What the SEC’s Proposed Rule Means for Investors

In the new year, we often make many promises. This time, we must resolve to protect the interests of retail and institutional investors from the meddling of proxy advisory firms. I have always argued for clear and navigable investment voting processes, and this moment is particularly critical. As the SEC’s recently proposed rule S7-22-19, Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice makes its way through the public comment period, investors must understand how this rule will bring long-overdue accountability to the proxy voting process, and what that means for bottom-line dollars. 

Proxy advisory firms amassed their influence through a series of unintended consequences and a prevailing lack of oversight. Until the SEC issued Staff Legal Bulletin No. 20 in 2014 clarifying that investors were not required to vote every proxy, the misconception that they were prompted institutional investors to disproportionately rely on proxy advisory firms to carry out their voting duties.

During that time, a duopoly flourished. Glass Lewis and International Shareholder Services (ISS) dominate 97 percent of the market, which affords them the ability to dictate the rules of the game with little competition. Proxy advisory firms position themselves as third-party “allies” to investors while wielding enormous power to sway voting outcomes and determine where and how fiduciaries invest others’ money. And that’s cause for concern. 

For one, proxy advisory firms are rife with conflicts of interest. Consider that ISS bases its voting recommendations, in part, on an analysis of a company’s governance performance demonstrated by an ISS Governance Score. ISS also offers a service to companies on how to improve their ISS Governance Score. Hence, ISS collects payment on opposite sides of the same mechanism. 

ISS also sells voting services to investors as well as consulting services to companies considering management-proposed resolutions. This introduces the risk of the proxy firm recommending that investors vote in favor of management when it’s a consulting client. The Ohio Public Employees Retirement System (OPERS) understood the danger this posed to its pension plan members’ long-term financial security and swiftly ended its contract with ISS in the mid-2000s. 

Conflicts of interest become even more troubling given the preponderance of automatic voting. On average, investors vote following proxy recommendations 80 percent of the time. A single negative ISS recommendation on say-on-pay leads to a 25 percentage point reduction in support.

As a fiduciary, an investment adviser owes each of its clients a duty of care with respect to services undertaken on the client’s behalf. However, proxy advisory firms provide several different voting guidelines that obfuscate fiduciary duty and skew investments toward subjective goals, including faith-based and sustainability guidelines. By relying on shadow reports, proxy firms offer investors the best of both worlds: the ability to vote how they please while simultaneously recusing themselves of any responsibility by supposedly following the unbiased advice of a third party.

As it turns out, everyday investors are becoming increasingly aware of the many flaws in the existing proxy advisory process. A recent survey found over 80 percent of investors in support of the SEC’s proposed rule at the end of the survey. Additionally, the survey found that the more asset managers and investors learn about proxy firms, their business and what drives their recommendations, the more they support responsible regulation. 

Currently, proxy advisory firms provide recommendations based on inaccessible, private data unavailable for public review. S7-22-19 would require proxy firms to ensure their recommendations include dissenting opinions and also allow companies the opportunity to correct inaccuracies in proxy advisory reports.

Proxy voting functions, fundamentally, as an “information production process”. These firms are modern-day factories; their product is information. A proxy firm survives only by maintaining a constant rate of production. By creating reports, data and analyses that tailor to specific political and financial agendas in secret, proxy firms are capable of re-defining public opinion among investors and manipulating large swaths of capital, almost single-handedly.

Though charged with helping investors generate revenue, it seems that proxy advisory firms are only concerned with one bottom-line: their own. The proposed rule rightfully addresses the many transgressions inherent in the proxy advisory process. With the help of the SEC, I believe that we can shift the balance back in favor of investors.


Chris Cummiskey has over two decades of experience in senior positions at both the federal and state levels, including as an Arizona state senator and state representative. He currently serves as an advisory board member at the Institute for Pension Fund Integrity.

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