On December 18, the Dow Jones Industrial Average climbed more than 200 points upon news that the GOP tax reform bill had cleared a key procedural hurdle on its way to becoming law.
But something else happened that same week in Congress that hasn’t received much attention – but could, if someday signed into law, be nearly as significant in helping to create jobs and boost the performance of retail investors’ 401(k)s.
You see, after years of reform efforts targeting Wall Street, a few of the worst actors remain virtually unregulated, able to batter public companies into making decisions that don’t necessarily serve the interests of their customers, employees or shareholders.
Proxy advisory firms such as Institutional Shareholder Services and Glass Lewis & Co. were created to help institutions and pension funds make informed decisions on how to vote on shareholder proposals. As shareholder activism has expanded, the number of proposals submitted has increased right along with it. Large investors, smaller institutions, hedge funds and pension systems now look to ISS and Glass Lewis recommendations to help guide their votes.
But these proxy advisers don’t always disclose the analysis that underpins the recommendations they create. What’s more, their decision-making process is often based on cookie-cutter policies that offer no recourse to targeted companies that disagree with how the proxy advisory firm arrived at whatever decision it reached.
But all this may be about to change, thanks to legislation authored by Rep. Sean Duffy (R-Wis.) that passed the House the same week as the headline tax bill cleared its last hurdle on its way to the Resolute Desk. The bill was nearly universally supported by Republicans, but also picked up a dozen Democratic votes as well – a rare bipartisan showing for this Congress. The Corporate Governance Reform and Transparency Act is now headed to the Senate. Passing and signing it into law would represent a huge step forward in finally bringing some measure of reform to a process — and broader corporate governance ecosystem — that is badly broken.
This legislation is critical to reforming a practice that has become less about corporate governance and more about money-making for the proxy advisory firms, often at the expense of business growth and retail investors.
ISS and Glass Lewis enjoy near-monopoly status when it comes to telling big stockholders how to vote on shareholder resolutions. But these firms are not themselves shareholders, employees or customers of the companies whose policies they are influencing. So, what motivates them, and what are their interests?
Because they aren’t shareholders, there’s no guarantee these firms are always interested in what’s best for investors or the companies when they intervene. They are not obligated to disclose information they considered when deciding how their clients should vote, the discussions they might have had with agenda-driven institutions that pay fees to the proxy advisory firms, or what products they have tried to sell to the companies holding votes.
This last practice, which has gone on for years now, is the most concerning. In addition to providing recommendations on important proxy votes such as executive compensation, employee stock option plans, and corporate governance proposals, proxy advisory firms also offer paid consulting services to help companies “navigate” these exact issues. It’s an obvious conflict, and this legislation finally gives the SEC some basic power to regulate the firms’ activities to ensure they aren’t as easily able to execute the kinds of corporate shakedowns that have become routine.
Employers and regulators have for years voiced concerns about the secrecy and possible conflicts inherent in the way these firms develop their recommendations, with little to no oversight to ensure they have the proper staff, expertise, or information at their disposal to issue such decisions. Companies complain their voices are not heard by the firms during the recommendation process.
Under the Corporate Governance Reform and Transparency Act, proxy advisors will have to register with the SEC, disclose a code of ethics, and identity any conflicts of interests they have when advising shareholders how to vote on company decisions. If the SEC determines that a proxy advisor has acted improperly, the regulator will have the power to revoke the proxy advisor’s ability to operate. And it provides a standard process for companies to review and comment on the firms’ voter recommendations.
It doesn’t happen often, but when Congress actually does stumble into doing the right thing, it should be acknowledged for it. The tax bill rightly received the lion’s share of the attention, and though far from perfect, we know that it will drive our economy forward in a big way in the New Year. The corporate governance bill represents an important complement to that package. With any luck, it will end up in the same place.
Eric Schlecht is president of OnPoint Strategies.