Keynote Remarks By ICI Mutual Funds And Investment Management Conference, US. SEC Commissioner Elad L. Roisman, San Diego, CA, March 18, 2019
Thank you, Susan [Olson], for the kind introduction. I am excited to join you here and deliver my first formal speech as a Commissioner. It has been a little over six months since I started in my new role at the Securities and Exchange Commission (“SEC”), and I can still say that it’s a very surreal feeling. Not a day goes by when I do not think about how incredible an honor it is to serve the investing public. My path to this job has not been linear. But my experiences along the way—working in private practice as an attorney, at the parent public company of a large stock exchange, in the role of counsel to an SEC Commissioner, and on the staff of the Banking Committee in the U.S. Senate—have given me a broad view of the markets that the SEC regulates and a deep commitment to the agency’s mission. I mean this, truly: it is a privilege to be serving in my role.
Today, I will talk about the proxy process. But, before I segue into any substance, this is a good time for me to provide my first standard disclaimer: My views and remarks are my own, and do not necessarily represent those of the SEC or other Commissioners.
Last year, Chairman Jay Clayton announced that the Commission would review the existing SEC rules that govern the proxy system. The staff held a roundtable that raised many issues in this area and invited public comment prior to and following the event.
Recently, the Chairman asked me to take the lead on the Commission’s efforts to consider improvements to the proxy process. I gladly accepted and feel honored to have this opportunity.
During my time at a law firm and as an in-house counsel at an exchange, as well as at the SEC and in Congress, I was able to interact with managers, directors, and shareholders of U.S. public companies. One of my most interesting professional experiences was working with the Corporate Secretary of my former employer, a job that involved preparing materials for board meetings and taking minutes. In these meetings, I saw, first-hand, how seriously directors took their jobs: challenging management, scrutinizing the business’s trajectory, and striving to act in ways that serve the interests of the company’s shareholders. I also worked on drafting the company’s proxy statement and annual report, as well as organizing and running the annual shareholder meeting. My interactions with management, directors, law firms, printers, proxy solicitors, proxy advisory firms, transfer agents, shareholders (including funds), and shareholder proponents still are fresh in my mind.
These experiences led me to take great interest in the proxy process and recognize its fundamental importance to our capital markets. They are premised on the notion that shareholders demand economic value from the companies they own and vote in ways that can influence their corporate management to deliver that value. This shareholder-company dynamic drives productivity in our economy and helps investors grow their wealth.
I remember thinking every April, as the annual meeting approached: is this the best system we have for the world’s best capital markets? (I also remember thinking “Who is Evelyn Y. Davis?” “Why am I responsible for escorting her to the meeting?” and “What does it mean to be ‘the Queen of the Corporate Jungle?’”) I thought some aspects of proxy season worked well and noticed others that did not. But after each meeting, I breathed a sigh of relief that nine or ten months stood between me and the next proxy season, and I’d start working on other matters.
Today, I am happy to bring all my experiences to my current role, where I am fortunate to engage with others who have equally passionate views on the proxy voting ecosystem.
This brings me to the here and now: I am excited to talk to this group, in particular, about proxy voting because you, in this room, represent some of the most influential shareholders in our economy today: the funds you manage. Long gone are the days when retail shareholders directly held the majority of shares in U.S. public companies. Today, over 100 million individuals, representing nearly 45% of U.S. households, own open-end funds. And, in today’s market, funds own 1/3 of the shares of U.S.-issued equities outstanding. Of course, that makes the task of voting proxies—as ICI put it in its comment letter last year—“no small job.” In the 2017 proxy season, the average mutual fund voted on 1,504 separate proxy proposals. It is an understatement to say that your voting has a direct impact on the economic returns of countless investors.
Today, I hope to follow up on a number of questions I posed at the November roundtable:
Since the roundtable, my staff and I have spent countless hours reviewing the roundtable transcript and comment letters submitted to the file, reading additional literature on the topic, and combing through a broad sampling of relevant disclosures (on Forms N-1A, N-PX, and ADV) and fund stewardship documents. We have also met with many participants from across the capital markets to discuss their views in greater detail.
As with many things in life, the more I learn, the more knowledge I wish I had. So, I would like to take this opportunity to share my current thoughts and pose some questions on which I hope you will engage with me further.
To give you a preview, I have noticed certain asset management practices with respect to proxy voting that have raised questions. In particular, why some advisers 1) aim to vote every proxy for every company in every fund’s portfolio; 2) centralize proxy voting functions within a complex and vote uniformly across funds in the complex; and 3) rely on third-party proxy advisory firms to assist with devising and implementing voting policies. These are not necessarily inherently problematic practices, but without further insight into the thinking behind them, I can see ways in which they might not align with the best interests of individual funds.
I recognize that there is great variety in the asset management industry; there are large fund complexes, as well as smaller and medium-sized fund groups that each have differing objectives and investments. I hope my remarks today will inspire further comments and engagement on these practices from many different types of advisers, but particularly the smaller managers to understand where they face greater obstacles for compliance. I would also be interested in feedback on how Commission action could provide clarity on or recalibrate how our current proxy voting system can best (or better) serve investors.
The SEC’s current rules governing fund advisers’ roles in voting proxies focus on principles and disclosure. Most relevant here, in 2003, the Commission adopted the explicit requirement that each investment adviser adopt and implement policies and procedures that are reasonably designed to ensure that advisers vote clients’ proxies in the clients’ best interests. Over a decade later, the Commission’s staff in the Divisions of Investment Management and Corporation Finance published additional guidance in a Staff Legal Bulletin. This Q&A stated that advisory clients (such as fund boards) could limit how often advisers vote proxies if the costs of voting on certain types of proposals or issuers do not serve a client’s best interest.
The Commission’s principles-based and disclosure-based approach to regulating in this area has left a lot of flexibility for fund advisers, relying on their fiduciary duty to fill in the gaps. We all know that funds invest other people’s money. While a large asset manager might exercise a high level of influence in our capital markets, its power emanates from this agency role. More than merely an agent, a fund adviser is a fiduciary, having the obligation not to place its own interests ahead of its clients’ interests. This applies in the proxy voting context: when advisers vote proxies for the funds they manage, they must do so in a way that serves the best interests of each fund.
This leads me to the critical question: What is in the best interest of a fund in the context of proxy voting?  I have thought about this a lot and continue to seek further insight on the question, as I believe its answer should form the basis of any Commission action in this area. As I have studied this issue, I have observed certain practices that I would like to understand better, in terms of how advisers believe they serve each fund under their purview.
For example, it appears to be the default position of many advisers that they vote every proxy, for every company, in every fund’s portfolio. This is interesting since, in any given proxy season, a fund’s shares could be voted on issues as far-ranging as independent auditor ratification to corporate political spending, for the largest and smallest of the fund’s holdings. Since a fund adviser derives its authority to vote from its position as the fund’s agent, I would think that the nature and scope of the fund’s investment objective would logically influence whether, when, and how the adviser votes the fund’s shares. Do advisers believe that voting on all of these issues is material to a fund’s investment objective and benefits the fund?
There is also the consideration of cost. The Commission acknowledged in the Proxy Voting Rule Release (and so did the SEC staff in SLB 20) that voting proxies has associated costs. Obviously, these include the adviser’s time and cost of performing research. Opportunity cost may also be significant, such as foregone income from shares on loan that have to be recalled to be voted or shares that are restricted from being lent out for this same reason. I imagine these costs could add up quickly, considering the differing matters of the many companies whose proxies fund advisers are often asked to vote.
I would like to hear input on whether it would be helpful for the Commission to provide further guidance in this area. There appears to be some understandable confusion about what our rules require with respect to whether an adviser must vote. SLB 20 included Question 2, which asks “Is an investment adviser required to vote every proxy?” I can’t help but notice that the 342-word answer did not contain either the word “yes” or “no.” I believe the answer should be, in some cases, NO. I would be interested in perspectives on what considerations could factor into an adviser’s analysis. Some that spring to my mind are: 1) Is a company a material part of the fund’s portfolio?; 2) Is the outcome of the vote material to the fund’s investment objective?;3) What is the opportunity cost to the fund of voting proxies for this company?; and 4) Would the potential benefits of voting justify the costs?
Next, it seems that some asset managers have moved toward centralizing proxy voting (and “stewardship”) functions within the fund complex, moving these roles farther away from portfolio management. Additionally, it appears that some asset managers aim to vote uniformly across funds. I would like to better understand how such practices account for differences between funds.
Funds themselves are distinct entities. They may be part of the same complex and managed by the same adviser, and even have some common investment objectives, time horizons, and portfolio holdings. But it seems to me that distinct funds could have different interests in proxy voting that could lead them rationally to desire different outcomes from the same company’s proxy contest, transformative transaction, or contested shareholder proposal.
One example is a merger, where the deal appears better for one company (say, the target) than the other (here, the acquirer, who may be taking on a struggling business and large debt obligations). Let’s say an adviser manages two funds, one with a long position in the target that would benefit from the merger, and another, heavily invested in the acquirer, that could lose value. Shouldn’t the adviser vote both funds’ shares differently, one in favor of the transaction, and the other against? More broadly, it seems that conflicts could exist between funds with different investment objectives. Consider the preferences of a portfolio manager at a growth fund, which targets companies with high growth prospects, and an income/dividend fund, which seeks to generate an income stream for shareholders in the form of dividends or interest payments. If there is a proxy contest led by an investor to increase dividend payments, shouldn’t these funds vote differently? It would seem to me that voting these funds’ shares the same way could risk subsidizing one fund’s votes with votes of another.
I am interested in exploring how advisers handle these types of conflicting interests. How have advisers remained cognizant of distinctions between funds when designing processes for centralizing voting and stewardship roles? Have advisers found voting policies that are flexible enough to apply to all funds, yet account for differences between them—in other words, can one size fit all?
Next, it has been widely recognized that many asset managers have come to rely on third party proxy advisory firms in several aspects of the proxy voting process. Let me say up front: I recognize that proxy advisory firms provide services that their clients greatly value. For that reason, I do not believe we should impose additional regulations upon them without thorough consideration. But, I believe it is incumbent upon their clients (i.e. asset managers) to use their services responsibly. And, I am interested to hear how asset managers have gotten comfortable that they are doing that.
For example, I have seen many Forms ADV, in which asset managers disclose that they have adopted the proxy voting policies developed by proxy advisory firms. Yet, after reading through some proxy advisory firms’ voting guidelines myself, I noticed several things that would give me pause before adopting them wholesale. These include instances in which various guidelines appear either to undermine existing legal rights or to set benchmarks unrelated to legal requirements and company-specific attributes.
How do asset managers come to understand what they are signing on to when adopting these guidelines or become comfortable that such guidelines best serve their clients? Also, to what extent are advisers customizing the guidelines before adopting them for their clients?
Regardless of which voting policies and procedures an asset manager decides to adopt, there is the matter of implementing them when voting. I have seen some evidence indicating that asset managers may be relying heavily on proxy advisory firms in this area. Some have characterized this as “robo-voting,” suggesting that proxy advisory firms are going too far in acting on behalf of their clients. Others argue that proxy advisory firms merely pre-populate votes in electronic proxy cards to make the process less burdensome. I would be interested to hear directly from asset managers about how they are utilizing proxy advisory firms to cast votes. For example, how much upfront instruction does an asset manager provide to a proxy advisory firm about how to pre-populate an electronic proxy card? How much discretion does this leave to a proxy advisor? To what extent do advisers review and sometimes override the pre-populated suggestions of the proxy advisory firms before submitting their votes to be counted?
As I consider how asset managers may be relying on proxy advisors, I remain cognizant of recurring concerns with aspects of how these firms operate. Many have criticized proxy advisors’ processes for developing recommendations as being prone to errors and suppressing viewpoints from the companies they research. I am primarily concerned about factual errors, rather than disagreements about the interpretation of those facts or unpopular recommendations resulting from accurate factual inputs. It is commonly known that proxy advisory firms do not allow most issuers an opportunity to review or correct errors in their reports in advance of sending the reports to clients, something that companies understandably find frustrating. When an asset manager discovers that a proxy advisory firm has made some material error in its recommendation or underlying research, how do asset managers reassess how they are using the proxy advisory firm? I am also interested in hearing how advisers receive or account for input from issuers before voting proxies (including issuers’ reactions to what they might characterize as proxy advisory firms’ analytical errors). Should the Commission explore ways of making it easier for advisers to get this information in a timely manner?
Another important concern with proxy advisory firms relates to their potential conflicts of interest, an issue that goes to the efficacy of the information and services they provide. These conflicts may emanate from proxy advisory firms’ organizational and ownership structure, affiliates, lines of business, clientele (including preferential treatment or disproportionate influence of certain clients), and other business relationships. For example, it is well-known that certain proxy advisory firms consult for public issuers on corporate governance matters. When corporate governance matters of the proxy advisory firms’ corporate customers are put forward for a vote, is it likely that the proxy advisors would recommend against their own consulting services?
It appears that proxy advisory firms have varying approaches to disclosing and otherwise mitigating these conflicts. I would be interested to hear how asset managers are diligencing proxy advisory firms’ conflicts and becoming comfortable with their methodologies before utilizing their proxy recommendations and products. Additionally, since these conflicts affect company-specific recommendations, it would be important to know—at the time an asset manager reviews the proxy advisory firm’s recommendations on each company’s proxy—whether the proxy advisory firm has a conflict with respect to that company or a shareholder proponent. I understand that some proxy advisory firms offer a way for their clients to have this information presented, along with their recommendations for each meeting, in the clients’ electronic portals. Do asset managers find that useful? Are there better ways to have this information presented or otherwise made more transparent? What ongoing monitoring or conflict review are asset managers conducting?
As the primary consumers of proxy advisory services, asset managers are in a unique position to provide input on these types of questions. From this input, I hope to understand whether industry demand could produce better results from proxy advisory firms or whether the Commission should consider other ways.
The Commission, undeniably, played a role in the evolution of proxy voting today, including the growth of proxy advisory firms. In 2004, the SEC staff gave investment advisers a green light to rely almost wholesale on proxy advisory firms, when it advised one firm that “the recommendations of a third party who is in fact independent of an investment adviser may cleanse the vote of the adviser’s conflict [of interest].” That same year, the staff also blessed a key conflict of interest endemic to many proxy advisory firms’ business models when it affirmed that selling corporate governance consulting services to companies “generally would not affect the [proxy advisory firm’s] independence.” 
I commend [the Division of Investment Management’s] Director Dalia Blass for withdrawing these staff letters. I do not believe that the SEC staff should unilaterally alter the intent of Commission rules by approving, across-the-board, practices that could be construed as outsourcing fiduciary duty or ignoring major conflicts of interest.
In light of this history and the questions I posed earlier, I believe it is a good time for the Commission to consider whether guidance would be helpful to asset managers as they consider how to utilize the services of proxy advisory firms. Relatedly, since proxy advisory firms rely on the proxy solicitation exemptions available under certain Exchange Act rules, it may be appropriate for the Commission to reassess whether their current practices fit within the intended scope and purpose of these exemptions.
I am also interested in other areas of the proxy process that are less directly related to asset managers, but which are worth noting here.
I have been focusing extensively on what the Commission can do to improve the “plumbing” that underlies our proxy voting system. The November roundtable shed light on how complex, inefficient, and, at times, unreliable this infrastructure is. I believe the Commission needs to consider not only “quick-fixes” that could marginally improve some aspects of how the system works, but also comprehensive solutions based on modern technology. For example, I think it is incumbent on all of us to find a way to achieve end-to-end voting confirmation. I am interested in hearing, from all those involved, about short-term and long-term ways to accomplish this and other improvements. For all of these suggestions, I particularly hope to hear feedback about what private ordering could accomplish versus what Commission action might be needed (either to remove barriers to private action or solve collective action issues among private actors).
Another aspect of proxy voting that I am interested in is thresholds for submission and resubmission of shareholder proposals. It is important to achieve a balance here so that we allow for robust shareholder engagement without providing a mechanism for certain shareholders with idiosyncratic views to use the shareholder proposal system in a way that does not benefit the interests of the majority of long-term shareholders. In that spirit, reviewing whether the current monetary threshold and holding period for submissions strikes this balance, or whether other alternatives could better do so, may be appropriate. Relatedly, I am interested in perspectives on whether raising or modifying resubmission thresholds would preserve management’s time, and shareholders’ money, from being spent considering the same proposals repeatedly, after they have been rejected by the majority of shareholders.
Another area where more discussion would be helpful is “proposal by proxy.” I am aware that the Division of Corporation Finance stated in 2017 that it is of the view that a shareholder’s submission by proxy is consistent with Rule 14a-8. But, I would like to further understand how it is in the long-term interest of shareholders to allow this practice, when the proponent either is not a shareholder or cannot qualify to bring the proposal on his or her own.
Let me conclude this round of 20+ questions with a sincere word of thanks to all of you who have already taken the time to meet with me or submit letters to the comment file. This includes, of course, ICI who thoughtfully and extensively provided comments to the Commission on many of these issues. I view it as a positive sign that proxy issues are receiving so much attention inside and outside the Commission—this is a testament to their fundamental importance to our capital markets. I look forward to engaging further with all interested stakeholders who would like to share their points of view. My door is open, and I hope you come and visit.