The Securities and Exchange Commission has proposed that publicly traded companies be given 48 hours to respond to the statements and voting recommendations made by proxy advisory firms, which provide analysis and research for investment fund managers. Because the SEC has determined that the proxy advisers’ recommendations are solicitations, these recommendations are the equivalent of a corporate raider’s proxy solicitation. But, the proxy advisory firms have no vested interest, no skin in the game.
The proxy advisory business is simple enough. Just two companies, Institutional Shareholder Services, ISS, and Glass Lewis, together have a 97% share of the market. They began as consultants to pension fund and investment funds managers who, although they are paid to be fiduciaries for their beneficiaries, could never quite find time to analyze the annual proxy statements of their portfolio holdings.
Court cases, leveraged buyouts, the rise of index vesting such as the Vanguard 500 mutual fund, and the churn of shares in hedge funds all brought to light the problems of administering proxy voting for both shareholders and issuers. When some shares are owned for just minutes, it is not always easy sorting out the shareholder of record as of the voting date. Corporations faced declining shareholder votes, and this threatened required quorums and the ratification of corporate proposals.
Today, the proxy advisory firms have a great business model. They are paid by investment managers for their proxy analysis. On the flip side, they are paid by corporations to learn more about the corporations. The advisory firms demur that they are not representing shareholders or investment managers or other clients, but they also market that knowing more about the corporations can only be accretive to their decision-making. Without that value proposition, corporations and other issuers would not have a reason to employ proxy advisors.
Recently, corporations have complained about “robo” voting of shares immediately following the publication of the proxy firms’ recommendations. When one firm issues an opinion and recommended vote, the impact is felt immediately by other shareholders voting in a block. In a business where every hour of labor is expensive, a young clerk at the investment manager can only lose by going away from herd and so a follow-the-leader mentality is prevalent.
Beneficiaries and corporate issuers rely on investment managers doing their job. Investment industry requirements are that managers exercise appropriate diligence and independence to develop a “reasonable and adequate basis” before making an investment recommendation. The shortcut of paying someone else to do the research is accepted practice today.
Globally, ISS is reputed to make recommendations for more than 40,000 annual meetings and Glass Lewis makes recommendations for as many as 20,000. The NYSE hosts trading for more than 2,800 companies, while the NASDAQ lists more than 3,100 companies. Just for the U.S. listed companies the rapid analysis of more than 5,900 proxy statements is required within a very short timeframe due to December year-ends. In the U.S., there are more than 9,000 mutual funds and hundreds of exchange traded funds (ETFs) that hold stocks, including index funds. For the Vanguard 500 index fund, there are 500 proxy statements to consider and vote in a short window in the spring of each year. To support this effort, the proxy advisory firms hire and train seasonal workers much like seasonal tax-preparation firms or seasonal retailers.
Even though the proxy advisory firms contract to evaluate, assess and recommend proxy votes for their clients, they specifically state that their recommendations come without any express or implied warranty or fitness for any use.
Suppose there is an error. Does the investment manager have recourse? The advisory firms already know that their investment management clients are lazy. What about the ultimate beneficiaries? The one-size-fits-all business model cannot apply for the vast array of pensioners, hedge funds, funds-of-funds, ETFs, and endowments. The spate of bankruptcies during the pandemic is exposing corporate boards that received positive ratings and recommended votes from the advisory firms. Ticking all of the boxes for Environmental, Social and Governance investing, or ESG, is not a substitute for industry expertise, as Chesapeake demonstrated in 2011 and 2012. There was no one on Chesapeake’s board who had leased an acre or drilled a well—no one who could challenge CEO Aubrey McClendon. Or, for a current example, a soap company executive appears to be the closest industry expertise on the board of a money-losing refinery—no one apart from the CEO has refinery expertise! What were the recommendations by ISS and Glass Lewis?
Does the issuer have recourse? No. But out of frustration and long study, the SEC is considering a regulation that would provide corporations a maximum of 48 hours to respond to proxy advisory firms proposed recommendations. Corporations could point out errors in fact to the advisory firms’ statements but, of course, could not force the firms to withdraw recommendations or otherwise restate their conclusions.
Published performance audits of ISS and Glass Lewis would be helpful both for investors and issuers.
ISS and Glass Lewis are the Siskel and Ebert of their business but have it better than any critic or any sportswriter because they are paid by both the moviegoers and the producers alike. They are paid twice to employ cheap labor to “analyze” thousands of proxy statements to issue opinions for which they accept no responsibility. Unlike with Siskel and Ebert, there are antitrust concerns for the two advisors with their 97% market share. Privately owned, the economic performance of the firms is masked. But the hallmarks of monopolistic behavior are high prices and lower levels of service than are found in competitive markets. There is a market opportunity here.