Proxy advisers' role: who's happy now?

Public companies and proxy advisers have been engaged in a heated feud from almost the moment ISS and Glass Lewis arrived on the scene. Too often, management feels unfairly judged by third parties that wield undue influence, while proxy advisers complain they’ve fallen victim to a shoot-the-messenger mentality whenever they disagree with management.

Last summer, when the SEC issued Staff Legal Bulletin 20, neither side got the vindication it had desired. ‘I don’t believe that document was what companies were looking for,’ says Kevin McManus, vice president and director of proxy services at Egan-Jones Proxy Services. ‘They were looking to return to the 1970s, when there were no proxy advisers.’

That public companies believe proxy advisers are omnipotent is an exaggeration, just as it’s hyperbolic to argue that proxy advisers don’t matter at all. As usual, the truth lies somewhere in the middle. In Stanford, Equilar and RR Donnelley’s 2015 investor survey, Deconstructing Proxy Statements – What Matters to Investors, when investors are asked what information sources their organizations rely on for making proxy decisions, 63 percent say ‘third-party proxy adviser’. That means proxy advisers rank third, behind the proxy statement (83 percent) and internal policy or analysis (73 percent), but above direct engagement with the company (58 percent).

Public firms and proxy advisers may have secretly harbored different hopes for how the SEC and Canadian Securities Administrators (CSA) would redefine their thorny relationship, but almost everyone agrees the regulatory weigh-in can only help. Ron Schneider, director of corporate governance services at RR Donnelley, notes that Staff Legal Bulletin 20 ‘basically confirmed that investors have the right to use proxy advisory firms.’

He says the SEC put much of the onus on investors, saying that institutions are responsible for voting in the best interests of their clients and making sure the advisers they hire have the capacity to do the job well. Investors should also evaluate how proxy advisers are managing conflicts of interest, and whether they are up to the task of issuing recommendations on critical governance matters.

Although European, Canadian and US regulators have each spoken out independently on the issue without any co-ordination, the gist of their messages has been quite similar: there is a consensus that regulating proxy advisers is not the answer, says Frédéric Duguay, partner at Hansell Advisory in Toronto. What’s needed is for regulators and practitioners to outline best policies and practices.

‘None of the jurisdictions has imposed what I’d call a regulatory regime where proxy advisory firms are subject to prescribed regulatory rules and have to report directly to the securities regulators, such as credit rating agencies do,’ he explains.

The CSA published National Policy 25-201 on recommended practice and disclosures for proxy advisers, which went into force on April 30. According to this policy, proxy advisers should prominently disclose ‘actual or perceived’ conflicts of interest when, for instance, a proxy adviser is providing other paid services to a particular issuer. They should also adopt codes of conduct and be more transparent about how they develop vote recommendations. ‘A lot of the criticism has been that proxy advisers take a one-size-fits-all approach to executive compensation plans,’ Duguay says.

In Europe, the outcome has been similar. European securities regulators decided against regulating proxy advisers, but suggested instead that market participants should agree on a code of best practices. The result? A drafting committee comprising ISS (Europe), Glass Lewis, IVOX, Manifest, PIRC and Proxinvest drew up the Best Practice Principles for Shareholder Voting Research 2014.

Sarah Wilson, CEO of Manifest, a non-recommendations-based proxy research company in the UK, is convinced the clarifications in Europe, Canada and the US are beneficial. She believes much of the storm about proxy advisers is misplaced. ‘Maybe companies were attacking proxy advisers as they couldn’t comfortably say what they wanted to say, which is that they thought the asset managers and the asset owners were outsourcing too much,’ she says.

‘[SEC chair] Mary Jo White was basically saying to the various constituents, You don’t really need to involve us as the securities regulator. You can sort these things out for yourself.’

Is the zombie vote real?

One compelling argument against proxy advisers is that they spawn ‘zombie’ votes cast by investors too lazy to think independently so they follow the recommendations of a third party. According to Duguay, the SEC responded to this argument by going farther than Canadian regulators and affirmatively addressing the duties of investors to cast thoughtful votes during proxy season. And he says in his experience ‘investors are increasingly becoming independent with respect to their voting decisions.’

In Canada, for instance, he points out that the largest investors are at the forefront, engaging with issuers and even publishing their own proxy voting guidelines. While two or three years ago a proxy advisory ‘no’ vote might represent 13 percent-20 percent of the overall vote, today ‘we’re seeing that influence decreasing.’

Schneider says many investors were miffed by the SEC’s admonition to vote independently of the proxy advisers. ‘Maybe they all dusted off their procedures to meet higher levels of scrutiny and best practice, but they felt it was insulting to suggest this wasn’t happening all along,’ he explains. In fact, he is convinced investors don’t vote a given way because of aproxy adviser’s recommendation. ‘Many of the adviser policies mirror the companies’ preferences, not necessarily the other way around,’ he says.

David Salmon, senior vice president at Laurel Hill Advisory Group in Canada, also maintains that proxy advisers’ influence has declined somewhat over the years and that their recommendations are increasingly weighed as one among many inputs. When one of his clients is non-compliant with the proxy advisers, it sparks a productive dialogue about why not. Often, when confronted with pioneering governance, clients gladly adjust their own stances, he says. 'If management communicates well, investors are not going to blindly follow the proxy advisory firms,’ he adds.

As a case in point, Salmon cites Goldcorp. Anna Tudela, vice president of diversity and regulatory affairs and corporate secretary at Goldcorp, says the company received 97.1 percent support for its say-on-pay proposal in 2013, before Glass Lewis issued a negative recommendation on the company’s pay practices. After the recommendation, Tudela approached the proxy adviser to explain why the mining industry’s metrics were different from other industries – without success.

In 2014 Goldcorp saw say-on-pay support plummet to 74.8 percent. Tudela looked into which shareholders worked with Glass Lewis and wrote each a letter explaining ‘why Glass Lewis was wrong in its analysis’. She followed up with a personal phone call to make her case for why the firm’s executive pay practices were appropriate. This year Goldcorp’s say-on-pay proposal received 89.2 percent support. ‘If we reach out to shareholders, we can make them understand where we’re coming from,’ says Tudela.

Are proxy advisers changing?

Wilson says it’s ‘too soon to tell’ how big a change the SEC, CSA and European securities regulators will have wrought. But she detects a shift in the rhetoric, with North Americans speaking more of ‘engagement’, as Europeans have done for some time now.

Duguay has noticed proxy advisers taking concrete action, often adopting or refining conflict-of-interest policies. ‘On their voting recommendation reports now, proxy advisory firms disclose whether there’s another relationship between the firm and that particular issuer or shareholder,’ he points out. Proxy advisers that provide consulting services to the same companies they monitor are starting to disclose such information more clearly. Strides have also been made in proxy advisers furnishing transparent disclosure on how they determine their voting recommendations and how they develop their proxy voting guidelines, Duguay adds.

Salmon points out that improved communication and clarity are essential. In the middle of the 2014 proxy season, ISS altered its stance on the timing for Canadian advance notice bylaws. Companies didn’t object to the change itself but, because the change had not been clearly communicated beforehand, it meant some issuers were getting ‘against’ votes undeservedly. ‘It created a level of frustration with issuers,’ Salmon says. ‘No one was opposed to the change; they just needed to know about it so they wouldn’t have [a negative recommendation].’

What’s more, Staff Legal Bulletin 20 spurred Egan-Jones to reverse its policy of not allowing companies to preview its research. Late last year Egan-Jones began letting companies check that directors’ names are spelled correctly and that directors are classified properly in terms of independence, which has ‘ended up in a better product for everyone,’ McManus says. While companies continue to dispute the proxy adviser’s findings, he believes the research has been made stronger by the additional layer of fact checking. ‘If we issue a report four weeks in advance of the vote and then find new information, why wouldn’t we update our report and vote recommendation to make sure that recommendation is the best it can be?’ he adds.

The market decides

For many, the bitterness of the battle between proxy advisers and issuers boils down to disagreements over a few divisive issues, the most heated of which is almost certainly executive compensation.

‘More than 95 percent of the times a company calls me, it has something to do with executive compensation,’ says McManus. ‘During proxy season, I field a lot of phone calls from companies asking, Why are you [voting against our pay practices]? Many times we’re looking at double-digit executive pay of $20 million-$30 million, or higher, while also looking at shareholder returns in the negative numbers.’

In the most recent proxy season, Egan-Jones recommended an ‘against’ vote for more than a third of say-on-pay proposals covered by the firm. ‘Our against vote is an order of magnitude higher than last year,’ McManus admits. But the new voting model doesn’t necessarily reflect the opinion of Egan-Jones: it reflects the concerns and priorities of existing and potential clients. ‘Very large institutions let it be known in no uncertain terms that executive compensation is a key issue,’ McManus adds. ‘We think some were unhappy with the level of support we’d given in the past, so we changed that.’

In many ways, the crux of the debate over proxy advisers’ influence hinges on the source of the recommendations – whether they reflect the governance priorities of ISS, Glass Lewis or Egan-Jones, or represent the concerns of the institutions paying for the research and voting the proxies. ‘Investors are paying for a service they find value in,’ says Salmon. ‘If they don’t find value in it, they won’t seek that service.’

For Wilson, recent clarifications on the roles and responsibilities of all parties in the issuer/proxy adviser tempest provide a true reset button for what’s been too adversarial a relationship. ‘The SEC and CSA have given the market a chance to pause and ask, Do we want corporate governance to be fight, fight, fight in the next decade? Or do we want it to be based on a mutual understanding and respect?’ she says. ‘Because here’s the reality: if [proxy advisers] didn’t exist, we’d have to be invented.’

Elizabeth Judd, a graduate of Yale and the University of Michigan, regularly writes about investor relations and corporate governance

This article appeared in the fall 2015 print issue of Corporate Secretary Magazine