The Securities and Exchange Commission has been busy of late, embarking on one of the most ambitious and politicized regulatory agendas in the Commission’s history. Under Chairman Gary Gensler it has used every opportunity possible to advance the interests of the environmental, social, and governance (ESG) movement, no matter what the costs may be to average investors who are simply looking for a decent return on their investments. Recent rule proposals regarding climate change disclosures for public companies and ESG mandates for private investment funds have garnered much attention and highlight how the SEC has injected hot-button social and political issues into its rulemaking.
Gone relatively unnoticed however, are the SEC’s efforts to gut critical reforms to the proxy advisory industry that were adopted less than two years ago. After an intense lobbying campaign spearheaded by special interests – including public pension funds and activist asset managers – the SEC has chosen to side with proxy advisory firms and their political allies over the vast majority of American investors.
Proxy advisory firms are supposed to provide institutional investors – such as mutual funds and pension funds – with objective, fact-based recommendations for how to vote on corporate director elections, shareholder resolutions, and other proxy issues that public companies consider at their annual meeting. But the proxy advisory industry has operated with major flaws for years. The two largest proxy firms – Institutional Shareholder Services (ISS) and Glass Lewis – control over 90% of the market and tend to prioritize political and social agendas over economic return for shareholders. These two firms are riddled with conflicts of interest and have been shown to make significant errors or lapses of judgement when issuing vote recommendations. Moreover, past SEC guidance effectively allowed institutional investors to outsource their voting obligations to the likes of ISS and Glass Lewis.
Proxy advisory firms are viewed as key allies by activist investors that for years have sought to impose ESG and other politicized agendas on public companies. A favorable vote recommendation from a proxy advisor is a big deal – one analysis demonstrated that 175 asset managers with $5 trillion in assets under management voted in lockstep with ISS 95% of the time. At any given point, institutional investors could disagree with pro-ESG recommendations, but the data collected to this point demonstrates a rooted allegiance towards proxy advisory firms through asset managers’ actions.
In 2020 and under the leadership of former SEC Chairman Jay Clayton, the SEC adopted meaningful reforms for proxy advisors that were based upon transparency and ensuring that vote recommendations were tied to economic return. The reforms were also refreshingly straightforward and simple: proxy advisory firms should provide greater disclosure about their potential conflicts of interest, ensure that their vote recommendations are based upon the most up to date and accurate information, and be held accountable by the SEC for any false or misleading statements they make while providing recommendations.
For opponents of these reforms, requiring proxy advisors to do better work and detail any potential conflicts of interest were a problem. Before the 2020 reforms even went into effect, the SEC announced a “no-action” policy towards enforcement of those reforms. That announcement was followed by a proposal in November 2021 that would revert back to the status quo where proxy advisors were subject to little oversight from the SEC. Refusing to enforce a rule that had yet to become effective is antithetical to the way the SEC has always operated and shows just how much pressure the SEC was under from the ESG industry to leave proxy advisors alone.
Chairman Gensler has also created a legal morass for the SEC. Soon after the “no-action” enforcement announcement last year, the National Association of Manufacturers sued the SEC, claiming the agency had violated the Administrative Procedure Act (APA) by refusing to enforce a rule that the full Commission had adopted. The SEC now finds itself in the curious position of publicly saying it will refrain from enforcing the proxy advisory rule, while claiming in court it has not violated the APA and that the rule remains in effect.
The SEC’s strategy for untangling this self-imposed mess remains to be seen, but we can expect quite the explanation for why the SEC is going out of its way to protect the proxy advisory industry and its efforts to push the ESG agenda. American investors deserve better from a regulator that is supposed to look out for their best interests.
