Later today, the U.S. Senate Committee on Banking, Housing and Urban Affairs will hold a hearing to discuss legislation related to corporate governance. The discussion is particularly timely given the unchecked influence that proxy advisory firms have in today’s marketplace.
The dynamic between investment advisers and proxy advisory firms is a complicated one. Proxy firms are supposed to provide unbiased, expert advice to these investors on how they should vote on shareholder resolutions that would govern the companies they hold stock in. As the number of proposals has grown in recent years, so too has the influence of two dominant advisory firms, Glass Lewis and ISS. Research shows that investment advisers follow proxy advisory firms’ recommendations 80 percent of the time.
But here’s the rub: All too often, proxy firms have undisclosed conflicts of interest that cloud their ability to provide impartial advice and adequately represent the interests of long-term retail investors. One particularly blatant example lies in the fact that ISS provides consulting services to institutional investors, while simultaneously rating the voting performance of those companies on politically motivated proposals. Unfortunately, it has become industry practice for fund managers and institutions to rely on the conflicted recommendations of proxy advisors, rather than conducting the necessary due diligence that their fiduciary duty requires. This results in retail investors being underrepresented, misrepresented, or selectively represented in favor politically motived shareholders.
Even Glass Lewis has acknowledged the problem with this state of affairs:
“We believe the provision of consulting services creates a problematic conflict of interest that goes against the very governance principles that proxy advisors like ourselves advocate … A consulting business is not only in conflict with the interests of our clients, but in conflict with the interests of the companies who are entitled to a fair, reasonable and independent assessment.”
Enough said.
Proxy advisory firms have taken on this outsized role among investment advisors because very few regulations are in place to limit their influence. The Securities and Exchange Commission has contributed to this phenomenon by deliberately reducing oversight of the industry. In 2004, it issued no-action letters that essentially allowed proxy firms to rely on their general conflicts of interest policies and ignore any specific instances of conflicts. This calls into questions whether fund managers are truly fulfilling their fiduciary duty to investors. The letters also allow investment advisors to classify the proxy advisory firms as “independent” even when they are clearly financially conflicted. As the letter argued:
“The mere fact that the proxy advisory firm provides advice on corporate governance issues and receives compensation from the Issuer for these services generally would not affect the firm’s independence from an investment adviser.”
This is an unacceptable conflict that exists nowhere else in the financial industry. Retail investors who have no idea that SEC staff no-action letters are shaping the way that investment advisers vote their shares are in desperate needed of protection. When objectives other than value maximization are driving the direction of shareholder votes, retail investors are harmed.
Thankfully a provision of H.R. 4105, the Corporate Governance Reform and Transparency Act of 2017, addresses this problem head-on, by directing the SEC to withdraw the 2004 no-action letters. The legislation has already passed the House of Representatives and will be featured at the Banking Committee’s hearing this week. While legislation would clarify government policy on proxy advisors, the SEC can and should act on its own.
The commission should move to immediately withdraw the 2004 no-action letters referenced above. By acting quickly to ensure that proxy advisory firms are working in the best interests of small businesses and retail investors, this will serve to enhance the public’s trust in America’s capital markets. It is past time that a solution to the problems proxy firms present is not just talked about, but acted upon.
The American Securities Association prioritizes safe guarding the interests of retail investors by promoting public trust and confidence in the US capital markets. We strongly support the Corporate Governance Reform and Transparency Act and the SEC withdrawing the 2004 no-action letters.
Christopher A. Iacovella is the chief executive officer of the American Securities Association.
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