Public companies haven’t been shy lately when it comes to voicing their frustrations with proxy advisory firms. And it seems the SEC has been listening.
The SEC voted on Aug. 21 in favor of two guidance initiatives designed to allow greater scrutiny of the voting recommendations made by proxy advisory firms such as Institutional Shareholder Services Inc. (ISS) and Glass Lewis. The new guidance could work against proxy advisory firms in a couple of ways. First, Applicability of the Proxy Rules requires more transparency from advisory firms, including, for instance, the disclosure of the methodologies they use to formulate their advice. Proxy Voting Responsibilities of Investment Advisers also arguably curbs the influence of proxy advisory firms by emphasizing that, when following voting advice, investment advisers must continue to mind their fiduciary duties to clients.
For the uninitiated: Institutional investors – mutual funds, pension funds, endowments, and the like – own approximately 80% of the U.S. equity market. As such, market participants worry that institutional investors can determine the fate of the shareholder proposals that come up every year at companies’ annual meetings. (For its part, Blackrock responds that even if the top three institutional investors ganged up, they couldn’t sway most votes.) However, investment advisers like portfolio managers typically run these funds, and they often rely on the recommendations of proxy advisory firms – almost exclusively ISS or Glass Lewis – to dictate how they vote on the proposals.
As SEC Chairman Jay Clayton noted, the new guidance doesn’t change anything fundamentally. Like before, investment advisers are still responsible for their own votes on shareholder proposals. Instead, the guidance serves as a warning that using a proxy adviser doesn’t constitute a get-out-of-jail-free card when it comes to how investment advisers vote. The directives even lay out ways for investment advisers to vet proxy advisory firms’ policies and procedures.
In practice, this will force proxy advisory firms to engage in more significant disclosure about their recommendations in order to mitigate the increased risk for investment advisers. Proxy advisory firms, which under the new guidance are clearly subject to an SEC rule that prohibits the sharing of false information, will also now face presumably higher costs to double and triple-check the accuracy of their reports.
Clayton came through for the more than 300 companies that joined the Nasdaq earlier this year in calling for more checks on the growing sway of proxy advisory firms. Not everyone at the Commission agreed with the move, however.
Democratic commissioners, Robert J. Jackson Jr. and Allison Herren Lee, provided the two dissenting votes on the decision. Jackson Jr. pointed to a laundry list of unintended consequences that could stem from the guidance. For example, he argued that if smaller investors can’t afford to review proxy voting advice, they may opt out of voting altogether. Furthermore, according to Jackson, raising proxy advisers’ own costs could raise barriers to entry in an industry that is already dominated by just two players.
Echoing some of Jackson’s sentiments in her own dissent, Lee noted that the guidance “introduces increased costs and time pressure into an already byzantine and highly compressed process.” She also pointed out that the guidance lacked firm evidence supporting the idea that it would produce outcomes that were in the best interests of investors.