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Jim Allen: Is the SEC Jeopardizing Financial Analyst Independence

This opinion piece by Jim Allen, head of Americas capital markets policy at CFA Institute, first appeared on the Institute’s blog on February 25, 2020.


In recent weeks the Securities and Exchange Commission (SEC) has proposed regulations that in our view will undermine financial analyst independence. As an organization with long-standing leadership on analyst ethics and need for professional independence, we, CFA Institute, see great danger to markets and shareowner governance with the release of SEC’s proposals, “Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice.”


Of specific concern are the provisions that would require financial analysts who provide proxy-voting recommendations to preclear their full reports and opinions with issuers, not once, but twice. First to spot issuer objections to facts used, and second to confirm whether the proxy firms addressed issuers’ concerns.


Perhaps more concerning is a proposed further step. If an analyst or firm do not satisfy an issuer’s objections, the issuer can force inclusion of its rebuttal in the final report. This would be a clear violation of long-standing professional analyst standards. It would destroy analyst freedom and violate the right of investors to contract for independent advice services. We would go so far as to say it infringes on free speech.


The proxy process is the heart-beat of shareowner rights and of a balanced corporate governance system. Honest and unconstrained analyses and opinions of expert proxy analysts have become vital to this framework. Customers want, and pay for, that independent review. The SEC proposal would threaten both the proxy analysts and users of the advice with violating securities laws and fiduciary duties if they create or use proxy voting analyses and recommendations that are based on fraudulent or misleading “facts.” This would ensure a protracted argument each time an issuer does not like a proxy-voting recommendation, by encouraging its framing as a factual inaccuracy.


US founding fathers believed everyone is entitled to their own views and interpretation of the facts. Free speech demands nothing less. Yet, proxy analysts and investment advisers are in danger of being forced to relinquish editorial control, privilege, and judgement to conflicted third-party issuers. Clearly, we do not believe this is the SEC’s intention nor its objective. Yet the practical danger is that unhappy issuers can block, challenge, and try to enjoin any vote recommendations that fail to meet with their satisfaction. We could hope for an issuer’s forthright use of the proposed rule, but expectations are that routine claims of factual error will arise whenever the proxy-voting outcome is in the balance.


We also object to the administrative process related to this proposal. Even SEC Commissioners note the limited and inadequate regulatory process given to these proposals when they were introduced. Among the shortcomings were the lack of a proper cost/benefit analysis, no details on proxy advise error rates prompting this proposal, and the rejection of the near-unanimous views of investors who are actual customers of the proxy advice services.


Capping all of this off, are the distortions being circulated by supporters of the proposal. It is troubling enough that our primary securities regulator features letters of support from dubious cadres of retail investors. Making matters worse, though, are the questionable TV ads company lobbyists have sponsored that include highly debatable claims that 80% of retail investors support these proxy adviser reforms. We find it hard to believe 80% of retail investors even know this industry exists, not to mention that their mutual and exchange-traded funds use these entities to efficiently vote on their behalf. We also see the SEC’s apparent acquiescence to regulatory capture by public companies’ attempt to stymie proxy analysts and their important services as short-sighted. Things didn’t work out well for issuers or investors the last two times issuers were able to influence the presumed independent views of investment analysts, and we have both the Sarbanes-Oxley Act and Dodd-Frank Act to remind of those problems.


Correcting factual errors in proxy-voting advice is welcome. And we agree it is an investment managers’ duty to use accurate information when voting proxies in the best interests of their customers. But we do enormous damage to the honesty and integrity of markets when we let issuers curb negative advice or subvert unfavorable recommendations under the pretext of factual errors. These proxy analysis proposals from the SEC will give issuers this kind of authority. It is a direction we should all reject.

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