As the U.S. Securities and Exchange Commission (SEC) completes a long overdue regulation on proxy advisors, SEC Commissioner Elad Roisman recently signaled that the Commission is still finalizing key details that will ultimately inform the workability and effectiveness of the entire rule. These potential changes should excite both those who opposed and supported the Commission’s original proposal.
In a speech to the Council of Institutional Investors (CII), Roisman indicated that the SEC might make significant changes that would impact the process for company review of proxy advisor recommendations. These reforms would address concerns from the advisors that the proposed timeline for companies to pre-review their final reports will cut down on their ability to deliver recommendations to their clients in a timely matter.
In their initial proposal, the SEC would require that companies have a window for fact-checking and the evaluation of analytic approaches employed by proxy advisors in their recommendations before recommendations are finalized. Proxy advisors could then review the company’s response and decide whether to alter their recommendation.
Effective pre-review periods ensure investors are furnished with more accurate information and that defective advice is challenged before it is disseminated. However, this approach would require a longer timeline for companies to have an initial review and then an additional two days to respond to a proxy advisor recommendation if they choose.
Proxy advisors have also voiced concerns that this process would make their recommendations less “independent” and beholden to the views of management at companies, despite not being forced to alter their recommendations in any way if a company objects to the report.
To address these concerns, Roisman floated the idea of a contemporaneous review period where reports would be sent to the companies to review at the same time they are sent to investors. If companies have an issue with the reports, proxy advisors would have to notify their clients of any objections to the advice from the company so that investors would have easy access to all relevant information before voting.
Contemporaneous review would cut down on time and effort for proxy advisors to facilitate multiple review periods and would allow their investor clients to view the information at the same time as companies, and therefore prevent any “company bias” from tainting the initial recommendation.
Roisman also alluded to another potential fix to address those who support the SEC’s proposal, but also want to ensure that it lives up to its purpose. He correctly noted that the practice of “set-it-and-forget-it” mechanisms, also known as “robo-voting,” would seriously undermine contemporaneous review because proxy advisors often automatically vote their clients’ proxies in line with their recommendations according to pre-set specifications that do not take the specific issues raised by shareholder proposals into account.
Evidence of vote spikes immediately following the issuance of advice demonstrate that institutional investors are not seriously reflecting on the advice they have been provided by the proxy advising industry.
Roisman is correct to be concerned about this issue and needs to ensure that robo-voting is addressed so asset managers use the additional information from company review and protect their clients by ensuring they truly are voting in their best interests, as required by the SEC. To meet that determination, asset managers must review all relevant information prior to casting their vote on contested matters.
Fortunately, even proxy advisors have noted that most shareholder votes are on routine issues and in those cases their recommendations are likely aligned with the recommendation of a company’s management. The SEC’s rule, regardless of its final form, will have little impact on these matters.
But when companies and proxy advisors disagree on how shareholders should vote on a proposal, common sense dictates greater review is necessitated by asset managers to ensure that their vote is in line with their client’s needs and not simply checking a box and outsourcing the decision to advisors who are unaccountable to their clients. A predetermined one-size-fits-all policy on how the proxy advisor should execute the asset manager’s vote at the end of the year cannot be considered sufficient in these more limited matters.
American shareholders rely on high-functioning corporate governance systems to ensure the operation of a business aligns with their interests as owners of the firm. The failure of the proxy advising industry to provide advice that is free of error and in the interests of those shareholders is a major shortcoming. The deficiencies of the proxy advisors compromise America’s competitiveness globally and robs investors of their retirement savings.
The SEC’s proposed rule has the potential to significantly improve the quality of corporate governance if there are sufficient mechanisms to ensure proxy advisors offer services to facilitate informed shareholder voting instead of encouraging their clients to hand them the keys by executing their votes on controversial decisions. The SEC is right to make sure their rule is workable by shortening the timeline, but they must also disable robo-voting to guarantee the rule ultimately has the intended impact on asset managers’ voting practices.
Burchell Wilson is a consulting economist with Freshwater Economics.