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19 Dec. 2018 | Comments (1)

On Governance is a series of guest blog posts from corporate governance thought leaders. The series, which is curated by the Governance Center research team, is meant to serve as a way to spark discussion on some of the most important corporate governance issues.

Following a Senate hearing, a public statement by SEC Chair Jay Clayton, and a long-awaited SEC roundtable on the “proxy plumbing” process over the past month, some changes are nearly certain for proxy advisory firms in 2019.

On Dec. 6, 2018, the Senate Committee on Banking, Housing, and Urban Development followed up the SEC’s Nov. 15, 2018 roundtable with a hearing on the proxy process. Much of the conversation revolved around shareholder proposals, resubmission thresholds and the role of the proxy advisory firms, according to Glass Lewis. In both the roundtable and the hearing, the conversation regarding proxy advisors centered on the need for more regulation and disclosure and the possible conflicts of interest.

The question for the SEC is how far it should go in addressing these changes. Do all proxy advisory firms need to be treated like investment advisers or do they need their own regime? What should they disclose? How will the way they do business change?

Regulation of proxy advisors

Here are comments made by interested parties at the roundtable and Senate hearing:

  • “For proxy advisory firms, I believe there is growing agreement that some changes are warranted. For example, there should be greater clarity regarding the division of labor, responsibility and authority between proxy advisors and the investment advisers they serve. We also need clarity regarding the analytical and decision-making processes advisers employ, including the extent to which those analytics are company- or industry-specific” – Jay Clayton, chair, SEC
  • “In the SEC’s 2010 Concept Release on the U.S. proxy system, the SEC confirmed that proxy advisory firms are ‘investment advisers’ as defined in the Advisers Act… ISS agrees. Not only does proxy voting advice clearly relate to the value of securities, but in the case of mergers, acquisitions and tender offers, it also relates to the advisability of purchasing, selling or investing in securities…. As it stands today, three of the five U.S. proxy advisory firms are registered under the Advisers Act [including ISS]. ISS urges the Commission to take steps to bring all proxy advisory firms under this fiduciary regulatory regime, adding a new ‘proxy advisory firm’ category to the Advisers Act” – Gary Retelny, president and CEO, Institutional Shareholder Services
  • “The SEC should enhance the conditions that a proxy advisory firm must satisfy to be exempt from the disclosure and filing requirements that apply to proxy solicitations. The SEC Divisions of Investment Management and Corporation Finance have explained in [Staff Legal Bulletin 20] that the Commission generally has found that furnishing proxy voting advice… constitutes a solicitation. However, a proxy advisory firm may be able to rely on one or more exemptions to the proxy rule disclosure and filing requirements…” – Thomas Quaadman, executive vice president, U.S. Chamber of Commerce Center for Capital Markets Competitiveness

 Conflicts of interest

  • “There were other issues raised at the [SEC] roundtable that we should consider, including (1) the framework for addressing conflicts of interest at proxy advisory firms and (2) ensuring that investors have effective access to issuer responses to information in certain reports from proxy advisory firms. The [SEC] staff is looking at these and other issues, and I have asked them to formulate recommendations for the Commission’s consideration. On timing, it is clear to me that these issues will not improve on their own with time, and I intend to move forward with the staff recommendations…”– Clayton
  • “[At the Senate hearing,] sentiment was again split on this topic [conflicts of interest] with some arguing that current disclosure is inadequate and others comfortable with the current policies. There seems to be, however, a continued lack of information on this topic. Mr. Quaadman, for example, advocated that proxy advisory firms should disclose whether a client is a shareholder proponent or dissident shareholder. In the case of Glass Lewis, a disclosure note is added to the front of the research report if an institutional investor client, or one or both of Glass Lewis’ owners, submit a shareholder proposal” – Nicol Garzon, senior vice president and general counsel, Glass Lewis
  • “The proxy advisory system in the United States has not been functioning properly for some time. The industry has been dominated for years by ISS and Glass Lewis… [B]oth firms operate with a startling lack of transparency, are riddled with conflicts of interest, and have been prone over the years to making significant errors in vote recommendations” – Quaadman

Over the past month, there has been momentum in the halls of Congress and the offices of the SEC for some kind of change to the way proxy advisors operate and are potentially regulated. Shortly before the all-day meeting in Washington, D.C., six U.S. senators announced a bipartisan effort to regulate proxy advisors as part of a comprehensive corporate governance legislative package that attempts to treat them as investment advisers. And, days before the roundtable the SEC announced it had withdrawn two 2004 no-action letters issued to Egan-Jones and ISS that considered both firms “independent” when hired by institutional investors to recommend proxy votes. While the withdrawal of the no-action letters does not affect guidance on proxy advisory firms issued in Staff Legal Bulletin No. 20, it does raise questions about the commission’s views on proxy advisory firms and where regulatory policy may be headed.

Wachtell, Lipton, Rosen & Katz pointed out in a Nov. 29, 2018 client memo, “At this point, it may be that proxy advisors’ role in the substantive and logistical task of making and implementing voting decisions throughout the proxy season has become too big to eliminate, absent some fundamental changes in the proxy voting process.”

On the day of the roundtable, Glass Lewis offered an alternative to the Senate proposal. “A different approach could include validating the standards of conduct already implicitly enforced by the industry, coupled with a mechanism to monitor and ensure compliance,” a Glass Lewis statement read. “Such a plan could be a more appropriate way to address the issues around the role of proxy advisors, conflicts of interest, accuracy and reliability, transparency, and increased oversight.”

Governance Center Executive Director, Doug Chia observed coming out of the SEC roundtable, “What seemed to leave the biggest impression with the SEC was the consistent explanation by the investors and investment advisers of how they use proxy advisory firms—for efficient review of ballot items, data aggregation, research, and vote execution.” Chia believes, “The SEC is likely to see where the proposed legislation in the House and Senate will go before taking any significant action.” In the meantime, Chia says the proxy advisory firms, “may do more to ensure data accuracy and be more transparent, but they are unlikely to change the way they make voting recommendations or share their reports with corporate issuers.” Regarding the continuing role of proxy advisory firms in the marketplace Chia thinks, “Cost pressures are too great for all but the largest investors to decrease their reliance on the services of proxy advisory firms.”    

The views presented on the Governance Center Blog are not the official views of The Conference Board or the Governance Center and are not necessarily endorsed by all members, sponsors, advisors, contributors, staff members, or others associated with The Conference Board or the Governance Center.

  • About the Author:Gary Larkin

    Gary Larkin

    Gary Larkin is a research associate in the corporate leadership department at The Conference Board in New York. His research focuses on corporate governance, including succession planning, board compo…

    Full Bio | More from Gary Larkin


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  1. Sarah Wilson 0 people like this 20 Dec. 2018 09:50 AM

    Thanks for the round-up of points, Gary. There is a lot of noise in this debate, and probably not as much clear signal as there could or should be. Obviously, being a proxy advisor, albeit not US-based and not recommendations-focused, I will have some cognitive biases that are going to colour my perceptions, but here are some thoughts: Firstly, how likely is it that Asset Managers are going to be told to reduce their reliance on platforms like Bloomberg or Refinitiv (new name for Thomson Reuters) and go back to working through market data by hand? Highly unlikely. Data and platforms are essential features of modern financial markets. We wouldn't see demands from investors that corporations should drop their use of data and intelligence solutions because they didn't like the results. If everyone is honest about this debate, accuracy is not really the issue. After all, the majority of votes are in favour of management, and produced by the same teams, the same way - are those votes "wrong" or "inaccurate" too? I can assure readers, we find plenty of errors in corporate statements. What this debate comes down to is ideology. Some people have different points of view about what should or shouldn't be done or said. But that's markets - and indeed democracy - for you. Both markets and democracies need different points of view, it's critical. Another point that's often forgotten in the shouting match, is that the largest target of the hostility is already regulated. Clearly regulation as an investment advisor isn't working. Maybe that's the problem, perhaps that regulation gives permission for too much outsourcing. I don't know because the research hasn't been done - and defining what is really meant by "outsourcing" would be a great start. What's often forgotten in this debate is that it's asset owners who matter, it's their money. Whether they are Main Street, ordinary families saving for college or pension funds saving workers' lifetime savings, it's their security at stake. It's the only reason any of us do this. Long-term, sustainable returns matter, governance is how we protect them and the companies and their workers, suppliers and customers. We (proxy advisors) don't have all the answers, neither do boards, neither do auditors or lawyers or regulators. No-one is infallible. I believe that we'd do a lot better by everyone if we focussed on what we have in common. No proxy advisor I know is ever complacent about accuracy and quality. We do need more diversity, and the wrong kind of regulation isn't going to help solve problem. I watched the entire roundtable from thousands of miles away and it was clear to me that there was common ground - fix the plumbing, help investors and companies communicate with each other. The US proxy plumbing, the bit that actually gets the votes to the meeting is hopelessly antiquated and costly. This should be our #1 priority right now if we are to rebuild trust.

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