[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
EXAMINING THE MARKET POWER AND
IMPACT OF PROXY ADVISORY FIRMS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
----------
JUNE 5, 2013
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Printed for the use of the Committee on Financial Services
Serial No. 113-27
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81-762 PDF WASHINGTON : 2013
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
ROBERT HURT, Virginia, Vice CAROLYN B. MALONEY, New York,
Chairman Ranking Member
SPENCER BACHUS, Alabama BRAD SHERMAN, California
PETER T. KING, New York RUBEN HINOJOSA, Texas
EDWARD R. ROYCE, California STEPHEN F. LYNCH, Massachusetts
FRANK D. LUCAS, Oklahoma GWEN MOORE, Wisconsin
RANDY NEUGEBAUER, Texas ED PERLMUTTER, Colorado
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan KEITH ELLISON, Minnesota
MICHAEL G. GRIMM, New York MELVIN L. WATT, North Carolina
STEVE STIVERS, Ohio BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MICK MULVANEY, South Carolina TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida
ANN WAGNER, Missouri
C O N T E N T S
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Page
Hearing held on:
June 5, 2013................................................. 1
Appendix:
June 5, 2013................................................. 37
WITNESSES
Wednesday, June 5, 2013
Bartl, Timothy J., President, Center on Executive Compensation... 8
Holch, Niels, Executive Director, Shareholder Communications
Coalition...................................................... 10
McCauley, Michael P., Senior Officer, Investment Programs and
Governance, Florida State Board of Administration (SBA)........ 11
Morgan, Jeffrey D., President and Chief Executive Officer,
National Investor Relations Institute (NIRI)................... 13
Pitt, Hon. Harvey L., Founder and Chief Executive Officer,
Kalorama Partners, LLC, on behalf of the U.S. Chamber of
Commerce....................................................... 7
Stuckey, Darla C., Senior Vice President, Policy & Advocacy,
Society of Corporate Secretaries and Governance Professionals.. 15
Turner, Lynn E., Managing Director, LitiNomics................... 17
APPENDIX
Prepared statements:
Bartl, Timothy J............................................. 38
Holch, Niels................................................. 150
McCauley, Michael P.......................................... 162
Morgan, Jeffrey D............................................ 169
Pitt, Hon. Harvey L.......................................... 182
Stuckey, Darla C............................................. 222
Turner, Lynn E............................................... 345
Additional Material Submitted for the Record
Garrett, Hon. Scott:
Written statement of Gary Retelny, President, Institutional
Shareholder Services Inc................................... 357
Letter from Susan Ferris Wyderko, President and CEO, the
Mutual Fund Directors Forum, dated June 4, 2013............ 374
Moore, Hon. Gwen:
Written statement of Sean Egan, Chief Executive Officer,
Egan-Jones Rating Company.................................. 375
Sherman, Hon. Brad:
Written statement of Ann Yerger, Executive Director, the
Council of Institutional Investors......................... 376
Waters, Hon. Maxine:
Written statement of Anne Simpson, Senior Portfolio Manager,
Investments, and Director of Global Governance, the
California Public Employees' Retirement System............. 395
Written statement of Katherine H. Rabin, Chief Executive
Officer, Glass, Lewis & Co................................. 402
EXAMINING THE MARKET POWER AND
IMPACT OF PROXY ADVISORY FIRMS
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Wednesday, June 5, 2013
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:01 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Hurt, Royce,
Bachmann, Grimm, Stivers, Fincher, Mulvaney, Hultgren, Wagner;
Sherman, Moore, Scott, Himes, Peters, Sewell, and Kildee.
Ex officio present: Representatives Hensarling and Waters.
Chairman Garrett. Greetings. Good morning. This hearing of
the Subcommittee on Capital Markets and Government Sponsored
Enterprises is hereby called to order.
Today's hearing is entitled, ``Examining the Market Power
and Impact of Proxy Advisory Firms.'' I thank our extended
panel who are here with us here this morning, and I thank the
Members from both sides, as well.
We will begin, as we always do, with opening statements,
and then look to the panel for your wisdom and input.
So at this point, I will yield myself about 9 minutes. I am
not sure I will use all of it.
With the 2013 proxy season currently in full swing, today's
hearing examines the market power impact of proxy advisory
firms and, more broadly, whether the proxy system is working
for U.S. companies and their shareholders.
Every year, investors vote over 600 billion shares through
the proxy system to elect boards of directors and take other
corporate actions, as well. Therefore, an accurate, efficient,
and transparent proxy voting system is important to ensuring
that our capital markets remain competitive.
While proxy voting can play an important role in promoting
good corporate governance and enhancing shareholder values, the
current system for distributing proxy materials and voting
shares has become so complicated that few outside of the proxy
process understand how it actually works, including most retail
investors, I would guess.
In addition, corporate proxy disclosures have become more
voluminous and complex than ever, and the Dodd-Frank Act and
SEC rules have significantly expanded the types of issues now
subject to shareholder vote. As a result, many institutional
investors and investment advisory firms have come to rely
exclusively on proxy advisory firms to help them determine how
to vote their clients' shares on literally thousands of proxy
questions companies pose each and every year. And much like the
overreliance on credit rating agencies during the financial
crisis, the rise of proxy advisory firms over the last decade
is attributable in large part to the unintended consequences of
government regulation.
Back in 2003, the SEC issued rules requiring mutual funds
and their investment advisors to construct policies and
procedures reasonably designed to ensure that proxies are voted
in their clients' best interest. The next year, however, the
SEC staff--rather than the Commission itself--interpreted the
rules in a manner that now allows mutual funds and investment
advisors to effectively outsource their fiduciary obligation
when voting their clients' proxies to supposedly independent
proxy advisory firms.
What is the result? Well, as a result of the SEC's actions,
proxy advisory firms now wield an enormous amount of influence
over shareholder voting here in the United States. Two firms in
particular you all know--Institutional Shareholder Services
(ISS), and Glass, Lewis & Company--account for around 97
percent of the proxy advisory industry.
Together, these two firms alone are reported to provide
voting recommendations to clients controlling between 25 and 50
percent of the typical mid-cap or large-cap company shares.
Studies indicate that ISS and Glass Lewis are able to sway at
least 20 to 40 percent of shareholder votes, particularly in
high-profile corporate elections.
Despite their outside influence, however, proxy advisory
firms have no duty to make voting recommendations in the best
interest of the shareholders, and they have no financial
interest in the companies about which they provide voting
advice. It should come as no surprise, then, that proxy
advisory firms often make voting recommendations based on one-
size-fits-all policies and checklists that fail to take into
consideration how voting recommendations affect the actual
shareholder value.
In fact, proxy advisory firms have increasingly teamed up
with others, such as unions and other activist shareholders, to
push a variety of social or political or environmental
proposals that are generally immaterial to investors and often
reduce shareholder value. For example, one recent study found
that the stock market reaction to say-on-pay voting
recommendations supported by proxy advisors has actually been
statistically negative.
So by exploiting the proxy system to push special interest
agendas, proxy advisory firms and activist shareholders have
increased the cost of doing business for many public companies
and disincentivized private companies from going public--all
without a corresponding benefit to the investor returns.
Questions have been raised regarding potential conflicts of
interest that proxy advisory firms may face when making voting
recommendations, for example, as I alluded to a moment ago,
activist shareholders--now some of ISS' and Glass Lewis'
biggest clients--which increases the risk that these two firms
will favor special interest proposals over those that actually
increase or enhance the shareholder values.
With all that said, while there may be concerns regarding
the manner in which proxy advisory firms operate, proxy
advisory firms still serve a valuable role, helping to promote
good corporate governance. These firms should not, however, be
enshrined as the sole corporate government standard-setters.
And finally, to the extent that regulatory changes to the
proxy voting system are necessary, these changes should be
aimed at improving the transparency and efficiency of proxy
voting and, most importantly, enhancing shareholder value. That
is, after all, the point of good corporate governance.
With that, I will yield back my remaining time, and I now
yield 5 minutes to the gentleman from California.
Mr. Sherman. Thank you, Mr. Chairman.
I want to thank the ranking member of the full committee
for asking me to sit in for the ranking member of this
subcommittee, who is attending the funeral of our esteemed
colleague, Senator Lautenberg; she was a close personal friend
of the Senator.
We once had a competition in this world between capitalism
and communism. The new competition is between free market
capitalism on the one hand and crony capitalism on the other.
The advocates of crony capitalism say that boards should be
in total control of their corporations, a small group of people
should control hundreds of billions of dollars, and
shareholders should be frozen out of the decision-making
process and given as little information as possible, as well as
be deprived of any advice that would help them question the
inside management.
Those who believe in free market capitalism believe that
shareholders should be in control of the corporation and they
need information, advice, voting, and freedom from frivolous
lawsuits. Yet those trying to protect inside power have denied
them all of those things.
As to information, we are told that shareholders can't know
about blood diamonds. They can't know about secret political
contributions because they are crazy if they want to make their
investment decisions or their proxy decisions based on those
decisions.
Investors are not only told that they will be deprived of
the information to make the decision; they are told they are
crazy for even wanting to make that decision.
This hearing is about depriving them of the advice. No one
in the corporate world has tried to deprive pension plans and
investors of all kinds of advice.
As a matter of fact, I have never met somebody on Wall
Street who wasn't talking to me about how to sell advice to
CalPERS. Yet in this one circumstance, all of a sudden they
should not be allowed to get the advice they want, as if these
are babes in the woods rather than the epitome of sophisticated
investors.
Then, we see a corporate world that has for many decades
united behind the lowest common denominator of shareholder
rights and corporate law. The rule is that whatever State can
have the most pro-management, anti-shareholder corporate law
will attract--will become the home domicile of major
corporations.
If we cared about shareholders we should be setting the
highest possible corporate standards for all--and shareholder
rights for all publicly traded companies instead of saying,
well, will Delaware or Nevada be the home of those corporations
trying to institutionalize crony capitalism?
Finally--and this is truly bizarre--the corporate world
formed an alliance with plaintiffs' trial lawyers to try to
terrorize or prevent pension plans from divesting from Iran and
use their corporate power in this very committee to hold up
until a few years ago a bill that simply allowed pension plans
to divest from those companies investing in Iran, because
depriving shareholders of their right to divest and thereby
influence management was thought to be an intrusion on the
power of boards.
It is about time for this committee to come out on the side
of free market capitalism, of making sure that shareholders are
given the information shareholders want, not called crazy
because they care about jobs, the environment, preventing
terrorism, or preventing secret political contributions. It is
time that those investors get the advice. It is time that they
have all the protections that a well-drafted corporate statute
can provide.
Instead, we are here focusing on the tiny bit of Wall
Street advisors that habitually question inside management.
That is not the role of this committee.
I know it is easier to protect those who currently control
corporations and therefore have power here in Washington, but
those of us who believe in free market capitalism should be
protecting shareholder rights, and that includes shareholders
being able to get the advice they want. And no one here is for
depriving them of any other kind of advice except to crack down
on those who advise them on how to cast their votes to assure
that we have jobs, open elections, and try to do something
about Iran and other sources of terrorism.
With that, I yield back.
Chairman Garrett. I am very pleased to hear that the
gentleman from California is all about free market capitalism,
and I look forward to the hearing today when we look to provide
that through transparency and the ending of conflict of
interests with regard to proxy advisors.
Mr. Sherman. Mr. Chairman, I would like unanimous consent
to enter into the record the statement of the Council of
Institutional Investors.
Chairman Garrett. Without objection, it is so ordered.
And I also look forward to the gentleman working with us
outside of this issue to end crony capitalism and realign for
free market capitalism and GSE reform, as well, so we can be on
the same page on these things.
With that, I yield to the gentleman from Virginia for 2
minutes.
Mr. Hurt. Thank you, Mr. Chairman.
Mr. Chairman, thank you for holding today's subcommittee
hearing to examine the market power and impact of proxy
advisory firms. As proxy advisory firms continue to have an
increasingly powerful role in corporate governance, it is
important that this committee conduct the proper oversight to
ensure that these entities are working within the appropriate
framework that leads to best practices in corporate governance.
As an enormous market share is controlled by two proxy
advisory firms, there must be sufficient transparency and
accountability. A lack of these critical elements could lead to
poor decisions that neither promote good corporate governance
nor increase shareholder value.
Additionally, as the SEC has acknowledged, conflicts of
interest may arise when proxy advisory firms both provide
voting recommendations for shareholder votes and simultaneously
offer consulting services to the same company. An appropriate
level of oversight, transparency, and accountability will
ensure that that investors will be protected and it will
strengthen corporate governance.
I would like to thank our distinguished witnesses for
appearing today before our subcommittee. I look forward to
hearing your testimony.
Thank you, Mr. Chairman. I yield back the balance of my
time.
Chairman Garrett. The gentleman yields back the balance of
his time--an extra 1 minute.
And with that, we look to Mr. Scott for 3 minutes.
Mr. Scott. Thank you very much.
This is, indeed, an important, important hearing. Two
issues certainly matter, I think, very much here: there are
reasons why we have Dodd-Frank; and there are reasons why we
have responded. From Enron to WorldCom to the 2008 financial
crisis to the failure of MF Global, there are numerous
examples--notable examples--of failures in corporate governance
in recent years.
And I am interested in finding out why only two companies
handle 97 percent of this market. I think we need to get a good
answer to that. Maybe there is a really good answer for it. But
certainly, it is a very important question.
With the 2013 proxy season under way, this hearing is quite
timely, if not overdue. Proxy votes are currently taking place
by institutional investors who typically own securities
positions in a large number of public companies. These votes
taking place are on matters such as director elections,
consideration of management and shareholder proposals, and are
also relevant to many of the delineated goals, as I stated
before, of Dodd-Frank in response to the financial crisis.
These can include issues such as: say on pay--which is very
important--which is a nonbinding vote on executive compensation
practices required under Dodd-Frank; splitting the role of CEO
and chairman of the board at a public company; issues regarding
employee nondiscrimination policies; or other corporate
responsibility measures, including environmental practices.
We must also recognize the possibility of, indeed,
conflicts of interest, especially in a market as highly
concentrated as proxy advisory, with the two largest firms,
again as I said, dominating as much as 97 percent of that
market--ISS and Glass Lewis.
As I said, this is a great concern. Some proxy advisory
firms also provide consulting services to issuers on corporate
governance or executive compensation. A 2010 SEC concept
release also noted the potential of conflicts of interests of
such firms and the criticism with regards to lack of accuracy
and transparency in firms formulating voting recommendation.
Yet, the SEC has not taken further action on this.
So as we go forward to address the many regulatory issues
raised by the directory of Dodd-Frank, we must balance concerns
on behalf of the consumer, the user, our constituents, with the
concerns raised by America's public companies, many of whom
also are run by our constituents and have stakes in our
communities. What policies, for example, or procedures do proxy
advisory firms use, if any, to ensure that their
recommendations are independent and are not influenced by any
consulting fees that they receive from issuers?
I think the American public is very interested in this
issue today, and I look forward to getting some very good
answers to these questions that I have raised.
Thank you, Mr. Chairman.
Chairman Garrett. The gentleman yields back. Actually, he
doesn't yield back; he went over.
Is there anyone else?
Mr. Scott. Thank you very much and I do yield--
Chairman Garrett. Ms. Moore is recognized for 2 minutes.
Ms. Moore. Thank you so much, Mr. Chairman and Mr. Ranking
Member, for holding this hearing. I am eager to hear from our
witnesses on proxy advisory firms, especially the increasingly
important role they play in concentration in the industry.
I want to discuss proxy access more conceptually and
restate my support for Section 971 of Dodd-Frank. This is an
area that has elicited considerable academic work and debate.
Speaking to the Practicing Law Institute in 2009, then-SEC
Chairman Schapiro said of shareholder access, ``Corporate
governance, after all, is about maintaining an appropriate
level of accountability to shareholders by directors whom
shareholders elect, and by managers who directors elect.''
Chairman Schapiro went on regarding the election of board
of directors, ``I believe that the most effective means of
promoting accountability in corporations is to make
shareholders' votes both meaningful and fully exercised.
However, in most cases today shareholders have no choice in
whom to vote for.''
Congress agreed, and included Section 971 in Dodd-Frank.
The State of Wisconsin Investment Board (SWIB) simply states
that SWIB encourages companies to ``establish reasonable
conditions and procedures for shareholders to nominate director
candidates to the company's proxy and ballot.'' I agree with
that.
One argument of opponents of Section 971-type proxy rules
is that high-quality directors may be less willing to serve on
boards if they face competition from shareholder-sponsored
candidates. It is a silly and offensive argument.
In an age when we tell college kids that they have to
compete globally to get a job in corporations, and tell workers
that they have to compete to keep their jobs in these
corporations, why should directors of the corporations
mysteriously be shielded from competition, especially from
challenges from the shareholders they should serve? To hear
some people tell it, Section 971 aids barbarians at the gate.
In reality, it is a measured proposal to enhance corporate
governance and accountability.
And I yield back.
Chairman Garrett. The gentlelady yields back.
We now turn to the panel. And again, I welcome the entire
panel.
Some of you have been here before. For those who have not,
you will all be recognized for 5 minutes, and the little lights
in front of you will be green when you begin; yellow at one
minute remaining; and red when your time us up.
Also, your entire written statements will be made a part of
the record, so we will look to you to summarize in your 5
minutes.
So with that, again, I welcome the panel. And we will turn
first to Mr. Pitt representing the U.S. Chamber of Commerce.
Welcome to the panel. You are recognized for 5 minutes.
STATEMENT OF THE HONORABLE HARVEY L. PITT, FOUNDER AND CHIEF
EXECUTIVE OFFICER, KALORAMA PARTNERS, LLC, ON BEHALF OF THE
U.S. CHAMBER OF COMMERCE
Mr. Pitt. Thank you, Mr. Chairman. It is a pleasure to be
back here.
Chairman Garrett, Representative Sherman, and members of
the subcommittee, I am pleased to participate in these
important hearings representing the U.S. Chamber of Commerce to
discuss the extensive but unfettered influence that proxy
advisory firms currently wield over corporate governance in the
United States.
As you have requested, I will not repeat the Chamber's
detailed written statement. Instead, I would like to briefly
highlight 5 points for your consideration.
First, effective and transparent corporate governance
systems that encourage meaningful shareholder communications
are critical if public companies are to thrive. Informed and
transparent proxy advice can promote effective corporate
governance, but only if transparency exists throughout the
proxy advisory process, and the advice provided directly
correlates to and is solely motivated by advancing investors'
economic interests. Sadly, these two essential components of
proxy advice have been lacking for some time.
Second, as has already been observed, two firms--ISS and
Glass Lewis--control 97 percent of the proxy advisory business
and dominate the industry. Together, they effectively can
influence nearly 40 percent of the votes cast on corporate
proxy issues, making them de facto arbiters of U.S. corporate
governance.
Third, these firms advocate governance standards to U.S.
public companies but they do not practice what they preach.
Serious conflicts permeate their activities, posing glaring
hazards to shareholder interests. They are powerful but
unregulated and they cavalierly refuse to formulate and follow
ethical standards of their own, render their advice
transparently, accept accountability for advocated standards,
and assume responsibility to avoid factual errors and shoulder
the burden to rectify the mistakes that they make.
This lack of an operable framework for those exercising
such a significant impact on our economic growth is wholly
unprecedented in our society. Indeed, 2 weeks ago ISS settled
serious SEC charges stemming from its failure to establish and
enforce appropriate written policies.
Fourth, significant economic consequences flow from proxy
advisory firms' unfettered power and lack of fidelity to
important ethical and fiduciary precepts, something that has
been recognized both here and abroad. Although U.S. regulators
have not fulfilled promises to address these issues, Canadian
and European regulators, among others, are speaking out.
Fifth, the answer to these concerns is not more regulation,
but rather a collaborative public-private effort to identify
core principles and best practices for the proxy advisory
industry. In March, the Chamber published best practices and
core principles which provides a crucial foundation for
successfully delineating standards for the industry to embrace
and follow.
What is essential is for responsible voices--this
subcommittee, the SEC, institutional investors, public
companies, and proxy advisory firms--to lend support to the
effort to promulgate and apply effective standards.
Mr. Chairman, members of the subcommittee, it is my hope
and strong recommendation that these hearings result in a
serious commitment to achieve those goals. Thank you.
[The prepared statement of Mr. Pitt can be found on page
182 of the appendix.]
Chairman Garrett. And I thank you for your testimony.
Next, from the Center on Executive Compensation, Mr. Bartl.
STATEMENT OF TIMOTHY J. BARTL, PRESIDENT, CENTER ON EXECUTIVE
COMPENSATION
Mr. Bartl. Thank you, Mr. Chairman.
Chairman Garrett, Representative Sherman, and members of
the subcommittee, my name is Tim Bartl, and on behalf of the
Center on Executive Compensation, I am pleased to present our
views on this very important topic. My comments today are based
in part on our paper, ``A Call for Change in the Proxy Advisory
Industry Status Quo,'' and I would ask that a copy of that be
submitted for the record.
Chairman Garrett. Without objection it is so ordered.
Mr. Bartl. By way of background, the Center is a research
and advocacy organization. We are a division of HR Policy
Association, that represents the senior HR officers of over 340
large companies, and the Center's subscribing members are
across industry group of the association.
Mr. Chairman, today I would like to focus on four points,
if I may: the role of proxy advisory firms; their influence
over company votes and practices; the impact, as Chairman Pitt
talked about, of conflicts of interest and inaccuracies; and an
example of the importance of oversight, both regulatory and
legislative, in procuring some of the issues changes we are
talking about today.
As you have heard both from members of the subcommittee and
from Chairman Pitt, proxy advisors fill an important role
regarding helping institutional investors fulfill their proxy
voting duties, but the speed with which the advisors must
analyze proxies leads to a check-the-box mentality driven in
part by the desire to present investors with a uniform,
condensed version of corporate pay disclosures, even though pay
programs are individualized, complex, and lengthy. This can
lead to errors, inaccuracies, or questionable
characterizations.
And in part, the irony is that the regulatory regime
effectively makes each issuer responsible, at least in part,
for ensuring the accuracy of its proxy advisory firm reports
even though the advisors are the experts. This calls into
question the legitimacy of the current model.
So as we look at the influence that the proxy advisors
wield--we heard members of the subcommittee talk about some of
the academic research, which is all in our written testimony.
But the Center data for the 2013 proxy season gives a good
illustration, talking about ISS recommendations against say on
pay for S&P 500 companies. If you received an ``against''
recommendation, you got an average of 64 percent support for
your say-on-pay vote, compared to about 93 percent if you got a
``for'' recommendation.
And despite this influence, proxy advisory firms have no
economic interest in the companies for which they are giving
the recommendations. As one company told us, ``It feels like we
are giving power over the board to a consultant without a horse
in the race.''
As we also talk about in our written testimony, proxy
advisory firms also influence company pay policies, and when we
researched this among our subscribers we found that about 54
percent said that they had changed a pay practice, policy, or
plan primarily to meet a proxy advisory firm's standard.
Let me talk for just a second about conflicts of interest
and inaccuracies or errors. The practice that ISS practices of
providing consulting services to corporate issuers on one side
while providing impartial--or so-called impartial--
recommendations to issuers and investors on the other is a
conflict that we find very troubling because it creates the
perception that there is an advantage to taking up the
consulting.
In addition, the consulting of ISS with investor clients
that are shareholder proponents also creates the perception
that ISS may favor those resolutions. And we believe that both
practices should be prohibited.
With respect to inaccuracies, there is an example in our
testimony, and I would urge you to take a look at it, with
respect to Eagle Bancorp, but about 53 percent of Center and HR
Policy members said in the survey that a proxy advisory firm
had made one or more mistakes in a final report during our
research of this.
Mr. Chairman, let me conclude by talking about the sentinel
effect of oversight, and this harkens back to 2012. Again, it
deals with ISS, the largest firm, which had adopted a new
practice--a new methodology for determining peer groups. And
the reason that peer groups are important in pay disclosures is
the linkage between peers and pay-for-performance. If the peer
group is wrong, the connection between pay and performance is
likely not to be seen.
And when the methodology was put out, about 23 of 45 S&P
500 companies filed supplemental filings with the SEC saying
that peer groups were a problem. This gained the attention of
the SEC. And even in conversations with investors, they raised
the issue and said they were going to raise it with ISS.
All of this attention, in conjunction with popular press
attention, led by early summer for ISS to say, ``We are going
to reexamine this.'' They looked at it, and they changed it. We
have even seen some of the salient effect since then on greater
engagement with us.
And so with that, Mr. Chairman, thanks again for allowing
us to testify, and I look forward to answering any questions
you may have.
[The prepared statement of Mr. Bartl can be found on page
38 of the appendix.]
Chairman Garrett. And I thank you for your testimony.
Next, Mr. Holch, the executive director of the Shareholders
Communications Coalition.
You are recognized for 5 minutes.
STATEMENT OF NIELS HOLCH, EXECUTIVE DIRECTOR, SHAREHOLDER
COMMUNICATIONS COALITION
Mr. Holch. Thank you, Mr. Chairman.
Chairman Garrett, Representative Sherman, and members of
the subcommittee, my name is Niels Holch, and I am the
executive director of the Shareholder Communications Coalition.
The Coalition is comprised of the Business Roundtable, the
National Investor Relations Institute, and the Society of
Corporate Secretaries. The Coalition was established in 2005
after the Business Roundtable filed a petition for rulemaking
with the SEC, urging the agency to conduct a comprehensive
evaluation of the U.S. proxy system.
Many of the current SEC shareholder communications and
proxy voting rules were adopted more than 25 years ago in 1985
and remain unchanged. These SEC rules were promulgated during a
period when most annual meetings were routine and very few
matters were contested. They were also developed at a time when
technology was not nearly as advanced as it is today.
Just for perspective, these SEC rules were adopted when
Ronald Reagan was starting his second term of office, the Dow
Jones Industrial average was at 1,500 instead of 15,000, and
Microsoft was still publishing software using its DOS operating
system.
After decades of inaction, the SEC began to tackle this
problem in July of 2010, when it released for public comment a
concept release describing concerns about the current proxy
process and discussing possible regulatory solutions.
Unfortunately, another 3 years has now passed, and the SEC has
not taken any action on its concept release.
Let me now provide you with a brief summary of how the
current proxy system is structured and why the Coalition
believes reforms are essential; 70 to 80 percent of all public
company shares in the United States are held in street name,
meaning in the name of a broker or a bank rather than its
customers, who are referred to as ``beneficial owners.''
Under SEC rules, brokers and banks are responsible for
distributing shareholder meeting materials provided by
companies to their beneficial owners and processing their proxy
voting instructions. Changes in corporate governance practices
have accelerated the need for public companies to communicate
more frequently and on a more time-sensitive basis with their
shareholders.
However, this is very difficult to accomplish under a
system that is controlled by the brokers and the banks.
Additionally, SEC rules classify investors as either
``objecting beneficial owners,'' called OBOs, or ``nonobjecting
beneficial owners,'' called NOBOs. The public companies
represented by the Coalition have one overriding goal in this
area: We want to know who our shareholders are, and we would
like to be able to communicate with them directly.
For these reasons, the Coalition supports the elimination
of the NOBO-OBO classification rule. This would give public
companies access to contact information for their beneficial
owners and permit direct communications with them. Once public
companies have access to shareholder information, they could
assume responsibility for distributing proxy materials
directly, making the process more efficient and promoting open
communications.
The proxy voting system also needs to be addressed. Reports
in the news media of voting miscounts and delays in determining
election results have raised questions about the integrity of
the voting process. Proxy voting should be fully transparent
and verifiable, starting with a list of eligible voters for a
shareholder meeting and ending with the final tabulation of the
votes cast at that shareholder meeting.
Public companies are also concerned about the role and
activities of private firms providing proxy advisory services
to institutional investors. Proxy advisory firms should be
subject to more robust oversight by the SEC.
For example, the current exemption from the proxy rules
that these firms enjoy should be conditioned on their meeting
certain minimum requirements governing their activities. The
SEC should also require registration of all proxy advisory
firms under the Investment Advisors Act. Additionally, the SEC
and the Department of Labor should review their existing rules
and interpretations to make sure that institutional investors
are complying with their fiduciary duties by exercising
sufficient oversight over their use of proxy advisory services.
As noted earlier, it has been more than 25 years since the
SEC's shareholder communications and proxy voting rules have
been updated. The Coalition urges this subcommittee to request
that the SEC turn its attention to addressing the issues raised
in its 2010 concept release.
Thank you.
[The prepared statement of Mr. Holch can be found on page
150 of the appendix.]
Chairman Garrett. Thank you.
Next, Mr. McCauley, from the Florida State Board of
Administration.
Welcome. You are recognized for 5 minutes.
STATEMENT OF MICHAEL P. McCAULEY, SENIOR OFFICER, INVESTMENT
PROGRAMS AND GOVERNANCE, FLORIDA STATE BOARD OF ADMINISTRATION
(SBA)
Mr. McCauley. Thank you.
Chairman Garrett, Representative Sherman, and members of
the subcommittee, good morning. I am Michael McCauley, senior
officer with the Florida State Board of Administration. I am
pleased to appear before you today on behalf of the State Board
of Administration.
My testimony includes a brief overview of the State Board
of Administration and its investment approach followed by a
discussion of our proxy voting process and procedures and our
use of proxy advisors to assist the SBA in fulfilling its proxy
voting obligations. I will also discuss some proposed reforms
that will make proxy advisors more transparent to the market
and more accountable to their clients.
The Florida State Board of Administration, or SBA, manages
more than 30 separate investment mandates and trust funds, some
established as direct requirements of Florida law and others
developed as client-initiated trust arrangements. In total, the
Florida SBA manages approximately $170 billion in assets, and
under Florida law, the SBA manages the funds under its care
according to fiduciary standards similar to those of other
public and private pension and retirement plans.
The SBA must act in the best interest of the fund
beneficiaries. This standard encompasses all activities of the
SBA, including the voting of all proxies held in funds under
SBA management.
In Fiscal Year 2012, the SBA executed votes on thousands of
public companies--approaching 10,000; it was approximately
9,500 individual meetings. The SBA makes all proxy voting
decisions independently, and to ensure that the SBA meets its
fiduciary obligations, it established the Corporate Governance
and Proxy Voting Oversight Group, or the Proxy Committee, as
one element in an overall enterprise risk management program.
SBA voting policies are based both on market experience and
balanced academic and industry studies, which aid in the
application of specific policy criteria, quantitative
thresholds, and other qualitative metrics. During 2012, the SBA
issued guidelines for more than 350 typical voting issues and
voted at least 80 percent of these issues on a case-by-case
basis following a company-specific assessment.
To supplement its own proxy voting research, the SBA
purchases research and voting advice from several outside
firms--principally the leading proxy advisory and corporate
governance firms. When making voting decisions, the SBA
considers the research and recommendations provided by advisors
along with other relevant facts and research, as well as the
SBA's own proxy voting guidelines.
But the SBA makes voting decisions independently and in
what it considers to be the best interests of the beneficiaries
of the funds it manages. Proxy advisor and governance research
firm recommendations inform but they do not determine how the
State Board of Administration votes, and they do not have a
disproportionate effect on SBA voting decisions.
In Fiscal Year 2012, again, the votes that the SBA executed
correlated with the recommendations of one single proxy advisor
firm 67 percent of the time. Other historical reviews of SBA
voting correlations have shown both lower and higher
correlations with individual external proxy advisor
recommendations, and that has been dependent on both the time
period that was under study as well as the specific voting
categories that were in question.
While the SBA acknowledges the valuable role that proxy
advisors play in providing pensions funds with informative,
accurate research on matters that are put before shareowners
for a vote, we believe proxy advisory firms should provide
clients with substantive rationales for vote recommendations,
minimize conflicts of interest, and have appropriate oversight.
Toward that end, the SBA believes that proxy advisors should
register as investment advisors under the Investment Advisors
Act of 1940.
Registration would establish important duties and standards
of care that proxy advisors must uphold when advising
institutional investors. And additionally, the mandatory
disclosures would expose conflicts of interest and how they are
managed and establish liability for firms that withhold
information about such conflicts.
Mandatory disclosure should also include material
information regarding the process and methodology by which the
firms make their recommendations, aimed at allowing all
stakeholders to fully understand how an individual proxy
advisor develops those voting recommendations. This would make
advisor recommendations more valuable to institutional investor
clients and more transparent to other market participants,
including corporations. In this way, registration would
complement the aims of existing securities regulation, which
seeks to establish full disclosure of all material information.
Thank you, Mr. Chairman, for inviting me to participate in
the hearing, and I look forward to the opportunity to answer
any questions.
[The prepared statement of Mr. McCauley can be found on
page 162 of the appendix.]
Chairman Garrett. And I thank you.
Next, Mr. Morgan, from the National Investors Relations
Institute (NIRI).
STATEMENT OF JEFFREY D. MORGAN, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, NATIONAL INVESTOR RELATIONS INSTITUTE (NIRI)
Mr. Morgan. Thank you, Chairman Garrett, Representative
Sherman, and members of the subcommittee for holding this
hearing and for inviting the National Investor Relations
Institute, or NIRI, to participate.
My name is Jeff Morgan, and I am president and CEO of NIRI.
Founded in 1969, NIRI is the largest professional investor
relations association in the world, with more than 3,300
members representing over 1,600 publicly traded companies and
$9 trillion in stock market capitalization.
My written testimony focuses on the two topics of this
hearing: proxy advisors; and improving communications and
engagement between public companies and shareholders. I will
focus my verbal comments on the communications aspect.
An open channel of two-way communications is needed for any
business between its owners and its investors. Businesses have
an obligation to keep their owners informed on business
operations, financial results, and other material information.
Owners have an obligation to ensure management is operating
within expected guidelines and to offer their input on key
decisions.
In all cases, I think most would agree that two-way
communications is much less effective when each party doesn't
know who the other party is. That is the situation with public
companies in the United States today and one of the many
challenges we have with our capital markets and proxy system as
they have evolved over the last several decades.
Shareholders know they own stock or equity in a company,
but the company has limited ability to know who the shareowners
of the company are at any point. Ultimately, better
transparency in shareholder ownership would improve the two-way
dialogue of companies and shareholders, creating healthier U.S.
capital markets.
While companies operate under a host of regulations, there
are few regulations to allow for shareholder information to be
provided to the company to ensure there is a healthy flow of
information and dialogue from company to shareholders.
One of the few mechanisms is the choice of shareholders to
be registered or to hold shares in street name. Registered
shareholders are those who directly register with the issuer or
publicly traded company, thus enabling the company to know the
identity of the shareholder, as well as providing for the free
flow of information between the company and the shareholder.
Street name shareholders are those who use a broker or bank
to hold the shares on their behalf. While the street name
shareholder is the beneficial shareholder, there is no direct
registration with the company, and consequently, the company
doesn't necessarily know the shareholder's identity.
Prior to the 1970s, estimates are that approximately 75 to
80 percent of shares were registered and about 20 to 25 percent
were held in street name. Today, the opposite is true, with
about 80 percent of shares in street name and 20 percent
registered with the company.
As our capital markets have evolved, companies have lost
the direct linkage with their shareholders. The only report
that provides some insight for a company into its larger
shareholders is SEC filing Form 13F. While not specifically
designed to help companies know who their largest shareholders
are, Congress established a reporting regime in the late 1970s
to provide public reporting by certain larger investment
managers of their equity position.
Every institutional manager who exercises investment
discretion having an aggregate market value of at least $100
million on the last trading day of the month must file a Form
13F. Managers must file these reports with the SEC within 45
days after the last day of each quarter.
The practical effect of this rule is that an investment
manager may buy shares on January 2nd and not have to report
that holding publicly until May 15th, more than 19 weeks after
the transaction. This is hardly a productive way for issuers to
know their shareholders.
Recently, the NYSE, the Society of Corporate Secretaries,
and NIRI submitted a petition to the SEC to reduce the
reporting delay from 45 days down to 2 days. As part of Dodd-
Frank, Congress mandated the SEC consider similar rules for
short selling, requiring disclosure every 30 days. So we
believe an evaluation of the entire equity ownership disclosure
process as part of the evaluation of proxy mechanics and proxy
advisors makes sense.
With the increasing involvement of shareholders in
corporate governance matters, it is clear that improvements to
our system for linking shareholders and companies are needed.
Public companies would welcome it, and this would dramatically
increase the ability of companies to engage with shareholders.
Action in this area, combined with an examination of our
20-plus-year-old proxy system, including a focus on the proxy
advisory service area, would go a long way to enhancing our
proxy and shareholder communications process in the United
States.
In conclusion, thank you for the opportunity to testify,
and I look forward to your questions.
[The prepared statement of Mr. Morgan can be found on page
169 of the appendix.]
Chairman Garrett. And I thank you for your testimony.
Next up, from the Society of Corporate Secretaries &
Governance Professionals, Ms. Stuckey is recognized for 5
minutes.
STATEMENT OF DARLA C. STUCKEY, SENIOR VICE PRESIDENT, POLICY &
ADVOCACY, SOCIETY OF CORPORATE SECRETARIES & GOVERNANCE
PROFESSIONALS
Ms. Stuckey. Thank you, Chairman Garrett, Representative
Sherman, and members of the subcommittee.
I am Darla Stuckey, senior vice president at the Society of
Corporate Secretaries & Governance Professionals. We have 3,100
members representing about 1,200 public companies and about
over half of those are small-and mid-caps.
Reading proxy statements is time-consuming. Few investment
managers will allocate capital to voting decisions that they
believe will not generate a return on investment. In short,
proxy voting, other than in a ``bet the farm'' type scenario,
is simply not worth the cost.
So outsourcing to proxy advisory firms is pragmatic, but
many investors use their reports like CliffsNotes: They read
the summary report but not the proxy. Some don't even read the
report; they just take the vote recommendation automatically.
But proxy statements are subject to full 1934 Act liability
and are filed with the SEC. Proxy advisory firm reports are
not, but should be.
My testimony will cover the proxy advisory firm influence
and problems we have with their policies, conflicts, and
errors.
Due to the sheer volume of companies, proxy firm reports
are based on one-size-fits-all policies. This is a problem
simply because companies are not the same.
Voting decisions and routine elections are even more
important now than they have been with the advent of say-on-pay
and majority vote for directors. Companies of all sizes now
must navigate proxy advisory firm policies and guidelines.
As you have heard, they control at least 20 percent and
maybe upwards of 40 percent of the vote. This is much larger
than the Schedule 13D threshold and even larger than the 10
percent affiliate status threshold, both of which require
public reporting.
In 2009 and 2010, IBM stated that the voting block that ISS
controlled had more influence than its largest shareholder.
This is the case even though the proxy advisory firms have no
economic stake in the company and have not made meaningful
disclosure about their power, conflicts of interests, or
controls.
Proxy firm voting policies are also not transparent. We
don't know how they are developed. Although ISS provides both
issuers and investors with an opportunity to take their survey,
the questions are often skewed and biased towards a narrow
agenda.
We don't know if the issuer's voice counts, and the number
of institutions who take the survey is very small. ISS reported
201 responses in 2010, representing only 15 percent of its
institutional clients--even fewer since. So consider that 15
percent of ISS' clients create policies that influence as much
as 20 percent of the vote of every public company.
They also influence corporate behavior. Just the threat of
an ``against'' vote causes boards to change their practices to
satisfy the one-size-fits-all guidelines. ``What will ISS
say?'' is regularly asked in the board rooms.
Proxy advisory firms are also subject to conflicts, which
you have heard, and which are discussed in my written
testimony.
I will explain one. Here is the story: One company member
received a call from a sales representative from Equilar, a
company working with Glass Lewis, 2 days after Glass Lewis
recommended against their say-on-pay proposal. The rep wanted
to sell the company a service that would shed light on the
recommendation.
The society member asked about the basis for the CEO
compensation number that had been used because its CEO had
changed in 2012 and it looked like Glass Lewis had used a
composite of the former CEO's compensation and the new CEO
comp. But even still, the number was 45 percent higher than
what was in the summary comp table.
The member asked for an explanation, but the sales
representative was unwilling to discuss it unless the company
subscribed to their service, which was about $30,000. Indeed.
And lack of access to reports is at the heart of the larger
problem of mistakes. Until recently, a company could get its
Glass Lewis report from its proxy solicitor or a law firm, but
no longer.
Instead, Glass Lewis will sell issuers a copy of the report
for $5,000 or they can buy the $30,000 service I mentioned. So
if an issuer wants to see the facts given to its investors,
their only choice is to pay for the report.
At the very least, proxy recommendation reports should be
provided to all issuers in advance of publication, free of
charge, to enable the issuer to check the factual accuracy of
the report, because votes that are not based on facts are not
informed votes and we don't believe an institution can satisfy
its fiduciary duties by relying on something that is not
accurate or that it doesn't know is accurate.
Other problems: Aside from conflicts, the reports can
contain mistakes. One example relates to ISS' peer group
selection methodology. A small-cap member wrote to me
yesterday--somebody with no access to the report in advance--
telling us that last week, ISS also recommended against its
say-on-pay proposal.
Here is what he described: The ISS peer group bears almost
no relationship to our industry. We are an e-mail data security
company. We sell B-to-B. They have designated as peers
consumer-oriented online media companies, personal dating
sites, online games, et cetera, that have nothing to do with
our industry. We don't compete with these companies for talent
and we have been consistently profitable for the measurement
period, whereas most of the companies to which they compare us
have not been.
In sum, both investment advisors and proxy advisory firms
must have an obligation to ensure that vote recommendations are
based on accurate facts and are in the best economic interests
of the shareholders.
Thank you.
[The prepared statement of Ms. Stuckey can be found on page
222 of the appendix.]
Chairman Garrett. Thank you.
And having the final word on the topic--well, maybe not--
Mr. Turner, you are recognized for 5 minutes.
STATEMENT OF LYNN E. TURNER, MANAGING DIRECTOR, LITINOMICS
Mr. Turner. Thank you, Chairman Garrett. It is indeed an
honor to be invited back again to testify before the committee,
and I would like to thank you and Representative Sherman.
I would like to make a few key points today, and my points
will be based upon my past experience: I have been a member of
the corporate boards of public companies which were subject to
the recommendations of the proxy voting firms; I have been on
the board of two institutional investors who did the proxy
voting; I have been a financial executive, vice president, in a
large international semiconductor company; I was a former
regulator at the SEC; and I also was a senior executive and
head of research at Glass Lewis during its initial formative
years, from 2003 to 2007.
First, let me note that proxy voting is an important right
to the owners of public companies. Proxy voting provides
investors with a very useful market-based mechanism with which
to establish the accountability of both the board of directors
and management, which is what makes our capital market system
work.
Second, many investors and their asset managers take this
responsibility very seriously. If you look at the Web sites of
the largest public pension funds and the 15 largest money
managers, such as Fidelity, Vanguard, and Blackrock, you will
find they all have their own custom designed proxy voting
guidelines, as well as staff dedicated to proxy voting. These
custom guidelines are similar at times to those of the two
proxy advisory firms on issues, but this is because investors
do have some common views on what is good governance in the
corporate community.
Third, asset managers may buy research from the proxy
voting services to gather useful information and assist with
their analysis of the issues. However, it is not uncommon that
they will vote differently than ISS or Glass Lewis and their
recommendations and often vote with management. And certainly,
one would think that buying of such research to add to one's
available information about the issue should not be criticized
in the context of trying to be fully informed about an issue.
Fourth, in today's global markets an investor asset manager
is going to invest in dozens of capital markets around the
globe. At COPERA, we invest in 7,000 to 8,000 companies. A
proxy advisory firm like Glass Lewis or ISS may issue
recommendations on 20,000 to 40,000 proxies a year around the
globe.
Clearly, the mutual funds and the pension funds don't have
the staff to go through all of those. It would be cost-
prohibitive. It would take well over 100 staff, I believe,
based on my experience, to read each of those in depth, do the
analysis, and vote the 8,000 proxies in a global marketplace.
If you had to add those staff to your pension fund or your
mutual fund, it would drive up the cost to investors
significantly and reduce their returns. I doubt people want to
do that.
Fifth, there is a significant amount of transparency today
when it comes to proxy voting. ISS, to their credit, goes
through a phenomenal public comment process, not dissimilar
from what the Federal regulators here in this government do.
They post their guidelines to their Web site; they talk about
their methodologies on their Web site. Most proxy and pension
funds also post their proxy voting guidelines, as I have
previously mentioned.
Sixth, pension and mutual funds do not view their proxy
voting guidelines as rigid documents. Quite often, when the
circumstances are appropriate, we will turn around and vote
differently than their guidelines. It is not a one-size-fit-
all, as some would argue.
Seventh, if there is a bias in proxy voting it is, in fact,
towards management. In 2002 at PERA, we voted with management
about 86 percent of the time. Even on shareholder proposals, we
still voted with management about 60 percent of the time.
And I think in the statement by the Council of
Institutional Investors, and the statement you heard from
Florida, they also indicated a bias towards management. In
fact, on the say-on-pay proposals so far to date this year,
there have been approximately 2,473 votes, and only 31 have
failed; less than 2 percent have failed.
When I was going to college, I would have signed up quickly
for any class where you had a 98.5 percent passing rate. This
is not way out of the mark.
Eighth and finally, I will just say that there are about
100 proxy voting contests each year that get a lot of
attention. It is typically because of a lack of performance, if
you looked at the recent example on Hewlett Packard, for
example--very contested, a lot of visibility in the media. In
that case, Hewlett Packard had been underperforming in the
market, had lost over $30 billion in market share, had turned
around and had negative performance in excess of 20 percent
over the previous 5 years, and was in the lower quartile in
their industry during that time period. That is what causes the
disputes on the proxy voting.
Thank you, and I would be happy to answer any questions.
[The prepared statement of Mr. Turner can be found on page
345 of the appendix.]
Chairman Garrett. Great. Thank you.
So again, I appreciate the panel's testimony, and we will
now go to questioning. I will try to run down the list in 5
minutes.
Chairman Pitt, in your written testimony you didn't exactly
say, you inferred, that the Egan-Jones no-action letter is one
of the main reasons that the largest proxy firms--we just
basically have two of them, a duopoly at this point. So for all
practical purposes, is it correct to say that the decision by
the SEC--and that was done by the staff, correct, not by the
Commission--has eliminated any fiduciary responsibility for the
actual mutual funds themselves and the investment advisors?
Mr. Pitt. I think it is correct to say that those letters
have enabled institutional investors to sidestep their
fiduciary obligations instead of actually fulfilling them
themselves.
Chairman Garrett. Right. And if they had a fiduciary
responsibility--just to lay this out clearly--that
responsibility would be to whom?
Mr. Pitt. That is correct. They have--
Chairman Garrett. To whom would it be if they had a
fiduciary responsibility? Who were you talking about? To the
investor?
Mr. Pitt. They do have clear fiduciary responsibilities.
Chairman Garrett. If those letters basically obviated,
eliminated, diminished the fiduciary responsibility by the
mutual fund or the investment advisor to the little investor
out there, let's see, did it shift that responsibility
someplace else? Does the proxy advisor now have that fiduciary
responsibility to the investor?
Mr. Pitt. No. The fiduciary duties still remain with
institutional investors. They cannot divest themselves of their
fiduciary obligations.
What the no-action letters do is provide a vehicle for them
to outsource the exercise of--
Chairman Garrett. Right. So basically, it says it satisfied
the responsibility by going to a proxy advisor.
Mr. Pitt. That is correct.
Chairman Garrett. Right.
Does the proxy advisor--if I am the little investor, does
the proxy advisor now have a fiduciary duty to me, because I
can't go back to the mutual fund?
Mr. Pitt. I believe that they do not have the same
fiduciary duties that the institutional investors have because
the institutional investors owe their fiduciary duties to the
shareholders in those institutions. Proxy advisory firms--
Chairman Garrett. Right.
Mr. Pitt. --do have clear obligations of truthfulness and
the like, and those are akin to fiduciary duties, but they are
not the same fiduciary duties.
Chairman Garrett. Someone on the panel--I don't think it
was you--made reference to the idea of just making them
responsible as an investment advisor. Would that solve the
problem?
Mr. Bartl. Yes. I don't think that was me, but--
Chairman Garrett. No, it wasn't. But would that solve the
problem? Because you were the one who said--
Mr. Bartl. In terms of registration as an investment
advisor, because of the services that proxy advisors provide,
it in and of itself is not going to put them in the shoes of
investors because they are in sort of a quasi-role between
analyzing company plans and giving advice to investors. It is
almost a different animal altogether.
Chairman Garrett. Right. You did point out, though, that
they basically just don't have, as you put it colloquially, a
``horse in the race,'' so they don't have that interest in it.
But you also raised also another potential conflict, which
is interesting, with regard to the advice that they actually
sell to the firms as well, which puts them into an additional
conflict situation.
Mr. Bartl. Yes. And the interesting part here is that the
companies still perceive that there is an advantage, and when
proxy advisors provide advice on one side of the house and the
other side of the house is giving the rating, regardless of
whatever disclaimers are made--in fact, ISS even says, ``Don't
tell us by contract--don't tell us that you talked to our
consulting side if you come to the research side to tell us
about your proxy''--it is a bit of a kangaroo court. The--
Chairman Garrett. Let me just break, because I only have 30
seconds here--I appreciate your kangaroo court opinion.
Ms. Stuckey and Mr. McCauley--Ms. Stuckey, you sort of say
that the one-size-fits-all does not work for these, and Mr.
McCauley sort of indicates that is true in the sense that 67
percent of the firms don't rely upon them exclusively for the
advisors. And yet some firms rely on them exclusively. Is that
right, Ms. Stuckey?
Ms. Stuckey. That is right. There is even a recommendation-
only service that some investors can buy where they don't even
get the reports at all because they don't have time to read
them. It is really the lowest common denominator; it is like a
compliance obligation on behalf of many smaller investors--not
Mr. McCauley.
Chairman Garrett. Right. Just checking the box. I
appreciate that.
And my time has expired.
I now recognize the gentleman from California.
Mr. Sherman. Mr. Turner, I want to thank you for pointing
out that the same proxy advisory firm could tell two different
clients a recommendation to vote in different ways just because
they are given different criteria and they correspond to that
criteria, just as a beer advisor might advise me to buy one
beer because it tastes great and advise him to buy a different
beer because it is less filling.
In California, we do everything by referendum. In effect,
every voter gets a proxy statement from the California
Secretary of State; it is paid for by the corporation, that is,
the State government legislature puts various referendum on the
ballot. And the opponents get as much space in that book as the
proponents of those referendum.
Few Democrats and, I assure you, many fewer Republicans
would advocate that only the management of the California
legislature be allowed space in that proxy statement. If
anybody wants to draw an analogy to the corporate world, they
are welcome to do so.
Ms. Stuckey, if someone was listening perhaps not as
closely as they should have to your testimony, they would have
thought you were advocating that these recommendations all be
filed with the SEC where they would be public. That would mean
that everybody who wanted to see these reports could see them
for free and that would, of course, abolish the proxy advising
industry.
I have a series of questions I want to ask everybody--
Ms. Stuckey. May I respond to that?
Mr. Sherman. No, because I am sure you didn't mean to do
that. I just want to caution those who might not have listened
carefully enough to your testimony. I want to go on.
We are here to talk about shareholder rights.
Mr. Turner, you are representing yourself, but everybody
else here is representing an organization, so I would ask them
to respond as to official positions of their organization.
Please raise your hand if the folks you represent have
taken a position in favor of requiring cumulative voting for
all corporations publicly listed.
Only Mr. McCauley's hand goes up.
How many of your organizations have taken a position in
favor of information being in the proxy statement about $1
million-plus political expenditures?
No hands go up.
We have a circumstance where you may have a management and
a board that is just doing a terrible job, and yet it takes 3
years to vote on the board because only one-third of the board
is up every election. How many of your organizations have taken
a position in favor of allowing the entire board to be replaced
within 365 days?
Mr. McCauley raises his hand; no one else raises their
hand.
As I alluded to before--and I know that we would have to--
if we wanted a statute on this, we would have to package it a
different way to pass the courts, but there are those who think
that if 5 percent of the shareholders want to put forward a
proposal or an argument to vote for a particularly different
slate of directors, that they should be able to use corporate
money to do that just as the corporate management does. How
many of you favor a proposal along those lines?
Mr. McCauley raises his hand--thank you very much--for the
record.
Mr. Pitt, I heard you say that the proxy advisor had an
obligation to advise the investors based upon their economic
interest. Do I have that right?
Mr. Pitt. To further the economic interests of investors,
yes.
Mr. Sherman. Okay. So let's say I want to invest not for
rate of return but I want to invest in companies that will
build a strong manufacturing base in the United States even if
that gives me a lower rate of return. Should it be illegal for
me to find a proxy advisor who will help me achieve that
objective through my votes in the companies I already own?
Mr. Pitt. Absolutely not.
Mr. Sherman. So we should have investment advisors who give
advice based on something other than the economic interest of
the investor.
Mr. Pitt. I think your point is that the advice should be
tailored to the interests of investors, and I quite agree with
that.
Mr. Sherman. Okay. Should a pension plan management be
subject to lawsuits alleging that they have breached their
fiduciary duty simply because they chose to invest or vote
based on what they thought was good environmental policy or
good antiterrorism policy?
Mr. Pitt. If they are subject, for example, to ERISA, yes.
Mr. Sherman. Did your organization support legislation that
would allow pension plans to divest from those companies
investing in Iran?
Mr. Pitt. I am sorry, to invest on what?
Mr. Sherman. To divest from those companies investing in
Iran. Did you support or oppose that legislation?
Mr. Pitt. No.
Mr. Sherman. You did not support or oppose?
Mr. Pitt. I'm sorry. I know I am--
Mr. Sherman. Okay. There was legislation before this
committee--finally passed years too late--over the under-the-
table opposition of the organization you are representing that
would simply allow Mr. McCauley to divest from companies giving
money to the ayatollahs in Iran without facing lawsuits, and I
wondered if that was still your position.
Mr. Pitt. I don't believe that the Chamber opposed that
legislation.
Mr. Sherman. There was a reason it didn't pass until long
after it should have.
I yield back.
Chairman Garrett. The gentleman yields back.
The gentleman from Virginia?
Mr. Hurt. Thank you, Mr. Chairman.
I do have a couple of questions for the panel. I did want
to allow Ms. Stuckey the opportunity to respond to what the
gentleman from California alleged in his question.
I just wanted to give you a moment to respond, if you would
like?
Ms. Stuckey. I would just like to say that we are not
advocating these proxy advisory firms be put out of business.
We believe they have every right to exist.
But yes, I did say that we would like their reports filed
and they could be filed after the fact. We don't want them to
give away their competitive information, but we do think that
having the reports filed will make them think harder about what
they are doing and making sure they get it right.
Mr. Hurt. Thank you.
I guess, let's start with Mr. Pitt on this question:
Obviously, the SEC has the responsibility to encourage capital
formation, investor protection, and fair and efficient markets,
and to that extent, Congress has that responsibility, I think,
to encourage policies that do encourage capital formation and
encourage that formation to take place in our public markets
that have served us well, I think, since the founding of our
country. And so to that extent, it seems that this is an
important issue that results or has consequences for those
three objectives of the SEC.
You said in your statement, I believe, that you don't think
these issues necessarily require more government regulation,
but I would like to know what specifically we or the SEC should
be doing to solve the conflict of interest problem and,
perhaps, the misalignment of fiduciary duties? If you could
just address that, and then I would like to hear from Mr. Bartl
and Mr. Holch.
Mr. Pitt. Yes. I think first and foremost what the Chamber
has done is published best practices and core principles. It
would be very constructive if this subcommittee encouraged all
of the participants to engage in a good faith, meaningful
dialogue on those principles, and to come up with a consensus
view on the ways in which this industry should be performing
and should practice, and I think if that occurs, there may
never be a need for formal regulation. If that doesn't work,
obviously this subcommittee should consider additional steps.
But until that dialogue begins, there is clearly no predicate
made for a regulatory solution.
Mr. Hurt. Okay.
Mr. Bartl?
Mr. Bartl. Yes. Thank you, Vice Chairman Hurt.
I think one aspect--and I talked about it in my testimony--
but is persistent and ongoing oversight in conjunction with
maybe the development of best practices because those that are
overseen by the SEC and by this body tend to pay more
attention, and we saw that in my peer group example.
The other thing is that regulation may have the effect of
entrenching the existing participants in the system, and there
was actually another player in this space until 2 years ago,
Proxy Governance, and one of the things they commented on was
the ability of the larger players in this space to basically
wipe them out economically. So if we are looking for greater
competition, as Mr. Scott talked about, that is one thing to
keep in mind here.
Mr. Hurt. Thank you.
Mr. Holch. Congressman, the Coalition is for regulation
here--not something of Dodd-Frank complexity, but what I would
call light touch regulation. We do believe that we will need
some ability to regulate in order to solve these problems. We
are not opposed to best practices as an approach, but we do
believe that these--
Mr. Hurt. What are the specifics of--
Mr. Holch. Sure. ISS, for example, is already registered as
an investment advisor, but the Investment Advisors Act--the
current framework really doesn't apply to their role. Their
role is very unique. They are not selecting investments for
their clients; they are providing advice on proxy voting.
And so we think the SEC should create a unique regulatory
framework that reflects their role using their authority under
the Investment Advisors Act: first, we would be for
registration; second, we also think that unique framework
should address some of these transparency problems that we have
identified, address the factual inaccuracy issue that we have
also talked about; and third, we do think both the SEC and the
Department of Labor should evaluate their fiduciary duty rules
and interpretations regarding investment advisors just to
clarify and to make sure that these investment advisors are
providing the proper oversight.
Mr. Hurt. Thank you.
Chairman Garrett. I thank the gentleman.
The gentlelady is recognized for 5 minutes.
Ms. Moore. Thank you so much, Mr. Chairman. Before I start
my questioning, I would like to ask unanimous consent to enter
into the record the testimony of Sean Egan, chief executive
officer of the Egan-Jones Rating Company. It has been mentioned
here.
Chairman Garrett. Yes. Without objection, it is so ordered.
And since you are doing that, I will use this time also to
enter into the record a--
Ms. Moore. You are using my time--
Chairman Garrett. No, I won't be using your--oh, your time
is--
Ms. Moore. Right.
Chairman Garrett. [Off mike.]
Ms. Moore. Right, right. So get that clock back--my 25
seconds.
Chairman Garrett. I wasn't going to use your time. I agree
to just entering testimony into the record.
Ms. Moore. Okay. You are running the hearing. You can do
it, but--
Chairman Garrett. We are going to reset you to 5 minutes;
and we are going to put the June 4th letter from the Mutual
Fund Directors Forum into the record, as well. Without
objection, it is so ordered. And the gentlelady's time is set
back to the original 5 minutes. I will even throw another 10
seconds on--
Ms. Moore. Thank you so much, Mr. Chairman.
I just want to start out by thanking the panel for coming.
This is a very, very interesting conversation.
I think that I heard some really broad agreement here, some
things that we need to think about whether or not the SEC ought
to regulate this industry more adequately. I think we did hear
some agreement--perhaps not from Ms. Stuckey; I am going to ask
her some more questions--about the value of having these rating
companies do the intense research that they have done.
And so with that, let me start out by asking Mr. Pitt--
Honorable Mr. Pitt, I found it very interesting in your
testimony that you said these rating companies didn't have a
horse in the race, or skin in the game, so to speak, and so I
was wondering whether or not you thought that--and since
another objection that many people have is that there are often
conflicts of interest, I was wondering if you didn't think that
by them not having a horse in the race, their information might
be more objective and it might be as a service?
Mr. Pitt. I don't believe that affects their objectivity.
Glass Lewis, for example, has a parent that is an activist
investor and Glass Lewis takes positions on their positions.
ISS takes positions with respect to companies that also
purchase corporate governance services from them, so--
Ms. Moore. Okay. Okay, thank you. That is good information.
Do you think regulation would change that?
Mr. Pitt. I think best practices and adopting fiduciary
standards would help.
Ms. Moore. Okay. Thank you for that.
Ms. Stuckey, I was very interested in your--everybody else
seemed to think that these companies did bring something to the
table, and maybe you clarified it a little bit when you were
given time to say that you don't think they should be out of
business, but you say that they produce a product and the--sort
of the cost-benefit is not realized. I guess I wanted to hear
just a little bit--a few seconds--about whether or not you
thought they brought any useful information to the table.
Often, companies internally cannot afford to do all this
research that they need in order to make good investment
advice, so I wanted you to clarify that for us.
Ms. Stuckey. We are companies. We like our shareholders.
Our shareholders tell us they need this type of information
from the marketplace. We don't have a problem with that.
Ms. Moore. Okay, good. I--
Ms. Stuckey. We don't have a problem with that. What we
have a problem with, though, is when we write a 100-page proxy
according to the SEC rules and then the services take the proxy
and they use junior people, perhaps--they use people who they--
they are trying to make money so they use maybe people who
don't really understand these things--they are complicated,
they come up with a summary report which then gets sent to the
investors--not all investors, but a lot of them--and they don't
have time to read our proxy--
Ms. Moore. I understand.
Mr. Turner, I am going to let you have the last word on
this. You mentioned something that hasn't come up previously in
questioning about the board of directors' lack of access to the
ballot, and how it disadvantages certain types of proxy voters
like labor unions. So I want you to talk about that, and also I
want you to respond to the whole skin in the game and cost-
benefit points that have been made.
Mr. Turner. I do think having access to the proxy is
extremely important for investors. At our pension fund, which
represents half a million investors, the fund has voted to
support proxy access, so we are a strong proponent of that, as
many of the funds are.
As far as the cost-benefit here, first of all, it is not
just junior staff who are preparing these things. That is a
misnomer; that is a myth that needs to be busted wide apart.
Those things are reviewed by senior people on up.
It is just the same as an audit firm does when they do an
audit. Junior staff do a lot of the work. Congressman Sherman
knows this very well. But before that product goes out, senior
people up the level do review it, so they are credible.
And in fact, I have found in using their reports that most
of the time, they are credible. If you are going to do 40,000
reports a year, are there going to be some misses? Yes. But for
the most part, they are well done.
And the benefit of that to the investing public is immense
because you usually get--in our case, we even get not only one
research report, we get a couple of pieces of information that
supplements what we do as our people do read the proxies at the
PERA board, and it does provide a number of different
viewpoints, which is the best way to become a well-informed
voter. So I think the system does work.
I actually do agree, I would do some form of registration
and take care of the conflicts, but for the most part, the
system is much better than what some would say.
Ms. Moore. Thank you.
Chairman Garrett. I thank the gentlelady, and I thank the
gentleman.
The gentlelady, Mrs. Wagner, is recognized for 5 minutes.
Mrs. Wagner. Thank you, Mr. Chairman.
And I would like to thank the witnesses for being here
today.
Mr. Morgan, I want to focus specifically on retail
investors and how the proxy process is working or not working
for them specifically. In your opinion, do you feel that the
proxy process is easy for the average retail investor to
understand?
Mr. Morgan. Thank you for the question, because they are
the missing piece in all of this.
Mrs. Wagner. I agree.
Mr. Morgan. Retail investors do not have access to the--
because they don't pay the fees to proxy advisors. Most of them
are not registered with the company; they are in street name.
So they come through a proxy process and there is not a lot
of communication. They get their proxy. As Darla said, it is
100 pages. They look at it, they are confused. Many of them
don't vote.
Retail voter accounts that vote is about 14 percent. It is
terrible. We just don't have the retail shareholders engaged,
and I--part of the changes to a proxy system would hopefully
address that to allow them to become reengaged in the process--
Mrs. Wagner. Let me get to that. So you do believe that it
is the complexity, I guess, of the proxy process that has led
to a lower level of retail investors' participation?
Mr. Morgan. I would say it is the complexity as well as we
are legally required to provide these proxies, and in order to
meet all the requirements; they are very dense. So it makes it
very difficult for a retail shareholder who isn't engaged in
this to understand them.
Mrs. Wagner. Then what steps can we take to simplify the
proxy statements so that the information could actually be
meaningful to retail investors?
Mr. Morgan. I think part of it is when we tell investors
something, let's tell them once, and put all this information
out there so it is easily understandable. I think looking at
the system, as we have talked about, registered shareholders
versus those in street name, we need to look at the process and
try to bring it back to how it was to where there is more
dialogue and engagement so they feel more informed when they
are making their decisions and feel more empowered.
Mrs. Wagner. So then the complexity, would you say, of the
proxy system has caused almost an overreliance on proxy
advisory firms at the expense of retail investors?
Mr. Morgan. I wouldn't necessarily say that. I would say
that retail shareholders are on their own, and by being on
their own they don't have the tools that institutional
investors do.
Mrs. Wagner. All right. Let me focus with Chairman Pitt,
please, if I could.
There are thousands of public companies that had nothing to
do with the financial crisis of 2008, yet a number of these
companies have been targeted by activist shareholders in recent
years. Dodd-Frank was passed as a supposed antidote to the
financial crisis, but how has Dodd-Frank encouraged some of
these activist shareholders to promote their agendas at
nonfinancial companies?
Mr. Pitt. It has in many ways. For example, it undertook to
Federalize a large portion of corporate governance, which
heretofore has been the province of State law. That in itself
has been a very troubling development as part of the
legislation.
It then takes issues that are perhaps important but that
don't affect the material outcome of a company's behavior, such
as conflict minerals--
Mrs. Wagner. Right.
Mr. Pitt. --doing business in certain countries, and it has
now encouraged people to use corporate disclosure documents for
purposes other than informing investors.
Mrs. Wagner. I think you are quite right.
I want to also ask about what was in your testimony
regarding Section 951 of Dodd-Frank, the so-called say-on-pay
provision. Why do you feel that ISS and Glass Lewis decided
that these say-on-pay votes should be held yearly as opposed to
every 2 years or even every 3 years?
Mr. Pitt. The problem with this is Congress, in its
wisdom--and it was wisdom--gave companies and shareholders a
choice of 1, 2, or 3 years. But ISS and Glass Lewis adopted a
one-size-fits-all position and have effectively been able to
mandate that all corporations do this on a yearly basis. This
is expensive and it doesn't produce any value for shareholders,
and there are studies that say it actually has acted to the
detriment of shareholders.
Mrs. Wagner. All right. Thank you.
Mr. Chairman, I think I will yield back my time since it is
waning. Thank you very much.
Chairman Garrett. If she yields it to me, I will just ask
this question to Mr. Morgan: Glass Lewis is owned by the
Ontario Teachers Fund, correct?
Mr. Morgan. Correct.
Chairman Garrett. So where are the retail investors who are
looking to being protected in that situation? Who is Glass
Lewis actually responsible to, their owner or the retail
investors?
Mr. Morgan. They are, as an institutional investor those
institutional investors represent those individuals, so there
is an intermediary there. So we were talking two different
things. One is the direct--
Chairman Garrett. Understood. But is there a potential for
conflict when you have a proxy advisor being owned by a--
Mr. Morgan. Oh, absolutely. It is a huge potential
conflict.
Chairman Garrett. Thank you.
With that, I yield to Mr. Scott for 5 minutes.
Mr. Scott. Thank you, Mr. Chairman.
Like to continue a line of questioning from my colleague
who mentioned about the say on pay. It is good for us sometimes
to be able to look around corners to see what is coming, and
there is a gathering storm that is coming at us, and it is this
huge gap in pay. We dance around it.
But I want to ask you, because--and I mentioned the
question about just having 2 firms control 97 percent of the
market, and let me just give you a glaring point on why this
compensation issue and perhaps this almost monopoly with two
companies might have something.
Last year, proxy advisor firm Glass Lewis urged votes
against management on their pay and compensation 17 percent of
the time. ISS urged votes against their management on their
compensation pay 14 percent of the time. But yet, 98 percent of
U.S. companies got the majority of support on their
compensation plans last year.
And I am wondering, at what point are we going to begin to
realize that this cannot continue?
We are a mass consumption economy, which means our success
hinges on many, many people being able to buy many, many
things. And so, the credibility is at stake. It is these people
who invest in the market--in their pensions, in their
retirements.
I am wondering, and I would like to ask--perhaps Mr.
McCauley or Mr. Pitt or Mr. Turner may have touched upon some
of this--either of you, what must we do about this? Why is it
that, one, we have just 2 companies controlling 97 percent of
this, and does this have anything to do with why we are not
getting the kind of response to taking a very jaundiced eye
look at the seriousness of this huge gap on compensation
between the top and the middle and the bottom and the impending
damage that it could do to our economy?
Mr. Pitt. The reason I think we only have two companies is
because of the government policies that have existed, and I
would urge you to consider an analogy. We saw the exact same
thing with credit rating agencies before the 2007 and 2008
meltdown, where competition based on government policies was
reduced and restricted. And as one of the panelists indicated,
new entrants into this field have found it impossible and have
been unable to compete. So one problem is that there is no
facilitation of competition here.
The issue you raise about compensation, in my view, is a
very serious one. I start from the premise that people should
be rewarded for performance, not for having a pulse. And so
when compensation comes up, it is absolutely crucial for
companies to do the due diligence that is required to set what
standards they want and then to develop metrics to measure
whether senior executives have actually met those metrics.
Although the SEC has tried to promote better disclosure,
the real problem is that many companies today simply cannot get
their arms around the process of setting compensation.
The one place where I have a concern, however, is that I
don't think it is the appropriate role for government to try
and figure out what is good compensation or appropriate
compensation. But I do agree with you: The bigger the
disparity, the more potential problems we will have, and it is
up to companies to do the discipline and then make appropriate
disclosures of what they have done.
Mr. Scott. I thank you.
Chairman Garrett. Mr. Hultgren is recognized for 5 minutes.
Mr. Hultgren. Thank you, Mr. Chairman.
Thank you all for being here.
Chairman Pitt, wonder if I could address some questions to
you. Can you describe how the SEC's regulation of proxy
voting--specifically the 2003 rules governing institutional
investors' fiduciary obligation to clients when voting client
proxies and also the 2004 no-action letters--contributed to the
rising influence of proxy advisory firms over the last decade?
And also, how is this scenario similar to the SEC's rule
mandating the use of credit rating agencies?
Mr. Pitt. Yes. In 2003--and I was Chairman at the time--the
Commission adopted rules which said that registered investment
advisors should disclose how they--what policies they apply in
voting proxies, and then at some point after a vote was taken
disclose how they voted so people could see whether the
policies aligned. And the theory was, these shares belong to
the investors not to the managers, and therefore there at least
ought to be policies with respect to that.
What happened thereafter was that the SEC staff issued two
no-action letters, which effectively permitted registered
investment advisors to obviate their own responsibilities with
respect to voting and instead rely on proxy advisory firms as a
general proposition to eliminate potential conflicts that any
investment manager might have with a particular company
situation.
The no-action letters were unique in that instead of
responding the way most no-action letters do, as you would
write in, for example, to the SEC and say, ``Here is what I am
planning to do. Can I do this?'' And the SEC would say, ``Yes,
you can do it, based on the facts we know. We won't bring any
action.'' These no-action letters effectively amended the SEC's
rules without any action by the Commissioners.
What this did was create an impetus in favor of the two
largest firms and the existing firms and made it easier for
them to sell their services based on the fact that there was no
requirement for investment managers to look to their own
conflicts of interest if their policy was to solicit and get
advice from these third party persons.
With respect to credit rating agencies, the SEC had
provisions--and I was astounded to learn this when I got back
there--that established nationally recognized credit rating
agencies and then made it impossible for other entrants to
compete. And the result was that you had an oligopoly and a
lack of real standards.
Mr. Hultgren. You kind of touched on this, but Chairman
Pitt, by allowing mutual funds and investment advisors to
outsource that fiduciary duty to act in their client's best
interest when voting their proxies to proxy advisory firms has
the SEC effectively decoupled the voting decision from the
fiduciary duty?
Mr. Pitt. I am sorry. Has the SEC--
Mr. Hultgren. Effectively decoupled the voting decision
from the fiduciary duty?
Mr. Pitt. I think that is a fair statement.
Mr. Hultgren. Taking this a little further, should mutual
funds and investment advisors be allowed to outsource that
fiduciary duty to proxy advisory firms in your opinion or in
the thoughts of the Chamber? And what reforms--I know you have
talked about some of these in your statement, but what reforms
need to be made to ensure that proxy advisory firms are making
recommendations that enhance shareholder value?
Mr. Pitt. Let me say first that the Chamber is studying
this issue. I can answer for myself, and my view is that
outsourcing of fiduciary responsibilities breaches the whole
concept of fiduciary duty, so I believe that the answer has to
be yes, you can go out and obtain this kind of guidance, but in
the end you must exercise your own fiduciary responsibilities
and you cannot rely on others to do that for you.
Mr. Hultgren. Okay.
Mr. Chairman, I see my time is just about out. I will yield
back. I don't know if you have a--
Chairman Garrett. No. I will--
Mr. Hultgren. Okay. I yield back. Thank you.
Chairman Garrett. Thanks.
I now recognize Mr. Mulvaney.
Mr. Mulvaney. Thank you, Mr. Chairman.
It strikes me that many of the complaints we are hearing
are sort of typical when you are operating in a marketplace
where there are only two providers, or 2 providers provide 97
percent of the services, so I want to drill down a little bit
on the questions that my colleagues, Mr. Scott and Mr.
Hultgren, just asked and start with you, Mr. Pitt, because
clearly one reaction would be to regulate this industry because
of the apparent concentration of market power, but obviously
competition would be another possible solution.
You said a couple of times in the last couple of answers
that there are government policies that are preventing new
entrants, but I haven't heard the specifics yet on what those
policies are. What is it specifically that the government is
doing that is preventing you and me from going into this
business and starting a new competitor?
Mr. Pitt. I think that some of the policies that exist are
an indifference, if you will, to the fact that the existing
advisory firms engage in a one-size-fits-all approach, that
there is no sense of concern about the failure of the two major
proxy advisory firms to consider the best financial interests
of shareholders, and--
Mr. Mulvaney. Okay, but let me catch up. Indifference is
not a policy. There is a difference between the government
getting involved to promote competition, okay--we could do
things to try and encourage competition, but there are also
things we do to discourage competition.
Is there anything that this government is doing now that is
discouraging me and Mr. Hultgren from getting into this
industry? Because indifference is not a policy.
Mr. Pitt. Yes. I think with respect to the subject of the
no-action letters, for example, the grant by the SEC staff of
the ability of the existing proxy advisory firms to permit
registered investment advisors to focus on their general
policies instead of whether there is a specific conflict has
diminished the ability to create competition in this field.
Mr. Mulvaney. So if you and I, or me and Mr. Hultgren, want
to start another--we can't get that same treatment. Is that
what you are saying?
Mr. Pitt. Yes.
Mr. Mulvaney. Someone else help me out here. What am I
missing? Is there something else? Why aren't there more
competitors in this market?
Don't everybody jump up at one time.
Mr. Holch. I will take a crack at--
Mr. Mulvaney. Mr. Holch, yes, sir?
Mr. Holch. I think one of the problems is for institutional
investors you need to have a certain amount of scale to
function in this market. You have to cover 13,000 annual
meetings. The proxy statements, as Darla Stuckey said earlier,
average 100 pages. You need to be of a certain size to really
service the marketplace.
There have been other firms that have tried to get into the
retail space and have really failed miserably because the
retail shareholders won't pay for it, either. So I think there
is a sort of a price and a cost dynamic that makes it really
difficult to compete.
Mr. Turner. Having started Glass Lewis, I would totally
agree with that. There have been others in the marketplace that
didn't get to the scale and failed financially, so you have to
be able to almost immediately--we had to go out and get venture
capital backing to give us the ability to ramp up quickly
because we had to be able to cover 5,000 or 10,000 companies
right out of the gate, so you have to have the ability to raise
some money, to ramp the scale, put in the technologies, and
then get institutional investors to be willing to sign on.
And they are reluctant to sign on to someone who has never
done it before, so--and it is not a big marketplace. If you
look at the revenues at Glass Lewis and ISS combined, they are
probably in the $250 million to $350 million range. This is not
a big marketplace. The ability to get a return if you do invest
in a company like this is not that great, so I just don't think
you are going to see--financially the market just isn't going
to support any other entrants.
Mr. Mulvaney. Mr. Bartl?
Mr. Bartl. Yes. It is interesting. If you look at the
current market participants and the scale and the competition
between them, you have one player in ISS that is substantially
bigger. When Glass Lewis makes an attempt to move, you see a
countermove as well by ISS, and if you look at the announcement
by Glass Lewis last spring of greater engagement with its
investors, ISS announced its feedback review board. Whether the
two are connected, I don't know, but you saw that.
Mr. Mulvaney. Okay.
Mr. Bartl. You saw peer groups with Glass Lewis and using a
more market-based participation. In addition to the blow-up I
discussed on peer groups, ISS adopted a similar procedure as
part of its procedure when it revised its process for 2013. So,
getting into the market and staying in deals with market
participation, and this has been discussed in other settings
before by other organizations that have explored the
competition in the market.
Mr. Mulvaney. Okay. That is helpful, because that is not
where I thought Mr. Pitt was going. I thought there was
something we were doing to prevent that type of competition,
which you have just described can be experienced in many
industries where economies of scale simply prevent new
entrants, so that is sort of a natural barrier to entry.
And there are different ways to deal with that, Mr. Pitt,
than dealing with something we are doing to affirmatively
prevent competition, so that is extraordinarily helpful.
I yield back. Thank you, Mr. Chairman.
Chairman Garrett. Thank you.
The gentleman from California?
Mr. Royce. Thank you, Mr. Chairman.
I would like to ask Mr. Pitt a couple of questions. Last
year, Glass Lewis offered vote recommendations for the Canadian
Pacific Railway shareholders meeting and the Ontario Teachers
Pension Board, the parent company of Glass Lewis--opposed the
board of directors of the Canadian Pacific Railway. Not
surprisingly, Glass Lewis issued a recommendation that
shareholders oppose the incumbent board of directors and vote
for an alternative slate.
According to a letter sent by the Chamber of Commerce to
the SEC, the case represents tangible conflicts of interest in
the operation of proxy advisory firms.
What I wanted to find out--the chairman has discussed this
issue, and you have alluded to it as well--is how common are
these types of instances, and would disclosing a conflict of
interest such as this be sufficient or, in your judgment,
Harvey, is it necessary to take more prescriptive measures in
order to address this, other than just disclosure?
Mr. Pitt. I think that at present, the disclosure that
exists is very vague and generic, i.e., ``We may have positions
or our parent may have positions,'' and then Glass--
Mr. Royce. That is not disclosure, right--
Mr. Pitt. It is not. When I was chairman, that is what the
research analysts did, and we prohibited that.
Mr. Royce. Right.
Mr. Pitt. I think one thing that has to occur is you have
to disclose real conflicts on real time. The second is there
has to be an accepted standard of behavior for these firms.
We think that can be achieved consentually. If that fails,
then there may be a need for government action, but right now
ISS and Glass Lewis have no interest in developing appropriate
standards on conflicts.
Mr. Royce. The post-Andersen debacle led to a situation
where what was once presumed effective Chinese firewalls--
clearly post-debacle that was addressed, and we get into the
issue here of ISS, and certainly the SEC and the GAO both
pointed out conflicts of interest arise when an advisory firm
runs a consulting business alongside its proxy advisory
services.
And there are times when they may be asked to advise on
shareholder proposals sponsored by someone who obviously is
also paying them on consulting work. Now, what is surprising is
when you go through the record how many cases you can find.
In 2011, AFSCME sponsored a shareholder proposal at Target
Corporation, and that same year AFSCME paid ISS as a client. In
2010, the Nathan Cummings Foundation sponsored a shareholder
proposal at Masco while paying ISS for, again, advice. In 2010,
the Connecticut Retirement Plans and Trust Funds sponsored a
shareholder proposal at Abercrombie and Fitch, and that same
year the Connecticut State Treasurer confirmed in a letter to
the SEC that the State was a client of ISS, and that she would
support initiatives to clarify potential conflicts of interest
on the part of proxy advisory firms.
So sure, these should be disclosed, but I want to take it a
step further. And maybe I could ask Mr. Morgan on this, because
Mr. Morgan in his written testimony called this an inherent
conflict of interest.
The question is, what would the solution be, in your
opinion?
Mr. Morgan. Certainly, if you can't regulate it starts with
transparency, and those conflicts should be stated and shown on
any recommendation that they make that they are also providing
consulting services for these activists or whoever is proposing
that position. So I think that would be the starting point so
that when the recommendation is read you can see that there
is--they have also supplied consulting services.
Mr. Royce. Harvey, would that be sufficient, in your
opinion?
Mr. Pitt. It could be. I think one of the things that would
solve this problem would be to eliminate the effect of these
no-action letters that permit firms not to detail specific
conflicts of interest before they recommend positions with
respect to those companies.
Mr. Royce. Thank you. Thank you, Mr. Chairman. I yield
back.
Chairman Garrett. The gentleman from California now yields
back.
That concludes the questioning from all the Members who are
here. We have just agreed with the ranking member that we
will--if the panelists can sit through 10 more minutes, we will
do an additional 5 minutes on each side.
The gentleman from California will have his 5 minutes. I
will share with whoever is still here on our side, or I will
use the 5 minutes.
But with that, I will yield to the gentleman from
California.
Mr. Sherman. I will, of course, generously share my 5
minutes with all the other Democrats who are here.
Mr. Pitt, do I as a--let's say there are two panels running
for board of directors, one of which is committed to divesting
from Iran, protecting the environment, and promoting American
jobs. The other, in my opinion, is going to earn one cent more
per share for all the shareholders. Do I as a shareholder have
a fiduciary duty to my fellow shareholders to vote for that
second panel?
Mr. Pitt. I don't think fiduciary duty determines which way
you vote. I think fiduciary duty dictates that your standard
should be what is in the best interests of those to whom you
owe the duty, and--
Mr. Sherman. As I said, these are my own shares.
Mr. Pitt. If you conclude that in the long run, a certain
vote will promote the best interests of those shareholders,
then--
Mr. Sherman. Okay. I own these shares. They are mine. Do I
have a fiduciary duty to vote in the best interests of all
those other people who have invested in IBM stock?
Mr. Pitt. No.
Mr. Sherman. Or can I--okay.
Mr. Pitt. No. You vote your shares for any reason.
Mr. Sherman. Ms. Stuckey, you suggested an after-action
filing of the report. Let's say the Smith Family Trust has
decided--its trustees--a big foundation, maybe a big family
trust--that they want to divest from Iran but they have decided
they don't want to divest from Sudan. If the report given to
them by their investment--their proxy advisors is filed with
the SEC then everyone in the country will know that the Smith
family is good on Iran but they are not tough on Khartoum. Is
that fair?
Ms. Stuckey. I think so, under that scenario.
Mr. Sherman. So you think that if the Smith family--just a
family trust, a couple of brothers put their money in--have
decided that they are going to pick their--
Ms. Stuckey. You don't know for sure that they followed the
recommendation.
Mr. Sherman. Are you saying that if Jack Smith and John
Smith have an investment partnership and they choose to get
advice on how to vote their proxies--
Ms. Stuckey. And assuming they were--
Mr. Sherman. --that the entire world has to know what their
proxy voting criteria are?
Ms. Stuckey. If they are an institutional investor with a
fiduciary duty--
Mr. Sherman. I didn't say an institutional investor; I said
Jack and John Smith.
Ms. Stuckey. Jack and John Smith probably didn't buy the
proxy advisory firm services. They are probably a retail--
Mr. Sherman. In my example, I said they were relatively
wealthy brothers with a big trust. They can buy what they want.
Ms. Stuckey. Then they have no obligation to--
Mr. Sherman. They have no obligation--
Ms. Stuckey. --follow the recommendations or not. They can
just--
Mr. Sherman. So now, let's say it is an ERISA pension plan.
Do you think they have an obligation to disclose their voting
criteria?
Ms. Stuckey. Yes.
Mr. Sherman. Okay.
Let's see. I didn't know we would get a second bite at this
apple.
So, Mr. Pitt, is it the Chamber's belief that we should
have this race to the bottom by the different States in trying
to deprive shareholders of any meaningful control and that
corporations should be--publicly traded corporations should be
free to incorporate in whichever State has the least cumulative
voting, the longest terms for board members, et cetera? Should
we have minimum national standards or should we invite States
to try to get this business from other States by offering the
most pro-management corporate law?
Mr. Pitt. With all due respect, there is a mixed metaphor.
The Chamber supports high standards; they do not support a race
to the bottom. With respect to the issue--
Mr. Sherman. How would we get those high standards? Or can
you be in a position to say, ``We as a Chamber support high
standards but we support a system in which States will
naturally race to the bottom and the Federal Government won't
stop them?''
Mr. Pitt. The support should be--and I think is--for the
system as originally adopted by Congress, which is that the
States decide the substantive rights of shareholders, and there
are a lot of very strong reasons why that was a very wise
policy.
Mr. Sherman. And it has given us the weakest possible
shareholder protection.
I see my time has expired. I yield back.
Chairman Garrett. Thank you.
And for the final 5 minutes, so in the testimony that we
have received today on one of the issues dealing with say on
pay--and I will throw this out to Ms. Stuckey and Mr. Bartl--
Congress was pretty explicit as to how say on pay was going to
play out, or should play out, but the way the proxy advisors
basically played it out was in contradistinction to where
Congress is. That is to say, it would be, what, every year.
Do you see by them doing that as a conflict or a
contradiction from Congress as it is laid out, or as a
potential conflict from their interest to the investors in this
situation?
I will start with Ms. Stuckey.
Ms. Stuckey. I think say-on-pay votes being every year
certainly increases the need for their services, so they are
perpetuating themselves in business. I will add to that, when
companies get recommendations that they don't like, they talk
to their investors. So they go out and talk to their investors
now more than they ever did before.
There are companies that tell us, ``We talked to every
single one of our top 50 investors, and they all want 3-year
say on pay.''
Chairman Garrett. Okay.
Mr. Bartl. I would simply echo that, Mr. Chairman. And even
for those who aren't saying, for 3 years now, they have been
saying, ``We are going to look at this over the time being,''
simply because the workload involved in an annual say-on-pay
analysis versus the benefit received is something that is
starting to weigh on the investor, as well. So there is
definitely a vested interest in keeping it at one year.
Chairman Garrett. Okay.
Just two other points. First of all, we got into a little
bit--actually, the testimony was Mr. Holch, with regard--and
some others, as well--to the point of what can be done, and you
laid out some of these points as to help facilitate more direct
communications between the entities--the companies and the
investors. And I think there is unanimity on the panel that
this is something that would be good to work on, and the
Congress should take an additional look at, that there is a
problem in this area, and this is an area where Congress has a
role to try to help facilitate. Mr. Holch?
Mr. Holch. The SEC has the authority to repeal their NOBO-
OBO rules, which I described in my testimony. The SEC also has
the authority to switch the responsibility of communicating
with shareholders from the brokers and the banks over to the
public companies.
But certainly Congress has a role, and I think it would be
great if members of this subcommittee could help us encourage
the SEC to move this along. The public company community has
waited a long time to try to address these issues and we are
supported by a number of institutional investors. There really
is a consensus for change, and so we just need to get this up
the priority list over at the SEC.
Chairman Garrett. There are a couple of different areas
that we heard from on this overall panel, and hopefully, this
is one area where we may find some degree of agreement, and
some degree of bipartisanship on as we look at it further.
The area where we may have a little bit more dissention is
the role and the--how we deal with proxy advisors. My
takeaway--and someone can correct me if it is wrong--is that
there is--whether we are talking about the retail--yes, when we
are talking about the retail investor, there is still a lack of
clarity as to what the obligation is of the proxy advisor to my
mom, the small retail investor, of the proxy advisor. There is
no obligation, basically. Yes, not clarity--I should say there
is no obligation.
Conversely, there--thank you. Mr. Morgan is agreeing with
me that there is no obligation of the proxy advisor to the
retail investor.
The other takeaway that I am getting from this as well is
that there might be--or there are various conflicts that the
proxy advisor currently has, whether it is the one that Ms.
Stuckey talked about just now, the one that Mr. Bartl talked
about earlier with regard to the selling of services on the
side, if you will, and also the one that others have pointed
out, the potential conflict of basically who owns these proxy
advisors, and who their largest clients also are may influence
their decisions as to their advice on these things.
Mr. Turner is shaking his head ``no,'' but as of right now,
I can't see why there is not a potential for a conflict of
interest when they do not owe me or the small retail investor
and there is not disclosure or transparency as to what those
potential conflicts are. Those potential conflicts potentially
can exist, and I think that is something that we can take a
look at.
And I will close on this, on the happy note that I think
Chairman Pitt raised, that maybe some of this can be done just
on a consensus basis with trying to bring the interested
parties together, because now Congress is taking a focus on it.
I will end on that happy note, although I think that when two
entities have 97 percent of the market share, I have a feeling
that they probably don't have a whole lot of interest in trying
to reach any compromise on this, but we will remain optimistic.
I thank all of you for your testimony.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
With that, we are now adjourned.
[Whereupon, at 12:00 p.m., the hearing was adjourned.]
A P P E N D I X
June 5, 2013
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