Activist Actions of Index Funds Need to be Restrained

In the world of finance, the Big Three asset managers - BlackRock, Vanguard, and State Street - hold a significant influence over corporate America, controlling more than 20 percent of the total U.S. stock market capitalization. One of these giants is the largest shareholder in 88 percent of S&P 500 companies.

The growing power of these passive funds has sparked debates about their role in corporate governance. James R. Copland, a senior fellow and director of legal policy for the Manhattan Institute, argues that the beauty of index investing lies in its humility, recognizing that most people can't beat the market and shouldn't try.

However, concerns have been raised about the potential influence of passives on corporate governance through shareholder pressure campaigns. To address these concerns, Senator Dan Sullivan reintroduced the INDEX Act. This legislation proposes a "mirror voting" rule, where passive funds cast votes in the same proportion as other non-passive shareholders if they can't determine the voting preferences of the underlying investor.

The INDEX Act aims to ensure that passives are not used to influence corporate governance, making passive funds essentially neutral, similar to abstaining from a vote. Under this rule, the large passive funds would vote the same way they invest: passively, mirroring the votes of those investors actively engaged in price discovery.

Despite the introduction of the INDEX Act, there is no clear information about the specific members of Congress who introduced the bill or any changes in the number of politically radical proposals receiving shareholder support. This year, shareholder voting in support of such proposals on big companies' proxy ballots is in decline. On average, left-leaning environmental and social proposals won support from just 16 percent of shareholders this proxy season, down from 33 percent in 2021.

The Biden administration has previously changed policy to prod investors toward Environmental, Social, and Governance (ESG) considerations, but the INDEX Act does not mention any policy changes by the administration or a future Democratic administration regarding ESG.

This trend of declining support for politically radical proposals could easily shift back again in the future. The INDEX Act suggests that Congress needs to act on this legislation to regulate passive funds' voting rights and maintain a balance in corporate governance.