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The ancient Chinese philosopher Lao Tzu famously observed that the journey of a thousand miles starts with a single step – an apt observation for any large undertaking and certainly one that fits with increasing the oversight of proxy advisory firms.
Proxy advisory firms are hired by institutional investors to make proxy vote recommendations and cast votes on corporate proxies or director elections on shareholders behalf. Two proxy advisory firms constitute 97% of the industry. Some academic studies have even shown that these two firms may indirectly “control” 36% of proxy votes. Many have expressed frustration with the Star Chamber like manner these firms develop voting policies and recommendations. The proxy advisory firms lack any meaningful transparency and also have significant conflicts of interest. One firm runs a consulting business to provide advice on corporate governance policies, while the other is owned by an institutional investor. This creates an environment where an investor acting as a proponent of a shareholder proposal may also be a client of the proxy advisory firm responsible for issuing influential recommendations for how to vote on that same proposal.
Despite this lack of transparency and accountability, the market power of these firms means they now set the corporate governance standards in the United States.
Concerned about the lack of oversight over proxy advisory firms, the U.S. Chamber released a set of best practices and core principles for proxy advisory firms authored by former Securities and Exchange Commission (SEC) Chairman Harvey Pitt. The Chamber principles made recommendations for transparency, accountability, disclosure of conflict of interests, and correlating proxy advice to a funds fiduciary duty, which includes shareholder return.
Following the release of the Chamber principles, Congress held a hearing in June 2013, and the SEC issued guidance on proxy advisory firms in June 2014. The SEC guidance for the first time imposed some form of regulatory oversight over proxy advisory firms. These requirements included disclosure of conflicts of interest and correlating proxy advice to economic return and the fiduciary duties of their clients. This year, the Chamber also released a primer for how companies should interact with proxy advisory firms under this new guidance.
This past summer, the Chamber, in conjunction with NASDAQ, conducted a survey of over 150 companies to see how proxy advice has improved under the new SEC guidance. The results are mixed at best. While many companies have started a continuous dialogue with their investors, communications between companies and advisory firms have ticked up only slightly. There are still significant issues with factual mistakes made by proxy advisor firms and companies’ ability to fix them and communicate changes to the market place. It remains unclear whether proponents of shareholder proposals and opposing director slates are clients of advisory firms. One of the surveys most troubling finding is that companies which suspected a conflict of interest at a proxy advisory firm found one over 40 percent of the time. Lastly, despite its oversight role, companies were not reporting issues to the SEC.
The road to a transparent, conflict free corporate governance system may appear to be 1,000 miles long, but the SEC has already taken the first step. Clearly, this is an evolutionary work in progress and more needs to be done. But it is a start. Responsibility for the next step lies with businesses, investors and proxy advisory firms who must work together to come up with the systems that work for all stakeholders in a fair and transparent manner. If that can’t happen, then the cop on the beat – the SEC – has some more work to do.