Founder’s Edition, by Joseph Neu
Investors and corporates need to know about conflicts of interest when proxy advisory firms team up with activist investors against management.
The former CFO of a company that successfully defended against an attack by an activist investor shared some key lessons learned from the experience at a NeuGroup meeting last week. Here’s a big one:
- Management at even the most shareholder-friendly corporations must court passive investors to counter the inherent power of proxy advisors that support the activists.
A powerful duopoly. An editorial in the Wall Street Journal on Monday highlighted the power of the proxy/corporate governance duopoly. It reveals:
- Institutional Shareholder Services and Glass Lewis control 97% of the proxy advisory market.
- ISS provides recommendations to 2,239 clients, including 189 pension plans, and executes 10.2 million ballots annually on their behalf.
- Glass Lewis, which is owned by the Ontario Teachers’ Pension Plan and Alberta Investment Management Corp., has more than 1,300 clients that manage more than $35 trillion in assets.
More: “Studies have found that the two firms can swing 20% of votes in proxy elections. An American Council for Capital Formation review last year found that 175 asset managers with $5 trillion of assets voted with ISS recommendations 95% of the time. Activist hedge-fund investors often enlist the proxy firms to shake up management, for better or worse.”
SEC scrutiny. This power has invited scrutiny from regulators. On November 5, the SEC voted to propose amendments to its rules governing proxy solicitations “to enhance the quality of the disclosure about material conflicts of interest that proxy voting advice businesses provide their clients. The proposal would also provide an opportunity for a period of review and feedback through which companies and other soliciting parties would be able to identify errors in the proxy voting advice.”
Allegations made by companies include:
- Disparity in governance ratings given to firms that pay ISS or Glass Lewis for consulting vs. those that do not.
- Conflicts of interest when proxy advisors are paid by activist investors or other institutional investors with an agenda.
- Lack of adequate means to dispute proxy advisor recommendations and even to correct factual errors.
- Poor transparency on shareholder vote counts, including point-in-time ownership and associated voting rights.
Of course, corporate managements only have themselves to blame if they don’t hold themselves accountable to governance standards—and increasingly to environmental and social standards for corporate behavior (E, S and G).
- Still, companies that do all they can to be good corporate citizens and look out for shareholders (and all stakeholders) should expect a fair hearing.
Don’t wait. The best advice is not to wait for a proxy battle to tell your positive story. “We had heard that good investor relations was to be proactive to passive shareholders,” the former CFO speaking to our members said. Not only IR, but the C-suite needs to meet regularly with investors to share the company’s business strategy along with its ESG story. This is the best way to counter the proxy duopoly.