About the author: Paul Andrew is Executive Director for Research, Advocacy and Standards at the CFA Institute. He is also a member of the CFA Institute Systemic Risk Council. Previously he was Secretary General of the International Organization of Securities Commissions, Vice President and Managing Director, International Affairs, of FINRA and Senior Managing Director, Business Operations Europe, at Nasdaq Europe.
The Securities and Exchange Commission recently passed new proxy voting rules. The July 13 press release announcing the new rules was harmless. SEC Chairman Gary Gensler is pleased, he said, to support efforts to “address issues related to the timeliness and independence of voting advice that would help protect investors and promote shareholder democracy.” Investors, he continued, need “independent and timely advice.”
As usual, to the casual observer, the SEC routinely made updates and clarifications to uphold US securities laws. In this case, however, routine belies the increasing politicization of the SEC. The regulation of proxy advisors has been decoupled from the goals of managing financial markets and is now just another political issue for Washington politicians to fight over. The increasing level of abuse and misinformation spread by companies about the proxy advisory business, and even the shareholders who use such services, has surprised even political professionals.
Proxies consulting firms provide clients with recommendations on how to vote on public company proxy voting proposals. These clients are typically large institutional investors invested in hundreds of individual portfolio companies, each of which generates proxies for review and voting each year. Proxy advisory services have been a godsend for the quality, efficiency, and transparency of the annual proxy voting process since the early 1990s. Among other things, these firms help their shareholder clients create detailed proxy voting policies. Once approved by the customer, these guidelines provide a consistent and transparent roadmap for conducting proxies.
Next up is proxy season, which is when proxy statements arrive. The advisory firms scour thousands of global and domestic proxies each year and perform in-depth, independent financial analysis. This analysis is then compared and contrasted with the client’s proxy voting policies. Based on this research, the consulting companies offer their customers well-founded voting recommendations. Advisory services have become a big deal in the world of corporate governance, both in terms of the tens of thousands of recommendations and votes they enable each proxy season and the growing impact their recommendations have on how shareholders ultimately vote.
Understandably, US corporate boards and CEOs do not appreciate negative voting recommendations on their voting rights issues. Over the years, some have gone to great lengths to both disparage consulting firms and block negative endorsements. This corporate response is textbook retaliation for analysts, something the CFA Institute is intimately familiar with. When an equity analyst makes a sell or sell recommendation for a company, the analyst, the methodology, and the accuracy or integrity of the recommendation are often quickly discredited. Negative proxy recommendations are met with a similar response from organizations, particularly on high-stakes governance issues.
The truth is that proxy opinions and advice don’t always match management’s opinions. Companies often dismiss the advisor’s negative recommendations not as a disagreement, but as analyst error, misanalysis, or worse – intentionally false and misleading. The aggrieved companies convince politicians that proxy advisors have a long history of wrong advice or error and need to be subject to stricter regulatory oversight because their recommendations have a significant impact on voting and shareholder meeting outcomes. In fact, a 2020 Council of Institutional Investors research report on error rates concluded that of more than 11,000 proxy advisor reports published in 2018, factual errors occurred in just 0.06%.
The issue of proxy advisors has been a political hotspot for years. As late as 2020, the SEC changed key provisions of the proxy rules in response to companies’ irritation that proxy advice was increasingly riddled with errors and material omissions. They explained that voting recommendations are beginning to control the results of annual meetings, thereby dictating the operations of public companies.
The SEC 2020 decided to impose further policy restrictions on consulting firms, some of which have all but destroyed the independence and integrity of proxy analysis and voting recommendations. In the 2020 amendments, the SEC required proxy advisors to provide affected companies with an opportunity to preview and provide feedback on proxy voting advice before it is issued. Next, it directed that proxy advisors are responsible for recording any dissenting views or objections by the firm to the advisor’s voting recommendations when submitted to clients. (For the record, the CFA Institute has consistently opposed enforcing the pre-approval of research recommendations with the offending company as a direct ethical violation of its professional standards of analyst independence).
Enter the SEC of 2022. Before any of the 2020 changes could go into effect, a new presidential administration took office in January 2021. With the arrival of new policy and SEC leadership, the SEC declared the 2020 changes for review and suspended all related enforcement actions. Then, in July of last year, we heard about a new set of rules for proxy advisors: the “2022 Amendments.” These changes repeal the 2020 changes, specifically the requirements that proxy consultancies must pre-clear proxy recommendations with the offending firm and the requirement to communicate firm rebuttals, and reaffirm the importance of proper disclosure of conflicts between proxy consultants.
There is no doubt that the reform of voting rights advice will continue to stir the political pot. What seems harmless today is just another act in a long-running play about corporate control and analyst independence. However, it is the latest reminder of how a politicized regulatory process is undermining regulatory certainty and threatening our world-class reputation for market integrity and investor protection. Politics has infiltrated every corner of Washington—perhaps it’s naïve to think the SEC would be any different.
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