Reforming The Proxy Advisory Firm Duopoly: An Analysis of Recent SEC Guidance and Its Implications for Public Pension Retirees

Since 2018, the U.S. Securities and Exchange Commission (SEC) has been evaluating the role that proxy advisory firms have regarding shareholder engagement. This has resulted in recent Commission-level guidance to clarify the relationship between proxy advisory firms and institutional investors. At the end of the day, public pension retirees rely on their pension systems and fund managers to make smart investment decisions to ensure a secure retirement. But is that possible when proxy advisory firms provide biased recommendations on shareholder resolutions that may not prioritize financial returns? 

In light of the SEC’s recent guidance and ahead of an upcoming House Financial Services Committee hearing on September 24 that will feature all four SEC Commissioners and the Chairman, the Institute for Pension Fund Integrity (IPFI) has released its latest report analyzing the rise of proxy advisory firm influence and the actions that the SEC has taken to date. 

The SEC is taking proactive measures to reform what has, over time, become a convoluted process that yields questionable results for public pension retirees and other retail investors. However, stronger action is still needed. The IPFI brief details the following:

  • Prior SEC guidance has produced a complex set of unintended consequences. Oftentimes, guidance that sought to clarify the responsibilities of investment managers and proxy advisory firms inadvertently led to the consolidated power of proxy advisory firms we see today. 
  • Lack of transparency and conflict of interest remain of paramount importance when it comes to reform. Only two major players, Glass Lewis Co. and Institutional Shareholder Services Inc. (ISS), dominate the proxy advisory market. Insufficient oversight and ambiguity surrounding recommendations provided by proxy advisory firms raise the question of how susceptible these firms are to outside influence. 
  • Institutional investors who manage public pension funds face unique challenges. Particularly, activists have attempted to exploit the proxy advisory system and impose an Environmental, Social, and Governance (ESG) agenda when they are unsuccessful in advancing their causes through the legislative process. But these investment strategies do not always produce profitable return margins as would other traditional investment strategies.
  • The SEC issued two interpretive releases in August 2019 that set a clear agenda for future reforms. One release defines proxy advisory services as “solicitations” which affects the extent to which proxy voting recommendations are subject to anti-fraud rules. The second release pertains to an investment adviser’s fiduciary responsibility as he or she employs proxy voting on a client’s behalf. This Commission-level guidance sets a clear tone on the SEC’s position that proxy advisory reform demands immediate attention and substantial re-evaluation. 
  • Robo-voting disenfranchises public pension retirees and retail investors and goes against their financial interests. “Robo voting” is a system that many public pension funds and institutional investors use to automatically dispense their responsibility to execute proxy votes to proxy advisory firms. When ISS or Glass Lewis advances an ESG-related shareholder resolution that prioritizes a political, social or environmental agenda over financial returns, the public retiree’s interests have been disenfranchised due to robo-voting.

IPFI President Christopher Burnham recently wrote in Forbes that “With the new SEC guidance, proxy voting firms, rather than being stealth conduits for politics, will now have to be far more transparent and accountable.” He continued saying, “the Commission-level guidance must still go further to fully address the underlying problem with proxy advisors: that they serve as a conduit for investing with a political purpose, violating fiduciary duty, and historically, negatively affecting public pension fund performance.”

IPFI maintains that investment advisers must place the financial considerations above any other factor. We conclude with recommendations on what steps the SEC can take to ensure that proxy advisory firms do not compromise the financial returns of America’s public pensions. Key recommendations include:

  • Fixing the Lack of Transparency and a One-Size-Fits-All Approach – One notable step proxy advisory firms can take to address concerns about the opacity of their recommendation process is to devise a system that demonstrates their recommendations are issuer-specific. Among the services offered by proxy advisory firms should be the assurance to shareholders and stakeholders that their organization’s needs and objectives were carefully factored into each vote. A public notice-and-comment process would also foster trust and inform proxy advisory firms on the general consensus of those affected by corporate decision-making.
  • Disclosure of Conflicts of Interest – To help reduce the negative financial consequences of potential conflicts of interest, the SEC must clarify the extent of proxy advisory firms’ fiduciary responsibility. Establishing a coherent regulatory guideline on this contentious matter will equip all relevant parties with a framework for assessing the utility and benefit of recommendations made by industry giants like Glass Lewis and ISS. 
  • Reforming Shareholder Engagement – The argument that proxy advisory firms operate in a closed circle without proper shareholder engagement is a common argument in favor of reform. Extended review periods would allow for increased dialogue between the two parties. This would also serve as an opportunity to document dissenting opinions that shareholders may raise. In this sense, the voices of those directly tied to major investments will gain prominence over those being raised from the sidelines. 

Read the latest issue brief, Reforming The Proxy Advisory Firm Duopoly: An Analysis of Recent SEC Guidance and Its Implications for Public Pension Retirees