Changing of the Guard

Can glass once broken be reassembled? That is the question that is keeping executives up late in San Francisco, where proxy advisory firm Glass Lewis is based, and also in Ontario, where its new corporate owners are headquartered. But just a year ago, none of this was expected, all of it would have seemed impossible.

Talk about topsy-turvy. Just ten months after the proxy voting advisor, Glass Lewis, was bought by China-based financial information firm Xinhua Finance, Xinhua turned around and unloaded Glass Lewis onto  Canada’s largest public sector pension fund, Ontario Teachers’ Pension Plan (OTPP aka Teachers’), in a transaction valued at C$46 million. Teachers’, a month after the acquisition, says it did not necessarily want to buy Glass Lewis – ‘what we wanted was an independent proxy advisory firm; it did not have to be owned by us,’ says Claude Lamoureux, Teachers’ CEO. But Teachers’ also felt that it had to act because it wanted to ensure that there would indeed be an independent and objective advisory voice, says Lamoureux. And there was no one else with deep enough pockets that evidenced any desire to jump into this fray, particularly since Glass Lewis, following a series of executive departures, by that juncture was widely seen as a distressed asset.

So serious was Teachers’ about the need for an independent proxy advisory firm, and so worried it was about what it considered to be conflicted and sometimes poorly considered recommendations, that earlier this year it formed a coalition with 14 other public fund managers to examine the possibility of establishing a new, investor-own advisory firm. With the purchase of Glass Lewis this plan has been put on hold – at least for the time being.

The ‘why’ of Glass Lewis’ unraveling under Xinhua has been widely reported. Profoundly troubling questions arose around Xinhua, including the reports of a National Association of Securities Dealers cease-and-desist order issued against a senior executive and a lawsuit alleging racketeering that had been filed in California. Staff defections – with senior Glass Lewis managers claiming internal governance issues at Xinhua were impacting Glass Lewis’ independence – were thoroughly documented in the media. The problem of a company that makes a living out of finding fault with other companies governance and ethics programs suffering from some rather serious failings of its own was self evident. The value of the asset was disintegrating.

The question is: Why didn’t Glass Lewis simply fade away, that is, collapse? It’s a very small company by any measure – perhaps 70 employees – and corporate death happens every day.

But in the case of Glass Lewis, death was averted by the entry in October 2007 of a white knight in the form of the Ontario Teachers Pension Plan.

What exactly is Teachers’ angle? Lamoureux elaborates, insisting that the reasoning behind Teachers’ purchase of Glass Lewis was because ‘we wanted to make sure the organization remained independent. Some of the competition [that is, other proxy advisory firms] are not as objective as we wished. We would have been happy if another firm committed to keeping Glass Lewis independent had stepped in and bought it, but nobody else did. So we did.’

To Teachers’, with over $106 billion in assets under management, the Glass Lewis purchase truly was a minor transaction, just pocket change really. Except for one thing: Serious questions persist regarding what this might mean for the increasingly important proxy advisory universe. With Teachers’ now directly involved in the advisory game, have all the rules suddenly changed? Interviews with senior Teachers’ leaders and with Glass Lewis’ leadership shine a bright light on what can be expected in the immediate future. Here’s a hint: Don’t expect the status quo to be maintained.

Money talks

For amplification of what came down regarding Glass Lewis, one place not to turn for answers is Xinhua, which has been comparatively mum in recent months following the sale. That reaction strongly contrasts the giddy exuberance expressed by Xinhua in December, 2006, when it announced it was buying the 80.1 percent of Glass Lewis that it didn’t already hold (it had bought 19.9 percent of Glass Lewis in August, 2006). Said Xinhua CEO Fredy Bush in a press statement: ‘We have come to realize what a great and growing opportunity there is in assisting investors to analyze and manage their financial, investment and reputational exposure to public companies.’

What price did Xinhua originally pay for Glass Lewis? The $46 million paid by Teachers’ is on the record. Xinhua’s total acquisition price, however, is not. It is understood that when the company bought the remaining stock in Glass Lewis in December 2006 it paid $36 million. What it paid for the original 20 percent is not clear. When pressed for an exact number, a Xinhua public relations spokesperson in New York reiterated that no official number had been released, but referred a reporter to a Wall Street Journal story that put the purchase price at $45 million.

The spokesperson also forwarded a statement from Bush, that was initially released in October at the time of the sale of Glass Lewis to Teachers’: ‘While Glass Lewis has continued to build on its reputation as a leading provider of independent proxy research as part of Xinhua Finance, both companies agreed that its business could best thrive under independent ownership outside the public markets. We believe this transaction is in the best interests of both Xinhua Finance’s shareholders as well as Glass Lewis’ employees and clients, and provides the best environment for Glass Lewis to achieve a new level of success.’

It appears that nothing further is coming out of Xinhua. In response to an email request for an interview in the aftermath of the Glass Lewis sale to Teachers’, Joy Tsang, a Xinhua spokesperson, replied: ‘Xinhua Finance has sold Glass Lewis to OTPP so we are not at an appropriate position to make comments.’ Read that anyway you wish but the one, firm conclusion is that Xinhua will not elaborate on why it abruptly sold Glass Lewis less than one year after buying it.

Does number two matter?

Ask Peter Gleason if the upheaval at Glass Lewis indicates an industry in trouble – or conversely that Glass Lewis now will lead the industry to new safety – and the chief operating officer of the National Association of Corporate Directors (NACD) chooses his words carefully. ‘Glass Lewis is interesting. But I don’t think that as Glass Lewis goes much of anything else goes.’

Size is the rub. Best guesses by the Government Accountability Office (GAO) in its June, 2007 report on proxy advisory services is that Institutional Shareholder Services (ISS) is the industry’s 900 pound gorilla with over 1700 clients whose equity assets total $25.5 trillion. Glass Lewis, by contrast, is estimated by  the GAO to have 300 clients (total assets around $15 trillion), but it has 70 employees compared to around 630 at ISS. Glass Lewis, founded in 2003, also lacks the deep roots of ISS, which dates back in various forms to 1985 when it was founded by prominent governance commentators and activist investors Robert Monks and Nell Minnow.

Is Glass Lewis just too small to matter? Teachers’, for its part, definitely disagrees with that contention.

Where Glass Lewis seems determined to differentiate itself from some of its competitors is, says Lamoureux, that it will not provide consulting in addition to advisory services. ‘That is a clear conflict,’ asserts the head of Teachers’, who added that the conflict is as severe as that of public accounting firms which once offered consulting services to auditing clients, but which no longer can, precisely because the dual relationships were perceived by regulators to be in blatant conflict.

‘Consulting is a great way to ruin this kind of business,’ added Brian Gibson, senior vice president, public equities at Teachers’, into whose portfolio Glass Lewis was put. ‘We did not invest to ruin it.’

Consulting is the bugaboo in the eyes of Teachers’ and, shave the words as you might, Lamoureux is unbending that his organization just does not want to do business with any fox that is also getting paid by the chickens for advice on how to run a cleaner coop. That duality within a role, he suggests, is just unacceptable for a proxy advisory service and, unfortunately, according to Lamoureux, more and more competitive proxy services firms are venturing across that divide.

Glass Lewis, he says, will not. Period. And therein lies a lot of the motivation for the acquisition.

What difference will new management make?

Optimism is the official by-word when leaders at Teachers’ and Glass Lewis are asked about future prospects for the proxy advisory firm. Katherine Rabin, CEO of Glass Lewis, in written responses to a series of questions, wrote: ‘The acquisition by Teachers’ takes us out of the public markets and ensures investors will have real choice when looking for qualified providers of global research and advisory services for years to come. The news of the deal was very well received by our clients and prospects.’

Lamoureux at Teachers’ said much the same in a telephone interview: ‘We know a lot of pension funds share our concerns about the need for a truly independent advisory service and we hope they will become clients of Glass Lewis.’

There are some people in the investment community who harbor some minor concerns about the new situation. While it has been made clear that Glass Lewis will not be offering other consulting services and effectively playing both sides of the same coin, other potential conflicts may exist. Some questions that have been raised are: As an active investor and major player in the North American market will OTPP be tempted to use Glass Lewis to advance its own investments or agenda? And what happens if independence is maintained and the advice provided by Glass Lewis contradicts the investment choices made by the parent company? Will this be a sustainable situation? For more information about the potential conflicts see below: (Is Teachers’ ownership a conflict?).

As for Rabin, she is pointedly upbeat, not only about Glass Lewis, but proxy firms in general. ‘As issuer engagement and proxy voting become more integrated with overall investment management at institutions worldwide, there will be increased demand for research, services and technology that help institutions vote proxies in accordance with their own custom policies,’ Rabin wrote in response to questions. ‘There is enormous and growing opportunity for advisory firms, like Glass Lewis, that can support the demand for such services worldwide.’

Regarding Glass Lewis’ situation in particular, Rabin wrote in an email that her business plan for the next year or two boils down to this: ‘You can expect us to build on our success to date at meeting the evolving needs of institutional investors. We are the largest provider of independent research and governance services in the world, covering more than 15,000 companies in more than 70 markets. Our clients include some of the largest money managers, mutual fund companies, pension funds and hedge funds in North America, Europe, Australia and Asia. This deal will most certainly lead to further global expansion and continued development and enhancement of our product and service lines for institutional investors.’

Gibson, meantime, sees a whole new proxy advisory landscape emerging, one that is in line with the heightened demand coming from pension funds and other large investors: ‘The age of this being an industry for start-ups is over. We envision there being two or three global players leading the industry, and we see room for Glass Lewis.’

He adds that Teachers’ felt it came into the acquisition with a key advantage: ‘We understand corporate governance and know what is important in this field. We sincerely believe we can grow this business over the next four to five years,’ says Gibson.

Rabin, for her part, paints a rosy picture of the near-term: ‘Since we launched in 2003, we’ve always been on the leading edge of developing products and services to meet the needs of institutional investors worldwide. We were the first research firm to combine governance and accounting research practices, the first to take a case-by-case approach to analyzing proxies, the first to develop a transparent voting platform to enable institutions to see the work being done on their behalf to ensure they are receiving and voting on all proxies they are eligible to vote on and the first to provide analysis that helps investors understand when to recall shares on loan. With strategic guidance from our parent, one of the most innovative and respected investors in the world, we will certainly continue to expand our offering to meet the evolving needs of investors globally.’

The bottom line, says Gibson, is that ‘Glass Lewis has a high number of clients who truly value governance.’ These are the clients that want the work done well, who are not necessarily penny-pinchers and who put a primacy on the clarity of advice and independence. And for these clients, thinks Gibson, Glass Lewis is the answer.

Put another way: Many consumers of proxy advisory  services feel that the market is too concentrated and clearly want alternative providers with a different take on what constitutes good governance. To them more choices of service providers is a positive thing. Many believe that having Glass Lewis in the hands of experienced investors who have a real understanding of and vested interest in the long-term performance of the companies they invest in can only lead to better, less politically motivated advice. Will they back up that sentiment with their checkbooks by committing to buy services from Glass Lewis? Stay tuned, because that answer won’t be known for a year, or three.