Amy Freedman, Michael Fein, and Ian Robertson, of Kingsdale Advisors write:
Anecdotally, at Kingsdale, we know, from our conversations with shareholders and from witnessing the expansion of in-house governance teams, that shareholders are taking back the decision-making process (to the extent it ever really left) as governance is increasingly seen not only as a risk mitigation screen but also as a lever to create value. Custom voting policies are being designed and refined to reflect underlying client appetites and to create a competitive advantage.
While ISS and Glass Lewis have become data points for further internal analysis, they are no longer seen as the ultimate decision-makers on how shareholders vote.
It is worth noting that for all the talk of conflicts of interest, a lack of transparency, and factual errors in their analytical processes, most of it does not appear to be coming from the most important part of the proxy advisor and shareholder voting equation: those who are actually paying for the vote recommendations. At an SEC roundtable held in November 2018, investors expressed general satisfaction with the service provided by proxy advisors. More recently, the Council of Institutional Investors issued a letter to the Commissioners of the SEC on October 15, 2019 expressing its concern over the latest actions that it feels “may reduce investor participation in the corporate governance voting process, and is likely to undermine investor protection, upend efficiency in the critical area of corporate governance and impair capital formation by diminishing corporate managerial accountability. The letter was co-signed by 60 public and union pension funds, religious orders, hedge funds, mutual funds, and other asset managers and investor organizations.
SEC Clampdown: Guidelines, Not More Regulation
On August 21, 2019, the SEC issued two sets of new guidelines to address these issues and clarify how various entities can comply with existing laws or regulations that it believes apply. Specifically, the SEC issued an interpretation clarifying why it believes proxy advisory firms’ advice is considered “solicitation”, or a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy”. As such, existing regulations require such entities to provide underlying facts, reasoning, and assumptions to demonstrate their advice is not misleading. The SEC also clarified that proxy advisors cannot share recommendations that are materially false or misleading under the applicable federal rules.
In addition, the SEC issued guidance to assist investment advisors in fulfilling their proxy voting responsibilities. The guidance did not impose any new requirements on asset managers but provided ways they can oversee proxy advisory firms and fulfill their fiduciary duty to their clients. Of note, they offer guidance for investment advisors on how to judge whether retaining a proxy advisor is appropriate, actions to take if they believe a proxy advisor has made an error of fact or omission, and how to evaluate the service provided on an ongoing basis.
SEC Guidelines for ISS and Glass Lewis
Proxy advisors should consider disclosing:
Methodology used to formulate advice and deviations from previous guidelines
Third-party sources used
The extent to which third-party materials were factored in
Conflicts of interest
That such conflicts of interest be explained in “reasonably sufficient detail”
As critics of proxy advisory firms have called the SEC’s guidelines a “first step” and expressed the desire to see it and other regulators take further action, we do not believe this issue has gone away. Yes, it may quiet down as the market digests the impact, but once a controversial decision again comes into the spotlight, it is likely business groups will again drive forward for full regulation.
In our view, the key issue is not the proxy advisors themselves but whether or not a company believes a shareholder is capable of making a fully informed decision, regardless of what ISS and Glass Lewis might say. It is akin to an athlete lamenting one call by a referee in the final seconds of the fourth quarter when the team did nothing to help its chances of winning for the first 99% of the game. Don’t put yourself in a situation where someone else can decide your fate.
The most common mistake we see is a lack of—or imprecise—disclosure by the issuer leading to analysis by the proxy advisors that the issuer deems unfair. Make your case thoroughly and clearly.
We do not believe shareholders are looking for politicians to dictate a structure that tells them how to interact with a private service provider they have contracted. Regulating or restricting an independent third party from providing voting advice would be like regulating the editorials of newspapers during political elections who espouse their views on how people should vote. We believe shareholders are more than capable of making their own judgments and critically reviewing the analysis they receive—if they choose to.
To the extent further change is demanded, that change should be within the purview of the subscriber and those they have contracted with to provide services. Presumably, if the service providers are getting it wrong, their clients will take them to task and policies will be updated via their respective annual survey processes.
Proxy advisors are providing what their subscribers have requested—advice that fits within the scope they have defined for how they want to vote on certain matters. They are not looking for additional commentary or arguments from management—that is already available to them in the company’s proxy solicitation materials and from direct engagement with management itself. If a company wants to ensure ISS and Glass Lewis provide clarity beyond the proxy materials they have filed, they have the opportunity to discuss it with them and to file additional information at any point prior to, or after, the release of the proxy advisors’ reports.
We indeed note the sensitivities around this topic, given that a small number of auto-votes can greatly impact the outcome of a proxy battle depending on shareholder composition.
Anecdotally, we have found that in certain situations, such as a contested vote or a questionable say-on-pay recommendation, subscribing shareholders are willing to hear an alternative argument from the company on why their circumstance should be considered unique. After all, with hundreds of millions if not billions invested, why wouldn’t they want to ensure they get it right?
We would be more inclined to give credence to the concerns raised if there were evidence that “passive” investing meant more passive voting and deferral to the proxy advisors alone, without sober second thought, but that does not appear to be the case.
It is incumbent on companies concerned about ISS and Glass Lewis to take accountability for ensuring their shareholders are fully informed before a vote—in fact, well before. Here is what we recommend:
Actively engage shareholders so the voices of ISS and Glass Lewis are not heard in isolation
Understand ISS and Glass Lewis policies and to what extent the unique circumstances of your company will be considered in their analysis
Understand how shareholders make their voting decisions, what their internal voting policies are, and the extent to which they deviate from the proxy advisors
Seek to engage the proxy advisors outside of proxy season to ensure their analysts are well versed in your company and its industry
If eligible, make use of ISS’s draft review process and the pre-publication review of annual meeting reports
Make clear disclosure (mainly via proxy materials) to justify the decisions made by your board