June 29, 2018
Yesterday, several Senators, including Senator Heidi Heitkamp (D-ND) and Senator Patrick Toomey (R-PA), expressed concern about the lack of oversight that proxy advisory firms enjoy and examined how these institutions may be negatively impacting Main Street investors and small businesses.
The United States Senate Committee on Banking, Housing, and Urban Affairs held a full committee hearing to discuss several legislative proposals which examine corporate governance issues. While a number of bills were discussed, committee members focused a significant amount of their attention on H.R.4015 or the Corporate Governance Reform and Transparency Act of 2017.
Senator Heitkamp’s testimony addressed a number of concerns about how the proxy advisory industry currently operates with effectively zero regulatory oversight:
“Right now, there is no regulatory apparatus that applies to all proxy advisory firms, they are functionally unregulated”
Furthermore, Senator Heitkamp highlighted the fact that proxy advisors wield an immense influence over a public company’s operations while bearing no responsibility for the financial impact of their recommendations, stating rhetorically “broadly, isn’t it true that proxy advisory firms do not owe a fiduciary obligation to shareholders, writ large?”
These deficiencies, when working in tandem, can prove to be especially onerous for companies, particularly those that are smaller in nature. Darla C. Stuckey, President and CEO of the Society for Corporate Governance, provided in her testimony a company’s story which clearly highlights the need for H.R. 4015.
In May 2016, a small cap company in the transportation industry received a report from ISS, one of the two dominant proxy advisory firms, which gave an “against” recommendation to the company’s proposal regarding Say-on-Pay. However, ISS based their recommendation on a on a conclusion they drew which was mathematically incorrect. Although ISS acknowledged the error, they refused to issue either a correction or a revised report. Consequently, the company’s Say-on-Pay proposal narrowly failed. The next year, ISS again issued a report recommending against the company’s Say-on-Pay proposal, stating that due to the prior year’s low vote outcome, shareholders must have demanded extensive changes to the company’s compensation system. This was simply false. To add insult to injury, ISS also recommended against the re-election of the company’s four-member compensation committee, including the only female board member, two racially diverse board members, and a new committee member who was not even on the board when compensation decisions were being made.
Ultimately, it took the effected company two years of extensive shareholder outreach and extensive resources to not only receive a “for” recommendation on their Say-on-Pay proposal, which received a 94 percent favorable vote, but also to vindicate the impacted board members.
This company’s story highlighs the significant issues which are prevalent in the current proxy advisory industry, and the serious need for reform.
Citing a new report by the National Association of Manufacturers, which found that activist shareholder proposals actually detract from shareholder value, Senator Patrick Toomey expressed his reservations about the use of proxies to advance contentious social and political agendas:,
“What concerns me is cases where maybe advisors or fund managers or minority activist investors are trying to use the corporate governance voting mechanism as a way to advance a social and cultural agenda that may be inconsistent with many investors’ wishes and may be inconsistent with maximizing what is best for the investors generally…if there is documented evidence that suggests that promoting this category results in a lower return to investors, then anybody advising that would be failing to live up to their fiduciary obligations.”
The hearing also addressed the blatant conflicts of interest that often exist in the proxy advisory industry. For instance, ISS operates a consulting division which provides advice to companies on how to achieve better ISS corporate governance ratings. One witness, Thomas Quaadman, Executive Vice President of the U.S. Chamber Center of Capital Markets Competitiveness, submitted into the record an email from ISS explicitly soliciting consulting business from an issuer by offering favorable recommendations. In his testimony, Mr. Quaadman also noted that while Glass-Lewis does not operate a consulting division, it is owned by two foreign, activist institution investors – the Ontario Teachers’ Pension Plan and the Alberta Investment Management Corporation – which raises an entirely different, but equally concerning, conflict of interest.
Yesterday’s Senate hearing successfully highlighted not only the multitude of issues which plague the proxy advisory industry, but also how firms like ISS and Glass-Lewis can materially impact American companies and retail investors. Ultimately, the serious, systemic issues that lawmakers and witnesses expressed in their respective questioning and testimony in yesterday’s hearing further emphasizes the alarming need for legislative reform of the proxy advisory industry.