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May 30, 2018

Proxy advisory firms should be regulated, says new report

Advisers’ recommendations may have outsize influence on behavior of issuers and investors, according to prominent conservative think tank

Governance decisions at US companies could be influenced by the recommendations of proxy advisory firms, according to a new report from the Manhattan Institute.

ISS and Glass Lewis control approximately 97 percent of the market for proxy advisory services in the US and the Manhattan Institute argues that they have an outsized influence on the behavior of issuers and investors.

ISS and Glass Lewis have faced waves of criticism and calls for regulation during the past year from the likes of NIRI, Nasdaq, the NYSE and the US Chamber of Commerce. A proposed law that would require ISS and Glass Lewis to register with the SEC as investment advisers passed through the House of Representatives last year. It is unclear whether it will be discussed in the Senate.

Influence on investors and issuers

The Manhattan Institute’s report – Proxy advisory firms: Empirical evidence and the case for reform ­– suggests the recommendations of proxy advisers have been influenced by public pension funds and social funds to focus on issues that may not actually be in the best interest of the broader investor community.

‘While the recommendations are clearly a reflection of what some institutional investors think, they depart from the median shareholder vote markedly in some areas,’ James Copland, report co-author and senior fellow and director of legal policy at the Manhattan Institute, tells Corporate Secretary sister publication IR Magazine. ‘They’re following what a subset of institutional investors wants, particularly those that don’t have to compete for private capital, like public pension funds and social funds.’

This is particularly the case in say-on-pay votes, the approval of company-wide equity compensation plans and in significant proxy contests, Copland adds.

Glass Lewis did not return a request for comment, but ISS refutes this claim, as Lorraine Kelly, head of proxy business at ISS, tells Corporate Secretary sister publication IR Magazine. ‘Institutional investors would take exception to such an assertion, with many holding strong views on what constitutes good governance while also maintaining their own, detailed voting policies,’ she says. ‘Further, ISS clients control both their voting policies and their vote decisions.’

ISS recommended voting against roughly 12 percent of say-on-pay resolutions at the top 3,000 companies in 2017, but just 2 percent failed to pass, Kelly adds.

The Manhattan Institute’s report also suggests issuers are making decisions about governance issues based on the voting recommendations of proxy advisers to increase the likelihood they receive a positive recommendation from them.

Copland cites 2012 research from the Conference Board, Nasdaq and the Rock Center for Corporate Governance at Stanford University, which found that 72 percent of companies review proxy advisers’ policies on executive compensation and seek feedback on their proposed policies. The research also found that 32 percent of companies had changed disclosure policies and 24 percent reduced or eliminated certain severance benefits based on the engagement.

In response, Kelly says: ‘ISS encourages corporations to make decisions that are solely in the best interests of their shareholders.’


The Manhattan Institute’s report further asserts that ISS and Glass Lewis lack transparency around their decision-making process. Glass Lewis does not disclose the process for updating its policy guidelines publicly, according to the report. ISS has a more public process, whereby it conducts a survey of issuers and investors, followed by a roundtable discussion of the results. It then posts draft recommendations and invites comments from its stakeholders.

But Copland says more can be done to make the process transparent. ‘They get a lot of comments and they just assert their conclusions,’ he says. ‘They don’t engage with counter-critiques, so while they’re open in the sense that you’re free to tell them what you think, they don’t tell you how they arrive at what they think.’

ISS points to its annual policy survey of hundreds of investors, issuers and governance specialists for its counterpoint. ‘We know of no other proxy adviser taking such steps,’ Kelly says.

‘Shareholder democracy is a disaster’

The Manhattan Institute proposes two main solutions to the issues it has with proxy advisory firms: greater regulation and/or not requiring investors to vote on every shareholder proposal. While the future of the Corporate Governance Reform and Transparency Act – the law passed by the House of Representatives but yet to be taken up by the Senate – is uncertain, Copland says there are things the SEC could be doing from a regulatory standpoint to reduce the influence of proxy advisers.

The more drastic proposal is for the SEC to reverse its decision to require all institutional investors, including mutual funds, to cast a vote in all shareholder proposals. Copland says this idea of shareholder democracy is at odds with preserving a company’s long-term strategy and, therefore, delivering shareholder value.

‘I’m not a person who thinks shareholder democracy makes a lot of sense,’ he explains. ‘As soon as you have multiple issues on the table, democracy doesn’t allow for a single outcome, which is why you have cycles in elections. The notion that we should just have a free-form democracy is a disaster for running large-scale business enterprises.’