On the Role and Regulation of Proxy Advisors

Summary of Study

Bottom Line: The SEC has not adequately encouraged investors to scrutinize not just potential proxy advisor conflicts of interest, but also the content of the advice they receive from them. Unless the SEC provides better guidance on what such scrutiny should entail and undertakes a sustained enforcement program to detect and discipline fiduciaries who fail to meet their duties, the beneficiaries of the funds these institutional investors manage will suffer.

Accepting the fact that proxy advisors play an important role in reducing costs for investors who are mandated to vote their shares, the lack of diligence with which many investors use the services of the advisors is cause for concern, particularly when many of the governance recommendations of proxy advisors are based on thin (or no) empirical evidence. 

Despite public statements that these advisors are merely data aggregators, it appears that institutional investors have become overly reliant on the recommendations of proxy advisors—often outsourcing analysis and voting decisions to the two largest firms in the market. 

Poor quality ratings by corporate governance ratings firms have serious consequences not just for the investors who purchase deficient ratings and advice, but also for the economy as a whole. Capital is allocated and crucial corporate governance decisions are often driven on the basis of these ratings and advice. 

Proxy firms wield significant influence over institutional investors, as proxy solicitors and corporate secretaries assert. This influence is not always evident in proxy voting; indeed, the traces of the influence are probably more likely to appear in the corporate governance choices of public companies from year to year.

It is not a stretch to say that corporate governance ratings firms serve as a de facto regulator, with some firms offering a set of one-size-fits-all best practices that directors and executives ignore at their peril.

Read the full comment letter here.