Council of Institutional Investors warns HR5311 would weaken governance in US public companies to the detriment of investors
Pension funds and other major institutional investors are fighting proposed legislation that they fear may severely restrict the ability of proxy advisers to fulfill their roles in the proxy voting process. The bill, HR5311, was introduced on May 24 and began the process of being amended by the House Committee on Financial Services on June 16.
If the bill, commonly known as the Corporate Governance Reform and Transparency Act of 2016, gets passed into law, it would require proxy advisory services to submit to a strict registration process with the SEC that would entail filing an application describing its methodologies for developing proxy voting recommendations, any potential or actual conflicts of interest related to the proxy adviser’s ownership structure and whether or not it has a code of ethics, as well as adequate financial and managerial resources to be able to consistently provide proxy advice based on accurate information. The bill would grant the SEC the authority to suspend or revoke a proxy adviser’s registration if the SEC decides this information hasn’t been provided to its satisfaction.
The proposed bill is the most recent expression of allegations that members of the US Chamber of Commerce and other business advocacy groups have made about the extent of influence proxy advisory firms may have on institutional investors voting their proxies. These allegations have escalated in recent years as investors have gained an advisory vote on companies’ executive compensation plans and as shareholder activism in general has grown.
In a letter of opposition sent to the House Committee, the Council of Institutional Investors (CII) voices concern that tighter regulation of proxy advisers would hurt investors and that ‘the bill could weaken public company corporate governance in the US, lessen the fiduciary obligation of proxy advisers to investor clients, and reorient any surviving proxy advisers to serve companies rather than investors.’
Timothy Smith, director of ESG shareholder engagement at Walden Asset Management in Boston, says his firm isn’t arguing that proxy advisory services don’t need some updating or checks and balances. ‘But if you read this bill, it [is clear it’s] hugely prescriptive, micromanaging to the extreme,’ he explains. ‘It would really block the work proxy advisory services are doing.’
The Society for Corporate Governance (formerly the Society of Corporate Secretaries and Governance Professionals) publicly supports HR5311, which has raised concern among some investment firms. In addition to sending its own letter to the House Committee on Financial Services, as numerous pension funds have done, Walden sent a letter to the society, thinking it important that it hear from investors that regularly engage with corporate secretaries.
Most corporate secretaries are well-enough informed about how the proxy process works to ‘know full well that ISS or Glass Lewis don’t commandeer the votes of their clients,’ Smith says. Walden’s appeal to the society is partly to make sure its leaders are aware ‘they’re working with folks [such as the Chamber of Commerce] who have a much larger campaign in mind’, which is to counter the efforts of major investors pushing to vote proxies not only on the basis of financial performance metrics but also on projected social and environmental impacts of business decisions, Smith explains.
The Society for Corporate Governance didn’t respond to a request for comments in time for inclusion in this article.
At the heart of the long-standing tension between issuers and proxy advisers is resentment among issuers that proxy advisers too often don’t agree with their executive pay plans and side with activist investors more often than with incumbent boards and management in proxy contests.
Francis Byrd, founder and CEO of Byrd Governance Advisory, believes proxy advisers ‘have been trying to respond to issuer concerns about actual mistakes and the need for corrections in their analysis.’ He also rejects the allegations of undue influence that proxy advisers have on voting results, citing increased efforts in recent years by investors to form their own governance teams and take proxy voting more seriously.
And the largest firms, such as BlackRock, State Street and TIAA, having seen a wide range of executive compensation plans put forward over the years, now ‘have more experience and understanding to be able to refine proxy voting guidelines for the institutions they work for,’ Byrd says. There should be more effort to encourage that evolution to continue rather than focus on getting proxy advisers to be more pro-management, he adds.
Stricter regulation, which could result in the SEC taking issuer complaints of bias against them more seriously when weighing proxy advisers’ registration applications, could also encourage proxy advisers toward more self-censorship when making voting recommendations, Byrd warns. He further cites the potential for unintended consequences over the longer term if increased regulation drives proxy advisers out of business. More institutional investors have been staffing up to be able to better determine what sort of voting guidelines they should have, partly in response to pressure from current and prospective customers asking about how various issues are being considered, how votes are cast and whether votes are being audited properly every year, he says.
‘If there are no proxy advisers [a few years from now], then the only way to prove you’re independent of the portfolio companies will be to vote against a larger percentage of management proposals,’ says Byrd. ‘Otherwise, how do you demonstrate you’re independent? It’s not the advice you receive because that’s been taken off the board. What’s left? We vote against management.’
He says he can foresee proxy votes becoming much more by rote, with a loss of opportunity for issuers to engage with investors, whose staff will have become overburdened in the absence of research they used to get from proxy advisers.