Does BlackRock's Shareholder Activism Breach Its Fiduciary Duties?
In Larry Fink’s (CEO of BlackRock) most recent letter to CEOs, A Fundamental Reshaping of Finance, Fink lays out a strategy for how BlackRock will use its considerable amount of delegated shareholder voting power to dictate its own vision of what a public company’s (a company traded on a U.S. stock exchange or over-the-counter) stakeholder relationships should be. These relationships represent the management of an enormous number of entities and individuals, entailing much complexity. That is why their management is placed in the hands of those who have the knowledge and expertise to manage them: the company’s management team. In this writing, I argue that BlackRock’s implementation of a strategy of interfering with a public company’s stakeholder relationships (“strategy”) is a form of shareholder activism that may breach the fiduciary duties owed to its investors.
As a means to implement its strategy, a strategy that allegedly is meant “to promote long-term value” for its investors, BlackRock will be requiring each public company that it invests in—virtually all public companies—to disclose data on “how each company serves its full set of stakeholders.” Moreover, noncompliance will not be tolerated. According to Fink, “we will be increasingly disposed to vote againstmanagement and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.” Based on first-quarter 2020 data, this threat appears to be playing out in reality.
In my previous op-ed, Why BlackRock’s Stakeholder Approach Won’t Work, I made three arguments to reach the conclusion that BlackRock’s strategy will lead to lower, not higher, shareholder returns. First, BlackRock is extremely resource-constrained even to attempt getting involved in such an undertaking on a per-company basis. It will be Larry Fink and his approximately 20-member U.S.-based investor stewardship team dictating required disclosures, business practices, and underlying strategies for the thousands of public companies that exist in the United States. With such limited resources, implementation will require a grossly inadequate one-size-fits-all approach.
Second, the BlackRock desire for an increased management role in our public companies must be based on an assumption that public companies as a whole are not paying enough attention to stakeholder relationships in order to maximize the long-term returns of shareholders. This is definitely a flawed understanding. Efficiently and innovatively dealing with these critical relationships is what the work of corporate management is all about. A failure to deal with these relationships in an integrated manner can lead a company to disaster.
Finally, it is hard to understand how it ever will be possible for BlackRock to identify when a public company is doing a good job in managing its stakeholder relationships. BlackRock exists outside the day-to-day of public companies. Moreover, from an informational perspective, BlackRock is in the worst possible position for getting involved in the management of these relationships. BlackRock, primarily a manager of passive index funds, expends hardly any effort in trying to value the firms that are held in the portfolios of those funds. If it knows nothing about their value, it certainly won’t know anything about how to manage these relationships efficiently.
These three arguments raise duty of care issues. For example, if BlackRock were an investment manager for a company’s 401(k) plan, an employee retirement plan that comes under the Employee Retirement Income Security Act of 1974 (ERISA) and administered by the Department of Labor, BlackRock would be required to discharge its duties “with the care, skill, prudence, and diligence … that a prudent man … would use in the conduct of an enterprise of a like character and with like aims.” In my opinion, because BlackRock is uninformed, in terms of both knowledge and expertise, implementing its strategy would not meet this standard.
BlackRock’s shareholder activism also raises duty of loyalty issues. Under ERISA, an investment manager must discharge his duties “solely in the interest of the participants and beneficiaries and for the exclusive purpose of” benefiting them. This means that BlackRock is duty-bound not to be guided by any third-party interest, including its own, when devising an engagement or shareholder voting strategy.
But what if BlackRock’s strategy is not really motivated by a desire to enhance shareholder value but to attract the investment funds held by millennials and, at least while they are young, their perceived preference for less financial returns and more social activism? Millennials will increasingly be the ones holding most of the wealth in the U.S., making it essential for advisers like BlackRock to start catering to their needs and developing their loyalty now, not later. This is an argument recently made by corporate governance scholarsMichal Barzuza, Quinn Curtis, and David Webber.
Or what if BlackRock’s strategy is used to appease shareholder activists who attack BlackRock’s management? For example, in November 2019, Boston Trust Walden and Mercy Investment Services submitted a shareholder proposal to BlackRock demanding that it provide a review explaining why its climate-change rhetoric does not correspond with how it actually votes at shareholder meetings. The proposal was reportedly withdrawn after BlackRock agreed to give increased consideration to shareholder proposals on climate change and join Climate Action 100, an investor group that targets its shareholder activism at fossil fuel producers and greenhouse gas emitters.
So while BlackRock’s shareholder activism may be a good marketing strategy, helping it to differentiate itself from its competitors, as well as a means to stave off the disruptive effects of shareholder activism at its own annual meetings, it seriously puts into doubt BlackRock’s sincerity and ability to look out only for its beneficial investors and therefore may violate the duty of loyalty that it owes to its current, and still very much alive, baby-boomer and Gen-X investors.
In sum, if I were running the Department of Labor or the Securities and Exchange Commission, I would seriously consider reviewing BlackRock’s strategy for potential breaches of its fiduciary duties.