SEC Roundtable Signals Continued Momentum for Reform of Proxy Advisory Firms

November 16, 2018

“I cannot defend the indefensible. There are conflicts of interest that arise from consulting when you are also in the proxy advisory business.” – Sean Egan, Egan-Jones Proxy Services

“If shareholder process is just another form of political speech then we need to look at this much more closely and in a much different way.” – Thomas Quaadman, U.S. Chamber Center for Capital Markets Competitiveness

Yesterday, the Securities and Exchange Commission (SEC) held its long-awaited roundtable on the proxy process. After a day of discussion, it seems there is now a platform for the SEC staff to build on the observations of Main Street Investors and implement much needed oversight of the proxy advisory industry. The roundtable also took place a day after a new bipartisan bill was introduced in the Senate aimed at addressing the lack of transparency and conflicts of interests in proxy advisory firms, and added to the sense that there is a real belief in the necessity for reform from both sides of the aisle.

Below is a rundown of the day’s events, with more of the best quotes from the event also available here.

Commissioners Make the Case for Main Street

There were numerous significant moments for Main Street investors during the day, with some of the most notable quotes coming from the Commissioners themselves. In his introduction, SEC Chairman Jay Clayton reaffirmed his commitment to Main Street investors and emphasized how the proxy process needs to work for them:

“The question on the table is: can we improve the [proxy] system and for whom? I believe the answer is long-term, main street investors – those who put 50, 100, 200 dollars away a month.”

Commissioner Kara Stein correctly observed, that the current system is “arcane at best” and stated the complexity of the system has even created a “cottage industry” of players who help one another navigate the system. She noted that the new senate bill emphasizes the growing consensus that the proxy system is in dire need of reform.

Commissioner Hester Pierce reflected that one issue with the shareholder proposal process is that it sometimes allow the “idiosyncratic preferences” of one shareholder to drive the preferences and concerns of others.

Perhaps most notably, William Hinman, SEC Director of Corporation Finance, said, “We’ve heard the frequent calls for more transparency and the concerns over conflicts of interest at proxy advisors.”

Panel I: Proxy Plumbing

The first panel focused on proxy voting mechanics and technology, also known as “proxy plumbing.” The panelists generally agreed that there is room for improvement, voicing a range of concerns including over-and under-voting, lack of efficient communication methods between issuers and shareholders, and overwhelming complexity, all of which act as an impediment to retail investor participation. David Katz, a partner at Wachell, Lipton, Rosen & Katz, summed it up: “Long-term Main Street shareholders shouldn’t be disadvantaged in this system.”

This requires more than just a “little nudge” in the right direction, as Paul Conn of Computershare stated. Panelists also agreed that baby steps would not suffice. “We should focus on fixing the bigger problem rather than the smaller problem,” Darla Stuckey of the Society for Corporate Governance said.

The disputes over how to ensure investor votes are recorded and voted – and each intermediaries’ role in that process was summed up by Commissioner Roisman, whose concluding remarks reminded the panelists of the core issue at stake for Main Street investors. “If I’m an investor and I own shares,” he explained, “I want to know that my vote is counted.”

Chairman Clayton struck a hopeful note with his concluding statement, emphasizing how helpful the discussion was and saying, “hopefully this is not the last meeting for groups like this.”

A hopeful Chairman Clayton thanks panelists

Panel II: Shareholder Proposal Process

The second panel of the day aimed at addressing potential issues with the shareholder proposal process. As expected, activist investor Jonas Kron and representatives of pension fund managers continued to promote the idea that the current shareholder proposal process is effective and has a positive impact on value creation. Unsurprisingly, those with experience working with publicly traded companies disagreed. Each explained that the burden of shareholder proposals is placed on individual companies and the other shareholders in that company. The reality that social and political resolutions can create tangible costs for non-proponent shareholders and companies’ impacting the long-term value of the companies was also discussed.

Representatives from the business community also agreed that raising the resubmission threshold, or the amount of support a proposal must receive to be re-introduced, could save companies from being repeatedly targeted by social or political resolutions which have little prospect of receiving majority support.

Tom Quaadman, Executive Vice President of the U.S. Chamber of Commerce, discussed how these types of zombie proposals have such staying power:

“We have a high number of zombie proposals that continue to kick around despite low and declining levels of support, which clog up communication channels and impose costs…Support from proxy advisors is enough to keep zombie proposals on ballots. ISS, on average, support about 80% of shareholder proposals well above average support from institutions in their own interests.”

Maria Ghazal, Senior Vice President and Counsel of the Business Roundtable, agreed:

“All non-proponent shareholders and the company bear the cost of a shareholder proposal. We believe the thresholds should be meaningfully raised to ensure that all proponents have a meaningful investment and holding in a company.”

Panel III: Proxy Advisory Firms

In Commissioner Roisman’s words, the final panel was “the most anticipated of the three panels,” and for good reason. The panel examined the impact of proxy advisors. Notably, there was a striking lack of unity amongst the firms themselves on how to address the clear issues facing the industry – conflicts of interest, transparency, and whether they have a fiduciary responsibility.

On the issue of conflicts of interest that arise when firms have a consulting business that advise the very businesses they are rating, Sean Egan of Egan-Jones Proxy Services was unequivocal when addressing the real conflicts that exist today:

I cannot defend the indefensible. There are conflicts of interest that arise from consulting when you are also in the proxy advisory business.” (emphasis added)

Katherine Rabin, CEO of Glass Lewis, stated her company also did not believe that it would be appropriate to provide such a consulting service, deliberately differentiating Glass Lewis from ISS. As stated in formal comments to the commission, Rabin notes:

“For instance, Glass Lewis strongly believes that the provision of consulting services to corporate issuers, directors, dissident shareholders and/or shareholder proposal proponents, creates a problematic conflict of interest that goes against the very governance principles for which we advocate. As a result, Glass Lewis does not have a consulting business. This helps ensure that our voting recommendations and analysis are disinterested.”

In response, Gary Retelny of Institutional Shareholder Services (ISS) argued that ISS Corporate Solutions is “data centric” with an “advisory element,” suggesting that the fire wall his company has in place in sufficient to ameliorate concerns around conflicts.

Another discrepancy between both major advisors’ approach is ISS registration as an investment adviser. While ISS believes that it is important that proxy advisors acknowledge that they do have a fiduciary duty to investors, Glass Lewis’ CEO continued to argue that it would be inappropriate under the current regime.

Aside from a growing gap between proxy advisory firms, issuers of corporate governance also weighed in on their experiences with proxy advisory firms. Adam Kokas, Executive Vice President and General Counsel of Atlas Air Worldwide, discussed the high stakes of proxy advisor recommendations:

“Once a report is issued, it is an uphill battle from a company perspective, where correcting the record is very difficult.”

He further explained that the reality of robo-voting is to blame for the limited time frame companies have to attempt to fix any errors in proxy recommendation:

“When a proxy advisory report comes out, 30% to 40% of our share capital is voted within 24 to 48 hours… When certain institutions vote directly based on a recommendation, I think it’s imperative that issuers get the opportunity to view the report and ensure it is correct.”

Multiple panelists, including proxy advisors, spoke at length about factual and analytical inaccuracies in proxy recommendations, which the American Council on Capital Formation has uncovered in two recent reports. Egan attacked proxy errors, proclaiming, “it is hard to defend inaccurate reports… With the shift toward indexation this problem is even more important.”

Gary Retelny of ISS even agreed, stating “it is unacceptable for an error not be corrected,”  but then admitted that exactly when that correction occurs is a different conversation.

Chairman Clayton made a final observation before the roundtable concluded:

“Main Street Investors want to know that they are making an informed company specific voting decision when their fund manager vote on proxies.” (emphasis added)

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