August 21, 2018
Since we launched, the Main Street Investors Coalition has sounded the alarm on the conflicted role and undue influence of proxy advisory firms. At the end of July, Securities and Exchange Commission (SEC) Chairman Jay Clayton announced that he will hold a roundtable on the proxy process, indicating that the SEC also recognizes the importance of addressing this subject to bring about proper reforms.
The chairman’s roundtable comes at a critical juncture for the proxy advisory process. Currently, Congress is considering legislation that would rein in conflicts of interest and bring transparency to proxy advisory firms. Recent pieces from The Wall Street Journal and Barron’s indicate that the media is taking notice of the problems within this industry as well.
As we’ve noted previously, Chairman Clayton has demonstrated that he understands the significance of this issue. He has even suggested that the Commission should consider opening the comment file on a 2010 “Proxy Plumbing” concept release to elicit feedback on what a specific regulatory action on the issue would look like. The concept release revealed that many of the issues raised by the Main Street Investors Coalition are longstanding issues considered by the SEC. Specifically, the concept release noted the issues surrounding proxy advisory firms’ conflicts of interest:
“The use of proxy advisory firms by institutional investors raises a number of potential issues. For example, to the extent that conflicts of interest on the part of proxy advisory firms are insufficiently disclosed and managed, shareholders could be misled and informed shareholder voting could be impaired. To the extent that proxy advisory firms develop, disseminate, and implement their voting recommendations without adequate accountability for informational accuracy in the development and application of voting standards, informed shareholder voting may be likewise impaired. Furthermore, some have argued that proxy advisory firms are controlling or significantly influencing shareholder voting without appropriate oversight, and without having an actual economic stake in the issuer.”
The issue was explored again at a 2013 SEC roundtable that focused solely on proxy advisory firms. Then Commissioner Daniel Gallagher highlighted the need for the SEC to act before the issue got worse. He compared proxy advisory firms’ conflicted business models to credit rating agencies that contributed to the 2008 financial crisis by giving bad companies good ratings to increase their profits.
“We did that with rating agencies. We did not address it even though we knew it was an issue. You know, in fact, in the mid-’90s there was a proposed rule to address that issue. It never went anywhere, and look what happened in the financial crisis. I’m not saying that the role of proxy advisors would be the same with respect to the financial crisis, but I think for this agency, for our core programs, the role is of that sort of substance. And so I think we’re uniquely poised to address an issue before it becomes a bigger problem, and I hope we do so.”
Additionally Commissioner Gallagher laid out a potential solution for the SEC to pursue to rectify the issues with proxy advisory firms:
“Commission guidance clarifying to institutional investors that they need to take responsibility for their voting decisions rather than engaging in rote reliance on proxy advisory firm recommendations would go a long way toward mitigating the concerns arising from the outsized and potentially conflicted role of proxy advisory firms.
In addition, as I have stated in the past, I believe that the Commission should fundamentally review the role and regulation of proxy advisory firms and explore possible reforms, including, but not limited to, requiring them to follow a universal code of conduct, ensuring that their recommendations are designed to increase shareholder value, increasing the transparency of their methods, ensuring that conflicts of interest are dealt with appropriately, and increasing their overall accountability.”
Unfortunately, the SEC ultimately did not act to address the issues with proxy advisory firms that were identified in the 2013 roundtable. As Commissioner Gallagher warned, the issues surrounding the immense influence and conflicts of interest proxy advisory firms have only grown. This is in part due to the rise of environmental, social, and political shareholder resolutions. Since these resolutions are outside the realm of traditional corporate governance, they provide proxy advisory firms with more space to develop arbitrary and opaque guidelines that companies to must follow to gain their support, which in turn increases the demand for their consulting services.
The opportunity to have an issue considered at a SEC roundtable does not come often, so we’re encouraged by Chairman Clayton’s announcement and request for comments. It’s critical that the SEC does not miss another chance to reform the proxy advisory process. The Main Street Investors Coalition will be watching this issue closely, and submitting comments which advocate for better oversight within the proxy advisory industry.