Pension funds lead push for proxy adviser oversight

Pension funds are pushing to require proxy advisory firms to register with the Securities and Exchange Commission as investment advisers.

Michael McCauley, senior officer-investment programs and governance of the $167.8 billion Florida State Board of Administration, Tallahassee, is among those calling for registration.

“There is very little to no regulation in this space,” Mr. McCauley said in an interview.

Amy Borrus, deputy director of the Council of Institutional Investors, Washington, agreed with registration. “We believe all proxy advisers should register and we've told them that.”

William R. Atwood, executive director of the $12.9 billion Illinois State Board of Investment, Chicago, has a more tempered view. “I don't have a strong opinion” on regulating the firms,” Mr. Atwood said in an interview. “They are obviously not buying and selling securities but they are managing an asset of the fund” — proxy votes, Mr. Atwood said. “They are vested with a great deal of authority over an asset of investors.”

The CII “believes that proxy advisory firms should register as investment advisers under the Investment Advisers Act of 1940,” according to a written statement by Ann Yerger, CII executive director. Ms. Yerger's statement was submitted at a hearing by the Subcommittee on Capital Markets and Government Sponsored Enterprises of the House Committee on Financial Services June 5.

In a June 13 letter to the SEC, Ms. Yerger urged the SEC “to gather empirical data on the proxy-voting practices of investment advisers,” aimed to “provide a factual basis for potential consideration of reforms.”

Proxy advisers “are important players in the market and they should be regulated,” Ms. Borrus said. “We don't think their methodology should be regulated, but there should be oversight for their services.”

Lynn Turner, a trustee of the $43 billion Public Employees' Retirement Association of Colorado, Denver, said in testimony to the subcommittee: “I believe proxy advisory services should be subject to SEC oversight. The SEC should establish a regulatory scheme that makes sense and can achieve the desired result.

“While some have called for all proxy advisory services to register as investment advisers, I am not sure that regime is designed to adequately (or smartly) address regulation of proxy advisers who typically do not give investment advice,” said Mr. Turner in prepared remarks. “Rather, regulation of proxy advisers should ensure they fulfill a fiduciary obligation to recommend votes in a manner that is in the best interest of investors” and “remain free of conflicts,” said Mr. Turner, a former SEC chief accountant, former senior executive and head of research of proxy adviser Glass Lewis & Co. LLC and a managing director of LitiNomics Inc., a Los Angeles-based economic and forensic consulting firm. He couldn't be reached for additional comment.

Mr. McCauley, who testified at the hearing, said in the interview that some people “argue (proxy advisory firms) shouldn't be put under that umbrella” of SEC registration because they “don't buy and sell securities for clients.” But because they “provide analysis and recommendations on how to vote,” Mr. McCauley said, “they make recommendations that impact valuation, that are implicitly tied to the underlying shareholder value.”

Registration would help address the issue of conflicts of interests of proxy advisory firm, he said.

Institutional Shareholder Services Inc. “is the poster child” for potential conflicts, because it provides proxy advisory services to corporations as well as to institutional investors, Mr. McCauley said.

“Glass Lewis also gets painted with the conflicts brush because they are owned by the Ontario Teachers' Pension Plan,” he noted. The Toronto-based plan oversees C$129.5 billion (US$126.73 billion) in assets.

As Mr. McCauley said in his testimony, “Registration would establish important duties and standards of care that proxy advisers must uphold when advising institutional investors. Additionally, the mandatory disclosures would expose conflicts of interest and how they are managed, and establish liability for firms that withhold information about such conflicts.”

Mr. McCauley said he was not finding fault with either Glass Lewis or ISS, just pointing out the potential for problems. He added that he believes ISS and Glass Lewis “have made pretty good disclosures.”

In regard to ISS, Mr. McCauley said, “We've never become aware or had any knowledge of a conflict on the corporate side impacting its analysis.”

No proxy advisory firm was invited to testify at the hearing.

Of the major proxy advisory firms, Rockville, Md.-based ISS, a unit of MSCI Inc., New York, is registered, while Glass Lewis, based in San Francisco, is not.

“ISS has been a registered investment adviser for more than a decade,” Cheryl Gustitus, ISS executive director, head of global communications, said in an e-mail response to a request for comment. We believe it is important to operate under the same SEC oversight as many of our clients, so we voluntarily registered and still believe that it is best practice for a proxy adviser to be registered.

“Contrary to some of the testimony (at the hearing), ISS has well-established conflict management processes and procedures in place,” Ms. Gustitus said. “Additionally, we disclose our corporate client list to any institutional client that requests it, so that they are aware of any potential conflict. As a commercial entity with subscribing clients, our disclosure responsibility is to our clients.”

Robert McCormick, chief policy officer at Glass Lewis, said in an e-mail response to a request for comment: “We do not believe registration is relevant to the proxy advisory business, since proxy advisers do not provide investment advice, execute trades or manage any client money nor do we think it would resolve the main concerns raised by companies regarding conflicts, transparency and quality.”

“Glass Lewis provides specific, prominent disclosure of all conflicts, including with OTPP,” Mr. McCormick said.

The disclosure is applied when “an employee of Glass Lewis or any of its subsidiaries, a member of (its research advisory) council, or a member of Glass Lewis' strategic committee serves as an executive or director of a public company.”

In addition, he said the disclosure includes when “an investment manager customer is a public company” or “a Glass Lewis customer submits a shareholder proposal or is a dissident shareholder in a proxy contest.”

Also, Glass Lewis disclosure covers companies “in which OTPP holds a stake significant enough to have publicly disclosed its ownership.”

The Florida board votes its own proxies based on its guidelines, Mr. McCauley said. It uses ISS, Glass Lewis and Manifest Information Services Ltd., a Witham, England-based service, to assist in research, Mr. McCauley said.

At the Illinois board, Mr. Atwood said ISS votes ISBI's proxies. “We incorporate their guidelines into our policies,” Mr. Atwood said. “ISS advises us how they are voting 10 days prior to the (annual meeting) and we have the ability ... to change it. But we don't do that very often.”

Among other firms that provide proxy advisory services, the SEC registration of Marco Consulting Group Inc., Chicago, includes its proxy-voting services in addition to its pension investment consulting.

Egan-Jones Proxy Services' parent company, Egan-Jones Ratings Co., is registered with the SEC as a nationally recognized statistical rating organization for its credit-rating services, not for proxy advisory services. “We are registered in a different way,” said Kent S. Hughes, managing director, Egan-Jones Proxy Services, Haverford, Pa. “We are part of the (credit) rating company. We are still subjected to SEC inspections.”

“I don't see why any of us need to be registered as investment advisers,” Mr. Hughes said.

Kevin Callahan, SEC spokesman, and David Popp, communications director, House Committee on Financial Services, didn't respond to requests for comment.

Harvey Pitt, former SEC chairman testifying at the hearing on behalf of the U.S. Chamber of Commerce, said, “More regulation is not the answer ... the chamber believes that Congress and the SEC should encourage public companies, investors and proxy advisory firms to engage in the necessary dialogue to create a system that will impose transparency and accountability on proxy advisory firms. This dialogue should build on other positive trends in the proxy system, including greater communication between companies and shareholders, and enhanced due diligence by asset managers in executing shareholder votes.”