Vanguard is one of the world’s largest asset managers, handling the retirement savings of millions of Americans. Its mission is to help people save for the future. At the same time, it’s playing a major role directing billions in funding to carbon polluters — companies maintaining and expanding the fossil fuel infrastructure that threatens to make the future uninhabitable.Fossil fuel stock prices are based on oil reserves that will not actually be burnable if we expect to avoid catastrophic effects due to climate change. Countries are already moving to restrict emissions and transition to clean energy alternatives. Money invested in fossil fuel infrastructure is likely to become ‘stranded assets’….Vanguard is behind the curve with only one socially responsible portfolio. That’s the Vanguard FTSE Social Index Fund, and with holdings in ConocoPhillips, Kinder Morgan, and other large oil companies, it’s hardly fossil free. But it’s the only mutual fund Vanguard offers with a responsible investing mandate.
Is Pollution Value-Maximizing? The DuPont Case is a case study by Roy Shapira and Luigi Zingales that finds even a billion dollar fine for violating environmental laws can be cost-effective in creating shareholder value. This is what we have referred to as “the externalizing machine,” the corporate structure that makes it not just possible but inevitable that corporations will maximise the upside for executives and shareholders while imposing all of the costs on the government and the community.
DuPont, one of the most respectable U.S. companies, caused environmental damage that ended up costing the company around a billion dollars. By using internal company documents disclosed in trials we rule out the possibilities that this bad outcome was due to ignorance, an unexpected realization, or a problem of bad governance. The documents rather suggest that the harmful pollution was a rational decision: under reasonable probabilities of detection, polluting was ex-ante optimal from the company’s perspective, albeit a very harmful decision from a societal perspective. We then examine why different mechanisms of control – legal liability, regulation, and reputation – all failed to deter socially harmful behavior. One common reason for the failures of deterrence mechanisms is that the company controls most of the information and its release.
The authors conclude:
There are two clear findings in this case. The first one is that inefficient pollution pays off, even when a company anticipates all the legal consequences of its behavior. While the specifics are very case contingent, the reasons why pollution occurs are not. Regulation does not work because the penalties are too low and the regulators too captured. Legal liability does not work because victims find it hard to collect the information and sue. Even when – through a series of lucky circumstances – victims win the
legal battle, the penalty comes too late to deter pollution. Market discipline in the form of reputational sanctions cannot operate given the asymmetric information, and the inability of academics and journalists to certify and widely diffuse opaque information. Even when bad news breaks, the company can still maneuver to reduce attribution of responsibility and mitigate any reputational damages.
The second finding is that the main way corporations succeed in reducing their expected liability is by suppressing and distorting information.
The only way to begin to address this balance is to ensure that incentive compensation is reliant on meeting or exceeding environmental standards and debarring board members of companies that pay multi-million dollar fines from serving on public company boards.
VEA Vice Chair Nell Minow interviewed Joshua Levin for the Huffington Post:
A new service allows even small investors to pick companies based on their values by swiping right. It is called OpenInvest, and it is available on iTunes. Joshua Levin, co-founder and chief strategy officer, explained how it works.
Where did this idea come from?
It comes from staring down “the giant paper packet.” If you own individual stocks, this is the thing that arrives at your doorstep, allowing you to vote in major company decisions. These shareholder votes are absolutely one of your most powerful tools to shape the world, often driving major corporate decisions on how to treat people and the planet – everything from climate change policies to treatment of LGBTQ employees and more. The corporations we all own are more powerful than governments and also happen to set the political agenda.
Yet no one fills these things out. It feels like you need a law degree and a free weekend, and none of your friends are doing it, so what’s the point?
Even worse, if you own funds, you’ve most likely signed away your voting rights. For example, in 2015, Vanguard voted against all 200 sustainability-related shareholder resolutions, according to Barron’s.
The shame in all this is that we actually have collective ownership of the economy. Individual investors directly and indirectly own nearly 80% of US equities markets. We’re literally in charge. The CEOs work for us and report to us. They are awaiting our commands. But no one is using their power due to unnecessary confusion, intermediaries, and red tape.
By disrupting this system, we are kicking off the world’s first digital democracy. We’ve spent years cutting through complexity and special interests on the back-end, to deliver a seamless and engaging democratic system on the front. People will only see the votes that matter to them, get a 2-sentence summary of the issue, vote with a swipe (as easily as picking a date on Tinder), and then share with others.
Does it just offer NYSE and NASDAQ stocks, or are other kinds of securities available?
Yes, OpenInvest portfolios are structured as a blended portfolio of equities listed in the S&P 500 index (which only has stocks listed on either the NYSE or the Nasdaq), but are reflective of the retail investor’s values, combined with a green or traditional bond fund. By design, each user’s equities portfolio will track the performance of the S&P 500. It’s like each person has their own index fund.
The SEC and state regulators have a lot of requirements about the information that has to be provided to investors. How do you make that work on a “swipe right” system?
OpenInvest is an RIA and Fiduciary that serves the best interests of our clients. We took great pains to provide a robust and fully compliant proxy policy for our users, which explains our approach in full and is amended into our SEC filings. When clients receive a distilled summary of a vote, it is a prompt with a link to learn more through the official corporate proxy statement. When they swipe, the client is informing our vote, which is cast in accordance with this policy. It’s like a digital conversation with a client, who we already know very well. This makes it sound simple, but it took years to develop and is patent pending.
What kinds of priorities can people put into the system to shape their portfolios?
We currently have 11 “themes” – which are both positive and negative filters – that an investor can choose from and mix and match to suit their values. They can also swipe individual names in and out to further customize. The current themes include Carbon Emissions, Fossil Fuels, Deforestation, LGBTQ Rights, Tobacco, Weapons Manufacturers, Women in the Workplace, Divest from Trump, Supporting Refugees, Divest from Dakota Access Pipeline, and Human Rights in the Supply Chain.
What other kinds of information will you be adding?
Most of our upcoming themes are top secret. But we are on the brink of launching a screen that helps people divest themselves of the prison-industrial complex. We are also adding significant amounts of financial education and video content. How does the rebalancing work? Is it affected by the limits customers place on their holdings?
The key to maintaining both diversification and values is technology. For example, when the Wells Fargo consumer fraud scandal occurred, many of our customers picked up their smartphones and swiped Wells right out of their portfolios. On the back-end, our systems instantly break apart and rebalance their portfolios to keep them diversified and tracking the performance of the benchmark. It’s the first time anyone can be a social activist investor, while always holding a passive portfolio.
By design, customers can select all of our screens and still hold a sufficiently diversified portfolio that broadly tracks the market. We do have some “power users” who divest from so many things that we have to engage them as a fiduciary. We let them know that they are at risk of creating significant variance (tracking error) from the benchmark, and we do not recommend that they proceed from a financial standpoint. However, if they would like to proceed, we can help them implement. We’re very happy to empower people; they just need to go in with their eyes open.
Do millennials have different priorities for investing than the previous generations?
When polled, 84% of millennials want to invest in companies that share their values, according to a Morgan Stanley study. Our internal data also shows, for example, that 63% of Americans under 40 care deeply about climate change, so that greatly affects their investment choices. However, millennials are also the most diverse American generation to-date. They desire customization to their particular values, as well as a visceral connection to their impacts, and an amazing digital experience. Recent tech developments are finally making this possible. We are putting socially responsible investing at the fingertips of the generation who will mainstream this movement.
VEA was proud to support the rulemaking petition at the SEC for better, clearer disclosure of human capital information. This is the comment we have filed.
September 27, 2017
Honorable Jay Clayton
U.S. Securities and Exchange Commission
110 F Street. N.E.
Washington D.C. 20549
Re: Human Capital Management Disclosures Rulemaking Petition
Dear Chairman Clayton,
We write in support of better disclosure of human capital information on behalf of ValueEdge Advisors, a consulting firm specializing in corporate governance, working primarily with institutional investors. This comment, however, reflects only our own views, based on decades of working in the fields of corporate governance and capital formation.
As you know, GAAP data came out of an era when a company’s primary worth was based on real property, equipment, and its inventory of tangible products. We now live on a time when companies’ primary assets and liabilities are all human capital, the abilities, knowledge, and relationships of its employees. You can hardly find an issuer’s annual report that does not claim the company’s primary assets are its people. And yet you would not know that from looking at balance sheets, which are skimpy when it comes to information we find essential for evaluating investment risk. Just as important, it is information corporate executives themselves must have in order to develop strategy and evaluate operations.
We strongly endorse the position of the Human Capital Management Coalition (HCM) as outlined in their comment letter of July 6, 2017, that better disclosure of an issuer’s record on human capital is achievable at very low cost, and of enormous value to investors, analysts, and the issuers themselves. The kind of information we would like to see includes employee turnover, employee training, and opportunities for advancement.
It is important to emphasize that this is not in any way a political agenda. It reflects concerns raised by respected institutional voices like BlackRock’s Larry Fink and the Sustainability Accounting Standards Board (SASB), which produces reports like “Human Capital in the Age of Fintech.” As noted in the HCM letter, “SASB has identified one or more human capital issues as ‘material’ for accounting purposes for at least some industries in each of its 10 sectors. It has characterized human capital as a ‘cross-cutting’ issue.” (footnotes omitted)
Such disclosure will not inhibit capital formation. Quite the contrary, it will make capital allocation more efficient, and any such claims should be closely examined for proof. And it will not impose any additional costs. The information needed for disclosure is already available and relied on by executives and managers, or, if it isn’t, they are overlooking critical data and that in and of itself is of vital interest to investors. If part of what investors need to do is evaluate risk, it is far more significant to know how much a company is investing in employee development and whether employees are satisfied enough to stay in their jobs, keeping crucial institutional knowledge in-house, than to know what the depreciation schedule is for some forklifts. There is hard data, readily available, about employee capabilities, training, and treatment. And there are unprecedented changes ahead from the development of AI and the increasing seamlessness of global outsourcing. Both can be enormous accelerants for corporate operations, but both pose enormous risks as well, in oversight and in the scope of problems, like cybersecurity, that are difficult to predict.
We will not reiterate the extensive points made by HCM; we incorporate them by reference, and provide this comment only to underscore our strong belief that this is an essential area for SEC action. We request that hearings be scheduled and would be glad to provide any additional information that may be of help.
Richard A. Bennett Nell Minow
President and CEO Vice Chair
Consider that the 2017 Impact Investor Survey by the Global Impact Investing Network calculated the amount of money deployed into impact investing as roughly $110 billion, a tiny fraction of the $70 trillion value of public companies. Unless impact investing becomes more inclusive and more accessible to everyday American investors — U.S. mutual funds are in fact the world’s largest component of corporate ownership — we will continue to miss out on 99 percent of the impact that investing can have by affecting existing companies and markets.
The New York Times also notes other recent examples of executives whose comments were deemed to hurt the company’s brand or reputation.
Engaging in problematic activity has forced several chief executives from their jobs.
■ Brian J. Dunn of Best Buy had a relationship with an employee (2012)
■ Matt Harrigan of PacketSled ranted on social media on election night about killing President-elect Trump (2016)
■ Brendan Eich of Mozilla donated $1,000 in support of a ballot measure to ban same-sex marriage, causing outrage in Silicon Valley (2014)
■ Klaus Kleinfeld of Arconic wrote to a hedge fund manager without the board’s knowledge (2017).
On July 26, at the annual shareholder meeting of McKesson, the nation’s largest distributor of pharmaceuticals, including opioid drugs, shareholders refused to approve the company’s generous executive-compensation plan after the International Brotherhood of Teamsters—which holds stock in McKesson—campaigned against it, citing the company’s “role in fueling the prescription opioid epidemic.” McKesson rejected that characterization, and denied that it had any such role. Calling the opioid, heroin, and fentanyl epidemic “complicated,” Jennifer Nelson, a spokesperson for McKesson, told me that “in our view, it is not to be laid at the feet of distributors.” The Teamsters, she charged, were trying to use the addiction crisis to their advantage in their ongoing labor dispute with the company involving the union’s efforts to represent workers at a McKesson distribution center in Florida.<P><P>The shareholder vote, which isn’t binding—McKesson says it’s still reviewing its current compensation plan—may seem like a minor slap over an esoteric bit of corporate governance, but it was a notable exception among public companies. According to the consulting firm Compensation Advisory Partners, of 447 say-on-pay votes among S&P 500 companies this year before early August, only five, including McKesson, suffered rejection. The Teamsters view the outcome as a success, especially at a time when unions’ power has waned. “Unions have been pushing for years for standard good-governance practices” in companies, says Michael Pryce-Jones, the union’s senior governance analyst. “This has importance across political divides.”
I’ve written earlier pieces about the failure of the people who manage our money, especially our retirement savings to provide essential feedback to the companies whose stock they buy on behalf of more than 40 percent of working Americans, charging us as many as 16 undisclosed fees and usually voting against shareholder initiatives on improving board, increasing the link between CEO pay and performance, and making better disclosures on climate change, cybersecurity, diversity, and other issues relating to investment risk and corporate reputation. There’s been a little bit of progress at Vanguard, one of the most powerful and influential money managers, with more than three TRILLION dollars invested, so I asked one of the most thoughtful leaders in this field, Tim Smith of Walden Asset Management, some questions about why that is important and what it means.
How much stock in big American companies is controlled by these firms? How much money is involved?
These are massive investment firms. BlackRock has over $5 trillion dollars in Assets they are managing and Vanguard approximately $3.5 trillion. The raw size of their holdings results in having tremendous power with the companies they own. Most firms that have outreach to their primary investors always make sure to arrange visits with Vanguard and BlackRock as a necessary stop.
Why does it matter how they vote on topics like climate change and disclosure of political contributions when even a 100 percent vote is advisory only and does not require the company do anything?
Shareholder resolutions filed on social and environmental issues have a 45 year history as investors raise important environmental , employee relations, human rights, workplace health and safety issues among others. These resolutions and the engagements that accompany them have had a significant long-term impact on company policies and practices. There are literally hundreds and hundreds of examples of companies responding positively to investor input by
* expanding their corporate disclosure for investors and the public
* changing their policies, practices, and behavior
* updating governance policy
*taking forward-looking steps on an issue like climate change
*making sure hazardous products are removed from food or a production process influencing workers.
*adding diverse candidates to the Board
And the list goes on. Whether a shareholder resolution is binding or not seems immaterial . Companies often see these issues as affecting their reputation and their credibility with investors or consumers as well as affecting them financially over time. Thus many companies take action stimulated by the case being made by investors — but also by their own sense of how acting in a responsible way is good for their business and long term shareholder value.
So how investors vote is vitally important because it is a clear indicator of how a company’s shareowners feel about an issue. To blindly vote for management in virtually all cases not only distances the investor from important decisions that affect them financially but is far from acting as a “responsible fiduciary.” In short, it definitely matters how they vote your shares!
Every mutual fund company files a form NPX each August disclosing how they vote. So there is a public record. In addition Ceres, the environmental organization, summarizes how funds vote on climate related issues, a good indicator of an investment firm’s voting stance. You can see which funds vote for climate resolutions 0 percent of the time or 15 percent or over 50 percent.
What have you been doing to try to get Vanguard and Blackrock to be more transparent and engaged in share ownership rights like proxy voting?
Over the last several years companies like BlackRock and Vanguard which had a consistent record of voting against all social and environmental resolutions faced growing pressure from clients and investors. In addition, media attention compared them unfavorably to companies like State Street which showed real forward progress in proxy voting. In addition, PRI expects its members to demonstrate seriousness in being an “active owner.”
Walden Asset Management, where I serve as Director of ESG Shareowner Engagement, led a shareholder resolution to both companies and was joined by other investors as cofilers. This prompted both companies to sit down with us to see if we could come to an agreement allowing the resolution to be withdrawn before the vote. As I said, even non-binding shareholder proposals can have an impact.
Both discussions were productive, leading to agreements, and both companies disclosed their new thinking about proxy voting on their websites, highlighting their deep concern about climate risk and their strong support for diversity on boards of directors.
What does this latest statement from Vanguard signify? Does it go far enough?
These are important steps forward by two of the world’s largest investment managers. Their engagements with companies send a strong message to executives that it is necessary to address and urgently act on climate change, for example. But their voting record is still at the bottom of the ladder. They voted for two resolutions, at ExxonMobil(62.3 percent shareholder support) and Occidental (67 percent shareholder support) but they voted no on dozens of other climate-related resolutions. It’s a start but still demonstrates a very modest voting record. Pressure will doubtlessly mount on these two giants to match their rhetoric with actual votes pressing companies to move with some sense of urgency on key environmental and social issues.
What more would you like money management firms like Vanguard and Blackrock to do?
Vote more aggressively, be transparent about what is put on the table in their meetings with companies (no need to mention companies by name), join other investors in speaking out on key environmental/social/governance issues affecting companies financially, meet with shareholder resolution proponents to better understand their positions, speak publicly about the value of the shareholder resolution process, and make sure will not be eradicated by proposals by led by the Business RoundTable or Chamber of Commerce.
ESG is an abbreviation used to identify investing priorities that do not fit into traditional financial metrics: environment, social, governance. But it is increasingly clear that traditional financial metrics miss a lot of what goes into assessing risk and creating long-term value and that ESG factors are an essential element in predicting investment risk and return. “ESG is the best signal we have found for future risk,” says a new study from Bank of America Merrill Lynch. “What if we told you how to avoid stocks that go bankrupt?” It concludes that “US corporates may be behind the curve… but investors are ahead of it & PE multiples are responding.”
And so, ESG investing has moved into the mainstream. A recent survey commissioned by State Street Global Advisors found that eighty percent of global institutional investors have an ESG component as part of their investment strategies, with seventeen percent reporting more than half of their assets based in part on ESG factors. More than two-thirds said that integration of ESG has significantly improved returns and that pursuing an ESG strategy has helped with managing volatility. Significantly three-quarters of respondents said they had the same performance expectations for ESG as they do for other investments.
John Goldstein, co-founder of Imprint Capital and a managing director in Goldman Sachs Asset Management has said that investing for ESG requires the same rigor and discipline as “traditional” investing, and the distinction between the two is growing increasingly irrelevant.
Signs of this trend include continued growth in the volume of managed assets that incorporate ESG research, increasingly sophisticated investor tools, more ESG information providers, more ESG information gathering frameworks, more indices incorporating ESG data, and the use of ESG factors across asset classes, including fixed income and alternatives. According to data collected by the Global Sustainable Investment Alliance, ESG investment strategies, broadly defined, currently account for 22.9 trillion dollars in managed assets worldwide, up from 13.3 trillion dollars in 2012.
The G in ESG is for governance. My former firm, GMI Ratings (now part of MSCI) developed a governance rating system based on board decisions (not rhetoric), like CEO pay and financial reporting. It was such a reliable predictor of litigation and liability risk that it was used by D&O insurers as well as investors and law and accounting firms.
Increasingly sophisticated tools for understanding ESG issues are used by those who hold stock as well as those who buy and sell it. Index funds have to manage risk and return without trading those shares that remain in the index. The exercise of ownership rights – proxy voting, litigation, and engagement on ESG issues including climate change, compensation, and board composition – has very attractive cost-benefit potential.
Just a few years ago, shareholder proposals relating to environmental concerns were a long way from majority support. This year, three climate change proposals at energy companies came close to getting support from nearly two-thirds of the shareholders. I serve on the board of the 5050 Climate Project, which provided support for these proposals which were submitted to ExxonMobil, Occidental Petroleum, and PPL (another proposal, at Chevron, was withdrawn following successful negotiations with the company).
S is for “Social,” which has been something of a catchall category, often been dismissed as non-quantitative, even a distraction from the business of business. But in a world where a video shot on a cell phone of a passenger being dragged off an airplane can go viral and cause a drop in the stock price, it is clear that “social” is no longer an adequate description for indicators of management vulnerabilities and blind spots. One telling recent example was also based in an online complaint that went viral. For years, concerns were expressed about the “bro” culture at Uber, but the attitude of analysts and insiders seemed to be “boys will be boys.” Perhaps there was a rueful headshake now and then, but apparently the board believed that the same qualities that made co-founder/CEO Travis Kalanick brash and boorish made him visionary and dynamic. That was until a programmer Susan J. Fowler wrote about her “one very strange year” of virulent mistreatment, ultimately leading to the departure of Kalanick as CEO (though he remains on the board, for now). A male director who made a sexist joke (Women sure do talk a lot! Funny!) at a meeting about sexism also resigned. A new CEO with a very different reputation has just been named.
“Social” concerns about respectful treatment of customers and a diverse workforce are not “nice to have.” Like environmental and governance excellence, they are “have to have.” Failure to address these issues in a robust and transparent manner presents risks, as the Uber experience shows, at the very highest levels. If “social” suggests actions irrelevant or even detrimental to financial performance, S should now be understood to stand for “strategy,” “sustainability,” and, of course, “shareholder value.”
It really hurts to do this because I have nothing but admiration for all these guys and they get huge bonus points for a completely hilarious title for this episode. But holy moly did they get it wrong. Here’s their description:
Felix Salmon, senior strategy officer at a political risk startup, Anna Szymanski, Slate Moneybox columnist Jordan Weissmann, and Julia Shin—vice president and managing director of Impact Investing at Enterprise Community Partners—discuss:
the disbanding of Trump’s CEO council
companies’ responsibilities to their shareholders
Here’s what they missed, very, very briefly:
Perhaps they think that their audience is primarily made up of the tiny fraction of Americans who sit at home and make individual stock picks. That’s not very likely; they’re over at Motley Fool. Most individuals, as the people on this podcast know very well, invest via mutual funds and pension funds. The story they should be looking at, which they touch on very briefly, is the evolving role of large institutional investors, like Blackrock, in the area they call “impact investing” or ESG, and, just as important, the way that evolving role reflects a more sophisticated understanding of metrics and indicators that are just as quantifiable and just as important for evaluating risk and return as too-easily manipulated traditional metrics like EPS and PE ratios. Both of these points are absolutely fundamental, but most of this podcast skirts those issues by accepting outdated notions about trade-offs between financial gain and investing to warm the cockles of the heart.
I won’t reiterate the extensive writing we have done on those issues, which we will continue to explore even more extensively in the future, I’m sure. We hope some day Slate will, too.