The Society for Corporate Governance (the “Society”) appreciates the opportunity to provide comments to the U.S. Securities and Exchange Commission (“SEC” or “Commission”) on the Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice (the “Proposed Rule”).
Founded in 1946, the Society is a professional membership association of more than 3,700 corporate and assistant secretaries, in-house counsel, outside counsel and other governance professionals who serve approximately 1,700 entities, including 1,000 public companies of almost every size and industry. Society members are responsible for supporting the work of corporate boards of directors and the executive managements of their companies on corporate governance and disclosure matters.
I. Introduction: Background and Context
The practices and influence of proxy advisors has been a long-standing focus area of the Society. We believe the firms influence as much as % or more of the vote at most registrants, yet their recommendations are not subject to a regulatory framework that provides for independent oversight or other protections to help ensure their accuracy. Proxy advisor reports and voting recommendations are not generally made available to the public to read (except to the institutions that purchase them). In fact, proxy advisors are the only participants in the proxy voting system who are not regulated in some way. Issuers, asset managers, proxy processors, shareholders, and anyone soliciting a proxy, are regulated. While one of the proxy advisory firms is a registered investment advisor, the business of vote recommendations has had no unique or relevant regulatory scheme.
Until now.
We applaud the SEC’s Proposed Rule, which we believe will help improve the proxy process by: 1) ensuring that proxy voting is done with the benefit of recommendations based on information generally available in publicly filed documents; 2) ensuring that all companies—not just the S&P 500—have advance access to the reports so that they can review and advise of mistakes of fact so the reports can be corrected before their shareholders vote; 3) providing all registrants the ability to include in the report a link to a publicly filed statement explaining a mistake of fact or analysis in the hopes that investors will see it in a timely manner contemporaneous with a proxy advisor’s recommendation or report; 4) requiring the proxy advisors to disclose their conflicts in a meaningful way; and 5) clarifying that the SEC and the listing exchanges are the corporate governance standard setters, and not the proxy advisors.
The Society would like to note that proxy advisors are important, indeed indispensable, to asset managers and other institutional investors who use them. We appreciate a recent comment by an investor who said that taking away the proxy advisor voting platform would be like taking away a Bloomberg terminal from a trader. We recognize their importance, particularly for the actual voting mechanics, and we understand the responsibilities of and burdens on investors, many of whom vote at hundreds or thousands of meetings in a single proxy season.
Given our members’ various roles as governance professionals, we care deeply about having an effective and efficient proxy voting system. As general counsels, corporate secretaries and other governance professionals, our members are charged with managing their company’s annual meeting and the associated shareholder voting process. We believe there is general consensus between issuers and shareholders that votes should be cast based on accurate information, free from conflict, and with transparency. While we believe many investors vote their shares in a thoughtful manner, the Proposed Rule will enhance access to and the transparency of relevant information for all investors.
We also understand some investors have raised concerns that if proxy advisors are regulated, their business models will be strained, which may result in fewer firms providing proxy advisor services. As further detailed below, the Society believes that the impact and benefits of the SEC’s Proposed Rule to improve the proxy voting process will outweigh the associated costs.
The current proxy advisory firm market is essentially a duopoly consisting of Institutional Shareholder Services Inc. (“ISS”), owned by the private equity firm Genstar Capital, and Glass Lewis & Co. (“Glass Lewis”), a portfolio company of the Ontario Teachers’ Pension Plan Board and Alberta Investment Management Corp. The proxy advisors have clients, which are primarily institutional investors who vote the shares of the companies they hold for their beneficial owners. The clients/institutional investors pay for the research and advice that the proxy advisors offer. This is their business.
However, one proxy advisor, ISS, has another business line. ISS pitches and sells vote consulting, compensation consulting, proxy drafting advice, and governance and ESG scoring consulting to issuers. The terms and prices charged for these consulting services vary and are not public. In fact, public companies that engage ISS consulting services are contractually prohibited from disclosing the consulting relationship publicly or to an ISS proxy voting representative. One reason provided by ISS for this restriction is to avoid a proxy voting employee possibly providing preferential treatment of some sort with respect to voting recommendations for consulting customers. To date, there has been no published data by ISS or others that we are aware of to
quantify the amount of revenue earned by ISS that is attributable to its consulting business. As we explain below, the Society estimates that ISS’ consulting business represents approximately $48 million annually in revenue—an amount, we believe, that is material to ISS’ overall financial performance and, therefore, warrants disclosure to investors of a conflict of interest.
Because proxy advisor vote analysis and recommendations are not available publicly— issuers and proxy solicitors who do receive them are not permitted to disclose them—mistakes in such reports and potential conflicts of interest with respect to consulting services are shielded from public view. This dynamic is why there are few comment letters from issuers in the file. Many registrants are unwilling to provide specific information on errors in reports or other issues they have with proxy advisors, including at SEC Roundtables and in comment letters. Registrants are also concerned that investors who are clients of the proxy advisory firms may have an adverse reaction if a company were to write a comment letter supporting the Proposed Rule. These factors make it difficult to conduct market and academic analysis of the direct and indirect impact of proxy advisors on the capital markets, the market for corporate control and the economy overall.
II. Proxy Advisory Firm Influence Merits Regulation to Ensure Transparency and Accuracy
A. Proxy advisory firms have a significant influence on voting results
Voting recommendations made by ISS and Glass Lewis have a significant impact each year on the composition of a public company’s board, its executive compensation policies, and an increasingly expansive range of shareholder proposals. Equally important, these recommendations can have profound ramifications on pivotal issues, transformative corporate events, and challenges throughout a company’s lifetime. This influence directly and significantly affects matters being voted on at annual meetings.
For example, in 2019, ISS recommended “for” (and contrary to the management recommendation) a compensation-related shareholder proposal on a Society member’s proxy statement. After the surge of initial voting, the proposal received 53.03% support of shares voted. Following this company’s filing of supplemental proxy materials, ISS changed its recommendation to “against,” which we presume was communicated through the automated voting platform to investors. Within 24 hours, support for the proposal went from 53.03% to 23.95%, thus clearly demonstrating the effectively real-time and outsized influence of the proxy advisor. The influence of the proxy advisor in this example clearly transcends the impact that even the company’s largest shareholder could have had.
This degree of influence is more prevalent with certain types of shareholders, such as quantitative fund managers, or those who simply own one stock as a hedge against another position. Unlike many large active and passive asset managers, certain investors, in particular those who believe they are compelled to vote on every proposal due to prior SEC guidance, lack an incentive
under their investment models to devote resources or expertise to in-house proxy teams to analyze and vote numerous ballot items for shareholder meetings. In contrast, large asset managers generally tend to have extensive in-house proxy teams that engage with issuers on corporate governance matters, analyze their company policies and proxy statements, and generate vote recommendations based on the respective manager’s mandate. In addition, large asset managers have extensive research tools and resources, and proxy advisory firms are simply one of multiple data sources. These teams conduct a deeper analysis on companies that deviate from their own internal policies.
Despite many investors’ commitment and practice of informed voting, an institutional investor’s approach may depend on what percentage of their portfolio is invested in the company. A 2018 study by the American Council for Capital Formation found that the largest institutional investors are less likely to deviate from proxy advisory recommendations when casting votes at small companies. With the largest institutional investors owning a majority of the shares at most small companies, the study found that small companies are significantly more affected by proxy advisor recommendations. Stated differently, large institutional investors may be relying more on proxy advisor recommendations for small companies, where their investment likely represents a small fraction of the investment portfolio.
Because smaller registrants not included in the S&P 500 index cannot view their ISS reports in advance of dissemination, and no registrants can view their Glass Lewis reports in advance, any mistakes included in a report may not be corrected before some or even the majority of investors vote. If mistakes are found after the proxy advisor report is released, it is possible (but not at all certain) to have such errors corrected and the report re-issued, but all investors may not review these updates and change their vote, if warranted.
The Proposed Rule will correct this and require that all registrants regardless of size be given the opportunity to see their reports in advance if they comply with the updated rule. This is one of the most important inequities that exist in the proxy voting process. We commend the SEC for proposing a rule that will remedy it.
B. Mistakes and errors happen
We expect some commenters who do not support the Proposed Rule to deny that mistakes are made, or argue that if they are, they are not prevalent. The Society recently conducted a survey of its members to solicit feedback on errors in reports. The survey asked first whether they were aware of any factual errors, omissions of material facts, or errors in analysis in the last three years.
A total of 134 members responded to the question, with 56, or 42%, answering in the affirmative. Here are many of the written examples they provided:
- Errors in the director information are routine, e.g. incorrect current employment, number of outside boards, independence status, committee memberships/chairs, and omitting to state that a director was retiring
- Incorrect statement that company would have no lead independent director when the current lead retired even though the company stated in its proxy that it would appoint one at the board meeting immediately following the annual meeting
- Incorrect number of record date shares outstanding based on third party data instead of using correct number of shares found in proxy statement
- Incorrect, non-GAAP financial information included in the report because the proxy advisory firm uses financial data from a third party that adjusts the data to “normalize” it
- Incorrect statement that benchmarking targets for various components of company’s compensation program were not disclosed when proxy stated that company does not use benchmarking targets
- Errors in the description of our equity compensation due to aggregating different types of equity with different terms into one category
- Repeated errors year after year on the terms of the company’s performance based restricted stock
- In proposals related to political activity and/or lobbying reporting, ISS understates what the company publicly discloses
- Error in reporting that CEO’s pay increased year over year when it had actually decreased: ISS failed to update the report from the prior year’s language. (This was corrected when pointed out in advance review)
- Error in the required number of anti-takeover votes
- Inconsistent application year over year of ISS’s own method on how to compute the value of CEO performance equity awards. As a non-S&P 500 company which did not receive a draft report, it took until a few days prior to the meeting for ISS to correct the error and change its say-on-pay recommendation from AGAINST to FOR
- Omitted facts that had been reported on Form 8-K or Form 4; reliance on media articles rather than issuer filings
- Error in understanding why performance target was lower than in previous year
- Error concerning an outside directorship of one director
- Error in reporting that a CEO served only for a partial year rather than a full year
- Inaccurate director related party transactions
- Say on pay recommendation based on a failure to account for a one-time item, incorrectly reporting that EBITDA target was set below forecast; misunderstanding of revised ROIC methodology. ISS issued a revised report and changed the recommendation from AGAINST to FOR
- Incorrect fact about director attendance leading to a change in recommendation
- Incorrect statement of percent of vote required for shareholders to call special meeting
- Misstated classes of stock
- Misapplication by ISS of their own three year look back policy for director independence—they carried over facts from four years prior, but corrected the analysis after being contacted by the company
- Error in analysis relating to a shareholder proposal which was corrected when company pointed it out in the review period. We contacted the proxy advisory firm during our preliminary report review period, and the final report did not contain the error
- Errors in biographical data on directors
- Errors in number of boards our CEO serves on
- Misapplying a US analysis to a foreign corporation
- Misinterpretation of company’s restricted stock plan and the annual grants and the effect of accelerated vesting of restricted shares on a change in control
- Errors regarding compensation elements, business mix and reliance on stale information
- Incorrect assumption that a 3 year performance period is short term
- Misrepresentation of the votes required to amend bylaws/charter
- Incorrect statement that company had no anti hedging policy when it did and the policy was publicly available
- Incorrect share count
- CEO compensation was incorrect
- ISS missed a bullet in the list of a Lead Director’s responsibilities and thus recommended against management on an independent chair proposal. ISS subsequently issued a corrected voting recommendation
- Glass Lewis incorrectly described part of a feature of our compensation plan that did not apply and had to issue a revised report
- Incorrect information about shareholder rights to call special meetings
- Penalized and then credited in separate years by one proxy advisor for the same clawback policy (i.e., one year proxy advisor said it was deficient, and the same policy was deemed by the same proxy advisor to be acceptable in a subsequent year)
We believe a 41% error rate indicated by this group of companies over the last three years is significant. Several times one of these companies had received the draft report and was able to get a correction from the proxy advisor; however, companies not in the S&P 500 do not get that opportunity from ISS. The burden for registrants to correct an erroneous recommendation after the report is distributed to the institutional investors is much more challenging, as previously noted.
While emphasizing the significance of the error frequency described above, we would also urge the Commission not to fall prey to the false argument that it cannot act to regulate proxy advice without a showing of “prevalent” errors. The SEC’s regulations reflect many instances of regulating undesirable conduct not based on its prevalence, but upon a belief that it should be avoided altogether.
C. Automated voting (i.e., robo-voting) amplifies the influence of proxy advisors
Automated proxy voting systems allow clients to: (1) populate each ballot with recommendations based on preset voting instructions or policies; and (2) submit the client’s ballots for tallying without requiring the client to review the proxy advisor’s analysis or confirm their vote. This precludes consideration of other sources of information and company-specific details before the vote is cast. In some cases, investors purchase a recommendation only service in which they do not receive the proxy advisory firm report—but merely the recommendation. The proxy advisor then populates the ballots as it has previously been instructed to do so based on agreed policies, and then the proxy advisor casts the vote, unless the investor overrides it. This process may be convenient, but allows for voting with no human input.
The Society believes that many small and mid-size institutional investors and managers outsource their voting to proxy advisory firms that provide automated voting services to fulfill what they believe to be their proxy voting compliance obligations at the lowest cost. Moreover, a number of these firms adopt ISS and Glass Lewis “default” voting guidelines and policies, and then let the proxy advisory firms apply these policies by generating ballots that reflect these default positions for each shareholder meeting. While technically the clients have the right to override a specific voting recommendation, in practice most of these ballots are submitted automatically without any client input or decision. These small investors collectively can own a considerable equity stake in a company. This practice is often referred to as “robo-voting.”
We believe the impact of robo-voting and the associated influence of proxy advisor recommendations are evident by reviewing the votes cast shortly after the release of their recommendations. The U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness and Nasdaq conducted a survey of the 2019 proxy season in which 172 public companies participated. This 2019 survey found, as it did for 2018, “that a large percentage of shares were robo-voted in the 24-48 hours after an ISS or Glass Lewis recommendation was released.” Moreover, large percentages of shares voted in line with proxy advisory firm recommendations.
Specifically with respect to ISS, in 2019, several companies reported between 15% to 40% (compared to 10% to 15% in 2018) of their outstanding shares were voted in line with ISS’ recommendations within the 24 to 48-hour period following the issuance of its recommendations. The same 2019 survey also determined that 5% to 10% (compared to less than 10% in 2018) of the respondents’ shares automatically voted in agreement with a Glass Lewis recommendation within 24-48 hours of its issuance.
Consistent with these survey results, we have provided an example of one Society member’s experience which illustrates how shares voted within the 24 hours following the release of its proxy voting reports appear to follow in lockstep with the voting recommendations in those reports. The Society member tallied the votes cast and tracked the time of the vote executions following issuance of the ISS voting reports in 2018 and 2017. An estimated 13.1% and 9.3% of the total votes cast in 2018 and 2017, respectively, were cast in accordance with ISS’ recommendations within one business day after the release of the ISS report. By comparison, the percentage of votes cast on other business days just before the release of the ISS report typically was between 0.2% and 0.3%
Given the relatively low retail shareholder participation rate in proxy voting, it seems quite likely that a substantial portion of ISS-outsourced managed accounts would, in fact, be voted in accordance with ISS default policies (with little further input from the managed account owners).
of the total votes cast in the annual meeting. To put this in perspective, the number of shares voted following release of the ISS report were larger than the total shares owned by this company’s largest shareholder.
Results from the recent Society survey of public company members regarding the amount and timing of shares voted within 48 hours of the release of proxy voting recommendations buttress the Chamber’s statistical evidence and company-specific anecdotes:
- 25% of respondents reported that more than 20% of shares are voted within 48 hours of the release of proxy voting advice;
- 32% of respondents reported that between 10-20% of shares are voted within 48 hours;
- 19% of respondents reported that between 5-10% of shares are voted within 48 hours; and
- 8% of respondents reported that between 0-5% of shares are voted within 48 hours.
The precise volume and timing of shares that are voted automatically in line with proxy advisor advice is difficult to determine due to lack of transparency in voting results released by the proxy advisory firms themselves. Regardless, the existence of robo-voting and its material impact in the proxy voting process and results merits oversight and regulation to ensure fairness and accuracy.
In light of the impact of robo-voting, the Society suggests that the SEC consider requiring proxy advisory firms to “disable the automatic submission of votes” if the registrant has submitted a response and where the proxy advisor is recommending against the management position. By disabling the robo-voting feature in these limited circumstances, the SEC can ensure that the appropriate level of human consideration is applied in the situations where it is most needed.
III. Process for Review of Proxy Voting Advice
The Society applauds and supports the Commission’s efforts to encourage greater accuracy and completeness in the voting recommendations and related information included in proxy advisory reports. By mandating a review-feedback-review process, the Proposed Rule creates the due process essential to providing accurate and timely proxy voting advice to investors. In addition, the opportunity for registrants to provide a hyperlink to a company response on a particular issue(s) will provide investors a much-needed and convenient way to access the company perspective on erroneous statements. The due process provided by the Proposed Rule is critical to ensuring “that proxy voting advice be based on the most accurate information reasonably available.”
Percentages do not equal 100 due to rounding.
A. Review Timelines
The Society appreciates that the Commission is proposing that all proxy advisory firms will be required to give all registrants the opportunity for advance review of their proxy advisor reports if certain deadlines are met. The Society appreciates that the proposed amount of review time for an issuer is potentially longer than the time currently provided, which in some cases can be less than 24 hours or over a weekend or holiday. As cited by the Commission in footnote 114 of the Proposed Rule, according to Broadridge Financial Solutions, Inc., registrants customarily file definitive proxy material 35-40 days before a stockholder meeting. As such, we note that many registrants will be required to accelerate their proxy statement preparation schedules to benefit from the full five-business day report review period included in the Proposed Rule, and that there are likely to be a significant number of registrants who will be unable to do so, at least in the shorter term. The Society’s recent survey supports this conclusion.
The Society also commends the Commission on proposing to incorporate a mandated review by the registrant of the final version of the report before it is distributed to the proxy advisory firms’ clients and to provide a method for the issuer to provide further correction or comment. As the Society survey data indicates, registrants’ proposed factual corrections and suggestions often are not incorporated, without explanation from the proxy advisory firm.
Some have argued that the Proposed Rule’s review process somehow compromises the independence of the proxy voting advice and that such advice is akin to buy-side analyst reports, which are prohibited from being reviewed by the company to avoid compromising the integrity of such reports. This argument is surprising since ISS voluntarily provides reports to a limited number of issuers today. ISS provides its reports to S&P 500 companies in advance and takes comment on any factual errors in a 48-hour timeframe, although companies are sometimes given less response time. It is difficult to understand how, if ISS’ voluntary review and comment processes do not currently compromise the independence of their advice, the Proposed Rule’s review and comment period for all public companies would do so. The Society believes that the independence of proxy voting advice will not be affected by the Proposed Rule.
B. Hyperlink to issuer response
The Society commends the Commission on proposing to provide a method for the issuer to correct mistakes in proxy advisory firms’ final recommendations or reports via a company hyperlink contained in the proxy advisors’ final report. Because factual errors have frequently been found after the voting recommendation has been disseminated to the many institutional investors who subscribe to ISS’ and Glass Lewis’ services, the impact of additional proxy materials can be
limited. As a result, the Society is supportive of the Proposed Rule’s requirement that proxy advisors must include a hyperlink to a written, publicly-filed, statement prepared by the issuer.
IV. Proxy Advisory Firms Offer Services That Constitute Proxy Solicitations
A. The Society supports amending the definition of the term “solicitation”
The Society agrees with adding the Proposed Rule’s new paragraph (A) to Rule 14a-1(l)(1)(iii) to clarify that the terms “solicit” and “solicitation” include any proxy voting advice that makes a recommendation to a shareholder as to its vote, consent, or authorization on a specific matter for which shareholder approval is solicited, and that is furnished by a proxy advisor that markets their expertise as a provider of such advice, separately from other forms of investment advice, and sells such advice for a fee.
The Society supports the Commission’s interpretation of the term “solicitation.” The Society agrees that the analysis of what constitutes a solicitation should not turn on whether the proxy advisor is seeking authorization to act as a proxy or is uninterested in the vote results. Moreover, the analysis also should not incorporate whether the proxy advisory firm provides recommendations based on the client’s own proxy voting guidelines or whether the client declines to follow the proxy advisor’s advice. The Society believes the Proposed Rule reflects the correct approach and concurs with the Commission’s explanation supporting its proposed interpretation.
In addition, the Proposed Rule states that each voting recommendation contained within the general benchmarking policies or specialty policies (sometimes referred to as specialty reports) would be considered a separate solicitation under the amended rules. The Society agrees with this determination. General benchmark policies and specialty policies are compilations of voting recommendations on a wide range of topics that could potentially be included on a shareholder agenda. The specialty policies, such as socially responsible investing policies or Taft-Hartley labor policies, provide recommendations that take into consideration certain values, regulatory
requirements or investment objectives of a particular investor audience and their recommendations are often predetermined.
B. ESG Ratings Firms
ESG ratings firms provide ratings and analysis of companies on a wide range of environmental, social and governance issues to many institutional investors. The number and influence of ESG ratings firms has been growing. As the asset management industry increases the number of ESG-related products offered and continues to commit to consider ESG factors in their investment decisions, some ESG ratings are being incorporated into portfolio construction, with concomitant impacts on capital allocation. The Society believes the SEC should be alert to changes with respect to capital formation, conduct appropriate analysis, and to the extent required, act accordingly.
We believe the Commission should consider current practices by proxy advisors with respect to the incorporation of ESG-related information or analysis in proxy voting reports and add appropriate clarifications in the Proposed Rule. For instance, ISS includes ESG related analysis in its “Proxy Analysis & Benchmark Policy Voting Recommendations,” even in cases where there is no specific environmental or social item to be voted upon. Having said that, the increased attention of investors on environmental and social (E&S) issues could make them relevant to an investors’ assessment of director performance, despite not being called out specifically in any particular item. In the context of E&S information and analysis being included in a proxy advisor report, we believe the Proposed Rule should be clarified to apply to such ESG information and analysis.
Glass Lewis presents a somewhat different context. Glass Lewis incorporates Sustainalytics E&S analysis in its “Proxy Paper” report, yet it retains all authority to actually make any E&S-related recommendations contained in its proxy voting advice. In effect, Glass Lewis is incorporating third party analysis into its proxy voting report but not necessarily its proxy voting advice. Nonetheless, it appears to the Society that such third-party information constitutes a part of the “solicitation” which, therefore, ought to be regulated under the Proposed Rule.
Accordingly, the information disclosure requirements contemplated under the Proposed Rule should properly apply to any third-party information incorporated into proxy voting advice, including with respect to methodology, sources of information, conflict of interest, and use of standards that materially differ from relevant standards or requirements that the Commission sets or approves.
V. The Society Supports the Proposed Conflicts of Interest Disclosure
The Society strongly supports the Commission’s proposal to require enhanced conflict of interest disclosure. As noted by the Commission in the Proposed Rule, proxy advisory firms regularly engage in activities that present conflicts of interest that should be disclosed to investors. For example, as noted above, ISS’ consulting business sells to corporate customers advice on the design of corporate governance structures or compensation plans and then ISS subsequently makes a recommendation to investor clients on how to vote for related proposals.
The conflict presented by selling consulting services (very frequently compensation, governance and shareholder proposal-related consulting services or, more recently, consulting related to ESG scores) is compelling. According to a recent Society survey, 62% of the companies polled noted that they have purchased ISS consulting services within the last three years.
Moreover, 39% of companies polled noted that they had been solicited by ISS “following a negative voting recommendation.” One registrant described it as follows: “As many issuers have found, it took ISS little to no time to send their sales team in our direction after our low “say on pay” vote, asking us if we would be interested in purchasing their consulting services to learn how we might avoid getting a negative recommendation in the future. This often feels like a request to pay protection money as the “route to safety” is often not knowable without paying an additional fee.”
The Society is not alone in its concerns about proxy advisor conflicts; a prominent labor union has expressed the same view. In 2013 at the SEC Roundtable on proxy advisors, an AFL-CIO representative noted that the “business model of having consulting services provided to issuers and at the same time providing proxy advisory services to investors…I think that business model is inappropriate, just as I don’t think that type of model is appropriate for an auditor. And this is a longstanding view that the AFL-CIO has expressed for a long time.”
Requiring conflicts of interest disclosure is further justified because the standard ISS consulting contract forbids the issuer from disclosing the existence of a consulting relationship. Requiring disclosure of these consulting relationships will allow much needed “sunlight” into this proxy advisor business area.
The Society therefore supports the detailed disclosures in proposed Rule 14a-2(b)(9)(i) in order to provide investors with information to understand the full nature and scope of proxy advisory firms’ conflicts of interest. Furthermore, we support the types of disclosure specified by proposed Rule 14a-2(b)(9)(i)(A) through (D), as these cover both the types of conflicts of interest that are problematic, as well as any policies and procedures of proxy advisory firms that may address such conflicts. Moreover, we support the Commission’s proposal to make the proxy advisory firms’ exemptions from the information and filing requirements of the federal proxy rules contingent upon the disclosures required by proposed Rule 14a-2(b)(9)(i).
A. The requirement to disclose consulting arrangements should NOT be subject to a materiality standard
Society survey data and ISS disclosed consulting information strongly suggest that the revenue earned by ISS through its consulting business, which we estimate at more than $48 mil annually, is material to the firm’s overall financial performance. This creates at least a theoretical conflict of interest relative to each recommendation subject to an existing (or even potential) consulting relationship. While any individual consulting relationship may not be economically material to ISS, the practical import of the conflict created by the overall consulting revenue manifests itself on a company-by-company basis. As a result, the only practical way to equip investors to adjust for the existence of a conflict is to require company-by-company disclosure, regardless of the “materiality” of that amount to the proxy adviser’s overall income.
For this reason, we believe that requiring only “material” interests, transactions, or relationships that present conflicts of interest may unduly limit the disclosure that proxy advisory firms provide. Rather, the Society recommends that the proposed Rule 14a-2(b)(9)(i)(A) through (D) should be clarified to require disclosure of any interest, transaction or relationship with respect to the proxy advisory firm that may present a conflict of interest, and the dollar amount thereof.
B. The Proposed Rule should ensure conflict of interest disclosures are user-friendly
On a related note, we are concerned that the Proposed Rule does not provide sufficient guidance to proxy advisory firms on the manner in which the disclosure on conflicts of interests should be provided. For example, we support clear disclosure that will inform investors about these conflicts of interests both in plain English and sufficiently sized font.
We further support adding instructions to the Proposed Rule specifying that a proxy advisory firm also provide a clear initial statement in its proxy voting advice, both in bold and sufficiently sized font size, that the proxy advisor does have a consulting relationship with the company subject to the voting recommendation. The SEC imposes disclosure location and appearance requirements in other contexts and should do so here.
VI. Proposed Amendments to 14a-9
The Society supports the SEC proposal to amend the list of examples in Rule 14a-9 to include the “proxy voting business’s methodology, sources of information, conflicts of interest or use of standards that materially differ from relevant standards or requirements that the Commission sets or approves.” The Society believes that including such examples in Rule 14a-9 will provide needed further definition as to the information necessary to ensure that proxy voting advice is not misleading due to lack of essential context.
We can see no principled distinction between subjecting an “ordinary” proxy solicitation to 14a-9 liability and somehow exempting a solicitation made by a proxy advisory firm. As the SEC noted in the release announcing the Proposed Rule, “we continue to believe that subjecting proxy voting advice businesses to the same antifraud standard as registrants and other persons engaged in soliciting activities is appropriate in the public interest and for the protection of investors.” We agree.
A. Disclosure of proxy advisor rules/standards that differ from SEC/stock exchange rules/listing standards
The Society strongly supports the inclusion in Rule 14a-9’s list of examples of the “use of standards that materially differ from relevant standards or requirements that the Commission sets or approves” (i.e., rules or standards promulgated by the SEC and/or its Staff or approved by the SEC as part of its oversight and regulation of securities exchanges).
Proxy advisors apply standards or policies that differ from SEC and/or stock exchange listing requirements frequently enough that it strains credulity to believe that the reasonable investor always understands whether a voting recommendation reflects (non)compliance with existing rules/regulations/standards or simply proxy advisor judgment. For example, proxy advisory firms apply standards that differ from SEC, stock exchange rules and certain state laws with respect to:
- Director independence
- Executive compensation
- Say on pay voting results
- Shareholder vote counting methodology
Ensuring that investors have the relevant information they need to understand whether a recommendation reflects issuer compliance with de jure regulatory requirements instead of a proxy advisor’s policy judgment will ensure that votes cast in accordance with the recommendations actually reflect an investor’s informed evaluation of the proxy advisor’s opinion.
VII. Proxy Advisors Should Not Be Permitted to Charge Issuers for Draft Reports
Question 31 of the SEC release asks whether proxy advisors should be allowed to “seek reimbursement from registrants and other soliciting persons.” We strongly believe that requiring issuers to pay for the draft reports would largely just recreate the status quo ante. Currently, ISS provides draft reports to S&P 500 companies. To quote a member:
Although ISS has a longstanding practice of circulating their draft reports to us for review, Glass Lewis does not have such a practice and has forced us to purchase reports from them, simply for the ability to review and comment on the report (and then pray that they’ll address any inaccuracies after it’s been published, which is often too late). A company may learn from its advisors what Glass Lewis has recommended, but these advisors are restricted from sharing the reports under their licensing agreements. This often feels like a hold up where we have to pay money simply to defend ourselves or know what has been said about us—if we don’t pay we find ourselves shadow boxing in response to rumors that we hear piecemeal. Requiring proxy advisory firms to circulate their reports for comment would eliminate this…”
The Society strongly believes that basic notions of fair play preclude charging issuers for the opportunity for due process in the formulation of recommendations applicable to what is for many registrants the single most important and impactful governance activity of the year.
We appreciate the opportunity to comment on this Proposed Rule and would be happy to provide further information or context, to the extent you find it useful.
* * *
The complete letter, including footnotes and appendix, is available here.
Society for Corporate Governance Comment Letter to SEC on Proposed Proxy Rules for Proxy Voting Advice
More from: Darla Stuckey, Society for Corporate Governance
Darla Stuckey is President and CEO of the Society for Corporate Governance. This post is based on a Society for Corporate Governance comment letter to the SEC in response to request for comments on the proposed rule regarding proxy advisors (discussed in posts here and here).
The Society for Corporate Governance (the “Society”) appreciates the opportunity to provide comments to the U.S. Securities and Exchange Commission (“SEC” or “Commission”) on the Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice (the “Proposed Rule”).
Founded in 1946, the Society is a professional membership association of more than 3,700 corporate and assistant secretaries, in-house counsel, outside counsel and other governance professionals who serve approximately 1,700 entities, including 1,000 public companies of almost every size and industry. Society members are responsible for supporting the work of corporate boards of directors and the executive managements of their companies on corporate governance and disclosure matters.
I. Introduction: Background and Context
The practices and influence of proxy advisors has been a long-standing focus area of the Society. We believe the firms influence as much as % or more of the vote at most registrants, yet their recommendations are not subject to a regulatory framework that provides for independent oversight or other protections to help ensure their accuracy. Proxy advisor reports and voting recommendations are not generally made available to the public to read (except to the institutions that purchase them). In fact, proxy advisors are the only participants in the proxy voting system who are not regulated in some way. Issuers, asset managers, proxy processors, shareholders, and anyone soliciting a proxy, are regulated. While one of the proxy advisory firms is a registered investment advisor, the business of vote recommendations has had no unique or relevant regulatory scheme.
Until now.
We applaud the SEC’s Proposed Rule, which we believe will help improve the proxy process by: 1) ensuring that proxy voting is done with the benefit of recommendations based on information generally available in publicly filed documents; 2) ensuring that all companies—not just the S&P 500—have advance access to the reports so that they can review and advise of mistakes of fact so the reports can be corrected before their shareholders vote; 3) providing all registrants the ability to include in the report a link to a publicly filed statement explaining a mistake of fact or analysis in the hopes that investors will see it in a timely manner contemporaneous with a proxy advisor’s recommendation or report; 4) requiring the proxy advisors to disclose their conflicts in a meaningful way; and 5) clarifying that the SEC and the listing exchanges are the corporate governance standard setters, and not the proxy advisors.
The Society would like to note that proxy advisors are important, indeed indispensable, to asset managers and other institutional investors who use them. We appreciate a recent comment by an investor who said that taking away the proxy advisor voting platform would be like taking away a Bloomberg terminal from a trader. We recognize their importance, particularly for the actual voting mechanics, and we understand the responsibilities of and burdens on investors, many of whom vote at hundreds or thousands of meetings in a single proxy season.
Given our members’ various roles as governance professionals, we care deeply about having an effective and efficient proxy voting system. As general counsels, corporate secretaries and other governance professionals, our members are charged with managing their company’s annual meeting and the associated shareholder voting process. We believe there is general consensus between issuers and shareholders that votes should be cast based on accurate information, free from conflict, and with transparency. While we believe many investors vote their shares in a thoughtful manner, the Proposed Rule will enhance access to and the transparency of relevant information for all investors.
We also understand some investors have raised concerns that if proxy advisors are regulated, their business models will be strained, which may result in fewer firms providing proxy advisor services. As further detailed below, the Society believes that the impact and benefits of the SEC’s Proposed Rule to improve the proxy voting process will outweigh the associated costs.
The current proxy advisory firm market is essentially a duopoly consisting of Institutional Shareholder Services Inc. (“ISS”), owned by the private equity firm Genstar Capital, and Glass Lewis & Co. (“Glass Lewis”), a portfolio company of the Ontario Teachers’ Pension Plan Board and Alberta Investment Management Corp. The proxy advisors have clients, which are primarily institutional investors who vote the shares of the companies they hold for their beneficial owners. The clients/institutional investors pay for the research and advice that the proxy advisors offer. This is their business.
However, one proxy advisor, ISS, has another business line. ISS pitches and sells vote consulting, compensation consulting, proxy drafting advice, and governance and ESG scoring consulting to issuers. The terms and prices charged for these consulting services vary and are not public. In fact, public companies that engage ISS consulting services are contractually prohibited from disclosing the consulting relationship publicly or to an ISS proxy voting representative. One reason provided by ISS for this restriction is to avoid a proxy voting employee possibly providing preferential treatment of some sort with respect to voting recommendations for consulting customers. To date, there has been no published data by ISS or others that we are aware of to
quantify the amount of revenue earned by ISS that is attributable to its consulting business. As we explain below, the Society estimates that ISS’ consulting business represents approximately $48 million annually in revenue—an amount, we believe, that is material to ISS’ overall financial performance and, therefore, warrants disclosure to investors of a conflict of interest.
Because proxy advisor vote analysis and recommendations are not available publicly— issuers and proxy solicitors who do receive them are not permitted to disclose them—mistakes in such reports and potential conflicts of interest with respect to consulting services are shielded from public view. This dynamic is why there are few comment letters from issuers in the file. Many registrants are unwilling to provide specific information on errors in reports or other issues they have with proxy advisors, including at SEC Roundtables and in comment letters. Registrants are also concerned that investors who are clients of the proxy advisory firms may have an adverse reaction if a company were to write a comment letter supporting the Proposed Rule. These factors make it difficult to conduct market and academic analysis of the direct and indirect impact of proxy advisors on the capital markets, the market for corporate control and the economy overall.
II. Proxy Advisory Firm Influence Merits Regulation to Ensure Transparency and Accuracy
A. Proxy advisory firms have a significant influence on voting results
Voting recommendations made by ISS and Glass Lewis have a significant impact each year on the composition of a public company’s board, its executive compensation policies, and an increasingly expansive range of shareholder proposals. Equally important, these recommendations can have profound ramifications on pivotal issues, transformative corporate events, and challenges throughout a company’s lifetime. This influence directly and significantly affects matters being voted on at annual meetings.
For example, in 2019, ISS recommended “for” (and contrary to the management recommendation) a compensation-related shareholder proposal on a Society member’s proxy statement. After the surge of initial voting, the proposal received 53.03% support of shares voted. Following this company’s filing of supplemental proxy materials, ISS changed its recommendation to “against,” which we presume was communicated through the automated voting platform to investors. Within 24 hours, support for the proposal went from 53.03% to 23.95%, thus clearly demonstrating the effectively real-time and outsized influence of the proxy advisor. The influence of the proxy advisor in this example clearly transcends the impact that even the company’s largest shareholder could have had.
This degree of influence is more prevalent with certain types of shareholders, such as quantitative fund managers, or those who simply own one stock as a hedge against another position. Unlike many large active and passive asset managers, certain investors, in particular those who believe they are compelled to vote on every proposal due to prior SEC guidance, lack an incentive
under their investment models to devote resources or expertise to in-house proxy teams to analyze and vote numerous ballot items for shareholder meetings. In contrast, large asset managers generally tend to have extensive in-house proxy teams that engage with issuers on corporate governance matters, analyze their company policies and proxy statements, and generate vote recommendations based on the respective manager’s mandate. In addition, large asset managers have extensive research tools and resources, and proxy advisory firms are simply one of multiple data sources. These teams conduct a deeper analysis on companies that deviate from their own internal policies.
Despite many investors’ commitment and practice of informed voting, an institutional investor’s approach may depend on what percentage of their portfolio is invested in the company. A 2018 study by the American Council for Capital Formation found that the largest institutional investors are less likely to deviate from proxy advisory recommendations when casting votes at small companies. With the largest institutional investors owning a majority of the shares at most small companies, the study found that small companies are significantly more affected by proxy advisor recommendations. Stated differently, large institutional investors may be relying more on proxy advisor recommendations for small companies, where their investment likely represents a small fraction of the investment portfolio.
Because smaller registrants not included in the S&P 500 index cannot view their ISS reports in advance of dissemination, and no registrants can view their Glass Lewis reports in advance, any mistakes included in a report may not be corrected before some or even the majority of investors vote. If mistakes are found after the proxy advisor report is released, it is possible (but not at all certain) to have such errors corrected and the report re-issued, but all investors may not review these updates and change their vote, if warranted.
The Proposed Rule will correct this and require that all registrants regardless of size be given the opportunity to see their reports in advance if they comply with the updated rule. This is one of the most important inequities that exist in the proxy voting process. We commend the SEC for proposing a rule that will remedy it.
B. Mistakes and errors happen
We expect some commenters who do not support the Proposed Rule to deny that mistakes are made, or argue that if they are, they are not prevalent. The Society recently conducted a survey of its members to solicit feedback on errors in reports. The survey asked first whether they were aware of any factual errors, omissions of material facts, or errors in analysis in the last three years.
A total of 134 members responded to the question, with 56, or 42%, answering in the affirmative. Here are many of the written examples they provided:
We believe a 41% error rate indicated by this group of companies over the last three years is significant. Several times one of these companies had received the draft report and was able to get a correction from the proxy advisor; however, companies not in the S&P 500 do not get that opportunity from ISS. The burden for registrants to correct an erroneous recommendation after the report is distributed to the institutional investors is much more challenging, as previously noted.
While emphasizing the significance of the error frequency described above, we would also urge the Commission not to fall prey to the false argument that it cannot act to regulate proxy advice without a showing of “prevalent” errors. The SEC’s regulations reflect many instances of regulating undesirable conduct not based on its prevalence, but upon a belief that it should be avoided altogether.
C. Automated voting (i.e., robo-voting) amplifies the influence of proxy advisors
Automated proxy voting systems allow clients to: (1) populate each ballot with recommendations based on preset voting instructions or policies; and (2) submit the client’s ballots for tallying without requiring the client to review the proxy advisor’s analysis or confirm their vote. This precludes consideration of other sources of information and company-specific details before the vote is cast. In some cases, investors purchase a recommendation only service in which they do not receive the proxy advisory firm report—but merely the recommendation. The proxy advisor then populates the ballots as it has previously been instructed to do so based on agreed policies, and then the proxy advisor casts the vote, unless the investor overrides it. This process may be convenient, but allows for voting with no human input.
The Society believes that many small and mid-size institutional investors and managers outsource their voting to proxy advisory firms that provide automated voting services to fulfill what they believe to be their proxy voting compliance obligations at the lowest cost. Moreover, a number of these firms adopt ISS and Glass Lewis “default” voting guidelines and policies, and then let the proxy advisory firms apply these policies by generating ballots that reflect these default positions for each shareholder meeting. While technically the clients have the right to override a specific voting recommendation, in practice most of these ballots are submitted automatically without any client input or decision. These small investors collectively can own a considerable equity stake in a company. This practice is often referred to as “robo-voting.”
We believe the impact of robo-voting and the associated influence of proxy advisor recommendations are evident by reviewing the votes cast shortly after the release of their recommendations. The U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness and Nasdaq conducted a survey of the 2019 proxy season in which 172 public companies participated. This 2019 survey found, as it did for 2018, “that a large percentage of shares were robo-voted in the 24-48 hours after an ISS or Glass Lewis recommendation was released.” Moreover, large percentages of shares voted in line with proxy advisory firm recommendations.
Specifically with respect to ISS, in 2019, several companies reported between 15% to 40% (compared to 10% to 15% in 2018) of their outstanding shares were voted in line with ISS’ recommendations within the 24 to 48-hour period following the issuance of its recommendations. The same 2019 survey also determined that 5% to 10% (compared to less than 10% in 2018) of the respondents’ shares automatically voted in agreement with a Glass Lewis recommendation within 24-48 hours of its issuance.
Consistent with these survey results, we have provided an example of one Society member’s experience which illustrates how shares voted within the 24 hours following the release of its proxy voting reports appear to follow in lockstep with the voting recommendations in those reports. The Society member tallied the votes cast and tracked the time of the vote executions following issuance of the ISS voting reports in 2018 and 2017. An estimated 13.1% and 9.3% of the total votes cast in 2018 and 2017, respectively, were cast in accordance with ISS’ recommendations within one business day after the release of the ISS report. By comparison, the percentage of votes cast on other business days just before the release of the ISS report typically was between 0.2% and 0.3%
Given the relatively low retail shareholder participation rate in proxy voting, it seems quite likely that a substantial portion of ISS-outsourced managed accounts would, in fact, be voted in accordance with ISS default policies (with little further input from the managed account owners).
of the total votes cast in the annual meeting. To put this in perspective, the number of shares voted following release of the ISS report were larger than the total shares owned by this company’s largest shareholder.
Results from the recent Society survey of public company members regarding the amount and timing of shares voted within 48 hours of the release of proxy voting recommendations buttress the Chamber’s statistical evidence and company-specific anecdotes:
The precise volume and timing of shares that are voted automatically in line with proxy advisor advice is difficult to determine due to lack of transparency in voting results released by the proxy advisory firms themselves. Regardless, the existence of robo-voting and its material impact in the proxy voting process and results merits oversight and regulation to ensure fairness and accuracy.
In light of the impact of robo-voting, the Society suggests that the SEC consider requiring proxy advisory firms to “disable the automatic submission of votes” if the registrant has submitted a response and where the proxy advisor is recommending against the management position. By disabling the robo-voting feature in these limited circumstances, the SEC can ensure that the appropriate level of human consideration is applied in the situations where it is most needed.
III. Process for Review of Proxy Voting Advice
The Society applauds and supports the Commission’s efforts to encourage greater accuracy and completeness in the voting recommendations and related information included in proxy advisory reports. By mandating a review-feedback-review process, the Proposed Rule creates the due process essential to providing accurate and timely proxy voting advice to investors. In addition, the opportunity for registrants to provide a hyperlink to a company response on a particular issue(s) will provide investors a much-needed and convenient way to access the company perspective on erroneous statements. The due process provided by the Proposed Rule is critical to ensuring “that proxy voting advice be based on the most accurate information reasonably available.”
Percentages do not equal 100 due to rounding.
A. Review Timelines
The Society appreciates that the Commission is proposing that all proxy advisory firms will be required to give all registrants the opportunity for advance review of their proxy advisor reports if certain deadlines are met. The Society appreciates that the proposed amount of review time for an issuer is potentially longer than the time currently provided, which in some cases can be less than 24 hours or over a weekend or holiday. As cited by the Commission in footnote 114 of the Proposed Rule, according to Broadridge Financial Solutions, Inc., registrants customarily file definitive proxy material 35-40 days before a stockholder meeting. As such, we note that many registrants will be required to accelerate their proxy statement preparation schedules to benefit from the full five-business day report review period included in the Proposed Rule, and that there are likely to be a significant number of registrants who will be unable to do so, at least in the shorter term. The Society’s recent survey supports this conclusion.
The Society also commends the Commission on proposing to incorporate a mandated review by the registrant of the final version of the report before it is distributed to the proxy advisory firms’ clients and to provide a method for the issuer to provide further correction or comment. As the Society survey data indicates, registrants’ proposed factual corrections and suggestions often are not incorporated, without explanation from the proxy advisory firm.
Some have argued that the Proposed Rule’s review process somehow compromises the independence of the proxy voting advice and that such advice is akin to buy-side analyst reports, which are prohibited from being reviewed by the company to avoid compromising the integrity of such reports. This argument is surprising since ISS voluntarily provides reports to a limited number of issuers today. ISS provides its reports to S&P 500 companies in advance and takes comment on any factual errors in a 48-hour timeframe, although companies are sometimes given less response time. It is difficult to understand how, if ISS’ voluntary review and comment processes do not currently compromise the independence of their advice, the Proposed Rule’s review and comment period for all public companies would do so. The Society believes that the independence of proxy voting advice will not be affected by the Proposed Rule.
B. Hyperlink to issuer response
The Society commends the Commission on proposing to provide a method for the issuer to correct mistakes in proxy advisory firms’ final recommendations or reports via a company hyperlink contained in the proxy advisors’ final report. Because factual errors have frequently been found after the voting recommendation has been disseminated to the many institutional investors who subscribe to ISS’ and Glass Lewis’ services, the impact of additional proxy materials can be
limited. As a result, the Society is supportive of the Proposed Rule’s requirement that proxy advisors must include a hyperlink to a written, publicly-filed, statement prepared by the issuer.
IV. Proxy Advisory Firms Offer Services That Constitute Proxy Solicitations
A. The Society supports amending the definition of the term “solicitation”
The Society agrees with adding the Proposed Rule’s new paragraph (A) to Rule 14a-1(l)(1)(iii) to clarify that the terms “solicit” and “solicitation” include any proxy voting advice that makes a recommendation to a shareholder as to its vote, consent, or authorization on a specific matter for which shareholder approval is solicited, and that is furnished by a proxy advisor that markets their expertise as a provider of such advice, separately from other forms of investment advice, and sells such advice for a fee.
The Society supports the Commission’s interpretation of the term “solicitation.” The Society agrees that the analysis of what constitutes a solicitation should not turn on whether the proxy advisor is seeking authorization to act as a proxy or is uninterested in the vote results. Moreover, the analysis also should not incorporate whether the proxy advisory firm provides recommendations based on the client’s own proxy voting guidelines or whether the client declines to follow the proxy advisor’s advice. The Society believes the Proposed Rule reflects the correct approach and concurs with the Commission’s explanation supporting its proposed interpretation.
In addition, the Proposed Rule states that each voting recommendation contained within the general benchmarking policies or specialty policies (sometimes referred to as specialty reports) would be considered a separate solicitation under the amended rules. The Society agrees with this determination. General benchmark policies and specialty policies are compilations of voting recommendations on a wide range of topics that could potentially be included on a shareholder agenda. The specialty policies, such as socially responsible investing policies or Taft-Hartley labor policies, provide recommendations that take into consideration certain values, regulatory
requirements or investment objectives of a particular investor audience and their recommendations are often predetermined.
B. ESG Ratings Firms
ESG ratings firms provide ratings and analysis of companies on a wide range of environmental, social and governance issues to many institutional investors. The number and influence of ESG ratings firms has been growing. As the asset management industry increases the number of ESG-related products offered and continues to commit to consider ESG factors in their investment decisions, some ESG ratings are being incorporated into portfolio construction, with concomitant impacts on capital allocation. The Society believes the SEC should be alert to changes with respect to capital formation, conduct appropriate analysis, and to the extent required, act accordingly.
We believe the Commission should consider current practices by proxy advisors with respect to the incorporation of ESG-related information or analysis in proxy voting reports and add appropriate clarifications in the Proposed Rule. For instance, ISS includes ESG related analysis in its “Proxy Analysis & Benchmark Policy Voting Recommendations,” even in cases where there is no specific environmental or social item to be voted upon. Having said that, the increased attention of investors on environmental and social (E&S) issues could make them relevant to an investors’ assessment of director performance, despite not being called out specifically in any particular item. In the context of E&S information and analysis being included in a proxy advisor report, we believe the Proposed Rule should be clarified to apply to such ESG information and analysis.
Glass Lewis presents a somewhat different context. Glass Lewis incorporates Sustainalytics E&S analysis in its “Proxy Paper” report, yet it retains all authority to actually make any E&S-related recommendations contained in its proxy voting advice. In effect, Glass Lewis is incorporating third party analysis into its proxy voting report but not necessarily its proxy voting advice. Nonetheless, it appears to the Society that such third-party information constitutes a part of the “solicitation” which, therefore, ought to be regulated under the Proposed Rule.
Accordingly, the information disclosure requirements contemplated under the Proposed Rule should properly apply to any third-party information incorporated into proxy voting advice, including with respect to methodology, sources of information, conflict of interest, and use of standards that materially differ from relevant standards or requirements that the Commission sets or approves.
V. The Society Supports the Proposed Conflicts of Interest Disclosure
The Society strongly supports the Commission’s proposal to require enhanced conflict of interest disclosure. As noted by the Commission in the Proposed Rule, proxy advisory firms regularly engage in activities that present conflicts of interest that should be disclosed to investors. For example, as noted above, ISS’ consulting business sells to corporate customers advice on the design of corporate governance structures or compensation plans and then ISS subsequently makes a recommendation to investor clients on how to vote for related proposals.
The conflict presented by selling consulting services (very frequently compensation, governance and shareholder proposal-related consulting services or, more recently, consulting related to ESG scores) is compelling. According to a recent Society survey, 62% of the companies polled noted that they have purchased ISS consulting services within the last three years.
Moreover, 39% of companies polled noted that they had been solicited by ISS “following a negative voting recommendation.” One registrant described it as follows: “As many issuers have found, it took ISS little to no time to send their sales team in our direction after our low “say on pay” vote, asking us if we would be interested in purchasing their consulting services to learn how we might avoid getting a negative recommendation in the future. This often feels like a request to pay protection money as the “route to safety” is often not knowable without paying an additional fee.”
The Society is not alone in its concerns about proxy advisor conflicts; a prominent labor union has expressed the same view. In 2013 at the SEC Roundtable on proxy advisors, an AFL-CIO representative noted that the “business model of having consulting services provided to issuers and at the same time providing proxy advisory services to investors…I think that business model is inappropriate, just as I don’t think that type of model is appropriate for an auditor. And this is a longstanding view that the AFL-CIO has expressed for a long time.”
Requiring conflicts of interest disclosure is further justified because the standard ISS consulting contract forbids the issuer from disclosing the existence of a consulting relationship. Requiring disclosure of these consulting relationships will allow much needed “sunlight” into this proxy advisor business area.
The Society therefore supports the detailed disclosures in proposed Rule 14a-2(b)(9)(i) in order to provide investors with information to understand the full nature and scope of proxy advisory firms’ conflicts of interest. Furthermore, we support the types of disclosure specified by proposed Rule 14a-2(b)(9)(i)(A) through (D), as these cover both the types of conflicts of interest that are problematic, as well as any policies and procedures of proxy advisory firms that may address such conflicts. Moreover, we support the Commission’s proposal to make the proxy advisory firms’ exemptions from the information and filing requirements of the federal proxy rules contingent upon the disclosures required by proposed Rule 14a-2(b)(9)(i).
A. The requirement to disclose consulting arrangements should NOT be subject to a materiality standard
Society survey data and ISS disclosed consulting information strongly suggest that the revenue earned by ISS through its consulting business, which we estimate at more than $48 mil annually, is material to the firm’s overall financial performance. This creates at least a theoretical conflict of interest relative to each recommendation subject to an existing (or even potential) consulting relationship. While any individual consulting relationship may not be economically material to ISS, the practical import of the conflict created by the overall consulting revenue manifests itself on a company-by-company basis. As a result, the only practical way to equip investors to adjust for the existence of a conflict is to require company-by-company disclosure, regardless of the “materiality” of that amount to the proxy adviser’s overall income.
For this reason, we believe that requiring only “material” interests, transactions, or relationships that present conflicts of interest may unduly limit the disclosure that proxy advisory firms provide. Rather, the Society recommends that the proposed Rule 14a-2(b)(9)(i)(A) through (D) should be clarified to require disclosure of any interest, transaction or relationship with respect to the proxy advisory firm that may present a conflict of interest, and the dollar amount thereof.
B. The Proposed Rule should ensure conflict of interest disclosures are user-friendly
On a related note, we are concerned that the Proposed Rule does not provide sufficient guidance to proxy advisory firms on the manner in which the disclosure on conflicts of interests should be provided. For example, we support clear disclosure that will inform investors about these conflicts of interests both in plain English and sufficiently sized font.
We further support adding instructions to the Proposed Rule specifying that a proxy advisory firm also provide a clear initial statement in its proxy voting advice, both in bold and sufficiently sized font size, that the proxy advisor does have a consulting relationship with the company subject to the voting recommendation. The SEC imposes disclosure location and appearance requirements in other contexts and should do so here.
VI. Proposed Amendments to 14a-9
The Society supports the SEC proposal to amend the list of examples in Rule 14a-9 to include the “proxy voting business’s methodology, sources of information, conflicts of interest or use of standards that materially differ from relevant standards or requirements that the Commission sets or approves.” The Society believes that including such examples in Rule 14a-9 will provide needed further definition as to the information necessary to ensure that proxy voting advice is not misleading due to lack of essential context.
We can see no principled distinction between subjecting an “ordinary” proxy solicitation to 14a-9 liability and somehow exempting a solicitation made by a proxy advisory firm. As the SEC noted in the release announcing the Proposed Rule, “we continue to believe that subjecting proxy voting advice businesses to the same antifraud standard as registrants and other persons engaged in soliciting activities is appropriate in the public interest and for the protection of investors.” We agree.
A. Disclosure of proxy advisor rules/standards that differ from SEC/stock exchange rules/listing standards
The Society strongly supports the inclusion in Rule 14a-9’s list of examples of the “use of standards that materially differ from relevant standards or requirements that the Commission sets or approves” (i.e., rules or standards promulgated by the SEC and/or its Staff or approved by the SEC as part of its oversight and regulation of securities exchanges).
Proxy advisors apply standards or policies that differ from SEC and/or stock exchange listing requirements frequently enough that it strains credulity to believe that the reasonable investor always understands whether a voting recommendation reflects (non)compliance with existing rules/regulations/standards or simply proxy advisor judgment. For example, proxy advisory firms apply standards that differ from SEC, stock exchange rules and certain state laws with respect to:
Ensuring that investors have the relevant information they need to understand whether a recommendation reflects issuer compliance with de jure regulatory requirements instead of a proxy advisor’s policy judgment will ensure that votes cast in accordance with the recommendations actually reflect an investor’s informed evaluation of the proxy advisor’s opinion.
VII. Proxy Advisors Should Not Be Permitted to Charge Issuers for Draft Reports
Question 31 of the SEC release asks whether proxy advisors should be allowed to “seek reimbursement from registrants and other soliciting persons.” We strongly believe that requiring issuers to pay for the draft reports would largely just recreate the status quo ante. Currently, ISS provides draft reports to S&P 500 companies. To quote a member:
Although ISS has a longstanding practice of circulating their draft reports to us for review, Glass Lewis does not have such a practice and has forced us to purchase reports from them, simply for the ability to review and comment on the report (and then pray that they’ll address any inaccuracies after it’s been published, which is often too late). A company may learn from its advisors what Glass Lewis has recommended, but these advisors are restricted from sharing the reports under their licensing agreements. This often feels like a hold up where we have to pay money simply to defend ourselves or know what has been said about us—if we don’t pay we find ourselves shadow boxing in response to rumors that we hear piecemeal. Requiring proxy advisory firms to circulate their reports for comment would eliminate this…”
The Society strongly believes that basic notions of fair play preclude charging issuers for the opportunity for due process in the formulation of recommendations applicable to what is for many registrants the single most important and impactful governance activity of the year.
We appreciate the opportunity to comment on this Proposed Rule and would be happy to provide further information or context, to the extent you find it useful.
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The complete letter, including footnotes and appendix, is available here.