Do we need to regulate the proxy advisory sector?

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By Felix Marks – Felix.Marks@EthicalBoardroom.com

In the US the Securities and Exchange Commission (SEC) is preparing to review new recommendations regarding regulatory procedures and actions related to proxy advisory firms. Some of the major proxy advisory firms include firms such as Glass Lewis and Institutional Shareholder Services (ISS). The services of these firms are set up to help institutional investors decide how to cast their votes when it comes to voting on important company issues. Example issues include board member election and setting of compensation amounts.

Stakeholders and regulators have been meeting more and more frequently to discuss a variety of issues regarding such proxy advisory firms. Common concerns include questioning whether the proxy advisory firms are disclosing potential conflicts of interest properly and a discussion of whether investment advisers rely on proxy advisor recommendations too heavily. These parties are calling for an improved level of disclosure of possible conflicts of interest and also more transparency about how much investment advisers actually do apply and rely upon proxy advisory firms. These parties are pushing for reform and increased regulation of the proxy advisory sector altogether. Investment advisers currently have no regulatory enforcement to consider in this area despite having a fiduciary duty and obligation to put the interests of their clients first.

There has been a call for regulation to increase transparency and to enforce proxy advisory firms to disclose whether a proponent of a shareholder proposal or a competing director slated for consideration is a proxy advisor firm client. Without this disclosure, the legitimacy of the proxy advisor firm must be put into question.  Clients need to ask themselves if the advice being dispensed by proxy advisory firms is undercutting the ability to meet their fiduciary duties to investors.

Proxy advisory firms such as MSCI’s Institutional Shareholder Services (ISS) and Glass, Lewis & Co. are typically hired by mutual funds, pension funds and other institutional investment groups to provide advice to them on how to vote on important corporate matters, such as executive compensation to board appointments. Numerous roundtables have been held over the last two years with industry experts discussing the role of proxy advisory firms as steps are being taken towards drafting of new regulations for this sector of industry. New rules are under consideration amidst growing concerns that proxy advisory firms are exerting subjective and non-independent influence on corporate decision making and elections.

Although many clients find the work of proxy advisory firms beneficial due to them taking on the heavy workload of working through thousands of proxy vote issues a year, these proxy advisor firms also now proving to be a lightning rod for attracting controversy. Corporate executives are increasingly alleging that these firms are starting to hold too much sway when it comes to shareholders’ voting decisions and are becoming so large that they do not respond to feedback and criticism and are not regulated adequately.

Over the last few years as the whole wider discussion and inspection of corporate governance issues, regulation and enforcement has been put under the spotlight the services of proxy advisory firms have garnered growing amounts of concern and prominence as an issue of discussion. Investment advisers who rely too heavily on proxy advisory firms for advice when casting corporate ballots are increasing the risk that they are not acting in the best interest of their clients. As it stands there is currently an increasing amount of investigation in this area but as yet no firm and formal regulation or rule-making has been put in place. In the US, the SEC is contending with a heavy workload with regards to developing the rules required by the Dodd-Frank Wall Street reform law. Similarly across the globe other regulatory and corporate governance issues have been put at the top of the list of their priorities. In the meantime the risks of the proxy advisory firm sector remain ever present.