If SEC Fails to Move on Proxy Advisers, Lawmaker Promises Congressional Action

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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 at an American Enterprise Institute event on proxy advisers.

Second, the commission should identify transparency, efficiency and accountability measures for the industry, McHenry said. “It is important that we know how the sauce is made,” he 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 should not be held legally liable for voting only on those matters, the lawmaker said.

Congressional Action

“If the SEC does not act, Congress will take action,” McHenry continued. He observed that HFSC Chairman Jeb Hensarling (R-Tex.) and Rep. Scott Garrett (R-N.J.), chairman of the HFSC Capital Markets subcommittee, share a similar view on the issue. “We all concur that if the SEC does not move appropriately, congressional action will be required.”

McHenry, who leads the HFSC's Oversight subcommittee, compared the proxy advisory situation to the credit rating industry, which he said also is dominated by a few firms and appears to have government approval for use of its services.

“I want to tell you that this is important to us on Capitol Hill,” the lawmaker added. “Those of us that work on substantive policy care deeply about this, getting it right, and the impact it will and can have on good corporate governance, investor protection and market returns.”

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.

At the same AEI event, former SEC commissioners and other panelists discussed possible measures on proxy advisers.


Proxy advisory firms are hired by institutional investors 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.

To contact the reporter on this story: Yin Wilczek in Washington at ywilczek@bna.com

To contact the editor responsible for this story: Phyllis Diamond at pdiamond@bna.com

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