New York Times DealBook, November 30, 2010 column
Legal/Regulatory | Deal Professor Proxy Firms Need More Rules, Companies Say By STEVEN M. DAVIDOFF
A battle over whether to regulate proxy advisory services represents a political turn of the tables. Public companies and their advisers are pushing for new rules from the Securities and Exchange Commission to restrict proxy advisory firms. Yes, these are the same interests who usually argue against regulation. They are pitted against corporate governance groups that seek an easier and cheaper way to nominate directors. But on the issue of the advisory services, they have put up a big don’t touch sign. Regulation, it would appear, is a good thing only when it serves your purposes. Yet the debate over proxy advisory services is an important one. Every year, some 4,400 listed companies hold annual meetings to elect directors and consider shareholder proposals. In 2010 Exxon Mobil shareholders considered the election of 11 directors and 11 shareholder proposals ranging from a shareholder say on pay policy to a greenhouse gas emissions policy. Institutional investors like mutual funds and pension funds do not have the resources to analyze and consider all these proposals. The large asset manager TIAA-CREF estimates that it holds stock in more than 7,000 companies and has more than 80,000 different votes to cast every year. To fill this gap, there are proxy advisory services. For a fee, these firms recommend how institutional investors should vote. There are fewer than a dozen such services and Institutional Shareholder Services is the largest with 1,300 clients. And they wield substantial influence. There is pressure on boards to conform to proxy firm recommendations — particularly those of I.S.S. These proxy firms formulate their own good governance principles to guide their recommendations. The problem with this approach is defining what exactly is good governance. Public companies have said that the proxy services interfere with their boards’ own internal governance. They criticize the services for what they say is the lack of evidential support for their recommendations. The S.E.C. has now given these companies an opportunity to vent. In July, the agency said it was seeking comment on the proxy system. More than 250 comments were submitted. The comments of governance groups were along the lines of Nell Minow of the Corporate Library. She objected in the “strongest possible terms” to any such regulation. But the claws also came out on the business side in comments arguing for heightened regulation. Wachtell, Lipton, Rosen & Katz, a law firm that has opposed proxy access on the grounds it was unneeded regulation, argued that there was “a dangerous gap” in the securities laws. Proxy advisory services, Wachtell argued, should be subject to the proxy solicitation rules. If these rules applied, shareholders and public companies could sue the advisory services over disclosure lapses in their recommendation reports. Wachtell did not add that by imposing this liability, the ability of proxy advisers to make recommendations would be chilled, if not killed. Other comments, like those from the Business Roundtable, which represents chief executives of top American companies, also argued for greater disclosure of proxy adviser conflicts. Currently, I.S.S. not only provides voting recommendations but also advises corporations on how to structure their corporate governance procedures. The argument is that companies have an incentive to employ I.S.S. to ensure favorable recommendations. Disclosure on these potential conflicts is sparse, although I.S.S. at least has a policy that clients can ask for and obtain further information if they desire. Other comments, submitted by the United States Chamber of Commerce, among others, focused on the standards of good corporate governance. Companies want more ability to comment on and propose changes in these standards as they are adopted by regulatory agencies, as well as to comment on recommendations of proxy advisers. These commentators generally argue that proxy advisory services should be subject to a strict regulation and disclosure regime, like credit ratings agencies. To some extent, corporate interests misunderstand or willfully distort the service provided by proxy advisory firms. These firms analyze and make recommendations on corporate issues for institutional investors that are too busy to do this research themselves. They are not like the credit ratings agencies, which can disrupt markets. Yes, proxy advisers can get things wrong, but their own clients have incentives to monitor them. Indeed, in its comment letter, BlackRock states “we reach an independent conclusion on the proxies that we review; we do not blindly follow any proxy advisory firm’s advice.” That view is echoed by nearly all the institutional investors who submitted comments to the S.E.C. And in recent prominent contests involving Barnes & Noble and Dynegy, I.S.S. clients went against the service’s recommendations. In fact, some regulation of proxy firms is already in place. I.S.S., for example, has registered as an investment adviser, allowing for S.E.C. oversight. Regulations should require this type of registration to keep all of the advisers on the agency’s radar. There is also probably some need for an enhanced policy concerning disclosures of possible conflicts of interest. But anything more would simply lend support to an attempt by corporations to upend these standards and water them down. And yes, I know that these standards themselves have problems, but better that the shareholders and institutions formulate them than corporations. Given the tenor of the institutional comments and the fact that more than 50 percent of the shares voted by I.S.S.’s clients are voted under individual or tailored policies on proxy recommendations, it appears that shareholders are acting to influence this market. The corporations aren’t going to like it, but this is one area where the market should best be left to work.
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions. |
