More Proxy Advisory Reform on the Horizon, Says SEC

Proxy advisory firms, such as Institutional Shareholder Services (ISS) and Glass Lewis among others, have been under the microscope for some time. Some believe they are critical to giving a voice to shareholders. Others think they have too much power without enough transparency.

I’ve written about proxy advisory firms in the past. Understanding the history of the issues helps clarify what’s going on now, including legislative efforts to regulate these firms.

At this time H.R. 4015 – the Corporate Governance Reform and Transparency Act of 2017 has passed in the House (December 2017). The bill now has to go in front of the Senate for a vote.

In the meantime, the Securities and Exchange Commission is making its priorities known regarding proxy advisory reform in the coming year.

In December 2018, SEC Chairman Jay Clayton gave a speech in which he discussed the SEC’s rulemaking priorities for 2019. Among these were initiatives to improve the overall proxy process in 2019. As part of that, he stated that when it comes to proxy advisory firms, “there is growing agreement that some changes are warranted.”

In his speech, Chairman Clayton outlined where proxy advisories could benefit from reform. I’ll outline those areas next.

Clarity around the proxy advisory’s division of labor, and the responsibility and authority between proxy advisors and the investment advisers they serve.

I believe Chairman Clayton is referencing the opaque nature of some of the relationships in proxy advisory world. It is not altogether clear, for example, if some investment advisors are more influential than others.

This is of particular importance in situations of a challenging proxy contest, for example, when activist investors are involved.

Clarity around the proxy advisory’s analytical and decision-making processes.

This is about more transparency into how proxy advisory firms reach their recommendations. It is well known that proxy advisory firms do not disclose exactly how they develop their guidelines or their recommendations to shareholders.

Indeed, some do not disclose their guidelines at all (the two largest proxy advisory firms, ISS and Glass Lewis, do).

Also, as I have noted in the past, there is a significant body of research that indicates that some of the factors proxy advisory services use to judge companies are not predictive of anything an investor would reasonably want, for example, returns or the chances that a firm will fail.

Given that these services are advisors on matters concerning corporate governance, their research on the efficacy of their rating systems would be useful information for the investing public.

This issue is particularly acute when it comes to “one-size-fits-all” recommendations. Two different companies may not thrive with the same corporate governance structure.

In his speech, Chairman Clayton pointed out that “some matters put to a shareholder vote can only be analyzed effectively on a company-specific basis, as opposed to applying a more general market or industry-wide policy.”

Looking closer at the framework for addressing conflicts of interests at proxy advisory firms. 

Conflicts of interest include the fact that proxy advisory firms can sell corporate governance consulting services.

If issuers can pay proxy advisory services for consulting, but these services also have investment advisors as clients, it may not always be clear which master is being served at a given moment.

Certainly on the issuer side there is widespread cynicism as to the nature of the payments the proxy advisory services seek from issuers.

Ensuring investors have access to corporate responses to information from proxy advisory firms.

This initiative would essentially give shareholders access to corporate rebuttals against recommendations from the proxy advisory firms, potentially leveling the playing field for decision-making.

Information like this is especially important for contested vote situations, for example a difficult set of compensation decisions.

Currently, companies can mount an expensive public relations campaign to support their position; it’s not clear that this expense is in the best interest of shareholders when the proxy advisory services could easily provide this information.

In his speech, Chairman Clayton made it clear that these and other issues arising at proxy advisory firms today “will not improve on their own with time.” In other words, he sees that the market has not self-corrected, and these services require some regulation. On this point, he further noted that he intends to “move forward with the staff recommendations, prioritizing those initiatives that are most likely to improve our markets for our long-term Main Street investors.”

For some, this is another step in the right direction to regulate the powerful proxy advisory duopoly that is ISS and Glass Lewis. For others, it is a way for corporations to gain more power at the expense of shareholders.

No matter what camp you’re in, it's likely that we will see some changes in the way proxy advisory firms operate in the future. But how soon is debatable – remember that the SEC has been talking about proxy advisory reform for at least six years.