Boards Should Minimize the Role of Proxy Advisors

James Woolery is Deputy Chairman of Cadwalader, Wickersham & Taft LLP, Co-Chair of its Corporate Department and head of its Business Development Group. The following post is based on a Cadwalader publication by Louis J. Bevilacqua, Co-Chair of the firm’s Corporate Department and the head of its Mergers & Acquisitions and Securities Group.

The boards of public companies are increasingly being assessed by a hoard of short-term focused “activist” investors and an increasingly third-party-advised stockholder base that relies heavily on proxy advisory firms to make important voting decisions for them. It is estimated that over 75 percent of all shares of public companies are held in a managed fund or institutional account.

Institutional Shareholder Services (ISS) and Glass Lewis control 97 percent of the market for proxy advice; and the two dominant proxy advisors reportedly affect 38 percent of votes cast at U.S. public company shareholder meetings. Their dominance in the proxy marketplace not only affects numerous votes but, more importantly, how companies manage and deal with their shareholders. Both firms wield enormous influence without having “skin in the game.” Perhaps even more concerning, given the influence they have on public companies, the proxy advisors (i) are understaffed and therefore establish generic voting recommendations and (ii) profit from engaging in activities involving material conflicts of interest, including marketing their advisory services to many of the same companies for which they provide proxy recommendations. In addition, Glass Lewis is owned by an activist fund with an agenda.

Unhealthy Influence

“Proxy advisory firms are unregulated; more significantly, they operate without any applicable standards—either externally imposed or self-imposed—and do not formally subscribe to well-defined ethical precepts, while cavalierly rejecting private sector requests for transparency in the formulation of their proxy advice, as well as increased accountability for the recommendations that they make,” said Harvey Pitt, former chairman of the Securities and Exchange Commission (SEC), in representing the U.S. Chamber of Commerce before a June 5 meeting of the House Subcommittee on Capital Markets and Government Sponsored Enterprises. “This lack of any operable framework for such a powerful presence on economic growth and corporate governance is unprecedented in our society.”

“No one should be able to outsource their fiduciary duties.”
— SEC Commissioner Daniel Gallagher, encouraging policymakers to focus on the influence of ISS and Glass Lewis

Subcommittee Chairman Rep. Scott Garrett said that “proxy advisory firms have increasingly teamed up with unions and others to push proposals that are generally immaterial to investors and often reduce shareholder value.” Mr. Garrett added that “proxy advisory firms have increased the costs of doing business for many public companies and disincentivized private companies from going public, all without a corresponding benefit to investor returns.”

While touting a commitment to transparency with respect to the procedures they use in formulating voting recommendations, the proxy advisors disregard a number of key factors. First, with respect to a number of important votes required by all public companies, the proxy advisors have established a “one size fits all” principle. Little consideration is given to either the specific facts relating to the company that is soliciting the vote, or to the investment principles of the fund or institution that is relying on the recommendation. A second significant issue relates to the solicitation of market information in formulating a recommendation. Numerous problems have been documented in the proxy advisors’ data collection methods, the size and composition of the participant peer pool, and potential bias errors in market surveys relied on by the proxy advisors.

Nonetheless, a National Association of Corporate Directors publication has stated that “over the past few years we have seen an increased reliance on the vote recommendation services being provided on an unregulated basis by proxy advisory firms. Institutional shareholders are often purporting to fulfill their fiduciary voting obligations, in part, by relying on the recommendations provided by these firms.”

Concern over the power of the proxy advisors has grown over the past several years and is currently the focus of a number of business organization initiatives, as well as a Congressional hearing that is considering requiring the registration of proxy advisors and the regulation of their activities. The U.S. Chamber of Commerce has dedicated significant resources to combating abuses by proxy advisory firms.

The run to safety from litigation created the unintended consequence of blind reliance on ISS and Glass Lewis.

How Proxy Advisors Came To Be

In 2003, the SEC required investment advisers who exercise voting authority over client proxies to adopt various policies and procedures designed to ensure their proxy votes coincide with the best interests of their clients. Advisors began to worry about their legal liability to fulfill a fiduciary obligation to vote. And as the issue of potential liability was considered, the conclusion was that it was safer and more cost-efficient to rely on a “professional” advisor. The ensuing run to safety from potential litigation created the unintended consequence of blind reliance on ISS and Glass Lewis, with the thought that no one can be negligent for following “professional” advice.

SEC Commissioner Daniel Gallagher recently criticized the ability of fund managers to blindly follow and hide behind the influence of ISS and Glass Lewis, saying “no one should be able to outsource their fiduciary duties.”

Market Dominance Notwithstanding, Proxy Advisors Are Not Invincible

Recently, a number of larger funds, including Blackrock and Vanguard, have been breaking away from strict reliance on ISS and Glass Lewis and have started to conduct their own independent analysis to determine how to best vote their proxies. The Wall Street Journal reported on May 22 (“For Proxy Advisors, Influence Wanes”) that, “big firms that sell recommendations on how to vote in corporate elections are losing some of their relevance, as companies more aggressively court key investors ahead of big votes and those investors handle more of the voting analysis themselves.” Moreover, a May 18 New York Times article echoes the notion that giant asset managers are increasingly flexing their corporate governance muscles by studying the relevant issues themselves, with due consideration to the economic interests of the shareholders they represent.

Shareholders’ rejection of a recent proposal aimed at splitting the dual roles of J.P. Morgan Chase & Co. Chairman and CEO Jamie Dimon is a testament to both the investment advisors appropriately making their own decisions and to the power of boards to combat the often cavalier recommendations of the proxy advisors. ISS and Glass Lewis firmly backed the splitting of the Chairman and CEO roles; however, only 32 percent of the shares voted agreed with the recommendation of the proxy advisors.

Directors should lend support to organizations advocating for legislative solutions to bad practices in the proxy advisory industry. Some of these organizations include:

  • Business Roundtable
  • The Conference Board
  • National Association of Corporate Directors
  • U.S. Chamber of Commerce

Our view

Clearly, it’s time to let shareholders know that the proxy advisors are not necessarily motivated to provide value to your company. There is simply too much evidence to the contrary. Boards should not be afraid to challenge proxy advisors, especially when their conclusions do not increase long-term shareholder value, or are not supported by the facts. There are several paths to consider to ensure that recommendations made by the advisor are balanced and fairly reflect the interest of your shareholders.

First, consider supporting the effort to require registration and regulation of proxy advisors. Communication, either directly or through well-positioned liaisons, is crucial, as the Subcommittee on Capital Markets and Government Sponsored Enterprises in the House Committee on Financial Services is still actively considering the case for oversight of advisors. Although there has been significant testimony relating to general problems with ISS and Glass Lewis, specific examples of bad practices should be brought to the Subcommittee’s attention. The SEC should also be made aware of specific bad practices by proxy advisors.

Second, influential business organizations, such as the U.S. Chamber of Commerce and Business Roundtable, are focused on the negative impact of proxy advisors and their lack of accountability. You can lend your support to their efforts by establishing a relationship with the appropriate committees that are advocating for legislative solutions to bad practices in the proxy advisory industry.

Third, and perhaps most important, be skeptical of the advisory firms’ work product. Discuss the procedures and results with ISS and Glass Lewis. Make sure they understand the relevant facts that are applicable to your company. If the proxy advisors don’t reflect the facts in their work product, challenge them and communicate directly to your shareholders. Make sure your shareholders understand your position and, if appropriate, your specific reasons for disagreeing with the proxy advisors. ISS and Glass Lewis cannot be allowed the final word to your shareholders. This type of shareholder campaign should start early (before there is a debate with the proxy advisors) to be effective, and must involve the most senior members of company management and the board. Most importantly, company leaders can mitigate the influence of proxy advisory firms by proactively communicating with shareholders on an ongoing basis.

As proxy advisory firms, in the opinion of some, become the sentinels of executive pay and the champions of special interest groups, their actions are bound to come under increased scrutiny. A corresponding increase in transparency and accountability is likely the most prudent response.

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One Comment

  1. James McRitchie
    Posted Thursday, October 31, 2013 at 11:26 am | Permalink

    The real problem for many on the business side is that ISS is advising how to vote ‘say-on-pay.’ CEOs and many directors don’t like it. Many directors in Silicon Valley are so mad at ISS they refuse to serve on the boards of any company that doesn’t have a controlling owner, like Mark Zuckerberg’s control over Facebook. Their rationale is that ISS doesn’t know how to properly assess pay and has no business telling boards how much CEOs should be paid. (see on, SVNACD: Red Flags of an Ethical Collapse & Alternative Proxy Voting Advice to Stem Dual Class IPOs)

    Granted, ISS must have a difficult time assessing pay and all the other proxy issues. Is that because they are evil? No, it is because their subscription business model doesn’t raise enough money so that they can devote the time necessary at each company to come up with better answers. Doing away with proxy advisors or cutting back on their resources will only make corporate governance worse. As per Gilson and Gordon, most large private funds don’t have an incentive to pay for better governance, so they won’t fill the gap.

    The big problem is the free rider issue that Latham and I are trying to address by proposing a proxy competition at Cisco. Spend more, pay based on shareowner vote, make the advice available to all and increase competition. That’s how we could improve proxy advice. Of course, any system that constrains CEOs will still face major opposition. Cisco attacked our proxy proposal based on cost but they probably spent far more on attorney fees trying to win a no-action request at the SEC then they would be spending on the proposed proxy contest. Robert Monks, who along with Nell Minow, was the original founder of ISS, provided one of the best explanations as to why attacks will continue. See his informative post, Attacking Proxy Advisors at

3 Trackbacks

  1. […] Conference Board, National Association of Corporate Directors, and U.S. Chamber of Commerce. See Boards Should Minimize the Role of Proxy Advisors, How ISS Dictates Equity Plan Design, and Stanford Academics Focus on Wrong Problems at ISS. For […]

  2. […] Conference Board, National Association of Corporate Directors, and U.S. Chamber of Commerce. See Boards Should Minimize the Role of Proxy Advisors, How ISS Dictates Equity Plan Design, and Stanford Academics Focus on Wrong Problems at ISS. Here […]

  3. […] reportedly affect 38 percent of votes cast at U.S. public company shareholder meetings.” (Boards Should Minimize the Role of Proxy Advisors by James Woolery, Cadwalader, Wickersham & Taft […]