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November 12, 2018

It's Time to Rein in Proxy Advisor Services

  Investor's Business Daily

On November 15, the Securities and Exchange Commission (SEC) is hosting a formal roundtable inquiry into the influence of proxy advisory services over the way corporations make key governance decisions.

And it's about time, too, as there have been many troubling developments since a tiny number of Wall Street companies asserted the right to determine how corporations should be run, while distancing from any fiduciary responsibility or liability for their recommendations.

Proxy advisors thrive from the fact that most investors, both large and small, are passive. Most of us don't invest in order to run the company. We just want to ride on the coattails of successful, profit-making enterprises and share in the success through dividends or appreciation in the stock price.

But even large institutional shareholders like the idea of not having to do research themselves, instead relying on the recommendations of supposedly skilled proxy advisory services.

Attention to mutual fund fees and expenses has driven fund managers to drive down costs by minimizing in-house research and relying more upon outside advisors. So there was an opportunity to exploit a knowledge and effort gap, and proxy advisors have filled it.

Even Bad Advice Pays

It's turned out to be a pretty lucrative business. Claiming to have the power to influence millions of shareholder votes has a way of opening doors for consulting relationships with those same corporations. It's cronyism, at the very least. Maybe worse.

"Nice little corporation you have here. It would be a shame if your shareholders suddenly started voting against you. Now, we wouldn't want that, would we?"

So there is an obvious concern about conflict-of-interest, transparency and disclosure. Those are things the SEC typically takes very seriously.

Another concern is the recommendations of these proxy advisors seem to be pointing in particular social or political directions. Companies with business lines often wholly unrelated are being asked to take action on issues like the rights of indigenous peoples, use of pesticides, deforestation, gender justice, clean energy and climate change.

Politicizing Corporate Decisions

Politicization of proxy recommendations seems like an illegitimate use of leverage over corporate governance, but even more importantly, often damages shareholder value, according to a 2009 study by three Stanford University economists.

But a just-released report suggests there is an even bigger, more egregious problem — the recommendations of proxy advisors are simply wrong in many cases.

In a study for the American Council for Capital Formation, Frank Placenti, founding president of the American College of Governance Counsel, finds that proxy recommendations are often just wrong — based on bad assumptions, bad data, or misunderstandings of corporate policies.

Companies respond to erroneous recommendations from proxy advisors through supplementary proxy filings too. Placenti found 139 significant errors in 107 supplemental filings reviewed from 94 companies.

In one egregious case, ISS issued a report critical of the executive compensation plan of Willis Towers Watson, a firm that specializes in, among other things, making recommendations about executive compensation.

ISS's report turned out to be filled with errors and bad recommendations, but the company was forced to correct those errors in a supplementary proxy filing that cost the company unnecessary time, money and aggravation.

Proxy Advisors And 'Robo-Votes'

And when these proxy advisors make their often-erroneous, agenda-driven recommendations, shareholders frequently "robo-vote" according to the proxy advisors' recommendations.

Companies report a spike in proxy vote activity in the first three days after an advisor makes a recommendation. So, despite all these problems with proxy advisory services, they are having a dramatic impact on corporate governance.

It's time for both the SEC and Congress to rein-in proxy advisors. Lawmakers have introduced legislation, but Congress doesn't actually seem much interested in legislating these days. So for now it falls to the SEC to assert its regulatory authority.

Rather than be distracted and harassed by proxy recommendations of dubious quality and hidden agendas, corporate governance should focus on maximizing shareholder value for the benefit of investors, employees and customers.

Giovanetti is president of the Institute for Policy Innovation (IPI).


 

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