Power and influence

Aren’t you glad that the Government Accountability Office, a branch of the Federal government better known as the GAO, has assured one and all that Institutional Shareholder Services (ISS) does not have undue influence? Don’t you sleep better at night, knowing that an impartial government entity has confirmed that ISS isn’t overly powerful? Not me. ISS drives me crazy. (My wife would say to that: Short drive, huh?)

Writing on his blog right after the GAO report came out, Broc Romanek of TheCorporateCounsel.net had some interesting reactions to the GAO study. He writes, ‘It appears that the GAO failed to talk to anyone other than investors and regulators. What about other key players? The issuer community? The proxy solicitors? Investor relations personnel?

‘One gets a sense that the GAO investigators didn’t really learn much. For example, the report mentions that issuers feel the need to get help from ISS to get a favorable recommendation – but then leaves it at that – without exploring what that means.’

Romanek continues, ‘Any proxy solicitor will tell you that ISS’ influence on voting issues can often be as high as 25 percent of the shares outstanding.’

As reports go, this one from the GAO is right up there with the Chicago Tribune’s headline in 1948, ‘Dewey defeats Truman’.

Be that as it may, here’s ISS with its noble slogan, ‘Enabling the business of corporate governance’, an organization that decries possible conflicts of interests on boards of directors, that supports majority voting and ‘say on pay’. Maybe I’m reading into ISS’ slogan, but I think the folks there are implying that their particular ideas of good governance are fair, truly American and as righteous as mom and apple pie. Anyone who disagrees with them is fundamentally misguided, unfair and un-American. (Could it get any worse?)

These are the people who urge large institutional investors to vote one way or another on company proxies – institutions that sometimes represent 25 percent of a corporation’s shareholder vote. And if the broker vote ends up going away, majority-voting models tied to director resignations come into play, and those lovely CD&As become more important at future annual meetings as the investing public learns how to read them (and if ‘say on pay’ comes to pass), well, it’s downright scary to think just how powerful ISS could become.

Speaking of ‘say on pay’, did anyone notice that RiskMetrics Group, the owner of ISS, recently bought a forensic accountant/risk assessment group? RiskMetrics said in its press release: ‘The addition of CFRA (Center for Financial Research & Analysis) will allow the ISS governance unit of RiskMetrics Group to offer institutional investors a deeper qualitative view into portfolio companies.’

Maybe I’m paranoid, but that sounds a lot like ISS is gearing up to have a gigantic ‘say on pay’ in the not-so-distant future. But I’m probably worrying about nothing, right? After all, these are the good guys, right? And the GAO assures us that we have nothing to worry about, right?

But ISS, this organization that implicitly wraps itself in the flag of fairness, doesn’t play by its own rules. Through the power of its influence in the proxy voting process, ISS has become a quasi-regulator that is not itself regulated. It doesn’t have to live by Sarbanes-Oxley. As a wholly-owned subsidiary of a privately held company, it doesn’t have to go through its own proxy votes. Its website lists eight directors on its board, five of whom are not independent by ISS’ own standards.

This paragon of corporate self-governance offers consulting services to help companies improve their own corporate governance.

You’ll never guess who the companies are that use the consulting service. Or maybe you will. They’re the very same companies that are rated by ISS. But Corporate America has nothing to worry about. ISS has assured everyone it has a completely effective Chinese wall that separates its consulting from its governance ratings. And the GAO doesn’t see any problems. Conflicts of interest? Nah.

Consider this quote from Cass Sunstein, professor of jurisprudence at the University of Chicago law school: ‘Human psychology can make conflicts of interest quite intractable. Often, for example, people believe that it is enough for those with a conflict simply to disclose it. Unfortunately, disclosure often does little or no good.’

Seems to me that Sunstein has one heck of a point there. I’m becoming knee-jerk reflexively cynical, but I’d extend Sunstein’s point and say that disclosure, even with a Chinese wall attached to it, does little or no good. I’d love to talk to ISS’ consulting clients and ask them completely confidentially if they really believe that ISS is helping them. Or do they buy the consulting service as a form of inoculation against bad proxy recommendations from ISS? (I’ve had this conversation with a couple of members of the Society of Corporate Secretaries and Governance Professionals who are both rated by ISS and buy consulting services from it, and they sure didn’t sound like ISS true believers to me.)

Where does all this fulminating about the unfairness of life with ISS leave Corporate America? After all, ISS is not subject to SEC regulation. The Society has often pleaded with the SEC to look at ISS; the staff always respond that there’s nothing they can do about it. And ISS doesn’t have to abide by stock exchange listing standards. You can’t hit it in the wallet; its power derives from its large number of clients who want an organization like ISS to research and to assess proxy votes from the institutional standpoint.

Does that mean we’re stuck with ISS and just have to learn to live with it? Well, not quite. ISS is an accredited financial services provider. And that makes it subject to a 67 year-old bit of Federal legislation that’s often overlooked.

David Smith, president of the Society, and a pretty smart attorney (and, in the interest of full disclosure, my boss!), says, ‘Let’s take a moment to consider the Investment Advisers Act of 1940 (the ‘1940 Act’), which upon the basis of facts disclosed by the record and report of the SEC, found that investment advisers are of a national concern.’

Smith continues, ‘An investment adviser under the 1940 Act is one who, for compensation and as a part of a regular business, issues or promulgates analysis or reports regarding securities. On information and belief, ISS is a registered investment adviser under the 1940 Act and subject to SEC regulation.’

Now the good part. Smith poses this query: ‘Why have the SEC and the Department of Labor refused entreaties to study the role and influence of ISS? Why is its overriding influence not a national concern as described in Title 15, Section 201 of the United States Code?’

About all I can say to that is, ‘Why indeed?’

So, whatever pull you have with the SEC, use it. Push them to do their job under the 1940 Act and look into ISS. Give your congressional representative a nudge. Point out that this is a case of institutional shareholders looking to diminish the power of Main Street investors (Congress loves anything that can be expressed with a populist twist).

Finally, if RiskMetrics ever goes public, buy a chunk of its stock and go to your archives and pull a copy of every ISS-endorsed precatory proposal you ever received and file a version of it for RiskMetrics. Talk about sauce for the goose.