The average American who owns stock in a public company through a 401(k) or a brokerage account has likely never heard of Institutional Shareholder Services. The firm is perhaps the most influential proxy advisor, advising pension funds and other institutional investors how to vote on shareholder proposals. Nonetheless, the secretive firm holds a vast amount of influence over how public companies operate.
ISS has great potential for conflict of interests because it provides shareholder voting recommendations on publicly traded companies and consulting services to those companies.
In the case of ISS, this means the subtle threat of adverse shareholder votes if companies don’t pay fees to ISS to become clients. Even Glass Lewis, which is owned by two activist pension funds, opposes the ISS model, calling the provision of consulting services “a problematic conflict of interest that goes against the very governance principles that proxy advisors like ourselves advocate.”
The Senate Banking Committee heard testimony recently on corporate governance issues, including a bill to require greater transparency from proxy advisory firms like ISS. (ISS is fighting this modest proposal for transparency and accountability in its practices, which is ironic because it has led the charge to mandate ever more onerous corporate disclosures.) The issue may seem like corporate inside-baseball, but the legislation would be a crucial step in returning more power to average investors and curbing the shady operating practices of some proxy advisors.
H.R. 4015, the Corporate Governance Reform and Transparency Act, passed the U.S. House late last year 238-182. The measure would require proxy firms to register with the Securities and Exchange Commission, disclose potential conflicts of interest and make public their methods for formulating proxy recommendations. Sen. Tim Scott, R-S.C., noted that just two firms dominate the proxy advisory market, controlling up to 38 percent of shareholder votes. “That’s a massive choke-hold that would seem to deserve an increased level of oversight,” he said.
Publicly traded companies in the United States must adhere to a disclosure regime administered by the Securities and Exchange Commission that is second to none in the world. Policy makers hold public hearings and conduct extensive research efforts to weigh the benefits of new disclosures and whether these benefits, if they exist, outweigh the costs–particularly for smaller companies, which can face prohibitive compliance burdens.
In recent years, nonprofit groups and other third-party organizations have taken it upon themselves to demand that publicly-traded companies disclose a broad gamut of activities far beyond what is legally required. Data from As You Sow, a nonprofit group, shows activist resolutions doubled between 2005 and 2010 and continue at record pace. The benefits such disclosures add are questionable at best. This system benefits politically-oriented, activist investors at the expense of the average investor.
A study by Harvard University professor Joseph Kalt and Adel Turki released earlier this month examines the expanded use of politically-charged proxy proposals, also known as environmental, social and governance resolutions. The study shows that activist resolutions targeted at prominent corporations can harm shareholder returns and provide a poor substitute for policy making via traditional political institutions.
The paper explores the impact of climate related-resolutions over the last 20 years, many of which call on target companies to conduct complex assessments of the potential future impact of climate change. Companies that passed climate-related shareholder resolutions simply do not perform better based on market benchmarks, either in the short run or the long run, according to the study.
Why does this matter to the average investor? It matters because more and more Americans’ wealth and retirement savings are at stake. An estimated $8.7 trillion in assets were invested according to ESG principles in 2016–about 22 percent of holdings. The sheer size of these funds shows their potential to impact returns to pension funds.
A group of national financial, retirement and manufacturing associations has mobilized to reform the proxy advisor system, which continues to deny an adequate voice to more than 100-million retail investors in the United States with more than $16.9 trillion in assets. They recently announced a new campaign effort called the Main Street Investors Coalition.
The timing is critical. Proxy season is in progress, and by the time it concludes this month, millions of votes will have been cast for and against thousands of individual shareholder proposals. But the focus of many of these proposals has shifted. They once aimed to improve business performance and financial returns. Now, too many advocate social or political causes. Unfortunately, most retail investors have no ability to influence what’s being done supposedly on their behalf–or even know that it is happening.
Citizens and retail shareholders who hold assets through their 401k(s), retirement plans, IRA or directly should demand that companies and their directors act in the best interest of all shareholders. The Senate could go a long way in reforming corporate governance by joining the House and passing the Corporate Governance Reform and Transparency Act.
