Tuesday, July 10, 2012

Canadian Securities Administrators Weigh Regulation of Proxy Advisory Firms

The Canadian Securities Administrators are consulting on the possible regulation of proxy advisory firms as market participants cite the potential influence of such firms over shareholder vote outcomes and the corporate governance of issuers, combined with the possible negative impact of conflicts of interest and transparency concerns. A broader concern is that proxy advisory firms may have become de facto corporate governance standard setters and that, as a result, issuers are compelled to adopt certain one size fits all standards which may not be suitable for their specific circumstances. It may be appropriate, said the Canadian Securities Administrators, to consider regulating proxy advisors if the above-noted concerns are validated and have a negative impact on the integrity of Canadian capital markets.

A conflict of interest may exist if a proxy advisory firm provides vote recommendations to institutional investors on corporate governance matters for which the same firm provided consulting services to the issuer. A proxy advisory firm’s independence may also be compromised by conflicts arising in the ownership structure of some proxy advisory firms. Transparency concerns appear to be a combination of both the lack of disclosure about how proxy advisory firms arrive at their vote recommendations and the lack of public disclosure of the actual report.

In the view of the CSA, proxy advisory firms are not in the business of advising in the purchase or sale of securities, and therefore, should not be required to register as advisers under Canadian securities acts. Although proxy advisory firms provide advice when they make voting recommendations to their clients regarding proposals put to shareholders, this advice is most often not directly with respect to an investment in securities or the purchase or sale of securities. Moreover, the activities of proxy advisory firms do not fit within the principles underlying the registration regime since these activities have little connection with registration in the traditional sense and are remote from the protection of retail investors.

If the CSA opted to regulate proxy advisory firms through the existing proxy solicitation framework, they would have to either remove the exception to the definition of solicit or add further conditions to that exception. Currently, the definition of solicit does not include a proxy advisory firm communicating to security holders, as clients, if the communication is in the ordinary course of business, the firm discloses any potential conflicts of interest, the firm receives remuneration only from clients, and the proxy voting advice is not given on behalf of a person soliciting proxies

To the extent that the Canadian Administrators conclude that a securities regulatory response to concerns around proxy advisors is warranted, their preferred regulatory solution would be the creation of a new stand alone securities regulatory instrument. Such an instrument would require clear legislative authority to regulate proxy advisory firms. This approach would not attempt to compel proxy advisors to comply with
requirements of existing regimes that were not designed with them in mind.

This new regulatory framework would be primarily based on disclosure to address concerns around conflicts of interest and transparency. Proxy advisory firms would be required to establish and disclose procedures designed to identify and manage any potential conflicts of interest that arise in connection with the issuance of a voting recommendation. Disclosure of a specific conflict in a vote recommendation report to their clients could also be required. Proxy advisory firms would also be required to separate their proxy voting services from their advisory or consulting services.

In order to increase transparency, proxy advisory firms would disclose internal procedures, guidelines, standards, methodologies, assumptions and sources of information supporting voting recommendations.