ROCKVILLE, Md. — If you're like most investors, it is a good bet that
shortly after hoisting, say, a 132-page
proxy statement from the mailbox this spring, you threw it away unread.
Few shareholders ever cast a proxy vote themselves. Moreover, according to a
recent poll of mutual fund investors, proxy voting policies ranked last
among the 19 issues that people consider before making a purchase. But for
institutional investors — pension funds, endowments, hedge funds and the
like — corporate governance is an entirely different matter. They may not
care deeply about it, but they need to pay attention as a fiduciary duty,
typically relying for advice on a tiny group of little-known companies.
"The influence these advisers wield is extraordinary," said David W. Smith,
president of the Society of Corporate Secretaries and Governance
The most prominent advisory firm is Institutional
Shareholder Services, based in an unremarkable office park in this
leafy Washington suburb. By the firm's own estimate, its opinions affect the
governance decisions of professional investors controlling $25 trillion in
assets — half the value of the world's common stock.
I.S.S. draws fire for both setting governance standards and helping
corporate clients meet them, provoking criticism that it profits handsomely
from a possible conflict of interest. It says that it has strictly separated
these functions in order to eliminate conflicts.
The firm researches proxy issues, makes voting recommendations to 1,635
investor institutions and electronically transmits their votes — and in some
cases casts those votes according to its guidelines unless the client tells
it otherwise. Another 700 clients are corporations.
"People always ask," said Patrick S. McGurn, executive vice president, "why
did this become the center of the universe?"
That is how many regard I.S.S., which leads a close-knit industry while
pressure is building on institutions to make full use of the corporate
ballot. I.S.S. decisions, for example, can affect whether directors serving
compensation committee should be re-elected. (I.S.S. recommended withholding
votes for two of four.) It also advises on major corporate acquisitions,
(It favored the deal.)
I.S.S.'s chief competitor in this business is Glass,
Lewis & Company of San Francisco. A third is Proxy
Governance in Vienna, Va., another Washington suburb. Both proclaim
themselves free of conflicts of interest, because, they say, they do not
advise corporations on governance issues.
This month, the combined, growing influence on the proxy system of all of
the advisory firms led a
New York Stock Exchange
working group, citing "potential for possible conflicts," to call for a
study of the advisers' role by the Securities and Exchange Commission. I.S.S.
said that while the recommendation seemed to be based on a "lack of
understanding, " it would be pleased to participate. The other firms said
that they would welcome S.E.C. scrutiny.
From its start in 1985, I.S.S. now has more than 500 employees and a dozen
offices around the world. Its clients range from mutual fund giants like
Fidelity to smaller groups like Mennonite Mutual Aid. Glass Lewis, founded
in 2003, has about 200 clients, according to Gregory P. Taxin, its chief
executive. Some clients use both services.
I.S.S. says that it was the first to advise institutions on votes, offering
broad research now covering 35,000 companies in 15 countries. It calls
itself the only provider of "soup to nuts" service, which includes
researching and making recommendations on issues like mergers, poison pills,
boards with staggered tenures and the fitness of directors. It also collects
and transmits ballots.
The logistical part of the business "has become equally, if not more,
important than the actual research part," said Cheryl Gustitus, a senior
vice president. "What clients have outsourced is the back office."
Critics complain that governance thinking has become overly concentrated and
that institutions shirk their fiduciary duty by farming out the job. "I
question the qualifications of all these firms in making recommendations,"
said Gary Lutin, a New York investment banker who is an adviser in corporate
control contests. "It's like having a bunch of ivory-tower political
theorists decide how to run the government."
Broader research by I.S.S., he said, would likely have uncovered more facts
during the spring about
National Presto Industries,
a Wisconsin maker of small appliances. I.S.S. favored management in ballot
issues involving the election of a director and the company's status as an
operating company. But the S.E.C. had found that the company should be
considered an investment company. I.S.S. defended its recommendations by
saying that the company would better serve shareholders as an operating
What's more, according to other critics, including competitors, the I.S.S.
approach tends to be one-size-fits-all. Most clients do subscribe to a
standard I.S.S. policy, a core of guidelines intended to allow consistent
application in all proxy reviews. But the firm rejects criticism of this,
saying that about 340 clients develop their own policies and then mesh them
with the I.S.S. guidelines. There are special policies for labor unions and
clients that follow what they call faith-based or socially conscious
The client "always has the final word," said Jamie Heard, vice chairman and
part owner of I.S.S., a privately held firm whose majority owners are the
British investment firms Warburg Pincus and
Hermes. "The idea that institutions are just
blindly following I.S.S." is false, he said. Some 75 percent of the votes it
transmits require a signoff by the client or are cast by specific
About 25 percent, added Ms. Gustitus, are on a policy of implied consent
under which votes are cast according to I.S.S.'s annually updated guidelines
unless otherwise instructed.
Glass Lewis, which has 105 employees in five offices, says its emphasis is
on identifying hidden risks in accounting, regulation, litigation or
governance. The goal, Mr. Taxin said, is to enable its clients to avoid
disasters like the Enron collapse. Mr. Taxin says that while clients include
short-selling hedge funds, more than 90 percent of clients maintain only
I.S.S. points to what it calls "robust" procedures to avoid possible
conflicts arising from its practice of serving both investors and publicly
traded companies. One, it says, is a firewall that separates corporate
services from the rest of the company. Another is the disclosure to investor
clients of detailed information about corporate relationships, including
dollar amounts of fees.
I.S.S. says clients would shy away if its structure made them uncomfortable.
"We have a 95 percent renewal rate across our client base," Ms. Gustitus
One largely satisfied customer is Mennonite Mutual Aid, based in Goshen,
Ind. It has about $1 billion in stock funds and other portfolios. "They help
us shape and sustain our faith-based voting policy," said Mark A. Regier,
the investment manager. Mennonite Mutual Aid pays I.S.S. between $40,000 and
$50,000 a year for advice, without which, Mr. Regier said, he would have to
Mr. Regier says he mostly goes along with I.S.S. recommendations. He called
it "troubling" that I.S.S. has corporate clients because this might make for
easy acquiescence to corporate assertions that a governance problem was
being properly addressed. In addition, Mr. Regier said he was displeased
when I.S.S. last year bought the Investor Responsibility Research Center, a
Washington research group on governance issues. "It took another voice out
of the marketplace," he said.
Proxy Governance, which declines to specify its number of clients, runs a
highly automated service from a single office. The company, a start-up aided
by money from the Business Roundtable, a group of corporate executives,
issued its first report in January 2005.
Steven. M. H. Wallman, founder and chief executive and a former member of
the S.E.C., says his competitors' services are not refined enough. Their
advice does not provide context, he said, for "ideas such as that poison
pills are always bad or all chairman and C.E.O. jobs should be split."
"What I saw in I.S.S. was an institution that had become quite insular in
its thinking," he added.
JOHN M. CONNOLLY, the chief executive of I.S.S., said last week at the new
Yale Center for Corporate Governance and Performance that he would favor
establishment of an industry database on governance to be available to
academics and the public, a project long advocated by Mr. Lutin. Mr. Taxin
said he would support such an effort; Mr. Wallman reserved judgment.
the moment, the firms do not provide advice for individuals. Those investors
who want to take the trouble must wade through weighty, often baffling,
proxies on their own. If you don't vote shares held by your broker, you are
by default siding with management, though the stock exchange study
recommends that brokers no longer vote such shares for election of
Online transmission of votes is an option for clients of
Foliofn, a brokerage firm and the parent of Proxy Governance. I.S.S.
officials smiled when asked whether their own firm might develop a retail
"We've looked at it from time to time," said Mr. Heard, but he does not see
much chance of a groundswell of interest that would make it profitable.
"It's more likely," added Mr. McGurn, that another electronic broker "would
be willing to pay for it in bulk and provide it to people as part of the