3 days ago
Everyone Loves To Hate Proxy Advisors
In June, Texas passed Senate Bill 2337, which imposes obligations on proxy advisors to provide 'specific financial analysis for any recommendations related to 'nonfinancial' factors.' In July, ISS and Glass Lewis, the two predominant advisory firms, sought to have the bill declared unconstitutional and sued Texas on First Amendment grounds.
Why all the angst over proxy advisors? Why does everyone love to hate them?
The role of proxy advisors seems relatively straightforward. Institutional investors – pension funds, sovereign wealth funds, mutual funds, etc. – often own thousands of stocks and are asked to cast their votes in director elections and on many other issues each year, usually in the same timeframe from May to June. The investors hire the proxy advisors to do four tasks: accumulate data from all of these companies, ensure that data is accurate and in a consistent format, make recommendations on votes according to the investors' policies, and manage the operations of casting all of the votes.
But proxy advisors tend to draw ire around the world for several reasons.
First, they analyze many companies in a short period with a staff that has a range of experience. And sometimes they miss things, like in the recent case where advisors initially failed to identify key concerns in Wise's US listing proposal regarding an extension of dual-class shares until an investor highlighted the issue. Second, they have little accountability for, or regulatory oversight of, their recommendations since the investor technically makes the voting decision. Third, conflicts of interest exist when advisors are selling services to the companies that they are analyzing.
In the aforementioned Texas case, the reason for the ire was that the proxy advisors were making recommendations on 'nonfinancial' factors – things like climate issues or diversity – that ran counter to the views of some companies and politicians.
It is a challenging role. Most institutional investors hire proxy advisors to do their homework for them, although some larger investors also have in-house teams. Meanwhile, companies expect proxy advisors to quickly and thoughtfully understand and analyze their specific issues within short timeframes. On top of that, proxy votes have become increasingly politicized, particularly in the US, where environmental or social issues have become a lightning rod. It's no wonder that nobody is happy. But there are some fixes that, while requiring action from key players that may seem unorthodox, would improve the current situation.
Pre-disclosure of proxy votes
Many large pension plans and sovereign wealth funds (such as CalSTRS and Norges) already disclose their proxy votes on key issues before they happen. Instead of waiting until the last minute before the annual meeting to make their intentions known, they put their votes on their websites for all to see. If a smaller fund doesn't have the resources to do its own homework, rather than simply resorting to the recommendation of its proxy advisor, it can see how other funds it respects have voted. This practice both provides funds with sources of information other than the proxy advisors and gives them the ability to test the proxy advisors' conviction in a particular path.
Some of the largest asset managers are wary of pre-disclosure for regulatory reasons; a way forward would be for regulators, such as the SEC in the US, to offer assurances that such pre-disclosure would not run afoul of the rules.
Unbundle the services of the proxy advisors
Proxy advisors provide several valuable services, and most investors would be hard-pressed to get through proxy season without their help. As mentioned above, they collect and collate data and manage the operations of proxy voting, as well as making recommendations on particular votes.
Some of the most sophisticated users of the proxy advisors' services have already unbundled them – only getting the data collection or the voting operations as needed. Rather than paying for the recommendation, they then make their own decision based on comparable data. In the age of AI, more investors will be able to perform this function in-house in order to apply their own views to their votes; not receiving proxy advisors' recommendations would ensure that they do make their own decisions.
When MiFID II – an EU requirement to separate payment for trading and research services – came into force and investors had to pay for research with their own money, their demands on the quality of the research rose substantially. Paying for proxy advisor recommendations would likely lead to a similar pattern of getting more value for money.
Spread out proxy season
Most proxy votes take place over the span of just a few months. Companies issue their proxies mostly around the same time in April, and votes have to be in by June. The vast majority of proxy votes are important or mandatory but routine – reappoint the auditor, re-elect directors, and the like. Running this routine process in the April-June timeframe is not an undue burden.
What really gets the blood pressure up around proxy season are the less routine issues, such as changes in corporate governance or shareholder proposals.
As an example, in 2015 Bank of America wanted to combine the CEO and Chair roles, after having divided them following the global financial crisis. It was a contentious issue, so they held a special vote in September of that year, rather than settling the issue at their regular annual meeting in June.
Pulling the contentious votes out to a different time of year would allow companies and investors to engage more deeply on these key issues, instead of simply relying on the recommendations of proxy advisors. Furthermore, if getting shareholders' input is what is desired, this process could lead to more effective approaches, such as polling or direct engagement without the costs of a proxy vote.
Proxy advisors often wear the 'black hat' in the investment world, given their role as the agents of the investor in imposing their views on companies. And many of the criticisms of proxy advisors are certainly valid. But rather than vilifying or muzzling proxy advisors, a few simple changes could make the proxy process more open, fair, and thoughtful.
