Regulating Proxy Advisory Firms

A proxy advisory firm reviews and analyses matters (be they issuer or shareholder proposals) put forth for a vote at shareholders’ meetings. It then makes voting recommendations on such matters to its clients, which are usually institutional investors. These matters range from the remuneration report, to the election of directors, to M&A transactions that involve a voting decision.


In Australia there are, in effect, four proxy advisory agencies:


1. Institutional Shareholder Services (ISS),

2. CGI Glass Lewis,

3. Ownership Matters, and

4. The Australian Council of Superannuation Investors (ACSI)


In addition, it is understood that Manifest, a UK proxy adviser, distributes its UK derived reports via Sirus. 


Each has their own guidelines, but ISS, Glass Lewis and Ownership Matters refer to ACSI’s guidelines while ACSI utilises analyses undertaken by Ownership Matters.


Since the non-binding vote on the remuneration report became effective from 2005, there arises, during and at the end of every proxy season, a chorus of protestations by directors leveled at the power and/or competence of proxy advisers. 


Interestingly, that chorus of disapproval appears to have become more muted since the two strikes law was introduced.  Directors were surprised, we think, to find the proxy advisers as allies in their dislike for the two strikes law.  And in accord with the recommendations of those proxy advisers, the number of strikes against the universe of companies covered by proxy advisers has been few since its implementation.  Indeed, it has been predominately companies not covered by proxy advisers that have suffered remuneration report voting strikes.


We have written about proxy advisers before (see HERE and HERE).  Our articles are supportive of the role proxy advisers play.  They help bring to institutional investors a comprehensive knowledge of market practice. This is not to say that mistakes are not made, but in our experience the Australian arms of the proxy advice firms seek out the company’s perspective if something seems awry, within the time constraints that they have.  It is probably these time constraints, plus the complexities of the proxy lodgement process, that hinder quality of proxy advice and vote outcomes in Australia more than other factors.


Still, there are some that are unhappy with the state of proxy advice, and there is bound to be a degree of validity to their concerns.  Therefore, it may be instructive to see how others are tackling the issue.


The most recent regulator considering action is the Canadian Securities Administrators (the CSA).  In June they requested comments from market participants on concerns raised about services provided by proxy advisory firms and their impact on Canadian capital markets in order to determine if, and how, Canadian securities regulators should address these concerns.


Concerns With Proxy Advisory Services


The CSA notes some market participants citing the potential influence of proxy advisory firms over vote outcomes and corporate governance, combined with the possible negative impact of conflicts of interest and lack of transparency, as support for greater regulatory oversight of proxy advisory firms. The Consultation Paper also notes critics arguing that possible risks to market integrity are greater because of limited competition in the proxy advising industry.


The Consultation Paper identifies the following specific concerns raised by market participants with respect to proxy advisory services. (Our comments on each point follow in italics).


1. Potential Conflicts of Interest: The Consultation Paper notes that a conflict of interest may exist if the proxy advisory firm provides voting recommendations to institutional investors for governance matters for which the same firm is providing consulting services to the issuer.

GA: None of the Australian proxy agencies do this in Australia.  However, there may still be conflicts of interest that arise from either ultimate ownership, or the provision of other services (such as advocacy services).


2. Lack of Transparency: The Consultation Paper also notes concerns relating to the lack of disclosure about how proxy advisory firms arrive at their voting recommendations and of public disclosure of the actual report.

GA: In Australia this is a problem.  Some of the agencies have difficult or impossible to find guidelines. However, they will most likely send you a copy if you ask.  As for their report, their first duty is to their subscribers, but they will generally provide a copy to the issuer if asked.  They do not make reports available to the “public”.


3. Inaccuracies and Issuer Engagement: The Consultation Paper notes concerns raised by some issuers with respect to inaccuracies in proxy advisers’ reports and that such inaccuracies may lead to misinformed decision-making, particularly in the case of complex, controversial voting matters or “close vote” situations.

GA: This happens in Australia. Sometimes it is the result of misunderstanding tortured and convoluted prose in some issuer’s disclosures and sometimes it is the inexperience of the initial analyst preparing the draft.  But often it is a function of time pressure on the senior people who review and finalise the reports.  Anecdotally, on the basis of remuneration report voting recommendations since 2005, the extent of error is reducing.


4. Development of Corporate Governance Standards: Another identified concern was that proxy advisory firms may have become de facto corporate governance standards setters, without necessary expertise and transparency, and that issuers are compelled to adopt “one-size-fits-all” standards, which may not be suitable in specific circumstances.  

GA: We hear this in Australia too. The proxy agency governance guidelines are dynamic to an extent, undergoing formal review most years.  The most significant influence on these standards is the needs of their clients.  A proxy adviser with guidelines that fail to reflect the views of its subscribers will lose those clients.  Notwithstanding, the proxy firms also have a significant influence on their clients’ guidelines too.  Even if the proxy firms’ guidelines vary from some of their clients, some provide a detailed data breakdown via electronic platforms; this allows the larger (and often offshore) institutional investors to identify for themselves the companies that do not conform to their own specific standards. It is the fiduciary responsibility of those institutional investors who lodge their vote to do so via a governance standard that is in the ultimate interest of the beneficiary


5. Overreliance by Institutional Investors: There are concerns that institutional investors may rely too much on the vote recommendations provided by proxy advisory firms.

GA: We hear this in Australia too.  This may be more an issue with how institutional investors operate than the proxy advisers they employ.


Possible Requirements


The Consultation Paper indicates that the potential amendments in a new securities regulatory framework for proxy advisory firms could require them to have policies and procedures designed to identify and manage potential conflicts of interest and to separate proxy voting services from advisory and consulting services. The Consultation Paper suggests that the securities regulatory framework could also require increased transparency in the activities of proxy advisory firms, through disclosure of internal procedures, guidelines, standards, methodologies, assumptions and sources of information supporting vote recommendations. The amendments could also require proxy advisers to implement policies in order to deal fairly with comments received from issuers by allowing issuers an opportunity to review the reports and proxy advisory firms to respond to issuers’ comments prior to issuing a report.


While the Consultation Paper indicates that the preferred securities regulatory framework may be a stand-alone instrument, the CSA note that they considered multiple frameworks: a “designation” framework similar to that in place for credit rating organizations, a “certification” framework where an appropriate person would certify compliance with the specific requirements, a “comply or explain” framework which would require proxy advisory firms to comply with specific best practices or explain if they have not so complied, and “best practices guidance” where the CSA policy would provide guidance on best practices for proxy advisory firms.


Implications for Australia


So far Australia does not seem to have experienced, to any significant degree, the proxy firm issues identified in some overseas regimes.  Nevertheless, there are ways that the advisory practices can improve.


1. Institutional investors, issuers, and the proxy firms themselves need to maintain vigilance that conflicts of interest do not arise due to either ownership or conflicted service provision. 


2. While the debate regarding governance guidelines has been healthy, proxy firms could do more to make their guidelines available to issuers as well as their clients. 


3. Most issuers do not get a chance to discuss issues prior to publication. Issuers are in the dark as to what the final recommendation is until after the report has been sent out.  Unfortunately this is mostly a function of the economics of the advisory business.  Proxy advisers cannot charge enough to cover the cost of resources that would allow this to happen.  While issuers usually receive a report on request, it is not usual for issuers to receive a report as a matter of course.  In effect, some issuers may not be aware of an issue that has been festering over previous years finally blowing up into a “no” recommendation until it is too late to amend its remuneration policies. Companies need to be proactive, and as part of their investor relations function, engage with all proxy advisers.


4.  While inaccuracies are not common, they do occur. If provided with reports before the 10 days prior to the AGM that institutions are required to lodge their votes, the issuer can enlighten the market with an ASX release. As it stands, the inconsistency in report provision, and tight timing, make this a difficult task.


See the CSA Consultation Paper 25-401: Potential Regulation of Proxy Advisory Firms dated June 21, 2012 (the Consultation Paper) HERE


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