Monday, April 12, 2021

SEC's ESG Momentum Turns to Proxy Voting

Proxy Regulations Haven't Kept Pace with the New Landscape

Author: David Schwartz J.D. CPA

Allison Herren Lee, the Securities and Exchange Commission's acting chair, called for more disclosure and transparency about proxy voting by mutual funds and institutional investors to ensure they line up with shareholder sentiment, particularly environmental, social, and governance (ESG) issues.


In her remarks before the Investment Company Institute's annual Mutual Fund and Investment Management Conference on March 17, 2021, Lee said that the SEC's proxy voting "regulations haven't kept up with what is a new landscape of institutional investor-driven corporate governance." Consequently, she announced that the SEC would focus on strengthening shareholder democracy by updating its rules and guidance surrounding proxy voting and corporate governance — including clarifying the proxy voting responsibilities of investment advisers and making existing proxy reporting more accessible and understandable to the now more expansive universe of investors. 


"Ultimately, corporate accountability is only possible when the funds that manage American investors' savings diligently exercise their authority to vote, clearly disclose their votes to investors and operate in a system that efficiently provides accurate information about vote execution."


Proxy Voting Responsibilities


Acting Chair Lee said she was concerned the Commission's guidance on the duties of investment adviser fiduciaries to vote proxies, particularly for shares on loan, "attempted to, and may have, tilted this calculus against shareholder voting without sufficient data or analysis to support the wisdom of doing so."


She explained that because index funds cannot sell out of their positions, proxy voting becomes an essential tool for maximizing value. But the economic benefits of voting are diffused among all shareholders. At the same time, index funds face economic pressure to lend out their shares or not recall shares instead of voting.


"These pressures can also present potential conflicts of interest for advisers in light of fee splits and revenue sharing that an adviser may receive,". . "The revenue generated by securities lending can lower costs when passed back to investors – but this should be carefully balanced against, and potentially moderated by, the value to shareholders in exercising oversight of boards and management in the companies they own."

As a result, Lee said that the SEC's staff would be taking a look at that guidance "to ensure that fiduciaries understand how to weigh competing concerns of all types in deciding whether and how to cast votes on behalf of their beneficiaries."


Acting Chair Lee made reference to recent academic papers that imply that advisers may have neglected their fiduciary duties in favoring securities lending income over proxy voting. This issue may be particularly sensitive for funds with affiliated lending arrangements given the potential risk of self-dealing. Mutual funds that pay an affiliated agent with a share of revenue must obtain exemptive relief from the Commission. They also must demonstrate on an ongoing basis that the fund's board is overseeing securities lending policies and practices in accordance with the conditions the SEC has placed on their affiliate program. Given the revenue sharing arrangement of affiliated lending programs, any tightening of the SEC's guidance on recalling lent securities to vote proxies versus leaving the loans out for revenue will put such programs in the SEC's cross-hairs. 


Better Proxy Voting Disclosure


Investors need better information about proxy votes to make sure their investments align with their ESG principles. According to Acting Chair Lee, the SEC will be looking to update Form N-PX, a publicly available form detailing mutual fund's proxy voting records for the most recent 12-month period. "It's high time to revisit this critical form and make it useful in creating needed transparency around the fundamental exercise of shareholder voting," she remarked.


"Retail investors need more meaningful insight into how their money is voted, and that insight is more important than ever with the growth of interest in ESG shareholder proposals,". . . "It's hard to see how retail investors can get an accurate and reliable picture of how a fund votes on ESG issues when they have to try to parse through these lengthy forms that use a kind of short-hand description of the proposals that were voted."



Only last month, the SEC included ESG disclosure and proxy voting among their exam priorities. Lee's remarks further emphasize the Commission's interest in how mutual funds are handling ESG issues and disclosures. "In sum, there is a lot of work to do in this area," Lee said. "And it is important work because it gets to the heart of ensuring that our system of shareholder democracy works."