Faculty of law blogs / UNIVERSITY OF OXFORD

How the SEC can Help Mitigate the 'Proactive' Agency Costs of Agency Capitalism


Bernard S. Sharfman
Senior Corporate Governance Fellow, RealClearFoundation


Time to read

4 Minutes

In the United States, investment advisers to mutual funds (mutual fund advisers), exchange traded funds, and separately managed accounts are typically delegated the authority to vote their clients’ securities, including the voting rights associated with a public company’s common stock. Therefore, it should not be surprising that the United States Securities and Exchange Commission (SEC or Commission), in its Release establishing the Proxy Voting Rule (Release), took the position that an investment adviser (15 USC 80b-2(a)(11)) ‘is a fiduciary that owes each of its clients duties of care and loyalty with respect to all services undertaken on the client’s behalf, including proxy voting.’ This was the rationale behind the Proxy Voting Rule[1] requiring investment advisers, including mutual fund advisers, to create and disclose their proxy voting policies and procedures.

However, the SEC and its staff have yet to clarify what these fiduciary duties mean for the largest mutual fund advisers, such as BlackRock, Vanguard, and State Street Global Advisors (the Big Three), now that they control an extraordinary amount of shareholder voting power at many of the United States’ largest public companies (see Shenkar, Heemskerk and Fichtner). This phenomenon did not exist at the time the Proxy Voting Rule was implemented (see Fichtner, Heemskerk and Garcia-Bernardo).

Moreover, this concentration of voting power is expected to increase over time. In a recent article, Professor Coates predicts that in the near future, the majority of voting shares of US public companies will be held by only 12 mutual fund advisers.

This concentration of voting power creates significant value for a mutual fund adviser if it can be traded for something that the adviser wants in return.  For example, an adviser may use its voting power to support the activism of current and potential institutional clients in exchange for the ability to acquire more assets under management. Or, an adviser may use its voting power to support the activism of its own shareholders at the advisor’s portfolio companies in exchange for those shareholders agreeing not to target the adviser itself for such activism. The result is that an adviser has not cast its delegated voting authority, to use the words of the Release, ‘in a manner consistent with the best interest of its client’ and has subrogated the ‘client interests to its own,’ a breach in its fiduciary duties to its mutual fund clients and its shareholders.

In my new essay, forthcoming in the American University Business Law Review, I describe these examples as creating a certain type of agency cost, the ‘proactive’ agency costs of agency capitalism. Agency capitalism arises, as it has in the US equity markets, when institutional investors, such as mutual fund advisers, not retail investors who provide the funds, come to dominate the ownership of common stock and other voting instruments. According to the publication Pensions & Investments, institutional investors currently own approximately 80% of the market value of US publicly traded equities. This compares to approximately 6% in 1950 (see Tonello and Rabimov). Agency costs of agency capitalism are generated when an institutional investor utilizes its voting power to satisfy its own preferences (and thereby enhances the welfare of the institutional investor or its managers) and not the preferences of investors who have provided it with the funds to purchase securities.

The understanding that proactive agency costs of agency capitalism exist is nothing new. For example, the SEC Release, Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment Companies, the companion release (Companion Release) to the Release, recognized the agency costs generated when mutual fund advisers are reluctant to vote against a company’s management for fear of losing the company’s retirement business. Even though it was not labeled as such, this type of agency cost falls in the proactive category.

Articles by Gilson and Gordon and by Bebchuk, Cohen and Hirst also focus on the economic disincentives mutual fund advisers have in becoming informed prior to voting their proxies. These can be referred to as the ‘passive’ agency costs of agency capitalism. Therefore, my essay is distinguished from those articles by its recognition of additional types of agency costs of agency capitalism that fall into the ‘proactive’ category, as well as the use of the term ‘proactive,’ and by categorizing the agency costs generated by the economic disincentives that discourage mutual fund advisers from becoming sufficiently informed voters as falling in the ‘passive’ category.

My essay does not address the ‘passive agency costs of agency capitalism.’ Instead, it focuses only on the ‘proactive’ agency costs generated by mutual fund advisers that hold large concentrations of delegated voting power. These are the agency costs that the SEC can help mitigate.

To combat the proactive agency costs of agency capitalism as described in the examples in my essay, I argue that the Commission should provide clarification that mutual fund advisers must disclose how they will deal with these new conflicts in their voting policies, consistent with their fiduciary duties to act in the best interests of their mutual fund clients and their shareholders. In addition, shareholder proposals are a prime area where this opportunistic use of an adviser’s voting power may be in play. Therefore, the adviser’s voting policy must also explain how voting on these proposals are linked to maximizing shareholder value.

Furthermore, the Commission should clarify that voting inconsistent with these new policies and procedures or omission of such policies and procedures will be considered a breach of the Proxy Voting Rule established by the Release. Such guidance should apply to any mutual fund adviser that is delegated voting authority. I urge the SEC to be diligent in taking enforcement action in response to breaches of the Proxy Voting Rule.

Bernard S Sharfman is the chairman of the Main Street Investors Coalition Advisory Council, an associate fellow of the R Street Institute, and a member of the Journal of Corporation Law’s editorial advisory board. The opinions expressed here are the author’s and do not represent the official position of the coalition or any other organization with which he is affiliated.

[1] 17 CFR § 275.206(4)-6 (2018). The Proxy Voting Rule was promulgated under the Investment Advisers Act of 1940, 15 USC 80b-6.


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