In the not-too-distant future, when someone authors the definitive book about the political battle over ESG investing, they’re likely to describe it as a fight between Wall Street and Main Street.
If they do, they’ll have missed the point. Others pushing the strategy, while presenting it as a money-maker, saw it as a means for limiting the development of new fossil fuel energy sources and to achieve other goals no legislature would ever approve, and no president would push to enact.
The real story, which is the focus of a Tuesday hearing of the House Financial Services Committee, involves the activities of firms that advise shareholders how to vote their proxies at corporate annual meetings. The two biggest, Glass/Lewis and Institutional Shareholder Services—ISS for short—play an outsized role in determining the outcome of these votes and have, no surprise, been a driving force behind many of the ESG and DEI steps taken toward them by corporate America over the last five years.
The congressional scrutiny is long overdue. While not a monopoly, the two firms have virtual control over what is admittedly a niche market. Glass/Lewis and ISS constitute what is, in effect, a duopoly, with their combined clientele amounting to approximately 90% of the market. Glass/Lewis openly touts its $40 trillion in assets across 100 global markets, providing recommendations for 40,000 shareholder meetings each year. ISS does not make similar claims. It’s much more circumspect about its breadth and power, but does admit advising 20,000 shareholder meetings across 100 countries, representing 3.8 trillion shares.
The problem is that for years, they have pushed affirmative votes on ESG investment strategies, DEI policies, corporate board membership, and executive pay without regard to the effect these resolutions will have on shareholder value and profit. Analysts suggest their advice can sway a proxy vote by up to 30%, making them quasi-regulators in capital markets.
Some would argue that’s just the free-market system at work. However, given the callous disregard shown for the federal regulations that require those who manage other people’s money to make decisions based on what will create the maximum possible return for the individual investor alone, it all goes further than that.
Problematically, the voting guidelines and decision-making processes of these firms are not at all transparent. Shareholders and corporate managers are left in the dark regarding how conclusions are reached. There’s no requirement to provide the logic behind the recommendations. Much of what is put forward could be called inconsistent across similar proposals among companies and even for the same company over time. Reasonable people and savvy investors alike cannot be blamed for asking what the objective is if it isn’t to get the best returns for those who use their services. Proxy advisors are not, and have not been, held to the same regulatory standards as others in the financial industry, raising serious and appropriate questions about accountability and investor protection. Jamie Dimon, CEO of JP Morgan, bluntly pointed this out at a Retirement Summit hosted in D.C. in March, calling proxy advisors “incompetent.”
Both Glass Lewis and ISS offer consulting services, specifically on ESG. ISS’s website clearly states “ESG No Longer Optional,” making their perspective on the matter, which they then push onto shareholders, noticeably clear.
Since the firms cast votes involving thousands of companies and trillions of dollars and provide consulting services to the same companies for which they issue voting recommendations, it’s not easy to tell where one interest stops and the other starts. Some might say that creates a conflict of interest.
Everything is now in turmoil. Corporate America and the money managers are backing away from ESG and DEI as quickly as they can. They’ve departed from climate initiatives like Climate Action 100+ and the Glasgow Financial Alliance for Net Zero. Asset managers are now voting more carefully on these issues than either firm suggests they should. Both, for example, have called for affirmative votes on 75% of social resolutions and 44% of environmental resolutions. At the same time, BlackRock, Vanguard, Fidelity Investments, State Street Global Advisors, Capital Group, and J.P. Morgan Asset Management backed fewer than 40 percent. In the latest Share Action report, the “Big Three” (BlackRock, State Street, and Vanguard) are shown to have abandoned ESG altogether.
Professional money managers are trying to alter the marketplace by expanding their voting choice programs so that more investors can vote for their own shares rather than relying on the proxy duopoly. That may be enough, but that’s not yet clear.
Proxy advice is essential, especially in an investor-class country like the United States. There’s too much going on for the small investor to digest without help. Whether the advice they rely upon is legitimately helpful as far as their interests go is now the question of the day. The Financial Services Committee is looking at six amendments to the Securities Exchange Act of 1934 that could set things right. It would be better for all concerned if it didn’t come to that, meaning Wall Street must continue to clean up its act before the government intervenes.
