By Dawn Lim 

GameStop Corp. shareholders vote this week to resolve a fight over the embattled videogame retailer's board. But the company's largest investors won't cast much of a vote.

The three biggest money managers in GameStop reported that their funds held some 40% of shares in the first quarter. When it was time to commit to voting, they controlled roughly 5% of ballots, according to count estimates reviewed by The Wall Street Journal. Each share of GameStop normally grants an investor one vote.

The main reason for the disparity is that BlackRock Inc., Vanguard Group and Fidelity Investments chose to loan out substantial GameStop shares for the rich stream of fees their investors stood to gain, according to people with knowledge of the matter. Firms from Dimensional Fund Advisors to State Street Global Advisors made similar choices to give up their full voting power.

These managers loan shares through brokers and intermediaries who act for clients unknown to the original lenders. Short sellers often borrow those shares to bet against companies, paying fees to funds that supply them with those shares. Those fees do get passed back to fund investors.

The catch is that if fund managers don't recall the shares in time for votes, they can't cast shareholder ballots.

Investors from hedge funds to pensions make these trade-offs all the time. For the biggest asset managers, the decision can occur on a massive scale as these firms direct trillions of dollars for investors.

While investing giants have raised their voices to prod companies to address society's most pressing problems, they sometimes decide not to control the ballots that drive change. Their choices to loan out shares in some of the heavily-shorted companies breaks with many people's assumption that firms overseeing economic interests in companies will cast full votes to maximize the value of the shareholdings.

"Securities lending has changed the way ownership is understood," said Richard Grubaugh, senior vice president of D.F. King & Co., a firm that assists companies with shareholder outreach. "Ownership and economic interests are decoupled from voting."

At GameStop, firm executives reminded shareholders that to cast ballots they had to recall shares on April 20, a key date to commit to voting. The Texas company with the motto "power to the players" and thousands of videogame stores is wrestling with shoppers shifting online.

It is trying to convince shareholders that it is on track with plans to be a bigger digital platform for gamers and has a strategy to improve customers' experience.

One investor group has called for more cost cuts and a clear long-term strategy, and put a pair of new board members up for a vote. That contest will be a referendum on whether GameStop is doing enough to overcome its challenges as a pandemic upends the retail industry.

The decisions by BlackRock, Vanguard, Fidelity, Street Street Corp. and others to forgo substantial votes will hand greater influence to others. The four firms said they decide whether to keep shares on loan or recall them for votes based on their duty to fulfill fund investors' best interests. Voting isn't the only way they can exert sway.

Many managers typically don't retrieve shares that have been lent out unless they think their vote is worth giving up income from lending out shares. The shares they put on loan are conduits for short selling. In the last two weeks of April, GameStop had roughly 90% of shares outstanding sold short, according to FactSet.

The Securities and Exchange Commission said in 2019 guidance on an older rule that asset managers could give up votes to keep lending income flowing to investors, so long as they were fulfilling duties owed to clients. Then-commissioner Robert Jackson raised a concern that "large institutional investors themselves will vote less" following the guidance.

Some SEC staffers were worried there wasn't yet full visibility into how securities lending affects voting patterns, said a person familiar with the matter. The staffers had tried studying the issue over the past year but were hampered by the lack of systemwide data.

The extent to which investment firms forgo votes for lending fees isn't known. Meanwhile, public companies rely on proxy solicitors to stitch together estimates from brokers and custody firms, and information on voting power tied to different investors is typically kept under wraps.

BlackRock said its investment stewardship team "has full discretion and will, in the limited circumstances in which the security is on loan, undergo a formal analysis to determine the approach that best protects and enhances our clients' assets." The firm said it typically receives borrowing demand of about 6% of lendable equity assets across portfolios it manages.

Vanguard restricts lending to securities that are hard to borrow as well as in high demand, and has a process to decide whether shares need to be recalled for votes, a spokeswoman said. "Casting proxy votes is a critical component of our overall stewardship program," she said.

A Fidelity spokesman said its proxy voting and securities lending programs coordinate to assess situations "on a case-by-case basis to ensure the best interests of fund shareholders." State Street's Asset Stewardship Co-head Ben Colton said the firm is committed to "effectively balancing the trade-offs between our securities lending activities and exercising our voting rights."

These firms stood to earn lucrative fees for fund investors from lending out their shares in GameStop during that crucial period. In the second half of April, new borrowers of GameStop stock paid 80% to 190% on the value of shares on an annualized basis to rent shares, said people close to bank stock-loan desks. Investors typically pay under 1% to borrow most stocks.

GameStop has come under pressure as its shares have slumped. It explored selling itself two years ago, but ended the effort. It named a new chief executive in 2019 and has revamped its board.

Last spring, an investor group led by Hestia Capital Partners LP and Permit Capital Enterprise Fund LP called for GameStop to cut costs, boost stock buybacks, and make other improvements. GameStop agreed to work with the group and address their concerns.

The shareholders, saying they were frustrated that GameStop wasn't doing enough, launched a proxy fight and put their proposed board candidates up for vote this year. Two major proxy advisers sided with them.

Other investors are stepping up in the power vacuum left by the biggest firms. Scion Asset Management, whose founder Michael Burry became famous after the book and movie "The Big Short," said it was backing GameStop.

"Securities lending is an important revenue opportunity for large institutional investors. But there's also a responsibility to vote shares in a fiduciary manner," said Kurt Schacht, who leads policy work for the CFA Institute.

"There can be a clash of both responsibilities. It's up to the institution to decide what is best."

Abhirami Shrinivas contributed to this article.

Write to Dawn Lim at dawn.lim@wsj.com

(END) Dow Jones Newswires

June 10, 2020 09:10 ET (13:10 GMT)