Comments received by the SEC on its proxy voting concept release, 34-62495, reveal a growing consensus in the corporate community that proxy advisory firms should be subject to federal regulation requiring greater transparency and accountability with respect to the formulation of voting recommendations and potential conflicts of interest. For example, in its comment letter to the SEC, General Mills said that proxy advisory firms should be subject to proxy rules and regulated as investment advisers, including mandated disclosure of specific conflicts of interest, and duties to adopt procedures ensuring the accuracy of their reports and voting recommendations. But Nell Minow of the Corporate Library objected in the strongest possible terms to the federal regulation of proxy advisory services, noting the absence of evidence that the proxy advisory firms have been anything but transparent about their approaches and the way they deal with conflicts of interest.
And, according to the Council of Institutional Investors, proxy advisory firms play an important role in helping pension fund managers fulfill their fiduciary duties with respect to proxy voting by providing an analysis of issues on the ballot, executing votes and maintaining voting records. Without proxy advisers, maintained the Council, many smaller pension plans would have difficulty managing their highly seasonal proxy voting responsibilities for the thousands of companies in their portfolios. While the Council supports the registration of proxy advisory firms, it opposes regulatory involvement in methodologies used by proxy advisers to determine vote recommendations.
Ever since the Department of Labor’s 1988 “Avon Letter,” which asserted that proxy voting rights are plan assets subject to the same fiduciary standards as other plan assets, pension fund managers have been on high alert to vote their proxies in the best interest of beneficiaries. Subsequently, over the two decades, institutional investors, including pension plans, and employee benefit plans, have substantially increased their use of proxy advisory firms, reflecting the tremendous growth in institutional investment as well as the fact that institutional investors have fiduciary obligations to vote the shares they hold on behalf of their beneficiaries.
In its concept release, the SEC raised a number of concerns about the increasing use of proxy advisory firms, paramount among these being possible conflicts of interest. For example, to the extent that conflicts of interest on the part of proxy advisory firms are insufficiently disclosed and managed, shareholders could be misled and informed shareholder voting could be impaired. Similarly, said the Commission, to the extent that proxy advisory firms develop, disseminate, and implement their voting recommendations without adequate accountability for informational accuracy in the development and application of voting standards, informed shareholder voting may be likewise impaired.
Over the last two decades, noted the Wachtell Lipton firm in comments to the SEC, this small ``hegemony of for-profit firms’’ have proclaimed themselves the arbiters of corporate governance practices and become de facto corporate governance regulators without accountability or regulation to the detriment of both issuers and shareholders. This problem is compounded each year, said Wachtell, as additional matters become subject to shareholder votes. When fully implemented, the Dodd-Frank Act will require shareholder votes on a host of compensation-related issues for which broker discretionary voting is prohibited. In Wachtell Lipton’s view, all of these changes will further empower the proxy advisors due both to the higher frequency of votes, such as say-on-pay, and the fact that the demands imposed by an increased number of votes each season are likely to cause institutional investors to outsource even more voting responsibility to the proxy advisory firms. In addition to requiring proxy advisory firms to register with the SEC, said the Wachtell comment letter, these firms should also be brought more squarely within the regulatory constraints of the proxy rules through a requirement to file recommendations as soliciting material.
In its comment letter to the SEC, General Mills said that greater transparency about how voting policies are developed and the clients that support those policies will help identify the influence of special interests and ensure that all clients are properly represented. Similarly, where executive compensation analysis or recommendations depend on specific data and financial formulas, such information is not fully available to investors or issuers. Full public disclosure of this supporting information would allow issuers and investors to better understand and evaluate the related voting recommendation.
To the extent that the recommendations of the proxy advisory firms are based on a factual analysis, noted the General Mills letter, issuers do not have an adequate opportunity to review the information, engage in discussion about possible changes, or inform investors about concerns or objections to the report.
In its letter to the SEC, Dupont urged that proxy advisers be subjected to additional disclosures aimed at improving the quality of ratings and recommendations, including disclosures of the depth of its research on recommendations, the effectiveness of its controls over accuracy of issuer data, and the procedures for communications with issuers. Dupont also asked that Form N-PX, the annual report of proxy voting of management investment companies, be amended to require disclosure of whether a proxy advisory firm was used by the investor, and if so, which one, and whether the investor voted in accordance with that firm's recommendation. The company believes that this would encourage institutional investors to give adequate consideration to the facts and circumstances of a given shareholder proposal.
While recognizing that proxy advisory firms play an important role within the proxy system, the Sidley & Austin firm has significant concerns regarding the manner in which they play that role. In particular, there is concern about the one-size-fits-all approach that some proxy advisory firms take in their articulation of voting guidelines and the influence that those guidelines carry. In addition, the firm cited numerous occasions in which voting recommendations issued by a proxy advisory firm appear to have been based on an apparent misapprehension of the underlying facts.
Sidley supports the views of the NYSE Commission on Corporate Governance report, which recommended that the SEC engage in a study of the role of proxy advisory firms to determine their potential impact on corporate governance and consider whether or not further regulation of these firms is appropriate. The report also said that proxy advisory firms should be required to disclose their methodologies for formulating voting recommendations, as well as material conflicts of interest, and to hold themselves to a high degree of care, accuracy and fairness in dealing with both shareholders and companies by adhering to strict codes of conduct.
In comments to the SEC, CalPERS also generally supports the recommendations of the NYSE report. Specifically, CalPERS backs complete disclosure of all conflicts of interest on the part of proxy advisory firms, especially as such conflicts relate to consulting services in conjunction with providing proxy vote recommendations, as well as disclosure of procedures for interacting with both issuers and shareowners, informing issuers and shareowners of recommendations, and handling appeals of proxy advisory firm vote recommendations.
In an effort to increase transparency, the Sullivan & Cromwell firm suggested the direct regulation of these firms to require enhanced disclosure, or the imposition of disclosure requirements on institutional investors that utilize a proxy advisory firm in making voting decisions or casting votes. For example, the investor could be required to disclose the firm on which it relies, and whether the firm makes disclosures about its policies for making recommendations with respect to the particular matter voted on.
For its part, the Council of Institutional Investors said that the contention that proxy advisory firms’ recommendations have too much influence on the outcome of voting at public companies is ``greatly exaggerated.’’ The notion that proxy advisory firms control the institutional vote wrongly assumes that institutions are a unified bloc of voters. In fact, asserted the CII, many institutional investors are passive voters that defer routinely to the recommendations of management.
Also, the CII noted that institutional investors’ use of proxy advisers’ services, whether research or vote execution, does not equate to the outsourcing of voting decisions. The Council emphasized that proxy advisers’ clients retain the ability to vote however they wish, and regularly diverge from their proxy advisers’ recommendations. Indeed, the CII believes many clients of proxy advisers use the firms’ research and recommendations solely as a supplement to their own evaluation of agenda items.
While the Council does not have a formal policy on proxy advisory firms, it acknowledges the importance of their role in providing pension funds with informative and accurate information about matters that are put before shareowners for a vote. It is reasonable to expect proxy advisory firms to provide clients with substantive rationales for vote recommendations; minimize conflicts of interest and disclose the details of such conflicts; and correct material errors promptly and notify affected clients as soon as practicable.