The companies that advise institutional investors how to vote when listed firms hold a ballot are opaque, bureaucratic and inept. Time for a clampdown, says Stephen Connolly.
Financial markets are so busy looking to the future that the past gets forgotten quickly. So having work publicly dismissed as “absolutely silly” is unlikely to cause lasting damage to a firm’s reputation. But when the words come from Warren Buffett, one of the world’s most respected investors, they tend to stick. No wonder, then, that “proxy advisers”, the groups he was attacking when he made his remarks 15 years ago, have come under ever-closer scrutiny recently.
Proxy advisers are firms that get paid by investment and pension funds to recommend how to vote when listed companies hold a ballot. They will also vote on fund managers’ behalf under terms agreed with them beforehand. Following mounting criticism of their behaviour, the Securities and Exchange Commission, the US investment watchdog, and lawmakers have raised the prospect of greater regulatory oversight.
Power without responsibility
This is no sideshow. The two largest advisers – Institutional Shareholder Services (ISS) and Glass Lewis – are said to control 97% of the US proxy voting market, eclipsing others such as Egan-Jones. They’re also the largest global operators and prominent in the UK market, which has its home-grown advisers PIRC and IVIS, as well. These groups are often in the spotlight giving voting recommendations on various companies, including giants such as WPP, AstraZeneca and Shell.
The sector has gradually expanded over the past 30 years or so with minimal oversight. As funds proliferated and came to hold more and more of the shares in circulation, it became logistically difficult for managers to research and vote on every issue up for debate at all the companies they owned. So the proxy advisers sprang up to do it for them. Research shows they do shift votes, giving them significant sway over the boards of blue-chips as well as minnows – a power that demands supervision. How votes are cast, whether electing directors or approving takeovers, can materially affect shareholders’ interests and returns, and getting it right is crucial.
Get it wrong, on the other hand, and you irk the likes of Buffett while undermining credibility. His gripe with proxy advice goes back to 2004, when ISS recommended throwing him off the board of The Coca-Cola Company. It reasoned, implausibly, that because other companies he invested in did business with Coke, he wasn’t independent.
However, there was no reason to suspect anything untoward in straightforward transactions such as fast-food chain Dairy Maid buying Coke syrup for its outlets and Coke buying advertisements in The Washington Post. ISS apparently ignored the fact that Buffett was sufficiently versed in corporate governance to manage his responsibilities impartially, and was appointed in line with New York Stock Exchange rules.
With too much focus on in-house criteria and not enough real-world analysis, ISS missed the wood for the trees. Buffett said at the time that “checklists are no substitute for thinking”. This has been a recurring problem. Concerns have been raised by Nasdaq, the EU financial regulator ESMA and the UK’s Financial Reporting Council. The FRC’s chairman, Sir Win Bischoff recently told advisers that box-ticking “does not serve the needs of your clients or promote high standards of corporate governance in the UK”.
A lack of transparency
In addition to concern over the paint-by-numbers approach, advisers have been dogged by a perceived lack of transparency. They don’t always publish in detail the criteria against which they assess companies. Critics point to mistakes and misunderstandings left uncorrected, compounded by an unwillingness by some to give companies advance sight of draft reports or even to engage with them at all.
Moreover, there are doubts that proxy advisers’ analyses can ever extend beyond the superficial: they cover a large number of companies with relatively few employees dedicated to research. They certainly get things crashingly wrong on occasion. Glass Lewis recently advised clients that Unilever’s move to the Netherlands was a great idea, contrary to what top fund managers were saying. ISS, meanwhile, admitted being partly responsible for millions of missing votes at Unilver’s annual general meeting in 2003.
Drawing particular ire is the ISS sideline of advising companies on getting votes passed. It insists this is wholly independent of its main role of telling fund managers how to vote. Some are sceptical. According to CNBC, the frustrated CEO of one US company contacted ISS after it recommended voting against a proposal and says he was eventually told that for around $30,000 a year he “could avoid all this, it would really be a lot smoother”. The CEO, a former police officer, interpreted the offer as payment for “protection”.
No wonder, then, that regulators are circling. Demanding excellence from businesses while your own is being criticised was never going to work forever. Only by embracing regulation will proxy advisers dispel lingering criticism that how they go about things is “silly” – or much worse.