Governing Index Fund Voting
Prior blog posts documented the outsized influence of index managers on corporate governance matter by looking at the concentration of share ownership in their funds and examining the recent ExxonMobil proxy vote as a case study around what can happen when the big three index providers flex their collective muscles. This post will focus on the potential options for governing index fund voting. As John Coates, now the SEC’s General Counsel, noted in 2018 “… analysis has shown that index providers are increasingly a, if not the, dominant force in governance of public companies. As they accumulate more and more assets, they accumulate more and more votes. Those votes, even if coupled to tiny staffs and modest expenditures on monitoring, create real power. That power creates a legitimacy and accountability challenge.”[1]
As Coates lays out in his essay, the policy options to deal with this significant and growing problem all have fundamental flaws. Additionally, the rules and regulations for creating checks and accountability have not kept pace with power accumulated. For example, the SEC rules require the index managers to disclose their proxy votes annually, which means that the underlying shareholders / investors have no idea for how their appointed agents have represented their interests for a full year. As noted in March of 2021 by then Acting Chair Allison Herren Lee, the Form N-PX “…disclosures have not lived up to their potential. They are unwieldy, difficult to understand, and difficult to compare across fund complexes.” How can any investor hold their agent accountable when they lack timely and transparent information?! In the age of smart phones and instant social connections, surely index managers can provide real-time, comparable vote disclosures.
In addition to improving governance tools for holding index managers accountable, more thought needs to be given to whether such managers should have the discretion to vote as they choose. When a passive manager starts taking voting decisions, they are no longer passive. They are presuming that they have the expertise and information to take informed decisions on behalf of millions of investors, who might object to their values or analytical process. A better practice would consider the true shareholders’ views and translate them into a dynamic proxy voting policy allocated according the shareholders’ ownership interests. The current operating and regulatory environment may make such an approach difficult, but changes are a foot. One only needs to look at the EU Shareholder Rights Directive to see what a more functional, efficient and transparent process could look like. More on this topic in the next blog.
[1] John C. Coates, The Future of Corporate Governance Part I: The Problem of Twelve, September 20, 2018. Electronic copy available at sssrn.com/abstract=3247337.
