It has recently been highlighted that proxy voting by index funds such as most mutual and electronically traded funds is a serious problem for corporate governance. We agree wholeheartedly – but we disagree just as wholeheartedly with a proposed solution: barring index funds from voting at all.
Quite frankly, this suggestion is dangerous. Index funds account for between 30 percent and 40 percent of the market. Either individually or collectively they are all owners, in significant quantity, of Fortune 500 companies. Our analytical work at Columbia Law School’s Millstein Center demonstrates the overwhelming significance of their holdings. As a matter of common sense, their voices must be heard. We should insist on this because the index funds are simply intermediaries for all of us who participate in them – and if their voices are not heard, ours are equally muted.
Removing this constituency from voting eliminates the voice of a key long-term shareholder. As long-term shareholders, because their portfolios are not subject to easy changes, the voices of index shareholders should be heard if we are to change the short-term mentality of the market.
The idea of barring index funds from voting would also leave corporate management and the board with nowhere to turn when targeted by an activist. Given the spike of investments by activist investors in recent years, this would be detrimental to both corporations and their shareholders.
We realize proxy voting presents significant challenges. Index funds have hired analysts, but are woefully understaffed given the tens of thousands of companies they cover. We understand this constraint but suggest the following: index funds could have their staff concentrate on those companies that are under fire from activist investors or are obviously failing in their performance.
This is, of course, a selective process but each index fund could choose the method by which to narrow down the number of corporations its staff would look at when voting proxies, beyond those targeted by activists or the subject of comment by proxy advisers such as Glass Lewis and ISS. Many funds have already begun this process.
Beyond this, at the Millstein Center we are encouraging boards to become more active in matters of governance and shareholder engagement. For example, any board believing the market is simply underestimating the value of its strategy can turn to mutual funds to try to elicit the support of long-term shareholders through more vigorous interaction. Moreover, under the law as it stands today, the board has the power to oppose mischievous or ill-advised proxy proposals and should have no fear of the courts when using care and prudence in coming to such a conclusion.
The elimination of the index funds from voting would in turn eliminate a source of long-term support for boards that need it for growth and innovation.
Ira Millstein is a senior partner at Weil Gotshal & Manges. He is writing on behalf of Columbia Law School’s Millstein Center
This article originally appeared in the Corporate Secretary special edition on shareholder engagement. Click here to view the full issue.
