An indictment last week of a former employee of the largest company providing proxy advisory services to money managers is a not-so-gentle reminder that the U.S. Securities and Exchange Commission (SEC) needs to take additional steps to ensure proper regulatory oversight of these advisory firms.
Proxy advisory firms provide recommendations to institutional investors about how to vote at shareholder meetings of public companies. On June 17, 2015, a former supervisor at Institutional Shareholder Services (ISS) was charged with one count of conspiracy to commit wire fraud in federal court. According to the indictment, this former ISS employee shared confidential information with a proxy solicitation firm about how certain large investors were voting on shareholder proposals. The defendant received tickets to various sporting events and concerts in return for this information.
The SEC pursued an enforcement action against ISS for this breach of confidentiality in 2013. ISS paid a fine of $300,000 and agreed to hire an independent consultant to review its policies and procedures to comply with the federal Investment Advisers Act.
This legal case, however, highlights a bigger problem: the patchwork quilt of regulation that applies to proxy advisory firms. For example, ISS is a registered investment adviser with the SEC, but the second largest proxy advisory firm—Glass Lewis—is not. If an employee at an unregistered proxy advisory firm starts to trade confidential information for something of value with a third-party, the SEC would be unable to bring an enforcement action under the Investment Advisers Act.
This is one reason Business Roundtable and the other members of the Shareholder Communications Coalition have been advocating a uniform regulatory framework that requires all proxy advisory firms to be registered with the SEC under the Investment Advisers Act.
This ISS case is not the only problem involving the misuse of confidential information. Another issue facing proxy advisory firms is the unauthorized release of pre-selected information to influence proxy voting decisions.
Since the substantial majority of shareholder meetings do not involve disputed or contested matters, this problem occurs only at the 1-2% of annual shareholder meetings involving some type of controversy. But these “contested” meetings have high stakes for both the proponents and the opponents of a shareholder proposal. Access to any kind of non-public information is extremely valuable to either side of these proxy disputes.
When there is a controversial shareholder proposal, it is now quite common for excerpts of proxy advisory firm reports to be leaked to the public, either through a press release or a news article. These reports are non-public documents, created only for the clients of a particular proxy advisory firm. Selective disclosure of proxy advisory firm reports harms the interests of institutional and individual investors who are not clients of these firms. With only a pre-selected portion of an advisory report out in the public domain, these shareholders are being denied access to the balance of the analysis and reasoning supporting each voting recommendation.
A regulatory system in which only some of the firms providing proxy advisory services are subject to SEC oversight should not be allowed to continue. And any new regulatory framework should ensure that all investors—large and small—have access to the same information when voting on matters at shareholder meetings.
The SEC has started down the road to address these issues. This recent SEC enforcement action against ISS is one more reason for the SEC to accelerate its efforts and develop a unique regulatory framework for proxy advisory firms that works for all participants in the proxy voting process.
June 23, 2015