August 10, 2007
Proxy Advisors Come Out Clean
by Anne Moore Odell
A report from the Government Accountability Office finds that the largest proxy advisor ISS and
other advisor firms disclose potential conflicts of interest.
After a nine-month investigation, the Government Accountability Office (GAO) has recently released a report to congressional requestors on
potential conflicts of interest between proxy advisors, clients, and corporations. The report
concludes that proxy advisors are up front about disclosing potential conflicts of interest and do
not hold too much sway in deciding proxy vote outcomes. Institutional Shareholder Services (ISS) of Rockville, MD, the largest proxy
advisory firm, received the most scrutiny in the report.
The report, "Corporate Shareholder Meetings: Issues
Relating to Firms That Advise Institutional Investors on Proxy Voting," recognized that conflicts
of interest could arise. However, proxy advisors have been diligent about reporting conflicts to
both government officials and clients. The Securities and Exchange Commission (SEC) likewise reported no major violations and found advisory firms
actually had a limited ability to influence the outcomes of proxy voting.
Richard Baker (R-LA), who sits on the House Financial Services Committee, requested the Report from
the GAO, the investigative arm of Congress. Proxy advisors have received criticism for the
influence they might have over the outcome of proxy votes and potential conflicts of interest
because of ties to companies that they review.
"The Report's description of potential
conflicts of interest at proxy advisory firms was a reasonable catalogue of these potential
conflicts," said Mark Bateman, Director of Research at IW Financial, a provider of ESG research for institutional
investors and others.
"The Report should have sought to evaluate the effectiveness of
policies in place at proxy advisory firms to avoid actual conflicts of interest where the
possibilities exist. The Report also skipped the opportunity to interview companies for their
perspectives on these questions. These two omissions significantly decrease the value of the
Report," Bateman added.
The GAO's Report also focused on the overshadowing position that
ISS holds in the proxy-advising field. ISS, established in 1985, was started to satisfy the desire
of managers of retirement plans to have help with their fiduciary responsibility in voting for
their clients' best interests. Because of ISS's ability to offer clients a full range of services
and its long standing history, other firms might have a difficult time getting new clients the
Report notes. Yet the Report acknowledges that other firms have the same access to public documents
filed with the SEC and that other firms have space to distinguish themselves from ISS.
Cheryl Gustitus, Senior Vice President of Marketing and Communications at ISS told
SocialFunds.com, "We applaud the GAO's Report. No one before has does an in-depth study of the
proxy advisor industry. There has long been a misperception that institutional investors abscond
their responsibility to their proxy advisors, but that's not the case. Institutions take voting
seriously and, especially the larger clients, have their own policies and views and their votes are
cast in an independent manner."
GAO interviewed 31 institutional investors to complete the
Report, 20 large institutions and 11 small institutions. It found that small institutional
investors relied more heavily on the research provided by proxy advisors than did larger investors,
as larger investors had more in-house staff and resources to research proxy voting issues.
The Report concludes: "The fact that large institutional investors cast the great majority of
proxy votes made by institutional investors and reportedly place relatively less emphasis on
advisory firm research and recommendations could serve to limit the firms' overall influence on
proxy voting results."
Yet there has been some criticism that GAO's Report underplays the
influence that ISS yields. Broc Romanek, editor of The CorporateCounsel.net
blog wrote that he "would not place much stock in commentary that the GAO Report means that ISS'
influence is overblown; if you have any actual experience with shareholder meetings, you know that
ISS' recommendation often is the difference between a controversial matter being approved by
shareholders or not."
ISS's Gustitus commented, "The myth is that ISS recommendations
carry so much weight, but most institutions use multiple proxy advisors and, in addition to all the
advisors, higher end institutions have their own polices."
Romanek summarizes input from
members of TheCorporateCounsel.net, "Any proxy solicitor will tell you that ISS's influence on
voting issues can often be as high as 25% of the shares outstanding. A prime example of ISS'
influence is the bumps felt by recent private equity deals when ISS recommended voting against them
(i.e., Clear Channel and Biomet). Not that that is a bad thing for shareholders, but it illustrates
ISS acknowledges that their business model has the potential for
conflicts, but ISS works to note all conflicts of interest on their website and separates its staff
into two buildings. In addition, Gustitus said the report should comfort investors that most
institutions conduct their own due diligence on proxy issues.
Bateman offered some ideas
on how to eliminate or significantly reduced conflicts of interest. "The most radical approach to
offering proxy voting services while minimizing potential conflicts would be to eliminate the final
voting recommendation. Rules or criteria determined by the investor could drive the voting
decision, eliminating the interpretation by the proxy advisory firm."
"If the GAO
interviews on the significance of proxy advisory recommendations to large institutional investors
is correct, one wonders if the business models could do without that final recommendation," Bateman
ISS proposed that proxy advisors register with the SEC to help level the playing
field. ISS, Marco Consulting Group, and Proxy Governance have already done so. "We feel that we
should be under the same scrutiny as our clients. The Report stops short of suggesting proxy
advisors should register as investment advisors. Perhaps it should be required," Gustitus said.
The Report concludes, "We could not reach a definitive conclusion about the firms'
influence because the institutional investors we contacted were not necessarily representative of
all such investors. Further, we could not identify any studies that comprehensively isolated
advisory firm research and recommendations from other factors that may influence institutional
investors' proxy voting."
The sheer number of proxy statements that are sent out year is
staggering. ISS gives the figure of publicly traded companies sending out proxy statements at
28,000, and each statement has a number of different and varied issues. Each proxy vote brings with
it its own history, compounded by the institutional investor's and the company's boards, missions
and policies. How a specific institutional shareholder votes on a specific proposal involves many
factors too numerous to list. A proxy advisor is just one sieve. GAO's Report might not satisfy all
critics, but it is a first step in addressing an incredibly complex subject.
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