Op-Ed:Regulating Proxy Advisors is Anticompetitive, Counterproductive, and Possibly Unconstitutional
Updated: Sep 27, 2018
This post originally appeared on March 2, 2018 on The Harvard Law School Forum on Corporate Governance and Financial Regulation and was written by Nell Minnow.
A party line vote in the House of Representatives approved H.R. 4015,  titled, with typical Capitol Hill oxymoronic newspeak the “Corporate Governance Reform and Transparency Act of 2017.” said in a statement that while proxy-advisory firms play an important role in advising clients. This bill is not just stupid and completely contrary to its stated purpose of promoting competition; it is probably unconstitutional. The proxy advisory firms, led by ISS (which I helped to found in 1986 as its first general counsel, ran for one year and then left in 1990) and Glass-Lewis, analyze public company proxy issues like executive compensation and board effectiveness and make recommendations to their clients, large institutional investors like mutual funds and pension funds, suggesting votes for or against the proposals on the proxy card from corporate management and sometimes from other investors. I have observed this industry from the beginning, but left it 28 years ago. Since then, I have been a proponent and dissident who has failed to gain the support of the ISS analysts more often than I have been successful, and I have had the opportunity to develop some objectivity. No one is required to use their services and many institutional investors do not. No one is required to vote according to their recommendations and the data show that the more complex and controversial the issue, like contested business combinations, the less likely the clients will follow their recommendations, though they do read and appreciate the underlying analysis. So, what we have is the most sophisticated institutional investors in the world, with access to the greatest resources for researching portfolio companies ever assembled, making a free market decision to pay for outside, objective analysis, no different from other securities analysis reports they may purchase, to help them better understand their holdings and better meet their obligation as fiduciaries for the people whose money they are investing to respond to corporate initiatives appropriately. There is no monopoly and no requirement to buy these services; they can buy from one, all, or none. There could not be a better example of market efficiency or a worse argument for government interference. And yet, here we are. Rep. Sean Duffy, R-Wis., sponsor of the bill, says it is necessary because the proxy firms are “susceptible to conflicts of interest.”  Financial Services Committee Chairman Jeb Hensarling, R-Texas, said in the same statement that his panel discovered “numerous instances whereby the two largest proxy-advisory firms (Institutional Shareholder Services and Glass Lewis) have issued vote recommendations to shareholders that include errors, misstatements of fact and incomplete analysis.” Assuming arguendo that both statements are true, that is still no basis for government intervention, especially from conservatives who are supposed to be ultra-sensitive to intrusive action by government that restricts or impedes the free market. It should be left to the consumers to decide whether the product is not reliable, though carelessness or conflicts.
The bill requires proxy firms to register with the Securities and Exchange Commission, disclose potential conflicts of interest and codes of ethics, and make public their methodologies for formulating proxy recommendations and analyses. Again, this should be left to the market, and certainly the government has no right to tell a business that it has to disclose its proprietary methodologies. The bill would also require the proxy advisory firms to submit their analyses to the companies before sending them to clients and, if the company objects to the analysis, to include its rebuttal in the report. ISS developed the proxy advisory business because as we were trying to sell another product entirely institutional investors kept telling us that what they wanted was an independent assessment of management and shareholder proposals. At the time, many of them subscribed to the IRRC reports, which analyzed proposals but did not give recommendations. They wanted advice that was knowledgeable and objective, and so that was the product we developed. When I left ISS in 1990, both our employees and our clients were in the low two digits. The fact that it became such a powerful international presence in the two decades that followed demonstrates just how badly its customers wanted those products. The fact that other substantial competitors have entered the market shows that there are very low barriers to entry. The firms often disagree with each other. They are transparent and highly competitive about their different approaches, and each does not hesitate in sales calls to explain in detail why their product is superior. Most clients choose the firm that best suits their own policies the rest prefer to do business with more than one and compare the recommendations to assist them in arriving at their own decision. This is exactly what markets do best and there is no reason to interfere. Corporate executives claim that these firms are too influential, a strange objection to make when they support management recommendations in the overwhelming majority of cases. In the small fraction where they recommend against management recommendations, it is important not to confuse correlation with causation. Clients follow because they agree that in those instances the executives are proposing matters that are not in the shareholders’ interest. There is no evidence that sophisticated institutional investors are abdicating their obligation as professionals and fiduciaries to consider these issues as carefully as they do their buy-sell-hold decisions, also based in part on the opinions of independent analysts. Just as two investors can look at the same data and make different conclusions about whether to buy, sell, or hold, they can look at a proxy advisory recommendation and make a different decision about whether to vote yes, no, or abstain. Corporate executives and Republican Congressional representatives seem stung to discover that investors may not believe management is acting in their best interests and believe that the answer is not to change their behavior or improve their communication but to smother outside analysis of their proposals. If executives object to the recommendations made by the proxy advisory firms, the answer is for them to respond directly and substantively in their communications with their shareholders, not to cut off outside assessment. The core founding principle of our democracy is freedom of expression. The recent Citizens United decision by the Supreme Court emphasized the importance of unfettered speech, justifying corporate participation in the political process explicitly through its accountability to investors because shareholder objections raised through the procedures of corporate democracy can be more effective today because modern technology makes disclosures rapid and informative (citation omitted). The core founding principle of our economy is to allow the market to determine the value of goods and services. Infringement of either free expression or the free market should only be done in the most extreme circumstances and no such justification is present here. Most significantly, consideration of this bill included no assessment of any kind of its potential for unconstitutional infringement of First Amendment freedom of speech and of the press. The proxy advisory firms publish reports that include facts, data, analysis, and opinion along the lines of a newspaper or magazine. No one is required to buy their reports or follow their recommendations. The bill’s requirement that these reports include rebuttals from the corporations they are analyzing would be allowing the government to direct the content of their publications, like requiring the New York Times to publish op-eds by the individuals in their news stories. A pending Supreme Court case may cast some light on this issue. National Institute of Family and Life Advocates v. Becerra concerns a requirement imposed on “crisis pregnancy” (anti-abortion) clinics. The California Reproductive FACT Act provides that staff of these facilities must inform the women who consult them that state-funded prenatal care, family planning, and abortion services are available by calling the county health department. If the Court rules that this exceeds permissible disclosure requirements like ingredient and nutritional labels on food or financial disclosures and warnings in securities filings, it would be likely to apply to this substantive content as well.