Since the passage of Dodd-Frank, in the summer of 2010,
there has been a constant drumbeat from representatives of the corporate
community, particularly the Business Roundtable and the U.S. Chamber of
Commerce, regarding the need for an increased level of regulatory oversight
focused on proxy advisory firms.
One recent example was Tom Quaadman of the U.S. Chamber
of Commerce's Center for
Capital Markets Competitiveness (2010): "The center "believes that proxy
advisers may fail to reliably represent the investors they purport to serve"
by, among other reasons, contending they have an apparent "decision and policy
development process that is arbitrary and capricious" and "economic incentives
(that) drive one-size-fits all policy which will not produce better informed
investors or managed companies." In that same year, The Business Roundtable
issued a press release (12/11/10): "In any event it is critical that the SEC
update its rules to promote greater efficiency and transparency in the proxy
voting system and enhance the accuracy and integrity of the shareholder vote, including
regulation of proxy advisory firms." (emphasis is mine)
At this point, we need to pause for a reality check: Are
the Business Roundtable and the U.S. Chamber of Commerce really calling for new
federal regulation? Is the cobra asking for a subsidy for mongoose
breeders? It must be a typo!
What do Proxy Advisors Do?
I must disclose that I was the founder of ISS, the "monopoly" proxy firm, which
is the subject of all this brouhaha. I don't know whether to laugh or to cry
when I reflect that it took two years to get a client whom I had not gone to
school with and five years to break even. My son disposed of our entire
interest about four years ago, so I can approach the subject with economic
independence. I do retain passionate intellectual convictions about the
utility and integrity of "my baby". Proxy advisory firms - ISS,
Glass Lewis - have the distinction of being the only category of professional
service providers, including lawyers and accountants, not to have been suborned
by corporate management. There has been not a single allegation of
proxy advisory firms either accepting bribes or of acting in bad faith. So
there is no back ground of abuse.
Their "crime" is that they represent a threat to the
autocracy of the CEO and incumbent boards through advice to shareholders in
voting on the particular matters, approved by the SEC, on the proxy for the Annual
Meeting. There is no compulsion - legal or implicit - on shareholders to employ
the services of proxy advisors firms. This is a business like others; a party
purchases a service if it is valuable to him and for no other reason. If he
finds defects in the product, he will doubtless not buy it again.
Consider carefully- what is the scope of activity of
proxy advisory firms: They give advice as to issues presented on company proxy
statements. They have no authority to raise issues on their own; they can
only advise on issues raised by others. Proxy advisors have no power to
vote, except as expressly authorized by the legal owners.
- Question:
What does ISS do? Answer: It provides information.
- Question:
To whom does it sell this information? Answer: A cadre of largely sophisticated
investors.
- Question:
Is anybody obligated to buy it - in the sense that Moody and S&P's
customers are "mandated" Answer: No.
Follow the Money
So what is the justification for governmental
involvement? ISS has no influence over what subjects shareholders present; ISS
has no influence on the varying policies of the SEC in interpreting 14(a)(8) of
the Exchange Act which is the final factor in determining precisely what
issues will be included on the company's proxy statement. ISS certainly is not
"soliciting" proxies in the common sense meaning of those words; they have no
stake, no interest, no contingency in how their customer uses the information
they provide.
Does it make sense for the SEC to extend its authority in
this direction? In its Concept Release
(7/22/10) the Commission becomingly summarizes:
"[B]ecause of the breadth of the definition of
'solicitation', proxy advisory firms may be subject to our proxy rules because
they provide recommendations that are reasonably calculated to result in the
procurement, withholding or revocation of a proxy."
What's the problem? The real problem is the failure of
the customer of the proxy advisory service to fulfill its fiduciary
obligations. The ultimate responsibility to take all steps necessary to
preserve the value of trust assets (including the proxy) rests on the legal
owner. Even in cases where the trustee-owner hires expert consultants, ultimate
responsibility lies at his door to make final determination as to the
appropriateness of the advice he receives.[1]
Why then is there this persistent effort to
hobble the proxy advisors? Why not regulate those parties legally
obligated to vote? Instead, the focus is on undermining the advisors: The Shareholder Communications
Coalition (a coalition of industry groups including the BRT, National
Investor Relations Institute and others) wrote to the Commission: "The SEC and
the Labor Department should consider establishing a more robust due diligence
process of institutional investors, so that the proxy voting enjoys a more
important role in the investment process and within the fiduciary
responsibilities of these investors."[2]
Hugh Wheelan of Responsible Investor wrote, "In
a sign of the firepower being ranged in the US against the proxy firms, a group
called The Shareholder Communications Coalition, which represents Business
Roundtable, an A-Z of US corporate chief executives with nearly $6 trillion in
annual revenues, said SEC rules giving shareholders a voting [sic] on executive
pay had made it "even more imperative" that the SEC move to regulate."[3]
The Coalition presumes SEC involvement and suggests a
regulatory precedent:
"As the SEC develops a regulatory framework for proxy
advisory firms, one possible avenue for guidance is the current evolving
regulation of credit rating agencies, also called NRSROs. A review of the SEC
and staff actions with regard to NRSROs during the past years shows that there
are numerous and significant analogies with regard to problematic practices and
regulatory improvements that should be considered for proxy advisory services."[4]
Has anyone thought about the SEC's backlog in regulations
mandated by Dodd Frank; has any one thought about priorities; has anyone
evaluated the relative urgency of this among other proposals? It's all about
money. Since Watergate, our national culture has relentlessly confirmed that
many questions can be answered most conclusively by "following the money".
Here is the background
ISS recommended a no vote at approximately 300 companies,
or about 12.5 percent of the Russell 3000 companies in the sampled universe.
Although harder to track, Glass Lewis seems to have recommended a negative vote
at a somewhat higher percentage of companies, reportedly as high as 17 percent.
Importantly, the difference between receiving a favorable recommendation from
ISS and an unfavorable one, on average, was a swing of approximately 25 percent
of all votes cast. Glass Lewis' recommendations seemed to produce about an
additional 5 percent swing in votes cast.
A second relevant key statistic is that companies
receiving a negative proxy advisory recommendation from ISS averaged less than
a 70 percent positive shareholder vote, compared to those receiving
positive proxy advisory recommendations, which routinely scored 90 percent or
higher positive shareholder votes.
The importance of the below 70 percent average positive
vote where ISS has issued a negative say-on-pay recommendation becomes
startlingly clear when set against ISS' almost certain voting policies for
2012. As is its custom, ISS has polled the jury of corporate governance opinion
and is on the verge of concluding that a less than 70 percent "yes"
vote is sufficiently indicative of investors' lack of confidence in a company's
pay practices to require corrective action by the company. Failing corrective
action, the ISS policy in 2012 would be to recommend a withhold vote for
directors on the Board's compensation committee and/or an automatic
recommendation to vote "no" at the next annual say-on-pay vote.[5]
And so, our tale comes to a predictable pause - the
problem is that ISS has acquired the appearance of power with respect to top
executives' pay. Protecting the absolute power of CEOs to set their own
pay seems to be what the coalition is all about.[6]
[1] For ERISA
fiduciaries, this is spelled out in an obscure document known as the "Monks
letter".
[2] SCC Letter to SEC,
October 20, 2010 at p 31
[3] Hugh Wheelan,
Responsible Investor, Major US corporate lobby groups tells SEC to regulate
proxy firms as investment advisors, January 26, 2012
[4] SCC letter to Mary
Schapiro, January 17, 2012
[5] Nathan, Barrall,
Chung, Say on Pay 2011: Proxy Advisory on Course of Hegemony, New York
Law Journal, 11/28/11.
[6] This is a bit of an
overstatement, as there are many portions of the Coalition's work NOT RELATED
to proxy advisors that focus on legitimate problems.
Read more blog posts on corporate governance at the Robert
A.G. Monks blog
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