Despite longstanding complaints about governance and the tyranny of a few who may or may not hold a meaningful economic interest in the company they founded and/or now control, investors have continued to allocate to controlled or quasi-controlled companies. What has changed is that minority shareholders are no longer content to sit quietly and go along for the ride, increasingly demonstrating they are willing to pull on the few levers of activism and change available at these companies.

Companies that were set up to inoculate themselves from the whims of shareholders have now become targets. Even if directors aren’t at risk of losing their seats in a vote, they are at risk of losing their reputations and being embarrassed into change.

While governance concerns usually provide the thin edge of the wedge to begin the advancement of change, the underlying driver for a minority shareholder is usually a dissatisfaction with the way the controlling entity is running the business—not just in terms of current performance, but also in a lack of willingness to explore other accretive opportunities that may impact the controller’s vision for the company and status quo.

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In 2003, the SEC put forward a rule that required institutional investors to disclose their votes and provide an explanation as to why they voted the way they did. This paved the way for the rapid growth and influence of proxy advisors such as Institutional Shareholder Services, Inc. (ISS) and Glass Lewis, & Co. (Glass Lewis), which quickly became a cost- and time-effective resource for funds seeking to rationalize their vote decisions.

The SEC has once again shifted the paradigm by recently declaring that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” and issuing guidelines for investment advisors to follow when voting for their clients. When the SEC started its process, it was clearly interested in reforms that would “rebalance” the role of the proxy advisors and “protect the interests of the broader shareholder universe.” Politicians had previously advanced this agenda by introducing bills—such as House Bill 4015, introduced in 2017 and passed in 2018, and Senate Bill 3614, introduced in fall 2018—requiring proxy advisors to register with the SEC, among other things. While none of these bills became law, they have helped to fan the flames of public attention on an issue most average investors know nothing about.

It is estimated that ISS and Glass Lewis have more than 97% market share in the proxy advisory space (Egan-Jones, Segal Marco Advisors, and ProxyVote Plus make up the balance) with many investors subscribing to more than one. Establishing a proxy advisory firm takes not only a significant financial investment but also a tremendous knowledge base, so it is unlikely a new entrant or even one of the smaller players will shift this balance any time soon.

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When designing proposals and considering governance topics such as board composition and tenure, it’s surprising how many issuers leave a key box unchecked when deciding on what they put forward. Working with their counsel and bankers, boards work hard to ensure a proposal aligns with the expectations of the regulators and conforms to market standards, and even gets a thumbs-up from ISS and Glass Lewis. However, in the process, they often forget to ask what their unique shareholder base wants.

With an increase in both the number and size of internal governance teams at institutional investors, more prescriptive policies being developed—such as those on ESG issues and diversity—and a decreasing willingness to farm out vote decisions to the proxy advisors, it is incumbent on issuers to ensure they not only understand, but also take into consideration, the voting policies of their shareholders to ensure vote success.

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