Executive Summary

Corporations have facilitated the most dynamic economic growth in history. Dispersed ownership has hampered their ability to address adverse externalities, like dark money and climate change. Mechanisms are needed to increase meaningful communications between Main Street investors and directors to ensure corporations reflect public sentiment. Ironically, the concentrated power of giant index funds presents an opportunity to address those issues through increased feedback mechanisms.

Real-time disclosure of corporate proxy votes will lead to competition among funds, based not only on historic costs and returns, but values expressed in vigorously debated proxy scorecards. Internet sites and phone applications will revolutionize how information is shared by investors and companies, allowing much wider participation in environmental, social, and governance (ESG) issues. Investors will have advocates. Directors will have constituents. Instead of being blamed for everything that goes wrong, corporations will be seen as fostering democracy and innovation.

Externalities and “Forced Capitalists”

Delaware Supreme Court Chief Justice Leo E. Strine Jr. excoriated the Big 4 mutual fund families (BlackRock, Vanguard, State Street, and Fidelity) for voting against shareholder proposals seeking to require approval of political contributions.

A combination of BlackRock, Vanguard, and State Street constitutes the largest shareholder at 40 percent of U.S. public companies and nearly 90 percent at S&P 500 firms. “Although the Big 4 never use their clout to affirmatively make proposals … they could put a system-wide break on excessive and illegitimate corporate political spending.” Three-fourths of survey respondents, including most Republicans and Democrats, back a constitutional amendment “outlawing Citizens United,” the Supreme Court decision that held restricting independent expenditures for communications by corporations unconstitutional.²

In Citizens United v. FEC, Justice Kennedy, writing for the majority, assumed access to information about corporate political spending would be readily available. In Justice Kennedy's own words:

With the advent of the Internet … shareholders can determine whether their corporation's political speech advances the corporation's interest in making profits, and citizens can see whether elected officials are ‘in the pocket’ of so-called moneyed interests. … [D]isclosure permits citizens and shareholders to react to the speech of corporate entities in a proper way. This transparency enables the electorate to make informed decisions and give proper weight to different speakers and messages.³

Of course, if spending is not disclosed, the “procedures of corporate democracy” cited by Kennedy cannot work. Shareholders must instead file political transparency proposals at each company. Passage depends on how the Big 4 vote. Strine calls workers “forced capitalists,” unable hold the funds that invest their money accountable. Most want their funds to vote for transparency, but they see no voting records. Real-time proxy vote disclosure would generate dialogue and competition around voting scorecards.

Lucian Bebchuk and Scott Hirst studied BlackRock, State Street Global Advisors, and Vanguard.⁴ They found index fund managers have strong incentives to underinvest in stewardship and defer excessively to corporate managers. Bebchuk and Hirst recommend prescriptive regulations, such as requiring each index fund to invest a specified minimum in stewardship. Jill Fisch et al. hint at a more market friendly approach.

Our key insight is that although index funds are locked into their investments, their investors are not … investors in index funds can exit at any time by selling their shares.… Because they cannot compete by exiting underperforming companies, passive investors must compete by using “voice” to prevent asset outflow.⁵

It is important that individuals have some ability to influence how large index funds vote their proxies, especially since many investors are “forced capitalists,” as Strine notes. They can sell, but the choices of Mr. and Ms. 401(k) are often limited to plans offered by their employers in the same fund families, with the same proxy scorecards.

Main Street Investors Should Have a Say

The search is underway for mechanisms to give Main Street investors more voice to ensure their investments reflect their values or moral sentiments, in the words of Lincoln. For example, the National Association of Manufacturers and others formed the Main Street Investors Coalition (MSIC). MSIC questions the recent surge in environmental and social investing. They surveyed 1,000 investors with assets in exchange-traded funds (ETFs) and found that 78 percent of “people invest in passive funds because they want low-fees and consistent returns—not to advance social and/or political causes.” Only 22 percent agreed that “it's about time that passive funds used their size and influence to promote worthy social and/or political causes.”⁶

MSIC “is demanding that fund managers focus on maximizing performance and ensuring that retail investors who own passive funds have a say in how their shares are voted.”⁷ So far, their recommendations have focused more on curtailing the power of proxy advisors than gaining a say for retail investors.

How could we give retail investors more say? John Wilcox dismisses “pass-through voting” as impractical. However, new technology opens the door to pass-through communications.

A case can be made that investors who delegate stock picking and proxy voting decisions to third-party professionals, while having no standing to vote at shareholder meetings, should have some means to voluntarily inform their fiduciaries about their views on issues affecting their investments. Pressure for such feedback mechanisms will surely increase as environmental and social concerns, shareholder activism, and risk oversight feature more prominently in public discussions about corporate purpose and boardroom accountability. ⁸

Having “a say” would involve private sector “informal pass-through referendums.” Such votes would then help funds shape their proxy votes and their marketing. However, funds are unlikely to provide uniform information to participants, such as how funds currently vote and why, unless required to do so. Real-time proxy vote disclosure would make a substantial body of core information available to referenda participants so they at least know something about current practices and what options are available.

Knowing How Funds Vote

Knowing how funds have voted on any given issue at specific companies is key to helping retail investors vote intelligently with a minimum of research by copying trusted brands. Funds must analyze proxies at thousands of companies each year. Typically, funds develop proxy voting policies, hire proxy advisory services to mesh their voting policies with proxy items, and engage staff in analyzing mostly exceptions prior to voting. The process requires subscription databases and tools largely unaffordable to individual investors. As a result, most Main Street investors do not vote.

From late 2009 to mid-2013, the website Moxy Vote gathered proxy votes from institutional investors that announced votes in advance of annual meetings. Retail investors could link their brokerage accounts. Then they could develop automated proxy voting policies by brand alignment with their own values, choosing to copy the votes of trusted institutional investors. For example, users could set preferences to vote with Domini. If Domini did not vote (e.g., they did not own shares), vote with Calvert. If Calvert did not vote, vote with Florida SBA, and so on. Investors also had the option of overriding their automated preferences, much like institutional investors can override their proxy policies often voted by proxy advisors on their behalf.

Unfortunately, Moxy Vote folded, hindered by antiquated SEC rules⁹ and higher processing fees per share than large institutional investors. However, they captured the imagination of tens of thousands of users and demonstrated a system that let shareholders vote their values without spending hours analyzing individual proxies. Moxy Vote provided a real-life example of what works. They also left a splendid cartoon¹⁰ on the power of shareowners that continues to inspire.

Proxy Insight¹¹ compiles voting data¹² but customers are large investment managers, activist investors, advisory firms, compensation consultants, investment banks, and academic institutions. Morningstar, another subscription service, acquired Jackie Cook's Fund Votes,¹³ which has long analyzed voting data. Frequent citations of their research by the New York Times, Wall Street Journal, Financial Times and others could drive billions of investments based on voting records but most of their analysis is not released publicly.

Organizing Around Common Values

When Lincoln noted the power of public sentiment over 160 years ago, it was driven by public speeches and print on paper. Investors are also heavily influenced by public opinion.

Institutional investors vote corporate proxies on behalf of underlying investors and beneficiaries. We show a strong relation between this voting and public opinion on corporate governance (as reflected in media coverage and surveys), with similarly strong results for voting by mutual funds. We also find that proxy advisors' recommendations are associated with public opinion.¹⁴

Today, social media drives public opinion and changes it daily. Companies that fail to engage often regret it, just as many regret not engaging with activist investors. Most are familiar with Facebook, YouTube, WhatsApp, Messenger, WeChat, Instagram, Tumblr, Google, Twitter, and other general-purpose social media sites. Newer social media sites and applications are being developed to generate public pressure around specific corporate accountability issues. Disclosure of proxy votes in real-time would help ground those developing opinions around factual information. Examples are as follows:

Say provides a framework for communications between companies and shareholders for many uses.¹⁵ Unlike SEC Rule 14a-8 shareholder proposals, Say is not limited as to what questions shareholders can pose to companies.¹⁶ See “Say.com Goes Live on Tesla.”¹⁷

Stake also facilitates the ability of individual shareholders to have their voices heard. Users create an “Ask” on any issue for public companies and funds.¹⁸ Once an Ask receives substantial support, a “Champion,” with a proven track record on social and environmental issues, is appointed to negotiate the Ask.¹⁹ Champions include Walden Asset Management and Zevin Asset Management.

Just Capital surveys thousands of Americans to identify issues most important in defining a “more just economy.”²⁰ Employees are gaining on shareholders as the top priority for Main Street at companies. An increased number also believe CEOs should take a stand on important social issues and that acting together can change corporate behavior. About 76 percent said they would take a job at a more just company even if it paid 20 percent less.²¹

Change.org claims nearly 200 million users in 18 countries.²² Petition-led campaigns targeted and changed Massage Envy (sexual assault issues), Walmart (banning dangerous paint strippers), and Starbucks (recycling), among others.

SumOfUs is “15,096,345 people stopping big corporations from behaving badly.”²³ Accomplishments include getting the European Union to ban “Bayer's bee-killing pesticides” and McDonald's to reduce plastic waste.²⁴

The Center for Political Accountability (CPA) leads efforts for corporate political disclosure and accountability²⁵ and publishes the annual CPA-Zicklin Index, benchmarking companies.²⁶ CPA's Track Your Company database includes undisclosed company election-related spending and profiles.²⁷ Collision Course examines the heightened risks companies face.²⁸

The Gender Diversity Exchange exposes “whether companies' intentions match their outcomes to reward those that do well, encourage other companies to do better, and share their results.”²⁹ The database includes information on each company's directors, diversity policy, quantitative targets, policy implementation, women in the C-suite, percent of women in management, and trends.

AsYouSow.org works directly “with corporate executives to collaboratively develop business policies and practices that reduce risk, benefit brand reputation, and increase the bottom line, while bringing positive environmental and social change.”³⁰ They file proxy proposals,³¹ provide free online tools to screen mutual funds on specific ESG issues,³² and issue reports (CEO Pay, Proxy Preview, Proxy Voting Guidelines).³³

As Main Street investors are targeted by social media, they will naturally want to know how their own money impacts proxy votes on issues of concern. Directors will dialogue with shareholder advocates just as they do now with activists.

Real-Time Proxy Voting Disclosure

The idea that fund voters should have “a say” might get traction at the SEC. Chairman Clayton has spoken widely of “facilitating public transparency that can energize competitive forces to benefit investors” to empower Mr. and Ms. 401(k).³⁴ “Our analysis starts and ends with the long-term interests of the Main Street investor.” “The Commission should review its rules retrospectively. We should listen to investors and others about where rules are, or are not, functioning as intended.”³⁵

SEC Rule 30b1-4 required funds to file annual reports of their proxy votes beginning in 2004 using the N-PX form.³⁶ The final rule stated, “increased transparency will enable fund shareholders to monitor their funds' involvement in the governance activities of portfolio companies, which may have a dramatic impact on shareholder value.” Disclosures would facilitate the ability of Main Street investors to evaluate funds based on their voting records.

My requested review by the Commission in the form of a rulemaking proposal would find N-PX filings are not fit for purpose.³⁷ Filings do not “enable fund shareholders to monitor their funds' involvement in the governance activities of portfolio companies.” Filings do not shed light on mutual fund voting to “illuminate potential conflicts of interest and discourage voting that is inconsistent with fund shareholders' best interests.” Filings do not enable shareholders to “evaluate how closely fund managers follow their state proxy voting policies, and to react adversely to fund managers who vote inconsistently with these policies.”³⁸

Proxy voting data are displayed in user-unfriendly format. The average 401(k) account balance is less than $40,000 for those under age 40, about the time many employees typically get serious about investing in retirement.³⁹ Hiring a researcher or subscribing to a database to conduct their own research would not be cost effective for most Main Street investors. Collected data is underutilized because it is dated and not freely available in a user-friendly format. Compare the sortable disclosure of Trillium Asset Management,⁴⁰ including the rationale for each vote, with the user-unfriendly format of Vanguard Index Trust Total Stock Market Index Fund.⁴¹

As noted above, the final rule requiring annual disclosure of mutual fund votes hypothesized that greater transparency of proxy voting would encourage funds to become more engaged in the corporate governance of issuers. Funds have become more engaged. However, the engagement did not follow implementation of the annual reporting rule in 2004. As recently as 2010, just 6 percent of S&P 500 companies reported investor engagement. As of June 2016, that increased to 66 percent. Since big passive funds cannot sell, they drive increased value by negotiating for best practices among portfolio companies.⁴²

Best practices are driven by news coverage, public opinion, and the proxy votes of big funds. Real-time proxy voting disclosure would enable news reporters and Main Street investors to compile scorecards, compare voting records, and pressure fund voting practices. It would go a long way in solving problems raised by Leo Strine, Lucian Bebchuk, and others regarding potential conflicts of interest and/or under-/overinvestment in ESG advocacy.

All funds claim to vote their proxies conscientiously in the “best interest” of their clients. Trade publication Pensions & Investments argues pensions have a fiduciary duty to announce their proxy votes in advance of annual meetings if doing so is likely to influence the vote.⁴³

Societal values were recognized as at risk in 1932 when Adolf Berle and Gardiner Means argued that with dispersed shareholders, ownership has been separated from their control.⁴⁴ Ironically, concentration of equities under the umbrella of a few largely indexed funds presents an opportunity to end that divide by facilitating better communications and more accountability to beneficial owners.

Currently, up to 91.6 percent of retail investors fail to vote, depending on delivery mode.⁴⁵ Rapid disclosure and reporting of proxy votes and the reasons for those votes would foster real dialogue on the issues faced by corporations and investors. Funds would begin to compete not only on the basis of cost and returns but also based on how their voting scorecards align with the values of Mr. and Ms. 401(k). Additionally, real-time disclosure would spark renewed interest in standing voting instructions by retail shareholders. For a discussion of current impediments, see “Standing Voting Instructions: Reviewed.”⁴⁶

Giant Funds Clash to Determine American Values

Competition among large funds based on voting policies has begun. Real-time disclosure of proxy votes would increase that exponentially, stimulating debate and action around the social purposes of public companies.

Ryan Bubb and Emiliano Catan developed fund voting scorecards. The “Traditional Governance Party” mostly supports management but also proposals to declassify the board and reduce supermajority vote requirements. The “Shareholder Intervention Party supports shareholder proposals at a rate of 84%, compared to only 49% for the Shareholder Veto Party.” A few funds, like Domini and Calvert, score highly on both dimensions of fund preference. “Our framework shows that these socially responsible fund families are extreme in their shareholder rights orientation, as expressed through their votes”⁴⁷ (emphasis added).

It may be a mistake to dismiss such funds as extreme. One out of every four dollars under professional management in the United States, $12.0 trillion, was invested according to socially responsible investment strategies as of year-end 2017.⁴⁸

Given growing pressures from the press, social media, and applications outlined above, a similar study undertaken in the near future could yield significantly different results. In his 2018 letter,⁴⁹ BlackRock CEO Larry Fink advised corporations to have “a sense of purpose.” Fink's 2019 letter clarified that “purpose is not the sole pursuit of profits but the animating force for achieving them.”⁵⁰

While all three of the largest funds have launched specialized ESG funds to appeal to consumer demand, they have not moved as quickly in their proxy voting practices.⁵¹ Fund families continue to vote proxies against shareholder proposals focused on the same ESG concerns.⁵²

Of the Big 3, State Street has been the most supportive of both climate change and political disclosure reports. Maybe that has something to do with their creation of the “Fearless Girl” statue, originally facing down the Wall Street Bull.⁵³ Was Fearless Girl merely a publicity stunt to support launch of the Gender Diversity Index (ticker symbol SHE)? Was it aimed at diverting attention from a $5 million settlement for allegedly underpaying women and employees of color, or was the statue a genuine commitment to diversity?⁵⁴

Original intent may not matter. Reality has a way of catching up to proclamations. Just as the words “all men are created equal” in the Declaration of Independence arguably became more revolutionary than the war those words sparked, the Big 3 may soon be held accountable to their own statements, if those statements around purpose actually reflect common American values.

State Street voted against 400 directors in 2017 for lack of diversity.⁵⁵ According to Rakhi Kumar, global head of asset stewardship and ESG with State Street, “The investor demand is there, but typically whom do CEOs and CFOs hear from? They hear from analysts on quarterly calls, where the time horizons are very different.”⁵⁶

Institutional investor support for social and environmental proposals increased from 19 percent in 2014 to 29 percent in 2018.⁵⁷ According to proxy advisor Institutional Shareholder Services, “Disclosure on ESG issues is only beginning to gain prominence among U.S. companies; therefore, given the right targeting, there is ample room for these types of proposals to gain additional support.”⁵⁸

Groups like the Main Street Investors Coalition believe giving beneficial owners a say in how their funds vote will decrease focus on ESG issues. Since retail shareholders supported ESG proposals at a rate 12 percent lower than institutional shareholders, they could be right. Others point to evidence that investors increasingly want to have a positive impact on the world, as well as earn a good financial return. Funds categorized as low sustainability led to net outflows of more than $12 billion, whereas those categorized as high sustainability led to net inflows of more than $24 billion. “Investors have a strong belief that better globe ratings positively predict future returns. We also find suggestive evidence of non-pecuniary motives, consistent with altruism or warm glow.”⁵⁹

Large indexed funds are being targeted both by those who want corporations to maximize shareholder returns and those who want corporations to better reflect the full range of human values. What currently appears as two diametrically opposed positions may converge. As universal owners, investors in large indexed funds only profit from earnings that are not canceled out by a greater loss of consumer purchasing power, disproportionate costs imposed on other firms, or on society. In short, rational fund managers should support honest competition but not profiteering tactics that externalize costs on others.⁶⁰ With updates in modern portfolio theory, rational fund managers may soon focus more on beta, rather than lower-impact alpha enhancements.⁶¹

Real-time proxy disclosure would help both profit maximizers and more holistic investors focus their arguments on proxy voting fiduciaries. The market can play an indispensable role in facilitating debate over values but only if proxy vote information is freely available in a structured, easily accessible, and sortable form to Mr. and Ms. 401(k).

Broader Shareholder Base Needed to Reflect American Values

In the United States, the wealthiest 10 percent of households own about 84 percent of corporate stock. Given that imbalance, proxy votes cannot truly reflect the full spectrum of American values. For the 1967 revised edition of The Modern Corporation, Berle added a new preface asking, “Why have stockholders?”

What contribution do they make, entitling them to heirship of half the profits of the industrial system, receivable partly in the form of dividends, and partly in the form of increased market values resulting from undistributed corporate gains? Stockholders toil not, neither do they spin, to earn that reward. They are beneficiaries by position only. Justification for their inheritance must be sought outside classic economic reasoning … justification turns on the distribution as well as the existence of wealth. Its force exists only in direct ratio to the number of individuals who hold such wealth. Justification for the stockholder's existence thus depends on increasing distribution within the American population. Ideally the stockholder's position will be impregnable only when every American family has its fragment of that position and of the wealth by which the opportunity to develop individuality becomes fully actualized.⁶²

As long as 84 percent of corporate stock is owned and controlled by 10 percent of Americans, corporations will not be trusted. As noted by the president and CEO of the U.S. Chamber of Commerce, “Despite overall economic gains nationwide, many Americans have lost faith in core institutions—public and private alike. They don't believe that government or business understand the challenges they face, or are willing or able to address them.”⁶³ A one percentage point increase in the Gini index for income inequality leads to a fall of two percentage points in the share of individuals who believe that “most people can be trusted.”⁶⁴

For capitalism to be compatible with democracy we not only need investment funds that align with shareholder values,⁶⁵ we need most American families to participate in share ownership. That should be part of the mission of every corporate director in order to maintain the legitimacy of capitalism.

After World War II, the New York Stock Exchange developed a marketing campaign, “Own Your Share of American Business” (OYS), to rebuff communism, restore profitability to retail brokerage firms, and convince Americans to lower capital gains taxes. OYS was never aimed at shifting power from the few to the many. Participation in corporate governance was not an objective. Giving small retail shareholders a “sense” of participating in capitalism was enough.⁶⁶

Imagine, instead, if most Americans had a substantive stake as well as a meaningful voice in corporate governance. Imagine if investing in shares was promoted as a way to participate in financial returns and in voting on what future we want to live in based on each company's “social purpose.” Creating a nation of small shareholders involved in corporate governance would be transformative. In order to map the future, we first need to know how shares are currently being voted on our behalf. Proxy scorecards for each company and each fund will help move debate and public sentiment.

About the Author

James McRitchie is one of the nation's most successful shareholder advocates, helping to declassify and elect directors by majority vote, end supermajority provisions, and allow special shareholder meetings and use of written consents. His 2002 petition to the SEC reenergized the movement for proxy access, allowing shareholders to place nominees on corporate proxies. His 2014 appeal of an SEC no-action letter led to suspension of Rule 14a-8(i)(9) for a proxy season and reinterpretation of the Rule closer to original intent. An activist campaign at Reeds Inc. led to replacement of four out of five directors, splitting chair/CEO positions, and a 70 percent gain in stock price.

In 1995, McRitchie began publishing Corporate Governance (Corpgov.net), which quickly became a leading online resource for news, commentary, and transformation, known for focusing on how theory and research can be put into practice through shareholder advocacy. Guest posts are welcome.

Previously, McRitchie had a career in California state service of several decades, heading legislative, rulemaking, environmental review, and business development functions, also serving as a director on several nonpublic corporate boards. He is a graduate of Southern Connecticut University (BS, 1972), California State University, Sacramento (MPA, 1979), and Boston College (MA, 1992).

McRitchie has testified before the SEC and other government bodies and is a frequent commentator in the financial press. On July 9, 2019, he petitioned the SEC (File 4-748, https://www.sec.gov/rules/petitions.shtml) to require funds to report proxy votes in machine-readable format within 24 hours of each vote cast. Disclosures will stimulate debate around environmental, social, and governance (ESG) issues. Investors should be able to evaluate funds based on fees, earnings history, and ESG values expressed through proxy votes.