As the Biden administration works to reverse ideological policies of its predecessor, the Securities and Exchange Commission should uphold the practical policies enacted under former Chairman Jay Clayton. The SEC has long been a crown jewel among federal agencies, where pragmatic investor protection beats out parochial politics, and incoming chairman Gary Gensler should maintain this legacy.
The leading example concerns shareholder voting and the role of proxy advisers, mainly Institutional Shareholder Services and Glass Lewis & Co. Such firms give recommendations to asset managers on how to vote on many issues, from governance such as director elections and executive pay to topics of environmental and social significance.
Proxy firm champions, especially many index investors, say advisers deliver insight on topics that investors, especially indexers casting tens of thousands of votes annually, simply cannot afford to research on their own. Critics, such as the business community and many investors who prefer to do such research themselves, have long worried that the two firms dominate the market with sweeping powers, yet until now have been unsupervised and opaque.
The new rules, finalized last July, accommodate the tension between these views: They neither give critics all they wanted nor cripple the proxy adviser business as some feared. The SEC now requires proxy advisers to give their customers transparent, accurate and complete information to use in voting decisions.
They address serious problems at low cost. The biggest problems are errors advisers make in recommendations investors mistakenly rely on. In director elections, for example, they may report attendance records or gender incorrectly; on executive pay, they may report disputed figures; and they may be incorrect on the intricacies of any number of environmental or social matters.
The rules were years in the making, not the "midnight rule" that outgoing administrations try to cram down on successors. Origins of these rules date to a 2010 SEC concept release on the proxy system and roundtables held in both 2013 and 2018. The final rule reflects the staff's careful attention to the thousands of public comments received, especially the specific concerns of advisers. This a model of democratic governance. The details are straightforward.
First, advisers must disclose any conflicts of interest they face. Second, when the adviser gives a recommendation to a customer, it must also give it to the subject company. If a company responds to a recommendation, advisers must create ways for clients to get copies of the response in ample time before the related meeting. (These were concessions to the advisers: the commission considered adding a two-day pre-review and objection period.)
Proxy firms obeying these rules are exempt from the more onerous rules on proxy solicitations, which require informational filings and pose liability risks. ISS is suing the SEC over this, with the two sides disputing how the SEC has historically treated such advice. ISS rightly points out that proxy solicitations usually come from contestants, such as dueling director slates, but advisers do have a dog in each fight: They benefit from their recommendations being followed and suffer embarrassment or business loss otherwise.
The rule is a compromise whose effectiveness will be determined when the rules come into place in December of this year. Whether the rules reduce errors significantly or if problems persist remains to be seen. After all, even under the new rule companies face a tight window to make corrections and the advisers weren't bound to a correction process.
Troubling features of the system remain. ISS and Glass Lewis control 97% of the proxy adviser market, putting a powerful duopoly at the heart of shareholder voice. The two sway 6% to 33% of any given vote. Although they help indexers on shoestring budgets, they are stretched thin, too, with 1,000 to 1,200 employees advising on 20,000-40,000 meetings annually. It might be desirable for legal or market forces to disrupt such concentrated power, but the SEC's rules do not come close to such a showdown.
Mr. Gensler's SEC should not revisit this rule-making or withdraw its guidance and should defend the rule in court against ISS. Anything to the contrary would drain significant scarce resources and prevent the agency from addressing this critical subject that has been festering for years.
The winners in a delay would be the titans of ISS and Glass Lewis and losers would be the diligent shareholders of corporate America. The Biden administration will find plenty of rules that its core principles require changing, perhaps even some at the SEC. But this one, squarely focused on protecting investors, should not be one of them.
Lawrence A. Cunningham is the Henry St. George Tucker III Research Professor of Law at George Washington University and director of C-LEAF, GW's research program in corporate governance, based in Washington. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.