Proxy advisory firms provide a cost-effective way for institutional investors to evaluate proposals, vote proxies, and meet fiduciary standards. However, these firms hold significant sway over executive compensation, corporate governance, and stakeholder management, yet are not fully accountable for their reports and often resist input from the companies they assess. The result is a flawed process that keeps shareholders from having the information they need to make an informed choice on important matters.
The SEC has been reviewing the proxy process for over a decade, aiming to address the lack of oversight in this critical area. In 2020, the SEC finalized a moderate set of reforms to make the proxy advisory process more transparent and accurate but was immediately sued by a major proxy advisor and wound up gutting the rules before they could even take effect. The move to rescind the rules was challenged, but both lawsuits are currently bogged down in court, while companies pay the price.
It is time to finish the job on reasonable proxy advisory reform—either through reinstating the 2020 rules, or if that is not possible, through new legislation or regulation.
Two Major Issues—and Their Solutions
The Problem: Lack of Opportunity to Provide Input
Right now, companies have no power to review or respond to proxy research reports before they are presented to investors as fact, along with specific recommendations about how those investors should vote. But the ability of issuers to evaluate and provide feedback on proxy reports before publication is crucial for maintaining the integrity of proxy voting.
- During proxy season, proxy advisors must quickly generate detailed reports on thousands of issuers, and often the report and vote recommendation are published very close to the annual meeting date.
- That recommendation carries weight. As numerous studies have shown, companies with an “Against” recommendation from a major proxy advisor can expect a significant decrease in vote support (the latest data shows an average spread of 28% for S&P 500 companies).
- To make matters worse, a large percentage of investor votes are cast within 24–48 hours following the final report. That leaves issuers and investors little time to resolve any issues with a final report.
- Finally, although proxy advisors may claim a nearly perfect accuracy rate, errors do exist (a recent report found 64 instances in which a company had alerted investors to an error via a supplemental filing).
Proxy advisors often have philosophies on executive compensation and corporate governance which differ from those of issuers, and nobody is suggesting that they should change their views. But if issuers are allowed to simply review their draft report and provide a hyperlinked response to the final report that goes out to investors, those investors will be better informed about contrasting viewpoints over important issues—information they should have before casting a vote as a fiduciary.
The solution: let issuers review, not change, draft proxy reports to ensure the data is properly validated before investors use it to make fiduciary voting decisions.
The Problem: Conflicts of Interest
Research has identified several potential conflicts of interest for proxy advisors, such as offering consulting services to the same companies they evaluate for investors. The effect of this type of conflict is that when proxy advisors change their methodology, it naturally drives business to the consulting side, which issuers then feel obligated to patronize in order to be in compliance. These dual roles may pressure companies to purchase consulting services to secure favorable recommendations.
The solution: Proxy advisors should be required to disclose conflict of interest information in each proxy report. This includes:
- Providing consulting to an issuer while also providing voting research and recommendations on that issuer;
- Providing consulting to a shareholder proponent while also providing recommendations to other investors on that shareholder’s proposal; or
- Being owned by an investor group that advocates on the same issues subject to recommendations by the proxy advisor.
The Path Forward
The Center On Executive Compensation supports efforts to reinstate the reasonable 2020 SEC rules overseeing proxy advisors, and agrees with the SEC that it has statutory authority to regulate proxy advisory firms and that vote recommendations constitute “solicitations” under proxy rules.
However, if those regulations are not reinstated, it seems very likely that Congress will take action. A bill that passed the House in September called for reforms similar to those laid out above, and is likely to be re-proposed this year.
Substantial efforts have been made to identify the necessary oversight for proxy advisory firms. Now, it’s time for the SEC to implement these reforms and complete the regulatory framework, ensuring a fair and transparent proxy voting process for all stakeholders.
