Constructive Engagement

Constructive engagement is, supposedly, the primary reason for the SEC’s proposed new rules. As Chairman Clayton noted,

Today’s proposed amendments follow from the staff’s extensive experience with shareholder proposals and recognize the significant changes that have taken place in our markets in the decades since these regulatory requirements were last revised, including, in particular, the types and use of communications, the types and frequency of shareholder-company engagement and the substantial shift to investing through mutual funds and ETFs, rather than directly by Main Street investors. The proposed amendments would facilitate constructive engagement by long-term shareholders in a manner that would benefit all shareholders and our public capital markets.

My rulemaking petition to the SEC, would do more to further those ends.

Constructive Engagement: What Investors Say

The consensus among investors is that the new rules would discourage constructive engagement and will delay needed corporate action. For example, Fiona Reynolds, the CEO of Principles for Responsible Investment writes:
The EU is advancing policies that will help make the financial system more sustainable – primarily through the EU action plan on sustainable finance.

Similarly, in the UK, other positive signals include the new Stewardship Code, which places systemic risks, collaboration with other investors and stakeholders, and the needs and views of beneficiaries at the heart of good stewardship.

But in the US, it is a different – and concerning – story. While it has been a laggard in its response to climate change, it is now advancing policies aimed at disenfranchising investors who seek to engage with companies directly to encourage them to behave more responsibly. Current policies in the US allow investors to submit proposals for a vote at a company’s AGM. Climate change, human rights and executive compensation are all common themes for shareholder proposals.

But yesterday, the Securities and Exchange Commission proposed rules that would create new roadblocks for investors seeking to use the process to elevate critical climate-related and other ESG issues with corporate leaders. The proposal would:

• Increase the dollar value of the stock an investor must hold in order to be eligible to submit a proposal.
• Dramatically increase the portion of the vote a proposal must receive to be resubmitted in subsequent years – it often takes several years for the investor community to appreciate the importance of an emerging ESG topic and integrate the appropriate response to shareholder proposals into their voting decisions. This would have the effect of cutting off discussion of emerging issues before investors have the chance to analyse them and integrate the latest thinking into voting behaviour.
• Undermine investors’ access to independent advice on matters brought to a vote at companies’ AGMs by requiring proxy advisory firms to allow companies to review and comment on voting recommendations before investors see them.

US investors are increasingly stepping up to push the business community to prepare for the economic impacts of climate change and escalating inequality – they are stepping in where government policy has failed. But the US government is now responding by working to silence the voices of responsible investors. These proposed rules are in direct violation of the SEC’s stated purpose, which is to protect investors.

These proposed rules are in direct violation of the SEC’s stated purpose, which is to protect investors.

Read press releases from other investors and you will find uniform opposition to the SEC’s proposed rules for similar reasons.

• ICCR: Proposed SEC Rules to Restrict Proxy Access Break Faith with Investors
• US SIF Opposes SEC’s Proposed Changes To Rule 14a-8 And Proxy Advisors
• The Investor Rights Forum posts news coverage and statements from investors.
• The SEC Thinks Its New Rules Would Improve Proxy Voting. CalSTRS’ Chris Ailman Thinks They Would Create the Next Enron

Please see my initial comments on File 34-87485, Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8 and my initial comments on File 34-87457, Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice. The SEC wants to hear from you too. 

Constructive Engagement: Morningstar on the Implications of the Rise in Passive Investing

An interesting Harvard law post by Jackie Cook and Jasmin Sethi, both of Morningstar, also focused on constructive engagement. Although based on a paper written before release of the two recently proposed SEC rules, they hint at a more constructive option. The authors chronicle the rise of passive investing and the Big Three, stewardship implications, and what others are doing. They conclude with a call to encourage more collaborative engagement and disclosure, especially by the largest passive funds.

• The rise of passive investing and growing awareness of the financial materiality of environmental, social, and governance considerations make the role of asset managers in corporate governance more important than ever before.
• While asset managers have incentives to engage with portfolio companies, countervailing incentives— such as cost, regulatory concerns, and risk of backlash—make their level of opposition to management in proxy voting suboptimal in addressing systemic financial risks like climate change.
• An evolving and converging stewardship practice can be traced through sign-on stewardship codes and growing collaboration amongst investors. These require investment fiduciaries to use their influence over corporate governance arrangements at investee companies to promote sustainable business practices.
• Given the apparent advantages to all investors of mobilizing passive investor stewardship muscle, this paper views stronger disclosure standards around engagements and supportive frameworks for investor collaboration as policy approaches that would encourage active stewardship by passive asset managers.

Cook and Sethi observe,

End investors care about fees. However, increasingly, they also care about what their funds are invested in and how their funds are stewarded. A health competition between providers of index funs and providers of managed funds in the provision of stewardship services reduces the incentive to economize on stewardship to reduce operational costs… Why not use active voting and active engagement in tandem?… Transparency allows for closer scrutiny of engagement activities.

Commissioner Jackson’s Critique of N-PX Reporting

Commissioner Jackson discussed at the IAA’s 2019 Investment Adviser Compliance Conference in March with IAA President & CEO Karen Barr. In corporate elections, if you convince the Big Four, you win. When you sit down and signup for your 401(k), you should know how the funds vote. He says you can take their voting records and see where they land. But, of course, Mr. and Ms. 401(k) don’t have access to a database that will do that. Let’s take the information the SEC has through N-PX filings and make it understandable to the ordinary investor.

Constructive Engagement: Better Option is Full Disclosure

I would love to see better the Big Three or the Big Four join stewardship coalitions and disclose more information about their engagement and voting, as Cook and Sethi recommend. I would love it if instead of discouraging analysis and dialogue, as the SEC’s proposed rules would do, the SEC made the proxy voting information filed by funds available to Main Street investors in an easily understood format that facilitates comparison, as advocated by Jackson.

My rulemaking proposal, requiring funds to report proxy voting in machine readable format in real time, would help accomplish both goals. It would stimulate engagement and more conscientious stewardship through that old-fashion capitalist mechanism, competition. See Rulemaking Petition for Real-Time Disclosure of Proxy Votes, SEC File 4-748, Jul. 9, 2019. Learn more about the real proposal to stimulate construction engagement at Mutual Fund Wars Over Fees AND Proxy Vote. At the bottom of that post, you will find instructions on how to take action by submitting comments. Please do.