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Key Takeaway: Suffering from Success

In our view, the largest asset managers—BlackRock, Vanguard, and State Street—face a growing problem due to their success in obtaining market share: increased scrutiny in the use of their proxy voting power - particularly to back ESG-related proposals. A viable solution, in our opinion, is to delegate that power to an independent and unconflicted third party.

Overview

A U.S. federal judge in the Eastern District of Texas recently ruled to allow the bulk of the antitrust claims¹ filed against BlackRock, Vanguard, and State Street (“The Firms”) to proceed past a Motion to Dismiss filed by those same three defendants.

In our opinion, the case represents a sea change in the way investment managers conduct themselves and may have widespread and long-lasting effects. Even if the eventual ruling of the court turns out in favor of these large asset managers, there is still a chilling effect from the allegations that asset managers will need to manage.

The Case

The claim is that The Firms engaged in anti-trust activity by discouraging coal mining companies from producing coal to satisfy carbon reduction goals. The Firms claim they are exempted from anti-trust liability because their holdings in public corporations were acquired “solely for investment.” However, the DOJ and FTC, which each filed a statement of interest in a case brought by various State Attorneys General, claim that anti-trust liability applies if “an investor has an intent to use stock to influence significantly or control management of the target firm.”²

Regarding the size of the minority stake, the DOJ and FTC argue the following:

“The size of the ownership interest need only be sufficient to exert an anticompetitive influence on the acquired company’s decision-making. For example, the du Pont Court found that a 23 percent holding was sufficient for du Pont to exercise an anticompetitive influence over General Motors’ purchasing decisions, noting that ‘the potency of the influence’ was enhanced due to diffusion of remaining shares … Whether an investor actually used its minority stakes in competing companies to influence their businesses’ decisions in a way that injured competition is a factual question.”³

Regarding the alleged actions:

“Plaintiffs allege that Defendants agreed to use their combined shares in competing coal companies to reduce production of coal in the United States, thereby driving down output and driving up prices.”⁴

BlackRock, Vanguard, and State Street are often the largest shareholders in America’s publicly held companies. This is no different for coal companies, where The Firms often hold a combined ~30%. Thus, if The Firms agree to use their power, and especially their voting power, the argument is that they can exert significant control over a firm.

A Case Study

These same three defendants have previously been accused of wielding their power in this way in connection with the proxy contest at ExxonMobil in 2021. In late 2020, Engine No.1, a hedge fund that held 0.02% of Exxon’s stock, launched a proxy campaign to replace four of Exxon’s directors with directors of their own choosing who would be more focused on energy transformation, sustainability, and creating a long-term plan for addressing climate change.

Ultimately, each of The Firms used their voting power to vote for at least one of Engine No.1’s candidates; three of the four candidates won seats on the board. BlackRock supported three of Engine No.1’s candidates based upon “Exxon’s failure to have clear, long-term greenhouse gas reduction targets.”

This proxy contest was a pivotal moment for ESG and shareholder activism. It also sparked backlash in Washington. The House Judiciary Committee released an interim report in December 2024, entitled “Sustainability Shakedown: How a Climate Cartel of Money Managers Colluded to Take Over the Board of America’s Largest Energy Company” detailing the alleged collusion of The Firms with climate activist groups and Engine No.1 to enforce ESG goals on Exxon.

The backlash hasn’t been limited to asset managers. Recent hearings have been held by the House Financial Services Committee and the House Judiciary Committee, criticizing legacy proxy advisors who helped to approve the Engine No. 1 nominees and who continue to be tied closely to ESG.

The Stakes

With the continued growth of these large asset managers, rigorous scrutiny is likely to continue, with some recalling the trust-busting actions of Teddy Roosevelt.

With any anti-trust violation, in addition to the normal hefty legal expenses, defendants can be subject to treble (triple) damages. Thus, the cost of defending and settling cases such as these can be substantial, particularly for managers of low-cost index funds.

Challenges for the Defense

Many asset managers have traditionally used legacy proxy advisors to provide research on issuers and proposals at shareholder meetings. However, those same proxy advisors (i) are tied to the ESG agenda, which encouraged the restriction of coal and other carbon production, and (ii) provide consulting to corporations, creating an untenable conflict of interest. In fact, the governance ratings that are developed during the corporate consulting engagements are used in legacy proxy advisors’ research. The conflict posed by legacy proxy advisors has been noted by stakeholders in private markets and government.

“[Referring to conflicted legacy proxy advisors] They are owned by the NGOs,” meaning non-governmental organizations. Their data is “wrong,” he continued, yet “they don’t have to correct them.” And companies “can hire them” to improve their corporate governance ratings. “Really? They should be gone and dead, done with,”

- Jamie Dimon, CEO JP Morgan

“[Referring to conflicted legacy proxy advisors] Okay, so you [a corporate issuer] can go consult with them before they give you the recommendations that are always followed. And if you don't consult with them, they might give you recommendations that in many ways harm the company and therefore harm the shareholders?”

- Jim Jordan, Chairman of the House Judiciary Committee

The conflict has also been noted, perhaps most shockingly, by a former President of the largest proxy advisor, who avoids using the services of her former employer. In a recent hearing in front of the House Judiciary Committee, she noted:

“[Referring to the offering of consulting services of a legacy proxy advisor] I disagree with it, but I’m all in favor of every possible option being offered to the market and letting the market decide.”

-    Nell Minow, Former President of ISS

A Likely Safe Harbor

While we are still in the early stages of the trial, there are a few conclusions that can be drawn. One is that coordinated activities of investment advisors is probably a non-starter as the legal risks are immense.

The second is that, since the heart of the issue is the power that is wielded through the proxy voting of asset managers, a likely safe harbor is the outsourcing of proxy advisory services to unconflicted and independent sources, so that the interests of beneficiaries can be properly protected. The Firms have already begun to do this with their proxy voting choice program, which provides the underlying shareholders whose capital is invested a say in how their proxies are voted.

As pressure continues to mount against these largest asset managers, they will likely continue to outsource their proxy voting, especially to unconflicted voices in the market.

Sources:

1. https://www.texasattorneygeneral.gov/sites/default/files/images/press/States%20v%20BlackRock%20Complaint%20Filed.pdf
   
2. https://www.ftc.gov/system/files/ftc_gov/pdf/StatementofInterest-TexasvBlackRock.pdf, page 11
3. IBID, Page 14 and 15
4. IBID, Page 21