October 19, 2010
Comments regarding proxy voting system reform
File Number S7-1410
Ladies and Gentlemen of the U.S. Securities and Exchange Commission:
I am delighted that the SEC is looking at the proxy system to consider updates that reflect changing technology and circumstances, and hope we can move to a system that recognizes the essential role that investors must play in providing oversight to minimize the agency costs and perverse incentives inherent in capitalism.
For too long, the system has been designed for the benefit of issuers, and it is not too strong a statement to say that the devastation of the financial meltdown could have been mitigated or even prevented if investors had been able to prevent the perpetuation of boards selected, compensated, informed (and misinformed) by insiders.
With regard to the list of items on which the SEC has invited comment, I would like to object in the strongest possible terms to the possible regulation of proxy advisory services. As the original general counsel and for one year CEO of ISS, I have observed this industry from the beginning. Having left ISS in 1990, and having been a proponent and dissident who has failed to gain the support of the ISS analysts more often than I have been successful, I have had the opportunity to develop some objectivity.
The core founding principle of our democracy is freedom of expression. The recent Citizens United decision by the Supreme Court emphasized the importance of unfettered speech, justifying corporate participation in the political process explicitly through its accountability to investors because shareholder objections raised through the procedures of corporate democracy can be more effective today because modern technology makes disclosures rapid and informative (citation omitted). The core founding principle of our economy is to allow the market to determine the value of goods and services. Infringement of either free expression or the free market should only be done in the most extreme circumstances and no such justification is present here.
ISS developed the proxy advisory business because as we were trying to sell another product entirely institutional investors kept telling us that what they wanted was an independent assessment of management and shareholder proposals. At the time, many of them subscribed to the IRRC reports, which analyzed proposals but did not give recommendations. In those days of hostile takeovers and management entrenchment, they wanted advice that was as knowledgeable and as objective as what they were receiving from securities analysts and other independent advisors.
When I left ISS in 1990, both our employees and our clients were in the low two digits. The fact that it became such a powerful international presence in the two decades that followed demonstrates just how badly its customers wanted those products. The fact that two other substantial competitors have entered the market shows that there are very low barriers to entry. The firms often disagree with each other. They are transparent and highly competitive about their different approaches, and each does not hesitate in sales calls to explain in detail why their product is superior. Most clients choose the firm that best suits their own policies the rest prefer to do business with more than one and compare the recommendations to assist them in arriving at their own decision. This is exactly what markets do best and there is no reason to interfere.
The issuers claim that these firms are too influential. Of course, they do not complain that they are too influential when they support management recommendations in the overwhelming majority of cases. They only complain that they are too influential in those selected occasions when they oppose managements recommendations. Do not confuse correlation with causation. Clients follow the advice of proxy advisory services because they like and trust the recommendations even, it is fair to say, because in those instances the issuers are proposing matters that are not in the shareholders interest. And it is absurd to suggest that the proxy advisory services take a one size fits all approach. That is demonstrably not true. The SECs own rule-makings and the stunning conformity and lowest-common-denominator benchmarking approach of the issuer community is far more one size fits all than the proxy advisors, who provide detailed and highly specific analysis of matters like executive compensation that are tailored by sector, market-capitalization, and other factors.
There is no reason to suspect that sophisticated institutional investors are abdicating their obligation as professionals and fiduciaries to consider these issues as carefully as they do their buy-sell-hold decisions, also based in part on the opinions of independent analysts like the proxy advisory firms. Indeed, the data show that while clients do often follow the recommendations on routine matters (which means voting with management), the more high-profile and controversial a proposal or proxy contest, the more likely that clients are to read the analysis and come to their own conclusion, often departing from the proxy advisory services recommendation, demonstrating the independence of their judgment. Just as two investors can look at the same data and make different conclusions about whether to buy, sell, or hold, they can look at a proxy advisory recommendation and make a different decision about whether to vote yes, no, or abstain.
The arguments made by the other side show such a stunning statistical illiteracy that they are either disingenuous, ignorant, or both. Issuers seem stung to discover that investors may not believe management is acting in their best interests and believe that the answer is not to change their behavior or improve their communication but to smother outside analysis of their proposals. If issuers object to the recommendations made by the proxy advisory firms, the answer is for them to respond directly and substantively in their communications with their shareholders, not to cut off outside assessment.
An ABA assessment of ISS recommendations noted that they supported dissident candidates two-thirds of the time, suggesting that this reflected an anti-management bias. On the contrary. Given that proxy contests occur only in a fraction of a percent of companies each year and by definition those are companies with the most severe performance issues, the fact that ISS supports management one-third of the time demonstrates that they take a very measured approach. Overwhelmingly, proxy advisory firms support management candidates. And overwhelmingly, their clients have shown that the firms pass the ultimate market test of credibility and legitimacy by buying their products.
No one has shown any evidence that the proxy advisory firms have been anything but transparent about their approaches and the way they deal with conflicts of interest as indeed it is in their best interest to do so in seeking sales. Some of them meet the stringent standards of registration as investment advisors. There is no reason to regulate their analyses and recommendations.
If the SEC has any concerns about institutional investors failing to meet fiduciary standards in exercising their share ownership rights, including not just proxy voting but making decisions about initiating shareholder proposals, running dissident candidates for the board, and filing lawsuits, the Commission should address those issues directly. As the Court noted in Citizens United, the remedy is not to restrict speech but to consider and explore other regulatory mechanisms. I would support the UK approach of putting the burden of proof on institutional investors to show why they have not been actively engaged in exercising those rights, and I would support a vigorous enforcement program to address the issues of conflicts of interest we have documented in the repeated failure of institutional investors to vote against value-destroying compensation plans (even when proxy advisory services tell them to do so). But any regulation of proxy advisory services is contrary to our commitment to freedom of expression and the free market, and it is a pity that the issuer community, which would rather cut off exactly the kind of information the market needs to be efficient than make a substantive response, needs to be reminded of this.
Again, I appreciate the Commission's examination of this and other topics relating to the proxy system and request that before issuing a proposed rulemaking the Commission hold hearings to explore these matters more thoroughly. I welcome the opportunity to answer questions on this comment or any of the other issues under consideration.
Nell Minow
Chair, The Corporate Library
56 Northport Drive
1st floor
Portland, Maine 04103