Harvard Law School urges boards to battle back against proxy advisors

Photo courtesy of NHS Confederation on Flickr

Photo courtesy of NHS Confederation on Flickr

Rob Swystun, Pristine Advisers

Harvard Law School believes boards of directors of public companies should minimize the role of proxy advisors.

This was evident in the school’s recently published article Boards should minimize the role of proxy advisors (they have a real knack for titles over at Harvard, apparently), written by James Woolery, deputy chairman of Cadwalader, Wickersham & Taft LLP.

Woolery says shareholders need to realize that proxy advisors aren’t necessarily motivated to provide value to the companies they make recommendations on. And because of this, boards should challenge proxy advisors, particularly when their conclusions don’t increase long-term shareholder value or when those conclusions aren’t supported by facts.

To ensure that proxy advisor recommendations are balanced and accurately reflect shareholder interest, Woolery makes his own recommendations.

  1. Support the effort to require registration and regulation of proxy advisors. The Subcommittee on Capital Markets and Government Sponsored Enterprises in the House Committee on Financial Services is still actively considering the case for oversight of advisors so if you have any proxy advisor horror stories, do share. And don’t forget to let the Securities and Exchange Commission (SEC) know, too.
  2. Aside from lending support to government initiatives, also lend support to the initiatives of business organizations like the U.S. Chamber of Commerce and Business Roundtable, who are advocating for legislation to combat bad practices in the proxy advisory industry. The Conference Board and the National Association of Corporate Directors also have initiatives in place to lobby for legislation.
  3. Be skeptical of the advisory firms’ work product and challenge them when the product is shoddy. Discuss procedures and results with the firms, ensure they understand relevant facts applicable to your company and, if the firms’ work doesn’t reflect those facts, communicate directly with your shareholders so they understand your position and your reasons for disagreeing with the proxy advisors, if that’s the case. (Remember that they’re your shareholders. The proxy advisors are just middlemen.)
  4. Also keep in mind that to be effective, a shareholder campaign should start early (before there is a debate with proxy advisors), and must involve senior members of company management, plus the board. Even better, company leaders should communicate with shareholders on an ongoing basis to mitigate the influence of proxy advisory firms.

Why companies need to fight back

An estimated 75% of all shares of public companies are held in a managed fund or institutional account. This opens the door for what Woolery calls short-term focused activist investors and an increasingly third-party-advised stockholder base that relies heavily on proxy advisory to sway shareholder sentiment.

The oligarchy of Institutional Shareholder Services (ISS) and Glass Lewis control 97% of the market for proxy advice, reportedly affecting 38% of votes cast at U.S. public company shareholder meetings, which impacts how companies manage and deal with their shareholders.

Both firms wield disproportionate influence over public companies, considering that both firms are reportedly understaffed and therefore establish generic voting recommendations and (more importantly) profit from activities involving material conflicts of interest. For example, they market their advisory services to the same companies for which they provide proxy recommendations. And the rotten cherry on this sour sundae is that Glass Lewis is owned by an activist fund with an agenda.

Unhealthy Influence

Maybe the most frightening thing about proxy advisory firms (especially the two big dogs) is that they’re not regulated.

Former chairman of the Securities and Exchange Commission Harvey Pitt said it best when representing the U.S. Chamber of Commerce before a June 5, 2013 meeting of the House Subcommittee on Capital Markets and Government Sponsored Enterprises:

Proxy advisory firms are unregulated; more significantly, they operate without any applicable standards—either externally imposed or self-imposed—and do not formally subscribe to well-defined ethical precepts, while cavalierly rejecting private sector requests for transparency in the formulation of their proxy advice, as well as increased accountability for the recommendations that they make. This lack of any operable framework for such a powerful presence on economic growth and corporate governance is unprecedented in our society.

Subcommittee Chairman Rep. Scott Garrett added that “proxy advisory firms have increasingly teamed up with unions and others to push proposals that are generally immaterial to investors and often reduce shareholder value. “Proxy advisory firms have increased the costs of doing business for many public companies and disincentivized private companies from going public, all without a corresponding benefit to investor returns.”

If proxy advisors have got you down, you don’t have to take it. As reported in places like The Wall Street Journal, a lot of big institutional shareholders are breaking away from ISS and Glass Lewis and have started doing their own independent analysis to figure out how best to vote their proxies. You can do your part in helping this along with committed shareholder engagement.


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