The Regulation of Proxy Advisors

Recently, the Senate Committee on Banking, Housing and Urban Affairs held a hearing on various legislative proposals aimed at improving corporate governance, including the Corporate Governance Reform and Transparency Act, H.R. 4015, that would regulate the activities of proxy advisory firms like Institutional Shareholder Services (ISS) and Glass Lewis.

This hearing is the latest step in the legislative process, following the House of Representative voting 238-182 on December 20, 2017 to send H.R. 4015 to the Senate for consideration. It is not yet clear that the Senate will move the legislation from the Committee to the full Senate, or whether the Committee will make significant amendments requiring a second vote from the House to endorse those changes, or some compromise to harmonize those differences. Moreover, any movement on H.R. 4015 in the near term seems unlikely, given the Senate’s focus on confirming President Trump’s nominee for the Supreme Court and on the mid-term elections.

According to a fact sheet published by Rep. Sean Duffy (R-Wis.), the House Bill’s sponsor, “H.R. 4015 would require Proxy Advisory Firms to register with the SEC and disclose among other things, the procedures and methodologies to develop proxy voting recommendations and any conflicts of interests.” The fact sheet also mentions that “In doing so it would grant companies sufficient time to respond to voting recommendations and require that firms demonstrate their capabilities to provide fair and accurate recommendations.”

The fact sheet notes that proxy firms would need to meet several requirements to qualify for SEC registration that would include:

• Sufficient staffing to provide voting recommendations based on current and accurate information
• Establishment of procedures to permit companies an opportunity to provide meaningful comment on firm recommendations
• Policies and procedures to manage conflicts of interest
• Publicly available procedures and methodologies used in developing proxy recommendations and analyses
• Proxy advisory firms annually reporting to the SEC on the firm’s recommendations, including the number of companies that are also consulting division clients

The legislation also would direct the SEC to withdraw two “no-action” letters issued by the SEC, which the fact sheet suggests “have led to overreliance on proxy advisory firm recommendations.”

The legislation appears to be widely supported by the business community, with the U.S. Chamber of Commerce and Business Roundtable sending letters of support to senators that recommend the bill moves forward in its current form. During the hearing, proponents of the legislation testified that lack of SEC oversight over these proxy advisory firms has allowed them to become too powerful. They took issue with the companies being hard-pressed to hire the consulting arm of a proxy advisory firm to assist with understanding the potential for a negative vote recommendation, stating their belief this is a clear conflict of interest. The testimony did not reflect how the proposed legislation itself would resolve these perceived conflicts through additional disclosures, although it appears that the proponents would be happy if proxy advisory firms simply curtailed their consulting business.

Opponents to the bill include the Council of Institutional Investors, the Consumer Federation of America, and many public sector pension fund managers. They argue that the legislation could impose additional costs for institutional investors passed on to them from proxy advisors required to beef up their internal compliance functions. They also noted that current law already provides recourse because proxy advisors can be sued by institutional investors for any errors leading to an unjustified voting recommendation. In addition, the opponents argued that the legislation would give companies too much control over the process by permitting them to delay vote recommendations, particularly as those may relate to executive pay-related issues.