Proxy Advisor Legislation: Let’s Fix What’s Broken And Leave The Rest Alone
It’s hard to believe we are getting into proxy season 2019. Where does the time go? Washington started the year with a “screeching” halt, and now, the beltway is breathing a sigh of relief that government will stay open. Meanwhile, investors continue to ramp up pressure on corporate boards through engagement and proxy contests.
Proxy advisors play an important role in the annual proxy review process. To that end, proxy advisors use the investors’ specific voting guidelines to review company disclosures and provide cost-effective, independent research and voting recommendations. This enables resource-constrained investors to cover hundreds, if not thousands, of issuers and engage with each as necessary to protect their investments.
For years, issuers have criticized proxy advisors, claiming that they are not fair, lack transparency, do not understand the company, and are difficult with which to engage. No wonder Congress, concerned about conflicts of interest with proxy advisors in general, and Institutional Shareholder Services (ISS) specifically, has introduced two pieces of legislation to regulate proxy advisors and their interactions with investors.
Given the debate around proxy advisor legislation, questions among investors are starting to surface, including: (1) do Proxy Advisors have too much uncensored power in the overall voting process? (2) if so, will the proposed legislation address the problem? and (3) to what extent do investors follow ISS and Glass Lewis’ recommendations on pay?
House Bill 4015
“House Bill 4015 amends the Securities Exchange Act of 1934 to: (1) require a proxy advisory firm to register with the Securities and Exchange Commission (SEC); and (2) prohibit an unregistered proxy advisory firm from using interstate commerce to provide proxy-voting research, analysis, or recommendations to any client. With respect to such firms, the bill: (1) establishes procedures for both registration and termination of registration; (2) requires each firm to employ an ombudsman, designate a compliance officer, and file specified documents with the SEC; and (3) prohibits unfair, coercive, or abusive practices.”
The Legislative Response
In response to the perceived increasing influence of proxy advisors, the U.S. House introduced House Bill 4015 in 2017 and passed it in 2018 before forwarding it on to the Senate. Not to be outdone, the Senate introduced its own Senate Bill 3614 in November 2018. These pieces of legislation differ, but both require proxy advisors to register with the SEC and subject themselves to audits for conflicts of interest. The House bill goes further, requiring that internal policies be established to avoid conflicts of interest. It also requires more oversight and accountability of Proxy Advisors (e.g., the hiring of a compliance officer and/or an ombudsman) to address issuer concerns over recommendations, file confidential financial statements with the SEC, and make voting recommendation methodologies available to the public.
None of this legislation sounds crazy on the surface. However, does it make sense to regulate organizations that cost-effectively provide voting recommendations to shareholders? In response to this potential legislation, ISS and The Council of Institutional Investors (CII) launched a website to provide their perspectives on proxy advisors and the important role they play within the investment community. Glass Lewis, in a letter to the SEC investor round table in November of last year, defended its clients’ independence, and minimized their own influence by highlighting that their clients very often vote differently from their recommendations. In fact, investors who have independent voting guidelines and use Glass Lewis’ research in their decision-making processes vote differently from Glass Lewis’ recommendations 37% of the time. Both investors and proxy advisors argue that proxy advisor research enhances an already robust decision-making process that is critically important to investors.
Our Farient Advisors team recently researched the influence of proxy advisors on Say on Pay (SOP) votes and the differences in how investors are using proxy advisor recommendations. We hypothesized that larger investors more often vote differently from ISS’ recommendations compared to smaller investors. We based this hypothesis on an initial assumption that the larger investment houses employ dedicated governance teams who develop their own voting standards, while the smaller houses do not have such teams.
Interestingly, our analysis only partially supports our hypothesis. To test our hypothesis, the team examined SOP votes cast for S&P 500 companies by 1,200 institutional investors. In fact, the largest 200 investors voted with ISS’ recommendations 84% of the time, while the smallest 200 investors voted with ISS’ recommendations 89% of the time. It appears as though smaller investors are only slightly more likely to vote with ISS recommendations compared to the larger ones.
However, a second finding runs counter to this pattern. We reviewed ISS “AGAINST” recommendations in isolation and found that larger investors are more likely to vote with ISS compared to smaller investors, 74% to 56%, respectively.
In addition, these summary statistics mask differences among investors in their “FOR” voting patterns. The top 20 investors, ranked by assets under management, vote very differently relative to ISS recommendations. For example, as shown in the chart below, BlackRock votes in support of SOP 97% of time, following ISS recommendations 90% of the time; while BNY Mellon votes in support of SOP 56% of the time, following ISS recommendations only 64% of the time.
SOP Support by Largest Investors and Their Voting Consistency with ISS Recommendations
The bottom line is investors consult proxy advisor research to inform their voting decisions, but in the end, follow their own advice in casting their votes.
Based on our research and experience working with proxy advisors and issuers, I encourage you to:
- Understand ISS and Glass Lewis recommendation methodologies and how your company will be rated;
- Know your major investors, their voting policies, and voting record relative to proxy advisor recommendations; and
- Target investors for engagement based on an understanding of the investor landscape.
As a board member, you have the power to tell your company’s story and provide a compelling narrative to ensure that proxy advisors do their jobs while you take the opportunity to reinforce the fact that you are doing yours. With this proxy season upon us, there is no better time than now to heed this advice.