While FTC Chair Lina Khan’s aggressive use of her commission to put pressure on big business has earned her the enmity of many free-market inclined economists, she has managed to forge an alliance with a number of “Khanservative” Republicans who share her distrust of big business.
Last week, a House Judiciary subcommittee held a hearing–essentially followed her lead--that focused on anti-competitive behavior in the market for proxy advisory services. However, it is not clear that the Democrats will align with Republicans on this one, because this is one case where a lack of competition serves their political interests.
The SEC requires investment managers to vote their proxies for all of the stocks they own in their fund. For a company offering an index fund that means it has at least 500 stocks it must do this for. Researching the board director nominees and the various proxy motions being considered for that many companies can be costly and time-consuming, so they engage the services of a proxy advisory firm.
Two such firms--Institutional Shareholder Services and Glass Lewis--effectively constitute a duopoly in this market. One way these firms exercise their market power is by recommending their clients vote their proxies in support of proposals that would advance a liberal political agenda when it comes to the environment, social issues, and corporate governance (or ESG) even when doing so may not benefit the firms or the people whose money they are investing.
Investment managers do not reflexively reject such advice: Bloomberg columnist Matt Levine observed that actions pushing down the returns equally for all investment managers do not necessarily affect their income, since they compete against each other on relative terms: If all index funds see annual returns fall by one percentage point, no index manager loses.. And this advice can be important: The two proxy advisors can sway proxy votes by as much as 30 percentage points.
The current administration has encouraged continued use of ESG investing, withdrawing a Trump Administration proposed rule that would have required investment managers to hew to a fiduciary duty and maximize investor returns. However, the Department of Labor replaced it with a rule that explicitly allows ESG investments by pension fund managers.
Some investors and politicians have begun to appreciate that the proxy advisory market duopoly is impacting investors--many of whom may not be aware of it--and have begun to take steps to arrest it. For instance, several states--most notably Texas--have passed laws prohibiting working with investment companies that put their pension money in ESG funds. Twenty-two other state Attorneys Generals have taken exception to actions by the two top proxy advisory firms.
Earlier this month BlackRock announced it would expand its Voting Choice program, which began in 2022, when it allowed large institutional clients to vote their shares. It will now permit individual investors to control their proxy voting choices as well, and they will soon add Egan-Jones as the third proxy advisor on their platform.
Egan-Jones Proxy Services is the third largest proxy advisory firm in the U.S. One of the proxy strategies it provides for investment managers is its Wealth-Focused Policy, which seeks to protect investor wealth and prioritize environmental or social goals. It explicitly promises to oppose proxy votes aimed at promoting diversity, equity, and inclusion and environmental protection, including scope 1, 2, and 3 carbon-neutral proposals.
More competition in this industry should be welcomed by both Democrats and Republicans--even Elon Musk has noted the power the proxy advisory duopoly has in the shareholder voting space.
Investment managers should put the investors they work for first, and their predilection to pursue a political agenda with the money they manage should be limited by the government and not explicitly encouraged. More competition in the proxy advisory space represents one way to correct this injustice.
