The US Securities and Exchange Commission’s (SEC) acting chair Allison Herren Lee, in a recent conference speech, has scrutinised the balancing act index funds must perform in exercising their voting capabilities while also maximising returns through an active securities lending programme.
At the 2021 ICI Mutual Funds and Investment Management Conference this week, the newly-appointed head of the US regulatory body questioned whether the agency’s 2019 advice regarding participation in corporate governance through voting versus the prospect of greater revenue from securities lending gave too much credence to the latter option.
Lee told the virtual audience she was “concerned” the commission’s guidance “attempted to, and may have, tilted this calculus against shareholder voting without sufficient data or analysis to support the wisdom of doing so”.
She explained that because index funds cannot sell out of their positions, proxy voting becomes a particularly important tool for maximising value. But the economic benefits of voting are diffused among all shareholders, while index funds face their own economic pressure to lend out their shares, or not recall shares, instead of voting.
“These pressures can also present potential conflicts of interest for advisers in light of fee splits and revenue sharing that an adviser may receive,” Lee noted. “The revenue generated by securities lending can lower costs when passed back to investors – but this should be carefully balanced against, and potentially moderated by, the value to shareholders in exercising oversight of boards and management in the companies they own.”
The chair went on to warn fiduciaries against “undermining the foundation of how shareholders engage with corporate management to maximise the long-term value of their holdings”.
In the same way deciding how to vote requires due diligence, the act of not voting requires equally careful consideration, she adds.
As such, Lee recommends that the SEC’s 2019 proxy voting guidance should be “revisited to ensure that fiduciaries understand how to weigh competing concerns of all types in deciding whether and how to cast votes on behalf of their beneficiaries”.
In closing, the chair acknowledges that “there is a lot of work to do in this area” and that as proxy voting becomes increasingly important to investors, “we must ensure that current incentives and rules for voting and voting disclosure are really serving the needs of investors today”.
The speech comes amid an overt effort by the SEC to put environmental, social and governance matters at the top of its agenda, with recent weeks seeing a slew of initiatives to enhance social responsibility in financial markets and shield retail investors from unreasonable risk or manipulation.
Lee, who only took over the top job in January, is currently facing one of the first big tests of her tenure as market players and politicians grapple with how to react in the aftermath of the GameStop short squeeze phenomenon.
After initial finger-pointing in several directions including at the regulator itself for its part in the saga, the spotlight has primarily fallen on the role of retail brokers, such as Robinhood, with discussions on Capitol Hill focused on what could or should be done to enhance market accessibility while also educating amateur investors on the risks of trading.
However, the SEC is mulling the introduction of additional disclosure and reporting rules for hedge funds for their short position and securities lending activities which currently face far less transparency than other markets such as the EU and the UK.
