The Regulation of Proxy Advisory Firms

Ken Bertsch is Executive Director of the Council of Institutional Investors. This post is based on a letter sent by the Council of Institutional Investors to the United States Senate Committee on Banking, Housing, and Urban Affairs, regarding the legislation of H.R. 5311, the Corporate Governance Reform and Transparency Act of 2016.

September 6, 2016

The Honorable Richard C. Shelby
Chairman
Committee on Banking, Housing, and Urban Affairs
United States Senate
Washington, DC 20510

The Honorable Sherrod Brown
Ranking Member
Committee on Banking, Housing, and Urban Affairs
United States Senate
Washington, DC 20510

Re:       Proposed Legislation Relating to Proxy Advisory Firms

Dear Mr. Chairman and Ranking Member Brown:

I am writing on behalf of the Council of Institutional Investors (CII), a nonpartisan, nonprofit association of employee benefit plans, foundations and endowments with combined assets under management exceeding $3 trillion. Our member funds include major long-term shareowners with a duty to protect the retirement savings of millions of workers and their families. Our associate members include a range of asset managers with more than $20 trillion in assets under management. [1]

This letter has been co-signed by 30 CII members and other organizations.

We are writing to share our concerns about proposed legislation currently under consideration in the U.S. House of Representatives regarding proxy advisory firms. H.R. 5311, the Corporate Governance Reform and Transparency Act of 2016, [2] aims to tighten regulation of proxy advisory firms to the detriment of pension funds and other institutional investors.

The proposed legislation appears to be based on the false premise that proxy advisory firms dictate proxy voting results. Many pension funds and other institutional investors contract with proxy advisory firms to obtain and review their research. But most large holders vote according to their own guidelines.

The independence that shareowners exercise when voting their proxies is evident in the statistics related to “say on pay” proposals and director elections. Although Institutional Shareholder Services Inc. (ISS), the largest proxy advisory firm, recommended against these proposals at 12 percent of Russell 3000 companies in 2016, only 1.7 percent of those proposals received less than majority support from shareowners. [3] Similarly, although ISS opposed the election of 6.5 percent of director-nominees during the most recent proxy season, just 0.2 percent failed to obtain majority support. [4] We are unaware of any compelling empirical evidence indicating that pension funds and other institutional investors are outsourcing their voting responsibilities to proxy advisory firms.

We believe the proposed legislation would weaken corporate governance in the United States; undercut proxy advisory firms’ ability to uphold their fiduciary obligation to their investor clients; and reorient any surviving firms to serve companies rather than investors. The U.S. system of corporate governance relies on the accountability of boards of directors to shareowners, and proxy voting is a critical means by which shareowners hold boards to account.

Proxy advisory firms, while imperfect, play an important and useful role in enabling effective and cost-efficient independent research, analysis and informed proxy voting advice. In our view, the proposed legislation would undermine proxy advisory firms’ ability to provide a valuable service to pension funds and other institutional investors.

We are particularly concerned that, if enacted, H.R. 5311 would:

  • Require that proxy advisory firms (1) provide companies advance copies of their recommendations and most elements of the research informing their reports, (2) give companies an opportunity to review and lobby the firms to change their recommendations, and (3) establish a heavy-handed “ombudsman” construct to address issues that companies raise.
  • This right of pre-review would give companies substantial influence over proxy advisory firms’ reports, potentially undermining the objectivity of the firms’ recommendations. On a practical level, this right of review would delay pension funds and other institutional investor’s receipt of the reports and recommendations for which they have paid.
  • The requirement that the proxy advisory firms resolve company complaints prior to the voting on the matter would create an incentive for companies subject to criticism to delay publication of reports as long as possible. Pension funds and other institutional investors would have less time to analyze the reports and recommendations in the context of their own customized proxy voting guidelines to arrive at informed voting decisions. Time already is tight, particularly in the highly concentrated spring “proxy season,” due to the limited period between company publication of the annual meeting proxy statement and annual meeting dates.
  • Moreover, the proposed legislation does not appear to contemplate a parallel requirement that dissidents in a proxy fight, or proponents of shareowner proposals, also receive the recommendations and research in advance. This would violate an underlying tenet of U.S. corporate governance that where matters are contested in corporate elections, management and dissident shareowners should operate on an even playing field.
  • Require the Securities and Exchange Commission (SEC) to assess the adequacy of proxy advisory firms’ “financial and managerial resources.”
  • The entities that are in the best position to make these types of assessments are the pension funds and other institutional investors that choose to purchase and use the proxy advisory firms’ reports and recommendations. In 2014, the SEC staff issued guidance reaffirming that investment advisors have a duty to maintain sufficient oversight of proxy advisory firms and other third-party voting agents. [5] We publicly supported that guidance. [6] We are unaware of any compelling empirical evidence indicating that the guidance is not being followed or that the burdensome federal regulatory scheme contemplated by the proposed legislation is needed.
  • Create costs for institutional investors with no clear benefits.
  • The proposed legislation would appear to result in higher costs for pension plans and other institutional investors—potentially much higher costs if investors seek to maintain current levels of scrutiny and due diligence around proxy voting. Moreover, the proposed legislation is highly likely to limit competition, by reducing the current number of proxy advisory firms in the U.S. market and imposing serious barriers to entry for potential new firms. This would also drive up costs to investors. Given these economic impacts, we are troubled that there appears to be no cost estimate on the provisions of this proposed legislation. [7]

Thank you for considering these views. We would be very happy to discuss our perspective in more detail. I am available at , or by telephone at (202) 822-0800. You may also contact our General Counsel Jeff Mahoney at , or by telephone at the same number.

Sincerely,

Kenneth A. Bertsch
Executive Director
Council of Institutional Investors

Louise Davidson
Chief Executive Officer
Australian Council of Superannuation Investors

Manuel Isaza
Associate Director, Governance & Sustainable Investment
BMO Global Asset Management

Anne Sheehan
Director of Corporate Governance
California State Teachers’ Retirement System

Julie Cays
Chair of the Board
The Canadian Coalition for Good Governance

Gregory W. Smith
Executive Director/CEO
Colorado Public Employees’ Retirement Association

Denise L. Nappier
Connecticut State Treasurer
Trustee
Connecticut Retirement Plans and Trust Funds

Dieter Waizenegger
Executive Director
CtW Investment Group

Michael McCauley
Senior Officer, Investment Programs & Governance
Florida State Board of Administration

Darren Brady
Hermes Equity Ownership Services Limited

Tim Goodman
Hermes Equity Ownership Services Limited

Stephen Adams
Head of Equities
Kames Capital

Andrew Shapiro
Managing Member & President
Lawndale Capital Management, LLC

Clare Payn
Head of Corporate Governance North America
Legal & General Investment Management

Freddie Woolfe
Responsible Investment Analyst
Newton Investment Management

Scott Stringer
New York City Comptroller

Gianna McCarthy
Director, Corporate Governance
Office of the New York State Comptroller

Carol Nolan Drake, J.D.
Chief External Affairs Officer
Ohio PERS

Karen Carraher
Executive Director Ohio PERS

Judy Cotte, LL.M.
V.P. & Head, Corporate Governance & Responsible Investment
RBC Global Asset Management

Deborah Gilshan
Head of Sustainable Ownership
RPMI Railpen

Lisa J. Morris
Executive Director
School Employees Retirement System of Ohio

Kenneth J. Nakatsu
Executive Director
Seattle City Employees’ Retirement System

Euan A. Stirling
Head of Stewardship and ESG Investment
Standard Life Investments

Ted Wheeler
Treasurer
State of Oregon

Bess Joffe
Managing Director
Head of Stewardship & Corporate Governance
TIAA

Meredith Miller
Chief Corporate Governance Officer
UAW Retiree Medical Benefits Trust

Councillor Keiran Quinn
Chair
UK Local Authority Pension Fund Forum

Janice J. Fueser
Research Coordinator, Corporate Governance
UNITE HERE

Lisa N. Woll
CEO
US SIF and US SIF Foundation

Daniel Summerfield
Co-Head of Responsible Investment
USS Investment Management

Timothy Smith
Director of Environmental Social and Governance Shareholder Engagement
Walden Asset Management

Theresa Whitmarsh
Executive Director
Washington State Investment Board

CC:

The Honorable Michael D. Crapo
Chairman, Subcommittee on Securities, Insurance, and Investment, Committee on Banking, Housing, and Urban Affairs

The Honorable Mark Warner
Ranking Member, Subcommittee on Securities, Insurance and Investment, Committee on Banking, Housing, and Urban Affairs

The Honorable Bob Corker
Committee on Banking, Housing, and Urban Affairs

The Honorable David Vitter
Committee on Banking, Housing, and Urban Affairs

The Honorable Patrick J. Toomey
Committee on Banking, Housing, and Urban Affairs

The Honorable Mark S. Kirk
Committee on Banking, Housing, and Urban Affairs

The Honorable Dean Heller
Committee on Banking, Housing, and Urban Affairs

The Honorable Tim Scott
Committee on Banking, Housing, and Urban Affairs

The Honorable Ben Sasse
Committee on Banking, Housing, and Urban Affairs

The Honorable Tom Cotton
Committee on Banking, Housing, and Urban Affairs

The Honorable Michael Rounds
Committee on Banking, Housing, and Urban Affairs

The Honorable Jerry Moran
Committee on Banking, Housing, and Urban Affairs

The Honorable Jack Reed
Committee on Banking, Housing, and Urban Affairs

The Honorable Charles E. Schumer
Committee on Banking, Housing, and Urban Affairs

The Honorable Robert Menendez
Committee on Banking, Housing, and Urban Affairs

The Honorable John Tester
Committee on Banking, Housing, and Urban Affairs

The Honorable Jeff Merkley
Committee on Banking, Housing, and Urban Affairs

The Honorable Elizabeth Warren
Committee on Banking, Housing, and Urban Affairs

The Honorable Heidi Heitkamp
Committee on Banking, Housing, and Urban Affairs

The Honorable Jeb Hensarling
Chairman, Committee on Financial Services
United States House of Representatives

The Honorable Maxine Waters
Ranking Member, Committee on Financial Services
United States House of Representatives

The Honorable Shawn P. Duffy
Committee on Financial Services
United States House of Representatives

The Honorable John C. Carney
Committee on Financial Services
United States House of Representatives

Endnotes:

[1] For more information about the Council of Institutional Investors (Council or CII) and our members, please visit the Council’s website at http://www.cii.org/about_us. We note that the two largest U.S. proxy advisory firms, Glass Lewis & Co. and Institutional Shareholder Services Inc. (ISS), are non-voting associate members of CII, paying an aggregate of $24,000 in annual dues—less than 1.0 percent of CII’s membership revenues. In addition, CII is a client of ISS, paying approximately $19,600 annually to ISS for its proxy research.
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[2] On June 16, 2016, the Committee on Financial Services of the United States House of Representatives approved H.R. 5311, as amended, by a vote of 41 to 18. All Actions, Congress.Gov, available at https://www.congress.gov/bill/114th-congress/house-bill/5311/all-actions?q=%7B%22search%22%3A%5B%22H.R.+5311%22%5D%7D&resultIndex=1&overview=closed#tabs. On June 23, 2016, Committee on Financial Services Chairman Jeb Hensarling issued a Discussion Draft of a bill that included the provisions of H.R. 5311. Financial CHOICE Act of 2016, §§ 1081-83, available at http://financialservices.house.gov/uploadedfiles/choice_act-_discussion_draft.pdf.
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[3] Semler Brossy, 2016 Say on Pay Results 2-3 (July 27, 2016), available at http://www.semlerbrossy.com/wp-content/uploads/SBCG-2016-SOP-Report-07-27-2016.pdf.
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[4] ISS Voting Analytics Database (last viewed on Aug. 4, 2016 & on file with CII).
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[5] Staff Legal Bulletin No. 20 at 3 (June 13, 2014) (“it is the staff’s position that an investment adviser that receives voting recommendations from a proxy advisory firm should ascertain that the proxy advisory firm has the capacity and competency to adequately analyze proxy issues, which includes the ability to make voting recommendations based on materially accurate information”), available at https://www.sec.gov/interps/legal/cfslb20.htm.
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[6] Letter from Jeff Mahoney, General Counsel, CII, to The Honorable Scott Garrett, Chairman, Subcommittee on Capital Markets and Government Sponsored Enterprises, Committee on Financial Services et al. 4 (July 23, 2014), available at https://www.sec.gov/interps/legal/cfslb20.htm.
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[7] It does not appear that the Congressional Budget Office has produced a cost estimate for H.R. 5311. CBO Cost Estimates Search (last viewed Sept. 6, 2016), available at https://www.cbo.gov/cost-estimates/search?search_api_views_fulltext=H.R.+5311&field_congressionalsession=1621.
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