The U.S. Securities and Exchange Commission is weighing whether proxy advisers have grown so influential in corporate elections that regulators should impose rules to make their business more transparent.
The roles of Institutional Shareholder Services Inc. and Glass Lewis & Co. LLC in shareholder voting is being debated by institutional investors, brokers, business groups and unions today at a meeting hosted by the SEC. ISS and Glass Lewis dominate the market for providing recommendations for votes on topics such as executive pay, nominees for boards of directors, and corporate mergers.
ISS, Glass Lewis and other proxy advisers agreed this year following a recommendation by the European Securities and Markets Authority to follow a voluntary code of conduct to manage conflicts of interest and disclose how they make recommendations. The U.S. Chamber of Commerce and Business Roundtable have pressed the SEC to require more disclosures by proxy advisers, including conflicts of interest and their method for grading company policies such as executive pay.
“They are not at all brokers and they are not quite investment advisers, so the question is how would you regulate them?” said David B.H. Martin, a partner at Covington & Burling LLP who led the SEC’s Corporation Finance division from 1999 to 2002. “The commission has gone about this carefully because it’s not very clear what they would regulate.”
Demand for proxy research has grown as institutional investors’ portion of voting shares has risen to more than 50 percent in recent years, according to Conference Board research. Institutional investors, including pension and mutual funds, are the traditional clients of proxy advisers, while ISS also provides consulting services to companies seeking to improve their corporate governance ratings.
Firms such as ISS and Glass Lewis owe their “outsized role” to SEC policy guidance issued in 2004, Commissioner Daniel M. Gallagher said this week. The SEC told investment advisers they could fulfill a duty to vote in shareholders’ best interests by relying on independent third party research.
“The resulting pair of staff no-action letters effectively blessed the practice of investment advisers rotely voting the recommendations provided by proxy advisers,” Gallagher, a Republican, said Dec. 3 at a conference organized by the European Corporate Governance Institute and Columbia Law School.
Commissioner Michael Piwowar, a Republican, said at today’s meeting that proxy advisers enjoy a status similar to credit-rating firms such as Moody’s Investors Service and Standard & Poor’s, whose ratings were blessed in some SEC rules as acceptable measures of credit worthiness.
“My concern is highlighted by the lack of competition in the proxy advisory market which appears to be a stable duopoly preserved by near-impenetrable barriers to entry,” Piwowar said today.
ISS and Glass Lewis say their influence on voting outcomes is more nuanced than such critics say. While ISS recommended against 13 percent of all say-on-pay proposals in the first half of 2013, only 2 percent of such votes failed to get majority support, ISS data shows.
“The reason they are so influential is that they provide advice that people think is important,” Nell Minow, a former ISS chief executive, said today. “I would hope the SEC would support independent analysis to protect investors.”
ISS advice shifts 6 percent to 10 percent of shareholder votes after controlling for other factors that influence voting outcomes, according to a 2010 paper by Jill E. Fisch of the University of Pennsylvania Law School and Stephen Choi and Marcel Kahan of New York University School of Law. Other studies have found ISS can influence shareholder votes by as much as 30 percent.
Institutional investors that tend to follow ISS “blindly” are smaller mutual funds that can’t afford to do their own homework for every shareholder resolution on which they must vote, Fisch said at the Dec. 3 conference.
Companies such as BlackRock, the world’s largest asset manager, commit their own resources to analyzing proxy votes and use the outside research “to flag the companies we know we need to take a look at more closely,” BlackRock managing director Michelle Edkins said at the same panel.
Proxy advisers now wield significant power over public companies’ governance decisions without being subject to significant SEC oversight, said Michael J. Ryan, a vice president for corporate governance at the Business Roundtable. In October, Nasdaq OMX Group Inc. told the SEC it should require “public scrutiny of the models and methodologies” used by proxy advisers and mandate disclosure of conflicts of interest.
The SEC in a 2010 report raised questions about conflicts of interest in ISS’s business model and whether the firm sufficiently discloses them to clients. ISS earned 21 percent of its revenue in 2011 from a unit that provides consulting services to companies that may be the subject of ISS recommendations, according to research by Warwick Business School finance professor Tao Li.
ISS says on its website that it “appropriately” discloses any conflicts “as they arise.” The company declined this week to discuss its business model or regulatory changes in advance of the SEC’s meeting.
“ISS welcomes the opportunity to participate in the upcoming roundtable discussion given our longstanding and unwavering commitment to providing unbiased governance advice, data and research to the global institutional investor community,” ISS said in a statement.
Glass Lewis, which plans to apply the European code of conduct globally, believes any new U.S. regulation should be “tailored” to proxy advisers, chief executive officer Katherine Rabin said in an interview. Glass Lewis works only for institutional investors and doesn’t provide consulting services to companies that are the subject of its recommendations, Rabin said.
The SEC should withdraw its guidance allowing mutual funds to rely on proxy advisory research when voting, Gallagher said this week. Regulators also should consider exempting smaller institutional investors from having to vote on every item on a company’s proxy, he said.
Rescinding the SEC’s no-action letters could create new problems, Fisch said, by forcing smaller funds to spend more on their own research and lowering returns to investors, she said.
“Limiting the ability of institutional investors to rely on the proxy advisers, that creates a void,” Fisch said. “What is a small institutional investor supposed to do?”
The SEC roundtable includes representatives of BlackRock, the California Teachers Retirement System, the Council of Institutional Investors, Glass Lewis, GT Advanced Technologies Inc., the Investment Adviser Association, ISS and Viking Global Investors. Former SEC Chairman Harvey Pitt also is scheduled to be a panelist.