November 9, 2018
Just days before the U.S. Securities and Exchange Commission (SEC) hosts a roundtable to discuss issues with the proxy process, the American Council for Capital Formation (ACCF) released a new report which found that a large group of asset managers, who collectively manage over $5 trillion in assets, have historically voted in lock-step with the recommendations of Institutional Shareholder Services (ISS), the largest proxy advisory firm. This report comes on the heels of another ACCF report, which quantified the extent of automatic or robo-voting, as well as instances of analytical and factual errors in the voting recommendations of proxy advisory firms.
The reality of widespread robo-voting directly contradicts the claims of proxy advisory firms who say they merely provide research and recommendations to their clients. ISS and Glass Lewis, who together control 97 percent of the proxy advisory market, attempt to downplay the immense influence they exert over corporate governance. Instead, they claim that their clients are truly independent and take their fiduciary duty to vote in the interest of their customers seriously.
According to ISS:
“Proxy advisors’ research and vote recommendations are often just one source of information used in arriving at institutions’ voting decisions…Said more simply, we are an independent provider of data, analytics and voting recommendations to support our clients in their own decision-making.”
According to Glass Lewis:
“The market is clearly working as shareholders are voting independently of both Glass Lewis and company management.”
These statements may be true for larger institutional investors who have more resources to dedicate to corporate governance, but small to mid-size investors often lack the resources necessary to properly deal with a matter that is ancillary to their primary business:
“While certain major institutions have the resources to put in place internal proxy voting processes, for the majority of institutions the requirement to vote represents a significant cost burden. For those entities, ISS and Glass Lewis provide a cost-efficient way of voting at thousands of meetings each year.”
A dangerous combination now exists where proxy advisory firms’ analysis is overwhelmingly influenced by their largest clients and, out of necessity, robo-voting is prevalent among smaller institutional investors:
“As ACCF has explored previously, proxy advisory firms are, by design, incentivized to align with the comments of those who use their services the most. Moreover, many votes are cast through electronic ballots with default mechanisms that must be manually overridden for the investor to vote differently than the advisor recommends.”
Proxy advisory firms are so influential that companies are now even making decisions that conform to their requirements to avoid negative recommendations:
“The practice of robo-voting can also have lasting implications for capitol allocation decisions that has resulted in ISS and Glass Lewis playing the role of quasi-regulator, whereby boards feel compelled to make decisions in line with proxy advisors’ policies due to their impact on voting.”
The findings of this report call into question the basic premise of corporate governance: that shareholders who have financial interest in the long-term value of a company should oversee the management of the company to ensure their actions are promoting this financial interest. Unfortunately, this bed-rock principle has been upended:
“…under the current system, corporate directors and executives are subject to decision making on critical issues by entities that have no direct stake in the performance of their companies; have no fiduciary duty to ultimate beneficial owners of the clients they represent; and provide no insight into whether their decisions are materially related to shareholder value creation.”
This report is yet another example of why proxy advisory firms need to be regulated, before they take the place of the regulators. The Main Street Investors Coalition is optimistic about next week’s roundtable, especially after the SEC announced that an entire panel of the event will be dedicated to proxy advisory firms. Now is the time to rein in the proxy advisory industry. Doing so will protect the integrity of corporate governance and the savings of Main Street investors around the country.