GAO Report on Proxy Advisors: No Smoking Guns

This post is from Broc Romanek of

I know a lot of people have been waiting a long time for the Government Accountability Office’s report on the state of the proxy advisory industry.  The GAO report–which had been requested by two members of Congress–was finally released to the public on Monday.

I guess the big surprise from the report is that there really was not much in the way of surprise.  It appears that the primary purpose of the report was to hone in on Institutional Shareholder Services’s potential conflicts of interest (i.e., taking on both investors and issuers as clients).  But since ISS fully discloses those arrangements–and investors told GAO that they were comfortable with ISS’s practices in this area–ISS’s conflicts of interest proved to not be much of an issue for the report.

Here are some of the “notable” findings in the GAO’s report:

(1) There are over 28,000 public companies worldwide that send out proxy statements–with over 250,000 separate issues. Nice stats to know.

(2) Most institutional investors indicate that they conduct their own due diligence to obtain reasonable assurance that ISS is independent and free from conflicts.  But in many cases, the investors’ diligence consists only of reviewing ISS’s conflict policy.

(3) Proxy advisors may also be conflicted where their owners do other business with issuers and investors (and where the owners of advisory firms serve on boards of other companies).  In my view, this is the real conflict risk that exists in the industry.

(4) A helpful chart on page 13 shows how dominant ISS is within the industry, with more clients than the other 4 proxy advisory firms combined.  I have to admit that I had not heard of Marco Consulting Group before–and it has been around for nearly 20 years.

(5) Many of the investors that GAO contacted said that they do not vote their proxies; they hire asset managers to do that for them.

So what did the GAO miss in its review of the proxy advisory industry?

First, I would not place much stock in the notion that ISS’s influence is overblown.  If you have any actual experience with shareholder meetings, you know that ISS’s recommendation often makes the difference as to whether a controversial matter is approved by shareholders.  So, as many commentators e-mailed me yesterday, when it comes to ISS’s influence on votes, the report does not ring completely true.

Here are some other “beefs” that members have sent me regarding the report:

(1) Failure to interview constituents affected by proxy advisors’ influence.  It appears that the GAO failed to talk to anyone other than investors and regulators.  What about other key players?  The issuer community?  Proxy solicitors?  Investor-relations personnel?

(2) Flying at a “1000-foot” level.  Reading the report, one gets the 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 the implications of that finding.  The report should have clarified that this isn’t a “pay to play” situation–that is, that issuers aren’t buying votes.  The report also should have explained that the bulk of ISS’s corporate consulting fees come from equity plan design, not helping issuers improve their corporate-governance rating scores.  Given the influence that ISS has on institutional shareholders–coupled with the proprietary equity-plan methodology that ISS uses–many issuers feel pressure to sign up for ISS’s consulting services to make sure that their plan will be approved by shareholders.

(3) Understating the extent of ISS’ influence.  In footnote 14, the GAO cites a recent study (The Role of Advisory Services in Proxy Voting) that examined the extent to which proxy-advisor recommendations can influence vote outcomes and stock prices.  But the report didn’t delve further into that important topic.  Any proxy solicitor will tell you that ISS’s influence on voting issues can often affect the votes for as many as 25% of the outstanding shares.  A prime example of ISS’s influence is the shaky reception several recent private equity deals received after ISS recommended voting against the transactions (i.e., Clear Channel and Biomet).  That’s not necessarily a bad thing for shareholders–but it does illustrate ISS’s influence.

(4) Lack of investigative research.  A serious problem with the report was the GAO’s tendency to accept at face value institutional investors’ insistence that they make independent decisions notwithstanding ISS’s influence.  Yes, some do.  But how many institutional investors would actually confess, when asked by the GAO: “Yep, most of the time I just vote the way they tell me.”  None of the smart ones, of course, because these institutions have fiduciary obligations when voting these shares.

Remember that most of these investors hold positions in thousands of companies; it would be a monumental task for them to conduct independent research on each item on each issuer’s ballot.  To do so, an institutional investor would have to have a staff the size of a proxy advisory firm in order to do the job adequately.  The reality is that institutional investors are trying to keep their expense ratios down–and even the larger institutions typically have only a few employees dedicated to vetting voting issues.

(5) Missing the “real” barrier to entry.  Although the report discusses barriers to competition in the proxy advisory industry, it ignores the real issue connected with that topic: vote execution.  No sane institutional investor is going to assume the risk inherent in moving thousands of accounts and ballots from ISS to another provider.  The chance that accounts would be lost, not voted, or voted incorrectly is far too great.  An ISS competitor has a rough road ahead in trying to duplicate the sophisticated vote-execution platform that ISS has built over the years.

(6) Short shrift to looming conflict issues.  One wonders if the conclusions of the GAO report would change if the rumors are true that ISS’s parent company, RiskMetrics, is about to go public?  I don’t blame the GAO for missing the boat on this issue; this is a complex area to tackle if you don’t have any “hands on” experience.  They did better than the Washington Post, which ran an article yesterday on the GAO report with a picture of the ISS executive team from about six years ago (including, ironically, Ram Kumar, who was infamously ousted because he had represented himself as a law school graduate to ISS although he has no law degree).

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One Comment

  1. James McRitchie
    Posted Friday, August 3, 2007 at 11:20 am | Permalink

    Second Thoughts on Proxy Advisory Services

    As I noted the other day, the GAO released its report on proxy advisory services (GAO-07-765: Proxy Advisory Services). Like many who rush through all the mail that piles up, I didn’t really say much about the report, other that to quote a few passages that implied the SEC did not identify any major violations, even with potential conflicts of interest, and that large institutional investors aren’t totally reliant on such services in voting their proxies.

    P&I appears to have gone a little overboard in an article entitled GAO: Proxy advisory firms’ influence overblown. (Compare with Is This the Most Influential Man on Wall Street?,, 10/16/02. Has ISS really gotten less powerful in the last five years?) Thankfully, this morning I woke up to a much more thoughtful read under the heading GAO Report on Proxy Advisors: No Smoking Guns at Blog (8/1/07). In it Broc Romanek poses six questions the GAO should have asked. Of the six, the most interesting to me is the following:

    “4. Lack of investigative research – A big flaw in the report was taking at face value that many of these institutional investors said they make independent decisions. Yes, some do. But how many of them, when asked, would be expected to say: “Yep, most of the time I just vote the way they tell me.” Not any of the smart ones, because they have a fiduciary duty to vote.

    Remember that most of these investors hold positions in thousands of companies; it would be a monumental task to conduct independent research about each item for each issuer’s ballot. To do so, an investor would have to have a staff along the lines of a proxy advisor to adequately do the job. The reality is that investors are trying to keep their expense ratios down – and even the larger investors typically have only a few employees dedicated to vetting voting issues.”

    Romanek gets to fundamentals by pointing out that even the largest institutional investors only have a few staff devoted to researching proxy issues for thousands of companies. Therefore, they really are more dependent on ISS than they would like to acknowledge. However, a brief analysis of ISS by Mark Latham doesn’t provide much solace to those of us who worry about how much focus is actually given to proxies and how shareowners vote.

    Latham quotes ISS, “Comprehensive analyses of proxy issues and complete vote recommendations for more than 10,000 U.S. companies are delivered by ISS’s seasoned U.S. research team consisting of more than 20 analysts.” He then goes on to observe:

    We can thus estimate about four hours of analysis per proxy, costing perhaps $2000 including ISS infrastructure costs. Considering the amount of money we shareowners pay CEOs and boards of directors who are elected and compensated based on our voting, and the amount of capital at stake in the typical company they manage for us, we should be spending more than $2000 to guide our voting.

    I agree, that’s why I have long supported Latham’s notion that “all shareowners of a company can solve the freerider problem by paying for voting advice as a group instead of one investor at a time. If we can pay with company funds, then all are paying together in proportion to the number of shares owned, thus in proportion to any benefit in share value from improved voting.” Of course, “the trick is to keep the advisor selection and payment procedure free of influence from the board of directors” and to come up with an easy and expeditious way for shareowners to select a proxy advisor for more in-depth coverage. (Proxy Voting Brand Competition, Journal of Investment Management, First Quarter, 2007)

    So far, Latham has been more successful in applying his model of brand competition to university than to corporate elections. (see Of course, the students of today will be the CEOs, directors, and fiduciaries of tomorrow. Just as there were early proxy access adopters, such as Apria Healthcare (2003) and Comverse Technology (2007), innovative companies will soon acknowledge the increased credibility an independent analysis of their proxy can provide. Just as all hire an “independent” auditor, they will soon begin funding proxy monitors. To ensure true independence, they should be asking shareowners to vote on their selection.