than $5.0 trillion in assets under management finds these funds have historically voted consistently with ISS recommendations 95% of the time, whether the matter at issue was a management proposal or a shareholder proposal. Of this group, nearly half – or 82 of the asset managers with over $1.3 trillion of assets under management -- voted in light with ISS’ recommendations 99% of the time. As the report concludes, these results mean billions of dollars are being voted in line with proxy advisor recommendations, no matter what.
Retail investors have no relationship with these companies; their relationship is with the manager overseeing their investments. Yet new research finds many institutional investors aren’t verifying the accuracy or fiduciary judgment of the advisors’ guidance before voting their clients’ shares. Instead, fund managers are “robo-voting,” or automatically following the guidance of proxy firms without conducting their own assessments.
This is the first statistical evidence that “robo-voting” is a real phenomenon and raises important questions over whether asset managers are meeting their fiduciary duty to investors.
Additional research from corporate governance expert Frank Placenti of Squire Patton Boggs also suggests that votes are cast before companies have time to respond or correct factual inaccuracies. Of a survey of 100 companies and their experience in the 2016 and 2017 proxy season, 100 percent of the companies surveyed indicated they would need at least three business days to communicate with shareholders in response to an adverse recommendation. This statistic should not be alarming when considering all that companies must endure to go through all that goes into the response process, yet eighty five percent of respondents indicated they received less than three days. Great news for the lucky 15% that received more than a mere 72 hours for such a cumbersome response process!
Indeed, when combined with the fact that many votes are submitted through electronic ballots that require a manual override for an investor to vote differently to the recommendation, the alarming takeaway is that thousands of votes are being cast nearly immediately in line with a proxy advisor’s guidance.
So exactly how often are proxy advisory firms’ recommendations inaccurate? Based on the snapshot provided from Placenti’s research and the 107 filings from 94 separate companies examined, there were 139 significant problems including 90 that contained factual or analytical errors. Imagine how many errors and problems exist if one were to look at every recommendation! Even worse, consider the financial loss to the average investor who may have felt this error impact a coveted retirement account.
The SEC should assess the ramifications of this research: That the volume of erroneous and factually inaccurate guidance issued is both significant and likely far greater than we know and is compounded by “robo-voting” and other disturbing protocols.
The result for investors is that their shares in companies may be voted on what information is available, instead of what’s accurate. The mission of the SEC is to “protect investors, maintain fair, orderly and efficient markets; and facilitate capital formation” yet these simple and fundamentals seem to have been forgotten. Retail investors deserve a fix. Proxy firms like ISS and Glass Lewis owe businesses and investors alike the common courtesy to practice what they preach when it comes to fairness and transparency. The SEC should consider ways to address what has become a critical failing in our “trust but verify” system.