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By Yin Wilczek
June 18 — The leadership of the House Financial Services Committee will act if the Securities and Exchange Commission fails to address the outsized influence wielded by the two dominant proxy advisory firms in the U.S., Rep. Patrick McHenry (R-N.C.) said June 18.
Institutional Shareholder Services Inc. and Glass Lewis & Co. LLC together control about 97 percent of the proxy advisory services market.
The first step the SEC must take is to repeal two 2004 staff no-action letters that may have inadvertently entrenched the use of proxy services, McHenry said.
Second, the commission should identify transparency, efficiency and accountability measures for the industry, McHenry said, adding that such measures also could ease barriers to entry for other firms.
Third, portfolio managers should be allowed to determine, “through a cost-benefit analysis,” which issues on the ballots are important for shareholder value and not be held legally liable for voting only on those matters, the lawmaker said. He spoke at an American Enterprise Institute event on proxy advisers.
SEC spokesperson Judith Burns declined to comment on McHenry's remarks. In March, SEC Chairman Mary Jo White said she was expecting staff recommendations on next steps to address concerns about the proxy advisory industry.
Institutional investors hire proxy advisory firms to advise them on, and sometime cast, their proxy votes. Corporate issuers have charged that there is little oversight over the firms, lack of accountability for inaccurate information and inadequate disclosure of conflicts of interest.
Critics—including SEC Commissioner Daniel Gallagher and former SEC Chairman Harvey Pitt—have suggested that 2003 amendments to the 1940 Investment Advisers Act and the two no-action letters encouraged portfolio managers to use proxy advisory services.
As amended, Advisers Act Rule 206(4)-6 requires investment advisers to implement policies and procedures to ensure—as part of their fiduciary obligations—that their clients' proxies are properly voted, and to avoid material conflicts of interest. The rule also provides that an adviser may avoid material conflicts if it voted in accordance with the recommendations of an independent third party.
In a no-action letter issued in May 2004 to Egan-Jones Proxy Services, the SEC's Division of Investment Management said that an adviser may serve as that third party. Subsequently, the division told ISS in a September 2004 letter that whether an investment adviser fulfills its fiduciary duty when hiring a proxy voting firm would depend on the facts and circumstances.
Meanwhile, panelists at the same AEI event in Washington said that the biggest concern about curtailing the reach of proxy advisers is the impact on smaller portfolio managers.
University of Pennsylvania law professor Jill Fisch noted that small institutional investors and mutual funds—because of their lack of resources—primarily are the ones outsourcing services to proxy firms.
“That's the biggest concern” in trying to curtail the proxy firms' reach, she said. “I think informed intelligent voting by institutional investors is really the gold standard, but can you really expect a small institutional investor to have the resources to do this effectively?”
Fisch also noted that portfolio managers are “stock pickers,” not corporate governance experts. “It's not clear you get better decisions if you force mutual funds” not to use proxy advisory services.
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