Nov. 2, 2022
Thank you, Chair Gensler. Director Birdthistle, congratulations on such a remarkable team. So remarkable is the team that I want to take a moment to recognize an impressive achievement by the Division of Investment Management—four rulemakings between this week’s and last week’s open meetings. All of these rules are substantial. I cannot overstate what a feat the teams have accomplished in an extremely compressed time period. Rulewriters’ midnight oil has been burning for many months now. Complementing their work are the intense efforts of many others across the Division—including staff in DRAO and the Chief Counsel’s Office charged with working with funds and advisers as they implement new rules—and across the Commission. Countless people have poured themselves into these rulemakings. The Division of Economic and Risk Analysis and the Office of General Counsel are under tremendous pressure to provide economic and legal analysis very quickly. Even if some of the policy choices embedded in these rules are not choices I would have made, I marvel at the staff’s work.
If we had confined ourselves simply to implementing the Dodd-Frank mandate on say-on-pay reporting for institutional investment managers, I would have supported this rulemaking. If we had paired that additional reporting obligation with an elimination of the 2003 rule to mandate the disclosure of proxy votes for funds, I would have supported this rulemaking with great enthusiasm. Rather than eliminating the 2003 mandate, however, we are expanding it. The expansion will serve the needs of third parties eager to pressure funds to vote their way, but will harm funds and fund investors. Accordingly, I cannot support this rulemaking.
For example, the final rule will require funds to identify the subject matter of each reported voting item from a selection of standardized, but non-exclusive, categories, which we claim will facilitate easier searches and increase comparability. In response to comments, the final rule contains fewer categories and has reworked subcategories into examples within the different categories. Funds must “select all categories applicable to the matter” voted, which the adopting release claims “will further aid investors in locating useful information by allowing them to identify multiple topics that may be of interest.” These groupings will fail of their purpose because of the unavoidable level of subjectivity involved in classifying each voting topic. Take, for example, the “Human rights or human capital/workforce” category, which encompasses “workforce-related mandatory arbitration” and “outsourcing or offshoring,” but not “environmental justice.” “Responsible tax policies” belong in “Other social issues,” as does “data privacy.” We suggest that a proposal that ties executive compensation to a successful merger should be in both the “Compensation” and “Extraordinary transaction” categories. If the merger involves a foreign entity, or a company with manufacturing facilities in a repressive country is it then also in the “Human rights or human/capital workforce” category? Will funds be able to make sense of these categories, and, if they do, will they make sense of them in the same way other funds do? What happens when today’s hot topics give way to tomorrow’s? Since fund investors are unlikely to be poring over these vote reports, maybe it does not matter much, but funds will incur categorization costs and categorization anxiety. Rather than run the risk of being second-guessed by Exams, Enforcement, and third parties, funds likely will err on the side of caution and take the “All of the above” approach.
Just as detailed chronicling of votes will not benefit the average investor, neither will requiring funds to disclose how many shares they have decided to leave out on loan instead of voting them help investors. A clear declaration of fund voting and lending practices would cost far less and enable the few investors who are so inclined to pick funds based on their approach to recalling shares. The mandated disclosure will be granular and costly to compile with precision, but will not provide worthwhile insight into the analysis that fund managers undertake in deciding whether to recall shares. As former SEC Commissioner Elad Roisman explained when we proposed the rule, the manager undertakes “a calculus that can involve, for example, weighing how significant that company’s shares are to the overall portfolio, how likely it is that the fund will influence the outcome of the vote, and what issues might be on the company’s agenda in the first place.” The manager also takes into account lending revenue that would be forgone if the shares were recalled, a factor that likely is of greater interest to many investors than whether shares are voted or how, unless, of course, the shares are being voted to further the interests of third parties.
Judging from the limited discussion accorded to the opportunity cost of recalling lent shares, the Commission does not seem to care much about the financial costs of voting. Many commenters expressed concern that mandating a disclosure of unrecalled securities, bereft of context and a discussion of consequences, will place significant pressure on managers to recall securities to avoid negative ESG ratings. Although the final rule allows managers to provide some context, the nudge to vote remains strong.
The lack of concern for the trade-offs around recalling lent securities to vote is part and parcel of a larger theme that courses through this rulemaking. Voting is presumed to be a fund’s highest function. As I routinely do, I asked the following questions when reviewing this rulemaking: What problem are we trying to solve? And for whose benefit are we doing this? The release asserts confidently that the added information serves shareholders, but evidence that investors want such detailed information is scant. Third parties with an interest in pressuring funds to vote in a particular way do have an interest in the information, but should fund investors be footing the bill to make it easier for third parties to assess funds’ voting patterns? This new requirement, I suggest, may turn out to be less about reporting voting practices than it is about manipulating them
The Commission is too enthusiastic about the rule’s purported benefits to pay much attention to its costs. For instance, in response to commenters’ concerns that some custodians do not provide the information managers will need to report the number of unrecalled securities, we suggested that disadvantaged managers engage their custodians to obtain it. Assuming custodians and securities lending agents are willing to provide this added service, fees will most certainly go up. Large fund managers will be able to absorb these additional costs or pass them along to clients, but smaller managers will be at a distinct disadvantage. The complicated manner in which we will assess who holds voting power also is destined to create confusion and generate costs.
Thank you again to the staff for the care that went into drafting this final rulemaking.
 See Comment letter from the U.S. Chamber of Commerce, December 14, 2021 (“More importantly, the SEC seems to be assuming with the Proposal that investor interests on certain issues will always revolve around topics that may have been popular during the 2020 proxy season. What if investors begin demanding that companies be
responsive to societal issues that are currently not on the SEC’s radar?”), https://www.sec.gov/comments/s7-11-21/s71121-20109518-263914.pdf.
 See, e.g., Comment letter from Federated Hermes, December 14, 2021 (“We are concerned that the proposed rulemaking, as currently written, could act as a deterrent to securities lending because of the potential negative implications of the required disclosures on Form N-PX, even in the many cases when engaging in securities lending has been determined by the investment adviser to be in the best interests of a fund and its shareholders.”), https://www.sec.gov/comments/s7-11-21/s71121-20109570-263927.pdf; Comment letter from Risk Management Association, December 14, 2021 (“In addition, we are concerned that this single data point indicating shares not recalled could be viewed in a negative light by market data firms providing ESG rankings. This could lead these firms to inappropriately compare funds based on the simple percentage of shares recalled to vote, rather than considering the full information about the decision-making process used by the manager to properly exercise their fiduciary duty to investors and to maximize shareholder value. Said differently, funds could receive a lower ESG ranking for the fact that their portfolio managers adhered to their fiduciary principles to seek to achieve maximum shareholder benefit while adhering to their fund’s investment mandate.”), https://www.sec.gov/comments/s7-11-21/s71121-20109561-263922.pdf.
 See, e.g., Comment letter from BlackRock, December 14, 2021 (“Finally, as an operational point, fund custodians are typically the primary source of data on which shares are on loan over a record date; however, the practice of
including this information with the proxy ballot currently varies. *** Absent a requirement that custodians furnish this data alongside each proxy ballot, the process of determining this information would be highly labor intensive for fund managers and impose increased administrative costs on investors, as each fund manager must determine the settled shares on loan as of the relevant record date for every position that could be voted on by a fund. While larger firms like BlackRock with sufficient technology resources could potentially compile this data, requiring such disclosure may be disadvantageous or overly burdensome for smaller firms.”), https://www.sec.gov/comments/s7-11-21/s71121-20109576-263949.pdf.