Securities regulators and institutional investors should be pushing proxy advisory firms to improve transparency and curb conflicts, argues a new paper from a Montreal-based governance advocacy group.
The Institute for Governance of Private and Public Organizations (IGOPP) has published a new policy paper outlining its concerns with proxy advisors, and calling for action from both institutional investors and regulators. It argues that proxy advisors “have come to exert undue influence” on the governance of public companies, and that they “play a troubling role” in contentious situations, such as proxy battles or takeover fights, where certain shareholders are opposing a company’s board.
“Proxy advisors now stand in a bully pulpit from which to harangue corporate management and boards of directors on all matters of governance and compensation; neither investors, nor investment advisers, they enjoy a franchise to ‘make recommendations’ to investors on how to discharge their fiduciary responsibility as shareholders,” the paper says.
It notes that their influence has only grown in recent years, in spite of criticism of their performance; that their recommendations lack transparency; their analysis can be inaccurate; and, it says that, in certain cases, they may harbour conflicts of interest.
The paper also says that the firms’ business model is flawed because it is so heavily seasonal, with many companies issuing proxies at the same time. “Neither regulated, nor supervised, proxy advisers rely on a business model that makes it virtually impossible for them to handle with care and responsiveness the sheer volume of reports they have to produce in a very short period of time,” it says. “In the case of ISS, the firm is also vulnerable to conflicts of interests.”
These criticisms of the proxy advisory business aren’t new. Last year, the Canadian Securities Administrators (CSA) published a consultation paper on the issue of proxy advisors, asking whether the firms, which are not currently regulated, should be subject to some sort of regulatory framework, given their role in the market. The CSA has not said whether it believes it is necessary to introduce regulation for proxy advisors.
However, the IGOPP paper recommends that regulators should indeed propose “an appropriate supervisory framework” for these firms. In particular, it recommends that: Canadian regulators should require that proxy advisors set proficiency standards for the analysts preparing their reports; that, when they are providing a voting recommendation on a corporate transaction, they should be subject to the same regulatory framework as investment bankers; that they should be obliged to disclose any possible conflicts when they are involved in making recommendations on contentious issues; and, that they should be prohibited from offering corporate services to the same corporations they also issue proxy voting recommendations on for institutional clients.
As for institutional investors, it recommends that they: voice their disapproval concerning the models used by proxy advisors to assess executive compensation; insist on disclosure from these firms regarding their business models and the training and expertise of their analysts.
“All in all, the business of proxy advisors, though seemingly filling a need, brings forth a host of issues, which, if they are not dealt with vigorously and effectively, may well result in a warped system of governance and a serious failure of accountability,” it concludes.