In shareholder votes, big investors often follow the lead of advisory firms. Do they have too much clout?
WASHINGTON – After an advisory firm recommended against proposed severance packages for Nash Finch Co. executives in a recent merger, nearly three-quarters of the Edina company’s stockholders voted that way.
While such votes often aren’t binding on a company, they signal the power of what are known as proxy advisory firms.
But now critics are pushing back, accusing the firms themselves of conflicts of interest and secrecy. Corporations are aiming to limit what they see as inappropriate influence.
Policies on pay and management “should not be driven by nonshareholders,” said David Strandberg, a lawyer with Nasdaq OMX, which in October petitioned the Securities and Exchange Commission to crack down on such firms.
Nasdaq OMX asked the SEC to force proxy advisers to disclose more about their decisionmaking processes and potential conflicts of interest in consulting and financial services that they offer at the same time they make proxy recommendations.
He called those things “perverse financial incentives.”
Patrick McGurn, executive director of advisory firm Institutional Shareholder Services (ISS), said his firm looks out for its clients’ interests every bit as well as company boards, which he says “are not reaching out to shareholders at all.”
“The idea that something nefarious is going on is ridiculous,” McGurn said.
The battle continues Thursday in Washington as proxy advisers and their critics try to make their cases to the SEC.
What cannot be disputed is that proxy advisory firms play a big role in votes cast by thousands of institutional investors, who, according to the Conference Board, now hold 75 percent of shares in publicly traded U.S. companies.
The Minnesota companies Best Buy, Digital River and Regis each had pay packages rejected in recent years after opposition from proxy advisers.
Mood of skepticism
Business ethics experts say outside scrutiny of corporate management is not bad for shareholders, given the poor and sometimes criminal choices made by executives at corporations like Enron, WorldCom, AIG and Lehman Brothers. Those decisions, blessed by boards of directors, wiped out the investments of millions of stockholders.
“We’re in an environment where shareholders are more skeptical,” said Richard Painter, professor of corporate and securities law at the University of Minnesota. “They are more interested in hearing a second opinion than they were 10 years ago.”
The question is whether those second opinions carry too much clout.
“I’m concerned that directors [on company boards] now make decisions based on what they think proxy advisory firms want” and not what is best for the company, said John Stout, the Minneapolis lawyer who leads the American Bar Association’s Corporate Governance Committee.
A faceoff at a recent ABA business law forum offered a snapshot of the tension between corporate boards and groups with the ability to defy them.
ISS’ McGurn and Nasdaq’s Strandberg traded verbal jabs about whether corporate boards or for-profit advisory firms best represent shareholder interests.
In its SEC petition, Nasdaq OMX accused proxy advisers of hiding specific information about how they make recommendations in order to drum up business for their consulting operations. The company also charged conflicts of interest because financial management businesses associated with advisory firms may be buying and selling shares in companies at the same time they are making recommendations on their proxies.
On its website, ISS publishes the general guidelines it uses for judging executive compensation and other corporate issues. It does not, however, provide precise details.
“Are you going to require Pepsi and Coke to put their formulas out there?” McGurn asked. “I find it strange that the business community says there should be no intellectual property protected.”
McGurn also says a “firewall” separates ISS’ research arm from its consulting business, which sells clients advice on how to structure proxy requests that can gain the support of institutional investors. The company makes available on its website explanations of its policies regarding potential conflicts of interest.
That has not been enough to silence critics who believe ISS and the other big proxy advisory firm, Glass Lewis & Co., have too much sway and face too few regulations. Together the pair control roughly 97 percent of the proxy advisory market.
Glass Lewis, owned in part by a pension fund and an investment company, joined ISS in blasting Target’s executive compensation plan this year. It did not respond to a request for comment.
A 2012 Stanford University study showed that proxy advisory firm objections to management-sponsored pay proposals increase no votes by as much as 20 percent.
The Stanford study also showed that 59 percent of businesses now seek guidance or input from proxy advisory firms in formulating pay packages.
Current and former members of the SEC have recently lambasted the power of proxy advisers in public speeches and Congressional hearings for forcing advisory votes on executive compensation more often than federal law requires and for being owned by companies that invest in the corporations that proxy advisers review.
The firms’ recommendations, however, do not always carry the day.
Best Buy, like Target, found itself at odds with ISS on executive compensation this year, with ISS arguing that more of CEO Hubert Joly’s pay should be tied to the company’s performance. The company’s plan still got 83 percent of the vote.
The U’s Painter served as the chief ethics lawyer to the George W. Bush administration from 2005 to 2007. He says shareholders are better off hearing a debate between management and outside proxy advisers than they are hearing a single point of view.
“I would not prohibit potential conflicts of interest,” Painter said. “But it has to be disclosed that you have a dog in the hunt.”