Social impact investors appear to be losing a battle with advocates of curbing the influence of ESG data on corporate decision-making, a feud playing out before business-friendly U.S. financial regulators that may shape a specialized corner of investing for years.

In a series of conference calls by the Securities and Exchange Commission last month to brief financial services stakeholders, a senior government official (whose anonymity was made a condition of participation in the calls) said the agency is writing new limitations on the proxy advisory industry to curb proxy advisors’ influence on corporate decision-making. 

According to the chief of sustainable investing at a major US pension fund who participated in one of the calls, the agency intends to make changes that will make it harder for “shareholders who come to the game with a political or cultural agenda to use proxy advisory firms to do their bidding.” The source spoke on condition of anonymity, citing SEC confidentiality demands.

Among the changes contemplated, according to the source: 

  • Raising the minimum ownership stake required of shareholders submitting proposals from $2,000 to $10,000. This would keep many nonprofits from qualifying.
  • Raising the level of support required (currently at 3%) for a previous shareholder resolution to be resubmitted. Critics see this as a way to prevent unwelcome resolutions on ESG matters from gaining support over time.
  • Requiring more disclosure from proxy advisory firms on how their shareholder proposals are formulated and whether clients – the actual institutional shareholders – participated in the process. 

In part, these reforms can be presented as a reasonable reaction to the dominance of two proxy advisory firms, Institutional Shareholder Services (ISS) and Glass, Lewis & Co. Researchers at George Mason University estimate that these two firms together have a 97% share of the market for proxy advisory services. 

Recent studies indicate that the industry’s institutional investment clients — pension funds, labor unions and other funds that hold 70% of all U.S. outstanding publicly traded shares — rarely play an active role in shaping shareholder proposals or proxy challenges. Despite being legally required to engage in the process they have effectively outsourced that role to proxy advisors. This, naturally, has raised the question of whether proxy advisors — and these two firms in particular — have too much power. 

“Should these firms be held to a fiduciary standard to ensure their recommendations are in the best interest of shareholders?” asks a May 2018 paper by three Stanford professors that was cited as “influential” by the SEC in its conference call. Significantly, the paper contains many of the proposals to curb proxy advisory firms outlined in the SEC conference calls. 

But the debate as framed by the SEC struck ESG professionals as being aimed at reversing recent trends favoring a broader interpretation of corporate responsibility. 

“The tone of the presentation, and previous remarks from SEC Commissioner [Elad] Roisman, suggest the agency is siding with those who believe ESG has gone too far,” the unnamed ESG professional said. “They’re going after proxy advisors as a way to curb it.”

Proxy advisory services are the third-party consultants who manage shareholder resolutions and proxy votes, often demanding changes in corporate governance, environmental or labor practices. They play a particularly big role for many ESG and impact investment clients, whose proxy advisors filed some 464 ESG resolutions in 2018, up from 407 in 2010, according to the Sustainable Investments Institute. 

Roisman, a Trump appointee who joined the SEC in 2018, has made his position clear. In a speech to a mutual funds conference in March, Roisman questioned the validity of ESG principals when they conflict with traditional ROI metrics. 

“It is important to achieve a balance here so that we allow for robust shareholder engagement without providing a mechanism for certain shareholders with idiosyncratic views to use the shareholder proposal system in a way that does not benefit the interests of the majority of long-term shareholders,” he said.

Soon after that speech, in May, the SEC formally issued notice that it will change the proxy process, though it did not release details of its plans. The conference calls that began in June are seen as a way to test stakeholder reaction to the idea of placing strong curbs on proxy advisory firms, and by association, the ESG principles they tend to promote.