Taking on proxy advisers in Canada

The furor that continues to grow in the US about the influence proxy advisory firms have over publicly traded businesses began bubbling over in Canada last June. That’s when the country’s securities authorities officially announced that they would follow the SEC’s lead and examine the role of proxy advisory firms in the marketplace to determine whether some sort of regulatory framework is necessary to govern them.

Just as in the US, issuers in Canada are becoming increasingly concerned about the treatment they receive from ISS and Glass Lewis. With shareholder activism in Canada growing – as evidenced by increasing numbers of proxy contests – similar complaints have surfaced about conflicts of interest, lack of transparency, errors in reporting and undue influence in proxy voting recommendations by these firms. This has forced Canadian regulators to acknowledge the situation and at least survey the markets. 

A number of leaders in the governance community have spoken out about the problems attributed to proxy advisory firms, including the Canadian Coalition for Good Governance and the Canadian Society of Corporate Secretaries. The Institute for Governance of Private and Public Organizations (IGOPP), an independent organization that reviews and comments on corporate governance matters, also weighed in on the influence of proxy advisory firms back in March, when it published a new policy paper entitled ‘The troubling case of proxy advisers: some policy recommendations.’ The organization and its chairman, Yvan Allaire, are promoting a shared-responsibility approach to solving the discontent with proxy advisory firms, suggesting that regulators, corporations and institutional investors all have a role to play in improving corporate governance under the current system. 

‘We are looking at what role they all play in enhancing governance and whether it’s a positive, negative or neutral one,’ explains Allaire. He notes that when Canadian securities authorities asked for comment letters on the issue last summer, IGOPP decided to ‘consult’ with regulators by writing the policy paper, but the group has also distributed the paper to institutional investors, pension funds and the chairmen of the largest corporations in Canada, as a way to get its views on the record. The hope is that the paper will help stimulate a dialogue that will turn into actionable change in how proxy advisory firms operate. 

For its part, IGOPP says it will be collecting feedback on its policy initiative from institutional investors and pension funds, calling many of them – if necessary – to see how each of them would like to handle the problem. Ultimately, IGOPP will contact regulators to share its findings. 

‘I’m very curious to see what the regulators will do,’ observes Allaire. ‘If they come back with a weak, placid recommendation to just collect more information, then we’ll go to the media – the National Post, the Globe – but I hope they will come with some type of solid position on this instead.’

The IGOPP position on proxy advisory companies is quite firm. In its paper, the organization says ‘proxy advisers now stand in a bully pulpit from which to harangue corporate management and boards of directors on all matters of governance and compensation. Their influence has grown in spite of repeated criticism of their performance, because investors seemed to find these ‘advisers’ useful in discharging what could be an onerous responsibility. Neither regulated nor supervised, proxy advisers rely on a business model that makes it virtually impossible for them to handle with care and responsiveness the sheer volume of reports they must produce in a very short period of time. In the case of ISS, the firm is also vulnerable to conflicts of interest.’

Allaire, who wrote the policy paper, says institutional investors and regulators have not fully accepted their responsibility when it comes to stopping proxy advisory firms from becoming so influential. He says responsibility for solving the problems needs to be placed on institutional investors. In fact, he all but accuses them of abandoning their responsibility to investors in their funds.

‘The position we are proposing is that the large institutional fund managers have a responsibility to ensure the process and the role proxy advisers play in it is a positive one; they can’t just say they have nothing to do with that,’ he explains. ‘They are the client – without this client, proxy advisers would not exist.

‘As the client, it’s incumbent upon institutional investors to be informed of the business model – how do these proxy advisers arrive at issuing so many reports in such a short period of time in the spring of each year? What kind of staffing do they have, and what kind of training do they provide? How does it come about that, as a client, these fund managers have a responsibility to inquire about any possible conflicts of interest and to make sure these are fully divulged to them as clients who receive ISS opinions, but at the same time some of the companies ISS writes about may be its clients? The divulging of conflicts of interest is not very transparent at this time.’

Speaking out

Allaire also suggests that unless institutional investors speak up forcefully, the influence of proxy advisers will continue to grow. ‘What is the responsibility of institutional investors?’ he asks. ‘Do they agree with the corporate governance standards that are adopted by the proxy advisers, or do they disagree? Do they agree that compensation should be assessed with total shareholder return over one year or three years as a measure of how real pay for performance works? Do they agree that the executives are correctly paid or not? If they don’t, they should say so, and not just say, This is just one piece of information to consider as we make up our minds. That may well be so, but I think they have a responsibility to be much more forthcoming on this.’

Allaire believes the Canadian securities authorities have a responsibility to recognize conflicts of interest and act before it is too late. ‘The securities authorities have to look closely at some aspects of the role they play in creating these problems,’ he asserts. ‘Proxy advisers have now become very key players in all proxy fights, so the relationship between activist funds and proxy advisers deserves to be very transparent. 

‘In the case of mergers or acquisitions, we sometimes find proxy advisers are actually giving advice to shareholders on whether they should or should not accept an offer. That comes pretty close to taking the role of a financial analyst who gives a recommendation. Both large institutional investors and securities agencies have to look at their role and hope we don’t make the same mistake we did with the ratings agencies – assuming everything was fine until the whole thing blew up.’

Compensation matters

Allaire’s policy paper proposes six main recommendations (see IGOPP recommendations regarding proxy advisers, below), the first of which concerns the say-on-pay vote. This is particularly important because whatever the proxy advisers measure becomes the norm in setting compensation at companies. 

‘If as a fund manager you don’t think there is an appropriate metric or an appropriate way to incentivize executives, then you should say so,’ says Allaire. ‘Otherwise, boards – being wary of getting a negative vote on their compensation program – will steer compensation in the direction desired by proxy advisers. We don’t think that’s desirable but institutional investors have to say, That’s not the way we want to look at it. We don’t think that the one-year, three-year measure of total shareholder return is the way to assess whether compensation is effective or not. If institutional investors don’t speak up, proxy advisers will have undue influence over what’s going to happen with compensation. We think setting compensation is the responsibility of the board, but the board should take into account quality factors in assessing management – board members are the ones who know many aspects of determining compensation are not measurable, but are still terribly important in the performance of a company. You cannot summarize everything with one or two financial numbers.

‘The ratings agencies have standards they have to meet, and they have to file information; they report on the standards of training and experience for their analysts. There are standards for the ratings agencies, and as the proxy advisory firms’ role is getting to be some times as important, they should be required to file their standards of training and experience with regulators.’

Finally, Allaire points out, ‘proxy advisers are big players in almost every proxy fight and every acquisition. There are many activist investors and hedge funds in their client bases – they themselves say their largest clients are activist funds and hedge funds. We have to be wary. We can debate how large a role they play, but certainly whenever proxy advisers come out in favor of a slate of directors, this is big news and it’s played very loudly by the activist funds in the media trying to sway shareholders to vote for their slate using the credibility of the proxy advisers and any supporting evidence. 

‘If proxy advisers get involved in takeover situations – and in fact there have been times where they have clearly told shareholders they should or should not sell their shares at a given price – that is very close to financial advisers or investment advisers giving an opinion to the board of directors. And what is more important to all parties concerned in these transactions is whether the proxy adviser acted as a consultant in any way for any of the parties involved in that transaction over the previous two years. We really have to put a framework around the activity of proxy advisers. It is critical.’

IGOPP Recommendations Regarding Proxy Advisers

Recommendation 1

Large institutional investors, to the extent that they share the views on compensation defended by IGOPP and others, should make it clear to corporations and to proxy advisers that they do not consider their guidelines on executive compensation appropriate or useful and that they will not give any weight to voting recommendations based on these metrics.

Recommendation 2

Clients of proxy advisers should insist all pertinent details of the business models used by proxy advisers are fully divulged: part-time versus full-time employees, location of employees, extent of work performed in foreign countries, and training of employees.

Recommendation 3

Regulators should require that proxy advisers report on their required standards of training and experience for their analysts.

Recommendation 4

Canadian regulators should prohibit ISS from offering corporate services to corporations about which it issues proxy voting recommendations to its institutional clients, just as auditing firms may not offer consulting services to corporations they audit.

Recommendation 5

Whenever proxy advisers get involved in takeover situations, they are recommending, in effect, that their institutional clients sell, or not sell, their shares to a would-be acquirer. In those circumstances, they should be subjected to regulations put in place for financial advisers and investment bankers giving an ‘opinion’ to a board about a merger or acquisition transaction. 

Any such advice provided by proxy advisers should inform all parties concerned as to whether the proxy adviser has acted as consultant in any way for any of the parties involved in the transaction over the previous two years.

Recommendation 6

In cases of proxy contests and other litigious matters, Canadian regulators should adopt the suggestion made by Wachtell Lipton Rosen & Katz in its submission to the SEC: 

‘Proxy advisory firms should be required to disclose in their recommendations whether the adviser has, currently or within the recent past, been engaged by any participant in the relevant proxy contest, whether any of the interested parties in a contest subscribe to the proxy advisory firm’s services, and the aggregate fees paid by the interested parties to the proxy advisory firm.’

For and Against: Other Opinions on Regulation of Proxy Advisors

Besides the Institute for Governance of Private and Public Organizations, several other organizations have called for proxy advisory firms to be regulated, each pushing for different types of reforms in comment letters submitted to the Canadian Securities Administrators. The Canadian Investor Relations Institute has pushed hardest for changes that can clear up inaccurate reporting by proxy advisory firms and provide more disclosure. Among the six regulations it proposes are:

• Proxy advisory firms should be required to provide to all issuers draft research reports and voting recommendations for review for factual accuracy, allowing 48-72 business hours for issuers to respond, prior to the report being distributed to the proxy adviser’s clients.
• Institutional investors that use a proxy adviser should comply, or explain why they do not, with a requirement to disclose how they assess the advice received from the firm and not automatically follow it.

In its comment letter, the Center for Capital Markets Competitiveness (CCMC) expresses concern about lack of transparency and potential conflicts of interest but adds: ‘We are also concerned that voting recommendations may not actually reflect the economic interest of the individual beneficiaries and other participants in pension plans and other institutional funds that outsource their proxy voting to proxy advisers. Indeed, given their lack of written standards and transparency, we are concerned that proxy advisers to some degree serve instead the narrow interests of a small group of vocal shareholder activists that may have an agenda unrelated to the best interests of [most] shareholders. A systematic failure to make the right voting recommendations, for the right reasons, can adversely impact the companies involved, and in the long run cause negative economic consequences for both the companies and their investors.’ 

One notable proposal from CCMC suggests regulators provide for an annual industry-wide review of the impact on policies of proxy voting in order to identify potential issues in the voting recommendation process. It further suggests a review of identified industry-wide impediments to the efficient and accurate use of these voting recommendations. 

The Ontario Teachers Pension Plan (OTPP), which owns Glass Lewis, wrote a comment letter largely in support of the proxy advisers. In it, OTPP says that ‘while we agree conflicts of interest and lack of transparency in the proxy advisory industry could be cause for concern, it has been our experience that proxy advisory firms consistently disclose the potential for conflicts and work to navigate the waters to ensure an independent opinion. Generally, the opinions generated by proxy advisers are used and evaluated by sophisticated investors capable of digesting the disclosed information and forming a view on whether it impacts the quality of the opinion. With respect to transparency, proxy advisory firms currently disclose the general principles that underlie their decisions and have stated guidelines on correction of errors within reports. We fear the proposed regulations could prove both ineffective and potentially damaging.’