An IRO’s Guide to Proxy Advisory Firm Relations

When the Canadian Securities Administrators (CSA) published proposed National Policy 25-201, Guidance for Proxy Advisory Firms, on April 24, 2014, the goal of provoking comments was handily met.

A host of capital market participants weighed in with concerns about how proxy advisory firms (PAFs) develop voting recommendations, the accuracy of the recommendations, the level of transparency in the recommendation process, the potential for conflicts of interest that could compromise the independence of recommendations, and the lack of enough engagement opportunities between PAFs and issuers before recommendations are made.

Given these concerns, and the fact that more than a few corporate boards, compensation schemes and takeovers have been voted down following delivery of a proxy advisor’s opinion, CIRI, among others, advocated for the CSA to regulate the proxy advisory industry. Instead, the CSA opted for a guidance-based approach, arguing that doing so will “(i) promote transparency in the processes leading to a vote recommendation and the development of proxy voting guidelines; and (ii) foster understanding among market participants about the activities of proxy advisory firms.” The CSA also noted that PAFs contend they have “appropriate policies and procedures in place to address concerns” and that institutional investors are generally satisfied with PAFs, believing that these firms provide “useful and cost-effective services.”

Understandably, many market participants were disappointed. 

Institute for Governance States Its Case

The Institute on Governance wrote, on July 16: “Proxy firms use these statistics [the thousands of public companies that they research] to justify their usefulness…But these very statistics create a fundamental issue for their service providers and raise basic questions about their business model. How can they cope with this mass of data and come up with fair and thoughtful recommendations for thousands of corporations in a matter of a few weeks in the spring of each year? They have to resort to one of two measures…a standardized grid, a sort of simplified algorithm (often termed a ‘cookie-cutter’ or a ‘one-size-fits-all’ approach) with which corporations are scored for their governance, boards are assessed, compensation is appraised and shareholder proposals are vetted…or hiring of temporary staff, as well as farming out of the analytical process to low-cost countries...that coping mechanism raises the issue of competence and training…These unavoidable circumstances…make the whole process highly suspect. If only one tenth of companies processed by proxy advisors were to submit that their reports contain errors and inaccuracies and request changes, these proxy advisors would be swamped and unable to cope…”.

Among other recommendations, the Institute on Governance suggested that clients of PAFs should insist on “divulgation” of all pertinent details of the business models used by PAFs, including employee training.

CEO Council Submits Its Ideas

The Canadian Council of Chief Executives in its submission stated: “…consultation with our member companies has revealed a significant level of concern with respect to a number of current practices among PAFs and considerable doubts about the effectiveness of the CSA’s proposed approach.” The Council recommended that the CSA implement a ‘comply or explain’ approach and suggested “at a minimum, PAFs should have a policy of communication with firms about which they intend to issue a vote recommendation, or explain why they reject such a practice.”

CIRI States its Disappointment

CIRI’s submission stated: “We contend that the existing practices of PAFs lack transparency, accuracy and engagement, all key drivers of market integrity and efficiency. While the Proposed Policy does go some way to improving transparency (assuming PAFs accept and implement the guidelines regarding disclosure methodologies and procedures), it does little to foster improved accuracy and engagement with issuers.”

Lack of issuer engagement came to light during a CIRI member poll that found only one third of respondents have had discussions with one or more PAFs when those firms were developing corporate governance policies/practices. All of the issuers that did have consultations were large capitalization companies and engagement was inconsistent and infrequent. Engagement with issuers at lower capitalization levels was essentially nonexistent.

Accordingly, one of CIRI’s recommendations was to require PAFs to share draft research with subject issuers “with a reasonable review period that allows for engagement should inaccuracies or misinterpretations be identified prior to distribution to clients. This is so factual errors can be identified and corrected, thus increasing the accuracy of such reports – to the benefits of all involved.”

In response to calls for regulation, the CSA wrote: “…it is for proxy advisory firms to determine whether or not to engage with issuers when they prepare vote recommendations and if so, in what manner…”. However, the CSA went on to say “we expect proxy advisory firms to publicly disclose their approach to any dialogue or contact with issuers.”

The CSA also reminded issuers that they are free to engage with their shareholders to explain why they adopted a corporate governance practice. This can’t be left to explaining in proxy circulars alone, since the investors are hiring the PAFs to read the circulars.

This is easier said than done due to the constraints of identifying Objecting Beneficial Holders with ownership positions of less than 10%. CIRI’s position that reducing the early warning reporting threshold to 5% would have helped, but the CSA has also recently announced it won’t be adopting that.

Teachers’ View

Institutional investors, the purchasers of proxy advice, take a different tack. In a 2012 submission, the Ontario Teachers’ Pension Plan stated: “The business of a proxy advisory firm is to provide to its clients opinions which are based on an analysis of the facts presented through an issuer’s public disclosure. From our experience, the majority of complaints of inaccuracies raised by issuers are related to proxy advisors’ recommendations on issues such as compensation and mergers and acquisitions. Proxy advisors analyze these issues by applying their own published methodologies to the facts presented in public documents. We believe that where a proxy advisor has made a recommendation at odds with an issuer’s position, this primarily reflects the fact that reasonable parties can come to differing conclusions based on their own perspectives and analysis. A difference in opinion does not necessarily reflect “inaccuracies” or a “flawed analysis” on the part of a proxy advisor. Quite the opposite, different opinions allow sophisticated parties to carefully consider and make informed decisions based on an independent analysis.”

For their part, the two PAFs (Glass Lewis and Institutional Shareholder Services, or ISS) serving the Canadian market have sought to assuage some concerns through active communication. ISS explains its issuer engagement process on its website, while Glass Lewis posts its conflict of interest statement on its website (see links on the 'Where To Get More Informaton' page). Both advisory firms have been active for many years. In fact, in 2000 ISS purchased the original Canadian PAF, Fairvest Corporation, which along with its predecessor Allenvest Group, was a pioneer in the field, waging governance fights with Canadian Tire Corporation, Torstar Corporation and Southam Inc. in the 1980s. Glass Lewis was purchased by Ontario Teachers’ Pension Plan in 2007 and now counts the Alberta Investment Management Corporation (AIMCo) as an owner.

Canada is Not Alone

Given the increased attention to governance, the resulting propensity for institutions to vote their proxies and the complexity of issues such as executive compensation, PAFs are not going away; nor is the CSA the only regulator to wade into the PAF debate. The U.S. Securities and Exchange Commission (SEC), the New York Stock Exchange, and the European Commission have all put PAFs under a microscope. The SEC issued guidance on July 1, 2014, in the form of a Q&A (see link on the 'Where To Get More Informaton' page). It remains to be seen if guidance alone will have an impact on PAFs. 

Where Does This Leave IROs?

In the meantime, there are four key pieces of advice for IROs.

One, institutional investors vote their proxies according to their own guidelines. All IROs would do well to remember this and, to the extent possible, take the opportunity to discuss governance issues with their owners prior to developing their management information circulars. This is often best done in conjunction with the Corporate Secretary. Doing so may just help to overcome a negative recommendation.

Two, consider reaching out to proxy advisors early and proactively to learn of upcoming issues that can be avoided when developing the management information circular. Engagement outside of prime time (i.e. ideally in January, or even earlier for calendar year-end companies) may produce more informative discussions with PAFs.

Three, a company should not settle for a PAF recommendation if it thinks the recommendation is incorrect, or if the company is open to revising its plans. There are many examples of PAFs changing their recommendations based on issuer engagement.

Four, make sure the management information circular language is clear. Institutional shareholders will not support something they cannot understand.    

Where To Get More Information