ATR MEMORANDUM: ESG Landscape 

BOTTOM LINE: Although “environmental factors” are usually mentioned in the news when talking about environmental, social, and governance (ESG) initiatives, activism in the boardroom could force companies to take tough stances when it comes to social or labor issues. During proxy voting, activist shareholders put up shareholder resolutions to require companies to issue reports on how guns contribute to human rights abuses, or require companies, such as Lowe’s, Walmart, and TJ Maxx to develop reports evaluating the risks and costs of restricted reproductive rights, including on employee hiring and retention. In these cases, the activist shareholder are groups like Trillium Asset Management, Clean Yield Asset Management, and Educational Foundation of America. 

Last year, Exxon Mobil lost a proxy battle with activist investor, Engine No. 1 because BlackRock and proxy advisory firms backed a proposal to substitute Exxon’s board with new members supportive of reducing Exxon’s carbon footprint. This ESG activism exemplifies the immense power that BlackRock, Vanguard, and State Street (the Big Three) and proxy advisory firms have in forcing public companies to implement policies and pursue initiatives that are based on woke left-wing policy priorities.   

Collectively, the Big Three manage more than $20 trillion in assets, and vote “about one quarter of all votes cast at annual meetings.” The significant consolidation of assets with a few asset management and proxy advisory firms could force these public companies to pursue policies that have no direct effect on financial performance or shareholder value. 

Shareholder activism also has the potential to be detrimental to technology companies– together, the Big Three own more than 15% of Alphabet, Google’s parent company; Meta; and Apple.

The extreme consolidation of assets under management (AUM) and the drastic increase in shareholder proposals that include political agendas has raised alarm bells with conservatives.

Lee Reiners, executive director of the global financial markets center at Duke University School of Law said it best:

Republicans have grown concerned and frustrated that the big three, primarily BlackRock, Vanguard, and State Street, are requiring publicly traded companies to take stances and do things that have nothing to do with shareholder value.

Institutional investors, such as asset management firms or pension funds, vote far more on the shares they hold than retail (individual) investors. According to one media report:

Individual investors as a group owned 29% of shares in 2020, compared to 71% with institutional investors, according to ProxyPulse, which tracks shareholder engagement. Interestingly, institutional investors’ voting increased to 92% of the shares they held (vs. 90% for the 2019 proxy season), while retail investor voting held steady at 28% of the shares they own.

Last month, Vivek Ramaswamy, the author of Woke, Inc.: Inside Corporate America’s Social Justice Scam, announced the launch of Strive Asset Management—a new asset management firm dedicated to depoliticizing public companies. The firm is backed by Bill Ackman, Joe Lonsdale, and Peter Thiel. Strive is meant to be an alternative to the Big Three. 

Proxy Advisory Firms

Proxy advisory firms advise investors on how to vote their shares. Institutional Shareholder Services Inc. (ISS) and Glass, Lewis & Co. (Glass Lewis) are the dominant players in the market, accounting for over 90% of the proxy advisory market. The market dominance of ISS and Glass Lewis has enabled them to control extensive amounts of influence over the proxy voting process for public companies in the U.S. Some studies have shown that the advisory firms tend to “slant their advice toward the preferences of investors with intense preferences.” In other words, much of the shareholder activism that takes place is induced by ISS and Glass Lewis.

Institutional investors largely defer to the proxy advisory firms on how they will vote on corporate matters. The investors participate in “robovoting” by voting their shares exactly in alignment with the recommendations of the proxy advisory firms. According to Paul Rose, a law professor at The Ohio State University:

      Overall, 114 institutional investors voted in lockstep alignment with either ISS or Glass Lewis in 2020: 86% of robovoting investors used ISS and 14% used Glass Lewis, reflecting the dominant market position of ISS.

      Robovoting institutional investors managed collectively more than $5 trillion in assets.

Sen. Bill Hagerty (R-Tenn.) has introduced the Restoring Shareholder Transparency Act of 2022 (S. 3945) to protect public companies from proxy voting advice that provides no benefit to the financial performance of a company. The goal of the bill is to limit ISS and Glass Lewis from advising investors to vote on “frivolous shareholder proposals.” This bill was included as a provision in The JOBS Act 4.0 bill that was introduced by Republicans on the Senate Banking Committee earlier this year. Cosponsors include: Sens. Steve Daines (R-Mont.), Thom Tillis (R-N.C.), and Cynthia Lummis (R-Wyo.).

ESG Legislation 

In addition to the Sen. Hagerty bill mentioned above, there are three bills in Congress that take different approaches to fighting ESG:

1.     Rep. Andy Barr (R-Ky.) has introduced the Ensuring Sound Guidance Act(H.R. 7151), which would require the Securities and Exchange Commission (SEC) and the Department of Labor (DOL) to ensure that fiduciaries only consider “pecuniary factors” when making investment decisions for Americans’ 401(k) retirement plans. Cosponsors include Reps. Rick Allen (R-Ga.), Elise Stefanik (R-N.Y.), Mariannette Miller-Meeks (R-Iowa), Mark Green (R-Tenn.), and Garrett Graves (R-La.).

2.     Rep. Chip Roy (R-Texas) has introduced the No ESG at TSP Act(H.R. 7896), which would prohibit investments under the Thrift Savings Plan (TSP) from investing in ESG funds. The TSP is the defined contribution plan for U.S. federal government employees, and the largest in the world. Cosponsors include Reps. Bob Good (R-Va.), Bill Johnson (R-Ohio), Michael Cloud (R-Texas), Louie Gohmert (R-Texas), Ted Budd (R-N.C.), Mary Miller (R-Ill.), Bill Posey (R-Fla.), Dan Bishop (R-N.C.), Buddy Carter (R-Ga.), Byron Donalds (R-Fla.), Debbie Lesko (R-Ariz.), Dan Crenshaw (R-Texas), and Scott Perry (R-Pa).

3.     Sen. Dan Sullivan (R-Alaska) has introduced the Investor Democracy is Expected (INDEX) Act (S. 4241), which would require advisers of passively managed index funds to solicit the voting preferences of the investors in the funds. Cosponsors include: Sens. Pat Toomey (R-Pa.), Mike Crapo (R-Idaho), Chuck Grassley (R-Iowa), John Cornyn (R-Texas), Thom Tillis (R-N.C.), Bill Hagerty (R-Tenn.), Cynthia Lummis (R-Wyo.), Steve Daines (R-Mont.), Kevin Cramer (R-N.D.), Marco Rubio (R-Fla.), John Kennedy (R-La.), and Rick Scott (R-Fla.).

SEC Rules on Proxy Voting 

The SEC’s Rule 14a-8, originally finalized in 1942, governs proxy solicitations. There are limits to what kind of proposals shareholders can put forward. 

According to a statement from the SEC’s director for the Division of Corporation Finance:

Rule 14a-8(i)(1) expressly provides that a company may exclude a shareholder proposal “[i]f the proposal is not a proper subject for action by shareholders under the laws of the jurisdiction of the company’s organization.” Further, Rule 14a-8(i)(7), the ordinary business exception, seeks to avoid undue interference by shareholders in matters that, according to corporate governance principles, lie within the purview of the directors and management. Recognizing that directors are charged with overseeing the “business and affairs” of the corporation, the Commission permits a company to exclude a proposal that “deals with a matter relating to the company’s ordinary business operations.” The purpose of the exception is to “confine the resolution of ordinary business problems to management and the board of directors, since it is impracticable for shareholders to decide how to solve such problems at an annual shareholders meeting.”

A PDF version of this memo can be read here.