When Big Business brings an elephant to squash a mouse, it's a safe bet money is involved -- lots of it. That's certainly the case with the current effort by the Business Roundtable and U.S. Chamber of Commerce to force proxy advisory services under the regulatory authority of the Securities and Exchange Commission.
The elephant in this instance is the Shareholders Communication Coalition, closely aligned with the Chamber and largely funded by the Roundtable, a who's who of chief executive officers of U.S. corporations with collective annual revenues of nearly $6 trillion. The mouse -- or mice, to be exact -- are two small firms, ISS and Glass Lewis, which between them constitute the entire proxy-advisory industry. (Full disclosure: Although I am no longer associated with ISS, I am its founder.) By way of comparison, total revenues of both proxy-advisory firms are roughly $100 million, less than one 100th of 1 percent of the earning power represented by the Coalition's main backer alone.
As disproportionate as the two sides are, conflict between them is all but endemic and much on display in this spring annual-meeting season, when shareholders are bombarded with proxy voting requests. Corporate boards tell shareholders how they should vote but offer the chance to abstain or dissent, with little to go on absent thrashing through the dense thicket of accompanying proxy materials. For a select few clients -- almost all of them large institutional investors -- proxy advisory firms do that thrashing themselves and produce recommendations based on clearly defined guidelines.
Proxy-advisory services, in short, are consultants. Like the big accounting firms and corporate lawyers, they digest massive amounts of material and render opinions on issues that arise in proxy statements and thus at annual meetings. Absolutely nothing compels a client to buy the services proxy advisers offer, and absolutely nothing compels a client who does buy those services to follow the advice rendered.
In theory, this is the free market as the Business Roundtable and the US Chamber of Commerce like to paint it: ideas, services, and products competing for the consumer dollar, with no government intervention to skew the odds in anyone's favor. In practice, this little mouse of a business seems to have scared the elephant so badly that it is willing to trample all over its own principles and appeal to government regulators to bring the tiny beast to bay. Why?
The official reasons got summarized in a January 17, 2012, letter from Neils Holch, executive director of the Shareholders Communication Coalition, to SEC Chairman Mary Schapiro. Where proxy-advisory firms are at issue, Holch wrote, "substantial concerns" exist about "(1) the conflicts of interest raised by several of their business practices; (2) a lack of transparency concerning their standards, procedures, and methodologies; and (3) their use of incorrect factual information to formulate specific recommendation."
These are serious charges and deserve a more lengthy refutation than I can offer here, but let me cut to the chase. True, ISS -- to cite the advisory firm I am most familiar with -- does offer consulting advice to corporations, whose proxy proposals it also independently evaluates, but it makes no secret of this fact and it has no influence over what subjects shareholders propose for inclusion in a company's proxy statements. Nor does ISS have any influence on the varying policies of the SEC in interpreting 14(a)(8) of the Exchange Act -- the decisive factor in determining what issues will be included on the company's proxy statement. In effect, the content on which ISS opines already is regulated 100 percent by the SEC.
Have there been instances when their recommendations have been based on false information? Of course, in the same manner as obtained with lawyers and other consultants. We are none of us perfect, but in the free market, customers are the judge of the worth of a product. If they find defects in the product, they won't buy it again. And times change, as well. Indeed, we now are seeing some of the largest investment firms, Blackrock and Vanguard among them, moving beyond proxy advisers in order to engage with companies according to their own judgment.
So why the hue and cry -- why the determination to slay a "beast" barely visible from the towering heights of the Shareholders Communication Coalition? No surprise, the answer is money. Small in stature though they are, ISS and Lewis Glass are the only independent advice available to public shareholders on the process of executive compensation.
Compensation consultants naturally enough incline their advice in the directions desired by those who employ them. Compensation committees are carefully chosen by boards of directors, which in turn are comprised to accord with the will of the Chief Executive Officer. That leaves the job of independently advising on CEO pay up to two small proxy advisory firms, and that explains the urgency of the attack against them since protecting the absolute power of CEOs to set their own pay is inevitably foremost on the agenda of the Shareholder Communications Coalition, being foremost on the agenda of its principal backer, the Business Roundtable.
It's not enough, apparently, that CEOs have captured government through their lobbying creatures, not enough that they are using the Supreme Court's odious Citizens United decision to dominate elections and legislators. Now, ironically, they are seeking to use the very regulatory process they otherwise despise to hobble even the most remote threats to their absolute authority and out-of-control compensation.
Will the SEC have the courage to push back? More than a half century of observation does not leave me hopeful.
There is no reason to suspect that sophisticated institutional investors are abdicating their obligation as professionals and fiduciaries to consider these issues as carefully as they do their buy-sell-hold decisions, also based in part on the opinions of independent analysts like the proxy advisory firms. Indeed, the data show that while clients do often follow the recommendations on routine matters (which means voting with management), the more high-profile and controversial a proposal or proxy contest, the more likely that clients are to read the analysis and come to their own conclusion, often departing from the proxy advisory services recommendation, demonstrating the independence of their judgment. Just as two investors can look at the same data and make different conclusions about whether to buy, sell, or hold, they can look at a proxy advisory recommendation and make a different decision about whether to vote yes, no, or abstain.
If issuers object to the recommendations made by the proxy advisory firms, the answer is for them to respond directly and substantively in their communications with their shareholders, not to cut off outside assessment.
The Shareholder Coalition has been doing excellent work on attacking the proxy plumbing problems and we have been happy to support them. This diversion takes them away from a very worthwhile goal which will save corporations a great deal of money and improve processes for shareholders.
What I find especially disappointing is the double standards being applied to investment research versus corporate governance research. Goldman Sachs has today settled with the SEC for massive failings of internal controls and there has been barely a mention from the anti-proxy advisory community? Why so? Sell side analysts can send share prices tumbling wherease proxy votes in many US corporations are non-binding (unlike in Europe).
As the US gears up for its presedential election this year I have no doubt that President Obama's record in office will be called into question. Any suggestion of trammelling free speech or voter franchise would send shockwaves through American society and the rest of the world. What of the tyranny of unaccountable (corporate) kings?
Sarah Wilson
CEO Manifest
England