Index Fund Proxy Voting and Fiduciary Liability

Could a general failure to address the importance of index fund proxy voting rights derail the ongoing indexing trend among ERISA plan sponsors?

By John Manganaro | May 08, 2015
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A recent report from Wintergreen Advisers argues there is a critical flaw underlying the current trend of plan sponsors pushing more and more assets into lower-fee index funds—a flaw that could be construed as a fiduciary violation.

The report’s title doesn’t mince words: “How the Votes of Big Index Funds Feed CEO Greed and Put Americans’ Retirement Savings in Peril.” Neither do David Winters, CEO of Wintergreen Advisers, and Liz Cohernour, chief operating officer (COO) of Wintergreen, in discussing what they see as major failures on the part of the big index fund providers to ensure individual investors are treated fairly.

Winters tells PLANSPONSOR that passive U.S. equity funds gathered an impressive $167 billion in assets in 2014, ending the year with about $2.2 trillion in assets under management (AUM). He suggests the growth has been fueled by “huge advertising and PR budgets” among some of the largest and well-known index fund providers—whom are well aware that sponsors running plans under the Employee Retirement Income Security Act (ERISA) are highly sensitive to fee issues.

This fee sensitivity has continued to increase with the prevalence of ERISA lawsuits and class action challenges around higher-priced investments, Cohernour notes, and with the reintroduction of the Department of Labor’s new fiduciary rule. As a result, sponsors feel a huge amount of pressure to use passive index funds that have lower stated fees than more active investments.

It’s a familiar story to most working in the ERISA domain—but Cohernour and Winters feel there is a key theme that has so far gone unnoticed by most industry practitioners. As Winters puts it, “The problem is simply that the big index fund providers have adopted a pattern of rubberstamping the compensation packages of executives across indexes such as the S&P 500, and this has led to truly runaway compensation and has actually damaged the returns of the end investors routing money into these major index funds.”

The Wintergreen report reviews voting histories of the largest S&P 500 index funds run by Vanguard, BlackRock and State Street, for example, and finds that over the past five years for the 25 largest companies in the S&P 500, these firms’ funds cast their votes in favor of management equity compensation plans 89% of the time, and actively opposed executives’ pay packages less than 4% of the time.

“If you take a step back, this really does not jive with ERISA and the fiduciary duty that sponsors have to ensure fees paid either directly or indirectly from plan assets are reasonable,” Cohernour suggests. “As you know, it’s a basic duty for all fiduciaries dealing with retirement money to look at the value of a security in a few ways. There is the basic price value—the cost of the stock itself. And then in addition to this there is the proxy voting value of the stock, which also has real value and must be considered by fiduciaries making investment decisions.”

This thinking is touched on in a 2008 interpret bulletin from DOL, which sets forth the department’s interpretation of Sections 402, 403 and 404 of ERISA, as those sections apply to voting of proxies on securities held in employee benefit plan investment portfolios. The guidance also touches on the maintenance of and compliance with statements of investment policy, including proxy voting policy.