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Rules Favoring Proxy Advisers Need Review, SEC’s Gallagher Says

Policy makers should examine the prominence of advisory firms in corporate elections and consider whether regulations give them preferential roles in the process, a top U.S. securities regulator said.

The U.S. Securities and Exchange Commission’s rules may spur too much reliance on proxy advisory recommendations in the same way investors relied too much on credit ratings for mortgage-backed securities that later proved toxic, Commissioner Daniel M. Gallagher said in a speech today in Dublin. Regulators and investors should scrutinize whether advisory firms’ recommendations financially benefit shareholders, he said.

Institutional investors such as public pension funds consider recommendations from companies such as Institutional Shareholder Services and Glass Lewis & Co. when they vote in annual corporate elections. ISS recommended this month, for instance, that shareholders separate the roles of chairman and chief executive officer at JPMorgan Chase & Co.

“It is critically important for policy makers to understand, evaluate and, if necessary, address the practices and business models of proxy advisory firms,” Gallagher said at the event focused on corporate governance. “No one should be able to outsource their fiduciary duties.”

The SEC last sought comment on whether to stiffen rules for corporate elections in July 2010. The so-called “concept release” asked whether investors properly voted shares and how firms giving ballot advice handled conflicts of interest.

Gallagher said a 2003 SEC rule sanctioned the use of advisory services in corporate elections. The rule said money managers could avoid conflict-of-interest claims if they relied on the recommendation of a third party when voting a client’s shares, Gallagher said.

“As it had earlier done with credit rating agencies, the SEC had essentially mandated the use of third-party opinions,” he said.

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