The corporate governance spotlight, at least in some circles, has often been on directors and shareholders. Today, the classic problems of some holding ‘other people’s money’, or the ‘separation of ownership and control’, have grown. Asset managers or banks (like BlackRock, Legal & General, or JP Morgan) are usually the registered shareholders in large corporations, all bought with other people’s money. This means more delegated agency problems. The EU is changing shareholder engagement rules, but everyone should be clear who shareholders are, and support the voice of the ultimate investor.
The ultimate investor in capital is usually someone saving for retirement, through a pension, life insurance or mutual fund. Those funds usually delegate investment tasks to asset managers – although this does not show up on UK share ownership (or most other) statistics:
As investment became less individual, more institutional and global, asset managers and banks took votes. They use votes, but make no investment. They can govern companies, but bear no economic risk. They bear no costs from unemployment, or dwindling retirement savings. So, corporate governance is developing – and it must – to ensure asset managers are bound to clients’ instructions by (1) intensifying legal duties globally, (2) applying established precedent in common law and equity, and (3) recalling the economic imperative to avoid conflicts of interest.
1. Global shareholder responsibility
At least three developments globally have intensified financial intermediary duties since 2008.
First, the UK Stewardship Code 2010 said stewardship’s aim is ‘enhancing and protecting the value for the ultimate beneficiary or client’. There is no goal of achieving or even maximising ‘shareholder value’ (a phrase with a cultural, not a legal basis) especially when shareholders are asset managers. The same year, an Association of Member Nominated Trustees organised, the first representative pension group of its kind, and has started to use its voice in corporate governance. In law, asset managers must protect the interests, not of themselves, but of their beneficiaries and clients.
Second, the US Dodd-Frank Act of 2010 §957, 15 USC §78f(b)(10) banned broker dealers voting on other people’s money without express instructions: to elect board members, on executive pay or issues the SEC considers ‘significant’. The US does not yet bind all intermediaries to instructions, but is ahead of the UK on this front: High Street retail banks still appropriate votes on other people’s shares.
Third, the Swiss People’s Initiative of 2013, with the second highest majority ever, banned banks voting on shares deposited with them. Pension funds have a new duty to vote themselves. By contrast, German banks still control around 60% of votes in public companies on other people’s money. They and Swiss banks are functionally equivalent to UK or US asset managers. But the Swiss public decided votes in the economy should no longer be monopolised by shareholder intermediaries.
Who should cast votes?
The big question is this: who decides on the interests of the true investor? Who gets votes in the economy? The answer the law gives is that the ultimate investor has those inherent rights, but may delegate voting power through express instructions or a representative voting mechanism. UK pension law (originally in 1995, codifying social standards) requires that pension trustees or directors are at least one-third nominated by beneficiaries (either through a direct election, or elected workplace representatives). Many pension funds like the Universities Superannuation Scheme or Railways Pension Scheme go beyond this representation minimum, by collective agreement. Different rules apply to Open-Ended Investment Companies (OEICS – pronounced ‘oiks’) or other EU collective investment schemes, that pension funds usually buy into.
But even the biggest pension funds delegate investment choices to asset managers. The asset manager (with, say, two or five members of staff in its corporate governance team) will have a standard policy on voting shares, set by fund managers. They send these policy instructions to proxy advice firms (usually Institutional Shareholder Services or Glass Lewis) for mass voting, like using a remote control. Asset manager policies usually support corporate directors, even if this means complacency about super-inflationary pay, short termism, or environmental damage. So what does the law say about voting power, without express statutory rules?
2. The fiduciary duty to follow instructions
The law requires asset managers to follow their clients’ voting instructions, whether money is pooled or not. The Cadbury Report in 1992 stated voting rights are ‘an asset, and the use or otherwise of those rights by institutional shareholders is a subject of legitimate interest to those on whose behalf they invest’ (para 6.12). The Hampel Committee in 1998 recommended ‘institutional investors of all kinds, wherever practicable, to vote all the shares under their control, according to their own best judgement, unless a client has given contrary instructions’ (para 5.7). Hard law goes even further.
Fiduciary duties and pooled funds
First, all money invested with an asset manager is impressed with fiduciary duties. In Barlow Clowes International Ltd v Vaughan  EWCA Civ 11,  on pooled mutual funds, the Court of Appeal unanimously held ‘assets and moneys’ with BCI Ltd were ‘trust money held on trust... and are not general assets of BCI.’ This investment relationship mixed companies, trusts and contracts. The law has discarded attachment to transactional form. It is irrelevant if money is pooled: the Court of Appeal has consistently affirmed that duties apply to the proportional share of the fund (see  EWCA Civ 11 and  EWCA Civ 917, ). In functionally similar investment relationships, the same duties will apply. Duties equivalent to trust law are found in contract, whenever it is ‘essential to give effect to the reasonable expectations of the parties’. Fiduciary duties are construed like implied contract terms.
Voting instructions as fiduciary duties
Second, whenever assets are invested in companies, there is a basic right to pass voting instructions. In Butt v Kelson  Ch 197, 205, the Court of Appeal held the ‘right of a beneficiary, or of the beneficiaries if they are united... is to compel the trustees to use their voting power in the best interests of the trust estate’. These principles are based on functions, not legal form (Schmidt v Rosewood Trust Ltd  UKPC 26, ). Butt creates a default rule: when trusts are complex and silent about voting rights (as is usual) instructions must be followed.
Is everything negotiable?
Third, faced with instructions, some asset managers may try to avoid the law. Most asset managers will truly want to pursue their clients’ interests. Their success is built on that. But bad practice may drive the competition, if the private gains of not following instructions outweigh social costs. An asset manager may delay, even face litigation, simply because of a status quo bias. They may try to charge higher fees to keep control of other people’s votes. They may try to change their standard contract terms. The Unfair Contract Terms Act 1977 section 3, Schedules 1 and 2 mean large asset managers cannot use bargaining power to exclude liability for breach of their duty to follow voting instructions. Freedom of contract is an essential value when there is equal bargaining power. When there is not, freedom is fake. After hard economic experience, UK law rejects the notion that ‘everything is negotiable’.
3. Conflicts of interest
This issue is so important because conflicts of interest arise when asset managers and banks vote shares with other people’s money. Asset managers in the UK, US and Commonwealth sell financial services to company retirement schemes. If they vote shares, they can influence companies (centre stage or ‘behind the scenes’) to buy their services. Banks in central Europe sell multiple services, and hold large stakes in insurance firms, which also sell retirement schemes to companies. This enables mass self-dealing. It enables a terrific concentration of economic risk: decision-making risks being concentrated into the hands of a self-perpetuating financial oligarchy, again. It risks the creation of an irrational, authoritarian economy, again. The very potential for conflict attracts equity’s focus, and has done so since the first stock market crash in 1720. In equity, asset managers are probably to be precluded from voting at all. From the asset manager or bank’s perspective, this is positive. Most will be glad to forgo the stewardship fuss, to focus on their specialism of stock selection or trading. So, do asset managers and banks control voting rights on your money? Not if time-honoured principles of law are clear, and we adhere.
This blog post summarises ‘Does corporate governance exclude the ultimate investor?’ (2016) 16(1) Journal of Corporate Law Studies 221-240.
Dr Ewan McGaughey is a lecturer in private law at King’s College, London and a Research Associate at the Centre for Business Research at the University of Cambridge.