Impact Investing

How does that index fund address social issues? SEC official seeks transparency

Key Points
  • Mutual fund companies are required to disclose how they vote on key shareholder issues such as climate change, gun control and CEO pay, but most investors do not know where to find the information or how to analyze it.
  • A top SEC official is in favor of prominently displaying a fund's proxy voting record as part of the mutual fund sales process, before an investor makes a decision to buy.
  • The SEC is weighing a broad rethink of mutual fund disclosures for the retail investor.
Protesters hold signs outside an Exxon Mobil annual shareholders meeting. In 2017, Vanguard Group joined other big fund companies including BlackRock and State Street Global Advisors that voted to require the oil giant to produce a climate change report.
Fort Worth Star-Telegram | Tribune News Service | Getty Images

The era of low-cost index funds from asset management giants such as Vanguard Group and BlackRock has simplified the fund-buying process — and that has been a good thing — but there is more work to be done.

The Securities and Exchange Commission is contemplating a new rule that would represent a fundamental rethink of the way funds disclose key information to investors, and, as technology advances, how information is released to them, as well.

One top SEC official, Commissioner Robert Jackson, believes this rethink should include discussion of how funds disclose their votes on key social issues.

Mutual fund investors have learned that there are a few critical pieces of information to ask about before making an investment purchase: How much does the fund cost, and how has its performance compared with other funds and the index? But that leaves out a layer of information that is becoming increasingly important to a new generation of investors: Does your fund care about social conditions across the Earth today and the future of the planet itself?

Investors can choose funds designed (and branded) as environmental, social and governance (ESG) investments. But the vast majority of investors are still in funds designed to buy stocks first and deal with the social repercussions after as they cast votes at annual meetings — the most votes of any public company shareholders.

Those proxy voting records of big fund companies on issues — including climate change, human rights, gun control and CEO pay — are a key metric to measure their social responsibility. On issues such as climate change, they've proven to be more talk than action.

"We should be showing how votes are cast with Americans' dollars at the point of sale," Jackson said in a recent interview with CNBC. "When you sit down with a broker and they put you in a fund, that investor ought to know how the money voted."

While mutual funds are required by the SEC to disclose their proxy voting record once a year in a public document called an N-PX, that information remains hidden from most investors — who wouldn't be able to understand the disclosure even if they knew how to find it.

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SEC Commissioner: Investors need more transparency on index fund voting patterns

"The N-PX are not well-structured disclosures," said Jackie Cook, founder of FundVotes, which was acquired last year by Morningstar as the investment research platform pushes further into the area of ESG investing data. "Votes need to be disclosed at the individual fund level, ballot by ballot, and proxy by proxy."

Cook said getting the information out of the N-PX and into a format that is more timely and readable should be key priorities.

Jackson said that, unlike many SEC proposals, this one would require no new statutory authority from Congress.

"We could do this under our existing authority," he said.

As a hypothetical example, he said the information could be plotted out on a grid showing how one asset management voted on an issue as compared with another. "Here is Fund Company A; here is Fund Company B," he said. "Let investors know this is how they will vote."

For long-term retail fund investors, Fund Company A and Fund Company B are increasingly Vanguard and BlackRock, which together manage roughly $11 trillion.

The late Vanguard Group founder Jack Bogle said in one of his last warnings in late 2018 that among the biggest issues the index fund giants would face in the future is their oligopoly status and societal influence. He was specifically referring to the fact that the dominant index funds vote corporate proxies on behalf of so many individual Americans, and on complex issues such as climate change.

Some experts have said when making a fund purchase online, a pop-up window could disclose information on proxy votes or prompt investors who are interested to learn more (though in comment letters on new disclosure ideas, fund companies, including Vanguard, have cautioned the SEC about adopting technology that may not display equally across platforms).

Cook said the exact nature of the technology used matters less than the fact that the technology exists today to disclose this information without a heavy lift on the part of fund companies. She said there is no reason why fund companies could not offer this information in real time as they vote shares rather than issuing the once-a-year N-PX document.

"From a technology perspective, no one needs more time," she said. "The data is already sitting in a database at the time a vote is cast."

"Right now we have the disruptive technology."

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"I think Jackson is a leader and ahead of his time on this," said Tim Smith, director of shareholder engagement at Walden Asset Management in Boston. "Remember, years ago the SEC had to be encouraged to require the N-PX report," he noted. "It didn't happen without support."

"He will get pushback, for sure," Smith added.

The pushback may come from within the SEC itself, where the top level of leadership — its commissioners — remain divided over the core issue of shareholder proposals submitted as part of proxy seasons. Smith noted that one of Jackson's co-commissioners, Hester Peirce, is a "severe critic of shareholders resolutions" who supports updating proxy rules to make it more difficult for shareholders to file resolutions.

"I'm not criticizing her [Hester Peirce] for having her view, but she has spoken her mind, just like Rob Jackson," Smith added. "These dynamics within the SEC will affect whether such an idea would get air time and be considered a priority, but you have to put these things forward to get public debate."

Jackson is a Democrat; Peirce a Republican.

Niels Holch, a mutual fund lawyer and head of the Coalition of Mutual Fund Investors in Washington, D.C., said he has found Jackson to be thoughtful and not partisan. "He joins with the GOP on some issues and the Dems on others.

"He is definitely an independent thinker, not just voting the party line."

SEC Chairman Jay Clayton, an Independent, said in a speech last December "it's clear" that the shareholder resolution process needs to be reviewed, specifically, the way in which proposals that fail one year are allowed to be resubmitted (shareholder advocates say it often takes several years to gather significant support). Since being appointed by Trump to chair the SEC in 2017, Clayton has received some criticism from Republicans for not showing enough support for Trump's pro-business policies.

Last week, President Trump signed an executive order requiring the Department of Labor to look into the issue of pension funds (which are overseen by the DoL) voting contrary to their fiduciary duties on climate change and other environmental issues brought up for proxy votes at the annual meetings of publicly traded companies.  

Smith said asset managers would be more likely to agree to more prominent, formal disclosure of proxy voting at the point of sales if it weren't also a requirement to show their data versus competitors. "They would fight very hard against comparing themselves to others," he said. "It would be easier to say 'Vanguard' should disclose on their website."

But Smith said comparing across companies is the best solution. Signs point to that happening in the future, whether or not the SEC requires it, and companies have to be dragged along. Morningstar — which played a key role in the disclosure of fund fee and performance information in recent decades — plans to use its acquisition of FundVotes to surface as much N-PX research from the 2019 proxy voting season as possible, and as soon as the N-PX documents are filed by fund companies.

Referring to the pushback from asset managers that came before N-PX was approved, Cook said, "We will see it again with any greater push for transparency."

I disagree with the notion people don't care how their money is voted. We don't know the answer to whether people care because the data is hidden. When we present them with the facts, we will find out.
Robert Jackson
SEC Commissioner

Cook said Morningstar won't initially include proxy voting records as part of its influential overall fund ratings. It already offers separate sustainability ratings on funds. But its plan is to enable investors to compare asset managers against each other, as well as at the level of their individual funds.

"We can aggregate the data at various levels," she said. "The mission is to give investors the information they need to make investment decisions."

"This is something more and more care about and will want to ask their financial advisor about when choosing between funds," Cook continued. "Newly or increasingly enlightened investors want this kind of data ... not only because it affects the value of their investments but their values."

The fund companies will say they put engagement with corporate boards over multiple years before proxy voting. BlackRock and Vanguard both make this argument generally, and specifically when their proxy voting records are pointed out as being poor.

A Vanguard spokesperson said, "We believe that engagements where we can provide constructive input to board and management teams effects meaningful change more so than voting." The spokesperson also cited its annual Investment Stewardship report which reports engagements with more than 700 portfolio companies, 200 of which are involved in carbon-intensive industries.

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BlackRock also issues multiple reports on its shareholder commitment and sustainability, including its annual stewardship outlook. BlackRock CEO Larry Fink noted in his annual report issued last week that the company is now requiring all investment teams — not just ESG-specific fund managers — to incorporate ESG as part of their investment process.

Both fund giants have issued public comment letters on the SEC's proposed retail fund disclosure rulemaking, but only dealing with the general themes and concepts, not the specific idea of proxy voting point-of-sales comparisons.

Jackson said some companies do a good job already of sharing proxy voting information, but that doesn't preclude doing more.

The most common skeptical line of attack to Jackson's push, which he has been working on since late last year: The public does not care enough about these issues and wouldn't use the information even if it was put right in front of their noses.

Jackson has a simple response: We won't know the answer to that question until we try.

"I disagree with the notion people don't care how their money is voted," he said. "We don't know the answer to whether people care because the data is hidden."

"When we present them with the facts, we will find out," Jackson added. "It makes sense to say all people want is the cheapest investment product, but it is also true that if we make understanding this easy, they will care more."

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Key Points
  • Two of the biggest index fund providers, Vanguard Group and BlackRock, have been more vocal in recent years on the subject of corporate responsibility.
  • As two of the world's largest asset-management companies, with more than $11 trillion invested on behalf of fund shareholders, they also are among the largest shareholders of stocks in the world.
  • A recent analysis of their proxy voting records on climate change shows them to be among the worst in the fund industry, but they are not alone. T. Rowe Price Group, Putnam Investment and Dimensional Fund Advisors also were among the bottom tier of fund companies.