The Bottom Line: If enacted, the Investor Democracy is Expected (INDEX) Act will potentially give sustainable investors an influential voice by shifting proxy voting power.
Summary/Conclusion
The concentration of corporate voting power in the hands of a small number of investment advisers who are perceived to be aligned with an ESG agenda is engendering pushback. State and local governments are being advised to assign investment mandates to pension fund managers that “don’t work against their residents’ best interests.” States are also being encouraged to pass model legislation developed by the American Legislative Exchange Council that requires government pension-fund managers to vote the state’s shares rather than delegating that authority to external managers. Most recently, the same agenda is being advanced with the introduction in Congress of the Investor Democracy is Expected (INDEX) Act that aims to deconsolidate the voting power amassed within a small number of the largest advisers of passively managed funds to neutralize their dominance by turning voting power in corporate governance to individual investors. Regardless of the motivation, the INDEX Act, if it should be enacted into law, would be positive for sustainability-oriented individual investors as well as institutional investors. The delegation of voting power will allow investors to express their sustainability preferences directly and, in the process, attempt to influence corporate behavior when deciding on proxy voting in their individual investments in funds, including 401(k) investments, assuming they take advantage of the option should it become available.
The INDEX Act is intended to shift proxy voting power to individual investors
Under the Investment Advisers Act of 1940, investment advisers rather than the underlying investors retain responsibility to vote proxies linked to stockholdings in mutual funds and ETFs held within or outside retirement plans. The INDEX Act, introduced on May 18, 2022 by Alaska Senator Dan Sullivan along with a dozen Republican cosponsors, proposes to change that by amending the Investment Advisors Act of 1940 to require investment advisers of passively managed funds to vote proxies in accordance with fund investors, not at the discretion of the adviser. Covered funds include passively managed funds that are private funds, employer-sponsored retirement funds, defined benefit and defined contribution pension plans and The Thrift Savings Plan (TSP) offered to all U.S. government employees. Refer to the INDEX Act below.
Top three investment advisers dominate index fund assets under management
In November 2018 John Bogle, the founder of The Vanguard Group, said that if historical trends continue, a handful of giant institutional investors will one day hold voting control of virtually every large U.S. corporation…Three index fund managers dominate the field with a collective 81% share of index fund assets… Such domination exists primarily because the indexing field attracts few new major entrants.¹” Fast forward to 2022 when, due to the run-up in assets under management since the 2007-2009 financial crisis, the top three investment advisers, consisting of BlackRock, Vanguard and State Street, now manage a combined total of about $20 trillion in assets and vote around 25% of all votes cast in annual meetings. These firms reportedly own an average of over 20% of any given S&P500 company, including firms like Apple, Microsoft, Google Amazon and Tesla, that together account for about 23% of the S&P 500 Index as of March 31, 2022². Concentrated voting power, due to the consolidation of voting power in the hands of investment advisers rather than individual shareholders, has raised concerns among corporate governance experts but also increasingly by Republicans, in particular, who maintain that the interests of businesses and their employees are being taken hostage by left wing interests who are promoting environmental, social and governance (ESG) goals. This year’s Exxon Mobil’s annual shareholder meeting results likely elevated their concerns. In late May a number of the world’s largest investment management firms and asset owners sided with an environmental activist hedge fund and the leading proxy voting firms to elect three dissident climate competent directors to Exxon Mobil Corp.’s Board of Directors. In particular, firms like BlackRock, Vanguard and State Street, which together reportedly held nearly 20% of the voting shares, along with the California Public Employees’ Retirement System (CalPERS) and the New York State Common Retirement Fund, to mention just a few, voted in favor of some of the directors put forward by Engine No. 1—a small hedge fund with about a 0.02% share ownership in Exxon Mobil Corp. The hedge fund ran a campaign over six months aimed at electing its proposed independent director candidates to the Exxon Mobil Board of Directors so that they might help the firm navigate the risks and opportunities facing the oil company in a rapidly changing industry. The outcome illustrated that institutional firms, when acting in unison, have the power to influence proxy contests that are not supported by the company. Individual investors in the form of US households, while they own 37.6% of total U.S. equities either directly or indirectly, in many instances can’t exercise voting control over public companies because theirs is an indirect ownership of shares via mutual funds and ETFs. This also extends to fund ownership interests in defined contribution 401(k) plans and other similar retirement plans. For further details, refer to article entitled OneFund allows investors to express views on proxy voting.
¹Wall Street Journal, November 29, 2018.
²The INDEX Act focuses on index funds only even as concentration of voting power extends to active fund managers with the top four, including Fidelity, accounting for an estimated one-fifth of global funds industry assets under management.
Attempts to disrupt ESG investing strategies are not new, but adversaries have become more active
Attempts to disrupt ESG investment strategies are not new, but adversaries, even as their understanding of sustainable investing strategies seems uninformed, have become more active. There were several attempts by the Trump administration to blunt the advance of ESG investing strategies. One was the 2020 effort by the Department of Labor to raise the bar for the inclusion of ESG factors in the selection of ESG funds in plans subject to the fiduciary duties defined under the Employee Retirement Security Act of 1974, as amended (ERISA). This initiative was turned back by the Biden administration. Another effort involved the Office of the Comptroller of the Currency (COC) that, in the final days of the Trump administration, proposed the Fair Access to Financial Services rule. The rule was intended to subject the largest banks to scrutiny when they deny services to any customer based on risk factors that cannot be quantified, such as with some environmental, social and governance risks, as well as reputational risks. The rule was put on pause, pending a review by the incoming COC. There have also been concurrent efforts at the state government level. For example, Texas passed a bill that prohibits Texas state agencies or entities from contracting with companies, including banks, who refuse to do business with firearm companies or firearm trade associations. S.B. No. 19 was signed into law by Texas Governor Greg Abbott on Jun 14, 2021. Several other states have also passed similar laws or are considering doing so.
The Investor Democracy is Expected (INDEX) Act
Source: The Investor Democracy is Expected (INDEX) Act.
