BETHESDA, Md. -- Institutional Shareholder Services, which makes recommendations to institutional investors on how to vote on corporate proxy proposals and shareholder resolutions, is under pressure to make changes in the way it operates.
The American Society of Corporate Secretaries, a New York-based organization that represents about 2,500 corporations, has had two meetings with top ISS officials to discuss the organization's concerns about the way ISS, which has more than 500 institutional investors as clients, does business.
"They have great influence on the proxy process," said David Smith, executive director of the society. "When something is as important as the proxy process, it behooves a big, influential player to be responsible."
One of the more important concerns is the formula ISS uses to evaluate stock option plans, including the repricing of options, which has become highly controversial as a result of the stock market's recent sharp decline.
Other concerns expressed by the society include: ISS can be "rigid and inflexible," according to Mr. Smith, in the way it makes its recommendations; many companies don't get to see ISS' recommendations about their companies or get an opportunity to respond before recommendations are published; and ISS doesn't always have the correct profile of the companies it analyzes, including the name of the correct person to whom its report should be sent.
As an example of the latter complaint, Mr. Smith points out that at Atlanta-based Home Depot, the giant home improvement retailer, Bernard Marcus, the chairman and chief executive, also is listed as the corporate secretary. But Laurence Menter, the senior corporate counsel, is the person who handles the proxy information. ISS should make the effort to find out who is the correct contact at each company, without just looking at the name on the proxy statement, said Mr. Smith.
He added that in some cases, the industry codes ISS uses for companies are wrong and so companies are put in the wrong industry group.
As to the options evaluation formula, "the feeling is that it's applied in a rigid way," said Mr. Smith. "They just say (plans are) too dilutive and don't take other factors into account. They have a formula and either the company fits into the formula or it doesn't and there is no judgment brought to bear," he added.
Asked about the charge that ISS can be "rigid" in its evaluations, Howard Sherman, president and chief executive, said, "I think that's a minority view." However, he added, "We're paid by our institutional clients to analyze proposals. A simpler test of the effect of -- issuing or repricing -- stock options is the voting power dilution."
"When we moved to using our option pricing model it made great improvements in how we analyze stock option plans," he noted.
Mr. Sherman attended the two meetings with the society.
ISS is reviewing its policy on the repricing of stock options. Once an internal ISS proxy committee has made its decision, "if there is enough time before the next proxy season starts, we will circulate the report among several groups, including the society," to get their input, said Mr. Sherman.
"This is a very controversial, high-profile issue," he said, and one that ISS will approach with a great deal of care.
The society also wants ISS to expand the number of companies to which it sends draft analyses of its recommendations. Currently the reports go to all of the companies in the Standard & Poor's 500 stock index. Mr. Smith said, "all companies should have an opportunity to react (to ISS recommendations). A relatively small public company may not know that ISS is recommending against its plan." He added, "At least every company should see a final analysis."
Pat McGurn, vice president of ISS, who also attended the two meetings, said, "We cover 8,000 domestic companies. Given the workload in the proxy season, it's physically impossible for us to give every company a copy of our review."
He added, "If there's a proxy contest, a contested solicitation or a unique proposal, we will go to companies to get their response. We will go back and forth with them (for their input). We'd love to get our analyses out to more companies." "We're working . . . to make the final analyses available to a broader range of companies."
ISS plans to use the Internet to make its information available to more companies. "We're trying to get companies' e-mail addresses, as a faster way to get information to them," added Mr. McGurn.
ISS also plans to have a page on its Web site on which companies can enter the correct contact information.
The idea for the meetings actually came out of the annual meeting the society's members have with officials in the securities law division of the Securities and Exchange Commission.
"We just told them about our concerns," said Mr. Smith. "But we never asked the SEC to intervene and never said to ISS that we would run to the SEC if it didn't do everything we wanted."
"It was a friendly meeting," said Terry Gallagher, director of corporate governance at Pfizer Inc., New York. "We're trying to find a way to work with ISS. Their policies have been around a long time and we'd like to see them updated. It looks like we might be able to work something out, but it's very early in the process."
Mr. Sherman noted the meetings, "were very constructive and friendly. It wasn't a meeting of just gripes. There was a lot of support about what we and other groups are doing for good corporate governance.
"Most companies would rather not have to deal with any negative proxy votes. They want as much positive support as possible. But they also realize that the corporate governance movement is a good thing."