Will the “pass-through” voting recently implemented at some index funds promote shareholder democracy? Skadden partner Ann Beth Stebbins leads a discussion with Dalia Blass of BlackRock, Gabrielle Wolf of Innisfree M&A and Skadden partner Marc Gerber. They explain how the process works and describe voting trends among retail and institutional investors. They also discuss the possibility the process could have the unintended consequence of increasing the influence of proxy advisory firms and activists.
In a move intended to “democratize” shareholder voting, several large index funds are giving their investors a say in how shares are voted, instead of leaving those choices to fund managers’ stewardship teams. In the pilot projects, aimed primarily at institutional investors, fund investors are given several options: to vote as the fund manager’s stewardship team recommends; to vote with management; to vote according to an advisor; or possibly some other formula to be administered by the fund manager.
The uptake of this new voting discretion is likely to be better with institutional shareholders than with retail investors, who are much less likely to vote, BlackRock’s Dalia Blass said.
Giving fund investors a say in voting underlying shares complicates shareholder communication for issuers, said Skadden partner Marc Gerber. Delegating the control of voting to fund investors makes it more difficult for companies to get their messages across to decision-makers and to receive feedback from investors. And, with pass-through voting, issuers do not know who will be making voting decisions.
Also, some investors — particularly retail investors — may ask for the right to vote their underlying shares, but not to follow through and actually vote. This can reduce the number of shares ultimately voted, shifting voting influence from mutual fund stewardship teams to active fund managers, activist shareholders and proxy advisory firms such as Institutional Shareholder Services and Glass Lewis, Gerber said.
Technically, “pass-through” is not correct, because the fund retains ownership of the shares, and its investors do not receive proxy cards; they are simply given an opportunity to direct the fund manager’s voting, Blass explained. “Directed voting” would be a more accurate term.
The potential problem of retail voters not voting is very real and significant, Blass said, because historically they have not voted in large numbers. You have to ask whose vote will be amplified by the new process – activists, for example? If retail investors claim their right to direct a vote and do not exercise it, it could make it difficult for companies to obtain the quorums they need to carry out essential corporate functions, Blass said.
Retail investors generally do not have the ability to conduct detailed analysis of complex measures, Wolf said. By contrast, fund managers have large stewardship staffs who have analytic skills and approach votes from a fiduciary’s perspective, Blass said. In addition, those teams are spread around the world and are thus capable of researching and evaluating complex corporate issues in a way that would be much more difficult for retail and smaller institutional investors, Blass said.
Index fund managers cannot vote with their feet, selling off shares when they are unhappy with a company or its management, Innisfree M&A’s Gabrielle said. Because they have to hold stocks in the index, they have to take a long-term view of value creation. Active fund managers and activists are more likely to focus on short-term value, she said. So, to the extent the pass through voting increases their voting influence, it could lead to more emphasis on the short-term.
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Ann Beth Stebbins (00:34):
Welcome to The Informed Board, Skadden’s podcast for directors. I’m your host, Ann Beth Stebbins, a partner in Skadden’s M&A practice. On today’s episode, I am delighted to be joined by our experts who will provide their insights on trends in stockholder voting, including the introduction of pass-through voting and the focus on shareholder democratization, including its potential unintended consequences.
I’m joined today by Gabrielle Wolf, a director at Innisfree M&A. Innisfree is a leader in shareholder intelligence. Dalia Blass, the head of external affairs at BlackRock, and prior to BlackRock, Dalia was the Director of the Division of Investment Management at the SEC. And finally, my Skadden partner, Mark Gerber, who focuses on corporate governance issues.
Several large asset managers have recently introduced pass-through voting. Gabby, what is pass-through voting and what’s the objective?
Gabrielle Wolf (01:34):
Some of the large index funds are conducting pilot programs or trials — some of them have been doing this already for a couple years — where they give individual retail investors or institutional clients in a number of equity index funds more discretion about how their shares are voted. And generally, the funds investors will have multiple voting options, including to have the index funds’ stewardship team continue to vote their shares, or voting in line with management’s recommendations, abstaining from voting, or relying on a third-party recommendation like ISS or Glass Lewis.
To the extent that pass-through voting is used by retail holders or institutions, it actually might mean that ISS and Glass Lewis have more influence. That said, I suspect that pass-through voting for institutional clients is a lot more prevalent and it‘s actually used versus pass-through voting for retail investors, which I think is …
Ann Beth Stebbins (02:43):
Who don’t vote.
Gabrielle Wolf (02:43):
Exactly. Retail investors generally are apathetic. The rule of thumb is that, without a steady cadence of solicitation, that 20% of them vote and, even with heavy solicitation, only about 40 to 45% of retail investors vote.
Ann Beth Stebbins (03:00):
And how does that compare to voting percentages for institutions?
Gabrielle Wolf (03:06):
Most institutions see it as their fiduciary duty to vote all the shares that they own, and they do. Now, there is some friction in the system, right, some foreign holders don’t necessarily vote in the U.S. Some holders might have held on the record date but no longer hold after the record date for the meeting so they don’t bother to actually vote the shares that they already sold. But, generally, institutions try to vote 100% of the shares that they own.
Ann Beth Stebbins (03:33):
And so, pass-through voting for institutions, they will express a point of view on the social, environmental, governance issues that are in these proposals and they will analyze those issues individually and vote.
Gabrielle Wolf (03:47):
I think the pass-through voting for institutional clients should be a lot more successful and I think has been a lot more successful than pass-through voting for retail clients.
Ann Beth Stebbins (04:00):
And Mark, has this given ESG proposals a higher rate of success when institutions have that individual voice?
Marc Gerber (04:10):
I don’t know that anyone has gone through and necessarily tracked and connected the dots. A lot of these programs are still relatively new, just in the last year or so. The issue or the concern from a company perspective is, you want to be able to communicate with your shareholders. You want to be able to get feedback from your shareholders, and you don’t know who these institutions are that hold through a large asset manager, so you can’t communicate with them directly to be able to make your point or hear from them and incorporate that feedback. And, certainly the risk is some of these institutional investors or retail holders may go through an analysis that is just as robust as the asset manager with whom they hold but, in many cases, it may not be, so they may default to an ISS policy or a Glass Lewis policy.
You may then see ISS and Glass Lewis actually increase in their influence. The risk would seem to be you have shareholders who say, “Yeah, I should vote. I’m going to vote. I’m going to go ahead and take my vote back from the asset manager,” but then when it actually comes to voting, they don’t vote. And so, now you actually, by virtue of not voting, by taking that vote off the table, you’ve given more influence to those who do vote, whether they follow ISS or whether it’s an activist or whether it’s an anti-ESG voter.
Ann Beth Stebbins (05:36):
So. Dalia, this is the unintended consequence of a policy that has democratization as its objective but may very well result in greater influence by ISS and Glass Lewis and not give retail the voice that pass-through policies are designed to give retail because retail’s not taking advantage of these policies and voting. And stewardship teams, including BlackRock’s stewardship team, are well-informed and well-versed on these issues and shareholders aren’t benefiting from the expertise of those stewardship teams.
Dalia Blass (06:17):
I think as an initial matter, starting with the concept of bringing more voices to the table, that’s a good concept, I think we can all line up behind that piece. It gets a little bit complicated once you go outside the institutional investor. At BlackRock, we pioneered voting choice. We started that in January of last year and that was essentially half our index equity assets, which is institutional clients, were able to participate in our voting choice. That ranged from you take back your vote completely, you do it on your own infrastructure, we have nothing to do with it, to you choose a guideline and we will execute it on our infrastructure.
You can also retain us, continue with the BlackRock stewardship team to a little bit more, some nuance pieces and we’ve actually had a really good uptake on that piece. The retail side, when you’re talking about mutual funds and ETFs, is where you get a little bit complicated because the owner, the actual beneficial owner is the fund, and the fund is a body and it has a board of directors that has a fiduciary obligation so it’s more complex. So actually, we’re not really talking about pass-through voting when we’re talking about funds. The programs that Gabby was talking about, that’s more of investors giving a flavor. It’s not passed through because they’re not getting the actual proxy in the same way an institutional investor does.
So there are complexities and different flavors when we’re talking about different types of investors here and how they’re voting but, ultimately, when you’re looking at fund guidelines that ISS or Glass Lewis would put together, you have to make sure before you give those flavors down to the retail investor that they’re appropriate for the fund. So that’s an important piece because this is a collective fiduciary obligation.
But then, you do have to be mindful of a few things. One is what Gabby pointed out, that shareholders tend not to vote. This is documented because funds have to go and get fund shareholders to vote. There is a very high quorum in the Investment Company Act for certain things that have to be put to fund shareholders and funds, they go time after time, go in for the proxy solicitation, trying to get to the quorum. It’s very high six figures to try to get that number so you can get the vote, so this is not theoretical.
We know that fund shareholders do not vote on fund shares and so you’re asking them to go a layer underneath, which is why the full pass-through, as nice as that sounds, is probably not a realistic option.
Then if they don’t participate, if they don’t vote, then you have to ask yourself who’s left? Who is actually going to be voting, and which voice is going to get amplified? You noted ISS, Glass Lewis maybe, but you also have potentially activist shareholders, others in the ecosystem so there is the question of whose voice will be amplified that we do have to think about because this is ultimately going to be about good corporate governance.
And speaking of good corporate governance, are you going to get quorum if you do any form of real pass-through? As I said, funds have a hard time getting to the’40 Act quorum. Are you now going to create the same issue in corporate America where you are not going to get quorum for management to get its business across the finish line? And then the final point, some of these votes are really routine but some are very complex. Some involve mergers or other reorganizations, some involve foreign law issues.
Who is going to give the shareholders the information they need to be able to make those nuanced decisions? I mean, at BlackRock we have the largest stewardship team in the industry. Our team sits day in, day out amassing this information to be able to vote as a fiduciary on behalf of clients. Who is going to put this information together for the shareholders to be able to make that informed decision? That is another really complex issue. None of these are easy issues but they have to be resolved so that you democratize voting in a way that really moves voting forward.
Ann Beth Stebbins (10:40):
Can there be an informed vote if shareholders don’t have the same level of information, the same expertise as BlackRock to analyze and make that informed decision?
And the time, this is their full-time job. They have a huge stewardship team of people who are trained as lawyers and ...
Gabrielle Wolf (11:00):
Talking about retail holders, they don’t necessarily have the time to dig into these things. I mean, the other point I would put out there is that in a proxy contest or contested merger vote, the company and the dissident will go out and meet with the stewardship teams at the index funds, at lots of institutional investors, not just the index funds, and active managers, the PMs, and analysts, and if you’re passing through the voting to retail holders, there might not be anyone to meet with to educate and make your case. I doubt they’re consuming these huge PowerPoint decks. I mean, I’m on a merger now where the deck got released by the dissident and it’s 75 pages.
Even a stewardship team, it’s helpful to have someone talk through that kind of volume, so there will be something lost. I mean, the other thing I would say that would be lost with passing through the vote to retail holders is the long-term perspective. BlackRock, Vanguard and State Street, they can’t vote with their feet. If your company is in an index, then they own you so they take a really long-term view, and I think that’s good. A lot of volatility that might otherwise be there, reactive voting is, I think, tempered by the longer term perspective that they take. If you had only active managers voting and then 20% of retail investors, I think would be a lot more short-term and reactive, which is not necessarily great.
Ann Beth Stebbins (12:35):
Another unintended consequence.
Dalia Blass (12:38):
One other thing just off of what Gabby was saying, when you look at index fund, its holdings are not just within the borders of the United States. There are capital allocations globally. Our stewardship team does not sit in New York, our stewardship team sits in global locations to be able to manage that vote, which is global. So it’s just adding to the nature of the complexity of this of how are you able to get the information to make that informed vote, it’s not easy, and Gabby’s also right. As index funds, you do take a very long-term view on the company and the purpose of the vote, and the engagement is actually to partner with the issuer to make sure that the issuer is producing those long-term sustainable results for the investor, because you’re not going to walk with your feet — you’re bound by the index. And so, that is a very different way of looking at the investment, looking at the voting than if you’re an activist investor or if you’re an active investor.
Ann Beth Stebbins (13:38):
I’d like to thank Dalia, Marc and Gabby for joining this discussion and I hope you’ve found it informative.
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