A potential for conflict

In January, San Francisco-based Glass Lewis became the most recent proxy advisory firm to be bought out by a larger company. After acquiring 19.9 percent of Glass Lewis in August, Shanghai’s Xinhua Finance paid $45 million for the firm, an amount over four times greater than Glass Lewis’ 2006 revenues.

Xinhua chief executive officer Fredy Bush, a US native, founded the Tokyo-listed company in 1999, helping it transform into the largest provider of financial information in China. The company boasts 75 businesses, including research subsidiaries such as IR firm Taylor Rafferty. Because Taylor Rafferty also provides proxy services, Glass Lewis is faced with a possible conflict of interest.

Like Xinhua, Glass Lewis is a young organization. Wall Street professionals founded the firm in 2003 to help companies and shareholders across the globe assess corporate governance standards and evaluate proxy voting decisions. Glass Lewis has since become one of the largest shareholder advisory groups in the US. With frequently revised governance rulings and increasingly complex financial statements, the company’s services are in greater demand than ever before.

An SEC requirement that mutual funds disclose how they vote has also helped spur the proliferation of such firms, and competitiveness among proxy advisory stalwarts has intensified. Financial resources help companies like Glass Lewis stay ahead of the game.

Glass Lewis insists it will remain autonomous. Xinhua also defends its impartiality in a press release announcing the buyout: ‘Xinhua is not engaged in providing public companies with corporate governance, compensation, accounting or other advice on topics that Glass Lewis covers.’ But its reason for purchasing the firm involves these same elements: ‘The acquisition further advances Xinhua’s mission of bringing transparency and corporate governance to China.’

Xinhua intends to use Glass Lewis’ corporate governance and accounting expertise to augment its own ‘independent research services.’ However, the company fails to draw attention to the perilously similar role of Taylor Rafferty. Interestingly, Glass Lewis also fails to mention Taylor Rafferty in its letter announcing the acquisition.

Conflict of interest

In the December issue of its Global Proxy Watch newsletter, Davis Global Advisors stated its apprehension about the acquisition: ‘Critics are already questioning whether a company assumed to have close ties to Beijing should influence sensitive corporate voting outcomes around the world.’

Because Xinhua also owns Taylor Rafferty, there is some concern among investors and corporates that Xinhua’s acquisition of Glass Lewis could influence processes. Scott Fenn, managing director of policy at Proxy Governance, suggests ‘I do think there will be a concern about some of the issues surrounding the Glass Lewis acquisition in the marketplace.’

In contrast, Xinhua chief operating officer Dan Connell stresses that because Taylor Rafferty’s central focus is not providing proxy advice, there is no conflict. But Fenn reinforces that ‘Taylor Rafferty is in the proxy solicitation business. … It’s not just an IR firm. It is difficult to think of a bigger conflict of interest for a proxy advisory firm than to be owned by a company also involved in proxy solicitation.’

On shareholder reactions to the acquisition, Fenn says ‘Certainly we have heard anecdotally of clients of theirs who were surprised or not pleased with this news.’ But Glass Lewis’ clients were tight-lipped when it came to discussing the acquisition on the record. It seems commenting on conflict could put them in conflict with their service provider.

Mergers with a twist

Glass Lewis isn’t alone on the list of prominent proxy advisory firms to have been through a merger. Institutional Shareholder Services (ISS) was purchased by RiskMetrics Group last year, and its influence, if anything, has grown, in spite of experiencing its own allegations of conflict, says Wesley Hall, president of Kingsdale Shareholder Services.

Glass Lewis president Greg Taxin doesn’t foresee problems either: ‘Glass Lewis remains a separate entity,’ he says ‘with its own research team and research philosophy and agenda, and we will continue to pursue the aims that we’ve always pursued: Assisting institutional investors in identifying and mitigating risk in public companies.’ He recognizes that Xinhua has a lot of businesses. ‘Among those are things one could worry about,’ he says ‘but from our perspective we continue to be operating in exactly the same way we were before the acquisition.’

But even for ISS, Fenn reckons it may be too early to tell what impact the merger might have. Both transactions occurred at the end of the sales season, he highlights, ‘so we’ll have to wait and see what the market shakes out.’ Still, he admits ‘the potential exists that [ownership issues] will make clients look at other options.’

Under the influence

In its Conflict of Interest disclosure, Glass Lewis says its ‘research team is unaware of Xinhua’s many other activities and operates independently, exercising its own viewpoints and judgments without involvement from people in other subsidiaries or parts of Xinhua.’ They stipulate that Glass Lewis will be subject to no undue influence, ‘serving institutional participants in the capital markets with completely objective advice.’

Lydia Beebe, corporate secretary at Chevron, agrees that Glass Lewis can operate independently. ‘They will do what they’ve always done. At best, the jury’s still out, or at worst, they’ll give it a try,’ she says, adding that concerns about conflicts are ‘premature.’

Tom Germinario, senior vice president at proxy solicitation and corporate communications firm DF King, respects Glass Lewis’ diligence and thinks the affiliation with Xinhua will only assist in growing the business. Glass Lewis is made up of people who ‘staked their reputation on their objectivity,’ he says. And since they have so much to lose, he doesn’t expect they will submit to influence.

Taxin shrugs off skepticism about the acquisition, seeing Xinhua’s ownership of other firms as a useful tool rather than a conflict. These new resources will be integral to growth as Glass Lewis can offer services to clients at Xinhua firms. ‘Influence isn’t on the agenda,’ says Taxin.

Taxin points out that since the transaction, Glass Lewis has gained ‘several dozen large institutional investor clients.’ And he’s optimistic that business will continue to flourish under the new parent company.

The situation at ISS is similar. ‘A lot of these companies can’t operate on a stand-alone basis,’ Hall says. Instead of ownership impeding partiality, the union is a way to keep Glass Lewis objective. They need ‘a big balance sheet to be able to sustain it, if they want to continue to be impartial. They can go out and start adding other things, but then they start compromising.’

Money talks

When a company is acquired, the benefits differ for each faction. Glass Lewis will ‘gain access to a very rich data set and information set on public companies around the world that Xinhua owns and possesses … with a special emphasis on emerging markets,’ says Taxin, who sees this benefitting clients.

Xinhua certainly gives Glass Lewis an edge, and financing to sharpen that edge. ‘It’s a resource no one else in this marketplace has,’ adds Taxin, ‘and I think we’ll distinguish our international research from any other provider.’ Now that Glass Lewis is under the umbrella of a massive financial conglomerate, Taxin looks forward to using those resources for ‘augmenting our people and capabilities through acquisitions, joint ventures and additional hiring.’

Like Glass Lewis, the benefits to ISS in being owned by the larger RiskMetrics stem from the combined client base. Sarah Cohn, director of communications at ISS, says this enables ISS ‘to better serve institutions’ risk management needs by offering an even broader range of risk management solutions.’

Global warning

It might be difficult to imagine the type of osmosis that will allow Glass Lewis and Xinhua to share expertise without sacrificing impartiality. Both parties insist this is feasible, with Glass Lewis committed to autonomous research committees and Xinhua serving as hands-off financier. Xinhua says it does not provide its companies with the same advice that Glass Lewis does, so Glass Lewis could ostensibly  be free of influence. Fears among the corporate and investing communities remain, however, fueled by the types of other firms that Xinhua owns.

Connell emphasizes the strength of the ‘Chinese walls’ that will be in place. ‘Glass Lewis and Taylor Rafferty will be in completely different divisions,’ he explains, ‘and Xinhua will not have a hand in determining voting outcomes.’

Hall proposes that if Xinhua ‘has an interest in the outcome of a particular vote, [Glass Lewis] will have to make sure those individuals who are in that decision-making authority don’t have control over the folks who are independently rating and giving advice to there clients.’

This is an instinctive but essential concept. Hall warns of some of the obvious signs that Xinhua could be influencing Glass Lewis: ‘If you start seeing the interest of one organization is always aligned with the interest of the guy that’s rating the report,’ he says ‘then one may question whether that is evidence of partiality.’

Overall, the decision to purchase Glass Lewis is an interesting one for Xinhua, which has not had involvement in corporate governance until now. Owning Glass Lewis gives them license to observe shareholder proxies in America. Xinhua clearly wants to increase its involvement in US markets, and Glass Lewis is eyeing a foothold in the rapidly growing Chinese capital and equity markets.

To avoid inferences about this new interest in Chinese markets, Glass Lewis says its aim is to bring ‘objective investment research and proxy advisory and voting services’ to China. Glass Lewis says it intends to cover Chinese companies. This isn’t a bad thing, but it does indicate a dramatic shift. Being owned by a Chinese parent gives Glass Lewis that foothold without the considerable time and expense required to build a client base organically.

Call for new regulation standards
The eerie similarity between Taylor Rafferty and Glass Lewis has left policy advisors and clients agog. Most comments from interested spectators include a mixture of hesitant and contemplative. ‘My sense is that investors are more perplexed,’ says Stephen Davis, president of Davis Global Advisors.

To instill confidence in shareholders, Chinese walls and internal regulation are about all we can rely on. There is no requirement for proxy advisory firms to register with the SEC. Cohn says ISS operates its research division as a separate entity in a manner ‘largely unchanged’ since the RiskMetrics merger, keeping it free from influence.

Though personal confirmations provide superficial relief, perhaps clearer regulations could elucidate vagaries. Even though there are no registration requirements, firms like Proxy Governance are registered as investment advisors. Taxin says Glass Lewis ‘improperly registered’ with the SEC, but after hiring lawyers and compliance specialists they were advised to deregister because the SEC ‘doesn’t want to spend resources on an entity that’s not really an investment advisor.’

In the coming months, we will see if this apparent conflict proves significant. Whether Glass Lewis remains impartial isn’t the big issue; speculation might be enough to incite a reevaluation of proxy advisor regulations. In some cases, perceived conflicts are just as damaging as actual ones. ‘Ultimately,’ Fenn says ‘the markets will decide.’