By John Filar Atwood
In a study of the state of the proxy advisory industry, the Government Accountability Office (GAO) heard from some corporate issuers that advisory firms continue to apply policies in a one-size-fits-all manner, which can lead to recommendations that are not in the best interest of shareholders. The GAO provided this and other results of the study in a report to the Subcommittee on Economic Policy of the Senate Committee on Banking, Housing, and Urban Affairs.
The GAO indicated in the report that corporate issuers said that they often do not understand the rationale for some advisory firm vote recommendations and would like to discuss them before they are finalized. Proxy advisory firms told the GAO that to maintain objectivity and satisfy research reporting timelines for clients, they limit the breadth of such discussions.
The subcommittee asked the GAO to review the current state of the proxy advisory industry given that institutional investment has grown over the last 30 years, and institutional investors increasingly rely on proxy advisory firms. Members of Congress, industry associations, and academics have raised issues about proxy advisory firms’ influence on voting and corporate governance, the level of transparency in their methods, and the level of regulatory oversight.
Advisory firm influence. The GAO found that institutional investors hire proxy advisory firms to obtain research and vote recommendations on issues, such as executive compensation and proposed mergers that are addressed at shareholder meetings. Market participants and other stakeholders with whom the GAO spoke agreed that with the increased demand for their services, proxy advisory firms’ influence on shareholder voting and corporate governance practices has increased, but disagreed on the extent of the influence.
Some study participants told the GAO that the influence of advisory firms can vary based on institutional investor size. Generally there is less influence on large institutional investors that often perform research in-house and have their own voting policies.
Proxy advisory firms, specifically Institutional Shareholder Services and Glass Lewis & Co., develop and update their general voting policies through a process that involves analysis of regulatory requirements, industry practices, and discussions with market participants. Corporate issuers and institutional investors told the GAO that unlike in the past, the firms have made more of an effort to engage market participants in the development and updating of voting policies.
According to the proxy advisory firms, they apply the general voting policies to publicly available company information to develop vote recommendations, the report states. The recommendations also are based on institutional investor voting instructions and criteria that firm analysts determine are applicable to the issue being voted on. According to the report, advisory firms have taken steps to communicate with corporate issuers and allow review of data used to make vote recommendations before they are finalized.
SEC oversight. The GAO said that the SEC’s oversight of proxy advisory firms and the services they provide has included gathering information, issuing guidance, and examining proxy advisory firms and use of the firms by investment companies. In 2010, the Commission summarized concerns regarding conflicts of interest, accuracy, and transparency of proxy advisory firms, and requested comments on potential regulatory solutions.
Late in 2013, SEC held a roundtable to discuss issues facing the proxy advisory industry, and issued guidance in June 2014 on disclosure of conflicts of interest. The GAO said that the Commission claims to still be addressing concerns surrounding proxy advisory firms through its examinations of investment advisers and investment companies that retain their services. The Commission made the examinations a priority in 2015 and an area of focus in its ongoing initiative for registered investment companies that had not been examined by SEC, according to the report.
ISS dominance. The GAO found that although the proxy advisory industry consists of five firms, ISS and Glass Lewis are the largest and most often used by institutional investors. To compete, proxy advisory firms must offer comprehensive coverage of corporate proxies and use sophisticated systems to provide research and proxy vote execution services, the GAO noted. The GAO concluded, as it did in 2007, that ISS’s long history of working with institutional investors, and its reputation for providing comprehensive proxy voting research and recommendations, makes it the most dominant proxy advisory firm.
The GAO stated that ISS’s dominance makes it difficult for competitors to attract clients and compete in the market. In addition, institutional investors may be reluctant to subscribe to a potentially inexperienced or less-established proxy advisory firm that may not provide thorough coverage of all of their institutional holdings. According to market participants and other stakeholders with whom the GAO spoke, these conditions continue to exist, and the initial investment required to develop and implement the necessary technology is a significant expense for firms.