Insight Into How Companies Should Be Run
November 9, 2005
ISS Advisor-Consultant Conflicts
Raised As Governance Activist Goes Corporate
By Tiffany Kary
Ira Millstein, known as
the “go to” man for companies with sensitive governance dilemmas,
has taken aim at a new organization - the very one that assesses the
governance of most U.S. companies, Institutional Shareholder
At ISS’s recent 20th
anniversary conference, Millstein, a senior partner at Weil Gotshal
& Manges LLP, criticized the proxy advisory for a conflict inherent
in its business model - taking pay for advising companies on how to
improve their corporate governance, while also proffering objective
recommendations to institutional shareholders on how to vote on
governance issues. ISS Chief Executive John Connolly, who fielded
Millstein’s barbs, said its consulting business is firmly separated
from its traditional vote advisory work by a “Chinese wall.” But
critics note that this excuse was also once used by the investment
banks and auditors before regulators
pried open a nest of conflicts.
While ISS’s alleged
conflict has existed for some time, many say it’s a bigger issue now
due to ISS’s recent merger with the U.S.’s second-largest proxy
advisor, Investor Responsibility Research Center Inc. (IRRC), and
the expansion of its nonadvisory services, including an M&A Insight
report and a corporate governance quotient (CGQ) index.
“Anyone who can’t see a
conflict between consulting and standards-setting has a problem with
their eyesight,” said Millstein.
Connolly said, “ISS has no
conflict. ISS’s integrity is not for sale,” he added, saying,
“‘Consulting’ is a misnomer from where we sit. It’s not a bad
The two points of view
revolve around an alleged conflict: Since companies pay ISS to tell
them how to improve their governance, there’s a concern that when
ISS recommends to institutional clients how to vote on directors and
shareholder proposals that the agency will side with management in
cases where it had consulted with the company - not necessarily
because the client had paid it, but because it had given their
policy its stamp of approval through consulting
While ISS said its vote
advisors aren’t aware of who the company’s corporate clients are and
has said the consulting just makes it a good-governance intermediary
between management and shareholders, critics note that because ISS
hasn’t been open about what its precise criteria are for different
standards on things like executive pay and director independence,
there’s a type of “black box” that could allow it to vary its
judgment from company to company, and perhaps favor its clients when
it makes recommendations.
“Who is the Wizard of Oz
creating these standards behind the iron curtain?” said Millstein,
who pounded his fist on the table and repeated, “Show me the Web
site,” in reply to all Connolly’s responses, suggesting that an
objective list of standards should be available online. Connolly
responded that ISS is becoming more transparent, and already has
open “policy jams” to establish its standards and spends time
communicating those standards to institutional clients.
Gary Lutin, an investment
banker who runs Lutin & Co. and shareholderforum.com, noted there’s
been some controversy over ISS’s M&A Insight product, noting that
ISS is offering to provide their “insights” and “interactive”
communications about their thinking in relation to contested
situations before making a recommendation.
“What they are doing with
the M&A Insight product is the equivalent of an influential
newspaper selling its advertisers an opportunity to guide the
editorial process,” he said.
ISS spokeswoman Cheryl
Gustitus said that the product doesn’t give an unfair advantage to
anyone. She said though it consists of two parts - notes, which go
out sporadically to subscribers as the merger situation evolves, and
a final analysis, which goes out to all clients - the notes use only
publicly available information.
The company’s CGQ product,
which gives companies an overall governance score, is also being
criticized as a black box, as ISS can consult with companies on how
to get a better score, and weights some criteria more than others
for individual companies, depending on variables such as performance
Some institutional clients
have expressed concern, while others say ISS has put any doubts to
rest by its openness about the issue.
“It’s an issue that’s not
going to go away,” said Cynthia Richson, corporate governance
officer of the Ohio Public Employees Retirement System (OPERS).
“They do good research [but] it’s short-sighted to act like this
conflict of interest issue is not important to its clients.”
Richson said OPERS chose
Glass Lewis & Co. to take over as its proxy advisor in 2006,
specifically dismissing ISS as a result of the “actual or perceived
conflicts”. The pension fund had previously used a combination of
services from IRRC and Glass Lewis.
Greg Taxin, chief
executive of Glass Lewis, said “a number of former ISS clients have
decided to use our services instead because of their concern about
the conflict of interest question.” Taxin noted that the IRRC
merger, as well as an interpretive letter from the Securities and
Exchange Commission that suggested the onus is on investment
managers and pension funds themselves to make sure that their proxy
advisory didn’t have any conflicts, has led to an increased concern
about potential ISS conflicts over the past two years.
But some ISS proxy
advisory customers aren’t concerned. Two at the conference, speaking
on condition of anonymity, noted that they go over voting policies
themselves anyway, and while they consider ISS recommendations, the
ultimate decision is with them.
Margareth Crosnier De
Bellaistre, director of investment management and banking for the
Episcopal Church, after hearing Millstein’s arguments, said that it
does “raise questions that ISS are consultants as well as advisors,”
but said she found Connolly’s comments reassuring.
Edward Knight, executive
VP and general counsel of The Nasdaq Stock Market, also speaking at
the conference, praised ISS’s openness in having Millstein speak.
“It’s evidence of why we have such strong markets in the U.S.,” he
Millstein suggested that
ISS’s problem was related to a broader trend at the organization to
answer to a profit motive rather than a social one. He suggested ISS
would be more credible if it was a not-forprofit, as IRRC was before
the two merged.
Millstein also suggested
that investors themselves, not the governance experts, lawyers or
other “governistas,” should decide voting policy, and there should
be more of a demonstrable link between voting policies and expected
“I see industrialization
as boiling something out of the process: judgment,” he said, adding
that the new market-oriented approach of ISS reminded him of Charlie
Chaplin on the factory floor in “Modern Times,” a movie about
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