Proxy advisory firms are facing new pressure to increase accountability and transparency. Congress aims to provide government oversight of the firms, which give institutional investors research and recommendations about how to vote on management and shareholder proposals at annual company meetings.
Proxy Advisory Firms and Accountability
The two firms at whom efforts in Congress are mainly aimed are Institutional Shareholder Services (ISS) and Glass, Lewis & Co., which together control 97% of the proxy advisory services given to investors. Rather than require them to be physically present at annual corporate meetings, the US Securities and Exchange Commission (SEC) allows shareholders to pass their votes on to these services. The shareholders proxy advisory firms primarily serve are institutional clients, for example banks, endowments, or pension funds, which own shares in too many individual companies to manageably attend to each proxy issue and vote.
The pressure proxy advisers face is manifold. First, a bill pending in the House of Representatives, H.R. 4015, would require advisory firms to register with the SEC, publicly disclose their methodology for taking positions on important issues up for vote, and provide companies the chance to review a draft of recommendations and submit a response before publication. In addition, the goals of the bill were reinforced earlier this year when six senators on the Senate Banking, Housing, and Urban Affairs Committee penned letters asking ISS and Glass Lewis for information about their reporting accuracy, potential conflicts of interest and factors that could allow them to claim exemption from federal proxy regulations. Company lobbying in support of the legislation to increase oversight of the proxy advisory business is double what it was in 2016, when an earlier version of the legislation was proposed.
This action comes as Congress also considers legislation designed to restrict shareholders’ ability to submit proposals for shareholder votes, which are popularity among some investors as a way of promoting change at companies. Known as the the Financial Choice Act, the proposed legislation has been passed by the House and is awaiting action in the Senate.
The Debate over the Role of Proxy Advisers
Critics of proxy advisory services maintain that their overwhelming market dominance creates “herd voting” on important shareholder issues—and that offering some companies consulting services could create a conflict of interest because the firms might recommend adoption of management proposals at companies where they have been paid consultants. The probusiness American Council for Capital Formation, a Washington, DC–based think tank, produced a research paper in May 2018 titled “The Conflicted Role of Proxy Advisors.” The paper cited five debatably problematic behaviors associated with proxy advisory firms and accountability, including robo-voting, in which institutions automatically vote as recommended by the proxy services, without evaluation. According to the paper, proxy advisory firms often recommend policy changes at companies that can create additional financial burdens, especially for smaller firms.
That said, backing of the bill is far from universal. Proxy adviser supporters maintain that the firms’ current scope and role are important in identifying issues—such as governance or environmental problems—that most institutional investors lack the resources to pursue on their own. The advisory firms say that the proposed legislation would deprive investment companies of crucial information about upcoming votes that could materially affect their shareholders. Some shareholder organizations have also defended the proxy advisers. For example, the Council of Institutional Investors (CII), an association of pension funds and foundations, argued that regulating proxy advisers would raise costs without producing any clear benefits. CII argues, too, that there’s no compelling evidence to support claims of herd voting and that proxy adviser recommendations tend to align with those of management.
With powerful figures and organizations standing on both sides of the debate, it’s still unclear whether or not Congress will succeed in reining in the activities of proxy advisory firms. For now, the advisers’ fate lies with asset management firms and investors—and whether or not they see a continued benefit from proxy advising.