The ESG proxy advisor game starts to crack

For many years “proxy advisory” services have been provided by a duopoly comprising two companies, Glass Lewis and Institutional Shareholder Services, with a combined market share of 97 percent engendered by blatant political favoritism.

“Proxy advice” means recommendations to investors, retirement funds and large asset managers holding major stakes in public companies on how to vote on shareholder motions and other such proposals.

Because of deeply perverse recent rulemaking both formal and informal, at the Securities and Exchange Commission, the proxy advisory process has been transformed into one in which large institutional shareholders in a given company are virtually required to accept the recommendations of the proxy advisors. In particular, an important SEC rule (Rule 14a-8) has been changed to require firms to consider resolutions of “wider societal interest.” The upshot of this system: Utterly without statutory authority, this proxy advisory duopoly has become a de facto regulator of public companies.

The proxy advisors can make recommendations that do not affect their own financial interests. Accordingly, they have indulged their political preferences, with little concern for the interests of retirees and shareholders.

The result has been a wave of proxy proposals promoting “environmental, social, and governance” objectives, the central examples of which are various greenhouse gas and climate proposals, discrimination against fossil fuel investments, the pursuit of racial and gender quotas for corporate boards, and other such pursuits of political objectives with other people’s money.

The blowback against this expansion of the ESG game has become formidable, an outcome unsurprising precisely because ESG represents a fundamental threat to the financial interests of large numbers of investors, retirees and firms.

Because retirement funds and institutional investors have fiduciary responsibilities to their clients, litigation has loomed large as a threat to the pursuit of ESG objectives, and various states have threatened litigation and disinvestment over such efforts to dilute the fiduciary responsibilities of pension funds and to discriminate against important local industries.

The three largest asset managers — BlackRock, State Street and Vanguard — already have retreated from their previous enthusiasm for ESG investing. In its 2023 annual stewardship report, BlackRock reported that it had supported only 7 percent of environmental and social resolutions, down from 22 percent in the previous cycle. Similarly, a 2022 report from ShareAction, reviewing the world’s largest asset managers’ voting records on ESG, shows that Vanguard and State Street supported only 10 and 29 percent of ESG shareholder resolutions, respectively. In 2023, support dropped even lower.

In a major new development, BlackRock has announced that it is adding Egan Jones as a third proxy advisor option, expanding its voting choice initiative by adding two new Egan Jones proxy policies, one of which “does not prioritize environmental or social goals.”

Ignore the soothing BlackRock blather about its “commitment to providing our clients with choices to support their growing range of investment preferences.” This BlackRock addition of Egan Jones as a third proxy advisor, with an emphasis on economic returns rather than ESG objectives, is a frontal assault on the duopoly described above and its preferences for politicized voting on proxy proposals. 

Ignore also the forthcoming assertions from those pursuing their own political interests with other people’s money, that ESG objectives are important for public companies and retirement funds, and are great for returns in any event. Artificial constraints on investment options — "divest from fossil fuels!" — cannot improve investment returns to a portfolio over the longer term, and are inconsistent with the diversification needed to maximize expected returns for given levels of risk. 

Accordingly, an additional option for proxy advice — one not driven by political objectives — is a godsend for investors and retirees, one that other major asset managers and retirement funds would be wise to emulate, as BlackRock now has created for itself a competitive advantage. Thus have market forces yet again proven central for the maximization of economic returns, that is, the protection of fiduciaries’ interests and the larger economic objective of greater economic productivity of capital investments and the aggregate capital stock.

The modern SEC is a regulatory agency deeply politicized. The proxy advisor duopoly serves its interests because it pursues political objectives that the SEC would not be able to implement due to its lack of statutory authority. The great benefits of the BlackRock announcement, even if it is matched by other assert managers, cannot fully overcome the adverse effects of perverse SEC regulatory behavior.

Accordingly, legislation is needed to reform the SEC regulatory framework so as to remove pressures for the managers of public companies and retirement funds to ignore the fiduciary interests of investors and retirees in favor of the recommendations of proxy advisors. 

Legislation is needed to constrain the efforts of regulatory agencies to pursue climate policies not authorized in law, uninformed by actual evidence, and justified on the basis of fundamentally dishonest cost-benefit analyses. Legislation reforming the SEC regulatory framework must make it clear that neutrality across investment alternatives must be a central component of the traditional SEC transparency and materiality regulatory objectives. Above all, legislation must remove the artificial barriers to entry for proxy advisory services, so that competitive market forces can serve the interests of investors, retirees and the economy writ large.

Benjamin Zycher is a senior fellow at the American Enterprise Institute.