Saturday, November 17, 2018
SEC Roundtable and Proxy Advisory Firms
The SEC held its Roundtable on the Proxy Process on Thursday, and I was able to watch the live webcast of the last panel on proxy advisory firms. (In a prior post, I discussed how, in advance of the Roundtable, the SEC withdrew two no-action letters that facilitated investment advisors’ reliance on proxy advisory services.)
One thing I’ll note about the Roundtable is that it felt a lot like oral argument in an appellate court, in that everyone had fun expounding their positions but it’s not where the real policymaking gets done; that’s going to take place in back offices based on private meetings and written submissions, not in a public theater.
Still, I was interested in what everyone had to say. The webcast just went online here, but I’ll offer a summary of what stood out to me.
(More under the jump)
First, in what seemed to be more of a carry over from the prior panel on shareholder proposals, Phil Gramm repeatedly protested the use of social proposals and similar items to shape corporate agendas. His basic argument was that political activists try to force companies to take certain action when they can’t persuade politicians to regulate, and they do that by pressuring proxy advisory firms into recommending, and index funds into voting for, social proposals. His concern was that index funds feel it necessary from a marketing standpoint to take a political stand, even when doing so does not actually contribute to wealth at portfolio companies.
He got pushback from other panel members: Rakhi Kumar from State Street insisted that votes are cast with a view to maximizing long term value, and Scot Draeger from RM Davis Private Wealth Management repeatedly emphasized that most companies don’t receive proposals and it would be the “tail wagging the dog” to burden proxy advisory firms with new regulations over such a miniscule issue (as one of the many academics who is fascinated by shareholder proposals, that certainly puts me in my place). But what struck me was that Gramm essentially conceded that index funds feel market pressure to pursue social goals. That means that at least some critical mass of human investors who purchase shares in index funds want their funds to attend to these issues. (As I’ve posted before, State Street obviously has a theory that if investors can choose from among any number of similar index funds, they might be inclined to pick the one that promises to vote for gender diversity). If the ultimate human investors do, in fact, want their funds to take social responsibility into account when voting their shares, why is that a problem for regulators to solve?
Second, spokespersons for ISS and Glass-Lewis mounted a few defenses of common challenges to the business model. They explained that the much derided “robo-voting” means only that a client has a pre-programmed set of preferences to manage routine voting issues, and ISS claimed that 87% of the clients that use its platform have their own customized preferences, rather than follow the ISS party line. (Glass Lewis also estimated that at least 80% of clients have customized preferences). In response to the charge that most votes are cast just after the proxy advisors issue their reports – suggesting that clients are blindly voting in line with advisors’ recommendation – Glass Lewis pointed out (as I understood it) that their computerized voting system casts ballots en masse at about the same time they circulate their reports, so the timing of the votes does not indicate that they were caused by the recommendation.
Both firms also defended themselves against charges that they offer conflicted advice. Glass Lewis does not offer consulting services, and it lists all of potential conflicts on the front of any recommendations. ISS, which does offer consulting, claims to keep the proxy advisor side of the business completely separate from the consulting side. And – and this I did not know, but it’s described on the ISS website (.pdf) – employees on the proxy advice side are not even supposed to be aware of the identities of clients on the consulting side. However, clients who receive proxy advice can see a list of all of ISS’s consulting clients, and how much they pay ISS. (Which makes me wonder how much of a secret their identities can really be from the proxy people, but whatever).
Unsurprisingly, Egan-Jones’s CEO, Sean Egan, was more critical of ISS’s conflicts (Egan-Jones also does not offer consulting services). But Egan-Jones’s main complaint, as I understood it, is that ISS’s computerized proxy voting platform dominates in the industry, but Egan Jones does not have access to it (presumably, to offer its own recommendations or voting algorithms). Egan viewed ISS’s dominance as a kind of monopolization.
Third, the two issuer representatives who spoke, Adam Kokas of Atlas Air and John Kim of GM, focused on the hot button question whether companies should have a chance to review proxy advisor reports before they are distributed to clients. Kokas was particularly concerned about having a chance to correct any factual errors, and he also felt that it was unfair that ISS distributes previews of reports to large companies – S&P 500 – but not smaller companies.
All of the proxy advisor reps insisted that they promptly correct any factual errors, and Glass Lewis said they make available, for free, to all companies, a complete report of the data that underlies their analysis before their report issues, so as to ensure that companies can correct any factual errors in advance.
Kim’s complaint was less about factual errors than about the company having a fair chance to make its case to proxy advisor service before the recommendation goes out. He said that for certain kinds of recurring issues, the company knows how the advisors are thinking about the problem and what they need to communicate, but when novel issues come up – especially during the proxy season when the firms are busier – it may be harder to have a conversation with the proxy advisor so as to discover and respond to their concerns before they distribute their report.
On this point, Kokas pointed out that often it was difficult to predict how a proxy firm would approach an issue and by the time a report issues it’s too late to object. For example, at Atlas Air, executive pay packages may remain the same for several years, but proxy advisor firms may choose different peer comparators in different years, resulting in different recommendations for say on pay votes – and Atlas Air can’t predict how they’re going to come out.
Jonathan Bailey of Neuberger Berman stated that in his experience, proxy advisor reports rarely contain factual errors; it is much more common that companies are disputing matters of opinion and interpretation. And when that happens, he argued, the companies can and do engage directly with investors/investment advisors to make their case. He – like the other investor representatives – insisted that he relies on the valuable analysis that proxy advisory firms provide but that he does not follow it blindly.
I’ll add to all of this - and this is a point that ISS made - it seems apparent that much of the ire about “factual errors” in proxy advisor recommendations is, in fact, a dispute about the content of their recommendations. Business Roundtable’s comment letter to the SEC kind of gives the game away on this point (.pdf):
Business Roundtable members also express concern that, when making recommendations, proxy advisory firms include or rely upon information not included in the company’s public SEC filings or base their recommendations on factors other than the regulatory scheme to which companies are subject. For instance, proxy advisory firms have their own guidelines for determining independence of directors. This has resulted in situations where a proxy advisory firm recommends against the election of a director because it has determined a director is not independent under its standards, despite the fact that the company’s board of directors, carrying out its fiduciary duties, determined that the director in question was independent under the requirements of the Commission and the company’s stock exchange listing rules and corporate governance guidelines. ... The Commission should reaffirm the fact that proxy advisors who rely on an exemption from proxy solicitation rules under Rule 14a-2(b) are still subject to liability for false and misleading statements under Rule 14a-9 and should specifically make clear whether these antifraud provisions apply when proxy advisory firms’ voting reports include information, statements or opinions that have not been included in material filed with the Commission.
As I understand it, then, it is the Business Roundtable’s position that it is a false or misleading statement under Rule 14a-9 for a proxy advisory firm to use its own criteria for determining director independence.
Third, Draeger pointed out that smaller investment advisors are not subject to the federal obligations regarding proxy voting. They may therefore not vote their shares, or not counsel their clients about voting their shares, because of the expense required to research the issues. He pointed out that if new regulations are imposed on proxy advisory firms that raise the cost of their services, it will ultimately lock smaller investment advisors – and their retail clients – out of the market, so that fewer retail votes are cast, precisely the opposite of what Commissioner Clayton has said he wants to happen.
Finally, at the conclusion of the panel, Commissioner Roisman said he had a new appreciation for how important proxy advisor recommendations are to shareholders, and that therefore it seemed reasonable to him that there be some kind of rebuttal period for companies to respond to firms’ recommendations and correct any errors. Which to me suggests some foreshadowing of what the SEC is likely to do.