The SEC Is Right to Demand Accountability From Proxy Advisors

The SEC Is Right to Demand Accountability From Proxy Advisors
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One of the most significant – and least discussed – processes underway in Washington at present is the move by the Securities and Exchange Commission (SEC) to reform the rules governing the conduct of proxy advisory firms.

These firms play an important role in providing institutional investors with data, research, analysis and--most importantly--recommendations on how to vote on management and shareholder proposals at the annual meetings of public companies. This gives proxy advisory firms a significant role in influencing many aspects of corporate governance.  

The emergence of proxy advisory firms over the past two decades stems in large part from a desire by institutional investors to better understand the companies they are investing in--as well as an SEC rule requiring them to vote their proxies. While proxy advisors have fulfilled this function, there have also been substantial concerns about a lack of transparency in their reports and potential conflicts of interest in their recommendations.

Prominent groups such as the U.S. Chamber of Commerce have urged the SEC to bring in new rules governing proxy advisory firms, averring that the advice proffered is often not consistent with maximizing with shareholder returns.  

In August, the SEC heeded this call and proposed new guidance designed to deal with the ethical and quality concerns around proxy advisors. 

The guidance covered a variety of practices. For example, it made proxy advisors liable for false or misleading statements in their advice to investors. It clarified that asset managers must take steps to ensure that proxy advisors’ advice is in line with their clients’ interests before voting with the recommendations. The guidance also urged proxy advisors to disclose more information about how they craft their recommendations.  

While policies such as prohibiting an advisory firm from knowingly making false statements seem basic and something that all market players should embrace, Institutional Shareholder Services (ISS), the largest proxy advisor, and its allies have greatly objected to these changes. Gary Retelny, CEO of ISS, framed the SEC’s proposed guidance as “hampering (his firm’s) ability to deliver independent, timely and accurate research, data, insights and perspectives to aid in the discharge of their fiduciary duties.”

Evidently, ISS can only perform its basic functions free of all scrutiny and legal liability.

With the SEC scheduled to follow up the August guidance with a vote on November 5 on new proxy advisory firm regulations, ISS has preemptively filed suit, arguing that the SEC exceeded its authority in issuing the guidance and that its litigation is designed to prevent a chilling of the “protected speech” of proxy advisors.

Translation: ISS insists that SEC has no right to demand that it be accountable for its actions.

The SEC has also taken steps to enhance the ability of companies to provide feedback and correct errors in proxy advisory reports.

While this may appear to be an innocuous step towards increasing transparency, ISS has derided the idea as onerous and pointless, and it told the SEC that it does not need company “oversight in order to produce accurate research reports.”

Ironically, ISS already complies with similar rules in France, which requires proxy firms to give companies an opportunity to review the factual accuracy of the data used in pending proxy analysis.

When France issued its rules in this area in 2011, ISS stated that it “believes (the) review process helps improving the accuracy and quality of its analyses, an outcome that is in the best interests of (everyone).”

The French division of ISS has this right.

It is also worth noting that Glass Lewis, the second largest U.S. proxy advisory firm, has proactively launched a pilot Report Feedback Statement service to allow companies and shareholder proponents to comment on their analysis and flag any errors or inconsistencies. 

Proxy advisors can contribute to the vitality of American capital markets. Yet, the substantial conflicts of interest and its dogged opposition to increased transparency undermines this role. 

All actors in a functional financial system must be accountable. It seems that it will take the regulatory power of the SEC to teach proxy advisory firms this lesson.

Eric Miller is a Global Fellow at the Wilson Institute Canada and president of Rideau Potomac Strategy Group. 

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