While the Society of Corporate
Secretaries and Governance
Professionals does not support
the DOL’s proposed definition of
fiduciaries for those providing
investment advice to an employee
benefit plan or a plan’s
participant, the Society does
believe that proxy advisory
firms should be considered
fiduciaries under the
definition. In a separate letter
to the SEC, which was also
attached to the DOL letter, the
Society said that proxy advisory
firms should register with the
Commission as investment
advisers. The Society believes
that the fact that investment
managers with fiduciary duties
can rely on proxy advisory firms
with no fiduciary duties to make
voting recommendations is a
disconnect in the current system
that needs to be remedied.
The DOL
proposes to redefine the term
fiduciary under section 3(21) of
ERISA and section 4975(e) of the
Internal Revenue Code.
Generally, the Society does not
support a broadly expanded
definition of fiduciary. The
Society is concerned that the
proposed regulation could
significantly expand the
circumstances under which
numerous persons supporting the
management of plan assets, but
not exercising discretion over
fiduciary decisions, would be
deemed to be fiduciaries. This
result would significantly
increase plan costs and harm
plan participants, fiduciaries,
and sponsors.
However,
noting that many investment
managers delegate their voting
responsibility to proxy advisory
firms without appropriate
oversight, the Society believes
that proxy advisory firms that
effectively exercise discretion
over proxy voting decisions
should be considered
fiduciaries. More broadly, the
Society urged the Department to
undertake a comprehensive review
of the practices of proxy
advisory firms as set forth in
its letter to the SEC.
In the SEC
letter, the Society said that
the voting influence exercised
by proxy advisory firms
undermines the integrity of the
proxy voting system because
firms are subject to conflicts
of interest and make factual
mistakes in their analysis, with
the effect that their voting
guidelines are erroneously
applied to the company’s
proposal and the voting
recommendation is inaccurate.
Further, proxy advisory firms
lack an economic interest in the
shares they vote and thus have
no responsibility to ensure
their recommendations achieve
the best economic outcome for
shareholders.
In the
Society’s view, proxy advisory
firms are subject to three types
of conflicts of interest. The
first occurs as a result of
selling their services to both
institutional clients and
issuers. The second conflict
arises when firms make
recommendations on proposals
submitted by their own investor
clients. The third conflict
stems from proxy advisory firms’
interest in recommending
proposals and adopting policies
that are likely to expand their
influence.
Society
members believe proxy advisory
firms often do not take into
account the specific
circumstances of the company,
but instead follow a
one-size-fits-all approach to
their voting recommendations.
Society members have reported
situations where the proxy
advisory firm recommended
against a governance practice
that had been approved in a
prior vote by the shareholders.
In addition, leading proxy
advisory firms often use largely
formulaic models in recommending
approval for equity compensation
plans, with little attempt to
take into account the particular
circumstances faced by a company
at a given point of time.
Further, the
Society noted that the
delegation by investment
advisers of their vote to proxy
advisory firms has resulted in a
divorce between the persons who
make the investment decision and
the persons who exercise the
vote. The result of this gap is
that voting recommendations may
bear no relation to the economic
performance of the company and,
therefore, such voting
recommendations may not improve
the performance of a company.
Because
proxy advisory firms do not need
to take into consideration the
economic consequences of their
recommendations, noted the
Society, they do not feel
compelled to specifically tailor
their recommendations to the
particular facts and
circumstances of each issuer.
For example, in some companies,
having a lead director may make
sense, but not in all.
The Society
urged the SEC to require proxy
advisory firms to establish
procedures to manage conflicts
of interest and disclose in
their reports any conflicts of
interest with the subject of
their recommendation. The firms
should also disclose the
methodologies, guidelines, or
assumptions they used in making
their recommendations, including
a discussion on whether the
methodology is a generic
methodology applied to all
issuers.
The SEC
should also require the
disclosure of the processes the
firms employed to gather their
information, including the
number of companies each analyst
reviews within a given time
frame and whether the
recommendations are reviewed by
a more senior manager. Firms
should also disclose their
executive compensation models
and standards so that companies
do not need to purchase
consulting services from a proxy
advisory firm in order to
determine if it will get a
favorable recommendation on a
stock plan.
Firms should
be required to report to the SEC
at the end of each proxy season
the number of incidents where
companies took exception to the
factual statements contained in
the proxy advisors’ reports or
appealed the recommendation of
the proxy advisory firm. Also,
companies should be given at
least five business days to
review draft reports prior to
their release.
Finally, the
Society recommends that proxy
advisory firms be required to
register as investment advisers
and become subject to SEC
examinations that would provide
additional discipline and
accountability to the system.
Once registered, proxy advisory
firms would need to establish an
oversight authority that they
are following their procedures
and would need to provide
factual support for the bases of
their disclosures. In addition
to the registration of proxy
advisory firms, the Society
believes the Commission should
require any investment adviser
or other fiduciary that uses a
proxy advisory firm to exercise
appropriate oversight of the
proxy advisory firm and its
recommendations.