Proxy advisory firms rose in response to helping shareholders vote their shares at the annual general meetings. As proxy firms have become part of the culture of the marketplace, there has been a growing concern about issues such as transparency and conflicts of interest with proxy advisory firms. Congress and the Securities and Exchange Commission (SEC) have noted issues with proxy advisory firms, but it’s not clear which body should be responsible for legal or regulatory changes. It’s also not clear what the most appropriate changes should be.
Congress has made some attempt to regulate proxy advisory firms, but they’ve been unable to pass meaningful legislation through both chambers. The SEC also has ideas on how to make suitable changes, and they seem to be moving in the same general direction as Congress, but they haven’t taken any significant steps to date either. The U.S. Senate seems to be waiting for next steps from the SEC before they move again. The SEC continues to explore various approaches to regulatory changes.
Congressional Activity on the Future of Proxy Advisory Firms
In 2017, the U.S. House of Representatives passed two bills related to proxy advisory firms. They were the Financial CHOICE Act and the Corporate Governance Reform and Transparency Act. Both bills died in the Senate. If passed, the bills would have prescribed new requirements for proxy advisory firms.
Since then, the U.S. Senate is taking their own look at how best to approach new rules for proxy advisory firms. On November 11, 2018, a bipartisan group from the Senate introduced the Corporate Governance Fairness Act, which is also simply known as the Fairness Act. If the Act moves forward, it would subject large advisory firms such as the ISS and Glass Lewis to the Investment Advisers Act of 1940. The Senate Finance Committee held hearings on the Fairness Act on December 6, 2018, but there hasn’t been any further movement on it to date.
If the Corporate Governance Fairness Act gets enacted, it would require the following of advisory firms:
- Register with the SEC as investment advisers under the Advisers Act.
- Meet the fiduciary duty of care when providing advice to their clients.
- Allow the SEC to inspect their books and records.
- Maintain policies and procedures to address conflicts of interest.
- Maintain and preserve certain books and records.
- Comply with anti-fraud requirements.
The Act wouldn’t require proxy advisory firms to submit disclosures. In addition, proxy advisory firms wouldn’t have to give companies the opportunity to preview and comment on preliminary vote recommendations. As a follow-up measure, within two years of the bill being enacted, the law would require the SEC to submit a report to certain Congressional committees to do the following three things:
- Evaluate the conflict of interest policies and programs of the proxy advisory firms.
- Evaluate registered proxy advisory firms’ policies and procedures that address issues regarding those who may knowingly make false statements or omit material facts that would call for making a statement to clients to ensure they’re not being misled.
- Examine whether investors need any additional protection.
The Act would also provide an opening for the SEC to make additional rules or legislation if warranted.
The SEC’s Activity on the Future of Proxy Advisory Firms
In like fashion, the SEC has also taken recent action to regulate proxy advisory firms. The SEC hasn’t changed operating models or addressed public companies’ concerns as of yet.
On November 15, 2018, the same date the Fairness Act was introduced, the SEC started some roundtable discussions about the proxy process and the role of proxy advisory firms. On December 6, 2018, SEC Chair Jay Clayton instructed SEC staff to recommend proposed regulations for proxy advisory firms.
The roundtable discussions consisted of three separate panel discussions. One of the panels was composed of a diverse team that focused on proxy advisory firms. The team included:
- General Motors
- Atlas Air Worldwide
- American Enterprise Institute (a business-leaning think tank)
- Four institutional investors
- A professor at NYU Law School
- CEOs of two major proxy advisory firms
- A co-founder of Egan-Jones
- A less-prominent advisory firm
Unsurprisingly, ISS and Glass Lewis supported leaving things as is. They contended that their firms don’t need regulatory oversight because of the current business models. They believe they offer highly valued services at a reasonable cost and are responsive to their concerns. The firms also noted that they believe they already adequately disclose and address the issue of conflicts of interest and that they believe their reports have an extremely low rate of error. Representatives of both firms contend that they don’t have as much influence on proxy voting outcomes as others portend.
The four investors on the panel expressed their opposition with additional regulatory oversight, citing concerns over increased costs that would prohibit them from accessing services from the proxy advisory firms.
The consensus from the two public companies was that they were concerned about the accuracy of the proxy reports coming from the proxy advisors and the inability for opportunities to preview draft reports or to participate in discussions with proxy advisors during the proxy solicitation period. Company representatives didn’t promote the idea of initiating new rules or regulations to govern the proxy advisory firms and they didn’t offer up any alternative solutions.
The panel failed to come to a consensus on the best way to move forward. At the same time, SEC Chair Clayton stated that they’re looking into future rules that may address the following four issues:
- How to fairly divide the labor, responsibility and authority between investment advisors and proxy advisors.
- Establishing a framework for how to address conflicts of interest at proxy advisory firms.
- How to create transparency around proxy advisors’ analytical and decision-making processes, as well as whether the analytics are company or industry-specific.
- How investors can access the issuer responses to information provided in the proxy advisory firms’ company reports.
While neither Congress nor the SEC has solidified any changes at this juncture, there is enough movement to suggest there will be soon. Board directors should also be discussing how potential changes may affect the board and executives. Board management software, as provided by Diligent Corporation and the suite of governance tools included in Governance Cloud, provide a highly secure environment in which board directors and managers can strategize around complex issues as regulations for proxy advisory firms.