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Regulation of Proxy Advisory Firms and Market Impact

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Over the year ahead, the Securities and Exchange Commission is expected to face a full slate of challenges related to corporate governance and financial disclosure. In particular, the Commission will be reviewing the possible regulation of proxy advisory firms and studying a switch to biannual reporting, among other issues.

To find out what market observers see as the best ways to address these matters, Mergermarket on behalf of Toppan Vintage spoke with four experts.

Toppan Vintage question: The issue of regulating proxy advisory firms is hotly debated. Do you think such regulation is necessary? And what effect do you think it would have on the market? Leading industry experts weigh in...

Professor Charles Whitehead, Cornell Law School says: I think there are three concerns that underlie current proposals to regulate proxy advisory firms. The first is simply a general uneasiness about any organization, particularly an unregulated organization, having the kind of influence these firms have. For many institutional shareholders, these firms’ recommendations on how investors should vote are considered to be a best practice, and so a large portion of the institutional world relies upon what ISS or Glass Lewis or other proxy advisory firms tell them to do.

Secondly, there has historically been a concern, including testimony in prior Congressional hearings, that ISS and others have conflicts of interest or, at the very least, the appearance of conflicts of interest due to their dual roles of advising shareholders on how to vote and counseling companies on how to manage their shareholders. They are paid by the same companies whose shareholders they're also advising. Even if there are internal firewalls separating the shareholder from the company divisions, at the very least, this looks like a conflict.

The third concern is with the process of correcting mistakes, or factual misunderstandings, in the recommendations the proxy advisory firms make. Proxy advisory firms work under a lot of time pressure, and there are peaks in the proxy season when they can become particularly busy. Not surprisingly, since people are people and sometimes make mistakes, a proxy advisory firm may not present the full picture when advising shareholders on how to vote, or they may simply be misinformed. The concern is that it's not always easy for a company to quickly correct those mistakes and it may not be entirely clear how to go about doing so.

So, on balance, I do think there is a strong argument for why proxy advisory firms should be regulated. What surprises me is that the firms have not gotten ahead of the curve and self-policed themselves. Most likely, what makes sense is for the SEC to exercise greater oversight over the proxy advisors, as well as (together with the Department of Labor) provide greater guidance regarding how investors should use the recommendations – something along the lines of, “Yes, you can look at what ISS or Glass Lewis says, but don't eat what they cook without understanding what's in the stew.”

Bill Ide, The Conference Board Governance Center adds: I agree with Professor Whitehead that proxy advisory firms should be regulated. We’ve got a real problem, because market forces have created a system without there being any real policy thought on the subject. All of a sudden, Glass Lewis and ISS have started influencing corporate decision making without any public oversight and transparency. Their guidelines do not go through any public oversight process, but they can have a significant impact on the public interest. That is the area where SEC oversight is needed.

If these firms were only in the business of gathering facts and handing them over to investors, that would be fine. But that’s not what they’ve done – they started there, but then began making recommendations, which in essence means they are impacting the vote. There has been some pressure on mutual funds not to delegate decision-making, but proxy advisors should be required to have SEC oversight of their practices. At the moment, there’s no way of knowing what their process is in formulating voting recommendations. So that’s the big need – for there to be SEC regulation requiring open disclosure and transparency from the firms.

The other issue is one also stated by Professor Whitehead, which is that ISS has a significant conflict of interest. They have their proxy advisory component, but then they also have a consulting component. And what do you do if you’re a company and ISS’s consulting wing calls and says, “Hey, you’re probably going to be dealing with ISS on their proxy vote recommendation – we can help you shape yourself.” That’s a complete conflict of interest. So those two entities need to be split.

I think the right method of regulation is for the SEC to just intervene. I don’t think legislation is going to work, and it would give more flexibility to the SEC to mold remedies according to the facts.

Scott Kimpel, Hunton Andrews Kurth weighs in: I, too, am concerned that the proxy advisory firms wield a disproportionate influence over the proxy voting process. Virtually every other participant in this process—brokers, banks, transfer agents, asset managers, even the public companies themselves—is subject to some level of regulatory oversight in this space, and it has always struck me as an anomaly that proxy advisory firms have for the most part escaped regulation. This is an area where I believe the SEC already has authority to regulate under the registration and antifraud provisions of the Investment Advisers Act, but for reasons not entirely clear to me, the agency has historically chosen not to do so. ISS has chosen to register as an investment adviser, but conducts its business in a way almost totally devoid of SEC oversight; Glass-Lewis is not registered or supervised at all.

I am intrigued by a recent bipartisan bill introduced in the Senate, the Corporate Governance Fairness Act. It is not as wide-ranging as some of the other bills that have made it through the House on the topic of proxy advisory firms, but I still believe the bill has some teeth. If enacted, the Act would require proxy advisory firms to register with the SEC and be subject to SEC oversight and inspection. A central feature of these examinations would be an assessment of the accuracy of the reports issued by proxy advisory firms, which is striking because one of the central critiques of the proxy advisory industry has been that the firms’ reports may be inaccurate. Once the SEC staff is given a mandate to inspect, they usually do not make a half-hearted effort to do so.

Under the bill, the SEC would also be required to make periodic reports to Congress on the state of play in this industry. Inevitably, any deficiencies found in the inspections of proxy advisory firms would make their way into these reports to Congress, perhaps building a record to support further legislative or regulatory reforms in the future if the record points in that direction.


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Over the year ahead, the Securities and Exchange Commission is expected to face a full slate of challenges related to corporate governance and financial disclosure. In particular, the Commission will be reviewing the possible regulation of proxy advisory firms and studying a switch to biannual reporting, among other issues.

To find out what market observers see as the best ways to address these matters, download our full report

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