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22 Mar. 2011 | Comments (0)

As the proxy season gets into full swing, the issue of the amount of power and influence held by proxy advisory firms – specifically ISS and Glass Lewis – is front and center thanks to the so-called Proxy Plumbing concept release issued by the SEC last year. While it has been no secret that many public company board members have a personal aversion to many of the proxy advisory firms, those same firms have been put on the defensive as many of the public comments to the concept release have been disclosed. Many letter writers are calling for strict regulation of third parties that have no economic interest in a company either giving advice to powerful institutional investors or voting shares for those investors. One reason for the perceived power of those firms is that new SEC regulations that call for better disclosure of how big institutional investors and mutual funds vote their shares. And since many of those investors (i.e. CalPERS, CalSTRS, TIAA-CREF) hold so many shares of  so many different companies, it is almost impossible for them to keep track of every share voted let alone how to vote on corporate governance issues or shareholder resolutions. A December 2010 article in Securities Technology Monitor, Proxy Advisory Firms: To Regulate or Not? does a great job of explaining of analyzing the proxy advisory firm power issue. The article lays out the field in that space of corporate governance, including some hard data to show how cumbersome the proxy voting process has become and explains why these firms have been ceded so much power. In addition to the aforementioned article, a recent review of other online literature on the subject yielded an academic white paper, a special report from a proxy solicitation firm, a comment letter from an executive compensation organization and a client memo from a law firm. The following are the literature I believe are worth reading…
  • Proxy Advisory Firms: To Regulate of Not?  Chris Kentouris, Securities Technology Monitor, Dec. 10, 2010. Summary: U.S. proxy advisory firms are now caught in the middle of a heated debate over how -- and even whether they should be regulated. These are the firms hired by mutual funds and other fund managers to help decide which way to vote on corporate issues. While they may not have been that important a decade ago, they are now thanks to new regulations requiring buy-side firms – namely mutual fund complexes – to publicly disclose how they vote their shares. That means that institutional investors are voting more often so they need all the advice they can get. Now the Securities and Exchange Commission wants to know just how it should oversee proxy advisory firms as part of its overreaching reform of the proxy distribution and voting industry. Institutional investors and corporate governance firms who follow their advice like the status quo. But publicly traded companies and their advisors are pushing the SEC to more closely oversee proxy advisory firms because they wield far too much influence on voting decisions made by fiduciaries and others with no regulatory oversight.
  • Proxy Advisory Firms: The Debate Over Changing the Regulatory Framework Kenneth L. Altman and James F. Burke, The Altman Group, March 1, 2011. Summary: The record developed by comments submitted in connection with the SEC’s Concept Release on the U.S. Proxy System suggests that there is no debate over the proposition that proxy advisory firms have strong influence over proxy votes by certain institutions. Whether the actions of ISS, GL, Egan-Jones, MCG, or other proxy advisory firms can, either independently or as an industry, swing 0.1 perce t of a shareholder vote or 30 percent of a vote is less relevant to the regulatory questions presented in the concept release than whether proxy advisory firms can affect the outcome of a close shareholder vote. There is little question that the actions of proxy advisory firms could be outcome determinative in close votes. Indeed, if there is risk that there could be a single instance in which the conduct of a proxy voting agent or proxy adviser might affect the outcome of a shareholder vote, then there is a need for the Commission to ensure that the regulatory architecture minimizes factual errors contained in reports distributed by proxy advisers, mitigates or eliminates conflicts of interest, and promotes a level of transparency on the part of proxy advisory firms that will increase confidence in the overall proxy voting system. 
  • Comments on Definition of Fiduciary Proposed Rule, Timothy Bartl, Senior VP and General Counsel, The Center on Executive Compensation, Comment Letter, Feb. 3, 2011. Summary: This comment letter narrowly focuses on the issues raised in the U.S. Department of Labor's proposed regulation with respect to the fiduciary status of proxy advisory firms. The Center does not endorse the broad definition of fiduciary in the Proposed Regulation. While the Center supports the intent behind the Proposed Regulation to protect ERISA plan participants, we believe that the far-reaching effects of the Proposed Regulation would have unintended consequences, including increasing plan costs. At the same time, the Center is very concerned that proxy advisory firms are insufficiently regulated and that the current lack of oversight of proxy advisory firms has permitted alarming conflicts of interest and material inaccuracies in the reports provided to institutional investors, including ERISA plans, and that these practices also harm plans and participants. … The U.S. Government Accountability Office has studied this issue and has noted that "corporations could feel obligated to subscribe to ISS’s consulting services in order to obtain favorable proxy vote recommendations on their proposals and favorable corporate governance ratings. 
  • Proxy Advisory Business: Apotheosis or Agogee? Latham & Watkins, March 2011. Summary: Apotheosis or agogee is the question for the proxy advisory business and, more generally, the institutional investment world. The answer is not clear. But it is not far-fetched to conclude that the very success of today’s corporate governance voting model carries within its own seeds of destruction. Too many votes on too many issues exposes the current model for what it is — a low cost, largely mechanistic answer to a perceived governmentally mandated requirement that institutional investors vote all portfolio shares on all matters. As the reality of the current institutional voting model becomes more apparent under the pressure of more shareholder votes on more issues, it will lead to increased frustration, certainly on the part of companies and company advisers and quite probably on the part of at least many investment decision makers in the institutional investor community. More important, the inevitability mechanistic current voting model seems to be leading to a fundamental reappraisal of the underpinnings of the current model — the belief that an institutional investor’s fiduciary duty to its clients requires it to vote all of its portfolio shares on all matters regardless of cost, complexity or potential to increase share value. In its place we might well get a recognition that different prudent investors would make different decisions about share voting under their particular investment thesis, and that, like so many other things in life and the law, there is no one “right” answer to dealing with the tens of thousands of annual votes that confront the investment advisory industry.  
  • The Power of Proxy Advisors: Myth or Reality? Stephen J. Choi and Marcel Kahan, New York University (NYU) School of Law; Jill E. Fisch, University of Pennsylvania Law School – Institute for Law and Economics, Emory Law Journal, Vol. 59, p. 869, 2010; University of Penn, Institute for Law & Economics Research Paper No. 10-24.Oct. 20, 2010. Summary: In this paper the authors analyze the significance of voting recommendations issued by proxy advisors. Their examination includes four advisory firms: ISS, Glass Lewis, Egan Jones, and Proxy Governance. They found, consistent with press reports, that ISS is the most powerful proxy advisor. Of the others, only Glass Lewis seems to have a meaningful impact on the shareholder voting. The authors conduct several tests to quantify the impact of an ISS recommendation. Although superficial analyses suggest that an ISS recommendation can have a marginal impact of as much as 20 percent, and press reports state that ISS has the power to shift 20 percent to 30 percent of the shareholder vote, the authors conclude that these numbers are substantially overstated. Furthermore, they find evidence that ISS’s power is partially due to the fact that ISS (to a greater extent than other advisors) bases its recommendations on factors that shareholders consider important. This fact and competition among proxy advisors place upper bounds on ISS’s power. Institutional Shareholder Services cannot issue recommendations arbitrarily if it wants to retain its market position. Doing so would lead institutional investors to seek the services of other proxy advisory firms. Thus, ISS is not so much a Pied Piper followed blindly by institutional investors as it is an information agent and guide, helping investors to identify voting decisions that are consistent with their existing preferences.
  • 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…

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