NEW YORK -- Ira Millstein, a governance expert and
lawyer who has advised Walt Disney Co. (DIS), Tyco International Ltd. (TYC)
and The World Bank, among other well-known institutions, has criticized
a perceived conflict at the very organization that determines governance
standards for most U.S. companies - Institutional Shareholder Services.
At ISS's recent 20th anniversary conference, Millstein,
a senior partner at Weil Gotshal & Manges LLP, criticized the proxy
advisory firm for what he and others believe is a conflict inherent in
its business model - taking pay for services that help companies improve
their corporate governance, while also proffering objective
recommendations to institutional shareholders on how to vote on
governance issues. Millstein was invited by ISS to speak on governance
issues in general, and made it clear he would address the controversial
issue. "Anyone who can't see a conflict between consulting and
standards-setting has a problem with their eyesight," said Millstein,
who did not name any company-specific cases where he saw conflicts
ISS Chief Executive John Connolly, who fielded
Millstein's barbs at the conference, said ISS's consulting business is
firmly separated from its traditional vote advisory work by a "Chinese
"ISS has no conflict. ISS's integrity is not for sale,"
Connolly said. "'Consulting' is a misnomer from where we sit. It's not a
In a telephone interview Wednesday, Millstein said his
interest in the issue of conflicts grew out of a paper on governance
reforms that he co-authored with Sir Adrian Cadbury, author of the
influential 1992 "Cadbury Code," which shaped standards in the U.K. and
Europe. "It's been a lingering irritation. It ought to be brought out,"
Millstein said of his interest in speaking on the topic.
The criticism is nothing new for ISS, which has been
involved in both these areas for some time. But as the firm becomes
larger and expands into new areas, many in the governance industry -
including some ISS clients - say it needs to be more open about its
business and more attentive to concerns about conflicts.
The issue has gained new attention since ISS's recent
merger with Investor Responsibility Research Center Inc., consolidating
the two largest players to form an entity that dwarfs relatively new
competitors Glass Lewis & Co. and Proxy Governance Inc. ISS has also
been expanding its non-advisory services, adding an M&A Insight report
and a Corporate Governance Quotient, or CGQ, index.
ISS, which says its consulting makes it a
good-governance intermediary between management and shareholders, said
its vote advisers aren't aware of who the company's corporate clients
are. Its Web site notes, "to avoid accidental discovery of a corporate
client, Corporate Services division uses segregated office equipment and
Millstein noted that the "Chinese Wall" explanation was
also used by investment banks and auditors before regulators pried open
a nest of conflicts.
While ISS says its vote advisers can't find out whom
the corporate clients are, the firm's institutional clients can. ISS has
a system by which institutional clients can ask for a list of corporate
clients if they give ISS their portfolio list, said ISS spokeswoman
The vote recommendations provided to those
institutional clients are one of several issues raised by critics, who
suggest that ISS doesn't reveal enough about the criteria for the
recommendations, creating a "black box" that could allow it to vary its
judgment from company to company.
"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" to all of Connolly's
responses. Connolly said that ISS is becoming more transparent and
already has open "policy jams" that let
institutional clients weigh in on detailed issues, like whether a
company's burn rate and the use of cash versus stock should be
considered when ISS evaluates the suitability of an executive
M&A Insight Criticized
Investment banker Gary
Lutin said that the new M&A Insight product - which provides analysis of
mergers and proxy contests - enables ISS to provide its
"insights" and "interactive" communications about its thinking in
relation to contested situations before making a recommendation. "What
they are doing with the M&A Insight product," he said, "is the
equivalent of an influential newspaper selling its advertisers an
opportunity to guide the editorial process." Lutin runs Lutin & Co. as
well as Shareholder Forum - a shareholder issues monitor that does not
compete with ISS.
Gustitus said the product doesn't offer any unfair
advantage. She said M&A Insight consists of two parts - notes, which go
out sporadically to subscribers as the merger situation evolves and use
only publicly available information, and a final analysis, which goes
out to all clients.
The company's CGQ product, also flagged by Millstein,
has been improved recently in a way that answers concerns about the
variability of the measures it uses to assign companies a governance
score, said Gustitus. In the most recent version, 3.0, ISS has added a
chart explaining how it weights variables such as director independence.
She also said the CGQ tool is a "self-help" device and that there's no
interaction with ISS whereby the adviser tells the company what to do.
Gustitus adds that ISS's clients get fuller information about its
weightings than the public does. "There are some things that are in a
model, a proprietary model that can't be given away," she says.
Connolly has said that he would get out of the
non-proxy advisory business immediately if he believed ISS's model was
flawed. "Our clients today say they are happy, and they renew. Why would
I put this business in danger?" Connolly said, noting that ISS is a
registered investment adviser and subject to oversight by the Securities
and Exchange Commission.
Indeed, two customers of ISS's proxy advisory services,
speaking on condition of anonymity at the conference, said they don't
have a problem with ISS's dual roles, and noted that they go over voting
policies themselves anyway. While they consider ISS recommendations, the
ultimate decision is with them, they say.
But at least one institutional client has voted with
its feet against ISS's corporate services.
"It's an issue that's not going to go away," said
Cynthia Richson, corporate governance officer of the Ohio Public
Employees Retirement System, or OPERS. "It's short-sighted to act like
this conflict of interest issue is not important to its clients."
OPERS has chosen competitor Glass Lewis to take over as
its proxy advisor in 2006, according to Richson, 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, CEO of Glass Lewis, said that "a number of
former ISS clients have decided to use our services instead because of
their concern about the conflict of interest question." Taxin refers to
the IRRC merger, as well as a 2004 interpretive letter from the SEC that
suggested the onus is on investment managers and pension funds to make
sure that their proxy advisory doesn't have any conflicts, as possible
ISS sent a letter to institutional clients in September
saying that it has had more detailed correspondence with the SEC on the
issue. According to the letter, the SEC has reiterated its position that
"the mere fact that a proxy firm provides corporate services and
receives compensation from the issuer for these services would not
affect the first's independence from the advisor for purposes of making
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-for-profit, as IRRC was before the two merged.
"I believe we have different points of view on the
issue of ISS as a business," Connolly responded. "Over the last 20 years
this has gone from a lifestyle-oriented approach to an industry."
(Corporate Governance, published by Dow Jones
Newsletters, covers company management, shareholder relations and the
regulatory environment in which businesses operate.)
-By Tiffany Kary, Dow Jones Newsletters; 201-938-4292;