When the Canadian Securities Administrators issued a call last summer for comment on the potential regulation of the proxy advisory industry, it was inundated with responses from general counsel, their companies, law firms, and others who seemed to have been waiting in the shadows for a chance to vent.
Given the response to the CSA’s Consultation Paper 25-402: Potential Regulation of Proxy Advisory Firms, while regulators don’t appear to be acting quickly to take action, the movement toward some kind of change has “legs” says John Tuzyk of Blake Cassels & Graydon LLP.
The input received from reporting issuers, directors, and the investor relations people that work for Canadian companies shows the idea obviously hit a nerve with many Canadian public companies of all sizes, says Tuzyk. “Given the volume of comments advocating some form of action from all these issuers in response to the comment period — there are very few issues of new proposed rules that so many issuers have commented on like this — I would be very surprised if they did nothing.”
Considerable pressure is coming from the reporting-issuer community and its organizations and director organizations that something happen soon. For example, the Canadian Investor Relations Institute submission to the CSA indicated there have been too many factual errors identified. “It’s not that there’s been one or two cases where people found mistakes in proxy reports, it seems that almost every issuer who wrote in had a specific experience where they believed factual errors have been made in their proxy reports which then leads to all sorts of problems,” says Tuzyk, who has had clients who have experienced this problem. Blakes, which has a large number of public company clients, also made a submission to the CSA. “Virtually everyone I’ve dealt with has had occasion to go correct a proxy report over the 20 years I’ve been doing this. It’s hard to think of an issuer who hasn’t had problems with a proxy advisory firm,” he adds.
With a greater recognition that anything governance related has to be conflict free, just about everything involved in corporate governance is getting a second look these days and proxy advisory firms are not exempt. Despite a general reluctance for more regulation, Tuzyk says it’s in everyone’s interest there be as much accurate disclosure as possible to bolster efforts towards good governance. “If we can minimize errors and inaccuracies and do it on a cost-effective basis, that seems to make sense and has to be a good thing,” he says.
The question of whether the proxy advisory industry should be regulated has been a polarizing issue for some time now. Depending on who you ask, there are strong opinions on both sides. Institutional shareholders are closely aligned with the proxy firms; law firms make their bread and butter from corporate management, while issuers and academics have concerns about many aspects of the process.
The CSA, which acts on behalf of the provincial securities regulators in Canada, invited input from all parties — issuers, institutional investors, proxy advisers, and other market players — on concerns over the activities of proxy advisory firms. The concerns range from a perceived lack of transparency in how they operate to conflicts of interest and inaccuracy of their work.
The activities of proxy advisory firms are unregulated in Canada. The call for consultation follows similar steps by regulators in the United States and Europe, as the perceived power of proxy firms, such as Institutional Shareholder Services Inc. and Glass, Lewis & Co., which provide proxy voting advice and other services, has been debated in recent years. The U.S. Securities and Exchange Commission embarked upon a similar exercise in 2010, but it has not resulted in any changes to date.
Some feel companies like ISS and Glass Lewis wield too much power and have too much influence. Insiders point to issuers who have been quoted in the press making comments along the lines of, “The proxy advisory firm is my number one shareholder because they control 50 per cent of my vote.”
That sounds good as a headline but it’s not really true, says Brad Allen, of Branav Shareholder Advisory Services Inc. “People continue to reinforce this image that proxy firms have all this power. They do have influence but their primary influence is their ability to communicate to a broad range of shareholders that hold an equity interest.”
As one of many companies that submitted a written response to regulators last fall, Magna International Inc. indicated its key concerns included potential conflicts of interest, lack of transparency, and potential inaccuracies as well as limited opportunity for issuer engagement. It also has concerns about the extent to which institutional investors in Canada rely on proxy advisers’ recommendations. “Our comments were directed to say, there has to be a level playing field so the issuers know exactly what is the basis on which we are being assessed,” says Bassem Shakeel, Magna’s vice president and secretary. “Right now that is one of the biggest problems; there just isn’t enough transparency around the detail — the basis on which some parts of the analysis is being completed and/or overly broad subjective discretion which can be used to override voting guidelines.”
“For me personally, the primary concern is one of transparency — I need to know exactly what is the standard I’m being assessed on to which I will be held,” says Shakeel. He acknowledges ISS is transparent. “Issuers may not like their policies, they may not agree with their methodologies, but at least you know the basis on which you are being assessed.”
Others argue the proxy companies aren’t as powerful as the issuers make them out to be. “My view is these proxy advisory firms don’t necessarily have as much influence as many people say they do because a lot of times when we speak to institutional investors, who are clients, they are proud to say, ‘Yes we receive the information but we’re not robots and we do spend some time on how we’re going to vote,’” says Jonathan Feldman, a partner at Goodmans LLP. “They say, ‘If we disagree with what the proxy advisers are suggesting, we won’t just follow them blindly.’”
Feldman disagrees with the conflict of interest accusation. While Glass Lewis is owned by the Ontario Teachers’ Pension Plan, it take steps to make full disclosure. “They have a good reputation and I don’t think they would jeopardize that reputation on the basis of owning this company. It’s well known they own it but I don’t think they influence it in a way that is in any way negative,” says Feldman.
The issues of conflict of interest, transparency, and lack of qualitative assessment of governance quality and predictive validity on shareholder value are all reasons why the proxy firms should be regulated, says Richard Leblanc, an associate professor of law, governance, and ethics at York University. “If I asked my students to pay me to help them with their score, it’s a conflict,” he says.
He says ISS and Glass Lewis use a “mechanistic, quantitative, and volume-based” approach to their business and don’t measure things that are important to the quality of corporate governance and to shareholder performance — essentially what happens inside the boardroom. “The assumption is what they are measuring matters but often what they’re not measuring might matter more,” such as individual people and the qualities and skills of directors, says Leblanc. “As a qualitative researcher I’m seeing this volume-based model that is conflicted because of the consulting stream to improve your governance score. Their input variables are basically a proxy circular. That does not capture corporate governance.”
To illustrate, Leblanc points to companies rated highly by the proxy advisory firms that have also had corporate governance failures, such as CP Rail, which was given a governance award by the Canadian Coalition for Good Governance. He says boards are often making decisions based on what ISS and Glass Lewis deem to be appropriate. “It seems directors are right when they contest that these firms are employing a one-size fits all model and are not allowing for customization and not measuring qualitative factors. They can often get it wrong,” says Leblanc.
Ultimately what may happen is delivery of an improved process, says Ed Waitzer of Stikeman Elliott LLP. “I think where they’re going with all of this is more transparency, which is fine but I don’t think it really goes to the root issue,” he says.
When it comes to proxy advisory firms, Waitzer says it’s a “focus on form rather than a focus on substance. They’re going through the motions a lot of the time — not just the advisers but their customers too. The advisers exist because there is a demand for low-cost advisory services and it’s one of many agency conflicts we’ve created in our rush to regulate corporate governance.”
Experts say the issues tend to fall more in line with whether issuers have enough ability to interact with the advisory firms during the process. “The timing is often tight,” says Allen. “If you look at the number of public companies and the number of circulars and they’re all in a concentrated season for what they do I don’t think it’s significant in terms of the number of mistakes made — but when there is one it’s near and dear to everyone’s heart.”
Chris Makuch, vice president of Georgeson Canada, doesn’t see the point of proxy adviser regulation. “There are a lot of things that go into proxy voting and whether companies get positive votes or negative votes and part of that has to do with proxy advisers. But to say proxy adviser regulation is going to improve the process — it’s a small piece of a very big process.”
At a recent presentation at the TSX, Makuch says Glass Lewis indicated 80 per cent of its clients have their own proxy voting guideline. That means they’re not relying on them entirely. For its part, ISS has indicated upwards of 60 per cent of the assets it represents have their own voting guidelines.
Makuch points out there is also an industry code of conduct all proxy advisers are working on that shows they are interested in addressing issues before the regulators do. “These people doing proxy advisory work are very smart people,” he says. “They’re not sloughing off comments and possible calls for regulation. I think they’re looking for an industry code of conduct.”
While most admit there are weaknesses with the process, a decent remedy might be greater disclosure to make everyone feel more comfortable with it. “I think there’s always a need for accountability in the public market and I think that’s why originally this push came to the commission as opposed to some legislation,” says David Salmon, senior vice president with Laurel Hill Advisory Group in Vancouver. “They’re private firms and you ultimately subscribe or don’t subscribe. If the service is good, you’re going to continue to subscribe. Perhaps there needs to be specific disclosure.”
For its part, ISS, which declined to be interviewed for this story, said in its submission to the CSA it has policies in place for when errors occur and has the ability to rectify them. The challenge, says Salmon, is they aren’t always rectified. Tuzyk says most issuers would be happy if there was an established process for the review of proxy reports so factual inaccuracies could be addressed. A close second would be greater transparency in the rules and methodologies applied so they don’t have to buy the service in order to get a favourable recommendation.
So what will come of the debate around the proxy companies? It’s unlikely the CSA will get out ahead of the SEC so it could take some time yet before something substantial actually happens but the discussion thus far has been viewed by all to be positive. “I think they are worried because this is crystalizing right now,” says Leblanc. “These are big firms and their up or down recommendations on various corporate governance items have significant effect — particularly if activist investors look to ISS for their recommendations. It’s in everyone’s interest that the recommendation be grounded, be empirically based, and transparent. These are all good governance practices and the proxy advisory firms need to open up the kimono and err on the side of abundance of caution.”
Feldman of Goodmans agrees. “I get the sense the CSA is ragging the puck a little bit on this one because I think there isn’t a clear answer. There may be some push for better disclosure of the process, of people to understand how the proxy advisers came to their conclusions — I don’t know what increased regulation is going to get us — I don’t see the benefit.”
Given the response to the CSA’s Consultation Paper 25-402: Potential Regulation of Proxy Advisory Firms, while regulators don’t appear to be acting quickly to take action, the movement toward some kind of change has “legs” says John Tuzyk of Blake Cassels & Graydon LLP.
The input received from reporting issuers, directors, and the investor relations people that work for Canadian companies shows the idea obviously hit a nerve with many Canadian public companies of all sizes, says Tuzyk. “Given the volume of comments advocating some form of action from all these issuers in response to the comment period — there are very few issues of new proposed rules that so many issuers have commented on like this — I would be very surprised if they did nothing.”
Considerable pressure is coming from the reporting-issuer community and its organizations and director organizations that something happen soon. For example, the Canadian Investor Relations Institute submission to the CSA indicated there have been too many factual errors identified. “It’s not that there’s been one or two cases where people found mistakes in proxy reports, it seems that almost every issuer who wrote in had a specific experience where they believed factual errors have been made in their proxy reports which then leads to all sorts of problems,” says Tuzyk, who has had clients who have experienced this problem. Blakes, which has a large number of public company clients, also made a submission to the CSA. “Virtually everyone I’ve dealt with has had occasion to go correct a proxy report over the 20 years I’ve been doing this. It’s hard to think of an issuer who hasn’t had problems with a proxy advisory firm,” he adds.
With a greater recognition that anything governance related has to be conflict free, just about everything involved in corporate governance is getting a second look these days and proxy advisory firms are not exempt. Despite a general reluctance for more regulation, Tuzyk says it’s in everyone’s interest there be as much accurate disclosure as possible to bolster efforts towards good governance. “If we can minimize errors and inaccuracies and do it on a cost-effective basis, that seems to make sense and has to be a good thing,” he says.
The question of whether the proxy advisory industry should be regulated has been a polarizing issue for some time now. Depending on who you ask, there are strong opinions on both sides. Institutional shareholders are closely aligned with the proxy firms; law firms make their bread and butter from corporate management, while issuers and academics have concerns about many aspects of the process.
The CSA, which acts on behalf of the provincial securities regulators in Canada, invited input from all parties — issuers, institutional investors, proxy advisers, and other market players — on concerns over the activities of proxy advisory firms. The concerns range from a perceived lack of transparency in how they operate to conflicts of interest and inaccuracy of their work.
The activities of proxy advisory firms are unregulated in Canada. The call for consultation follows similar steps by regulators in the United States and Europe, as the perceived power of proxy firms, such as Institutional Shareholder Services Inc. and Glass, Lewis & Co., which provide proxy voting advice and other services, has been debated in recent years. The U.S. Securities and Exchange Commission embarked upon a similar exercise in 2010, but it has not resulted in any changes to date.
Some feel companies like ISS and Glass Lewis wield too much power and have too much influence. Insiders point to issuers who have been quoted in the press making comments along the lines of, “The proxy advisory firm is my number one shareholder because they control 50 per cent of my vote.”
That sounds good as a headline but it’s not really true, says Brad Allen, of Branav Shareholder Advisory Services Inc. “People continue to reinforce this image that proxy firms have all this power. They do have influence but their primary influence is their ability to communicate to a broad range of shareholders that hold an equity interest.”
As one of many companies that submitted a written response to regulators last fall, Magna International Inc. indicated its key concerns included potential conflicts of interest, lack of transparency, and potential inaccuracies as well as limited opportunity for issuer engagement. It also has concerns about the extent to which institutional investors in Canada rely on proxy advisers’ recommendations. “Our comments were directed to say, there has to be a level playing field so the issuers know exactly what is the basis on which we are being assessed,” says Bassem Shakeel, Magna’s vice president and secretary. “Right now that is one of the biggest problems; there just isn’t enough transparency around the detail — the basis on which some parts of the analysis is being completed and/or overly broad subjective discretion which can be used to override voting guidelines.”
“For me personally, the primary concern is one of transparency — I need to know exactly what is the standard I’m being assessed on to which I will be held,” says Shakeel. He acknowledges ISS is transparent. “Issuers may not like their policies, they may not agree with their methodologies, but at least you know the basis on which you are being assessed.”
Others argue the proxy companies aren’t as powerful as the issuers make them out to be. “My view is these proxy advisory firms don’t necessarily have as much influence as many people say they do because a lot of times when we speak to institutional investors, who are clients, they are proud to say, ‘Yes we receive the information but we’re not robots and we do spend some time on how we’re going to vote,’” says Jonathan Feldman, a partner at Goodmans LLP. “They say, ‘If we disagree with what the proxy advisers are suggesting, we won’t just follow them blindly.’”
Feldman disagrees with the conflict of interest accusation. While Glass Lewis is owned by the Ontario Teachers’ Pension Plan, it take steps to make full disclosure. “They have a good reputation and I don’t think they would jeopardize that reputation on the basis of owning this company. It’s well known they own it but I don’t think they influence it in a way that is in any way negative,” says Feldman.
The issues of conflict of interest, transparency, and lack of qualitative assessment of governance quality and predictive validity on shareholder value are all reasons why the proxy firms should be regulated, says Richard Leblanc, an associate professor of law, governance, and ethics at York University. “If I asked my students to pay me to help them with their score, it’s a conflict,” he says.
He says ISS and Glass Lewis use a “mechanistic, quantitative, and volume-based” approach to their business and don’t measure things that are important to the quality of corporate governance and to shareholder performance — essentially what happens inside the boardroom. “The assumption is what they are measuring matters but often what they’re not measuring might matter more,” such as individual people and the qualities and skills of directors, says Leblanc. “As a qualitative researcher I’m seeing this volume-based model that is conflicted because of the consulting stream to improve your governance score. Their input variables are basically a proxy circular. That does not capture corporate governance.”
To illustrate, Leblanc points to companies rated highly by the proxy advisory firms that have also had corporate governance failures, such as CP Rail, which was given a governance award by the Canadian Coalition for Good Governance. He says boards are often making decisions based on what ISS and Glass Lewis deem to be appropriate. “It seems directors are right when they contest that these firms are employing a one-size fits all model and are not allowing for customization and not measuring qualitative factors. They can often get it wrong,” says Leblanc.
Ultimately what may happen is delivery of an improved process, says Ed Waitzer of Stikeman Elliott LLP. “I think where they’re going with all of this is more transparency, which is fine but I don’t think it really goes to the root issue,” he says.
When it comes to proxy advisory firms, Waitzer says it’s a “focus on form rather than a focus on substance. They’re going through the motions a lot of the time — not just the advisers but their customers too. The advisers exist because there is a demand for low-cost advisory services and it’s one of many agency conflicts we’ve created in our rush to regulate corporate governance.”
Experts say the issues tend to fall more in line with whether issuers have enough ability to interact with the advisory firms during the process. “The timing is often tight,” says Allen. “If you look at the number of public companies and the number of circulars and they’re all in a concentrated season for what they do I don’t think it’s significant in terms of the number of mistakes made — but when there is one it’s near and dear to everyone’s heart.”
Chris Makuch, vice president of Georgeson Canada, doesn’t see the point of proxy adviser regulation. “There are a lot of things that go into proxy voting and whether companies get positive votes or negative votes and part of that has to do with proxy advisers. But to say proxy adviser regulation is going to improve the process — it’s a small piece of a very big process.”
At a recent presentation at the TSX, Makuch says Glass Lewis indicated 80 per cent of its clients have their own proxy voting guideline. That means they’re not relying on them entirely. For its part, ISS has indicated upwards of 60 per cent of the assets it represents have their own voting guidelines.
Makuch points out there is also an industry code of conduct all proxy advisers are working on that shows they are interested in addressing issues before the regulators do. “These people doing proxy advisory work are very smart people,” he says. “They’re not sloughing off comments and possible calls for regulation. I think they’re looking for an industry code of conduct.”
While most admit there are weaknesses with the process, a decent remedy might be greater disclosure to make everyone feel more comfortable with it. “I think there’s always a need for accountability in the public market and I think that’s why originally this push came to the commission as opposed to some legislation,” says David Salmon, senior vice president with Laurel Hill Advisory Group in Vancouver. “They’re private firms and you ultimately subscribe or don’t subscribe. If the service is good, you’re going to continue to subscribe. Perhaps there needs to be specific disclosure.”
For its part, ISS, which declined to be interviewed for this story, said in its submission to the CSA it has policies in place for when errors occur and has the ability to rectify them. The challenge, says Salmon, is they aren’t always rectified. Tuzyk says most issuers would be happy if there was an established process for the review of proxy reports so factual inaccuracies could be addressed. A close second would be greater transparency in the rules and methodologies applied so they don’t have to buy the service in order to get a favourable recommendation.
So what will come of the debate around the proxy companies? It’s unlikely the CSA will get out ahead of the SEC so it could take some time yet before something substantial actually happens but the discussion thus far has been viewed by all to be positive. “I think they are worried because this is crystalizing right now,” says Leblanc. “These are big firms and their up or down recommendations on various corporate governance items have significant effect — particularly if activist investors look to ISS for their recommendations. It’s in everyone’s interest that the recommendation be grounded, be empirically based, and transparent. These are all good governance practices and the proxy advisory firms need to open up the kimono and err on the side of abundance of caution.”
Feldman of Goodmans agrees. “I get the sense the CSA is ragging the puck a little bit on this one because I think there isn’t a clear answer. There may be some push for better disclosure of the process, of people to understand how the proxy advisers came to their conclusions — I don’t know what increased regulation is going to get us — I don’t see the benefit.”
