April 17, 2013

New Report Finds Fundamental Flaws in America’s Proxy Advisory System; Offers Three Policy Recommendations to Fix Broken System

James K. Glassman

J. W. Verret

Senior Affiliated Scholar
Summary

The Securities and Exchange Commission’s proxy voting rules were meant to ensure well-informed proxy votes that reflect the interests of shareholders. However, the rules have instead given rise to two influential proxy advisory firms that have an inordinate amount of influence on corporate governance, according to a new report released by the Mercatus Center at George Mason University.

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The Securities and Exchange Commission’s proxy voting rules were meant to ensure well-informed proxy votes that reflect the interests of shareholders. However, the rules have instead given rise to two influential proxy advisory firms that have an inordinate amount of influence on corporate governance, according to a new report released by the Mercatus Center at George Mason University.

The authors, Securities and Exchange Commission (SEC) Investor Advisory Board Member James K. Glassman and Mercatus Center Senior Scholar J.W. Verret, find troubling problems with the regulation and operation of the dominant proxy advisory firms.  In the report, titled “How to Fix Our Broken Proxy Advisory System,the authors argue that the interpretation of a 2003 SEC mandate has unintentionally resulted in a flawed system that harms shareholders and investors. Glassman and Verret recommend three steps that the SEC can take to fix what is broken in the system.

The paper demonstrates that the current proxy advisory system is shaping the corporate governance practices of public companies in a perverse manner that is diminishing, rather than enhancing, shareholder value. Meant to minimize conflicts of interests between institutions and shareholders, the 2003 rule has had the opposite effect. The authors write, “Instead of eliminating conflicts of interest, the rule simply shifted their source. Instead of encouraging funds to assume more responsibility for their proxy votes, the rule pushed them to assume less. Instead of providing informed, sensitive voting on proxies, the incentive has been to outsource decision-making to two small organizations…[that] lack the resources to examine proxy questions in depth and with regard for the nuances inherent in the management of specific corporations.”

The authors recommend three key steps to “return efficiency to a broken system and put the authority for shaping corporate governance where it belongs - in the hands of shareholders, corporate directors and managers.”

  1. Limit proxy voting requirements of mutual funds and pension funds so that those institutions will be the sole arbiters of when it makes sense to vote using active analysis of the question at hand.
  2. End the preferential regulatory treatment that proxy advisers currently enjoy in the law.
  3. End extraneous proxy requirements such as “Say-on-Pay” votes.

“Without immediate and meaningful reform that recognizes the legal and economic realities associated with voting thousands of proxies, shareholders will remain at risk of experiencing a decrease in value of their investments,” said Verret.  “Entrenching proxy advisory firms that take a ‘one-size-fits-all’ approach to voting recommendations is inconsistent with investor desire for good corporate governance.”

“The overly-broad interpretation of shareholder voting regulations imposed on institutional investors by the SEC and Department of Labor is concentrating the power into the hands of two conflicted and overly-burdened firms, ISS and Glass Lewis & Co.,” added Glassman.  “The two dominant proxy advisory firms are neither adequately informed to make recommendations concerning the governance of publicly traded companies, nor are these firms incentivized to provide voting recommendations suitable to serve the needs of all shareholders.  The SEC must take immediate corrective action.”