Say on Pay: Who Is Watching the Watchmen?

Joseph Bachelder is founder and senior partner of the Bachelder Law Firm. This post is based on an article by Mr. Bachelder, with assistance from David T. Ling and Andy Tsang, which first appeared in the New York Law Journal.

This column looks at four circumstances having special impact on the governance of executive pay today and then focuses on one of them, proxy advisers (with particular attention to the largest one, Institutional Shareholder Services (ISS)). It concludes with suggestions as to steps that might be taken to better regulate proxy advisers.

Four Influential Factors

Increasing Complexity of the Executive Pay Discussion. Discussions of executive pay in proxy statements are often extremely complex and lengthy (frequently 30 to 40 pages of narrative and tables). Many companies are putting into the Compensation Discussion and Analysis (CD&A) their own tables (most especially their own competing version of the Summary Compensation Table) in order to express their own views on the correct way to explain and justify executive pay at the issuer. It has become a challenge to understand any one company’s executive pay arrangements and an even greater challenge to understand how that company’s executive pay arrangements relate to those at competitor companies.

Institutional Shareholders. Institutional shareholders represent an overwhelming proportion of the vote at publicly traded companies. (They own approximately 75 percent of the market value of exchange- traded companies.) These institutional shareholders owe a fiduciary duty to the persons who own their shares or are beneficiaries of the trust funds managed by them. This duty includes understanding how the companies in which they have invested are managed, including management of executive pay. The explosion of data noted in the preceding paragraph has meant a challenge to these institutional shareholders in trying to understand the executive pay practices at thousands of companies that they (collectively) are investing in.

Say-on-Pay Under Dodd-Frank Section 951. [1] Say-on-pay under Section 951 of Dodd-Frank took effect for annual shareholder meetings occurring on or after Jan. 21, 2011. [2] Under Dodd-Frank Section 951 issuers must provide shareholders with the opportunity to cast non-binding votes of approval or disapproval of the issuer’s executive pay program. [3]

Proxy Advisers. Proxy advisers have been giving advice to their shareholder clients for many years. They now have added say-on-pay to their portfolio of advice to shareholders. Shareholders (primarily institutional shareholders), for a fee, can receive a proxy adviser’s recommendation on whether to vote yes or no on a say-on-pay resolution, together with information explaining the basis for the proxy adviser’s recommendation.

ISS is a subsidiary of MSCI Inc. (a public company that provides investment decision support tools to investors). Another large proxy adviser is Glass, Lewis & Co., wholly owned by the Ontario Teachers’ Pension Plan Board. Others include Egan-Jones Proxy Services, a division of Egan-Jones Ratings Company, and Marco Consulting Group.

Numerous commentators have criticized proxy advisers. [4] Issuers themselves have many criticisms, of course, including those made in filings with the Securities and Exchange Commission in additional proxy solicitation materials on Form DEFA 14A under Rule 14A. [5]

Concerns Over Proxy Advice

Methodology. The only proxy adviser that the author is aware of that publicly discloses its methodology is ISS. [6] The basic methodology used by ISS for determining whether to register concern (three grades: “low,” “medium” and “high”) and, ultimately, whether to recommend a vote for or against a say-on-pay proposal, is a three-step process. First, it compares the relationship of CEO pay to Total Shareholder Return (TSR) for the issuer in question and then compares this with similar relationships at 14 to 24 other companies selected by ISS. This comparison is made for both one-year and three-year periods. Second, another CEO pay/TSR comparison is made for a five-year period at the issuer only. Third, the ratio of the issuer’s CEO pay to the median CEO pay for the selected comparator group is calculated. These three steps comprise the basic test, which ISS describes as the “quantitative” test.

If an issuer fails the “quantitative” test (i.e., ISS determines the measures noted in the preceding paragraph do not reflect favorably on the issuer) then ISS will register its concern. If it is bad enough, in its thinking, a “high” level of concern will be expressed and ISS may recommend a vote “against” the say-on-pay proposal.

A consistent criticism by issuers of the basic test is that the comparator companies (14 to 24 chosen by ISS) are selected by ISS in an inappropriate way resulting in “stacking the deck” against the complaining issuer. Another asserted flaw in the basic test is the way ISS compares CEO pay to TSR. ISS takes the incentive pay elements, for the most part, from the Summary Compensation Table of the proxy statement, and relates them to the TSR for the prior fiscal year(s). The incentive pay amount in this comparison, it is argued, should be based on incentives that have been “earned” or “vested” in the year(s) as to which the CEO pay/TSR comparison is being made. ISS’ exclusive use of the grant-date value disconnects the pay period from the performance period. Those challenging this methodology say that the TSR for 2011, for example, should be compared with the long-term incentive awards being earned out in respect of 2011. TSR for the three-year period 2009–2011 should be compared with long-term incentive awards being earned out with respect to 2009–2011. By comparing TSR for 2011 with grant-date values for long-term awards made in 2011 (which, of course, are tied to future performance), ISS, it is argued, is comparing apples and oranges. [7]

If an issuer receives a “high” concern from the “quantitative” test then the issuer would be given a “qualitative” test. ISS says that, under the qualitative test, it analyzes the issuer further by looking at six specific “qualitative” factors including a “ratio of performance-based compensation to overall compensation”; “[a]ctual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both absolute and relative to peers”; “[s]pecial circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices”; and, in addition, “any other factors deemed relevant.” However, an issuer would never really know whether ISS actually did a rigorous analysis of the “qualitative” factors and to what extent the “qualitative” factors could help an issuer avoid a negative recommendation from ISS. [8]

Finally, even if an issuer does pass the basic test, ISS might still recommend a vote against the say-on-pay proposal if ISS believes that the issuer “maintains significant problematic pay practices” and/or “the board [of directors of the issuer] exhibits a significant level of poor communication and responsiveness to shareholders.” This allows for a great deal of subjectivity on ISS’ part in deciding whether an issuer has passed the last two tests.

Conflicts of Interest. ISS itself acknowledges that it provides advice on how to vote on say-on-pay to shareholders of some of the same companies to which ISS and/or its affiliates provide consulting advice. ISS, in its own defense, says that it maintains a “firewall” between those at ISS who provide proxy advice and those at ISS or its affiliates who are providing consulting advice to issuers. In contrast to ISS, Glass, Lewis & Co. has publicly stated it does not provide consulting or other services to issuers as to whose stock it provides proxy advice.

Third-Party Influences on a Proxy Adviser. While not in the same category as conflicts of interest noted in the preceding paragraph, another concern is the ability third parties may have to leverage their own agenda by encouraging a proxy adviser to take a point of view on an issue that these third parties have with regard to a particular company. As stated by FedEx in a report to the SEC, “a small, but vocal, group of activists, unions, pension funds and hedge funds have the ability to unduly influence the voting policies and recommendations of the proxy advisory firms.” [9]

Improving Proxy Advice

1. The Regulation of Credit Rating Agencies as a Possible Precedent for Regulating Proxy Advisers. Credit rating agencies are subject to rules and regulations issued by the SEC governing the manner in which they issue ratings on various companies. For example, Section 932 of Dodd-Frank requires credit rating agencies to disclose their methodologies used in reaching their credit ratings. As noted above, while ISS outlines the methodologies it uses, it does not give a full picture of how it applies the methodologies in specific cases (i.e., the weight it gives to “qualitative” versus “quantitative” criteria). And other proxy advisers reach their conclusions without any real disclosure of the methodologies used in reaching their conclusions. This suggests that the SEC might adopt a set of rules requiring fuller disclosure by proxy advisers of their methodologies and other elements of their practices as it has done with regard to credit rating agencies. This might be done under the Investment Advisers Act of 1940 (“Advisers Act”) or Congress might consider legislation specifically authorizing such regulation by the SEC of proxy advisers.

2. Adopting Rules to Regulate Proxy Advisers Under the Advisers Act. Proxy advisers would appear to fall within the definition of an “investment adviser” as set forth in Section 202 of the Advisers Act. [10] But even though a proxy adviser such as ISS is “covered” under the Advisers Act, there is not much in the act or regulations adopted under it that meaningfully regulates the conduct of a proxy adviser. Section 206(4) generally prohibits the adviser from engaging “in any act, practice, or course of business which is fraudulent, deceptive or manipulative.” A generalized prohibition against fraud or deception does not address most of the concerns described above regarding the advice on say-on-pay being given by proxy advisers.

Following are two suggested rules that would be directed specifically at concerns raised with regard to proxy advisers like ISS. These specific rules could be incorporated into a broader regulatory scheme analogous to that applicable to credit rating agencies discussed in paragraph 1 above.

(i) Require that each proxy adviser’s report on an issuer be filed by the proxy adviser with the SEC within 30 days after the annual meeting of the issuer; and

(ii) Require that a proxy adviser not be affiliated with any other business that provides consulting or other services to the issuer as to which the proxy adviser is giving advice.

As an alternative to (ii), the SEC could require that each proxy adviser disclose in its proxy advice to a shareholder the fees, if any, that it has received for consulting or other services provided to the issuer as to which it is giving proxy advice.

3. Clarifying Whether a Proxy Adviser Is a Fiduciary Under Current SEC Regulations. Sections 1 and 2 above have indicated that one approach to regulating the behavior of proxy advisers would be for the SEC to adopt and implement specific rules. Another approach, one based on standards rather than specific rules, would be for the SEC to adopt a definition of “fiduciary” that would encompass proxy advisers such as ISS and thereby impose on them a heightened standard of care and loyalty as fiduciaries. Some have expressed the view that proxy advisers already are fiduciaries under the existing SEC regulatory framework. [11] Others take the opposite view. [12]

The Advisers Act itself does not define the term “fiduciary.” Under common law, “fiduciaries” have an elevated duty of conduct imposed on them in carrying out their responsibilities. Two examples are a trustee holding property for the benefit of another and a director of a corporation charged (under corporation laws) with special responsibilities to act on behalf of shareholders in overseeing the activities of the corporation. Such fiduciaries have heightened duties of loyalty and care, and good faith, in dealings on behalf of those intended to be benefited by those fiduciaries’ actions. It would be helpful if the SEC in its rulemaking under the Advisers Act (or other law) would clarify whether proxy advisers are fiduciaries, at least as to the shareholders to whom they are giving advice. [13]


Proxy advisers who give advice as to say-on-pay votes also impact on judgments of those having direct responsibility for oversight of executive pay. [14] A consequence of Dodd-Frank is the outsourcing of a significant share of influence over executive pay to parties without a stake in the running of our public enterprises. We should, at the very least, take steps that reasonably assure that the advice they are giving is appropriately determined.


[1] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §951, 124 Stat. 1376, 1899 (2010). Dodd-Frank Section 951 amended the Securities Exchange Act of 1934 by adding Section 14A (codified as amended at 15 U.S.C. §78n-1).
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[2] For prior discussions on say-on-pay developments after Dodd-Frank, see prior NYLJ columns, Aug. 25, 2011, and Dec. 1, 2011.
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[3] Dodd-Frank Section 951 requires that issuers provide their shareholders (at least once every six years) with the opportunity to determine the frequency of say-on-pay votes, which must occur at one-, two- or three-year intervals. Such say-on-frequency votes are non- binding on issuers, but each issuer must provide say-on-pay votes at least at three-year intervals.
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[4] For two papers offering insightful comments on proxy advisers, see “A Call for Change in the Proxy Advisory Industry Status Quo,” published by the Center on Executive Compensation (January 2011), available at Proxy Advisory White Paper_FULL COLOR_.pdf) and “Proxy Advisory Firms: The Debate Over Changing the Regulatory Framework—an Analysis of Comments Submitted to the SEC in Response to the Concept Release on the U.S. Proxy System,” published by The Altman Group (March 1, 2011) (the “Altman Report”), available at On July 14, 2010, the SEC issued its “Concept Release on the U.S. Proxy System,” available at (“Concept Release”). The Concept Release elicited many letters and comments in response to it. A list of letters and commentary submitted to the SEC (along with links to these documents) is available at
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[5] Links to the Schedule 14A filings that have been made as of the date this column was written in connection with annual meetings taking place in 2012 can be found in “2012 Say on Pay Results—Russell 3000,” published by Semler Brossy (March 14, 2012), available at
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[6] A summary of ISS’ methodology is included in “2012 U.S. Proxy Voting Summary Guidelines,” published by ISS (Jan. 31, 2012) (available at; see also “Evaluating Pay for Performance Alignment,” published by ISS (Feb. 17, 2012) (available at
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[7] It is estimated that ISS has approximately two months to study the proxy statements of the several thousand calendar year companies that it looks at in the spring of each proxy year and then to assemble and analyze the compensation information necessary to make its basic “quantitative” analyses. The analytics that can be applied by ISS are limited by this time frame. For example, analyzing the earned/vested value of long-term incentives (meaning stock options, stock awards and other forms of long-term awards) for a given year would take a much longer time than using the award date value. As noted in the text, many issuers have complained that the award date value is not the correct value to use.
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[8] The “quantitative” test as described in the text is only applicable to Russell 3000 index companies. In the case of non-Russell 3000 index companies, ISS looks for “misaligned pay and performance” but does not apply the “quantitative” test as such.
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[9] See Letter from FedEx Corporation, “Re: Concept Release on the U.S. Proxy System,” dated Oct. 20, 2010, available at
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[10] Section 202 of the Advisers Act defines an investment adviser, subject to certain exceptions not applicable here, as “any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.”
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[11] For examples of such viewpoints, see the Concept Release, supra at note 4, and also Lori A. Richards, “Fiduciary Duty: Return to First Principles,” Feb. 27, 2006, at A director in the SEC’s Office of Compliance and Inspections, Richards indicated in a disclaimer that the views expressed in the speech were her own and not necessarily those of the SEC itself.
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[12] For an example of this viewpoint, see Letter from Wachtell, Lipton, Rosen & Katz, “Re: Comments on Release No. 34-62495,” dated Oct. 19, 2010, at page 6. (“Unlike the issuer’s board of directors, the proxy advisory firms owe no fiduciary duty to the issuer’s shareholders or its other constituencies.”) Document available at
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[13] In October 2010, the Department of Labor issued a proposed regulation that would have expanded the definition of fiduciary to include, in certain cases, investment advisers within the meaning of the Advisers Act who are giving advice to pension funds and other parties intended to be protected by ERISA (Employee Retirement Income Security Act). See Proposed Rule (“Definition of the term ‘Fiduciary'”), 75 CFR 65263 (proposed on Oct. 22, 2010). In September 2011, this proposal was withdrawn by the Labor Department for the purpose of further consideration including review of comments that had been submitted in respect of the proposal. See Employee Benefits Security Administration News Release, Release No. 11-1382-NT, dated Sept. 19, 2011, available at The effort on the part of the Labor Department to apply the concept of fiduciary under ERISA to investment advisers could be a helpful precedent for the SEC to do the same.
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[14] See “The Influence of Proxy Advisory Firm Voting Recommendations on Say-on-Pay Votes and Executive Compensation Decisions,” published by The Conference Board (March 2012).
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One Comment

  1. Wayne Isaacks
    Posted Tuesday, April 17, 2012 at 10:38 am | Permalink

    As we stir the paint pot it homogenizes to a muddy brown, and transparency, the goal, is lost to immutable physics, you can’t see through mud, and shenannigans proliferate in the abcense, not so much of transparency, which would help (many shennaigans cant stand the light of day); but the principle culpret is a culture of corruption typified by: 1. taking the money and not doing the job, and 2. in any event, take the money and act normal.

    Those who have failed to take the money have generally done poorly, and those who do are rarely troubled, or come to no worse ends than rich men who die of heart disease or cancer anyway.

    I deplore the loss of integrity, and ethical principles from our culture.

    Soon we will again see the rise of totalitatian states to restore order and these will be as bad as the batches from 1900-1955.

2 Trackbacks

  1. […] Say on Pay: Who Is Watching the Watchmen? (The Harvard Law School Forum on Corporate Governance and Financial regulation, 11 de abril de 2012). […]

  2. […] rather investment advisors who shirk their fiduciary duties.   Executive compensation attorney, Joseph Bachelder III, recommends that the SEC clarify whether a proxy advisor is a fiduciary under current regulation, and if they are not, have the SEC adopt a definition to encompass proxy […]