The institutional investor now dominates shareholder voting. A major reason for this domination has been the changing preferences of the retail investor. The new retail investor prefers to invest in mutual funds and exchange-traded funds (“ETFs”) that track a market index, such as the S&P 500, instead of spending the time and resources necessary to manage a portfolio of individual stocks held in a brokerage account. When this happens, the voting authority of retail investors is transferred to the investment advisers of these funds.
This shareholder voting power, representing trillions of dollars’ worth of equity securities, has now become concentrated in the hands of a small number of investment advisers—BlackRock, Vanguard, and State Street Global Advisors—that may be both uninformed and potentially conflicted when it comes to voting their proxies. This concentration of voting power may lead to lower market rates of return if it is used to interfere with the strategic decision-making of the companies that make up the indices, financially harming millions of index-fund investors. As a result, retail investors should seek ways to take back some of their voting authority.
The problem of concentrated voting power is illustrated in a resolution that will be voted on at HSBC’s shareholder meeting in London on May 28. Initially, a group of institutional investors in HSBC Holdings, the largest bank in Europe, had put forth a shareholder resolution that directs the board of directors to start implementing a program of reducing its lending to companies that are in the fossil fuel industry. This resolution has since been withdrawn; but in its place, the company has submitted a compromise resolution that provides much of what the shareholders want. Under U.K. law, if this resolution gets at least 75% of the votes cast, it becomes binding upon the company.
The obvious objective of the resulting resolution is to accelerate the move from energy sources dominated by fossil fuels to energy sources dominated by renewables. However, this objective must also contend with the reality that the world is going to be dependent on fossil fuels for decades to come. As stated by Larry Fink: “Under any scenario, the energy transition will still take decades. Despite recent rapid advances, the technology does not yet exist to cost-effectively replace many of today’s essential uses of hydrocarbons.”
The reality is that billions of people’s lives and livelihoods as well as their expectations for an economically better life in the years to come will depend on the significant use of fossil fuels during this transition period. Unfortunately, implementation of the HSBC resolution and similar resolutions at other companies will only result in reducing the world’s ability to meet its growing energy needs during this decades-long transition period. Naturally, those who suffer the most from a reduced availability and higher cost of energy will be the world’s poorest people.
Moreover, the use of the shareholder resolution (“proposal” in the U.S.) process to guide HSBC’s strategic decision-making is an example of inefficient governance. This is because the process results in shifting the decision-making that goes into managing the company’s core business—its lending portfolio—from the most informed (the board of directors and executive management) to the least informed (shareholders).
It is easy to see how a typical retail shareholder would most likely conclude that the forced restructuring of HSBC’s portfolio of loans will lead only to reduced company profitability, while also doing financial harm to a critical industry sector (which the shareholder may also hold investments in) that needs to be functioning efficiently for the next several decades. Therefore, such a shareholder would sensibly vote no on this proposal.
But here is where the concentration of voting power in the hands of investment advisers to index funds causes problems. It has been reported that two of BlackRock’s pension-fund clients, PensionBee and Merseyside Pension Fund, have been pressuring the company to support the original resolution and, most likely, will continue to pressure the company to support the compromise proposal. This alone should not sway BlackRock, but it has also positioned itself as a leading climate-change activist, primarily to attract the business of millennials and keep shareholder activists from disrupting its own corporate governance. In regard to the former, Larry Fink acknowledged the critical need of marketing to millennials in his 2020 Letter to CEOs. Therefore, in order to mitigate the harm caused by activists accusing it of not walking the talk, voting against this shareholder proposal may be very difficult for BlackRock to do.
BlackRock is not the only investment adviser that faces these conflicts of interest when voting its proxies. I am sure that these conflicts are also faced by Vanguard and State Street as well as other investment advisers. My solution for mitigating this issue is for investors to request their index funds to provide them with the option ofconforming their proportional voting interest, as represented by their percentage of ownership in a specific fund, to a requirement that when a shareholder proposal is presented, the investment adviser is to: 1) abstain from voting; or 2) vote based only on the board’s recommendations. Yes, the board, even though it is the most informed, has its own bias. But, as I explain in my law review article Enhancing the Value of Shareholder Voting Recommendations, this is mitigated by board members being required to adhere to the fiduciary duties they owe to shareholders, their own ethics, and the ability of shareholders to file suit if they believe that the board is damaging their financial interests.
While I am no technologist, it would appear that incorporating these general investor preferences into the shareholder voting of investment advisers should not be that difficult. If enough investors request the implementation of their voting preferences, this would have a significant impact on reducing the current concentration of voting power that has been created by the rapid growth of index funds, helping to bring the focus of shareholder voting back to where it belongs: the interests of retail investors.