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Responsible Investment Requires a Proxy Voting System Responsive to Retail Investors

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Responsible Investment Requires a Proxy Voting System Responsive to Retail Investors

Abstract and Figures

There is growing awareness amongst retail investors of the importance of environmental, social, and governance (ESG) factors to the performance of their stocks. The same factors impact their lives from a broader societal and economic perspective. Institutional investors have incorporated ESG issues into their proxy voting and corporate engagement. Retail investors who invest in stocks directly have the same voting rights, and collectively a similar power, but data shows that their voting rates have declined precipitously over the past forty years. This chapter traces the history of property rights and proxy voting, examines them within the current regulatory context, and posits that economic rights have been well protected but ownership rights have been neglected. An established framework for stages of capitalism is re-imagined, situating retail investors’ disengagement from the proxy process and highlighting suggestions to regulators for addressing the proxy voting gap.
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CHAPTER 8
Responsible Investment Requires a Proxy
Voting System Responsive to Retail Investors
Ian Robertson
8.1 INTRODUCTION
Shareholders of public corporations are entitled to two property rights: a
share of the economic benet, usually through dividends or capital gains; and
a means of asserting their ownership views by voting their shares in person or
by proxy in corporate annual general meetings (AGMs) or other special
meetings.
1
Economic rights have developed over centuries (Macfarlane
2002) and remain strong today (La Porta et al. 1999). Shareholders may
be large institutions or small retail (individual) owners, but whether they
invest in a corporations shares directly or through intermediaries
(e.g. mutual funds), lawmakers and regulators have ensured they receive
an equitable share of prots.
However, the effective exercise of ownership rights has bifurcated since
the 1970s; institutions have increased their proxy voting as a core element of
responsible investment (Clark and Hebb 2004), while retail investorsproxy
voting rates have decreased substantially (Broadridge 2015; U.S. Securities
and Exchange Commission 1976). Retail shareholders own approximately
half of publicly traded shares (U.S. Federal Reserve Board 2014a), and if
I. Robertson, CFA (*)
University of Oxford, Oxford, UK
199©The Author(s) 2018
T. Walker et al. (eds.), Designing a Sustainable Financial System,
Palgrave Studies in Sustainable Business In Association with Future
Earth, https://doi.org/10.1007/978-3-319-66387-6_8
responsible investment is to continue its growth trajectory (Global Sustain-
able Investment Alliance 2015), their participation must be encouraged.
Institutional investors began to vote their proxies to inuence compa-
niesgovernance (G) and later their environmental (E) and social
(S) practices (now collectively labelled ESG). The re-assertion of ownership
rights had its origin in two developments: the enactment in 1974 of the
Employee Retirement Income Security Act (ERISA) in the United States,
which established a duciary duty for pension plan managers and required
them to vote proxies in plan-holdersbest interests; and the connection of
ESG issues to long-term nancial performance (Clark and Hebb 2004).
The incorporation of ESG factors into the selection of stocks and the voting
of proxiesthe core activities of responsible investmentappears to pose a
challenge to retail investors under the current regulatory system.
What began as a duciary responsibility and means to improve nancial
performance has expanded from company-specic ESG considerations to
encompass broader aspects of capitalism and society. For example, engage-
ment with companies about CEO pay is a governance issue with a direct
nancial impacteach dollar not paid to a CEO is an additional dollar to be
split amongst shareholders. The same CEO pay issue can also be considered
within the context of the current era of liberal (free-market) capitalism that,
in addition to generating global wealth, has produced both high levels of
domestic income inequality and the global nancial crisis (Kotz 2009;
Milanovic 2016). Proxy voting is a point of intersection between individual
property rights and capitalism.
Recommendations to re-engage retail investors in responsible invest-
ment will be most effective if they reference: the history of property rights
and the development of the corporation, the social context of liberal capi-
talism, how the retail brokerage and proxy systems serve retail investors, and
the impact of recent changes within the brokerage and proxy systems.
Regulators focus predominantly on operational issues within the proxy
system, such as end-to-end reconciliation of vote totals (Canadian Securities
Administrators 2013; U.S. Securities and Exchange Commission 2015b).
Consideration of low retail participation rates is typied by suggestions to
vary the colour of envelopes to entice higher response (U.S. Securities and
Exchange Commission 2015b), though on occasion more comprehensive
consideration is given (U.S. Securities and Exchange Commission 2010).
All suggestions to improve the proxy system should be encouraged, but
re-engagement of retail investors requires re-imagination of the system
within the broader context outlined here. The primary focus is on the
200 I. ROBERTSON
United States, but where helpful reference will be made to other jurisdic-
tions, in particular England for historical context and Canada for compar-
ison of regulatory frameworks.
8.2 STAGES OF CAPITALISM:THE LINEAR MODEL(S)
Academic models can be useful for illustrating relationships over time or
within a system. Robert ClarksFour Stages of Capitalismmodel shows
the dissociation of ownerseconomic rights over time (Clark 1981). Clark
wrote that capitalism could be divided into four overlapping stages, and
Clark (no relation) and Hebb (2004) later added a fth:
1. an entrepreneurial start in the nineteenth century when legal frame-
works were rst established and corporations grew in popularity, size,
and scope under owner/operators;
2. a second stage leading up to the Great Depression when professional
business managers were employed, which introduced the agency issue
and the separation of economic interests (capital) from control;
3. a third stage beginning in the early 1900s and peaking in the 1960s,
which introduced nancial intermediaries such as investment man-
agers, which further separated capital ownerseconomic interests
from the selection of companies;
4. fourth, beginning in the late 1970s, a second set of nancial interme-
diaries which directed even smaller pools of capital such as employee
retirement savings to different investment managers;
5. fth, rising in use and impact in the new millennium, the incorpora-
tion of pension fundsactive engagement with companies on ESG
issues (Clark and Hebb 2004).
The successive models proposed by Clark, and then Clark and Hebb, are
intuitive because the stages are chronological, but they mix the treatment of
economic and ownership rights and are therefore incomplete. The eco-
nomic and ownership components of property rights are combined at the
rst stage but separate at the second. Stages three and four describe nancial
intermediaries that separate owners from their capital, yet economic rights
remained strong, and benecial share-owners continued to receive the
nancial benets to which they were entitled. The fth stage re-introduces
ownership rights (Fig. 8.1).
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 201
This chapter introduces a new pentagonal Stages of Capitalismmodel
which shows the evolution of economic and ownership rights within capi-
talism. Both the linear and pentagonal models share the rst two stages in
common, but the pentagonal model claries the relationship between eco-
nomic and ownership rights by combining stages three and four and draw-
ing a connection between the nal and the second stages to make a closed
rather than linear system. This situates responsible investment within the
current era of liberal capitalism, highlights a gap in the exercise of ownership
rights by retail (minor) investors, and serves as a foundation from which to
recommend improvements to the proxy system. The new model allows the
recommendations to be appreciated in support of two broad goals: to nudge
corporate ESG behaviour towards social norms rather than just legal
requirements and to re-engage retail investors within liberal capitalism.
Before returning to the pentagonal model, the rst two stages of capi-
talism will be examinedthe evolution of property rights and the develop-
ment of the corporationdrawing on events of English history and then
shifting to the American context. Further, a helpful chronological frame-
work will be introducedthe alternating eras of liberal and regulated
1. Owner / Operators
2. Major Owners
2. Business Managers
3. Minor Owners
(Retail)
3. Portfolio Managers
Property Rights
4. ESG Proxy Voting
Fig. 8.1 Stages of capitalism (Adapted from Clark (1981) and Clark and Hebb
(2004))
202 I. ROBERTSON
capitalism described by Kotz (2015)which also relies heavily on property
rights and corporate development and the philosophical underpinnings
of the social contract introduced by Thomas Hobbes and John Locke.
Figure 8.2 shows the pentagonal model within the evolution of property
rights and the stages of capitalism, which are described next.
8.3 PROPERTY RIGHTS AND CORPORATIONS
8.3.1 Property Rights
Writing during the uncertainty of the English Civil War, Thomas Hobbes in
his book Leviathan reasoned that in the absence of some form of organiza-
tion, individuals would be in perpetual conict. It would be a free-for-allas
individuals fought to obtain goods or protect those they already possessed
and the resulting life of man would be solitary, poor, nasty, brutish and
short(Hobbes 2009). Hobbes proposed that individuals instead should
Structures & Concepts Eras of Capitalism
Property Rights
Trust
Corporation (Democratic)
Robber Barons /
Corporation (Plutocratic) Gilded Age
Agency Issue Progressive Era
Roaring Twenties
Intermediaries (economic)
Golden Age
Disisociation (ownership)
Responsible Neoliberalism
Investment (Institutions)
Responsible
Investment (Retail) ???
1.
2.
2.
3.
3.
Property Rights
4.
Fig. 8.2 Stages of capitalismhistorical context (Adapted from Clark (1981) and
Clark and Hebb (2004))
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 203
enter in to a social contract whereby they would trade some of their rights to
an all-powerful state in return for protection of their property and the ability
to emerge from their state of nature’—a proposition that contained ele-
ments of liberalism and totalitarianism.
Writing a short time later, John Locke proposed his own version of a
social contract for the protection of rights, which formed the basis of
liberalism (Taylor 2010), and was incorporated into the founding principles
of the United States (Fukuyama 1992; Hartz 1991).
Governments have responded to the unequal impact of capitalism by
considering the best ways to maintain or adapt the social contract. These
have included alternating eras in the United States in which the govern-
ments role has been limited to the effective protection of property rights
(liberal capitalism) or expanded to moderate certain aspects (regulated
capitalism) (Kotz 2015).
Legal historian F.W. Maitland chronicled the evolution of laws and pre-
cedents from Anglo-Saxon timesour common lawwhich led to a new
form of organization based on the individual. This gave rise to three
important structuresthe Trust, the Corporation, and the Stock
Exchangeand over time developed into our liberal market system
(Macfarlane 2002; Michie 2001b).
8.3.2 The Trust
Macfarlane (2002) notes Maitlands conclusion that the Trust was a unique
institutional structure which sprang from Englands impersonal, contract
based economy in the thirteenth century. The Trust could be used to pass
property from one generation to the next, or to establish entities engaged in
public good or charity, and to maintain the propertys independence from
king or state. The private man who creates a charitable trust does some-
thing that is very like the creation of an articial person, and does it without
asking leave of the State(Fisher 2015, pt. 1704).
8.3.3 The Stock Market
The origins of the modern global securities market lie in medieval Italy
(Michie 2007, p. 2). From that thirteenth century origin, securities trading
shifted north over the centuries to reect new trading and commercial
centres, establishing successive hubs in Bruges, Antwerp, and Amsterdam.
204 I. ROBERTSON
State directed commerce and trade, known as mercantilism, led to the
creation by government charter in 1602 of the Dutch East India Company,
which raised permanent capital through the issuance of a large number of
shares to the public to nance its trading operations (Michie 2007). Though
the English East India Company predated the Dutch one and was impor-
tant for its role in popularizing the joint-stock company form, it was very
closely held and therefore had little impact on the development of the
London securities market.
Later that century the South Seas Company was chartered in England
and the similarly purposed Mississippi Company in France. They enticed
investors into an investment frenzy and market bubble. The inevitable
market collapses led the British government to pass the Bubble Act of
1720 [which] made illegal the formation of any unincorporated joint stock
company, and the issue of transferable shares therein(Johnson 2010,
p. 114) and which set back the formation of corporations (incorporation)
in the UK for one hundred years(Mayer 2013, p. 101). The Bubble Act
was repealed in 1825, and the subsequent passing of four separate acts
between 1844 and 1862 laid the legal framework for corporate capitalism
which brought exponential growth in material wealth to much of the world
(Johnson 2010).
Michie offers a helpful denition of a stock exchange by which he
identies the rst stock exchange forming in London in March 1801.
A market where specialized intermediaries buy and sell securities under a
common set of rules and regulations through a closed system dedicated to
that purpose. (Michie 2001a,p.5)
In the United States, the Buttonwood Agreement of 1792 codied
New Yorks informal system for trading bonds and established what
would become the New York Stock Exchange, but it did not yet meet
Michiesdenition as a closed system.
8.3.4 The Corporation (Stage One)
8.3.4.1 Market Liberalization
The centuries long thread of customs, practice, and legislative progress
outlined by Maitland helps explain Englands unique standing (Macfarlane
2002), but Johnson (2010) notes that in practice there were still two types
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 205
of changes needed before more fertile ground would allow the joint-stock
company to ourish. First, the individual needed more opportunity within
the marketplace and second, better protection before the courts. Both issues
remain fundamental to liberal capitalism today, with the former represented
by various global trade agreements (Baumol et al. 2007) and the latter by
strong property rights (La Porta et al. 1999).
8.3.4.2 Corporate Ownership and Proxy Voting
Like European mercantilist corporations, Dunlavy (2004, p. 5) writes that
in the United States, the early corporation was a state-created, legal
personwith well-dened powers.Shareholders were active rather than
passive corporate owners, trustees of its capital(Dunlavy 2004, p. 5).
Property rightseconomic and ownershipwere intact, and the corpora-
tion was subordinate to the state, consistent with the social contract pro-
posed by Hobbes and Locke. Dunlavy continues:
Then, in the last two decades of the nineteenth century, a momentous change
occurred: the corporation came to be regarded, on the one hand, as intrinsi-
cally private that is, as arising not out of state action but out of the private
actions of individuals and ultimately, on the other hand, as a natural
person.(Dunlavy 2004,p.6)
The same change had evolved over centuries in England, and in both
places it produced the same result; the once active member [shareholder]
became merely a passive investor in the corporation(citing Horowitz,
Dunlavy 2004, p. 6). Corporations began increasingly to raise capital and
trade through stock exchanges, further dissociating formerly active
owners.
How shareholders exercised their ownership rightstheir proxy votes
also has a long history. Dunlavy summarizes the methods as bound by two
extremesa democratic one vote per shareholder (similar to how we elect
governments); and a plutocratic one vote per share (which gives larger
shareholders greater input, and is the system we generally use today for
public corporations)with a variety of mixed methods that gave a declining
number of additional votes for increased shareholdings. The democratic
form was inherent to the membership orientation of mercantilist corpora-
tions and professional guilds (and would be familiar to members of
co-operatives today), but by the late 1700s sustained debate about the
merits of plutocratic voting rights led to partial adoption of the other two
206 I. ROBERTSON
methods. By the early to mid-1800s the democratic, mixed, and plutocratic
forms were equally common, and by the late 1800s plutocracy was the norm
(Dunlavy 2004).
The establishment of the corporation as a natural personwith inherent
rights, the dissociation of minority shareholdersownership rights through
plutocratic voting, and the geographic distribution of ownership via stock
exchanges all served to cleave the formerly combined economic and own-
ership rights. The dissociation continued in the following decades and has
accelerated more recently to the point where proxies are seldom voted by
retail investors (Broadridge 2015).
Plutocracy and minority shareholding also contributed to the agency issue
described below. In the late 1800s, however, the shareholdersprimary con-
cern was receipt of their fair share of the prots. Questions of the corporations
place within the social contract wouldnt be raised for almost fty years as part
of corporate social responsibility, and the value of proxy votes to engage
corporations on ESG issues wouldnt be considered for almost a century.
In the meantime, on both sides of the Atlantic, the rst stage of capital-
ismthat of the entrepreneurwas dawning. Well-known gures such as
the industrialists, bankers, and speculators Cornelius Vanderbilt, John
Rockefeller, Andrew Carnegie, J.P. Morgan, and Jay Gould were emerging
as owner-operators, and they enjoyed both the economic and ownership
rights of their companies (Geisst 2012; Kotz 2015). The gures have been
referred to as Robber Baronsand the era as the Gilded Age, and it marked
the beginning of the rst period of liberal market capitalism (Kotz 2015)
and the rst stage of capitalism on both the linear and pentagonal models.
8.3.4.3 Eras of Capitalism: Liberal Versus Regulated
Classic Liberalism, which built upon Hobbesand Lockes social contract
and which from the eighteenth century had equated liberty with property
rights, began to give way under the new corporate form to regulated
capitalism in the late nineteenth and early twentieth centuries (Gaus et al.
2015; Kotz 2015). It was based upon three beliefs: that markets based upon
private property could be unstable, that government could help mitigate the
instability, and that property rights generated an unjust inequality of power
that led to a less-than-equal liberty ... for the working class(Gaus et al.
2015, pp. 89).
Responding to the excesses of the Robber Barons, in 1900 a new era of
regulated capitalism began under the leadership of the banks, which desired
a more stable environment for growth and control. Popular support was
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 207
provided by two social movements, the Progressives and the Socialists (Kotz
2015), and the period became known as the Progressive Era. After World
War I, it was followed by a second period of unregulated liberal capitalism
known as the Roaring Twenties, which featured both housing market and
stock market bubbles and ended in the Great Depression.
In the early years of the Great Depression, two academics, Adolf Berle
and Merrick Dodd, debated whether corporations should be treated as
public institutions with obligations to mitigate the [economic] systems
inherent instability, even if these obligations conicted with maximizing
shareholder returns(Bratton and Wachter 2008, p. 102). It had much in
common with the Progressive eras regulated capitalism and was an early
consideration of whether corporations had a social responsibilityin addi-
tion to prot maximization (Bratton and Wachter 2008, p. 102). It was also
an argument that would resurface decades later as part of responsible
investment.
It wasnt until after WWII that a second sustained era of regulated
capitalism began, this time with a post-war cooperative spirit between
labour and capital, the promise of new multi-lateral institutions and global-
izing trade and a new economic keelKeynesian economics, in which
government scal policy helped stabilize the natural boom-and-bust busi-
ness cycles. This Golden Age of regulated capitalism produced more than
two and a half decades of high growth which was widely shared among
most, if not all, of the population(Kotz 2015, pt. 876). Eventually it was
met by new challenges, including declining corporate prots, high ination,
and high unemployment. According to Kotz (2015), the challenges were
met by businessabandonment of collective bargaining, corporatisation of
media and politics, and a new (free-market) economic orthodoxy led by
Milton Friedman and Frederick Hayek. A third era of liberal capitalism
began, referred to as Neoliberalism, starting symbolically with the elections
of Thatcher in the United Kingdom and Reagan in the United States.
Neoliberalism is ...a theory of political economic practices that proposes that
human well-being can best be advanced by liberating individual entrepreneur-
ial freedoms and skills within an institutional framework characterized by
strong private property rights, free markets, and free trade. (Harvey 2005,
pp. 12)
The denition could easily describe the Gilded Age, the Roaring
Twenties, or the Victorian eras legislative changes that established the
208 I. ROBERTSON
corporation. As in the Roaring Twenties, it set the US economy on a path of
corporate expansion and wealth generation but also asset bubbles and
growing inequality (Milanovic 2016; Picketty 2014). From 1986 to 2012,
for example, almost half of U.S. wealth accumulation [was] due to the top
0.1% alone,and wealth inequality was almost as high as in the 1916 and
1929 historical peaks(Saez and Zucman 2016, pp. 521,523). Visible new
members of the ultra-wealthy cohort include the newly stock-optioned
super manager class of corporate executives, who have enriched themselves
on the back of a narrowing shareholder base (Picketty 2014; U.S. Federal
Reserve Board 2014b).
On a global scale, Neoliberalism has delivered uneven results. Many
developing (particularly Asian) economies have benetted enormously,
while in the West it has failed to deliver palpable benets to the majority
(Milanovic 2016, p. 21). Instead, it has fostered populist opposition
evidenced by: the 1999 Seattle World Trade Organisation protests, the
2011 Occupy Wall Street protests, and the 2016 Brexit vote and US
election rhetoric. Kotz (2015) identies popular support as an important
catalyst in the see-saw shifts between liberal and regulated eras of capitalism
and notes that high levels of inequality have acted as harbingers of change.
He concludes that the global nancial crisis in 2008 marks an inection
point away from Neoliberalism, but as transitions can take time (fteen years
between the Roaring Twenties and the Golden Era), he does not specify the
attributes of the next era. The pentagonal Stages of Capitalism model
introduced in this paper will show that responsible investment could be
both the social catalyst for and the economic foundation of the fourth stage
of capitalism. The second and third stages must be examined rst.
8.3.5 The Agency Issue (Stage Two)
Writing at the end of the Roaring Twenties, Berle considered another aspect
of the corporationthe agency issuein which professional business man-
agers are employed, and the suppliers of capital (i.e. the companys owners)
are separated from both their economic rights and ownership rights (Berle
1928).
2
An informational asymmetry between management and owners
shifts control and economic return from the latter to the former and
marks the onset of the second stage of capitalism on the linear and pentag-
onal models. The owner-operator Robber Barons faced no agency issue but
increased public ownership through stock markets diluted controlfrom a
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 209
single owner, to a small group of owners, and ultimately to a larger group of
dispersed shareholders.
A 1976 paper by Jensen and Meckling re-examined the agency issue and
codied it as the reduced value of the rm caused by the managers
consumption of perquisites(Jensen and Meckling 1976, p. 327), essen-
tially a nancial tug-of-war over money (economic rights) between man-
agers and shareholders. The paper ignored ownership rights, and any notion
of corporate social responsibility was dismissed (Jensen and Meckling
1976). The dual nature of shareholder rights had been reduced to a narrow
nancial interest. Twenty-ve years later, the shift in perspective had
become dominantthe nancial aspect of property rights had become the
normative lens for economistsand it coincided with the shift to Neoliberal
capitalism.
The shareholder-oriented model does more than assert the primacy of share-
holder interests, however. It asserts the interests of all shareholders, including
minority shareholders. More particularly, it is a central tenet in the standard
model that minority or non-controlling shareholders should receive strong
protection from exploitation at the hands of controlling shareholders. In
publicly traded rms, this means that all shareholders should be assured an
essentially equal claim on corporate earnings and assets. (Hansmann and
Kraakman 2001, p. 442)
Even core governance issues within responsible investment, such as CEO
pay, were reduced to an agency issue (Bebchuk and Fried 2003), with no
consideration of its contribution to inequality or impact on society. If the
economic rights of minority (retail) shareholders could be protected
through statutes, regulation, and the actions of larger shareholders
(La Porta et al. 1999), then ownership (proxy) rights became secondary.
8.4 RETAIL INVESTORS
8.4.1 Stock Ownership
Aggregate ownership may be measured in two ways: the number of retail
investors who own stock and the percentage of stock owned by retail
investors. First, recent survey data indicate that in 2013 approximately half
of the households in the United States owned stock in some form, with
about 14% holding it directly in registered or street form
3
and the remainder
210 I. ROBERTSON
indirectly through, for example, mutual funds (U.S. Federal Reserve Board
2014a). This is consistent with 2013 and 2016 US Gallup polls, both of
which found 52% of adults owned stock either individually or with a spouse
(Gallup 2016). The widespread ownership testies to the importance of
retail investors to establishing the popular support that Kotz (2015) notes is
essential during shifts between liberal and regulated capitalism. As will be
shown below, the 14% of investors who hold stocks directly face challenges,
but according to the pentagonal model of capitalism, also offer great
promise (Fig. 8.3).
Second, in 2015 individual investors owned approximately one half of
the total value of corporate stocks, with about 40% held directly and 24%
through mutual funds (U.S. Federal Reserve Board 2016).
4
This is a decline
from direct ownership of approximately 93% in 1945 and 85% in 1965 but
still substantial (citing Goldman Sachs, Ro 2015; Rosenthal and Austin
2016). The size of retail investorscorporate ownership highlights the
importance of their proxy votes to full realization of responsible investment
goals.
If both aspects of ownership are taken together, they show that approx-
imately 14% of households account for 40% of direct corporate stock
ownership (and likely some of the indirect ownership), while 36% of house-
holds account for the balance of the 24% of indirect ownership.
0%
20%
40%
60%
80%
100%
1989 1992 1995 1998 2001 2004 2007 2010 2013
Directly Held Combined Direct & Indirect Holdings
Fig. 8.3 Retail stock ownership: families with stock holdings (Source: U.S. Federal
Reserve Board (2016))
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 211
8.4.2 Investing in Stocks: Three Channels
To invest in stocks directly, retail shareholders usually utilize one of three
brokerage rm channels: discount, full-service, or portfolio management.
Each brokerage channel entails, respectively, increasing levels of service,
advice, and responsibility, with related implications for the service and
advice for proxy voting. Though they are regulated by many different
organizations, brokerage activities are primarily overseen by the self-
regulatory organization Financial Industry Regulatory Authority (FINRA).
Brokerage rms serve an essential role in capital markets. Historically,
they charged a commission per transactionthey controlled access to the
market and were paid for the brokering of a trade between buyer and
sellerbut over decades have steadily increased the scope and value of
their services.
Like the informational asymmetry between company management and
shareholders identied by Berle (the agency issue), there is often one
between brokerage rms and the investors they serve. This has led to
regulations that specify different levels of responsibility to clients depending
upon the intermediarys role and relationship, but the rules for economic
advicethat is, investment in a stockare inconsistent with those for
ownership rights or the voting of proxies. This mismatch at the brokerage
level may be a key contributor to the decline in retail investor proxy voting.
Only at the highest level of responsibility, that of a duciary, are the
responsibilities equal.
8.4.2.1 Fiduciary Duty
Fiduciary duty may be based in common law or prescribed by statute. The
relationship is one in which one party (the duciary) exercises discretionary
power over the signicant practical interests of another (the beneciary)
(Miller 2014, p. 69). FINRA licensed brokers do not have a duciary duty.
However, if they also become licensed to provide portfolio management
services under the Securities and Exchange Commission, they will be
required to act as duciaries when exercising discretionary powerover
the selection of investments and in the voting of proxies.
5
The situation is different in Canada where brokers may, and portfolio
managers do have a duciary duty based in common law rather than statute
when licensed under that countrys self-regulatory counterpart. The Cana-
dian system lacks the clarity of the SECs statutory directive to its portfolio
managers regarding duciary duty and the voting of client proxies
212 I. ROBERTSON
(Canadian Securities Administrators 2012a; U.S. Securities and Exchange
Commission 2003). While the denition of a duciary is clear, its applica-
tion can be uneven, and this poses a challenge to effective responsible
investment by retail investors in the United States by brokers and in
Canada by both brokers and portfolio managers.
Both the United States and Canada are considering changes to increase
the number of advisers subject to a duciary standard (Canadian Securities
Administrators 2012a; U.S. Department of Labor 2017). The proposed US
legislation has withstood a court challenge by industry participants (Lynn
2017) but was put on hold shortly after President Trump took ofce in
2017 (Trump 2017). The American and Canadian initiatives are notable for
their stated goals of improving the consistency and level of advice to retail
investors regarding economic interests, but are also important for their
potential impact on ownership rights and proxy voting, like ERISAs impact
on pension managers after 1974.
In some instances, a duciary duty will be imposed upon an adviser due
to their professional designation, regardless of their licensing. For example,
Chartered Financial Analysts and candidates for the CFA charter ... must
act for the benet of their clients and place their clientsinterests before
their employers or their own interests(CFA Institute 2014, p. 2). Profes-
sional organizations can support regulators by strengthening their own
duciary standards and by linking them to the principles of responsible
investment and enhanced shareholder returns.
8.4.2.2 Full-Service Brokerage
Full-service brokerage rms offer trade execution, settlement, and custodial
services. They employ brokersdened as any person engaged in the
business of effecting transactions in securities for the account of others
(U.S. Securities and Exchange Commission 2008a,p.4)who offer advice
tailored to each retail investors circumstances. In the words of one major
US brokerage rm, when handling a brokerage account, your Financial
Advisor must have a reasonable basis for believing that any recommendation
is suitable for you, but will not have a duciary or investment advisory
relationship with you(Morgan Stanley 2014, p. 2).
Proxies are usually delivered directly to investors, but unlike the eco-
nomic advice provided regarding the suitability of a stock, usually no advice
is offered regarding how to vote. Brokers do have some discretion to vote
proxiesfor benecial rather than registered owners who hold their shares
electronically at the brokerage rm (see following section)but only on
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 213
routine matters. This has the effect of increasing quorum and voting par-
ticipation rates, but as brokers usually vote in line with management
(Gulinello 2010), may be counter to the thoughtful ESG voting required
in responsible investment, and does not link investorsESG views to their
ownership rights.
8.4.2.3 Discount Brokerage
In 1975, the Securities and Exchange Commission deregulated commis-
sions (U.S. Securities and Exchange Commission 1975), which together
with technological and communications advances that fostered cost-
efcient trading platforms, led to the advent of the discount brokerage
channel. Discount brokerage rms do not offer client-specic advice and
essentially offer trade execution, settlement, and custody of investments for
a low price, usually through an on-line platform rather than personal
contact. Because investors conduct their own research and determine for
themselves the suitability of an investment, the obligations from the dis-
count brokerage rm are lower (and less costly) than they would be for a
full-service brokerage rm. Proxies are delivered directly to investors and,
consistent with the level of economic advice, no advice is given on how
to vote.
8.4.2.4 Portfolio Management
If discount brokerage is a stripped-down provision of direct access to the
stock market, portfolio management is a step up in service, advice, and
responsibility from full-service brokerage. As noted above, portfolio man-
agers have a statutory duciaryobligation to clients rather than the suit-
abilityobligation that applies to brokerage relationships. Portfolio
managers work with clients to establish overall nancial objectives and
then invest on their behalf in portfolios of securitiesusually leveraging
sophisticated platforms to diversify amongst a larger number of investments
than a typical brokerage account.
Portfolio management was historically offered to larger institutions such
as endowments, pension plans, and ultra-wealthy individuals by dedicated
portfolio managers. In the past, if a portfolio manager wished to offer its
investment expertise to a retail investor, it was usually done via a mutual
fund accessed through a third party (such as a broker or nancial planner).
Just as technology allowed discount brokers to offer new management
services to retail investors, portfolio managers were also able to offer discre-
tionary management of individual securities at lower asset levels, which
214 I. ROBERTSON
meant that retail investors were now served by two groups with different
origins.
Regardless of their rm origin, US portfolio managers are required to
vote proxies. Canadian retail clients may delegate proxy voting to their
portfolio manager, but the administrative infrastructure does not support
this well, nor is there a regulatory requirement for the manager to actually
vote (Canadian Securities Administrators 2013). Many retail clients will
therefore still receive proxies for stocks selected by their portfolio manager.
8.4.3 The Proxy System
The important distinction amongst the three types of retail delivery chan-
nels is in the level of service and advice and in the level or type of respon-
sibility owed to the client. In all three brokerage channels, though, the retail
client remains the benecial owner of the securities. Brokerage clients (full-
service and discount) receive proxies in their mailbox or inbox. Portfolio
managers are required to vote proxies on behalf of retail clients in the US
but not in Canada.
The proxy system is complex, with more than a dozen participants
engaged in over fty activities (Shareholder Communications Coalition
2017). The core function is the delivery of notice and materials for corpo-
rate meetings and, since most shareholders are not able to attend in person,
proxies for the casting of their votes. Voting is a key obligation under the
Principles of Responsible Investment, and proxies may include shareholder
initiatives aimed at particular ESG concerns (UNPRI 2017). In contrast to
institutional practices, retail shareholdersinability to vote their proxies
effectively is a signicant gap in the effectiveness of responsible investment.
Several shareholder choices impact the system, including the way shares
are held, and whether the shareholder has agreed to disclose their contact
information to the corporation.
8.4.3.1 Registered or Street Form?
Each corporation sets a record datefor which shareholders will be entitled
to receive proxies and vote in a corporate meeting. To focus on their own
business activities, corporations usually contract shareholder record keeping
duties to an independent transfer agent (U.S. Securities and Exchange
Commission 2015a).
Shareholders who are registered directlyfor example, if they have a
physical certicate or if they have taken an extra step to have their shares
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 215
registered directly with the transfer agentwill have their meeting mate-
rials and proxies sent directly to their registered address. While this system
was very common before the SEC reforms in the 1970s, the vast majority
of investors hold their shares in street form, or electronically, at a
centralised depositoryDepository Trust & Clearing Corporation
(DTCC) (U.S. Securities and Exchange Commission 2015a). A record of
each shareholders investments is maintained by the brokerage, but the
shares themselves are held and registered collectively (i.e. all clients
together) at the depository. DTCC is the registered owner, the brokerage
rm is the intermediary, and the investor is the benecial owner.
8.4.3.2 The OBO/NOBO Distinction
When opening a brokerage account, each investor chooses whether to
Object to disclosure of their Benecial Ownership (OBO) or Not to Object
to disclosure of their Benecial Ownership (NOBO) to the companies in
which they invest. Just as corporations use a transfer agent, brokerage rms
usually contract out proxy voting duties to a specialist rm (usually
Broadridge).
Most investors choose not to disclose their contact information, so
companies are not able to send them information directly, but rather must
rely on the brokerage rm (intermediary) to relay it. It is due to their roles as
intermediaries that brokers can vote on routine proxy matters even if they
have not received instructions from their client.
When reviewing their shareholder lists with their transfer agent, issuing
corporations will see the contact information for all NOBOs, but for OBOs
would see just the combined shareholdings and the name of an intermediary
(brokerage rm). Noting how the proxy system dissociates investors from
their ownership rights, the Shareholder Communications Coalition wrote
to the SEC regarding the current OBO/NOBO system:
There are no standards or regulatory requirements for how a broker-dealer or
bank reviews this classication with its customers at account opening, or on a
periodic basis to ascertain if a customers preferences have changed. The
NOBO/OBO classication is also not established on a company-by-company
basis, and many investors especially individual investors do not even know
how they have been categorized. The NOBO/OBO system impedes com-
munications between shareholders and public companies and also creates
barriers to communications among shareholders themselves. NOBOs also
represent only a portion of a companys shareholder base (Shareholder Com-
munications Coalition 2016, pp. 34).
216 I. ROBERTSON
8.4.3.3 Notice-and-Access
Cross-border securities trading and settlement between the United States
and Canada is common so administrative procedures are often reviewed
contemporaneously. Both countries have moved to Notice-and-Access
protocols whereby benecial owners are sent notice of a meeting along
with instructions about how to access meeting materials (usually electron-
ically) and to vote (Canadian Securities Administrators 2012b;
U.S. Securities and Exchange Commission 2007). The notice-and-access
system follows the communication chains prescribed by form of sharehold-
ing (registered or street) as well as OBO/NOBO elections and allows
companies to send different forms of information and instruction to differ-
ent groups. The new protocol saves printing and postage costs but relies
further on retail investors seeking the information required to vote their
proxies responsibly.
8.4.3.4 Proxy Voting Trends
Figure 8.4 shows that in 1976 almost 70% of retail shareholders always
voted, and an additional 23% sometimes voted their proxies
6
(U.S. Securities and Exchange Commission 1976). These data points are
extrapolated to show the decline in voting participation between then and
now (20082015 data) (Broadridge 2015).
7
The trend line supports the
recommendation that regulators should focus more on reversing the secular
decline than on ne-tuning the mechanics of the proxy system. Retail
0%
20%
40%
60%
80%
100%
FY75 FY80 FY85 FY90 FY95 FY00 FY05 FY '10 FY '15
Always + Sometimes Always Actual
Fig. 8.4 Proxies voted by retail investors (Extrapolated between 1976 and 2008
Sources: SEC (1976) and Broadridge (2015))
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 217
investors will not be engaged in responsible investment if the current trend
isnt reversed.
An explanation for the declinethat retail shareholders, unlike their
institutional counterparts, have been persistently dissociated from their
ownership rights since the mid-1970sis offered below. The continued
dissociation entrenches further the third stage of capitalism in the pentag-
onal model and highlights the challenge remaining in stage four: the
re-engagement of retail investors in responsible investment. If retail inves-
tors dont vote at all, an important voice in responsible investment is left
silent.
8.5 STAGES OF CAPITALISM:THE PENTAGONAL MODEL
Both the four-stage and ve-stage linear models presented earlier are
incomplete. The four-stage model is not descriptive of capitalism but rather
just the various ways in which investors supply their capital for economic
gain. The linear form is consistent with the shift in analytical tone regarding
agency issues between Berle (1920s) and Jensen and Meckling (1970s), in
which ownership rights became secondary to economic rights, despite their
centuries long co-development. In the four-stage model, ownership rights
disappear after stage two.
Clark and Hebb (2004) in their ve-stage model focus on the
re-integration of ownership rights, but the linear model can be modied
to demonstrate better the re-connection. The new pentagonal or house
shape highlights the importance of responsible investment and shows the
challenges that remain for retail investors investing directly through bro-
kerage rms. The new model emphasizes processes or concepts related to
property rightseconomic and ownershiprather than the linear models
heavier reliance on institutional form. Note that the pentagonal model
combines the original stages three and four (both relate to intermediaries)
so the model again includes just four stages.
8
8.5.1 Dissociation (Stage Three)
Recall that the rst stage of capitalism is represented by entrepreneurs, or
owner-operators, who reached their Robber Baron zenith in the Gilded
Age, but who continue today in smaller companies. The second stage is
distinguished by the separation of ownership and control and the introduc-
tion of an agency issue. Major owners are large and resourceful but are at an
218 I. ROBERTSON
informational disadvantage compared to the full-time business managers. In
the third stage, retail owners have been further dissociated. They invest
smaller amounts of capital and are at an even greater informational disad-
vantage. Financial intermediaries separate minority (retail) investors from
corporations, though their property rights remain strong (La Porta et al.
1999). Several additional factors have further dissociated retail investors
from their ownership rights, but these rights have not yet received the
same level of protection as have economic rights. Without better protection
from regulators, responsible investment will remain inaccessible to retail
investors.
8.5.1.1 Dematerialization
The steady growth of stock exchange trading volumes combined with the
manual process of registering, printing, and delivering stock certicates to
owners led to the distressing events of 19681971 when an unexpected
surge in trading volume caused the securities industry to almost drown in a
sea of paperwork(U.S. Securities and Exchange Commission 1975, p. 2).
An unwelcome downturn in markets at that time led to a crisis of paperwork
and condence and to three substantive reforms: the establishment of a
central depository for shares, the imposition of net settlement of trades at
the end of the trading day, and shifting to electronic or street form
holdings of shares instead of physical share certicates, a process called
dematerialization (U.S. Securities and Exchange Commission 2015a).
The reforms were an effective response but dealt only with the economic
rights of share ownership. The SEC considered the broader impact of
dematerialization but reasoned it had no other practical option
(U.S. Securities and Exchange Commission 1976). Proxies and annual
reports continued to be delivered by mail. Dematerialization dissociated
shareholders from the tangible aspects of ownership they had enjoyed in the
United States since the 1700sthe physical share certicate (Donald 2007;
U.S. Securities and Exchange Commission 2015a).
9
The implementation of
stock dematerialization mirrors the decline in proxy voting shown in
Fig. 8.4.
8.5.1.2 Proxy System Reforms: Notice-and-Access
Figure 8.5 shows investors who receive full proxy packages are much more
likely to vote than are those who receive an electronic package or a notice-
and-access letter. The signicant decrease in information sent to retail
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 219
investors correlates with an immediate and noticeable decline in retail voter
response (U.S. Securities and Exchange Commission 2008b).
Declining voter turnout in general electionshas been linked to votersages
(Blais and Rubenson 2013), and is a plausible explanation here, as older
voters may be more likely to request a full package over electronic delivery.
An alternate explanation, also based on election research, is that receipt in the
mail of a full package reinforces an ownership connection with the company
and an obligation to vote as part of a social norm (Gerber et al. 2008). The
social norm explanation is consistent with the high proxy voting rates in 1976
shown in Fig. 8.3, before the dematerialization of physical share certicates.
Figure 8.6 shows the number of shares voted, rather than the number of
shareholders (positions). The number of shareholders voting their proxies is
considerably lower than the number of shares voted, indicating that small
shareholders are less likely to vote. Two possible explanations are that larger
(wealthier) shareholders are more likely to be served by portfolio managers,
who as duciaries vote their proxies, or that smaller shareholders may be
more inclined to free ride,asit is simply not worthwhile ... to acquire
information so as to vote(Downs 1957, p. 147).
Retail investorsdissociation from their proxy rights is evident and most
pronounced amongst smaller shareholders and those receiving notice
rather than a mailed package. Though the pentagonal model of capitalism
diagram is symmetrical, retail investors at the third stage vary in their separa-
tion from the business managers in the top left, depending upon their level of
dissociation. Regulators should take note that it is heading in the wrong
direction.
0%
10%
20%
30%
40%
50%
FY '08 FY '09 FY '10 FY '11 FY '12 FY '13 FY '14 FY '15
Full Packages E-Delivery Mailed Notices Total
Fig. 8.5 Retail positions voted by delivery method (Source: Broadridge (2015))
220 I. ROBERTSON
8.5.1.3 Behavioural Finance
Behavioural research has contributed much to nance and offers explana-
tions of many retail investor actions. A 1975 study showed that subjects
who chose a lottery ticket themselves attached a much higher value to it
than did those who were assigned a ticket. Though the economic value was
identical in each case, participants felt a sense of ownership and control over
the outcome when they participated in the process (Langer 1975). Portfolio
managers choose stocks for retail clients, resulting in greater dissociation
compared to investors who choose stocks themselves at a discount broker-
age. Advice from a broker on a suitable stock would fall between the two.
Investors have been similarly dissociated by an increase in the number of
stocks in their portfolios. Brokerage rms have used technology and mass
customization to efciently recommend and track a larger number of stocks.
As a result, the stock positions in a brokerage clients portfolio are often
smaller, more numerous, and less familiar to them.
The short-term focus of market participants has been suggested to be the
self-reinforcing activities of two groups: business leaders, who publicly set
short-term earnings targets and then manage results to meet those goals;
and investors who are attracted to the short-term results (Brochet et al.
2012). Both business leaders and investors may be predisposed to short-
term focus (Clark 2011); the former may be incented nancially, while the
latter may be responding to behavioural issues such as overcondence
(Barber and Odean 2000) or to a weaker ownership connection.
0%
10%
20%
30%
40%
50%
FY '08 FY '09 FY '10 FY '11 FY '12 FY '13 FY '14 FY '15
Full Packages E-Delivery Mailed Notices Total
Fig. 8.6 Retail shares voted by delivery method (Source: Broadridge (2015))
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 221
Diminished participation in the stock selection process, increased diver-
sication, and shorter holding periods may combine as both cause and
symptom of dissociation, resulting in a lower propensity to vote proxies.
Behavioural research supports the concept that portfolio managers who
choose stocks should also vote proxies
10
and questions the asymmetry
between brokersprovision of stock but not proxy advice.
8.5.1.4 Globalization and Neoliberalism
Ownership rights were rst dissociated in the Victorian era by the establish-
ment of the corporation as a natural personwith inherent rights, the
dissociation of minority shareholdersrights through plutocratic voting,
and the geographic distribution of ownership via stock exchanges. Since
that time, corporations have grown in scale and geographic reach. The
export-led growth of the Golden Era was followed by foreign branch plants
and then multi-national operations in the Neoliberal Era (Harvey 2005),
which increased the geographic separation of shareholders from corporate
head ofces (Westbrook 2015). What in the past had been localgood for
both General Motors and Americabecame more complicated; the con-
nection to corporate operations had become connection to a brand.
Retail investorsafnity for a company is often based on proximity and
familiarity (brand) (Barber and Odean 2008), similar to the process
described below for values-based investing. Based upon the increase in
stock trading frequency (Barber and Odean 2011) and declining proxy
voting rates, retail investors are less inclined to voice dissatisfaction via
their proxies than by selling (or not purchasing) a stock.
The multi-national scope of corporations, their size relative to many
nation-states, and their transformation into brands raises questions about
the original social contract between individuals and the state. Mercantilist
corporations of the 1600s such as the Dutch East India Company were also
large with expansive operations, but they were creations of the state
charter companieswith a democratic shareholder membership. Because
retail shareholders seldom vote their proxies, they are unable to ensure
corporate citizens respect their role within the social contract.
Neoliberalism has pervasive effects on ways of thought to the point
where it has become incorporated into the common-sense way many of us
interpret, live in, and understand the world(Harvey 2005, p. 2). Ironically,
while it emphasizes the signicance of contractual relations in the market-
place(Harvey 2005, p. 2), it relies on corporate supremacy and relegates
small (retail) shareholders to the provision of capitaland as demonstrated
222 I. ROBERTSON
by the low proxy voting levelswith little accommodation for or interest in
their ownership rights.
One of the governance issues addressed by responsible investment is
executive pay, which has contributed to wealth inequality and to a socio-
economic gap in which corporate elites gather globally at events such as the
World Economic Forum in Davos, Switzerland to exchange ideas (Harvey
2005; Picketty 2014). The gap is also one of powera version of the
labour/capital struggle (Kotz 2015). Retail investors have less in common
with corporate leaders and feel less connected to the companies in which
they invest, and their dissociation contributes to a lowering of expectations
regarding the efcacy of their proxy voting.
8.5.1.5 Summary
The evolution from stage two to three is more than the introduction of
portfolio managers as intermediaries. Retail investors have been dissociated
from their stocks because of discrete actions such as the dematerialization of
physical share certicates (and introduction of summary paper and then
on-line statements) and by the imbalances caused by Neoliberalism.
Though the pentagonal diagram is presented symmetrically, the distance
between stage two and three is dependent upon the number of economic
(portfolio manager) intermediaries and upon the variable impacts of own-
ership (proxy voting) dissociation.
The three investment channelsportfolio manager, broker, and dis-
count brokerare notable for the different gaps they generate. They disso-
ciate investors to different degrees, but also offer opportunities to reconnect
retail ownership rights through responsible investment, completing the
fourth stage of the pentagonal model that was started by pension managers
and more recently incorporated by portfolio managers serving retail clients.
8.5.2 Responsible Investment (Stage Four)
8.5.2.1 History
Responsible Investment is a broad term encompassing several areas. In the
nineteenth century, groups of mostly Christian investors began screening
their investments for activities they considered sinful,and in 1928 the rst
fund using similar values screens became available to investors (Knoll 2010,
p. 684). Values-based negative screening gained popularity, including
efforts to avoid military contractors during the Vietnam War, companies
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 223
conducting business in South Africa during apartheid, and more recently to
avoid fossil fuel companies. Values-based investingoften referred to as
Socially Responsible Investing or SRImay also involve positive screening,
focussing on companies producing positive social outcomes (e.g. solar
power) or those which meet higher social standards. In both negative and
positive screening, the focus is on investment returns and not on active
ownership or proxy voting.
A recent further step along the values chain has been the development of
impact investing, which combines the twin goals of an investment return
and a social impact. Though it re-integrates economic and ownership rights,
it is not usually part of retail investorsparticipation in the broad public
markets.
8.5.2.2 The Ownership Voice
With their large, illiquid holdings, and their duciary obligations to opti-
mize returns and reduce risk over long timeframes, pension funds and other
institutional investors are hampered in using values-based screens to exit
investments. Instead, wrote Albert Hirschman in 1970, they are advised to
use their voice to change rather than to escape from an objectionable state
of affairs(Hirschmann 1970, p. 30). The use of voice through direct
engagement and proxy voting is consistent with the more recent concept
of a universal owner, in which the externalities of one rm impact the
operations and protability of others, rendering divestment ineffective
both economically and with respect to ESG. Divestment leaves externalities
unaddressed and results in the portfolios underperformance (Monks and
Minow 2011); nonetheless, it is still the primary method by which retail
investors holding individual stocks act on their ESG concerns. Several
studies show investment outperformance over benchmark indices for
responsible investment strategies broadly (Clark and Viehs 2014;Nagy
et al. 2015) and for corporate engagement specically (Dimson et al. 2015).
The adoption of responsible investment by institutional investors over-
laps with the growing awareness of environmental issues, popularized by
Rachel Carsons 1962 book Silent Spring and more recently the issue of
climate change. It also coincides with the decline of the Golden Eras
regulated capitalism and the subsequent rise of inequality under Neoliber-
alism. Although the aim of responsible investment is to enhance economic
outcomes by advancing social ESG norms, it may also be viewed as a
response to the macro aspects of Neoliberalism and globalization. For
example, global expansion has allowed companies to use labour or
224 I. ROBERTSON
environmental practices that would be unacceptable in their home jurisdic-
tions, prompting institutional investor response.
Figure 8.7 shows the recent increase in responsible investment assets in
several jurisdictions. It includes institutional assets (e.g. pension funds) as
well as retail investments such as mutual funds. It does not include stocks
held directly by retail shareholders but is consistent with another recent
survey of that group and does indicate a broad level of interest in responsible
investment. When combined with the proxy voting data from Fig. 8.4, the
data highlight the gap between retail investorsinterest in ESG issues and
the efcacy of the proxy voting system in support of that interest if they
invest directly in stocks. The voice of pension funds, endowments, and other
stage-four investors is organized, funded, and articulate, but it is dwarfed by
the tens of millions of retail investors who own stock directly and who can
provide the social momentum necessary for change noted by Kotz (2015).
The voice of retail investors who own stocks directly is quiet but offers
tremendous support to the institutions that have led the way so far in
responsible investing and the fourth stage of capitalism.
Figure 8.7 shows large differences amongst countries. This may be due to
several factors, including differences in: regulatory and institutional support,
demand levels, and models of capitalism (European welfare liberalism versus
US Neoliberalism), and could be investigated in a separate paper, perhaps
correlating responsible investment with types of capitalism.
2012 2014
Europe 49.0 % 58.8 %
Canada 20.2 % 31.3 %
United States 11.2 % 17.9 %
Australia 12.5 % 16.6 %
Asia 0.6 % 0.8 %
Global 21.5 % 30.2 %
Fig. 8.7 Responsible investment managed assetslevel and trend by region
(Source: Global Sustainable Investment Alliance (2015))
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 225
8.5.2.3 Reintegration of Ownership Rights
Active ownership emerged through institutional investors, in particular
pension funds, which rst engaged companies in aspects of governance to
address agency issues and transparency, and later incorporated environmen-
tal and social issues into their dialogue and proxy voting in order to mitigate
long-term ownership risks (Clark and Hebb 2004). The integration of ESG
issues into corporate engagement and proxy voting provided a new frame-
work for the analysis and selection of suitable investments and was distin-
guished from the values-based screening embraced by retail investors by the
reclamation of ownership control over corporate behaviour. The United
Nations backed Principles for Responsible Investment (UNPRI) provided
legitimacy and promulgated a framework that asset owners, investment
managers, and industry could adopt, but other than an educational module,
they do not yet include the retail investor channel.
The pentagonal model shows dissociation as the third stage of capitalism
and the reconnection of ownership rights through active proxy voting as the
fourththe link that reconnects the ownership rights back to the business
manager. The agency issue identied by Berle between the business owner
and the business manager is central to the second stage and is shown as a red
curved line in the diagram. There exists a similar agency issue between
portfolio managers and business managers, which in stage four is
represented by the same red arc in Fig. 8.8.
Notice that the fourth stage includes only one retail investment channel,
so while the outside lines are now connected (major investors, portfolio
managers), two brokerage channels (green dotted lines) remain
unconnected. In Canada, all three brokerage channels are unconnected,
which enforces the importance of regulatory clarity and action. Statutory
duciary obligations would be appropriate for Canadian portfolio managers
and should be considered for brokers in both countries, but this would be
inappropriate for discount rms.
8.6 RECOMMENDATIONS
Kotz draws a pattern in the ebb and ow of types of capitalism, with
inection periods after economic crises or stagnation and extremes in wealth
inequalityan observation supported by Pickettys centuries long time-
series data (Kotz 2015; Picketty 2014). Appraising property rights, the
corporate form, and stock markets over a similar time frame situates the
226 I. ROBERTSON
rise of responsible investment as the start of a fourth stage of capitalism. To
capitalize on Kotzsinection point, it still requires popular support, part of
which can come from the broad base or retail shareholders.
With over one half of stocks in the United States owned by retail
investors, and with the data showing their interest in responsible invest-
ment, re-establishment of effective ownership rights should not only lead
to positive ESG outcomes and improved investment performance but also
help embed responsible investment within the next era of capitalism. The
catalyst for broader ESG engagement should be reappraisal of the proxy
system for retail investors, for the very vitality of the capital markets
depends so heavily upon informed and knowledgeable communications
(U.S. Securities and Exchange Commission 1971, p. 1). Institutional inves-
tors have been important leaders in this regard, using their proxies and
direct engagement to change corporate behaviour. Despite their large
ownership stake and proxy voting power, they are small in number and
work within the existing system rather than advocating for systemic change.
Institutional investors have the resources to work within the current system,
but retail investors have neither the resources nor incentive to self-organize.
1. Owner / Operators
2. Major Owners
2. Business Managers
3. Minor Owners
(Retail)
3.1 Portfolio Managers
Property Rights
Direct Interaction
4. ESG Proxy Voting 3.3 Discount
Brokers
3.2 Retail
Brokers
?
?
Fig. 8.8 Stages of capitalism: the retail ownership gap (Adapted from Clark
(1981) and Clark and Hebb (2004))
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 227
Unless the number of individuals in a group is quite small, or unless
there is coercion or some other special device to make individuals act in their
common interest, rational, self-interested individuals will not act to achieve
their common group interests(Olson 1971, p. 1). The effort required for
individual investors to become informed about each issue for each stock
they own is an insurmountable challenge. Regardless of how smooth or
nely tuned the proxy system becomesthough regulators and practi-
tioners should continue to work to this endretail investors will neither
vote directly nor organize collectively to produce a solution. The solution
rests primarily with regulators, who will require support from industry
participants, corporations, and not-for-prots interested in issues of gover-
nance or responsible investment.
The proxy system is under review by the SEC and Canadas securities
regulators, but their indicated approaches do not address the broader,
systemic issue of the secular decline in retail investor proxy voting shown
in Fig. 8.4. They should continue to address the inefciencies in the
systemimportant goals to be surebut if they leave unaddressed the
broader issue of engaging retail investors, responsible investment will not
reach the full promise of embedding ESG factors in capitalism and society.
Instead, like the use of colourful envelopes cited earlier, the changes will
produce benets at the margin. Regulators should seek transformative
change in the following three ways.
8.6.1 Fiduciary Duty (Part II)
The ERISA legislation in 1974 established the requirement for corporate
pension and employee benet plan managers to act as duciaries, including
the voting of proxies (U.S. Department of Labor 2008). Portfolio Man-
agers not governed by ERISA will in any case be regulated by the SEC
(in some cases delegated to the state), which similarly requires them to vote
proxies on clientsbehalf (U.S. Securities and Exchange Commission
2003). The Department of Labors proposed (now paused) new rules
would have required all investment professionals offering advice on indi-
vidual retirement plans such as IRAs and 401(k)s to be considered as
duciaries. They are primarily intended to address potential conicts of
interest and are silent with respect to proxy voting, but might be expected
to evolve to include provisions in the future, thereby nudging the retail
operations of FINRA regulated brokers to a more effective proxy system.
The prospective changes would apply only to individual retirement plans
228 I. ROBERTSON
and not taxable accounts, but any changes to the proxy voting architecture
for the former could easily work with the latter; an individual client often has
both retirement and taxable accounts with the same broker. Discount
brokerage rms are unlikely to be included as duciaries, but other potential
measures are possible.
The distinction between duciary and non-duciary roles and accounts
may still be unclear to many retail investors, but each step towards common
requirements is helpful. The regulatory goal should be similar levels of
responsibility for economic rights and ownership rights, commensurate
with the level of service and advice in each of the three retail channels
described earlier.
In addition to regulatory change, CFA charterholders could be required
to vote proxies as part of their duty to serve clientsbest interests (CFA
Institute 2014), in particular if the duty is linked to evidence of better
investment performance. Like the conclusions reached earlier by many
ERISA pension funds, a 2015 study found that responsible investment itself
was a duciary dutythat incorporation of ESG factors in to the selection
of stocks and in the voting of proxies was obligatory (Sullivan 2015). The
studysndings support the recommendations made here to both regulators
and CFA Institute.
8.6.2 The Client Account Form
The proposed regulatory and professional organization changes are based
on broad principles (i.e. duciary duty). Administrative changes may also be
effective. For example, when opening a brokerage account, acknowledg-
ment of the level of investment risk an investor is willing to assume (low,
medium, high) is required. A similar question regarding ownership rights
(i.e. proxy voting) could also be asked regarding an investors interest in
responsible investment.
While ensuring investment recommendations are suitable to the stated
level of risk, the individual stocks in an account may differ amongst brokers,
but their selection will be based upon common principles of risk (e.g. size,
liquidity, earnings stability, and growth). Ideas regarding responsible invest-
ment, including proxy voting, will also differ amongst brokers and investors,
but they too will be based upon common ESG principles.
Regulatory changes in 2009 to brokersability to vote proxies without
clientsinstruction prompted the suggestion that brokers receive blanket
instructions up front, so they may vote accordingly on clientsbehalf (Beller
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 229
et al. 2010). While the suggestion was not linked to responsible investment,
blanket guidance could easily incorporate questions about responsible
investment.
8.6.3 Client Account On-line Access
ERISA required duciaries to make available proxy voting procedures and
records of past votes, and while the Department of Labor doesnt specify
how, many larger organizations provide it on-line (U.S. Department of
Labor 2008). Some take the additional step of sharing in advance how
they intend to vote, which can be helpful to discount brokerage investors
who conduct their own research. Market participants may wish to consider
how publicly available proxy guidance could be aggregated and summarized
for ease of use by these investors.
Most brokerage rms offer on-line access so clients can view their invest-
ment holdings and transactions. This should be expanded to include proxy
voting. Information of upcoming votes and past voting records should be
included. Many brokerage rms use Broadridge for both investment record
keeping and proxy voting, but despite Broadridges signicant work in
on-line proxy voting platforms, the two systems have evolved differently
and are accessed separately. Work would be required to bring them
together. In a letter to Canadas regulator regarding the distribution of
mutual fund reports to investors, Broadridge commented about the con-
venience to investors of accessing fund reports at one familiar site for all
positions held rather than accessing each of the reports at a different fund
company site(Broadridge 2015, p. 21), which supports in principle the
centralized proxy viewing system suggested here.
Blockchain, a promising new technology best known for its Bitcoin
application, may offer help in this regard. Blockchain is a new system of
record keeping in which records of ownership are maintained by a distrib-
uted network rather than central corporate servers. Many participants in the
capital markets, including stock exchanges, regulators, nancial intermedi-
aries, and market participants, are exploring its use, which could include
reintegrating the economic and ownership rights of investors.
8.7 CONCLUDING REMARKS
The governance issues within corporations and stock markets are complex,
and retail investor proxy voting is just one of many items to be addressed.
Regulators must also grapple with the independence of proxy advisory
230 I. ROBERTSON
rmsadvice, the effect of monopolist rms such as Broadridge, the struc-
ture and election process of corporate boards, policies for shareholder pro-
posals, and whether issuing corporations want to engage their retail
shareholder base (some may not like the feedback they receive).
While property rights developed over many centuries, corporations and
modern capitalism are relative latecomers. We should strive for a more
inclusive systemfor its own sake, because property rights are important
and because it offers the promise of a better futurebut we should not be
disheartened if it takes time.
The different eras of capitalism must have seemed so promising at rst
and then so terrible when they petered out (1970s) or collapsed (1929), but
they gave way to reection on the social contract and, as Kotz describes, to
popular support for the next era. Writing about the early European securi-
ties markets, Michie notes that their evolution was not dictated by govern-
ment or the needs of any particular regimebut rather by the broader
demands of trade and nance (Michie 2007, p. 27). Today, it is the
demands of responsible investmentthe need to address the negative
externalities of corporate capitalism while still enjoying the very many
benets it has producedthat impel changes to the retail proxy voting
system.
Broad support for responsible investment can be signicantly enhanced
by engaging the democratic base of retail shareholders. Large institutional
investors and portfolio managers enjoy the plutocratic voting power of their
shareholdings and are lauded for their role in addressing ESG issues, but
they are not substitutes for popular support. If they truly believe in the
substance of their ESG corporate engagement, they should also advocate to
regulators and government for systemic change to complete the fourth
stage of capitalism that they so capably began.
NOTES
1. While corporations may issue multiple, subordinated, or non-voting shares,
it is assumed here that each share is entitled to one vote.
2. Writing a century earlier, Adam Smith in The Wealth of Nations identied
agency issues as well, but Berles work is more contextual to the public
corporation and liberal capitalism.
3. The actual gure will be higher than 14% as retirement accounts and man-
aged assets, which may also hold directly owned stock, are not included.
4. Including personal retirement accounts but excluding dened benet plans.
RESPONSIBLE INVESTMENT REQUIRES A PROXY VOTING SYSTEM... 231
5. Portfolio manager is a generic term describing the function. The regulatory
terms for the positions are Registered Investment Adviser (RIA) for the rm
and Investment Adviser Representative for the individual. Both rm and
individual are usually called RIAs.
6. The survey had a 24% response rate (23,600 out of 97,100 questionnaires).
Respondents identied as individuals (21,143), institutions including trusts
and estates (2263), and no response (189). Proxy voting behaviour: always
(16,467), sometimes (5463), never (1417), and no response (253).
7. Some care should be taken interpreting the data as the SEC and Broadridge
methodologies are different and they may also use different denitions of
retail investor.Broadridge also publishes an annual report (Broadridge
2016) which shows a 28% participation rate. The lower gures used in the
graph are consistent with my professional experience, but either set of gures
would represent a signicant decline from the 1976 SEC data.
8. Though there is some overlap, the four stages of capitalism should not be
confused with the alternating eras of regulated and liberal capitalism
described by Kotz (2015).
9. In my early days in the investment business in the 1990s, I encountered
many investors who had purchased their shares many years prior and who
despite the extra risk and work involved in keeping their certicates safe and
in depositing quarterly dividend chequeswere loath to deposit their certif-
icates into street form. They valued the physical ownership, much as many
today still retain their old record albums or CDs despite the availability of
subscription digital music services.
10. The behavioural research also highlights again the gap in Canada between
the portfolio managers selection of stock but lack of proxy voting
obligation.
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