Proxy Firms Need More
Rules, Companies Say
STEVEN M. DAVIDOFF
A battle over whether to regulate proxy advisory services represents a
political turn of the tables.
Public companies and their advisers are pushing for new rules from the
Securities and Exchange Commission to restrict proxy advisory firms. Yes,
these are the same interests who usually argue against regulation.
They are pitted against corporate governance groups that seek an easier
and cheaper way to nominate directors. But on the issue of the advisory
services, they have put up a big don’t touch sign.
Regulation, it would appear, is a good thing only when it serves your
purposes. Yet the debate over proxy advisory services is an important one.
Every year, some 4,400 listed companies hold annual meetings to elect
directors and consider shareholder proposals. In 2010 Exxon Mobil
shareholders considered the election of 11 directors and 11 shareholder
proposals ranging from a shareholder say on pay policy to a greenhouse gas
Institutional investors like mutual funds and pension funds do not have
the resources to analyze and consider all these proposals. The large asset
manager TIAA-CREF estimates that it holds stock in more than 7,000 companies
and has more than 80,000 different votes to cast every year.
To fill this gap, there are proxy advisory services. For a fee, these
firms recommend how institutional investors should vote. There are fewer
than a dozen such services and Institutional Shareholder Services is the
largest with 1,300 clients. And they wield substantial influence. There is
pressure on boards to conform to proxy firm recommendations — particularly
those of I.S.S.
These proxy firms formulate their own good governance principles to guide
The problem with this approach is defining what exactly is good
Public companies have said that the proxy services interfere with their
boards’ own internal governance. They criticize the services for what they
say is the lack of evidential support for their recommendations.
The S.E.C. has now given these companies an opportunity to vent. In July,
the agency said it was seeking comment on the proxy system.
More than 250 comments were submitted. The comments of governance groups
were along the lines of Nell Minow of the Corporate Library. She objected in
the “strongest possible terms” to any such regulation.
But the claws also came out on the business side in comments arguing for
heightened regulation. Wachtell, Lipton, Rosen & Katz, a law firm that has
opposed proxy access on the grounds it was unneeded regulation, argued that
there was “a dangerous gap” in the securities laws. Proxy advisory services,
Wachtell argued, should be subject to the proxy solicitation rules. If these
rules applied, shareholders and public companies could sue the advisory
services over disclosure lapses in their recommendation reports. Wachtell
did not add that by imposing this liability, the ability of proxy advisers
to make recommendations would be chilled, if not killed.
Other comments, like those from the Business Roundtable, which represents
chief executives of top American companies, also argued for greater
disclosure of proxy adviser conflicts. Currently, I.S.S. not only provides
voting recommendations but also advises corporations on how to structure
their corporate governance procedures. The argument is that companies have
an incentive to employ I.S.S. to ensure favorable recommendations.
Disclosure on these potential conflicts is sparse, although I.S.S. at least
has a policy that clients can ask for and obtain further information if they
Other comments, submitted by the United States Chamber of Commerce, among
others, focused on the standards of good corporate governance. Companies
want more ability to comment on and propose changes in these standards as
they are adopted by regulatory agencies, as well as to comment on
recommendations of proxy advisers. These commentators generally argue that
proxy advisory services should be subject to a strict regulation and
disclosure regime, like credit ratings agencies.
To some extent, corporate interests misunderstand or willfully distort
the service provided by proxy advisory firms. These firms analyze and make
recommendations on corporate issues for institutional investors that are too
busy to do this research themselves. They are not like the credit ratings
agencies, which can disrupt markets.
Yes, proxy advisers can get things wrong, but their own clients have
incentives to monitor them. Indeed, in its comment letter, BlackRock states
“we reach an independent conclusion on the proxies that we review; we do not
blindly follow any proxy advisory firm’s advice.”
That view is echoed by nearly all the institutional investors who
submitted comments to the S.E.C. And in recent prominent contests involving
Barnes & Noble and Dynegy, I.S.S. clients went against the service’s
In fact, some regulation of proxy firms is already in place. I.S.S., for
example, has registered as an investment adviser, allowing for S.E.C.
oversight. Regulations should require this type of registration to keep all
of the advisers on the agency’s radar. There is also probably some need for
an enhanced policy concerning disclosures of possible conflicts of interest.
But anything more would simply lend support to an attempt by corporations to
upend these standards and water them down.
And yes, I know that these standards themselves have problems, but better
that the shareholders and institutions formulate them than corporations.
Given the tenor of the institutional comments and the fact that more than 50
percent of the shares voted by I.S.S.’s clients are voted under individual
or tailored policies on proxy recommendations, it appears that shareholders
are acting to influence this market.
The corporations aren’t going to like it, but this is one area where the
market should best be left to work.
Steven M. Davidoff, writing as The Deal Professor, is a
commentator for DealBook on the world of mergers and acquisitions.
The New York Times