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The trouble with proxy advisors….

Is that everyone loves to hate them but, investors at least, can’t actually do their jobs without them. If we didn’t exist we’d have to be invented. So, what’s to be done?

Yes, true, that opening statement was an enormous over-simplification, but the time has come to properly upack all the arguments – simple and complex – surrounding corporate governance and stewardship practices, and in particular the role that proxy analysis plays.

The recently-announced public consultation on a series of “Best Practice Principles for Governance Research” is probably the best opportunity the investment and issuer community has had for some years to have a more balanced debated about the role of information in vote decision making.

Many pixels have been spilled in the past 5 years about the alleged crimes and ommissions of firms such as Manifest whose job is to provide investors with a coherent and objective analysis of the corporate governance practices of their investee companies. Having a vested interest in the debate we’ve spent a long time analysing those allegations, who is making them, understanding the conflicts of interest behind the accusations and, very importantly, how best to address them so that we can get on with the job in hand – serving our clients and ensuring their votes are getting the meeting and have been based on professional, high quality analysis.

Some of the assertions made by industry critics we can agree with – the market for governance research services IS, by any objective measure, dysfunctional. If, as a society, we are worried about 6 power firms in the UK controlling our heating bills or 3 audit firms dominating accounting assurance, then it really is cause for concern that two competitors control 97% of the market for proxy research services between them.

But leaving that aside for the moment, there are many areas where all the proxy research providers are in agreement:

  • the overwhelming bulk of allegations don’t stand up to objective scrutiny (or put bluntly they aren’t just plain wrong, they verge on libel);
  • many of the criticisms are little more than corporate grand-standing against accountability or scrutiny;
  • it’s easier for the critics of corporate governance to take pot shots at a small community which, relative to sell-side analysts, is less resourced, than it is to say anything directly to the shareholders i.e. let’s all blame the messenger.

To be fair to the issuer community, they are not at the root of the criticisms either. A forensic analysis of the most aggressive anti-governance research criticisms shows that it comes from: stock exchanges such as NASDAQ; trade/lobby associations such as Business Roundtable; and corporately sponsored business schools such as Stanford whose David Larcker churns out non-peer reviewed “working papers” which become entangled in wider thinking as “academic evidence” for the malign effects of using third party research to support voting decisions.

Much of the anti proxy analyst rhetoric is also not UK or European in its orientation, it largely comes from the US where shareholders’ rights are substantially less than our even our Victorian forebears would have considered necessarily democratic.

Let’s consider a few of the accusations:

Assertion: NASDAQ has inferred that corporate governance is an “increasingly expensive distraction” which is putting companies off from going public (Wall Street Journal Opinion October 7, 2013).

Our Comment: Really? Corporate governance is a “distraction”? Not an essential protection for the providers of capital? This surely couldn’t have something to do with the SEC’s scrutiny of the problems of high frequency trading and stock exchange outages, could it?

Assertion: Proxy advisors make recommendations (so wide spread there are too many references to cite).

Our Comment: No, SOME proxy analysts make recommendations, not all. In any event, even if they do, recommendations are not binding on their readers, they are a point of view.

Assertion: Fund managers “outsource their thinking/voting/responsibility” to proxy firms.

Our Comment: Fund managers outsource a great number of services to support their professional activities, that doesn’t mean they have outsourced their responsibility. If they have then there are remedies that should be enforced to ensure that doesn’t happen. BP outsourced exploration and extraction in the Gulf of Mexico, but that hasn’t absolved them of responsibility for the subsequent oil disaster. Are investors different? Yes, concepts of fiduciary responsibility are different between the US and UK/EU, however both markets have enforcement regimes for fund manager conduct of business.

Assertion: Proxy analysts operate behind closed doors.

Our Comment: Clearly the corporate advisors are too busy criticising proxy analysts to bother reading our websites where they will find plenty of information about conflicts of interest, research methodologies etc. However, we would say at this point – proxy analysts serve their clients, the investors and asset owners. It is they that we are accountable to – as well as to the laws of the land, obviously. If issuers want to understand why shareholders vote the way they do, the answer is simple – pick up the ‘phone and talk to the investor (or outsource that to someone who’ll do it for you if you haven’t got the resources – the proxy solicitation market seems positively crowded in comparison with proxy analysts). Yes, it is true that not all of us serve just investors and asset owners, and to be fair to our competitor, they are quite clear about their business model. However, given ISS’s market share, it would seem to suggest that shareholders are happy to accept what critics call a “conflicted model”.

Assertion: Proxy analysts won’t give us access to their reports before publication or talk to us.

Our Comment: They are right, we don’t share our research with anyone except our clients; neither would issuers be given such access by journalists and nor will sell-side analysts if they are operating to the CFA objectivity standards. The bad news for companies is that, sad to say, we’ve found more mistakes and issues with their filings and disclosures at a factual level, let alone any subjective opinions, than they have ever found with our research when we have let them had goodwill copies post-publication. What we have had in return are threatening letters and phone calls from lawyers and other advisors because CEOs are unhappy that we’ve managed to work out their total pay packet and the lack of any robust performance conditions. We know we have also suffered copyright abuse through mass redistribution of our work by companies to their highly-paid advisors –  because those advisors have told us.

Assertion: Proxy analysts should be “regulated”.

Our Comment: Our largest and most criticised competitor, ISS is already regulated by the SEC. So is that regulation working if there are still so many complaints? But pro-regulation critics forget that we are all already regulated – by the laws of the lands in which we operate and by our client agreement letters.

We would also say that analysing corporate disclosures does not constitute “investment research” because we are not making recommendations for the sale or purchase of shares. Rather we are giving a judgement, a point of view, on the quality of public disclosures made by a company and protecting shareholders’ rights under company law. As such, regulation under securities laws is entirely inappropriate and would be yet another step down the slippery slope which has seen shareholder protection become subservient to the market and its intermediaries.

What Manifest sees in all of this debate is a mass communication failure. Which is why Manifest has been a very active participant in the development of the Best Practice Principles for Governance Research. We see a need to make things much more clear, particularly where the lines of responsibility begin and end and to lay out exactly that our duties to our clients, the investors, are our utmost consideration. Our clients are the judge of our competence and they set the ground rules for what they want us to examine.

So what is the “trouble” with proxy advisors? In truth not that much, indeed the European regulator, ESMA, said they found no market failure (as opposed to any competition failure which they didn’t address). It’s a small industry which does its utmost to serve its clients in what is a very complex and constrained logistical framework. Although we are actively participating in the creation of the principes, Manifest believes that there are far bigger problems that need to be addressed in the proxy space – such as corrupted cross-border voting systems which regular readers will know we have a bit a of a thing about. Simply attacking free speech does nothing to address a problem which damages issuer and investor dialogue.

The anti-proxy analyst lobbying has been heavily skewed by vested issuer and adviser interests. Possibly investors don’t feel compelled to respond because they don’t share the issuers’ concerns. Unfortunately, even if they don’t, their silence doesn’t silence the critics.

The public consultation on the role of governance research is investors’ opportunity to make it clear who is the owner. So please, everyone, read the consultation closely, answer the questions, but before you do, if you are in any doubt as to the motivation or rationale behind the principles, ask questions before making assumptions. Issuers especially, if you don’t ask us, ask your owners, that’s what engagement is for.

Unless investors explicitly reject the McCarthy-ist witch hunt of the corporate governance community, their silence will be taken as a permissive consensus.

PS: Some readers may wonder why we have largely avoided the use of the term “Proxy Advisor”. That’s very simple, because, just like “fiduciary responsibility” in US and UK English it has a different legal meaning, as is explained in the consultation document itself.

Last Updated: 1 November 2013
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