ANALYSIS: The Key to ESG: Controlling the Shareholder Vote

Congressional committee holds 3 days of hearings on the firms that vote the shares you own

U.S. House of Representatives in Washington on March 23, 2023. (Richard Moore/The Epoch Times)

At the same talk where BlackRock CEO Larry Fink told his audience that his firm was “forcing behaviors” on companies, he also divulged a key lever used by the progressive movement to control corporations: proxy voting.

The term “proxy voting” refers to the practice of fund managers using the corporate shares they own to vote on behalf of investors, influencing company activities and strategies. With the rise of mutual funds, pension funds, and index funds, more than three-quarters of all stocks in the United States today are held not by individual investors but by a short list of very large asset management firms.

Mr. Fink said at a 2017 New York Times conference: “[Index fund managers] are the ultimate long-term holder; we have to own all the companies that are in an index.

“If you’re an active manager and you don’t like a company, you can sell it. I can’t sell. I have only one power, and I’m going to use that power heavily. And that’s the power of the vote.”

BlackRock, the world’s largest asset manager, has more than $8 trillion in assets under management. Vanguard, the second largest, has more than $7 trillion under management. State Street has about $3.5 trillion under management.

At the same time, two proxy agent companies, International Shareholder Services (ISS) and Glass Lewis, have arisen to advise fund managers on how to vote on numerous shareholder proposals. Critics argue that fund managers and proxy agents now have undue influence over shareholder votes and that they have used that power to successfully push a left-wing agenda known as the environmental, social, and corporate governance (ESG) movement on companies.

Congressional Hearings on ESG

In a series of Congressional Financial Services Committee hearings this week, Republican representatives hammered the ESG industry for manipulating free markets for political goals, while Democrat representatives accused the GOP of racism, climate denial, and Trotskyism.

“I support shareholder democracy, but it should be their say and not external third parties who exploit the existing process to impose their own social and political beliefs onto American public companies,” Committee Chairman Patrick McHenry (R-N.C.) said at the July 12 hearing.

“We must address the burdensome climate reporting and other requirements imposed by the Biden administration Securities and Exchange Commission. The SEC has proposed a 500-page climate disclosure rule that would replace voluntary sustainability reports with mandatory disclosures, and the question of materiality is really thrown out the window.

“The SEC is not a climate regulator, nor has Congress authorized it to mandate environmental policy via the disclosure regime.”

Democrat lawmakers, however, were united in their view that the hearings on ESG shouldn’t have been held in the first place.

“Today is the first of six areas this month where Republicans will partner with a network of dark money climate deniers and conspiracy theorists to wage their latest culture war against responsible investing,” Rep. Maxine Waters (D-Calif.) said.

“For over 100 years, the followers of Leon Trotsky and the Socialist Workers Party have waged war against this capitalist model,” Rep. Brad Sherman (D-Calif.) said. “Today, elements of the Republican Party join them in that effort. Ronald Reagan would be ashamed.”

How Proxy Voting Works

The hearings focused on how to address the role of proxy agents and how to deal with efforts by financial regulators under the Biden administration to impose extensive climate reporting rules on all listed companies. New regulations by the SEC would require companies to produce audited reports on their CO2 emissions and those of their suppliers and customers.

“Coupled with the recent politicization of the SEC, proxy advisory firms have seized immense power to shift policy ... to promote a liberal social and political agenda,” Rep. Bill Huizenga (R-Mich.) said. “The proxy process is broken; it no longer promotes long-term shareholder value and operates without transparency or accountability.”

The proxy process begins with shareholder proposals, for which the SEC acts as a gatekeeper, determining which proposals can proceed to a shareholder vote and which cannot. Under President Joe Biden in 2021, the SEC shifted its policy to make it easier for ESG proposals to be put to a vote.

“The SEC’s new position is that corporate annual meetings must permit the smallest of shareholders to force shareholder votes on any social or policy concerns whether or not it is material to the company’s business,” James Copland, a fellow at the Manhattan Institute, told committee members. “This change in policy has predictably led to a significant increase in socially oriented shareholder activism.

“In 2022, the first year after the SEC’s new guidance, the number of shareholder proposals faced by the large companies tracked in our proxy monitor database jumped 33 percent over the prior three-year average. To date in 2023, with approximately 10 percent of companies yet to file a proxy statement, companies have already seen a record number of shareholder proposals.”

Jonathan Berry, a partner at law firm Boyden Gray, testified at the July 13 hearing that the SEC has shown a bias toward green-lighting pro-ESG proposals while rejecting anti-ESG proposals.

“Environmental and social proposals now represent a majority of all proposals in Russell 3000 companies, 58 percent of proposals in 2022,” he said. “This last proxy season, my client, the National Center [for Public Policy Research], took a shareholder proposal that the SEC had blessed on a discrimination issue and substituted the terms ‘viewpoint’ and ‘ideology’ for the prior proposal’s terms ‘sexual orientation’ and ‘gender identity.’

“But the SEC said that my client’s proposal could be struck off the ballot, that viewpoint discrimination in the workplace was not a significant social policy question.”

National Association of Manufacturers Vice President Christopher Netram said that in recent years, “third parties have hijacked the proxy process.”

“Activists use the proxy ballot to advance political and social agendas,” he said.

“Proxy firms dictate corporate governance decisions, and the SEC is empowering these groups while also proposing ESG disclosure mandates of its own. Turning the proxy ballot into a debate club diverts time and resources away from shareholder value creation and forces companies to wade into controversial topics over which they have no control.”

Examples of companies’ wading into controversial topics include Disney’s fight in 2022 against parental rights laws in Florida, Coca-Cola’s fight in 2021 against voter I.D. laws in Georgia, and Anheuser–Busch’s and Target’s recent attachment of their brands to the transgender movement. In many cases, venturing into politics proved harmful to brand perception, reduced sales, or caused a substantial decline in the company’s stock price, all to the detriment of end investors.

Those who support ESG say it’s merely a means of getting important information to investors and that the SEC’s green accounting mandate and permissive approach toward ESG shareholder proposals is simply the free market at work.

“Investors need to know how companies are addressing climate risk, how they pay their employees, how diverse their workforce is, and more investors want this information, because it’s good for the performance of their investments, which is also good for society,” Ms. Waters said. “Rest assured that committed Democrats will continue to thwart this anti-capitalist, anti-investor, anti-business and anti-American effort.”

But ESG critics say there’s more to it than that.

“ESG efforts are not primarily about providing information,” Scott Shepard, director at the National Center for Public Policy Research, told The Epoch Times. “They’re about forcing companies to adopt political-schedule decarbonization, equity-based discrimination, and hard-left positions on social policy.”

According to Will Hild, executive director of Consumers’ Research, much of the information that comes from environmental or racial audits that companies are compelled to produce will not be used to increase shareholder value but rather “to give far-left activists a cudgel to use against these companies” via lawsuits, negative publicity campaigns, and additional shareholder proposals.

The Proxy Agent Duopoly

ISS and Glass Lewis hold a duopoly in the proxy agency market, together representing more than 90 percent of it.

“Both earlier and recent regulatory actions by the Securities and Exchange Commission have created a duopoly in the market for proxy advisory services and powerful incentives for firms and funds to retain proxy advisers and to adopt their recommendations often on an automatic basis,” Benjamin Zycher, a fellow at the American Enterprise Institute, told lawmakers.

“The advisers themselves have weak incentives to consider the fiduciary interests of shareholders and fund participants, thus freeing them to indulge their own political preferences and little or no cost to themselves. Unsurprisingly, environmental social and government’s political objectives have come to influence proxy advice heavily.”

Steven Friedman, ISS general counsel, testified that ISS is a registered investment adviser that “provides institutional investors with objective, timely and expert proxy research and vote recommendations based on the proxy voting policies selected by the clients.”

“ISS and other proxy advisers play an important but narrow role in the proxy voting process,” Mr. Friedman said. “It’s the client who creates and selects the voting policy guidelines that reflect their own fiduciary obligations and investments strategies.”

A 2018 report by the Harvard Law School Forum on Corporate Governance states: “Proxy advisory firms have significant influence over the voting decisions of institutional investors and the governance choices of publicly traded companies. However, it is not clear that the recommendations of these firms are correct and generally lead to better outcomes for companies and their shareholders.”

According to this report, ISS and Glass Lewis are able to swing between 10 percent and 30 percent of shareholder votes in line with their recommendations.

A 2018 report by the American Council for Capital Formation states that 175 asset managers, with more than $5 trillion in assets under management, followed the advice of ISS more than 95 percent  of the time.

A July 12 Wall Street Journal article states that both ISS and Glass Lewis supported an audit of the employment practices of Starbucks this year, which shareholders passed with a 52 percent majority, and that the duopoly backed a racial equity audit at McDonald’s that passed with 55 percent support.

Policy recommendations included breaking up the proxy adviser duopoly and passing laws to check the administrative overreach of financial regulators such as the SEC.

“One thing they should do is look at why it’s a duopoly in the first place,” Mr. Hild said. “Generally speaking, we don’t allow that in any major industries and certainly not something as big and important as the proxy advising services.”

Mr. Zycher said Congress should focus not on the Big Three asset managers, but rather on reforming the SEC regulatory framework.

“I urge Congress to enact legislation constraining the efforts of regulatory agencies to pursue climate policies not authorized in the law, uninformed by actual evidence and justified on the basis of fundamentally dishonest benefit-cost analysis,” he said.

“Such regulatory efforts continue to engender vast costs and no benefits.”