GAO Report on Proxy Advisors: No Smoking Guns
I know a lot of people have been waiting a long time for the Government Accountability Office's report on the state of the proxy advisor industry. The GAO report - which had been requested by two members of Congress - was finally released to the public on Monday.
I guess the big surprise from the report is that there really was not much in the way of surprise. It appears that the primary purpose of the report was to hone in on ISS' conflicts of interest (ie. taking on both investors and issuers as clients). But since ISS fully discloses its conflicts - and investors told GAO that it was comfortable with these conflicts - this proved to not be much of an issue for the report.
Here are some of the GAO's reports "notables":
1. There are over 28,000 public companies worldwide that send out proxy statements with over 250,000 separate issues. Nice stats to know. (pg. 6)
2. Footnote 7 neglects to mention that Bob Monks left the Pension Welfare Benefits Administration - after issuing the Avon letter, which created the need for proxy advice - in the early '90s to establish the precurser to ISS. Brillant move by a regulator! (pg. 7)
3. Most institutional investors report conducting due diligence to obtain reasonable assurance that ISS is independent and free from conflicts. But in many cases, this consists of just reading ISS' conflict policy. (pg. 11)
4. Other potential conflicts consist of owners that do other business to issuers and investors (and the owners of advisory firms serving on boards of other companies). To me, this is the real conflict risk that exists in the industry. (pg. 11-12)
5. A chart shows how dominant ISS is within the industry, with more clients than the other 4 proxy advisory firms combined. I have to admit I had not heard of Marco Consulting Group before - and its been around nearly 20 years. (pg. 13)
6. Many of the investors that GAO contacted said that they do not vote their proxies; they hire asset managers to do that for them. (pg. 21)
So What Did the GAO's Proxy Advisor Report Miss?
I would not place much stock in commentary that the GAO report means that ISS' influence is overblown; if you have any actual experience with shareholder meetings, you know that ISS' recommendation often is the difference between a controversial matter being approved by shareholders or not. So as many members e-mailed me yesterday, when it comes to ISS' influence on votes, the report does not ring completely true.
Here are some "beefs" that members have sent me regarding the report:
1. Failure to interview impacted constituents - It appears that the GAO failed to talk to anyone other than investors and regulators. What about other key players? The issuer community? The proxy solicitors? Investor relations personnel?
2. Flying at a "1000 foot" level - One gets a sense that the GAO investigators didn't really learn much. For example, the report mentions that issuers feel the need to get help from ISS to get a favorable recommendation - but then leaves it at that - without exploring what that means. The report should have clarified that this isn't a “pay to play” (ie. vote buying) situation - and it also should have explained that the bulk of ISS' corporate consulting money comes from equity plan design; not helping with governance rating (ie. CGQ) scores.
Given the influence that ISS has on institutional shareholders - coupled with the proprietary equity plan methodology that ISS uses - many issuers feel pressure to sign-up for ISS' consulting services to make sure their plan will be approved by shareholders.
3. Understating the extent of ISS' influence - In footnote 14, the GAO cites a recent study that examined the extent to which recommendations can influence vote outcomes and stock prices. But the report didn't delve further into that important topic. Any proxy solicitor will tell you that ISS’s influence on voting issues can often be as high as 25% of the shares outstanding.
A prime example of ISS' influence is the bumps felt by recent private equity deals when ISS recommended voting against them (egs. Clear Channel, Biomet). Not that that is a bad thing for shareholders, but it illustrates ISS' influence.
4. Lack of investigative research - A big flaw in the report was taking at face value that many of these institutional investors said they make independent decisions. Yes, some do. But how many of them, when asked, would be expected to say: “Yep, most of the time I just vote the way they tell me.” Not any of the smart ones, because they have a fiduciary duty to vote.
Remember that most of these investors hold positions in thousands of companies; it would be a monumental task to conduct independent research about each item for each issuer's ballot. To do so, an investor would have to have a staff along the lines of a proxy advisor to adequately do the job. The reality is that investors are trying to keep their expense ratios down - and even the larger investors typically have only a few employees dedicated to vetting voting issues.
5. Misses the "real" barrier to entry - Although the report talks about barriers to competition, it ignores the real issue connected with that topic: vote execution. No sane institutional investor is going to assume the risk inherent in moving thousands of accounts and ballots from ISS to another provider. The chance that accounts would be lost, not voted, or voted incorrectly is far too great. An ISS competitor has a rough road to try to duplicate the sophisticated vote execution platform that ISS has built over the years.
6. Short shrift to looming conflict issue - One wonders if the conclusions of the GAO report change if the rumors are true that ISS’ parent company, RiskMetrics, goes public?
I don't blame the GAO for missing the boat; this is a complex area to tackle if you don't have any "hands on" experience. They did better than the Washington Post, which ran an article yesterday on the GAO report with a picture of the ISS executive team from about six years ago -including Ram Kumar, who was infamously ousted because he had represented himself as a law school graduate to ISS, a degree he did not possess...