In Defense of Proxy Advisors

September 30th, 2010
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Contributed by: Michael R. Levin, The Activist Investor
Barnes & Noble suffered a setback...when a powerful advisory firm backed a slate of directors proposed by the billionaire investor Ron Burkle over its own candidates.

Hertz Global Holdings gained support for its...takeover proposal for Dollar Thrifty Automotive Group on Tuesday, as the big proxy advisory firm Institutional Shareholder Services backed the merger.

New York Times, September 21, 2010

The New York Times isn’t the only one who thinks ISS has the clout in corporate elections these days. Corporate interests have long complained that proxy advisors, including ISS, Glass Lewis, and a few others, have too much influence in board elections and other shareholder votes.

Investors might also think the SEC has it in for proxy advisors, at least based on the most recent concept release on “proxy plumbing”. As we commented earlier, the SEC seeks input on potential regulation of proxy advisors, much like the SEC oversees credit rating agencies (Standard & Poor’s and Moody’s).

We studied further the SEC’s analysis (about 16 pages’ worth) and questions for commenters (all 47 questions, including “Do proxy advisory firms control or significantly influence shareholder voting without appropriate oversight?”). Other analysis and scholarship, from the US General Accountability Office, the Millstein Center, and from academics, probes this subject.

I don’t get the uproar. I mean, I understand why CEOs and their lackeys want to fight proxy advisors, who have tended to support investors’ board candidates, oppose entrenchment of directors and management, and fight executives’ pet value-destroying deals. However, the push to regulate these firms flies in the face of the free enterprise principles that these CEOs usually adore.

Complaints about proxy advisors, succinctly captured in the SEC’s concept release, revolve around two concerns: independence and competence. Independence of course pertains to whether the firm provides services to clients without any undisclosed bias or influence. In this case, at least one firm, ISS, also advises corporations about governance. ISS claims to have painstakingly separated the two different service lines, and the GAO report seems to agree.

Competence of course involves whether a proxy advisor delivers a quality product. In particular, the SEC has heard corporations complain that firms are “ accept attempted communication from the issuer.” From this follows accusations of inaccurate and opaque analysis.

The SEC now wonders whether proxy advisors “operate the kind of national business” similar to credit rating agencies, and thus deserve the same form of regulation. This would be a big mistake.

Fundamentally, proxy advisors are consulting firms, similar to McKinsey, Towers Watson, KPMG, and tens of thousands of others. They provide advice for a fee, in this case proprietary subscription reports with their opinion about how an investor should vote in corporate elections.

As consultants proxy advisors confront the same problems with independence and work quality as all these other firms do. Their principal clients, investors, have every right and some legitimate basis to worry about whether one or another bias will enter into their advisor’s opinion.

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