Considering the Index Fund Voting Process (U.S. Senate Committee on Banking, Housing, and Urban Affairs)

 

Hearing	Considering the Index Fund Voting Process
Committee	U.S. Senate Committee on Banking, Housing, and Urban Affairs
Date	June 14, 2022

 

Hearing Takeaways:

• Index Funds: The hearing largely focused on the popularity of index funds within the U.S. and how these funds impact U.S. corporate governance. Index funds are financial instruments that encompass a portfolio of stocks and bonds that track the returns of a market index. Committee Members and the hearing’s witnesses attributed this popularity to the fact that index funds tend to have low expenses and could be passive investments. They also noted how index fund managers can exercise the voting rights of the stocks held within the index funds, which enables them to exert significant influence over companies.
  • The Market Dominance of BlackRock, State Street Corporation, and Vanguard: Committee Republicans, Sen. Dan Sullivan (R-AK), and Prof. Griffin expressed concerns over how the three largest index fund companies (BlackRock, State Street Corporation, and Vanguard) can exert significant influence over companies. They noted how these firms manage $20 trillion in combined assets, are the largest shareholders in 90 percent of S&P 500 companies, and cast nearly 25 percent of all votes at U.S. public company annual meetings. They stated that this ability to vote shares that the firms themselves did not own themselves has provided the firms with significant influence over proxy votes and selection processes for corporate boards of directors.
  • Perceived Pursuit of Social and Political Goals by Index Fund Managers: Committee Republicans and Sen. Sullivan contended index fund managers are inappropriately exercising their influence derived from their voting power to pursue social and political goals. They specifically expressed concerns that index funds are dictating that companies adopt aggressive energy policies at the behest of environmental activists that are not in the best interests of the companies themselves. They asserted that these funds are expected to be passive in nature and that the pursuit of social and political goals did not comport with this expectation. Full Committee Chairman Sherrod Brown (D-OH) remarked however that ensuring the long-term success of a company sometimes necessitate the adoption of corporate policies that account for climate change risk, promote workplace diversity, or support human capital management. Prof. Griffin discussed how there are various motivations for index fund managers to pursue social and political goals in their voting strategies. He noted that one theory is that index fund managers view index fund voting as a compliance cost and that these managers are very willing to offload this cost to outside parties. He noted that another theory is that index fund managers adopted activist positions to differentiate themselves from their competitors to attract investment.
• The INvestor Democracy is EXpected (INDEX) Act: The hearing largely considered the INDEX Act, which is a bill that would restrict the ability of index fund managers to vote their shares. This bill would require any asset manager of a passive index fund with more than one percent of a company’s voting shares to vote those shares in accordance with the fund’s investors or not vote at all. This bill would require asset managers to permit third-party vote recommendations on their platforms to provide investors with guidance on their votes. The bill’s supporters argued that this legislative proposal would be a logical extension of the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which prohibited broker-dealers from voting shares held on behalf of clients.
  • Use of Pass-Through Voting: A key areas of contention regarding the INDEX Act was its permittance of pass-through voting. Pass-through voting refers to the practice of allowing for index fund investors to provide voting instructions for the fund’s shares and to not be forced to delegate their voting power to index fund managers. Committee Democrats and Prof. Coates argued that while pass-through voting appear democratic, they asserted that pass-through voting proposals fail to consider the cost and complexity associated with obtaining direction, as well as the sheer number of votes involved. They also questioned the potential take-up of pass-through voting from index fund investors and predicted that most of these investors would chose not to exercise their voting power. They emphasized however that all index fund investors would bear the costs associated with requiring additional information disclosures, regardless of whether individual investors made use of it. They asserted that these new costs would make index funds less attractive and impede their ability to provide benefits to consumers. Committee Republicans, Sen. Dan Sullivan (R-AK), and Prof. Griffin contended that pass-through voting would restore agency to index fund investors and provide a check against the dominance of the three largest index fund companies. Prof. Griffin acknowledged that while pass-through voting proposals did carry costs, he asserted that these costs are very manageable. He noted how index funds are already pursuing pass-through voting systems voluntarily for both institutional and retail clients. He further noted how the INDEX Act would only apply to index funds controlling more than one percent of the voting shares of a given stock. He stated that this provision would effectively target the largest investment advisory firms and commented that these firms could bear these costs.
  • Impact on Shareholder Votes: Another key area of debate surrounding the INDEX Act was its impact on shareholder votes. Committee Democrats and Prof. Coates argued that the bill’s requirement that index fund managers solicit voting instructions from index fund investors could lead the funds to forgo voting (and thus avoid the costs and complexities associated with obtaining the instructions). They warned that this dynamic could lead short-term investors, foreign investors, and proxy advisory firms to have even more influence in shareholder voting (as index funds would be less likely to exercise their voting power). Prof. Griffin argued however that the status quo of prevalent empty voting (which refers to the situation where one party has control rights over a vote while lacking the economic ownership associated with those rights) creates misaligned incentives. He acknowledged that while an allowance of pass-through voting might result in a reduction of predictability for corporate voting outcomes, he asserted that the current predictability in corporate votes stems from the outsized power of large shareholders. He commented that this outsized power from large shareholders is detrimental because it creates a “corporate governance monoculture” across all large public companies.
  • Potential Use of Indirect Democracy for Shareholder Voting: Prof. Griffin suggested that policymakers could pursue indirect democracy in shareholder voting where investors could instruct management to vote their shares in alignment with a third-party representative. He noted that these third-party representatives might include corporate management, index fund managers, or non-profit organizations. He stated however that he prefers the use of pass-through voting.
  • State Laws that Resemble the INDEX Act: Sen. Kevin Cramer (R-ND) discussed how several states, including Texas and West Virginia, have passed laws that were similar to the INDEX Act. Sen. Cramer and Prof. Griffin raised concerns however that these state laws addressing the proxy voting practices of index funds could politicize the issue and create a fragmented regulatory landscape for index fund managers. They expressed their preference for a federal policy solution to this issue.
• Other Policy Issues: The hearing also considered various topics related to shareholder voting and the current corporate governance landscape.
  • Current Private Sector Efforts to Improve Shareholder Voting: Committee Members, Prof. Coates, and Prof. Griffin expressed interest in how market participants are currently developing technology solutions (including pass-through voting systems) to improve the corporate voting process. Prof. Griffin noted how index funds are already pursuing pass-through voting systems voluntarily for both institutional and retail clients. Prof. Coates stated that while he is receptive to having index funds take instruction from their investors on shareholder votes, he asserted that this work would require pilot projects and experimentations to ensure that it is done in a cost-effective way. He also highlighted how BlackRock’s current pass-through voting pilot programs are focused on institutional investors. He asserted that the provision of pass-through voting for individual investors would be significantly more complicated and expensive to implement. He further stated that index fund investors that choose not to exercise their new voting powers under the INDEX Act would still need to bear the costs associated with setting up and operating a pass-through voting system.
  • Weakness of the Best Interest Standard: Prof. Griffin remarked that the requirement that index fund managers vote in the best interest of their investors is the only substantive legal constraint governing empty voting. He contended that this requirement is “surprisingly weak” and noted how not a single index fund vote had ever been deemed to violate the best interest standard. He stated however that he could not definitively assert that index funds are voting against the interests of their investors because index funds are not required to solicit any input on proxy votes from their investors. He added that index funds do not generally engage in “meaningful” efforts to voluntarily solicit input from their investors.
  • Reforms for Private Companies: Sen. Jack Reed (D-RI) discussed how many public companies were working to avoid scrutiny and transparency through going private. Prof. Coates recommended that Congress revisit the thresholds for public companies set forth under the Securities Exchange Act of 1934. He noted how index funds made it possible for most listed companies to have fewer than 300 shareholders and still amass large amounts of capital.
  • The U.S. Securities and Exchange Commission’s (SEC) Process for Considering No Action Letters: Sen. Kevin Cramer (R-ND) expressed interest in determining whether the SEC is fairly granting and denying no action letter requests. Prof. Griffin noted how there exists some academic research that suggests that the SEC’s decision to grant or deny a no action letter was somewhat impacted by the staff member that receives the no action letter request. He also mentioned how the SEC had made recent changes governing what could and could not be excluded from a shareholder proposal. He noted that many no action letter requests might now be related to these exclusions and commented that the SEC’s recent no action letter decisions may have disturbed longstanding positions in this area. He remarked however that the SEC’s no action letters do not significantly impact index fund proxy voting at the current time.
  • Corporate Disclosures of Political Giving: Sen. Robert Menendez (D-NJ) and Prof. Coates expressed support for having the SEC require that companies disclose their political spending to shareholders. They argued that this information was material to investors and noted how the SEC’s ability to issue rules in this area is limited by a current budget rider. Sen. Menendez also mentioned how he had introduced the Shareholder Protection Act of 2021, which would enable investors to influence the political spending of publicly traded companies more directly.
  • Efforts to Ensure that Index Funds Adhere to their Stated Principles: Sen. Menendez further asserted that investors should be able to verify that index funds are voting in line with their stated principles. Prof. Coates mentioned how the SEC currently had a rule pending that would improve the detail with which index funds have to disclose their votes. He also expressed support for requiring more frequent reporting from the large index fund companies. He noted how these large index fund companies are currently required to issue annual reports and how these funds issue quarterly reports on a voluntary basis. He contended that these large index fund companies could issue reports on an even more frequent basis.

Hearing Witnesses:

Panel I:

1. The Hon. Dan Sullivan, U.S. Senator, Alaska

Panel II:

1. Prof. John C. Coates IV, John F. Cogan, Jr., Professor of Law and Economics, Harvard Law School
2. Prof. Professor Caleb Griffin, Assistant Professor of Law, University of Arkansas School of Law

Member Opening Statements:

Full Committee Chairman Sherrod Brown (D-OH):

• He remarked that index funds have become increasingly important for American families in recent decades as corporations have either cut or eliminated pension plans and as the rate of unionization of workers has declined.
  • He commented that labor unions had traditionally fought for the retirement security of American workers.
• He discussed how index funds had received a variety of criticisms, including allegations that the funds were Marxist, that the funds promoted anti-competitive business behaviors, that the funds were too active in the affairs of the companies that they own, and that the funds were too passive in the affairs of the companies that they own.
• He stated that the hearing would consider how index funds vote using their corporate shares and whether fund investors should be able to vote on the shares held and managed by the fund advisor.
  • He asserted that the crux of the hearing involved who should exercise the market share that index funds have gained.
• He noted how current corporate and securities laws provide power to index fund directors and managers to make investment decisions.
  • He mentioned how some critics argue that these laws entrusted a limited number of people with too much power.
  • He also mentioned how some critics argue that index fund companies are abusing their power to pursue activist social policies while other critics argue that these companies are not doing enough to address social issues.
• He stated that index funds have long-term investment horizons and expressed interest in how these funds are ensuring that corporate executives are considering the long-term value of their companies.
  • He asserted that a corporate focus on workers and communities would be key to realizing this long-term value.
• He remarked that ensuring the long-term success of a company sometimes necessitates the adoption of corporate policies that account for climate change risk, promote workplace diversity, or support human capital management.
• He raised concerns that the INDEX Act proposed by Sen. Dan Sullivan (R-AK) would cause index fund managers to not cast votes on key corporate governance issues.
  • He also stated that while this legislation is meant to address the largest index fund companies, he expressed concerns that the legislation might also impact smaller index fund companies.
• He noted that the INDEX Act would preclude index fund managers from voting their held shares without direction from their fund’s investors.
• He commented that while the idea of obtaining direction from index fund investors prior to a vote appeared democratic, he asserted that this proposal failed to consider the cost and complexity associated with obtaining direction, as well as the sheer number of votes involved.
  • He indicated that popular and widely held index funds would need to reach out to hundreds of thousands of clients for direction on over tens of thousands of corporate votes each year to be in compliance with the INDEX Act.
• He noted how industry data indicates that individual stockholders tend to vote their shares only 30 percent of the time.
  • He commented that index fund holders are less likely to vote their shares given the passive nature of the investment.
• He remarked that the INDEX Act would leave index fund investors with two bad outcomes: no voice on corporate decision making or being inundated with votes on thousands of corporate issues.
  • He also warned that the INDEX Act could provide more power to short-term investors or large foreign investors.
• He stated that the INDEX Act could particularly harm smaller companies because the legislation would make it more expensive and time consuming to reach out to stockholders.
• He contended that any reforms to index funds should not undermine low-cost access to diversified savings and investments.
• He discussed how the SEC is working to improve the corporate voting process and increase transparency.
  • He also mentioned how market participants are developing technology solutions to improve the corporate voting process.
• He stated that while the current corporate voting system is imperfect, he asserted that moving to a system that would suppress corporate voting or provide more influence for short-term interests would be unwise.

Full Committee Ranking Member Patrick Toomey (R-PA):

• He remarked that the U.S. had experienced a democratization of its capital markets over the previous several decades and stated that U.S. retail investors now have unprecedented access to investment products at lower costs.
  • He highlighted how U.S. retail investors can access zero-commission trading, narrower bid-offer spreads, and convenient and user-friendly interfaces.
• He discussed how U.S. retail investors have access to numerous low-cost or zero-expense passive index funds and exchange-traded funds (ETFs) and commented that these investment funds were very popular.
  • He highlighted how index funds had held $12.5 trillion in assets at the end of 2021.
• He stated however that the “tremendous growth” of index funds presents a problem in that a retail investor that purchases an index fund technically does not own the stocks in the fund.
  • He explained that the index fund itself owns the stocks and that the index fund’s manager could decide how to vote the index fund’s shares.
• He remarked that this situation provides index fund managers with “enormous” influence over companies, even though they are voting with shares purchased with other people’s money.
• He further raised concerns that the concentrated nature of the index fund industry and commented that this market dynamic makes a small number of asset managers disproportionately influential with every large public company in the U.S.
  • He noted how BlackRock, State Street Corporation, and Vanguard are collectively the largest voting blocs in nearly 90 percent of S&P 500 companies.
  • He indicated that these companies derive much of their voting power from ordinary Americans that purchase index funds.
• He stated that some index fund asset managers are using their voting power to advance their own political agendas and commented that these asset managers could use their voting shares to apply pressure to companies outside of formal votes.
• He recounted how BlackRock, State Street Corporation, and Vanguard had recently backed the efforts of Engine No. 1 to install directors on ExxonMobil’s board of directors who were sympathetic to Engine No. 1’s views on climate change issues. 
  • He explained that Engine No. 1 is a small hedge fund that owned just 0.02 percent of ExxonMobil’s voting shares.
• He asserted that the support of BlackRock, State Street Corporation, and Vanguard had been key for the success of the Engine No. 1 ExxonMobil proposal.
  • He questioned whether the support of these companies for the Engine No. 1 ExxonMobil proposal had been reflective of the views of the investor clients of the companies.
• He remarked that investors could choose to invest in actively managed funds if they want to pursue certain policy goals.
  • He commented however that passively managed funds are not supposed to impose a strategic vision or agenda on companies and are instead supposed to neutrally follow the market.
• He also highlighted how index fund asset managers are voting shares that have been purchased using other people’s money and asserted that these asset managers should not be using the voting power of their clients to pursue their own political agendas.
  • He commented that investors select index funds to track (rather than influence) the market.
• He remarked that Congress must address how large asset managers vote using other people’s shares and how these large asset managers have consolidated corporate voting power.
• He called on the U.S. to return voting power in companies to the true investors of the companies and mentioned how he is a cosponsor of the INDEX Act.
  • He explained that this legislation would require any asset manager of a passive index fund with more than one percent of a company’s voting shares to vote those shares in accordance with the fund’s investors or not vote at all.
• He also noted how the INDEX Act recognizes that index fund investors might want some guidance in deciding how to vote their shares.
  • He indicated that the legislation would require asset managers to permit third-party vote recommendations on their platform to provide investors with guidance on their votes.
  • He also indicated that the legislation would require asset managers that provide third-party recommendations to do so in a non-discriminatory fashion.
• He further noted how the INDEX Act would allow for recommendations to take the form of general voting instructions given in advance.

Panel I Opening Statements:

Sen. Dan Sullivan (R-AK):

• He remarked that the impetus for the INDEX Act was his frustration with large U.S. banks and insurance companies that had pursued policies to prevent oil and gas development in his state of Alaska.
  • He called these policy stances hypocritical given how these same banks and insurance companies were concurrently engaging in business in communist China.
• He attributed the decision of many large U.S. banks and insurance companies to impede oil and gas development to pressure from the three largest U.S. investment advisory firms (BlackRock, State Street Corporation, and Vanguard) and their index funds.
• He remarked that the BlackRock, State Street Corporation, and Vanguard have disproportionate influence in U.S. public markets.
  • He noted how these firms manage $20 trillion in combined assets, are the largest shareholders in 90 percent of S&P 500 companies, and cast nearly 25 percent of all votes at annual meetings for U.S. public companies.
  • He added that these numbers had been even larger prior to the recent market correction.
• He noted that while the growth in popularity in index funds has benefited investors in terms of greater market diversification and lower fees, he stated that this growth in popularity has also resulted in unintended consequences.
  • He commented that these unintended consequences include the “unprecedented” consolidation of stock ownership and voting power of BlackRock, State Street Corporation, and Vanguard.
• He remarked that BlackRock, State Street Corporation, and Vanguard wield their market dominance through “behind the scenes” engagement with corporate management and warned that these companies could steer public markets toward their preferred policies.
  • He commented that this steering circumvents the political accountability of the legislative process.
• He contended that the influence of BlackRock, State Street Corporation, and Vanguard should be concerning to all Americans, regardless of political party.
  • He commented that while many might agree with the policy preferences of these companies, he noted that changes in leadership could lead these companies to pursue different policies.
• He asserted that the INDEX Act was politically and policy neutral and was focused on addressing the “unprecedented” power being amassed by large investment advisory firms.
• He noted how the INDEX Act would require investment advisors of passively managed funds to vote their proxies in accordance with the instruction of fund investors and not at the discretion of the advisor.
  • He commented that this proposal would return voting power back to the beneficial owners of the shares.
• He stated that the INDEX Act would be a logical extension of the Dodd–Frank which had prohibited broker-dealers from voting shares held on behalf of clients.
• He remarked that the INDEX Act would both neutralize the “massive power” that the largest investment advisors have amassed and empower the real beneficial owners of the shares.
  • He asserted that the legislation would foster a healthier, more competitive, and more democratic corporate governance system.

Panel II Witness Opening Statements:

Prof. John C. Coates IV (Harvard Law School):

• He remarked that policymakers should approach the current situation involving index funds as one that involves tradeoffs.
• He stated that index funds have and continue to provide “enormous” benefits to U.S. investors, including low fees, diversification and downward pressure on investment fees.
  • He further highlighted how index fund investors did not need to spend time monitoring the funds because the fund’s investments were tied to an index.
• He commented that while the INDEX Act is well-intentioned, he contended that the legislation would do more harm than good.
• He stated that the INDEX Act would pose significant pass-through costs on all investors through forcing funds to provide information on votes for their various companies.
  • He commented that current data suggests that few people would take advantage of this information and ability to vote on shareholder proposals.
• He emphasized that all index fund investors would bear the costs associated with requiring additional information disclosures, regardless of whether individual investors make use of it.
  • He asserted that these new costs would make index funds less attractive and impede their ability to provide benefits to consumers.
• He noted that the INDEX Act would enable index fund investors to vote their shares in the same way as other investors or refrain from voting their shares.
  • He asserted that both approaches would be worse than the status quo.
• He remarked that these new voting approaches would lead to unpredictability in outcomes through shifting voting power from index funds to other institutions, such as proxy advisors, activist hedge funds, or corporate management.
• He stated that while the goals of the INDEX Act are laudable, he asserted that any remedy to current index fund voting issues must be more cautious and conservative.
  • He expressed support for increasing index fund transparency for shareholders and suggested that index funds could adopt conflict of interest rules at the complex level.
• He also expressed his receptiveness to having index funds take instruction from their investors on shareholder votes.
  • He commented however that such work would require pilot projects and experiments to ensure that it was done in a cost-effective way.

Prof. Caleb Griffin (University of Arkansas School of Law):

• He remarked that the U.S. corporate governance system is largely based upon empty voting and commented that this dynamic has led to distorted incentives.
  • He also stated that the best interest standard (which currently governs index fund voting) is insufficient.
• He contended that pass-through voting would solve the aforementioned empty voting problem and would restore agency to investors.
  • He also commented that pass-through voting constitutes the lowest cost approach for “meaningfully” addressing the empty voting problem.
• He discussed how index funds have assumed a new and unprecedented role as the most influential players in corporate governance and stated that BlackRock, State Street Corporation, and Vanguard play a “pivotal role” within this space.
  • He noted how these three investment advisory firms cast about 25 percent of the votes at S&P 500 companies and indicated that this figure is expected to grow over the coming decades.
• He called it ironic that index funds have made their managers among the most powerful corporate governance actors and asserted the current reliance on empty voting is suboptimal.
  • He explained that empty voting refers to the situation where one party has control rights over a vote while lacking the economic ownership associated with those rights.
  • He also mentioned how Congress had eliminated the practice of empty voting within the broker dealer space more than a decade ago.
• He stated that empty owners have interests that are poorly aligned with the interests of true owners and are more susceptible to conflicts of interest.
  • He noted however that virtually all public companies in the U.S. face the prospect of being controlled by empty voting.
• He remarked that the requirement that index fund managers vote in the best interest of their investors is the only substantive legal constraint governing empty voting and contended that this requirement is “surprisingly weak.”
  • He noted how not a single index fund vote had ever been deemed to violate the best interest standard.
• He raised concerns that the weakness of the best interest requirement is leading index funds to vote in a manner that might be “totally untethered” from the interests of their investors.
• He stated however that he could not definitively assert that index funds are voting against the interests of their investors because index funds are not required to solicit any input on proxy votes from their investors.
  • He added that index funds did not generally engage in “meaningful” efforts to voluntarily solicit input from their investors.
• He remarked that the U.S. should transfer some of the voting power from index fund managers to index fund investors and suggested that this could be accomplished through two approaches.
• He indicated that the first approach would involve permitting individual investors to set their own voting instructions.
  • He suggested that this could be accomplished through categorical pass-through voting, which would involve having investors provide semi-specific instructions.
• He indicated that the second approach would involve indirect democracy where investors could instruct management to vote their shares in alignment with a third-party representative.
  • He noted that these third-party representatives might include corporate management, index fund managers, or non-profit organizations.
• He remarked that pass-through voting would constitute the lowest cost approach and would address existing shareholder voting issues.
  • He mentioned how many parties (including BlackRock) were already working to develop pass-through voting technology.
• He stated that other remedies for addressing the market dominance of incumbent investment advisory firms (such as breaking up or capping the largest firms) would be more costly.
  • He commented that pass-through voting would preserve the economies of scale of the large investment advisory firms while addressing concentration of voting power concerns.

Congressional Question Period:

Full Committee Chairman Sherrod Brown (D-OH):

• Chairman Brown noted that while the concept of passing through voting rights from index fund managers to index fund investors seems appealing, he commented that such pass-throughs would be complicated to implement. He asked Prof. Coates to describe the logistical and practical concerns associated with passing through voting rights from index fund managers to index fund investors.
  • Prof. Coates first discussed how index funds have hundreds of thousands of investors and that pass-through voting would require these funds to obtain voting instructions from all of these investors. He also highlighted how many index fund investors are funds and commented that these funds might also be subject to pass-through voting requirements. He then discussed how much of the investment in index funds comes from omnibus accounts, which are brokerage accounts that aggregate individual accounts. He noted how these omnibus accounts shield the identity of their investors from index funds for competitive reasons. He commented that the process for obtaining voting instructions from these investors is also very complicated given the complex nature of the arrangements. He then described the current shareholder voting process as a “work in progress” and stated that a new pass-through voting system would likely be costly, time consuming, and error prone. He noted how the major players in the basic shareholding voting system are just now attempting to provide confirmations back to investors about whether their voting instructions have been followed. He stated that the INDEX Act’s pass-through voting proposal would provide additional layers of complexity to the existing shareholder voting system, which he asserted are already complex. He concluded that pass-through voting remains “unworkable” at the present time.
• Chairman Brown then mentioned how Prof. Griffin’s testimony suggests that the INDEX Act could allow for a variety of options to obtain voting input from index fund investors. He also noted how Prof. Griffin had suggested that some index fund managers were already pursuing efforts to obtain voting input from index fund investors. He asked Prof. Griffin to indicate whether these efforts to obtain voting input from index fund investors have potential.
  • Prof. Griffin answered affirmatively. He stated that while having individuals pass-through several thousand votes would be unmanageable, he suggested that the ability of shareholders to delegate their voting powers to third-parties would address the problems of empty voting. He acknowledged that while pass-through voting proposals do carry costs, he asserted that these costs were very manageable. He noted how index funds are already pursuing pass-through voting systems voluntarily for both institutional and retail clients. He also remarked that there could be serious costs associated with having empty voting dominate U.S. corporate governance. He commented that misaligned incentives could result in significant costs and how empty voting could lead to monopoly effects. He mentioned how Columbia Law School Professor Zohar Goshen had asserted that the corporate governance philosophy espoused by BlackRock, State Street Corporation, and Vanguard has been responsible for decades of wage stagnation for employees. He concluded that pass-through voting is very feasible.
• Sen. Brown asked Prof. Coates to provide recommendations for both the SEC and index fund companies to ensure that public companies are more accountable and more transparent. He acknowledged that his question period time had expired and requested that Prof. Coates respond to his question in writing.

Full Committee Ranking Member Patrick Toomey (R-PA):

• Ranking Member Toomey discussed how BlackRock, State Street Corporation, and Vanguard wield significant influence in casting proxy votes and noted how these three companies control a plurality of proxy votes. He commented however that the influence of these investment advisory firms extends beyond proxy voting and stated that the three firms exert significant influence over corporate boards of directors selection processes. He asserted that this ability to influence corporate boards of directors selection processes makes corporate management teams more willing to take direction from the large investment advisory firms. He asked Prof. Griffin to comment on this dynamic.
  • Prof. Griffin remarked that the large investment advisory firms exercise power through proxy votes, electing corporate boards of directors, and through setting industry standards. He elaborated that public companies tend to quickly adopt the preferred governance positions of the large investment advisory firms. He acknowledged that while an allowance of pass-through voting might result in a reduction of predictability for corporate voting outcomes, he asserted that the current predictability in corporate votes stemmed from the outsized power of large shareholders. He commented that this outsized power from large shareholders is detrimental because it creates a “corporate governance monoculture” across all large public companies.
• Ranking Member Toomey then mentioned how Prof. Coates’s main criticism of the INDEX Act was that it would be challenging and expensive to implement. He acknowledged that while an index fund might be responsible for voting on a very large number of issues, he stated that the INDEX Act’s authors had worked to address this complexity. He also mentioned how BlackRock views this issue as manageable. He asked Prof. Griffin to discuss the mechanisms under consideration that could address the complexities associated with providing index fund investors with more voting rights.
  • Prof. Griffin first noted how the INDEX Act would only apply to index funds controlling more than one percent of the voting shares of a given stock. He stated that this provision would effectively target the largest investment advisory firms and commented that these firms could bear these costs. He then noted how there exist feasibility concerns related to the delegation of votes from index fund managers to index fund investors on a wide variety of issues. He contended that the use of categorial pass-through voting and indirect democracy could address these concerns. He also discussed how the INDEX Act would provide a neutral platform for third-party recommendations for shareholder votes. He stated that this use of a neutral platform could support the competition of ideas within the shareholder voting space, which could be beneficial.
• Ranking Member Toomey emphasized that the INDEX Act will allow for index fund investors to delegate their votes to index fund managers if they wish to.

Sen. Jack Reed (D-RI):

• Sen. Reed noted how many investment managers currently engage outside proxy advisory firms for guidance on shareholder votes. He asked Prof. Coates to address how the INDEX Act would impact how investment managers use outside proxy advisory firms.
  • Prof. Coates discussed how institutional funds that did not invest through index funds often relied upon proxy advisory firms, such as Institutional Shareholder Services (ISS) and Glass Lewis, for shareholding voting advice. He noted how BlackRock is currently pursuing pilot programs to enable institutional investors to vote their index fund shares. He stated that institutional investors that participate in these pilot programs will likely be forgoing the stock voting advice of an index fund manager (i.e., BlackRock) and will instead be relying upon the stock voting advice of proxy advisory firms. He remarked that these pilot programs would merely change who institutional investors would receive voting advice from and commented that the outcome would likely fall short of the INDEX Act’s goals. He also highlighted how BlackRock’s pilot programs were focused on institutional investors. He asserted that the provision of pass-through voting for individual investors would be significantly more complicated and expensive to implement. He further stated that index fund investors that chose not to exercise their new voting powers under the INDEX Act would still need to bear the costs associated with setting up and operating a pass-through voting system. He suggested that the imposition of a fee on index fund investors that sought to exercise their new voting rights could address this issue. He stated however that such a fee would not be permitted under the Investment Company Act of 1940 and commented that the INDEX Act does not address the aforementioned issue. He concluded that the INDEX Act would result in proxy advisory firms becoming even more powerful.
• Sen. Reed then discussed how many public companies were working to avoid scrutiny and transparency through going private. He asked Prof. Coates to indicate whether private companies should be required to report basic information (such as their audited financial statements) if they reach a certain size.
  • Prof. Coates noted how index funds provide significant amounts of capital to companies through a single entity. He discussed how the actual number of record holders of publicly listed companies had fallen “dramatically” over the past 20 years. He also noted how most of the companies that had gone public in 2021 did not exceed the thresholds that required SEC registration. He stated that this decline in the number of record holders meant that modern public companies have very different characteristics than the public companies that had been in existence when U.S. securities laws were first written. He recommended that Congress revisit the thresholds for public companies set forth under the Securities Exchange Act of 1934. He noted how index funds made it possible for most listed companies to have fewer than 300 shareholders and still amass large amounts of capital.

Sen. Kevin Cramer (R-ND):

• Sen. Cramer mentioned how he is a co-sponsor of both the INDEX Act and a sponsor of the Fair Access to Banking Act. He then expressed interest in the SEC’s process for granting and denying no action letter requests. He asked Prof. Griffin to address whether the SEC is fairly considering no action letter requests with respect to index funds.
  • Prof. Griffin noted how there exists some academic research that suggests that the SEC’s decision to grant or deny a no action letter was somewhat impacted by the staff member that receives the no action letter request. He also mentioned how the SEC had made recent changes governing what could and could not be excluded from a shareholder proposal. He noted that many no action letter requests might now be related to these exclusions and commented that the SEC’s recent no action letter decisions may have disturbed longstanding positions in this area. He remarked however that the SEC’s no action letters do not significantly impact index fund proxy voting at the current time.
• Sen. Cramer then discussed how several states, including Texas and West Virginia, have passed laws that were similar to the INDEX Act. He asked Prof. Griffin to project the impacts associated with having states address the proxy voting practices of index funds.
  • Prof. Griffin remarked that state laws addressing the proxy voting practices of index funds could politicize the issue and create a fragmented regulatory landscape for index fund managers. He commented that this dynamic could increase costs for index funds. He contended that a unified standard for proxy voting practices and federal action would thus be desirable.
• Sen. Cramer stated that federal action to address the proxy voting practices of index funds would be preferable to a fragmented state-based approach. He then criticized the current metrics being used to assess energy companies as being overly political. He suggested that the metrics used to assess energy companies should account for factors like energy reliability and energy costs. He contended that metrics for assessing companies should be based on current factors and not on perceived crises that were years away from materializing.

Sen. Robert Menendez (D-NJ):

• Sen. Menendez noted how current rules do not require that companies disclose their political spending to shareholders. He stated that corporate executives could thus spend investor money on political causes without any consideration of shareholder views or the company’s public commitments. He asked Prof. Coates to indicate whether shareholders of companies expect that the companies will act in a manner that is consistent with their publicly stated company policies.
  • Prof. Coates answered affirmatively.
• Sen. Menendez mentioned how many public companies had pledged to suspend or reevaluate their political donations to members of Congress that had voted against the certification of U.S. Electoral College votes from the 2020 U.S. Presidential election. He asserted that these pledges demonstrated that political donations are material business decisions. He noted however that many of these public companies have subsequently resumed their political donations to members of Congress that had voted against the certification of U.S. Electoral College votes from the 2020 U.S. Presidential election. He asked Prof. Coates to indicate whether corporate political spending constitutes material information that should be disclosed to investors.
  • Prof. Coates stated that corporate political spending was “on average” material information that should be disclosed to investors. He expressed his support for the Democracy Is Strengthened by Casting Light On Spending in Elections (DISCLOSE) Act of 2022 and for eliminating the current budget rider that has prohibited the SEC from addressing the topic of political donations. He remarked that the political involvement of some companies is “first order” to their strategies and asserted that the disclosure of this involvement is important for investors.
• Sen. Menendez expressed agreement with Prof. Coates’s response. He noted how he had long advocated for strengthening the SEC’s political spending disclosure rule. He also mentioned how he had introduced the Shareholder Protection Act of 2021, which would enable investors to influence the political spending of publicly traded companies more directly. He stated that the enhanced disclosure of relevant information for publicly traded companies would empower investors. He discussed how many investment fund managers will voluntarily issue proxy voting guidelines that provide an outline for how the funds tend to vote their proxies. He asked Prof. Coates to indicate whether this type of disclosure was useful to investors.
  • Prof. Coates answered affirmatively. He stated that this type of disclosure would be critical for enabling index fund investors to make informed corporate governance choices when using their new shareholder voting rights (as contemplated in the INDEX Act). He added that corporate political activity should be included as part of investor disclosures.
• Sen. Menendez reiterated that investors need corporate political spending information so that they could make informed decisions. He also remarked that it was important for investors to be able to verify that index funds were voting in line with their stated principles. He asked Prof. Coates to address how Congress could make disclosures regarding votes that have been taken more informative and comprehensible for investors.
  • Prof. Coates mentioned how the SEC currently has a rule pending that would improve the detail with which index funds have to disclose their votes. He also expressed support for requiring more frequent reporting from the large index fund companies. He noted how these large index fund companies are currently required to issue annual reports and how these funds issue quarterly reports on a voluntary basis. He contended that these large index fund companies could issue reports on an even more frequent basis. He stated that having more real-time and better disclosure would enable markets (rather than laws) to direct the operation of companies more efficiently.

Sen. Chris Van Hollen (D-MD):

• Sen. Van Hollen first expressed agreement with Sen. Robert Menendez’s (D-NJ) remarks regarding the importance of corporate investor disclosures. He then discussed how index fund investors can choose to invest in the underlying stocks of the fund and noted how index fund managers has a duty to look out for the best interest of their investors. He asserted that the INDEX Act would not advance shareholder democracy because it would permit index fund managers to opt out of voting their shares. He stated that this opting out would result in no one looking out for the best interest of index fund investors. He asked Prof. Coates to indicate whether he agreed with his statement.
  • Prof. Coates expressed agreement with Sen. Van Hollen’s statement. He asserted that the INDEX Act would lead to less voting by the longest-term investment funds.
• Sen. Van Hollen asked Prof. Coates to indicate whether reduced shareholder voting from index fund managers would increase the share of shareholder voting from hedge funds and other short-term investors.
  • Prof. Coates answered affirmatively.
• Sen. Van Hollen mentioned how he had never voted his shares when he had owned individual stocks. He predicted that the enactment of the INDEX Act would lead many individual shares to go unvoted. He commented that this non-voting of index fund shares would increase the voting power of other shareholders. He then asked Prof. Coates to discuss the costs that would be imposed by the INDEX Act. He stated that many people currently invest in index funds because of their low-cost nature.
  • Prof. Coates recounted his experience distributing money through a fair fund at the SEC to mutual fund investors. He stated that the identification of mutual fund investors had been an “incredibly complex” process and noted that many of the mutual funds did not know the identities of their investors. He explained that many mutual fund investments come from brokers and indicated that the brokers often do not want the mutual funds to know the identities of their clients. He remarked that it would be expensive for mutual funds to identify their investors for the purposes of obtaining shareholder voting instructions. He predicted that most investment fund advisors would abstain from voting the shares of their retail investors under the INDEX Act because it would be very expensive for them to identify all of their investors. He remarked however that there exists an opportunity for the U.S. to improve the shareholder voting process and commented that this would require experimentation and pilot programs.
• Sen. Van Hollen asked Prof. Coates to indicate whether the INDEX Act would allow for an index fund investor to easily delegate their voting power to the index fund manager.
  • Prof. Coates remarked that the INDEX Act contains some ambiguities. He stated that the current version of the INDEX Act would not allow for index fund managers to provide their investors with an opt-in or opt-out option for shareholder voting. He indicated that the legislation calls on index funds to request pass-through voting instructions from each of their investors or to abstain from voting their shares.
• Sen. Van Hollen asked Prof. Coates to indicate whether the INDEX Act would require index fund managers to request voting instructions on each of the companies whose shares were held in the index fund.
  • Prof. Coates answered affirmatively.
• Sen. Van Hollen concluded that the INDEX Act’s failure to enable index fund investors to easily delegate their shareholder votes is anti-democratic.

Sen. Thom Tillis (R-NC):

• Sen. Tillis discussed how index funds provide retail investors with access to low cost and diversified investment portfolios that do not need active management. He stated however that the index fund industry’s concentration had grown significantly since its inception. He mentioned how the share of assets managed by the five largest investment advisory firms had risen from 35 percent in 2005 to 54 percent in 2021. He asked Prof. Coates and Prof. Griffin to indicate whether the index fund industry’s increasing concentration is an unintended development.
  • Prof. Coates answered affirmatively.
  • Prof. Griffin answered affirmatively.
• Sen. Tillis noted how BlackRock, State Street Corporation, and Vanguard collectively cast an average of 25 percent of the shareholder votes for S&P 500 companies. He called this figure significant. He noted how there are projections that these three companies could control as much as 40 percent of shareholder votes for S&P 500 companies within two decades if current trends continue. He asked Prof. Coates and Prof. Griffin to indicate whether they agreed or disagreed with these trendlines.
  • Prof. Coates predicted that the voting share of index funds would continue to grow over the next ten years. He called the goal of the INDEX Act laudable in that it sought to address the accountability problems associated with the growth of index funds.
  • Prof. Griffin also predicted that the voting share of index funds would continue to grow over the coming decades.
• Sen. Tillis then discussed how a small number of institutional investors are using their voting power to impose their views on companies. He asked Prof. Griffin to indicate whether institutional investors ought to be subject to due diligence requirements when backing shareholder proposals.
  • Prof. Griffin remarked that due diligence requirements for institutional investors could be beneficial. 
• Sen. Tillis also asked Prof. Griffin to indicate whether institutional investors should be required to disclose their analyses to prove that their votes were in the best economic interests of their shareholders.
  • Prof. Griffin remarked that requiring the disclosures of analyses from institutional investors could be beneficial.
• Sen. Tillis mentioned how he is a co-sponsor of the INDEX Act and stated that the legislation would help to address the distortion of power in U.S. capital markets. He remarked that the legislation would return voting power to individual investors from institutional investors. He asked Prof. Griffin to opine on the INDEX Act.
  • Prof. Griffin remarked that pass-through voting is the best and lowest cost option for addressing the current problems within the U.S. shareholder voting system. He specifically stated that pass-through voting would help to address the concentrated nature of the U.S. shareholder voting space. He expressed his support for pass-through voting pilot programs. He also suggested that Congress consider extending the INDEX Act’s implementation to 3 years post-enactment (instead of 2 years post-enactment).
• Sen. Tillis lastly expressed interest in how ISS and Glass Lewis currently maintain a duopoly within the proxy vote advisory space. He asked Prof. Coates and Prof. Griffin to provide their opinions on this situation for the hearing’s record.

Sen. Steve Daines (R-MT):

• Sen. Daines expressed his support for the INDEX Act and stated that the legislation would shift corporate voting power away from investment advisors and toward individual investors. He remarked that while passive investing through index funds has provided “tremendous” benefits to investors, he contended that “woke” investment managers have created problems for index fund investing. He stated that investment managers (including BlackRock, State Street Corporation, and Vanguard) are using their client’s capital to advocate for viewpoints that their clients disagreed with. He remarked that the concentration of power among a small number of investment advisory firms should be of concern to all Americans. He specifically raised concerns over how activist hedge fund Engine No. 1 had been able to leverage their 0.02 percent of ExxonMobil’s shares and the support of BlackRock and Vanguard to replace three ExxonMobil corporate directors with “climate activist” board nominees. He noted how Engine No. 1 had subsequently pressured ExxonMobil to cut its oil production in October 2021. He stated that the world now faces an energy crisis and mentioned how President Biden is now pushing for increased oil production. He indicated that he would soon be introducing legislation to codify a 2020 U.S. Department of Labor (DoL) rule that would require plan fiduciaries in retirement plans to prioritize financial factors above all other considerations when making investment decisions. He then noted how there are arguments that it would be too difficult to permit individual index fund investors to vote the individual shares that are held in their index funds. He asked Prof. Griffin to indicate whether he agreed with these arguments.
  • Prof. Griffin remarked that there exist a variety of tools that would enable individual index fund investors to vote their shares.
• Sen. Daines asked Prof. Griffin to indicate whether concerns over increased shareholder participation in the proxy voting process are based on fears that this participation would reduce the influence of “woke” asset managers and corporations.
  • Prof. Griffin remarked that the voting motivations of index fund managers are difficult to discern. He noted that one theory is that index fund managers view index fund voting as a compliance cost and that these managers are very willing to offload this cost to outside parties. He noted that another theory is that index fund managers adopt activist positions to differentiate themselves from their competitors to attract investment.
• Sen. Daines asked Prof. Griffin to opine on how a small activist hedge fund has been able to leverage its small investment and two large investment advisory firms to oust three activist corporate directors from ExxonMobil.
  • Prof. Griffin stated that this episode involving Engine No. 1 and ExxonMobil had demonstrated the concentration of voting power among the three largest investment advisory firms. He called this concentration of voting power dangerous and asserted that it did not support good corporate governance.