[Senate Hearing 115-455]
[From the U.S. Government Publishing Office]
S. Hrg. 115-455
PROXY PROCESS AND RULES: EXAMINING CURRENT PRACTICES AND POTENTIAL
CHANGES
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HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIFTEENTH CONGRESS
SECOND SESSION
ON
EXAMINING SEVERAL ASPECTS OF THE CORPORATE PROXY VOTING SYSTEM,
INCLUDING THE ROLE OF PROXY ADVISORY FIRMS, THE SHAREHOLDER PROPOSAL
PROCESS AND RETAIL SHAREHOLDER PARTICIPATION
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DECEMBER 6, 2018
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Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Available via the World Wide Web: http://www.govinfo.gov
__________
U.S. GOVERNMENT PUBLISHING OFFICE
34-527 PDF WASHINGTON : 2019
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
MIKE CRAPO, Idaho, Chairman
RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
DEAN HELLER, Nevada JON TESTER, Montana
TIM SCOTT, South Carolina MARK R. WARNER, Virginia
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada
JERRY MORAN, Kansas DOUG JONES, Alabama
Gregg Richard, Staff Director
Mark Powden, Democratic Staff Director
Jonathan Gould, Deputy Chief Counsel
Jen Deci, Professional Staff Member
Laura Swanson, Democratic Deputy Staff Director
Elisha Tuku, Democratic Chief Counsel
Dawn Ratliff, Chief Clerk
Cameron Ricker, Deputy Clerk
James Guiliano, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, DECEMBER 6, 2018
Page
Opening statement of Chairman Crapo.............................. 1
Prepared statement........................................... 26
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
Prepared statement....................................... 26
WITNESSES
Daniel M. Gallagher, Chief Legal Officer, Mylan N.V. and Former
Commissioner, Securities and Exchange Commission............... 4
Prepared statement........................................... 28
Responses to written questions of:
Senator Warner........................................... 63
Michael Garland, Assistant Comptroller for Corporate Governance
and Responsible Investment, Office of the New York City
Comptroller Scott Stringer,.................................... 5
Prepared statement........................................... 45
Responses to written questions of:
Senator Warner........................................... 64
Thomas Quaadman, Executive Vice President, Center for Capital
Markets Competitiveness, U.S. Chamber of Commerce.............. 7
Prepared statement........................................... 52
Responses to written questions of:
Senator Warner........................................... 72
Additional Material Supplied for the Record
Letters to the Committee submitted by Chairman Crapo and Senator
Brown.......................................................... 75
(iii)
PROXY PROCESS AND RULES: EXAMINING CURRENT PRACTICES AND POTENTIAL
CHANGES
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THURSDAY, DECEMBER 6, 2018
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Mike Crapo, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN MIKE CRAPO
Chairman Crapo. The Committee will come to order.
Today's hearing will focus on several aspects of our proxy
voting system, including the role of proxy advisory firms, the
shareholder proposal process and retail shareholder
participation.
As SEC Chairman Clayton noted earlier this year,
shareholder engagement is a hallmark of our public capital
markets, and the proxy process is a fundamental component of
that engagement. I commend the SEC for its ongoing attention to
this issue, including its recent staff roundtable on the proxy
process and rules, and I encourage them to move forward with
their reform efforts.
Many of these rules have not been examined for decades. In
that time, there have been a number of changes to the proxy
environment, including the growing influence of proxy advisory
firms and fund managers on voting outcomes and, more generally,
corporate behavior.
There has also been a rise in the number and substantive
scope of proposals pursuing an environmental, social, or
political agenda. Many of these proposals have little or
nothing to do with a company's financial performance or
shareholder value, but companies and investment advisors alike,
nevertheless, devote time and resources to evaluate these
proposals, often relying upon proxy advisory firms or other
consultants to assist them and reduce their costs.
It is time to reexamine the standards for inclusion of
these proposals as well as the need for fiduciaries to vote all
proxies, on all issues in light of the proliferation of
environmental, social, or political proposals, and the rise of
diversified passive funds.
Chairman Clayton has also expressed concerns that the
voices of long-term retail investors may be underrepresented or
selectively represented in corporate governance.
According to an SEC staff estimate, retail investors own
roughly two-thirds of Russell 1000 companies, often through
mutual funds or pensions. But it is not always clear whether
the proxy rules promote the long-term financial interests of
those retail investors, many of whose interests are expressed
through intermediaries.
Last week, John Bogle, the creator of the index fund,
warned that if historical trends continue, a handful of giant
institutional investors will one day hold voting control of
virtually every large U.S. corporation.
With this level of concentration and intermediation, it is
even more important that the proxy voting process and voting
decisions of fiduciaries reflect the clear economic interests
of the retail investors on whose behalf these institutional
investors engage.
I look forward to hearing the views of our witnesses on
these and other proxy-related issues, and I thank them for
their willingness to appear here today.
Senator Brown.
STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Mr. Chairman.
Thanks to our three witnesses.
All too often, we see corporate boards and executives focus
on short-term profits instead of long-term investments in their
companies and their workers.
We saw very painful and clear evidence of that this week.
General Motors announced it would lay off 14,000 workers and
close five plants. Ohio, the number two GM State in the country
for decades, no longer, if GM continues with this, will
assemble any of their vehicles in Ohio.
The Chevy Cruze plant in Lordstown is slated to lose jobs.
In the last 2 years, GM has laid off nearly 3,000 workers at
the Lordstown plant. This most recent decision suggests they
will lay off another 1,500, the whole workforce. The decision
is devastating for the Mahoning Valley, a three-county area
with about 500,000 people.
Meanwhile, GM has spent more than $10 billion on stock
buybacks--$10 billion on stock buybacks since 2015, double what
it expects to save from the cuts and the plant closings.
Lordstown workers and their families and the supply chain
company workers and the owners of many of those companies are
angry.
The President claimed last year's Republican tax bill would
mean more money in workers' paychecks, but instead, we have
seen these stock buybacks explode this year to a record $894
billion. Executives claim these record buybacks are supposed to
reward shareholders. They do not seem interested, however, in
hearing from shareholders when they raise concerns.
The bad corporate decisionmaking does not stop with GM and
with buybacks and layoffs. Marriott announced on Friday, it had
a data beach between 2014 and 2016, affecting 500 million
customers. It only discovered that in September of 2018.
Cyber breaches are so common now that it is routine for
Wall Street analysts to estimate the stock price hit, companies
will take in the week after they have announced a breach. Then
it is
business as usual. It does not even matter that companies
cannot secure their customers' personal information.
These are just the most recent examples of corporate
mismanagement and abuse of workers and customers.
Excessive executive compensation packages, abuses and
scandals that can wreck customers' financial lives like we have
seen at Wells Fargo, price gouging for vital prescription drugs
like we have seen at the company Mr. Gallagher works for, it is
clear these corporations are not making good decisions for
their companies, for their customers, for their workers. It is
why we should foster more shareholder engagement, not less.
But that is not how corporate lobbyists and special
interests see it. The Wall Street business model does not see
workers like those in Lordstown as vital to their company. They
see them as cost to be minimized.
But, incredibly, we are here today to discuss how to make
it even more difficult for shareholders to hold management
accountable. Several bills introduced this Congress undermine
shareholder oversight of the companies they own. These measures
would deny all but the largest shareholders the right to submit
proposal for a vote, requiring investors to own billions of
dollars of stock to be eligible to submit a shareholder
proposal.
Current rules permit small shareholders to submit
proposals, but apparently, folks in this town want to stack the
deck even more. Every day, there is another attempt to stack it
even further against Main Street, against small-time investors.
This hearing will consider proposals that make it harder
for institutional investors to have timely access to research
and analysis from proxy advisory firms that the investors have
hired. These proposals would give corporate interests access to
this information before the public retirement systems,
investment fund managers, and foundations who manage money for
hardworking Americans. And what is fair about that?
You will hear about errors and inaccuracies in those
reports, but what it really amounts to is an effort to make an
independent analysis less so. That is just the wrong answer.
Shareholders of all sizes deserve to have every tool
available to hold executives accountable, forcing them to think
beyond their short-term self-interest and manage for the long
term. Companies and shareholders and workers and other
stakeholders all benefit when the system promotes fairness and
communications and trust.
Mr. Chairman, before I finish, I wanted to note that
Senator Reed must leave for another committee. I want to take a
moment to thank him for his work on a bipartisan bill on proxy
advisors and ask him to describe his bill briefly, and, Mr.
Chairman, I appreciate your willingness to do that.
Jack.
Chairman Crapo. Thank you.
Senator Reed. Thank you, Mr. Chairman, and thank you,
Ranking Member Brown, not only for holding this hearing, but
for giving me an opportunity to speak, as I must go to another
Armed Services committee meeting.
Investors have been clear that continued access to proxy
advisory firms is critical. Given this, it is important that
proxy advisory firms are appropriately regulated and held
accountable.
That is why I am very pleased that Senators Perdue, Jones,
Tillis, Heitkamp, and Kennedy have joined me in introducing S.
3614, the Corporate Governance Fairness Act, which preserves
the vital role played by proxy advisory firms, but also holds
these firms accountable to investors.
In addition to the broad bipartisan support here for the
legislation, a wide range of stakeholders, including the
Consumer Federation of America, SEC Investor Advisory Committee
member John Coates of Harvard Law School, the New York Stock
Exchange, and the Society for Corporate Governance also support
the Corporate Governance Fairness Act.
I thank all the stakeholders for this, particularly my
colleagues, Senators, Perdue, Heitkamp, Tillis, Jones, and
Kennedy. Thank you all.
And, again, I thank the Chairman for his graciousness.
Thank you very much.
Chairman Crapo. Thank you, Senator Reed and Senator Brown.
And also, again, thank you to our witnesses for agreeing to
be here and to share with us your expertise.
Our witnesses today--and we will have them speak in the
order I introduce them--are the Honorable Daniel M. Gallagher,
Chief Legal Officer of Mylan N.V. and former Commissioner, U.S.
Securities and Exchange Commission; Mr. Michael Garland,
Assistant Comptroller, Corporate Governance and Responsible
Investment in the Office of the Comptroller of New York City;
and Mr. Thomas Quaadman, Executive Vice President of the U.S.
Chamber Center for Capital Markets Competitiveness.
And to each of our witnesses, as you know, your testimony
has been entered into the record, and we encourage you to pay
attention to the clock, so that you do not go over 5 minutes in
your oral presentations, so that we will have opportunities for
the Senators. And I again remind our Senators, they have a 5-
minute clock too.
With that, Mr. Gallagher, you may proceed.
STATEMENT OF DANIEL M. GALLAGHER, CHIEF LEGAL OFFICER, MYLAN
N.V. AND FORMER COMMISSIONER, SECURITIES AND EXCHANGE
COMMISSION
Mr. Gallagher. Thank you, Chairman Crapo.
Chairman Crapo, Ranking Member Brown, and Members of the
Committee, it is an honor to be here today to discuss the
critically important issue of corporate proxy voting.
During my tenure as an SEC commissioner, few issues
generated as much discussion and controversy as the various
facets of the proxy voting system, and I was recognized for
actively engaging on those issues. That is why I was invited
here today to share my views on the three issues identified in
the invitation letter and how the SEC can, or should, respond
to these issues.
This is very important, as more than 3 years after I left
the Commission, these issues have become even more pronounced
from so-called ``proxy plumbing issues'' to the concerns about
the role of proxy advisory firms. The intensity of the debates
is evidence of the importance of these issues to U.S.
investors, corporations, policymakers, and ultimately the U.S.
economy.
Many of these issues are exactly the types of technical
matters that independent agencies like the SEC were created to
address, subject to congressional oversight, and I am happy to
tell you that the current Commission is exceptionally well
situated to fix many of the problems related to proxy voting.
Chairman Clayton has proven to be a strong principled
leader of the agency, and his fellow commissioners have deep
expertise in the proxy voting area. The relevant senior staff,
including Division of Investment Management Director, Dalia
Blass, and Division of Corporation Finance Director, Bill
Hinman, are incredibly capable leaders and experts on proxy
voting issues.
Despite the SEC's expertise in this area, however, the
Commission is operating within a very antiquated statutory
framework when it comes to proxy voting.
Accordingly, and certainly with respect to certain high-
impact issues such as the ever increasing importance of proxy
advisory firms, the time is right for meaningful congressional
attention. And so I am very happy that this Committee is
focusing its limited time on these issues.
Indeed, I will note at the outset that Members of this
Committee are working on bipartisan legislative efforts to
address the proxy advisory firm concerns, and the House is
similarly focused on these issues and has passed bipartisan
bills that provide solutions to many critical proxy voting
problems.
I hope that effective legislation can, if needed, be
enacted in the near future.
Thank you again for inviting me here today, and I look
forward to answering any questions you may have.
Chairman Crapo. Thank you very much, Mr. Gallagher.
Mr. Garland.
STATEMENT OF MICHAEL GARLAND, ASSISTANT COMPTROLLER FOR
CORPORATE GOVERNANCE AND RESPONSIBLE INVESTMENT, OFFICE OF THE
NEW YORK CITY COMPTROLLER SCOTT STRINGER
Mr. Garland. Thank you, Member Brown and Members of the
Committee.
I am the Assistant Comptroller for Corporate Governance and
Responsible Investment in the Office of New York City
Comptroller Scott Stringer. Comptroller Stringer serves as a
trustee to four of the five New York City public pension funds
and as the investment advisor and custodian to all five, which
collectively have more than $200 billion in assets under
management. These five independent pension funds provide
retirement security to more than 700,000 of the city's active
and retired teachers, police, firefighter, and other employees.
It is an honor to be invited to provide this Committee with our
perspective on important matters of shareowner responsibility.
Because of our long investment horizon and largely indexed
investment strategy, we cannot readily sell shares in a company
at which we have concerns. In those instances, the most cost-
effective way we can protect and create long-term shareowner
value is to be an active owner by exercising our rights, our
legal rights, as shareowners. Therefore, we actively vote our
proxies at each portfolio company and actively engage our
portfolio companies mainly through shareowner proposals and
dialogue ensuing from those efforts.
Our capacity to fulfill these fiduciary responsibilities to
our beneficiaries relies heavily on the timely receipt of
expert independent proxy research and our longstanding ability
to submit shareowner proposals.
The unfounded suggestion from critics is that when it comes
to voting proxies, which are considered plan assets under
relevant fiduciary law, sophisticated institutional investors
whose job it is to manage billions of dollars of investment
capital are like lemmings, blindly following the
recommendations of proxy advisors in a proxy vote decision-
making.
This does a great disservice, and I want to disabuse
Committee Members of the notion that the argument of undue
proxy advisor influence has merit. Although I assess the
largest proxy advisory firm, recommended voting against say-on-
pay proposals at 12.3 percent of the Russell 3000 in 2018, only
2.4 percent of those companies received less than majority
support on their say-owner proposals.
For the year ending June 30, 2018, our office cast 71,000
individual ballots at 7,000 shareowner meetings in 84 markets
around the world. In the U.S. market, every ballot item is
individually reviewed and voted on by our experienced staff.
All votes are cast according to our own guidelines,
irrespective of the proxy advisors' recommendations. Our
ability to apply our own guideline rests, in large part, on a
timely receipt of the expert research we receive from our proxy
advisors, which presently included both Glass Lewis and ISS.
Because different companies present key information in
different ways and places, we rely on our advisors to pull
information to a consistent format that enables quick reference
to comparable data.
As an example of our independence, while the New York City
funds voted against say-on-pay at 25.4 percent of our U.S.
portfolio companies for the year ending June 30, 2018, ISS only
recommended against say-on-pay at 16.7 percent of those
companies.
In our view, additional regulation of proxy advisors would
likely increase our cost and delay our receipt of research,
with no clear benefit to our process.
Our funds have filed more than 1,000 shareowner proposals,
almost certainly more than any other institutional investor in
the world, and our proposals have led to significant market
changes that benefit long-term shareholders.
For example, largely in response to the Boardroom
Accountability Project launched by Comptroller Stringer and the
New York City funds in 2014, roughly 540 companies, including
70 percent of the S&P 500, now have proxy access bylaws, up
from about six companies when the project was launched. Proxy
access allows shareowners to nominate one or more directors to
a company's board using the company's proxy and ballot.
A July 2015 study by economic researchers at the SEC
analyzed the public launch of the Boardroom Accountability
Project and found that 0.5 percent average increase in
shareowner value at the first 75 firms that received proxy
access shareowner proposals from the New York City funds.
In response to a shareowner proposal in 2013, we
successfully negotiated an enhancement to Wells Fargo's
clawback policy. Those changes enabled the Wells Fargo board to
announce in September 2016 that it would recoup $60 million
from two senior executives in order to hold them financially
accountable for the fake account scandal that has caused
significant financial and reputational harm to the bank.
But large institutional investors do not have a monopoly on
good ideas. In our view, shareowners of any size should have
the opportunity to use the shareowner proposal process.
Additionally, our track record shown in our proposals to
prohibit workplace discrimination based on sexual orientation
and gender identity has shown that there are good reasons for
not increasing the resubmission thresholds. It can take many
years to build investor support for a shareowner proposal.
In summary, we believe critics of shareowner proposal
rights and proxy advisors are seeking to remedy problems that
do not exist.
Thank you again for the opportunity to testify today. I
look forward to your questions.
Chairman Crapo. Thank you, Mr. Garland.
Mr. Quaadman.
STATEMENT OF THOMAS QUAADMAN, EXECUTIVE VICE PRESIDENT, CENTER
FOR CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE
Mr. Quaadman. Thank you, Chairman Crapo, Ranking Member
Brown, Members of the Committee. We appreciate this Committee's
continued focus on removing obstacles that prevent businesses
from growing from small to large.
The 20-year decline of public companies has brought
economic consequence. The 2012 Kaufmann Institute study found
that between 1996 and 2010, 2.2 million jobs were created by
businesses that went public. Additionally, in the 1980s and
1990s, mainstream investors directly benefited from IPOs.
Today, companies go public at a much later stage, shutting
those mainstream investors out from that wealth creation.
Additionally, if companies do not go public, they are not
creating jobs.
This hearing presents a spotlight on three important
issues: the lack of oversight of the proxy advisory duopoly,
distraction of boards and inefficient use of company assets,
and disenfranchisement of retail investors.
We know many of the issues around proxy advisory firms, yet
in response to a recent Banking Committee letter and the recent
SEC Roundtable, ISS claims to be a fiduciary, yet disclaims any
fiduciary obligations. Proxy advice should correlate to the
fiduciary duty of their clients.
ISS and Glass Lewis have conflicts. Both a consulting
business and activist investor ownership are well known, yet
they both share a common conflict of interest in that neither
discloses to the public if a shareholder proponent is a client
of an advisory firm.
Indeed, a recent ACCS study found that 139 supplementary
filings between 2016 and early 2018 disputed proxy advisory
inaccuracies as well as mistakes. That is a 2 percent error
rate that we know of on proxy advice. A 2-percent error rate in
any fiduciary duty is unacceptable. Clients, in other words,
are not getting the total mix of accurate, useful information
needed to decide how to vote.
Opponents of proxy advisory oversight raised cost concerns,
but what about flawed decisionmaking processes that reduce
returns for retirees, families, or individuals who are looking
to secure their livelihood?
We appreciate the introduction of the Bipartisan Corporate
Governance Fairness Act. We support a transparent process in
the development and dispensation of proxy advice.
We think this legislation could be changed in a couple of
ways. One, proxy advisory firms should certify recommendations
are based on material accurate information. Two, they should
disclose conflicts. Three, they should disclose to the public
if a shareholder is a proponent. We look forward to working
with the sponsors of that bill.
There are additional problems as well. Zombie proposals--
those shareholder proposals that are repetitively introduced,
yet have lower declining support--harm the shareholder process.
Those proposal constitute one-third of shareholder proposals,
yet 90 percent of them are continually rejected. Proxy advisory
firms supported those proposals. ISS supports 79 percent of
them, allowing them to be propped up. This creates a waste of
assets, company assets, and distraction for both boards and
investors.
At some point in time, the will of the majority must mean
something. The resubmission thresholds were first introduced in
1954 and have not been updated. The investor base is the mirror
image of what it was in 1954. We think that the 1997 Arthur
Levitt proposal to raise these thresholds to 6, 15, and 30
percent should be a basis for reform.
We also have four individual investors known as ``gadfly
investors'' that submit 30 to 40 percent of the shareholder
proposals in the S&P 250. Ninety-one percent of those proposals
fail, and it is unclear if those investors actually own the
shares or if at times are actually acting as a front for third-
party entities.
We believe that if a shareholder issues a proposal, there
should be disclosure and verification of ownership as well as
an articulation of the interest that they are supporting.
Finally, retail shareholders are being disenfranchised.
Direct retail share ownership today constitutes 32 percent of
shares, yet only 28 percent of that block is actually voted, in
contrast to 91 percent of institutional investors. We do not
have a level playing field.
We think that innovative new technologies, such as client-
directed voting, virtual meetings, and blockchain can be a
remedy for this.
We can no longer wait on these issues. Our international
competitors are making their public capital markets more
efficient. It is time for the SEC and Congress to act to
promote competition and preserve U.S. competitiveness in a
global economy.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you, Mr. Quaadman.
I will start with you, Mr. Garland, in the questions. As I
understood your testimony, you do not just take the proxy
advisor's advice, per se. You actually take their research,
look at their recommendations, and then go in and do a due
diligence analysis of their recommendations. Is that correct?
Mr. Garland. That is correct, Mr. Chairman.
I would not say that we do a due diligence analysis of
their recommendations. Our obligation is to implement the
guidelines that were approved by our boards of trustees, and
our guidelines are different than the guidelines from the proxy
advisors.
Let me give you an example. Some issue can be fairly
binary. There may be a proposal for an independent board
chairman. ISS or Glass Lewis may recommend against that
proposal because they believe that the company has another
mechanism in place. For example, lead independent director,
that is adequate. Under our guidelines, we will always support
a vote for an independent board chairman.
Chairman Crapo. So on these guidelines you are talking
about, are they specific to each corporation?
Mr. Garland. No. They are a set of governance principles
that inform our view of value and what we think is our best
long-term interest. As long-term owners, we articulate a
philosophy about boards of directors, executive compensation,
and also many of the matters that may be subject to vote
through shareowner proposals.
Chairman Crapo. So are those guidelines consistent across
all corporations that you own?
Mr. Garland. We maintain two sets of guidelines. We have a
set for U.S. companies, which are available on our website, and
we have a set for non-U.S. companies because the items subject
to vote vary by market, and all of our domestic guidelines and
all of our global proxy votes are disclosed on our website, so
that our participants and beneficiaries and our portfolio
companies can review them.
Chairman Crapo. OK. One last quick question for you, and
that is, do these guidelines all focus on increasing
shareholder value and the value of the corporation, or are
these guidelines also focusing on environmental, social, or
political objectives?
Mr. Garland. Well, the proxy vote relevant under State law
for us, we consider that to be a fiduciary asset. So the
guidelines are constructed in a manner, and they are
recommended to the board in a manner solely to maximize long-
term shareowner value.
Many of the issues which often are referred to as social or
political, we believe they are directly on long-term shareowner
value.
So when we cast a proxy vote, we are voting because we
believe that is in our long-term best financial interest.
Chairman Crapo. All right. Thank you.
I would love to go into that much further with all three of
you, but I want to shift to Mr. Quaadman and Mr. Gallagher. A
question for both of you, and then I will probably be out of
time. Please pay attention to my clock because I do not want to
violate it for my colleagues here.
But the SEC staff recently withdrew staff guidance dating
from 2004 on the use of proxy advisory firms and held an
important roundtable to get to our next steps. I am interested
in learning more about the tradeoff between long-term investing
and a social agenda and a fiduciary's calculation and how
retail investors should be involved.
I know that is a question that requires a long answer, but
I would like you to each take about 45 seconds to respond to me
on that.
Mr. Gallagher. Well, thank you, Senator, for the question.
I think it is a critically important issue that you have
teed up for this hearing about retail participation because I
think we have lost, and the trend toward institutional
ownership of shares and sort of disintermediated retail
participation in the United States, we have lost the retail
voice, which sometimes thinks very differently than the
collective institutional asset manager.
The SEC was right to tee this up. I think Jay Clayton, the
Chairman of the SEC, has been a real voice for what he calls
the ``Main Street investor,'' and I think the Roundtable
started the dialogue in a very meaningful way.
Chairman Crapo. Well, thank you.
I would request further thoughts of yours on this as we
proceed in analyzing this.
Mr. Quaadman.
Mr. Quaadman. Mr. Chairman, both the Roundtable and
withdrawal of those two letters were important steps forward.
We are very concerned because both--first off, environmental,
social, and political shareholder proposals make up over 50
percent of those that are submitted, yet almost none of them
pass.
ISS and Glass Lewis have recently started both ESG ratings
that is going to put even more fuel behind that. Those
proposals are not directly linked to economic return. So we
think that increased SEC oversight over proxy advice is very
important, particularly as ESG is beginning to gain more of a
foothold.
Chairman Crapo. Thank you, Mr. Quaadman.
Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Mr. Garland, briefly describe how shareholder proposals
help to hold management accountable, briefly.
Mr. Garland. Yes. Thank you, Senator Brown.
For us, it is a critical tool for holding management
accountable. I think a good example would be--and in your
opening remarks and in my remarks, we referenced Wells Fargo.
In 2013, we filed a shareowner proposal at Wells Fargo asking
them to strengthen their clawback policy.
We filed it at Wells Fargo and a number of other banks. We
were concerned that in the banking industry, no senior
executives were held financially accountable in the wake of the
financial crisis. We think accountability is key for setting a
proper tone at the top for responsible business practices and
ethical conduct. If you are not held accountable, you
essentially can have the incentive to look the other way if you
are benefiting from the misconduct of those below you.
So when the fake account scandal happened at Wells Fargo,
we sent a letter to the Compensation Committee and said, ``You
now have this new policy,'' and the policy that they adopted
that we negotiated with them, it has three key components. And
these are all requested in the proposal.
First, there is a misconduct trigger that the board has the
authority to clawback compensation in the vent of misconduct.
Second, what we call the ``up-the-ladder provision,'' that
you can be held financially accountable for misconduct for a
supervisory failure. So, in the case of Wells Fargo, for
example, the fact that John Stumpf may not himself have engaged
in misconduct, but the board had the authority to clawback
compensation because he was held ultimately accountable, that
is a way of ensuring accountability and eliminating the
perverse incentive to look the other way.
And the final prong is public disclosure so that investors
have the ability to monitor enforcement of that policy.
And one last point on accountability, the fact that most
companies in the U.S. market now have annual elections for
directors, which is a fundamental accountability mechanism, and
have majority voting in direct elections is largely the result
of successful shareowner proposals.
Senator Brown. And you can certainly make the case. This is
a yes or no here. You can make the case, certainly, that those
proposals adopted by Wells Fargo made a big difference in the
clawback, correct?
Mr. Garland. Yes. And it is really the way the process is
supposed to work. It never went to a vote. It is an invitation
to engage. You submit the proposal. They called us up, and then
we had a very productive negotiation.
Senator Brown. In your testimony, Mr. Garland, you
mentioned the risks if regulation creates obstacles for
investors to use proxy advisors. How would additional
regulatory burdens on proxy advisors limit investors' ability
to hold company management accountable?
Mr. Garland. I think that some of the proposals from
critics seek to insert the issuers in between investors and the
advisors who we hire. These are our advisors, and I think that
could compromise their independence. We rely on the independent
expert research they provide to us.
There is also a big concern about timing. The volume of
proxy voting during proxy season is tremendous. We only have a
very little time to apply our guidelines from the time that the
company files its proxy until it has its annual meeting. Our
process generally does not start until we receive the research
from the proxy advisors, and we are not looking at the
recommendations. But just seeing issues like dilution or
diversity on board, looking at the hedging and pledging
policies of the company, there are all kinds of metrics in
those reports that we need to interpret our own guideline.
Senator Brown. Thank you.
Let me ask one last question and preferably a simple yes or
no, and I will start with you, Mr. Quaadman. If a shareholder
is concerned that a company is price gouging, say, for a
critical medicine and it could affect long-term value in the
company's reputation, should we take tools away from that
shareholder to hold management accountable?
Mr. Quaadman, let us start with you. Yes or no, if you
would.
Mr. Quaadman. Shareholders should keep companies
accountable, and that is a dialogue that companies should have
with their shareholders, but when that process is perverted for
political or social gains, that is where it becomes a problem.
Mr. Gallagher. Mr. Garland.
Mr. Garland. I think that drug pricing can create
reputational risk for companies, which is why we have called on
companies like Merck filing the EpiPen price increase to
elevate oversight of drug pricing to the board.
Senator Brown. I was not sure what you meant on political
or social, but maybe we can get back to that if we have time.
Mr. Gallagher, your comments on that?
Mr. Gallagher. Senator, Thank you for the question.
I am never one to say we should take a voice away from
investors. I think the proposals that are being discussed
today, in particular, 14a-8, amendments all have to do with
what is a meaningful ownership position such that the voice
should be heard.
And I do not personally believe that any of the discussions
we have had about potential amendments are of the type that
would diminish the voice of shareholders, such that we have
heard.
Senator Brown. So you would say that we should not take
away tools from the shareholders to hold them accountable?
Mr. Gallagher. I would say that, but I would also say that
the proposals I have seen would not do that. So I do not think
that is what is at stake with some of the modest amendments
that have been discussed with 14a-8.
Chairman Crapo. Senator Kennedy.
Senator Kennedy. Thank you, Mr. Chairman.
Thank you, gentlemen, for coming.
I am here to learn. You know more than I do. I am going to
ask you a few questions. I only have 5 minutes. I would just
like you to answer them straight up and talk to me like I am a
tenth grader, OK?
It has been alleged that proxy advisory firms have
conflicts. Do they? If so, how?
Mr. Gallagher, we will start with you.
Mr. Gallagher. Senator, when I walked into the Commission
as commissioner in 2011, I did not know what a proxy advisory
firm was. But I will tell you, it was the number one issue
presented to me by the business community, by others in the
corporate governance world. I am sure you can share some of the
same stories in your offices.
The stories I have heard, there are facts and----
Senator Kennedy. Do they have conflict?
Mr. Gallagher. They do. They absolutely do.
Senator Kennedy. Then tell me about them.
Mr. Gallagher. There are two types of conflicts. One is a
pretty obvious one that I actually do not view as that
problematic. That is when you have a proxy advisory firm
providing consulting services to the issuers that they are
providing recommendations on. That is disclosed and knowable,
and in fact, everyone, I believe, assumes that there is that
conflict in place.
Senator Kennedy. So the proxy advisory firm is giving
advice to the institutional investor----
Mr. Gallagher. Right.
Senator Kennedy.----but it is doing work for the company
about whom it is giving advice?
Mr. Gallagher. Absolutely correct, Senator.
Senator Kennedy. OK.
Mr. Gallagher. And then there is a second, which I think is
a more insidious potential conflict, which is that the proxy
advisory firm is providing advice to institutional investors,
some of whom pay more in fees than others to the proxy advisory
firm, given the volume of votes, given the volume of assets
under management.
Senator Kennedy. What is wrong with that?
Mr. Gallagher. Well, there might be an outsized influence
by one institutional investor over another in that context,
where they might pressure a proxy advisory firm.
Senator Kennedy. OK.
Mr. Garland.
Mr. Garland. The practice of selling services to companies
they provide ratings on does constitute a conflict of interest.
Senator Kennedy. How so?
Mr. Garland. Mr. Gallagher's point with respect to one of
the advisors, ISS, there is a conflict that we as clients I
think have a responsibility to oversee.
Mr. Quaadman referenced another conflict with respect to
the other advisor, which is owned by a large Canadian pension
fund. In my view, that ownership does not present a conflict.
That really is an alignment of interests.
Senator Kennedy. OK.
Mr. Quaadman.
Mr. Quaadman. Yeah. Let me just add a couple more. One is
actually an example with Glass Lewis. We have sent letters to
both SEC and DOL with McGraw-Hill and also Canadian Pacific,
where on day one, a dissident director slate is proposed. Day
two, Ontario Teachers' Pension fund announces its support. Day
three, Glass Lewis announces it support for that dissident
director slate. That is at least the appearance of a conflict,
and we think that that should be looked at.
Number two, as I mentioned in my opening statement, both
firms do not disclose if a shareholder proponent of a proposal
or a dissident director slate is also a client to the advisory
firm.
Senator Kennedy. OK.
Mr. Quaadman. Now, that is important because you can think
of the economic return.
Senator Kennedy. Let me stop you a second----
Mr. Quaadman. Yep.
Senator Kennedy.----because I have only got 2 minutes.
Mr. Quaadman. Sure.
Senator Kennedy. Each of you are King for a Day. You can do
whatever you want. Politics be damned, OK? What, if anything,
would you do with respect to regulation of proxy advisory
firms?
Mr. Quaadman.
Mr. Quaadman. Disclosure of conflicts, open and transparent
process for advice, there is a level playing field, and
everybody knows exactly what the advice is. And that there is
no hidden third parties trying to push an agenda.
Senator Kennedy. Mr. Garland.
Mr. Garland. I think transparency with respect to conflicts
with the issuers, which is currently disclosed to clients.
Senator Kennedy. OK.
Mr. Gallagher. Senator, thanks for the question.
I could not agree more with Mr. Quaadman. It is about
transparency and accountability too. In any situation in which
you have a fiduciary duty running from a principal to an agent
and you cut that off by inserting a third party who arguably
does or does not have a fiduciary duty, you have a problem. We
see that in certain areas.
Senator Kennedy. But you do not think they have a fiduciary
duty now? It is uncertain?
Mr. Gallagher. Well, based on the letter that ISS sent you
that I read, I am a little confused. They clearly have a
registered investment advisor in their holding group. There had
been some debate about where the recommendations came out of.
Senator Kennedy. Would the three of you support creating an
explicit fiduciary responsibility?
Mr. Gallagher. Yes, Senator.
Mr. Quaadman. Yes.
Senator Kennedy. OK. Mr. Garland.
Mr. Garland. Yes.
Senator Kennedy. OK.
Is there anything in Mr. Reed's bill that should not be
there or that is there--that should be there or should not be
there?
Mr. Gallagher. Senator, I think the bill is great for a
bunch of purposes. The biggest one is the recognition of the
need for action. I think it is pretty bare bones. It is very
simple.
Senator Kennedy. OK.
Mr. Gallagher. I think there are a few things that we could
tweak.
Senator Kennedy. OK. Briefly, gentlemen. I am sorry to cut
you off. I just do not want to run over. Quickly, either of
you?
Mr. Quaadman. It is an important first step, and I
mentioned in my opening statement, I think there are three or
four things that could be added that I do not think are that
problematic that can help disclosure and a level playing field.
Senator Kennedy. Mr. Garland.
Mr. Garland. We do not oppose the bill.
I think our concern is that it is enforced in a manner to
protect the investor clients rather the issuers who are being
rated.
Senator Kennedy. All right. Thank you.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Cortez Masto.
Senator Cortez Masto. Thank you, Mr. Chair.
And let me follow-up on the line of questioning by my
colleague, Senator Kennedy.
And thank you, all three, for being here as well. This is
very instrumental for learning as we move forward.
Do you think disclosing a conflict is enough to address the
conflict? I am going to ask all three of you.
Mr. Gallagher. Thanks for the question, Senator.
That is the premise of pretty much the entirety of the U.S.
securities laws. The disclosure, and in a clear way without
fraud or misrepresentation, should be enough for an investor to
make proper investing decisions, including in this context, the
voting decision.
So, yes, I think disclosure goes a long, long way.
Senator Cortez Masto. Mr. Garland.
Mr. Garland. As a matter of practice, we generally support
disclosure as a tool to address conflicts of interest.
The conflict under discussion here is a little less
relevant to us because it speaks to compromising a
recommendation on which we do not rely.
Mr. Quaadman. I agree with Mr. Gallagher's comments.
I would also say, too, that in the current system that we
have, advisory firms do not have to disclose all their
conflicts, nor do their clients have to ask about those
conflicts.
The other thing that disclosure does is it also forces the
clients of the advisory firm to manage those conflicts and
ensure that they are meeting the fiduciary duties that they
have to their investors.
Senator Cortez Masto. Do we need to be concerned that proxy
advisory firms recommend votes in favor of management
recommendations more often than an alternative view? Are we
concerned at that at all?
Mr. Gallagher. Senator, I think to the extent that that
would imply that they are not doing the hard work, that that
number is skewed in some way, then yes. I mean, one of the main
criticisms of the firms is that the quality of the work is not
up to snuff. So to the extent it is 90 percent or more and
folks view that that not to be appropriate, I think that is a
question in and of itself, separate from issuer concerns that
they are getting matters wrong and misinterpreting in a way
that is negative for the management proposal.
Senator Cortez Masto. OK.
Anyone else?
Mr. Quaadman. One other thing I would just add with that,
if you take a look at ISS, they have 180 employees to evaluate,
analyze, and make recommendations on 250,000 issues. Think
about that workload. They are not properly resourced to do
their job, and that should be something that is also troubling
because at the end of the day, if investors are not getting
decision-useful information, they are not meeting their
fiduciary obligations.
Senator Cortez Masto. Do you think that the proxy advisors
need to be regulated by the SEC?
Mr. Gallagher. Senator, I am not a real regulatory type; by
nature, more free market. But I think we have reached the point
in this industry where, yes, there needs to be a role for the
SEC because, as I mentioned in response to Senator Kennedy's
question, whenever you have a fiduciary duty flowing and you
have that from the institutional investor to the beneficiary,
but you put in the middle of that a third party that may or may
not have a duty, I think things get twisted in a way. And I
think that you need someone, an entity like the SEC, to come in
and regulate that flow, much like Congress did with credit
rating agencies in 2000.
Senator Cortez Masto. Thank you.
Gentlemen, yes or no. I am running out of time as well.
Mr. Garland. No, I think it depends what that regulation
looks like.
Senator Cortez Masto. OK.
Mr. Garland. If it flows our access to information,
compromises their independence, and poses significant cost
incentives, we would oppose it.
Mr. Quaadman. We provided ISS with a proposal in 2010 for
an open and transparent system and for disclosure, and the
response that we got, because they were being sold at the time,
was ``We are not interested. It is going to cost too much
money.''
We are 4 years past SLB 20 being introduced by the SEC. We
thought that was an important step forward, but clearly, there
are still flaws in the system that need to be addressed. So
there needs to be a heightened level of oversight.
Senator Cortez Masto. OK. And then, Mr. Garland, I am
curious. You talked about the guidelines that New York State
has set in the Comptroller's Office with Senator Crapo, and I
know there is an association of State comptrollers. Those
guidelines that you have identified, is that a best practice
across the country for the State comptrollers, or is that
something you, just New York State, has identified?
Mr. Garland. We have maintained our own proxy voting
guidelines since 1987 when we took back voting control from
external investment managers. We believe that having guidelines
is best practice, and we would like to believe that our view on
particular issues reflects best practice.
Senator Cortez Masto. OK. Are you aware of the association,
national comptrollers, and do they address this issue as well
as a national level?
Mr. Garland. I am aware of a national--many of my
principal's peers with respect to his responsibilities fall
with State treasurers as opposed to comptrollers, and we work
with many of the public funds in the country. Many of our peers
maintain guidelines and vote proxies in a very similar manner,
as we do.
Senator Cortez Masto. Right.
I notice my time is up. Thank you very much. I appreciate
the conversation today.
Chairman Crapo. Thank you.
Senator Toomey.
Senator Toomey. Thanks very much, Mr. Chairman, and thanks
to all of our witnesses for joining us.
You know, I just want to start off with a quick observation
about really a fantastic development over recent decades for
small and retail investors, which is really the collapse in the
fee structure.
I mean, the cost for a middle-income individual or family
to invest in our capital markets is a tiny fraction of what it
once was, and this is a fantastic development for retail
investors. It gives access to huge categories of asset classes.
It gives access to those classes that just was not there
before, and I sure want to make sure that we are not doing
anything to impede not only that development, and then I will
put in a plug for a constituent, Vanguard, that has clearly
been at the forefront of this. It is stunning how the kinds of
services that they provide that are virtually free. It is just
amazing, and it is great for investors.
But not everybody is as big as Vanguard, and one of the
things that concerns me is the cost of some of these
shareholder vote requirements for a money manager that may not
have the resources of a Vanguard, for instance.
I think there may be some disagreement among the panelists
over whether or not and the extent to which there in fact are a
lot of shareholder proposals that are not fundamentally about
the operation of the company.
And so let me pose a question to each of you briefly. Is it
your view that there are frequently shareholder proposals that
are really about a social or environmental or political or
cultural issue and not fundamentally about the return to
shareholders of the company?
Starting with Mr. Gallagher, does that actually happen?
Mr. Gallagher. Well, thank you for the question, Senator
Toomey, and I can give you an example of another one of your
constituents, which is PNC Bank.
I remember when I was on the Commission one day commuting
down from my home in Baltimore, reading the Wall Street
Journal, and seeing reported in the Journal that PNC had gotten
a shareholder proposal on the environmental impact of its
lending activity. I also was reading that the SEC had decided
against PNC in that regard, which was news to me. So you can
imagine how happy I was when I walked into that office that
morning----
Senator Toomey. Yeah.
Mr. Gallagher.----which gave me a very good insight into
the internal staff process, and we can talk about that later,
if you like.
Senator Toomey. So do I infer your answer is yes----
Mr. Gallagher. Absolutely.
Senator Toomey.----that this happens?
Mr. Gallagher. Yes.
Senator Toomey. This does happen?
Mr. Gallagher. It does.
Senator Toomey. Mr. Garland.
Mr. Garland. No. We are often criticized for filing
proposals that I think some would characterize as political or
social in nature.
One example that we are very proud of dates back to 1992
when we filed a proposal to prohibit workplace discrimination
at a company--Cracker Barrel--that fired some employees because
they were gay, and so we have since then, we and other
investors, filed hundreds of proposals to prohibit workplace
discrimination based on sexual orientation and gender identity.
Senator Toomey. Is not that illegal? Is not there a law
against that?
Mr. Garland. In some States. It is not uniformly illegal,
and there is research from Credit Suisse that says they value
diversity and also the notion that you want to cast a wide net
to get the most talent. We think there is a direct correlation
to value.
Senator Toomey. OK. Mr. Quaadman, do you think these, the
answer to my question?
Mr. Quaadman. Yes, Senator Toomey.
Manhattan Institute and even ISS data shows that over 50
percent of shareholder proposals now are of a nature that are
environment, social, or political.
Senator Toomey. And not fundamental to the well-being of
the company or returns to shareholder?
Mr. Quaadman. Correct.
Senator Toomey. Fifty-percent. Over 50?
Mr. Quaadman. Over 50 percent, and almost none of them ever
pass.
In fact, there was a study by the University of Tennessee
in 2015 that looked at public pension plans that had a very
overt political, social, or environmental bent with what they
do, shareholder proposals. They had the lowest rate of return,
creating tens of billions of dollars of unfunded liabilities
for State taxes.
Senator Toomey. I am running out of time, but very quickly,
if you do not blindly follow the proxy advisors, would it not
be potentially extremely expensive to systematically evaluate
all of the proposals for all of the companies if your business
model requires that you be invested in many, many companies?
Mr. Quaadman. One of the issues that was addressed in SLB
20--and I think it needs to be maybe highlighted a little
further--was that it specifically stated that institutional
investors do not have to vote on every single issue. So that
they should only do so if they feel it is material.
Senator Toomey. Mr. Gallagher, I think you wanted to add
something.
Mr. Gallagher. Yeah. I just wanted to jump on that because
I was at the Commission at the time of SLB 20. That was
unfortunately revolutionary at the time. The interpretation of
the '03 rule that gave rise to the purported obligation to vote
every share, every vote, we dispelled that myth, and we thought
that would set folks free and give you a zero-cost ability to
say we are not going to vote on this one, we are going to pre-
direct our voting in accordance with management, in accordance
with the New York Comptroller. You could pick whoever you want.
We have not seen the uptake, though, on that, which is a shame.
Senator Toomey. All right. Thank you.
I see I have run out of time. Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Jones.
Senator Jones. Thank you, Mr. Chairman, and thank you for
this important hearing.
Thank you for the witnesses to come here today.
Obviously, this is a major issue, with the thousands of
proxy issues that take place every year, especially during the
high season. It has gotten complicated, technical, and I think
ripe for reform. And I am pleased to be part of the bipartisan
group of Senators who are working to bring some--a little bit
of reform to this, and I look forward to trying to continue
that process.
In addition to just reform, though, one of the things I
have got a concern about is just the lack of competition in
this area. I firmly believe that having more competition in the
marketplace on anything provides better options for investors.
It also pushes best practices in this industry, push them right
to the forefront.
What can be done? As I understand it, it is like two firms
that dominate like 95 percent or more of this industry. What
can we do or look at to maybe encourage more competition in
this whole area going forward?
I will open that up to the panel.
Mr. Gallagher. Well, thanks for the question, Senator. I
will take a stab at it.
This is the exact same issue I already referenced that
Congress dealt with in 2006 with the Credit Rating Agency
Reform Act, which was how do we regulate these critically
important advisors that weigh in in a substantive way on the
merits of a product or an issuer, which is kind of similar to
proxy advisory firms. How do we do that without either
regulating them out of business or creating barriers to entries
such that you do not have competition? And I know Congress
struggled with that at the time.
And what they came out with in the Credit Rating Agency
Reform Act was a sort of low-threshold, low-touch registration
requirement at the SEC that encouraged application, and then in
return, you got an imprimatur that was used in a very special
way throughout the securities markets.
It has not exactly panned out, 12 years later. I think you
still have market domination by three big players in the rating
space, but you do have 16 or 17 other registrants that came
behind them that did not exist as NRSROs, so-called ``NRSROs,''
before that legislation came through. I think I even noticed
one of them in the audience here today. So there is a tension.
Your Act, I think would be different in that just the
requirement of investor advisor registration. It is a known
paradigm that the SEC oversees. Whether it increases
competition amongst firms, brings them in, adds too many costs,
I do not know because I have not gone through that sort of
cost-benefit thinking, but I did want to bring back the
parallel analysis that Congress did with the credit rating
agencies.
Senator Jones. Great. Thank you.
Mr. Quaadman. Senator Jones, 11 years ago or so, there was
a firm, PGI, that tried to enter the market. A few years ago,
there was another firm, Proxy Mosaic, that tried to enter the
market, and they had a difficult time because of the market
power of the two dominant firms.
Look, the Chamber is not a proponent of regulation,
normally.
Senator Jones. Right.
Mr. Quaadman. But even if you take a look at what we are
proposing here, if you take the direction that your bill is
going in, we think that there should be some additional
disclosures around that. I think that allows for the
appropriate oversight of those firms, and I agree with what Mr.
Gallagher was saying. This is analogous to the credit rating
agencies.
Look, this is a situation that we have, and until there is
another entrant that is going to be successful, we have to have
this level of oversight for a level playing field.
Senator Jones. Great.
Mr. Garland. Senator Jones, I share your underlying concern
about the lack of competition. Investors would be better served
if there were more advisors, rather than less. I think the fact
that the bill has a carve-out for smaller is appropriate.
Senator Jones. Right.
Mr. Garland. And the challenge is the barriers to entry.
For clients like us, our portfolio is so massive that it is
very hard for a new entrant to be able to provide us with the
tools we need to vote across in 84 markets around the world.
Senator Jones. All right. Thank you.
Real quick, as my time is running out, this whole proxy
process is incredibly complicated. I did not think I could find
anything more complicated than trying to navigate between the
Dirksen, Russell, and Hart Senate Office Buildings, but this
process certainly is.
Are there takeaways from the Roundtable about maybe helping
the whole process? Are there things that can be done to
streamline that? And we have only got a little bit of time
left.
Mr. Gallagher. Senator, I will take a 5-second opportunity
just to plug technology. I think technology can resolve a lot
of the issues that were highlighted in the SEC Roundtable,
whether it be the plumbing issues for sure, whether it be
voting issues.
I do not want to speak for Michael here, but I think the
institutional investors would love more transparency and
accountability that you can get through technology.
Senator Jones. Great.
Mr. Quaadman. Same. I think particularly when you take a
look at retail shareholders who have been disenfranchised, if
you start to take a look at things like blockchain and client-
directed voting, that will allow them to be more of a
participant, and I think that is also going to help make the
system more efficient.
Senator Jones. Great. Thank you.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Schatz.
Senator Schatz. Thank you, Mr. Chairman.
Thank you all for being here.
I want to start with Mr. Quaadman. I was struck--I was
going to start with Mr. Garland, but I was struck with
something you said about the process being perverted for social
and political goals. And I just kind of want to flesh this out
because I think here is what I worry about. I assume you are a
conservative. I am a known liberal, and so we may disagree on
any number of issues, including climate change or LGBTQ or
whatever.
But the question that I have for you, is a climate change
proxy proposal by definition, in your view, a sort of social,
political goal? Because it seems to me that when you are
talking about publicly traded companies that may have stranded
assets or publicly traded companies that may have power plants
or real estate assets in coastal areas that get flooded, it is
perfectly reasonable for shareholders to say, ``Hey, hold on a
second. We need to account for this better. We need to have a
more robust climate strategy.'' And so the question is, in a
case like that, is that a social-political end, or are you
referring to something else?
Mr. Quaadman. So if you take a look at climate change, if
you take a look at what EEI has done, they have actually
created standards for disclosure for utilities for how they can
provide that information out to their investors and to other
stakeholders who are interested in that information.
When you take a look at ESG disclosures and ESG movement,
that is used for a variety of different stakeholders. It is
used for investors. It is used for employees, consumers, and
even vendor management.
So what there is right now is there is a struggle as to how
we are going to deal with that. When you take a look at
environmental, social, and political shareholder proposals,
they make up over 50 percent of the shareholder proposal.
Senator Schatz. Hold on, but let us slow down.
Mr. Quaadman. Yeah.
Senator Schatz. What is an environmental, social, or
political proposal? Because it seems to me that basically you
are defining it as anything that you do not like that does not
service short-termism, that is not advancing your clients' and
your institution's interest, which is fine, but I am having a
hard time understanding what it is that you mean by that except
the stuff that I do not want companies to have to deal with.
And one more point here, it seems to me that under the law,
shareholders have a perfect right to make that determination
themselves about what is in the interest of the company as part
owners of the company. So can you clarify what you mean by
social-political? Because the Cracker Barrel example is a
really good example. In '92, that may have been viewed as a
sort of political question, but now it is clearly a
reputational and shareholder question, and so who gets to make
that determination? In my view, not the regulators. In my view,
not the legislative branch. In my view, the shareholders
themselves.
Mr. Quaadman. So directors have a fiduciary responsibility
to long-term management and strategies of----
Senator Schatz. I know that.
Mr. Quaadman.----preservations of assets, correct? So if
you take a look at, let us say, political and lobbying spending
disclosures in, let us say, the defense aerospace industry,
right? There are studies that have found that that type of
lobbying and those expenditures are critical to the
profitability of that company, yet those proposals fail by over
80 percent.
So the question is, over the course of time, what we are
saying here is, particularly with the resubmission thresholds,
if these proposals keep on coming up, yet 80 percent of the
shareholders have said it is not material and the SEC has said
that is not material, at some point in time, it should just be
given a time-out if you reform the resubmission thresholds.
So I think it is a matter of also looking. Are those
proposals pushing a political agenda, or are they actually tied
to----
Senator Schatz. And who decides that?
Mr. Quaadman. Are they tied to the profitability of a
company? But I think the other question is, are we also----
Senator Schatz. Hold on. Hold on. Hold on.
Mr. Quaadman. Yeah. Go ahead.
Senator Schatz. You are restating the claim over and over
again, and I would like you to define what it is that is a
political agenda other than stuff you do not want companies to
have to talk about because, in my view, just because a company
continually refuses to deal with the stranded assets problem,
just because a company refuses to deal with the fact that they
may have resources in the coastal areas that they are denying
are in peril or not insured properly or subject to severe
weather, just because you think they should continue to ignore
that does not mean that they ought to.
I am going to finish with Mr. Garland because I would like
you to respond to the exchange that we had, with my remaining
seconds, please.
Mr. Garland. Thank you, Senator Schatz.
I appreciate that you raised climate change as an issue,
which is something that our boards have been spending a lot of
time on.
In 2015, Mark Carney, the Governor of the Bank of England
and the Chair of the Financial Stability Board, said climate
change presents a systemic risk to the global financial system,
and so he and the G20 tasked the Financial Stability Board with
coming up with a framework to help markets price and understand
risks within individual companies.
And what Carney said is climate change is the--if you are
familiar with the tragedy of the commons, as externalities with
respect to environmental issues, climate change is a tragedy of
the horizons. The most devastating consequences are not going
to affect today's decision-makers. It is going to be the next
generation.
Given our time horizon, our time horizon is measured in
generations. So we have to take those risks very seriously, and
climate change does present risks and opportunities, the risks
both of transition to a low-carbon economy and the physical
impacts from severe weather and rising ocean levels.
So our boards last year, we hired a consultant to help us
integrate climate change into our investment strategy and asset
allocation and provide a set of recommendations, which we are
now moving on.
In September of this year, Comptroller Stringer and Mayor
de Blasio and other trustees announced a commitment to double
our investment from $2 billion to $4 billion in clean energy
solutions.
Senator Schatz. Thank you.
Chairman Crapo. Thank you.
Senator Van Hollen.
Senator Van Hollen. Thank you, Mr. Chairman, and thank all
of you for what you are doing here today. As Senator Jones
said, it is a complicated area. It is an area that I think may
be able to use some reform, but I am struck the way the sort of
tables are turned here.
Mr. Gallagher, you mentioned you were from Baltimore. I am
glad to have you as a Maryland constituent. As you know, in
Baltimore, we also have a firm, T. Rowe Price, and I have a
letter here from T. Rowe Price strongly opposing this
legislation.
I just want to read to you part of what they say here. They
are responding both as an institutional client of a proxy
advisory firm as well as a corporate issuer covered by proxy
advisors. So they are seeing this from both perspectives, and
in this letter, they write:
We make our own voting decisions using the independent research
provided to us by our proxy advisor as one factor, among many,
used to inform our firm's voting positions. The House bill,
which I understand you support, Congressman Duffy's bill, would
diminish the independence of that research and therefore its
value to us as a client.
I have a simple question. Why are you supporting the bill
that diminishes the value of that information, and why did we
want regulation that says to T. Rowe Price, we need this
regulation because we know what is better for you, T. Rowe
Price? We need for you to have all this regulation so that you
can make the right decisions for your investors.
I just find that this whole thing has been turned on its
head.
Mr. Gallagher. Well, Senator, thank you for the question. I
am happy to be your constituent.
I am not here to support the Duffy bill or any bill, quite
frankly.
Senator Van Hollen. OK.
Mr. Gallagher. That is for you guys to decide. I am an old
SEC staffer who is used to taking congressional direction and
running with it, so whatever Congress chooses to do is best.
In this context, I would disagree with T. Rowe. I do not
believe the Duffy bill would do what they say. I do not think
the Duffy bill would do a lot of what its opponents would say.
As I understand the Duffy bill and I have studied it over
the years--I have not looked at it in a while, but it is, as we
talked earlier about the Credit Rating Agency Reform Act of
'06, predicated based upon that body of statute, which was
meant to be incremental, which was meant to bring in oversight.
Senator, I do not come to Congress and ask for regulation
and legislation a lot. I am more of a free-market guy, but I
will tell you this is one spot, like I said earlier, that I
heard more about these issues, the proxy advisory issue in
particular, than anything else as an SEC commissioner, from
sheepish executives and others who would not want to come and
do this today, who would not want to raise their profile, who
whisper. And you hear the anecdotes, and it drove me to think
that we need to do something in this space. And if we are going
to do it, why not do it in a way where we leverage something
that Congress found to be pro-competitive? Because I am really
worried about the concern of new entrants and everything else.
Senator Van Hollen. Right.
I would just suggest that adding this additional layer of
requirement and requirements on people who are providing advice
actually will raise the cost of new entrants.
Mr. Gallagher. Yeah.
Senator Van Hollen. It will make it more difficult----
Mr. Gallagher. Right, right.
Senator Van Hollen.----for people to compete.
I appreciate--I believe that you were in favor of the Duffy
bill, but here is the thing. So you are saying here is a major
firm, T. Rowe Price----
Mr. Gallagher. Right.
Senator Van Hollen.----that essentially is saying this
legislation is telling us that Congress wants to put in these
protections. We do not want the protections. They will actually
undermine the value of the information we are receiving.
Mr. Gallagher. Right.
Senator Van Hollen. And I do find it a strange world where
we are equating that to credit rating agencies. I mean, there
may be some of the reforms registering. That is fine. Credit
rating agencies have a model where they collect information
from consumers without the support of--without the consent of
consumers.
These are big firms, in many cases, and small firms who are
choosing, who believe it in their economic interest----
Mr. Gallagher. Right.
Senator Van Hollen.----to hire a proxy advisor, to give
them advice. They can choose to reject the advice or accept the
advice, but here we are coming along saying, ``You know what?
You, T. Rowe Price, do not really know what is good for you,
and we are going to insist that we go through this other
process''----
Mr. Gallagher. I hear you.
Senator Van Hollen.----``and to the Chamber.'' What is your
response to this?
Mr. Quaadman. Look, as I stated earlier, we do not come at
this position lightly that we think that there should be
regulation and oversight, but the fact of the matter is, as I
said in my opening statement, as far as we can see, flawed
information, from what we saw with the supplementary filings,
means at the end of the day, they are not getting decision-
useful information that can impact the return of the clients of
T. Rowe Price.
Senator Van Hollen. Yeah.
Mr. Quaadman. So if that return is being impacted, that is
going to affect retirees, families, homeowners, and that is
something that I think we need to take a cost-benefit analysis
to look at.
Senator Van Hollen. Look, I am with you, but the suggestion
there is that T. Rowe Price does not know how to weigh the
information they are getting from these proxy advisors.
I would also point out in the same letter, they say that
from their perspective as a corporate issuer, because they are
also subject to these proxy advisors, that we appreciate having
effective ways to address factual errors and proxy advisor
research reports, but in this regard as well, the proposed
legislation is unnecessary, given current practices and
available legal remedies. In other words, that a lot of this
has to be put on a portal, right, available to review, and here
we are, this bill. I am not saying this bill--the Duffy bill
essentially says to T. Rowe Price, you know, ``We know better
than you.'' I just find it a strange----
Mr. Quaadman. I would just say quickly, Senator--I know
your time is up, but I think T. Rowe and some of the other
firms, as Senator Toomey said with Vanguard, they use proxy
advisory reports as one data point of many to make their
decisions.
The problem is you have a large group of smaller
institutional investors that completely outsource their
functions or their thinking to the advisory firms, and that is
where the problem lies.
Senator Van Hollen. I understand that. I just think, again,
that risk should be borne by those firms that make that
decision. If they do not like that proxy advisor, get rid of
them. Do something else. Tell them you want them to do a better
job. But, in this case, we are coming in and again saying that
they do not know what they are doing. I just find it overly
burdensome.
Chairman Crapo. Thank you.
And I would like to thank all of our witnesses again for
coming today, not only your testimony here today, but the
testimony you have supplied and the advice and support and
guidance that you will supply as we continue.
For Senators who wish to submit further questions for the
record, those questions are due on Thursday, December 13th, and
I encourage the witnesses, as I suspect you will get some
additional questions, to please respond to those as promptly as
you can.
Again, thank you very much for being here, and with that,
the hearing is adjourned.
[Whereupon, at 11:09 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
Today's hearing will focus on several aspects of our proxy voting
system, including the role of proxy advisory firms, the shareholder
proposal process and retail shareholder participation.
As SEC Chairman Clayton noted earlier this year, ``Shareholder
engagement is a hallmark of our public capital markets and the proxy
process is a fundamental component of that engagement.''
I commend the SEC for its ongoing attention to this issue,
including its recent staff roundtable on the proxy process and rules,
and I encourage them to move forward with their reform efforts.
Many of these rules have not been examined for decades.
In that time, there have been a number of changes to the proxy
environment, including the growing influence of proxy advisory firms
and fund managers on voting outcomes and, more generally, corporate
behavior.
There has also been a rise in the number and substantive scope of
proposals pursuing an environmental, social or political agenda.
Many of these proposals have little or nothing to do with a
company's financial performance or shareholder value.
But companies and investment advisers alike nevertheless devote
time and resources to evaluate these proposals, often relying upon
proxy advisory firms or other consultants to assist them and reduce
their costs.
It is time to re-examine the standards for inclusion of these
proposals as well as the need for fiduciaries to vote all proxies on
all issues in light of the proliferation of environmental, social or
political proposals, and the rise of diversified passive funds.
Chairman Clayton has also expressed concerns that the `voices of
long-term retail investors may be underrepresented or selectively
represented in corporate governance.'
According to an SEC staff estimate, retail investors own roughly
two-thirds of Russell 1,000 companies, often through mutual funds or
pensions.
But it is not always clear whether the proxy rules promote the
long-term financial interests of those retail investors, many of whose
interests are expressed through intermediaries.
Last week, John Bogle, the creator of the index fund, warned that
``if historical trends continue, a handful of giant institutional
investors will one day hold voting control of virtually every large
U.S. corporation.''
With this level of concentration and intermediation, it is even
more important that the proxy voting process and voting decisions of
fiduciaries reflect the clear economic interests of the retail
investors on whose behalf these institutional investors engage.
I look forward to hearing the views of our witnesses on these and
other proxy-related issues, and I thank them for their willingness to
appear here today.
______
PREPARED STATEMENT OF SENATOR SHERROD BROWN
Thank you, Chairman Crapo, and welcome to our witnesses.
All too often, we see corporate boards and executives focus on
short-term profits, instead of long-term investments in their companies
and their workers.
We saw pretty clear evidence last week.
GM announced it would lay off 14,000 workers and close five plants,
including the Chevy Cruze plant in Lordstown, Ohio. In the last 2
years, GM has laid off nearly 3,000 workers at the Lordstown plant and,
after this most recent decision, that number may grow to 4,500 workers
who have gotten a pink slip. This decision is devastating for the
Mahoning Valley.
Meanwhile, GM has spent more than 10 billion dollars on stock
buybacks since 2015--more than double what it expects to save from the
job cuts and plant closings. Of course, Lordstown workers and their
families are angry.
The President claimed last year's Republican tax bill would mean
more money in workers' paychecks. But, instead we've seen stock
buybacks explode this year to a record 894 billion dollars. Executives
claim these record buybacks are supposed to reward shareholders, but
they don't seem interested in hearing from shareholders when they raise
concerns.
And the bad corporate decisionmaking doesn't stop with GM and with
buybacks and layoffs. Marriott announced on Friday that it had a data
breach between 2014 and 2016, affecting 500 million customers, which it
only discovered in September.
Cyber breaches are so common now that it's routine for Wall Street
analysts to estimate the stock price hit companies will take in the
week after they announce a breach. Then it's business as usual, and it
doesn't even matter that companies can't secure their customers'
personal information.
These are just the most recent examples of corporate mismanagement
and abuse of workers and customers.
Excessive executive compensation packages; abuses and scandals that
can wreck customers' financial lives like we've seen at Wells Fargo;
price gouging for vital prescription drugs like we've seen at the
company Mr. Gallagher works for--it's clear these corporations aren't
making good decisions for their companies, their customers, or their
workers. It's why we should foster more shareholder engagement, not
less.
But, that's not how corporate lobbyists and special interests see
it. The Wall Street business model doesn't see workers like those in
Lordstown as vital to their companies--it sees them as a cost to be
minimized.
But incredibly, we're here today to discuss how to make it even
more difficult for shareholders to hold management accountable. Several
bills introduced this Congress undermine shareholders' oversight of the
companies they own.
Those measures would deny all but the largest shareholders the
right to submit proposals for a vote, requiring investors to own
billions of dollars of company stock to be eligible to submit a
shareholder proposal. Current rules permit small shareholders to submit
proposals, but apparently, folks in this town want to stack the deck
even further against Main Street, small-time investors.
This hearing will also consider proposals that make it harder for
institutional investors to have timely access to research and analysis
from proxy advisory firms that the investors have hired. These
proposals would give corporate interests access to this information
before the public retirement systems, investment fund managers, and
foundations who manage money for hardworking Americans.
You'll hear about errors and inaccuracies in those reports, but
what it really amounts to is an effort to make independent analysis
less so. That's also the wrong answer.
Shareholders of all sizes deserve to have every tool available to
hold executives accountable--forcing them to think beyond their short-
term self-interest, and manage for the long term. Companies,
shareholders, workers, and other stakeholders all benefit when the
system promotes fairness, communication, and trust.
Thank you, Mr. Chairman.
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF MICHAEL GARLAND
Assistant Comptroller for Corporate Governance and Responsible
Investment, Office of the New York City Comptroller Scott Stringer
December 6, 2018
Good Morning, Chairman Crapo, Ranking Member Brown, and Members of
the Committee. My name is Michael Garland and I am the Assistant
Comptroller for Corporate Governance and Responsible Investment in the
Office of New York City Comptroller Scott Stringer. Comptroller
Stringer serves as a trustee to four of the five New York City Pension
Funds and as the investment advisor and custodian to all five funds,
which collectively have more than $200 billion in assets under
management and a long history of active share ownership on issues of
corporate governance and sustainability. It is an honor to be invited
to provide this Committee with our perspective on important matters of
shareowner responsibility.
The NYC Pension Funds (or ``NYC Funds'') together constitute a
system made up of five independent public pension funds that provide
retirement security to more than 700,000 of the City's active and
retired teachers, police, firefighters, school employees, and general
employees. Each of these constituencies has member representatives on
the board of its respective fund.
With an average retirement benefit of $38,000 per year, it is
likely that many of our members only participate in the capital markets
through their role as pension fund beneficiaries. Our members are true
Main Street investors, as opposed to a group using that name that
represents the interests of company managers.
The NYC Pension Funds make up the fourth largest public pension
system in the United States. We are long-term share owners of
approximately 10,000 public companies around the world, including more
than 3,000 U.S. companies.
Because of our long-term investment horizon, and the fact that we
allocate more than 80 percent of the funds' investments in U.S. public
equity through passive index strategies, we cannot readily sell shares
in a company when we have concerns about the company's performance,
board composition and quality, management, executive compensation,
workplace practices or management of risks, including those related to
climate change.
In these instances, the only way we can protect and create long-
term shareowner value is to be an active owner of our portfolio
companies by exercising our legal rights as shareowners. We (1)
actively vote our proxies at each portfolio company, and (2) actively
engage our portfolio companies, mainly through shareowner proposals and
dialogue ensuing from those efforts, in order to promote sound
corporate governance and responsible and sustainable business
practices. In fact, over the last 30 years, the NYC Pension Funds have
been the most prolific filer of shareowner proposals in the Nation.
As long-term owners, we expect companies to create long-term,
sustainable value. We push them to address a range of environmental,
social and governance risks that are fundamental to ensuring long-term
profitability. This is part of our fiduciary duty as long-term
shareowners.
We believe sound corporate governance and sustainable business
practices--the latter including responsible labor, human rights and
environmental practices--are fundamental to creating and protecting
long-term shareowner value and sustainable economies.
The link between environmental, social and governance factors
(ESG), on the one hand, and risk management and long-term value
creation on the other, is supported by a growing body of empirical
research, including an important study from Harvard Business School in
2011.
The study tracked the performance of 180 U.S. companies for 18
years and found that that ``High Sustainability'' companies
outperformed ``Low Sustainability'' companies in terms of both stock
market performance and profitability. According to the study, High
Sustainability companies are those that embrace corporate policies
related to the environment, their employees, community, products, and
customers.
Our capacity to fulfill our proxy voting and engagement
responsibilities to our beneficiaries depends heavily on (1) the timely
receipt of expert, independent proxy research, and (2) our longstanding
ability to submit shareowner proposals and to cast votes on proposals
submitted by other shareowners, regardless of their size or
sophistication (or whether institutional or retail).
The NYC Funds have been filing shareowner proposals and voting our
own domestic proxies for more than 30 years.
Mr. Chairman, it is an honor therefore to be invited to provide
this Committee with our perspective on (1) the role of proxy advisory
firms, their involvement in the voting process and their current
regulatory treatment; (2) the shareowner
proposal process; and (3) the level of retail shareowner participation,
its causes and whether the relatively low level of retail participation
compared to institutional investors is cause for concern.
The remainder of my testimony will address each of these topics in
order.
Proxy Advisors
With respect to proxy advisory firms, we oppose any additional U.S.
Securities and Exchange Commission (SEC) actions that would compromise
the independence of research, reduce the amount of time we have to
review research aimed at voting at that company's annual meeting, or
that would otherwise impose additional costs on our participants and
beneficiaries in terms of either added burdens on our staff resources
or additional compliance costs imposed on our advisors, which we, as
paying clients, would ultimately bear.
While proxy advisory firms have been the subject of vocal
criticism, I find it remarkable the impetus for onerous regulation of
those firms is coming from those who are the subject of the analysis--
particularly board members, corporate executives and their lobbying
organizations--rather than from the institutional investors who pay for
the research services. To the extent that there are concerns on the
quality of proxy advisory firm research, that is our problem as
investor clients. Many of those who are the subject of the proxy
analysis do not like to be criticized and receive negative vote
recommendations, so they are reportedly lobbying aggressively and
inappropriately to insert themselves between the proxy advisers and the
clients of those advisors.
The chief allegation of these lobbyists is that proxy advisor
clients ``automatically follow'' proxy advisor recommendations and
therefore the proxy advisors have too much influence. This argument was
reflected in the testimony before this Committee last June by Thomas
Quaadman of the U.S. Chamber of Commerce. The Chamber and similar
lobbyists apparently seek to sow seeds of doubt about the capabilities
of institutional investors to exercise their own judgment. The
unfounded suggestion is that when it comes to voting proxies, which are
considered plan assets under relevant fiduciary law, sophisticated
institutional investors--whose job is to manage billions of dollars of
investment capital--are like lemmings, blindly following the
recommendations of proxy advisors in our proxy vote decisionmaking.
This does a great disservice and I want to disabuse Committee Members
of the notion that the argument of undue influence has merit.
Although Institutional Shareholder Services (ISS), the largest
proxy advisory firm, recommended voting against say-on-pay proposals at
12.3 percent of Russell 3000 companies in 2018 (through November 1),
only 2.4 percent of Russell 3000 companies received less than majority
shareowner support on their say-on-pay proposals. According to Proxy
Insight, which analyzes the voting records and policies of over 1,800
global investors and is the world's leading source of information on
global shareowner voting, ``the number of investors delegating their
entire policy and voting to a proxy voting advisor is actually very
low--from a sample of 1,413 investors, 75 percent have their own
dedicated proxy voting policy representing a significant 92 percent of
the assets under management.'' According to ISS, 85 percent of its top
100 clients use a custom voting policy.
The NYC Funds are among the proxy advisor clients that use custom
policies. In our case, we have one policy that applies specifically to
the U.S. market, which we first adopted in 1987. We have a second set
of policies, adopted later, that apply to non-U.S. markets. While we
have been voting our own U.S. proxies for more than 30 years, just this
year the Comptroller's Office took back voting control of our entire
global portfolio from our outside investment managers. Both policies,
which are updated regularly, establish voting principles and positions
on a broad range of issues, consistent with our views on how best to
maximize long-term shareowner value.
I would like to provide the Committee with a window into our proxy
voting process and the essential role that proxy advisors play in
enabling institutional investors like us to comply with our fiduciary
duty to vote proxies.
Like other institutional investors with custom policies, we use the
research we receive from both of our proxy advisors as a critical
inputs into how we apply our own guidelines. The specific proxy voting
recommendations from the proxy advisors are entirely irrelevant to our
process. In fact, as I will discuss in a moment, there is little
correlation between their recommendations and our votes on executive
pay, perhaps the most sensitive and contentious issue from the issuers'
perspective (and likely the most important element leading CEOs and
their representatives to seek onerous regulation of proxy advisors).
For the year ending June 30, 2018, our office cast 71,000
individual ballots at 7,000 shareowner meetings in 84 markets around
the world, each market with its own governance norms and matters
subject to shareowner voting. Consistent with our commitment to
transparency, all of our proxy voting decisions are available on our
website for our participants and beneficiaries, and our portfolio
companies, to review.
During the peak of U.S. proxy season, which runs from April to the
end of June, the number of meetings and votes is very large, putting a
premium on having a high-quality, efficient process, to which the proxy
advisory firms are indispensable. In the U.S. market, every ballot
item, including each management and shareowner proposal, is
individually reviewed and voted by our voting staff. We have five full-
time staff dedicated to proxy voting during peak season, and our least-
tenured investment analyst has 12 years' experience applying the NYC
Funds' domestic proxy voting guidelines. All votes are cast according
to our own guidelines irrespective of the proxy advisors' voting
recommendations. Given the volume of annual meetings, and the
complexity of company proxy disclosures, particularly with respect to
executive compensation, our ability to apply our own guidelines rests
in large part on the timely receipt of the independent, expert research
we receive from our two proxy advisors (presently ISS and Glass Lewis).
Much of the information we obtain from the advisors' research
reports is available in company proxy statements. But different
companies present much of the important information in different ways
and in various places. Just as our investment advisors rely on
intermediaries like Bloomberg and FactSet to organize data from company
disclosures, we rely on proxy advisory firms to pull information into a
consistent format that permits quick reference to comparable data. Our
ability to locate and calculate the necessary data points without this
research would impose an unreasonable burden on the investment analysts
who vote our proxies.
In addition to organizing and presenting in a uniform way
information that is already somewhere in the proxy statement, the proxy
advisors provide independent value-added analysis, such as peer group
comparisons for executive compensation and total shareowner returns,
the robustness of hedging and pledging policies, board gender diversity
by percent--all of which are required to apply our guidelines. I would
note that many company complaints of ``inaccuracies'' are that the
proxy advisors use their own frameworks, rather than those of the
company involved, to analyze issues (e.g., ISS and Glass Lewis have
their own definitions of director independence, leading to multiple
company complaints of ``inaccuracy'' because the analysis does not
parrot the company-favored definitions).
As an example of our independence, while the NYC Funds voted
against say-on-pay at 25.4 percent of our U.S. portfolio companies for
the year ending June 30, 2018, ISS only recommended against say-on-pay
at 16.7 percent of these same companies.
We recognize our responsibility to vote proxies with diligence and
integrity, and in the best long-term interests of our participants and
beneficiaries. We do not want company management interposed between us
and our research service providers, and this is even more true if it
involves additional cost and delay, giving us less time for our due
diligence on each proxy vote.
Shareowner Proposals
In our experience, as both a proponent and proxy voter, the
shareowner proposal process is an essential and cost-effective tool for
investors to protect and enhance value by aggregating and expressing
their views to management, boards and other shareowners on major
governance issues, corporate policies and important and emerging risks
and opportunities. The NYC Funds have used shareowner proposals to
prompt portfolio companies to constructively engage on specific
concerns in ways that benefit the investing public.
Critics of shareowner proposal rights are seeking to remedy
problems that do not exist. For example, critics of shareowner
proposals claim that such proposals are deterring companies from going
public, and thereby distorting our capital markets. This claim is
highly implausible.
Proposals generally are nonbinding, and the average Russell 3000
company can expect to receive a proposal once every 7.7 years. Most
proposals go to larger, established companies.
The notion seems to be that a company would forgo the benefits of
efficient public equity markets to avoid the possibility that, sometime
in the next decade or so, a shareowner might submit a nonbinding
proposal to (for example) ask for improved disclosures around climate
risk. This claim too is simply not plausible.
U.S. public equity markets are efficient, broad and deep. It is
true that private equity markets also are larger and more efficient
than in the past, and that some new economy companies have less need
for capital than companies that emerged in earlier years, and can gain
high valuations without needing to go to public markets. But that has
nothing to do with shareowner proposals.
Outside investors (in both publicly held and private companies)
want some means to protect their interests, and to hold management
accountable. For public companies, that means providing outside
shareowners with certain rights, including the right to file shareowner
proposals, along with other regulatory and disclosure requirements that
are the cost of admission to public markets, where companies have a
dispersed shareowner base.
The NYC Funds have a proud record of engaging our portfolio
companies on a broad range of environmental, social, and corporate
governance issues, and thereby working to enhance long-term shareowner
value, often through shareowner proposals. Our funds have filed more
than 1,000 shareowner proposals, almost certainly more than any other
institutional investor in the world, with a record dating back 30
years. And our shareowner proposal initiatives have led to significant
market changes.
Among important changes that the NYC Pension Funds' shareowner
proposals have helped achieve over the last 30 years (and often working
in parallel with other institutional investors):
Substantial independent majorities on boards of directors
Enhanced standards of independence for members of company
audit and compensation and nominating committees
Strengthened policies to enhance board diversity
Enhanced company disclosures on board composition and
skills
Annual election of all directors
Proxy access rights
Majority vote standards in election of directors
Shareowner advisory votes on executive compensation
Effective clawback policies
Company disclosure of corporate lobbying and political
spending
Emphasis on performance-based awards in executive
compensation
Company policies prohibiting discrimination based on sexual
orientation or gender identity
A particularly good example of market change from shareowner
proposals relates to ``proxy access''--that is, a mechanism to permit
shareowners to include their nominees on the company proxy card for a
minority of board seats under certain circumstances. In 2014,
Comptroller Stringer and the NYC Funds launched the Boardroom
Accountability Project, a campaign to implement proxy access on a
company-by-company basis in the U.S. market using shareowner proposals.
Proxy access had long been a top priority for the NYC Pension Funds
and other institutional investors. We applauded in 2003 when the SEC
first proposed a proxy access rule in response to board failures at
Enron and WorldCom. The SEC in 2009 again proposed a proxy access rule
as a key response to the governance failures that contributed to the
financial crisis of 2008. As authorized by the Dodd-Frank Act of 2010,
the SEC enacted a proxy access rule in August 2010. The rule provided
shareowners that collectively held 3 percent of a company's shares for
at least 3 years the ability to nominate director candidates
representing up to 25 percent of the board using the company's proxy
materials. In September 2010, however, the Business Roundtable (BRT)
and U.S. Chamber of Commerce successfully challenged the proxy access
rule in Federal court. While the BRT and the Chamber opposed a
universal rule, they implicitly endorsed the kind of private ordering
they now oppose, and we called their bluff with our shareowner proposal
effort.
Today, largely as a result of the Boardroom Accountability Project,
approximately 540 U.S. companies, including 70 percent of S&P 500
companies, have enacted proxy access bylaws with terms similar to those
in the vacated SEC rule, up from only six companies in 2014 when we
launched the project.
In July 2015, economic researchers at the SEC released a study that
analyzed the public launch of the Boardroom Accountability Project and
found a 0.5 percent increase in shareowner value at the first 75 firms
that received proxy access shareowner proposals from the NYC Funds.
(See http://www.sec.gov/dera/staff-papers/working-papers/
24jul15_bhandari_public-vs-private.html.) The SEC staff's findings were
consistent with a 2014 CFA Institute study that found that proxy access
on a market-wide basis has the potential to raise U.S. market
capitalization by as much as 1 percent, or $140 billion.
As another example, the NYC Funds won significant change on company
clawback policies, making use of shareowner proposals. Motivated by the
small number of top executives held accountable for the excessive risk
taking and compliance failures that led to the global financial crisis,
the NYC Funds have fought for strong policies to enable boards at many
major banks to claw back compensation from senior executives
responsible for egregious misconduct that causes financial or
reputational harm to their companies. In 2013, in response to a
shareowner proposal, we successfully negotiated this enhancement to
Wells Fargo's clawback policy. It was that policy that then enabled the
Wells Fargo board of directors to announce in September 2016 that it
would recoup $60 million from two senior executives in order to hold
them financially accountable for the fake account scandal that involved
the loss of jobs by 5,300 lower-level employees and cost Wells Fargo
$185 million in fines and penalties.
Rule 14a-8 and the No-Action Process
SEC Rule 14a-8--which governs the shareowner proposal process--is
largely effective, and is based on sound analysis of costs and
benefits. Adjudication through court proceedings are substantially more
expensive for all parties than the no-action process. We know this from
experience, as we usually are satisfied with the SEC no-action process
on our shareowner proposals (and have usually accepted rulings against
our proposals), but on occasion have been moved to go to court when we
believed an SEC staff decision was not warranted.
The 13 permitted exclusions reflect the SEC's determination as to
what issues are or are not important enough to shareowners as a whole
to warrant giving shareowners a vote. Thus, if a shareowner who meets
the holding requirements wishes to present a topic that surmounts the
13 enumerated bases for exclusion, there is a benefit to all
shareowners in terms of being able to have a say on what is, by
definition, a policy matter affecting their interest as shareowners.
While the SEC has generally applied the rules fairly, there have
been instances in which the SEC reversed precedent unfairly and to the
significant detriment of investors, sometimes prompting the NYC Funds
to seek legal recourse.
The first such instance was in 1992, when the New York City
Employees Retirement System (NYCERS, one of the five NYC Pension Funds)
filed a shareowner proposal asking Cracker Barrel to adopt a policy of
nondiscrimination based on sexual orientation (the company had a policy
against hiring gay employees). The SEC not only permitted the company
to omit the proposal from its ballot because it dealt with ``ordinary
business,'' but also set a new standard whereby employment-based
shareowner proposals would ``always be excludable by corporations.''
NYCERS challenged the decision in court. While the lawsuit was
unsuccessful (NYCERS lost on appeal), the resulting investor outcry
later prompted the SEC to reverse its position, paving the way for
investors to challenge workplace discrimination and address employment
practices in shareowner proposals.
Today, largely in response to hundreds of shareowner proposals
submitted by the NYC Funds and other investors, nearly 92 percent of
Fortune 500 companies have nondiscrimination policies protecting
employees on the basis of sexual orientation, and 82 percent include
gender identity in those policies. A 2016 analysis by Credit Suisse
found that 270 companies that provided inclusive LGBTQ work
environments outperformed global stock markets by 3 percent for the
previous 6 years.
Together with proxy access, this is among the NYC Funds' signature
shareowner initiatives in terms of changing market practice.
Just as the SEC's Cracker Barrel decision threatened to unfairly
and permanently exclude shareowner proposals on employee-related
issues, last year's decision by the SEC to permit EOG Resources to
exclude a proposal relating to greenhouse gas (GHG) emissions threatens
to similarly undermine investors' ability to file proposals addressing
fundamental risks related to climate change. The proposal would have
required EOG to ``adopt company-wide, quantitative, time-bound targets
for reducing greenhouse gas emissions and issue a report, at reasonable
cost and omitting proprietary information, discussing its plans and
progress toward achieving these targets.'' The SEC staff found
exclusion appropriate on the grounds that the proposal sought ``to
micromanage'' the company, despite the broad language in the proposal
simply seeking the use of goals, as used by many other companies (more
than 60 percent of Fortune 100 companies already set GHG emission
targets). This was a sharp reversal of earlier SEC views on climate
change proposals.
In 2018, the NYC Funds requested that six additional companies
include nearly identical resolutions in their proxy solicitation
materials. The proposal was withdrawn at four of the companies, with
three agreeing to substantially implement the proposal.
We plan to file similar proposals for 2019. Already though, one
recipient of that proposal, perhaps feeling emboldened by last year's
EOG no-action letter, has sought no-action relief from the SEC on the
grounds of ``micromanagement.''
I would like to address two elements of Rule 14a-8 that have
received particular attention in recent months: the ownership threshold
(currently $2,000 in shares or 1 percent of shares, whichever is lower)
and voting support thresholds to resubmit a proposal.
Ownership threshold: There was no ownership threshold (other than
ownership of at least one share of stock) until 1983, when the SEC
began requiring that the proponent(s) have held at least $1,000 in
shares continuously for at least 1 year. The SEC raised this threshold
to $2,000 in 1998, more or less in line with inflation in the
intervening period. The SEC's view in adopting a threshold was that
retail and other smaller investors should have access to use of
shareowner proposals, but with some minimal level of ownership.
In our view, shareowners of any size should have the opportunity to
use the shareowner proposal mechanism. Large institutional investors do
not have a monopoly on good ideas. New York City pension funds
supported about 77 percent of shareowner proposals in 2018, many from
smaller investors including retail shareowners.
Section 844 of the Financial Choice Act, approved by the U.S. House
of Representatives in 2017, includes a provision that would
dramatically increase the ownership threshold, and require investors to
have held a minimum of 1 percent of an issuer's voting securities for
at least 3 years. If this had applied in the past, it would have
eliminated all or nearly all shareowner proposals that have ever been
submitted. For example, despite being among the largest pension
investors in the world, NYC Funds rarely hold more than 0.5 percent of
any individual company, and most often hold less. As a result, the
Choice Act would effectively prevent our funds entirely from
participating in the shareowner proposal process. To submit a
shareowner proposal today at Microsoft or Apple, given share prices at
the end of November, would have required ownership of at least $85
billion in shares at each company, far more than the $1.6 to $2.2
billion we currently have invested in each of these two companies.
Keith Higgins, the former director of Corporation Finance at the
SEC, said in 2018: ``How do you ever determine the `right' level of
ownership that should trigger the right to cause the company to include
a shareowner proposal in its proxy statement? $2,000 seems low--but
what is a better number? A February memo from the House Financial
Services Committee suggested modernizing the threshold for inflation,
but that is unlikely to have any meaningful impact.'' (An adjustment
for inflation would put the threshold at about $3,000 in 2018 dollars.)
Resubmission thresholds: In 1948, the SEC first set a resubmission
threshold, providing that a proposal that failed to earn at least 3
percent support in a year could be excluded from company proxy
materials the next year. In 1954, the SEC set the current rule,
providing for exclusion if a proposal did not earn at least 3 percent
support the first year it is voted on, 6 percent the second year and 10
percent the third and subsequent attempts within 5 years. Attempts to
raise the thresholds modestly in 1983 and drastically in 1997 failed,
in 1997 because of overwhelming investor opposition that led the SEC to
conclude that higher thresholds just did not make sense.
There is good reason for keeping resubmission thresholds relatively
low. It can take many years, and different approaches and iterations,
to build investor support for a shareowner proposal. The proposal for a
sexual orientation nondiscrimination policy at Cracker Barrel received
only 14 percent of the vote when it was first on the ballot in 1993.
Similar proposals received less than 10 percent of the vote into the
early 2000s, but by 2011, the NYC Funds received a 62 percent majority
vote on such a proposal at KBR. Similarly, proposals for annual
election of all directors, increased board diversity, and better
disclosure on environmental impacts and risks all started out with
limited support that grew substantially over the years.
Moreover, a proposal with limited support in a given year can
become highly important if circumstances change. In 2007, a nonbinding
shareowner proposal for an independent chair at Bank of America won
only 16 percent support. Two years later, an unusual binding proposal
for an independent chair was approved by Bank of America shareowners,
after the company's share price had declined more than 90 percent in a
short period of time during the financial crisis. That proposal became
a key element in expression of shareowner views on changing leadership
at the bank, without the necessity or disruption of a hedge fund
activist campaign to elect a new board majority. While not diminishing
regulatory influence in improving Bank of America governance, I would
argue that that successful shareowner
proposal, which received such limited support 2 years earlier, was
critical in
evolutionary change that built a much better, more stable bank that was
responsive to shareowners as well as regulators.
To highlight another concern, the SEC resubmission rule applies
broadly to proposals ``on the same subject matter.'' A proxy access
proposal at Netflix received support from 4.4 percent of the vote in
2013. From 2015 to 2018, Netflix shareowners annually approved a
different NYC Funds' proxy access proposal--advocating different
eligibility requirements--that would have been excluded if thresholds
had been raised. And recently, we have seen efforts to pre-empt
proposals in a given year urging stronger policies on climate change by
a group submitting a proposal to go in the opposite direction. With
high resubmission thresholds, that kind of mischief-making would be
encouraged on a broader scale as long as the SEC policy refers to ``the
same subject matter'' rather than ``the same proposal.''
The Netflix case points to another concern: the playing field is
tilted in favor of management when shareowners propose change. The fact
that Netflix has refused to implement multiple shareowner proposals
receiving majority votes, and challenges to shareowners in submitting
binding proposals of the sort used at Bank of America in 2009, shows
this is not an even playing field, as does the fact a company is
unlimited in the length it can use to oppose a proposal, while the
shareowner proponent is limited to 500 words; corporate management can
call on company resources to hire counsel to pursue no-action requests,
while the proponent engages in that debate at her own cost; and
management has access to preliminary voting tallies, which can help
management organize its effort when there is a close vote, while the
shareowner proponent now has access to such tallies only with
permission of management.
Finally, we need to recognize that a significant subset of U.S.
companies provide insiders with special voting rights that make the
current resubmission thresholds effectively quite high, as they are
based on ``votes'' and not ``shares.'' At Facebook this year, a
shareowner proposal requesting that the board establish a risk
oversight committee received support from 11.6 percent of votes, but
that appears to represent 34.2 percent of shares held in the publicly
traded share class (that is, setting aside the super-voting shares with
10 votes per share held almost completely by insiders). Another
proposal requested a report to shareowners on management of risks posed
by content management policies (including election interference, fake
news, hate speech, sexual harassment and violence) to the company's
finances, operations and reputation. That proposal was supported by
10.2 percent of votes, but apparently our votes were among the 30.0
percent of shares held in the publicly traded share class that voted
for the proposal.
While Facebook minimized the need to improve risk management,
others would point to the substantial loss of shareowner value since
the company's 2018 annual meeting as validating the concerns of a
significant portion of outside shareowners. It would be unfortunate if
resubmission thresholds ruled shareowner proposals on risk management
at Facebook out of bounds for the next several years.
Retail shareowner participation
All shareowners regardless of their ownership stake, should have
the opportunity to fully exercise the rights of share ownership,
casting proxy votes consistent with their investment preferences and
objectives, and submitting shareowner proposals.
Retail shareowner participation in proxy voting has fallen in
recent years. According to Broadridge, retail voting participation
averaged 28.4 percent for the 10 years ending June 30, 2017, compared
to over 90 percent for institutional shareowners. While encouraging
retail shareowner participation is commendable, it may be that some
retail shareowners prefer to abstain from voting so that they can defer
to the corporate governance expertise of institutional investors who
have a fiduciary duty to vote. One trend is apparent from the data. The
recent decline in retail voter participation is directly correlated to
companies choosing to eliminate paper mailings of proxy materials as a
cost savings measure. Retail shareowners are twice as likely to vote
when they receive paper proxy materials relative to e-delivery or
notice and access mailings, illustrating that technology-based
solutions can have unintended consequences . For this reason, the
electronic delivery of proxy materials should be opt-in, not opt-out.
We should encourage efforts like CorpGov.net, FundVotes, and Stake
PBC that in various ways seek to foster retail voting and participation
in the shareowner proposal process. Some other proposals on the table,
such as client directed voting, whereby a shareowner could choose to
automatically vote with management, are potentially problematic. Such a
system would only be democratic if retail shareowners are given a
genuine choice in who would cast their votes.
Absent genuine choice, client-directed voting would simply be a
form of ``robo-voting'' for management. It is curious that some of the
same groups who are advocating for client-directed voting are sounding
alarms that some institutional investors may follow vote
recommendations from independent, expert proxy advisors.
Conclusion
In summary, I would argue that the rights of investors to vote
proxies, consistent with our investment objectives and preferences as
informed by the advice of our expert advisers, and to constructively
engage our portfolio companies using shareowner proposals are the kind
of system of property rights that Nobel Prize winning economist Milton
Friedman argued are fundamental to the efficient functioning of a
Capitalist economy. Friedman also argued that the proper role of
Government should be to protect and enforce property rights. We oppose
any SEC actions that would infringe on these fundamental investor
rights, which in their present form have served investors and market
participants well.
Thank you again for the opportunity to testify today. I commend the
Committee for holding this hearing and welcome your questions.
______
PREPARED STATEMENT OF THOMAS QUAADMAN
Executive Vice President, Center for Capital Markets Competitiveness,
U.S. Chamber of Commerce
December 6, 2018
The U.S. Chamber of Commerce is the world's largest business
federation, representing the interests of more than three
million businesses of all sizes, sectors, and regions, as well
as State and local chambers and industry associations. The
Chamber is dedicated to promoting, protecting, and defending
America's free enterprise system.
More than 96 percent of Chamber member companies have fewer
than 100 employees, and many of the Nation's largest companies
are also active members. We are therefore cognizant not only of
the challenges facing smaller businesses, but also those facing
the business community at large.
Besides representing a cross-section of the American business
community with respect to the number of employees, major
classifications of American business--e.g., manufacturing,
retailing, services, construction, wholesalers, and finance--
are represented. The Chamber has membership in all 50 States.
The Chamber's international reach is substantial as well. We
believe that global interdependence provides opportunities, not
threats. In addition to the American Chambers of Commerce
abroad, an increasing number of our members engage in the
export and import of both goods and services and have ongoing
investment activities. The Chamber favors strengthened
international competitiveness and opposes artificial U.S. and
foreign barriers to international business.
______
Chairman Crapo, Ranking Member Brown, and Members of the Committee
on Banking, Housing and Urban Affairs: my name is Tom Quaadman,
Executive Vice President of the Center for Capital Markets
Competitiveness (``CCMC'') at the U.S. Chamber of Commerce
(``Chamber''). Thank you for the opportunity to testify today regarding
the rules governing the U.S. proxy system and potential regulatory
changes that we believe must be implemented to modernize our capital
markets.
Over the past several years, the Chamber has put forward a number
of reports and recommendations to improve corporate governance in the
United States and to make the public company model more attractive to
growing businesses. These reports have included:
2013: Best Practices and Core Principles for the
Development, Dispensation, and Receipt of Proxy Advice, a
report that helped kick-start an important debate over the
broken proxy advisory system in the United States;
2014: Corporate Disclosure Effectiveness: Ensuring a
Balanced System that Informs and Protects Investors and
Facilitates Capital Formation, a report that included two dozen
specific recommendations to modernize the SEC's disclosure
regime;
2017: Essential Information: Modernizing Our Corporate
Disclosure System, which emphasized the importance of the
longstanding ``materiality'' standard for corporate disclosure;
and
2017: Shareholder Proposal Reform: The Need to Protect
Investors and Promote the Long-Term Value of Public Companies,
which outlined seven recommendations on how to fix the outdated
shareholder proposal system under Rule 14a-8 of the Securities
Exchange Act.
Earlier this year, the Chamber--along with seven other
organizations--issued a report entitled Expanding the On-Ramp:
Recommendations to Help More Companies Go and Stay Public, which
included 22 recommendations that would expand upon the success of the
2012 Jumpstart our Business Startups (JOBS) Act. Many of these
recommendations have also been incorporated into the JOBS And Investor
Confidence Act, legislation that the Chamber strongly supports and
which passed the House of Representatives in July by an overwhelming
vote of 406-4.
The Chamber also appreciated the opportunity to participate in the
recent Securities and Exchange Commission (``SEC'' or ``Commission'')
roundtable on the proxy process, which we believe was an important step
toward reform. In advance of that roundtable, the Chamber offered the
following reform recommendations to the SEC:
Proxy Advisory Firms
1) The SEC should take steps to ensure that the guidance laid out in
Staff Legal Bulletin 20 results in appropriate changes to
compliance systems for proxy advisory firms and investment
advisers, particularly in light of the recent withdrawal of the
2004 Egan-Jones and ISS no-action letters;
2) The SEC should enhance the conditions that a proxy advisory firm
must satisfy to be exempt from the disclosure and filing
requirements that apply to proxy solicitations;
Shareholder Proposals
3) The resubmission thresholds under Rule 14a-8 should be raised so
that proponents must receive a meaningful level of support
before resubmitting proposals that are overwhelmingly unpopular
with investors;
4) The SEC should withdraw Staff Legal Bulletin 14H (CF) issued in
October 2015;
5) Shareholder proposal proponents should be required to provide
sufficient disclosure regarding their economic interests and
objectives for any company in which they submit a proposal;
Universal Proxy
6) The SEC should abandon efforts to mandate the use of universal
proxy cards during proxy contests; and
Retail Investor Participation
7) Initiatives to increase retail investor participation in the
proxy process--such as client directed voting (``CDV'')--should
be pursued.
Discussion
The Chamber has long advocated for policies that promote effective
communication between public companies and their shareholders. Strong
corporate governance is critical to promote the long-term performance
of public companies and to enhance shareholder value.
Over the past 15 years, significant progress has been made to
improve corporate governance and transparency. There has been a marked
increase in the level and quality of communication amongst boards,
management, and investors, and many asset managers have taken steps to
enhance their due diligence regarding proxy voting.
However, a number of negative developments have also occurred
during this time. Public companies and their shareholders are
increasingly targeted through the proxy system and other means over
issues that are unrelated to--and sometimes, even at odds with--
enhancing long-term performance. Topics that should be reserved for the
legislative and executive branches of government--including a variety
of social and political issues that may not be directly correlated to
the success of the company--are increasingly finding their way into
proxy statements and being debated in boardrooms. This has created
significant costs for shareholders and in many instances has distracted
boards and management from focusing on the best interests of the
company.
As the Manhattan Institute has pointed out, labor-affiliated
pension plans have historically been the most active at advancing such
agendas that do not correlate with long-term performance. From 2006-
2015, labor-affiliated investors sponsored 32 percent of all
shareholder proposals at the Fortune 250, many of which deal
topics of a social or political nature.\1\ Both the Department of Labor
(DOL) Inspector General and the United States Court of Appeals for the
D.C. Circuit have expressed skepticism as to whether the shareholder
activism engaged in by labor-affiliated funds is actually connected to
increasing share value.\2\
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\1\ Manhattan Institute Proxy Monitor 2016 Report https://
www.manhattaninstitute.org/sites/default/files/pmr_2016.pdf.
\2\ E.g. Business Roundtable & Chamber of Commerce of the U.S. v.
SEC, 647 F. 3d 1144, 1152 (D.C. Cir. 2011); Department of Labor OIG
report ``Proxy Voting May Not Be Solely for the Economic Benefit of
Retirement Plans (March 31, 2011).
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The DOL took action this year in order to ensure that Employee
Retirement Income Security Act (ERISA) fiduciaries are making
investments based on economic factors and not elevating environmental,
social, or governance (ESG) impacts over returns. On April 23, 2018,
the DOL issued Field Assistance Bulletin No. 2018-01 to provide further
guidance on Interpretive Bulletins 2015-01 and 2016-01 relating to ESG
investments and proxy voting in ERISA plans.\3\ Specifically, FAB 2018-
01 reiterates that ``the Department has rejected a construction of
ERISA that would . . . permit plan fiduciaries to expend trust assets
to promote myriad public policy preferences. Rather, plan fiduciaries
may not increase expenses, sacrifice investment returns, or reduce the
security of plan benefits in order to promote collateral goals.'' This
is an important step in order to ensure that fiduciaries are making
investments in investors' best interests based on economic returns as
the primary consideration.
---------------------------------------------------------------------------
\3\ https://www.dol.gov/agencies/ebsa/employers-and-advisers/
guidance/field-assistance-bulletins/2018-01.
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FAB 2018-01 should also be viewed in the context of evidence that
has also been put forth regarding shareholder activism and its impact
on returns for public pension plans. A 2015 Manhattan Institute Report
found that the social activism engaged in by certain public pension
plan systems--such as the California Public Employee Retirement System
(CalPERS) and the New York State Common Retirement System (NYSCR)--is
actually correlated with lower returns for the plans.\4\ In other
words, public pension plan beneficiaries and taxpayers in such
jurisdictions are
actually harmed when the overseers of public pension plans emphasize
social or political goals over the economic return of the plan.
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\4\ Tracie Woidtke--Public Pension Fund Activism and Firm Value
(September 1, 2015).
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Outdated SEC proxy rules have allowed motivated special interests
to take advantage of this system to the detriment of Main Street
investors and pensioners. The problems we face today have in part
stemmed from a lack of proper oversight over proxy advisory firms and a
failure to modernize corporate disclosure requirements. Activists have
been able to hijack shareholder meetings with proposals concerning pet
issues--all to the detriment of the vast majority of America's
investors.
The deficiencies within the U.S. proxy system must also be viewed
against the backdrop of the sharp decline of public companies over the
past two decades. The United States is now home to roughly half the
number of public companies than existed in the mid-1990s and the
overall number of public listings is little changed from 1983. While
the JOBS Act helped arrest that decline, too many companies are
deciding that going or staying public is not in their long-term best
interest. There is little doubt that the current proxy system--which
disadvantages long-term investors and creates serious challenges for
companies--has made the public company model less attractive. With
fewer public companies come fewer investment opportunities for Main
Street investors and fewer growth opportunities for the U.S. economy.
The public company model has been a key source of strength and
growth which has made the United States economy the strongest and most
prosperous in world history. When businesses go public, jobs are
created and new centers of wealth are formed. During the 1980s and
1990s, stories of the Microsoft executive assistant or the UPS driver
becoming a millionaire were not uncommon after a company went through
the initial public offering (``IPO'') process. A 2012 study done by the
Kaufmann Foundation found that for the 2,766 companies that went
through the IPO process between 1996 and 2010, employment cumulatively
increased by 2.2 million jobs.\5\ Other benefits also accrue to
companies when they go public, such as revenue growth.
---------------------------------------------------------------------------
\5\ Post-IPO Employment and Revenue Growth for U.S. IPOs June 1996-
2010.
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Activist campaigns, as well as routine proxy matters that companies
deal with today, are also magnified by the outsized influence of proxy
advisory firms. Two firms--Institutional Shareholder Services (``ISS'')
and Glass Lewis--constitute roughly 97 percent of the proxy advisory
firm market, yet both are riddled with
conflicts of interest, operate with little transparency, and are prone
to making
significant errors in vote recommendations that jeopardize the ability
of investors to make informed decisions in their best interests.
In addition, the economic interests of proxy advisory firms is not
always aligned to ensure the firms are best equipped to research and
understand the conditions of the companies they are rating. These
factors combine to create an incentive system that does not prioritize
accurate recommendations or to provide accountability throughout the
rating process. The Chamber and many others have long called for
greater oversight of this industry in order to better protect investors
and maintain the competitiveness of our vibrant public markets.
These firms by some estimates can ``control'' up to 38 percent of
the shareholder vote because some of their clients van automatically
follow vote recommendations.\6\ And according to ISS, the firm covers
more than 20,000 companies around the globe, and executes 9.6 million
ballots representing over 3.7 trillion shares. Such an unfettered role
in the public capital markets demands an oversight function to ensure
that investor returns are always a top priority.
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\6\ ISS 24.7 percent Glass Lewis 12.9 percent Source: Ertimur,
Yicca, Ferri, Fabrizio, and Oesch. Shareholder Votes and Proxy
Advisors: Estimates from Say on Pay (February 25, 2013).
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The recent decision taken by the SEC staff to withdraw the 2004
Egan-Jones and ISS staff no-action letters (``2004 no-action letters'')
was an important step toward fixing a broken proxy advisory system.\7\
These letters allowed investment advisers to outsource their fiduciary
voting duties to proxy advisory firms, thus entrenching the position
and influence of the firms. The letters also allowed investment
advisers to rely on the general policies and procedures a proxy
advisory firm had related to its own conflicts, instead of requiring
the identification of specific conflicts related to a particular
company. The unintended consequence of these letters was to allow
conflicts of interest to proliferate in the proxy advisor system, and
to further bolster the role and influence of the two dominant firms.
---------------------------------------------------------------------------
\7\ Statement Regarding Staff Proxy Advisory Letters--Division of
Investment Management https://www.sec.gov/news/public-statement/
statement-regarding-staff-proxy-advisory-letters.
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With the 2004 no-action letters now withdrawn, the SEC should take
steps to ensure that the 2014 guidance laid out in Staff Legal Bulletin
20 \8\ (``SLB 20'') will actually result in appropriate changes to
compliance systems for proxy advisory firms and investment advisers.
The conditions that a proxy advisory firm must satisfy in order to be
exempt from the proxy solicitation rules should also be enhanced in
order to address many of the concerns that have been raised over the
years regarding proxy advisory firm recommendations and reports.
---------------------------------------------------------------------------
\8\ Proxy Voting: Proxy Voting Responsibilities of Investment
Advisers and Availability of Exemptions from the Proxy Rules for Proxy
Advisory Firms, June 30, 2014.
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In addition to addressing proxy advisory firms, the SEC should
implement reforms to the shareholder proposal process under Rule 14a-8
of the Exchange Act, and implement a Client Directed Voting (``CDV'')
framework that empowers retail shareholders by making it easier for
them to participate in the proxy process. We also believe that the SEC
should abandon its ill-advised 2016 proposal on universal proxy
ballots.
SEC Roundtable
The November 15th SEC roundtable examined all aspects of the U.S.
proxy system, including proxy voting and proxy ``plumbing'' issues, the
shareholder proposal system, and proxy advisory firms. While many
issues were laid on the table, we believe that the top priority for the
SEC should be reforming the proxy advisory system.
As the Chamber pointed out in our November comment letter (see
https://www.centerforcapitalmarkets.com/wp-content/uploads/2018/11/
11.12.18-Chamber-Proxy-Roundtable-Letter.pdf?) for the roundtable, we
have long been concerned about the concentration, conflicts of
interest, and lack of transparency in the proxy advisory system. ISS
and Glass Lewis also have a significant level of influence over the
manner in which public companies are operated. All of these factors
harm our capital markets, impair capital formation, and discourage
companies from going and staying public.
One key takeaway from the November 15th roundtable is that there is
no uniform, baseline set of regulations or even standards that apply to
proxy advisory firms. Just about every other market participant in the
proxy process--brokers, banks, transfer agents, asset managers, public
companies--are subjected to at least some type of regulatory oversight.
The lack of an oversight regime for proxy advisory firms stands in
stark contrast to past determinations made by the SEC and Congress
regarding the need to oversee and regulate the proxy process for public
companies.
The roundtable also reinforced that the two largest proxy advisory
firms view their roles and responsibilities very differently. ISS has
chosen to register under the Investment Advisers Act and holds itself
out as a fiduciary, stating that ``we have a fiduciary obligation to
our clients to provide advice that is in their best interest.''\9\
Glass Lewis, on the other hand, has chosen not to register at all with
the SEC and therefore presumably does not view itself as a fiduciary.
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\9\ ISS Comment Letter for November 15 Roundtable.
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Furthermore, ISS continues to operate a consulting business to
issuers in addition to its core institutional investor business. ISS
claims that such a business model is not a problem because of the way
it manages conflicts, and claims the existence of a ``firewall''
between the two divisions. Glass Lewis, meanwhile, stated in a recent
letter to Members of the Senate Banking Committee that ``unlike ISS,
Glass Lewis does not provide consulting services to issuers. We believe
the provision of consulting services creates a problematic conflict of
interest that goes against the very governance principles that proxy
advisors like ourselves advocate.''\10\ (Emphasis added).
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\10\ http://www.glasslewis.com/wp-content/uploads/2018/06/Glass-
Lewis-Response-to-May-9-2018-Chairman-Heller-Letter_0601_FINAL.pdf.
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We can think of no other area under the securities laws where two
dominant market participants in the same industry operate under two
completely different sets of rules and standards--with one of those
participants choosing not to register with the SEC at all. While
commenters will disagree as to the proper regulatory regime for proxy
advisors, we think there should be broad agreement that allowing proxy
advisory firms to choose their own regulatory model is not the right
approach. From the Chamber's viewpoint, we believe that the business
and regulatory models of both ISS and Glass Lewis are deficient, and
would advocate that the SEC or Congress adopt baseline standards for
proxy advisory firms to follow.
Congressional Action to Address Proxy Advisory Firms
In December 2017, the House of Representatives passed H.R. 4015,
the Corporate Governance Reform and Transparency Act, bipartisan
legislation which would
require proxy advisory firms to register with the SEC and become
subjected to a robust regulatory regime. The Chamber strongly supports
this legislation as we believe it will provide for much needed
transparency and oversight by requiring proxy advisory firms to
disclose conflicts of interest, grant companies sufficient time to
respond to voting recommendations, and require that firms demonstrate
their capabilities to provide fair and accurate voting recommendations.
The Chamber also appreciates the work of Sens. Reed, Perdue,
Tillis, Kennedy, Jones, and Heitkamp to introduce S. 3614, the
Corporate Governance Fairness Act. This legislation would require
certain proxy advisory firms to register under the Investment Advisers
Act, and directs the SEC to conduct periodic inspections of firms. The
SEC would also be required to submit a report every 5 years to the
Senate Banking and House Financial Services Committee that evaluates
the policies and procedures proxy advisory firms have to, amongst other
things, manage conflicts of interest and avoid making false statements
in vote recommendations. While the Chamber continues to evaluate this
legislation, we believe such a bipartisan effort in the Senate
demonstrates the broad belief that the status quo of the proxy advisory
firm industry must be changed.
Recommendations
Proxy Advisory Firms
In 2013, the Chamber released a report, Best Practices and Core
Principles for the Development, Dispensation, and Receipt of Proxy
Advice. (``Chamber principles'') The goal of this report was to improve
corporate governance by ensuring that proxy advisory firms:
Are free of conflicts of interest that could influence vote
recommendations;
Ensure that reports are factually correct and establish a
fair and reasonable process for correcting errors;
Produce vote recommendations and policy standards that are
supported by data driven procedures and methodologies that tie
recommendations to shareholder value;
Allow for a robust dialogue between proxy advisory firms
and stakeholders when developing policy standards and vote
recommendations;
Provide vote recommendations to reflect the individual
condition, status, and structure for each company and not
employ one-size-fits-all voting advice; and
Provide for communication with public companies to prevent
factual errors and better understand the facts surrounding the
financial condition and governance of a company.
With the issuance of these principles, the Chamber sought to foster
an environment where Government would encourage proxy advisory firms,
public companies, and investors to work together in order to create a
system of accountability and transparency that would build off other
positive developments in corporate governance that have occurred in
recent years. Importantly, since 2013 both Congress and the SEC have
become interested in reform--the House Capital Markets Subcommittee
held a hearing on the proxy advisory system in June 2013, and an SEC
roundtable on the topic was held later that year.
Staff Legal Bulletin 20--issued in June 2014--implemented several
concepts from the Chamber principles, and reaffirmed that enhancing
shareholder value must be the primary consideration for proxy advisory
firms when dispensing voting advice and for investment advisers when
making proxy voting decisions. The guidance also reinforces the fact
that the fiduciary duty of investment advisers permeates all aspects of
the development and receipt of proxy advice. This was a positive action
taken by the SEC that drew further attention to issues within the proxy
advisory firm system.
Regrettably, notwithstanding the issuance of SLB 20 and the
increased attention by the Chamber and others regarding the issues, it
has become clear that many longstanding problems still remain. As
mentioned previously, without proxy advisory firms having a fiduciary
duty or an economic interest to the companies they are rating, there is
very little incentive for these problems to resolve themselves given
the proxy advisory firms' for-profit business model. Since 2015, the
Chamber and NASDAQ have conducted an annual survey of public companies
to better understand the experience that issuers have with proxy
advisory firms during the proxy season. What these surveys have
consistently found is that while incremental progress has been made in
recent years, further action is necessary.
This year's survey (see https://www.centerforcapitalmarkets.com/
resource/2018-proxy-season-survey/)--which was completed by 165
companies of varying sizes and across several industries--found that a
lack of communication and concerns over the quality of vote
recommendations remain two significant problems.
For example, when companies requested the opportunity to meet with
a proxy advisory firm in order to discuss issues subject to shareholder
votes, that request was denied 57 percent of the time. Companies also
reported being given insufficient time to provide input both before and
after a firm's recommendations were finalized, a problem compounded by
``robo-voting'' practices that lead to the automatic casing of large
blocks of proxy votes in the immediate aftermath of the proxy advisory
firms' recommendations. Some companies reported that 10-15 percent of
their shares would automatically vote in line with an ISS
recommendation, while others estimated that between 25-30 percent fell
into that category. The amount of time granted to provide input ranged
from 30 minutes to 2 weeks, with 1-2 days being the most common
response. And only 39 percent of companies believe that proxy advisory
firms carefully researched and took into account all relevant aspects
of a particular issue for which it was providing a vote recommendation.
To help the Committee better understand some of the concerns over
the quality of proxy advisory firm vote recommendations, attached to
this testimony is a recent compilation of supplemental proxy filings
made by companies during the 2016, 2017, and 2018 proxy seasons
detailing issues they have run into with proxy advisory firms. The
issues outlined in these supplemental proxies include difficulty in
communicating with proxy advisory firms, issues with peer group
selection, and in some cases outright errors made on behalf of the
proxy advisory firms. It is also likely that these issues are only a
small cross-section of the systemic problems associated with proxy
advisory firms, as many companies likely do not file supplemental
proxies.
This is an error rate of approximately 2 to 2.5 percent. But the
error rate is much higher as many companies decide not to file a
supplemental proxy. Such an error rate based upon the fiduciary
responsibilities is not acceptable. Furthermore, an error rate of over
2 percent means that proxy advisory firms are failing to provide their
clients with the decision useful information that they need to make
proxy voting decisions. If the clients of advisory firms are not
getting decision useful information then they are not meeting their
fiduciary duty.
One of the complaints about process reforms is that it will impose
costs upon the clients of proxy advisory firms. We agree with those
concerns. However, an error rate of over 2 percent and failing to
provide investors with decision investor information also adversely
impacts return. Lower investor return will harm the retail clients of
institutional investors to the tune of billions of dollars dwarfing any
increased costs in process and regulatory compliance.
The Chamber also remains very concerned regarding the conflicts of
interest that pervade both ISS and Glass-Lewis which can improperly
influence voting
recommendations. ISS continues to operate a corporate consulting
business that
provides advice to companies as to how they can achieve better
corporate governance ratings. ISS's ownership of both a research
division and a consulting arm--accepting fees from both the
institutional investors who receive their proxy voting advice as well
as the companies that are the subject of that advice--has rightly been
a focal point of criticism over the conflicts inherent in this business
model.
While Glass Lewis does not operate a consulting division, its
ownership structure presents a different conflict of interest. Glass
Lewis is owned by activist institutional investors--the Ontario
Teachers' Pension Plan and the Alberta Investment Management
Corporation. The Chamber has in the past brought to the attention of
the SEC examples of how this ownership structure could result in
tainted vote recommendations.\11\
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\11\ See e.g., Letter of May 30, 2012, to SEC Chair Mary Schapiro
http://www.centerforcapitalmarkets.com/wp-content/uploads/2010/04/2012-
5.30-Glass-Lewis-letter-release.pdf.
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While the lack of action to address these issues directly led to
the congressional action referenced above, the SEC does not need to
wait on Congress to act. There are actions the SEC can take based on
its existing authority that would benefit investors by enhancing
transparency and accountability in the proxy advisory industry.
SLB 20
In response to criticisms of proxy advisory firms raised by market
participants, academics, Members of Congress, and others, SEC staff
issued SLB 20 in June 2014. This guidance provides public companies,
proxy advisory firms, and investment advisers with five principles to
adhere to:
Fiduciary duties permeate and govern all aspects of the
development, dispensation, and receipt of proxy advice;
Enhancing and promoting shareholder value must be the core
consideration in rendering proxy-voting advice as well as
making proxy voting decisions;
The proper role of proxy advisory firms is to provide
accurate and current information to assist those with voting
power to fulfill their fiduciary duty and further the economic
best interests of those who entrust their assets to portfolio
managers;
Clarifies the scope of portfolio managers' obligations to
exercise a vote on proxy issues, and it emphasizes the broad
discretion investment advisers have to refrain from voting on
every, or even any, proposal put before shareholders for a
vote; and
In light of the direction provided, proxy advisory firms,
portfolio managers, and public companies need to reassess their
current practices and procedures and adopt appropriate changes
necessitated by SLB 20.
There is an important nexus between the withdrawal of the 2004 no-
action letters and the fact that SLB 20 remains in effect. At its core,
SLB 20 emphasizes that, as a fiduciary, an investment adviser must
exercise proper oversight over a proxy advisory firm when the adviser
uses such firm's recommendations in deciding how to vote. This helps
ensure that the adviser is sufficiently confident in the soundness of a
recommendation that the adviser relies on when voting. The value of
oversight is heightened where so many concerns have been raised about
inaccurate information and conflicts of interest affecting proxy
advisory firm recommendations. Accordingly, the SEC should take steps,
such as Commission guidance, rulemaking, or a combination of the two,
that will ensure that the guidance laid out in Staff Legal Bulletin 20
results in appropriate changes to compliance systems for investment
advisers and, by extension, proxy advisory firms themselves.
Exemption from the Proxy Solicitation Rules
Under the Exchange Act, entities, including proxy advisory firms,
which engage in a proxy ``solicitation,'' are subject to various
disclosure and filing requirements in accordance with the SEC's proxy
rules. The SEC Divisions of Investment Management and Corporation
Finance have explained in SLB 20 that the Commission generally has
found that furnishing proxy voting advice, as a proxy advisory firm
does, constitutes a solicitation. However, a proxy advisory firm may be
able to rely on one or more exemptions to the proxy rule disclosure and
filing requirements if the firm meets certain conditions.
In light of the many legitimate concerns that have been raised over
the years about proxy advisory firm recommendations and reports, the
SEC should enhance the conditions that a proxy advisory firm must
satisfy to be exempt from the
disclosure and filing requirements that apply to solicitations. The
enhanced conditions would help ensure that a proxy advisory firm's
failure to comply with the proxy rule disclosure and filing
requirements does not unduly compromise the goals of transparency.
Specifically, to get the benefit of an exemption, a proxy advisory
firm, should, at a minimum, have to:
ensure that any recommendation that the firm makes is not
based on materially inaccurate information or unsubstantiated
assumptions, by requiring that the proxy advisor:
identify any information the firm is using in the
analysis which is contested by the issuer or differs from the
information disclosed by the issuer; and
include a written justification for why the issuer's
disclosed information was not used
adequately disclose and otherwise manage any conflicts of
interest;
provide an issuer with adequate time to meaningfully review
a recommendation and, relatedly, the proxy advisory firm must
accept engagement requests by the issuer before publishing a
recommendation and require that the proxy advisory firm
disclose the nature of the engagement;
not proceed with any automatic voting of client proxies if
a company contests an adviser's recommendation so that the
client has an opportunity to review both the adviser's
explanation and any additional information the company may
choose to provide and can make its own fully formed voting
decision;
explain in sufficient detail the proxy advisory firm's
methodologies and how the proxy advisory firm has adhered to or
deviated from such methodologies in determining each
recommendation as to an issuer, including the extent to which
the firm has relied on the recommendations, analysis, or
rankings of any third party and, if so, which ones;
explain in sufficient detail the reason for the proxy
advisory firm's peer group selection(s) if it has chosen to
construct its own peer group in lieu of the issuer's, including
a detailed description of the impact of the proxy firm's
decision to change an issuer's peer group and how the analysis
or resulting recommendation of an issuer's executive
compensation program would have differed had the issuer's own
peer group been used; and
explain in sufficient detail why the proxy advisory firm
has determined that any one-size-fits-all recommendations are
appropriate given the particular facts and circumstances of the
issuer and how the analysis or resulting recommendation would
have differed had the issuer's own disclosed performance
measures been utilized.
Shareholder Proposals
The current rules governing shareholder proposals are administered
by the SEC under Rule 14a-8 of the Securities Exchange Act. For
decades, the basic purpose of the shareholder proposal system was to
allow investors to put forth constructive ideas on how to improve a
company's governance and performance. The SEC often rightly took the
position that proposals dealing with personal grievances, or those of a
social or political nature, were not proper subjects to be considered
or debated at annual meetings, largely because such proposals sought to
advance idiosyncratic objectives rather than enhance the long-term
performance of the company.
Unfortunately, the shareholder proposal system today has become
dominated by a minority of special interests that exploit an outdated
system in order to advance parochial agendas. According to the
Manhattan Institute's Proxy Monitor report, 56 percent of shareholder
proposals at Fortune 250 companies during the 2017 proxy season dealt
with social or policy concerns.\12\ And a small group of activists is
responsible for a significant proportion of all shareholder proposals,
a vast majority of which relate to governance matters--in fact, during
2017, just three individuals and their family members sponsored 25
percent of proposals submitted at the Fortune 250.\13\
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\12\ Proxy Monitor 2017: Season Review, available at https://
www.manhattan-institute.org/html/proxy-monitor-2017-season-review-
10757.html.
\13\ Id.
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In July 2017, the Chamber released a report, Shareholder Proposal
Reform: The Need to Protect Investors and Promote the Long-Term Value
of Public Companies, which outlined seven recommendations for how to
improve Rule 14a-8. The most impactful of these recommendations would
be to raise the ``resubmission thresholds'' which determine when a
proponent is allowed to resubmit a proposal which previously garnered
low support. In 2014, the Chamber along with eight other organizations
also submitted a rulemaking petition calling on the SEC to raise the
resubmission thresholds under Rule 14a-8.\14\
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\14\ Petition for Rulemaking Regarding Resubmission of Shareholder
Proposals Failing to Elicit Meaningful Shareholder Support (April 9,
2014) Petition submitted by U.S. Chamber of Commerce, National
Association of Corporate Directors, National Black Chamber of Commerce,
American Petroleum Institute, American Insurance Association, The
Latino Coalition, Financial Services Roundtable, Center on Executive
Compensation, and Financial Services Forum.
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Current rules allow a company to exclude a shareholder proposal if
it failed to receive the support of:
Less than 3 percent support on the previous submission if
voted on once within the previous 5 years;
Less than 6 percent support on the previous submission if
voted on twice within the previous 5 years;
Less than 10 percent support on the previous submission if
voted on three or more times within the previous 5 years.
Thus, a proponent can keep resubmitting a proposal even if nearly
90 percent of shareholders have rejected it on multiple occasions. Such
a system forces the vast majority of investors--who are primarily
concerned about the economic return of their investments--to bear the
costs of having to deal with frivolous proposals year after year. It
also creates significant distractions for the board and management of a
company, which should focused on long-term performance.
We believe that, at a minimum, the SEC should raise the
resubmission thresholds to levels that were first proposed by the
Commission in 1997.\15\ That proposal would have raised the
resubmission thresholds from the current 3-percent-6-percent-10-percent
system to a more reasonable 6-percent-15-percent-30-percent. Raising
the thresholds would still allow retail and others shareholders to
submit a proposal and have their voice heard, but would require that
they receive a reasonable level of support before submitting it again
in a subsequent year.
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\15\ Proposed Rule: Amendments to Rules on Shareholder Proposals
Release No. 34-39093 Sep 19, 1997.
---------------------------------------------------------------------------
To help the SEC better understand the need to raise the
resubmission thresholds, in October 2018 the Chamber released a report
(https://www.center-
forcapitalmarkets.com/wp-content/uploads/2018/10/CCMC_ZombieProposal_
Digital.pdf) on ``zombie'' shareholder proposals. A zombie proposal is
defined as one which has been submitted at a company three or more
times but has failed to receive majority support. The Chamber report
highlights a recent thought leadership piece that examined 2,449
shareholder proposals submitted from 2001 to 2018 relating to special
meetings, environmental and social, political and social, and human
rights matters. According to this analysis:
Only 5 percent of these types of proposals passed;
Zombie proposals made up 32 percent of all failed
proposals; and
Out of the 2,449 total proposals examined, 723 were zombie
proposals--almost a full 30 percent.
Importantly, had the SEC implemented a new threshold rule of 6
percent-15 percent-30 percent prior to the period examined, only 27
percent of zombies would have been eligible for a fourth year on
company ballots. In other words, more reasonable thresholds would in
many cases have protected shareholders and companies from the costs and
distraction associated with having to register their opposition on
multiple occasions.
In addition to raising the resubmission thresholds, two important
reforms to Rule 14a-8 are necessary: The SEC should withdraw Staff
Legal Bulletin 14H and require shareholder proponents to provide
sufficient disclosure regarding their economic interests and
objectives.
Staff Legal Bulletin 14H was issued in the wake of a January 2015
decision to suddenly reverse a previous SEC staff decision regarding a
shareholder proposal at Whole Foods. This bulletin ultimately limited
the ability of companies to use an exemption under Rule 14a-8(i)(9)
which allows for the exclusion of a proposal if it conflicts with one
of the company's own proposals and has added a great deal of
uncertainty to the no-action process. Although it significantly altered
the utility of an exemption recognized by Rule 14a-8, Staff Legal
Bulletin 14H was never considered or approved by the full Commission.
The SEC should also take steps to ensure transparency regarding the
proponents of shareholder proposals. There is currently a gap between
the information a company must provide to investors in its proxy
statement and the information--or lack of information--that is provided
by many shareholder proponents. This gap is particularly pronounced
when proposals are submitted via proxy in whom the proponent nominally
represents the true beneficial owner of the shares, yet owns no shares
of its own. To level this playing field and protect investors,
proponents should--at a minimum--be required to disclose:
Personal information such as name and address;
The number of shares that the proponent owns or has a right
to acquire, as well as why the proponent acquired the shares
and the objectives the proponent has with respect to the
issuer;
A description of any contracts or arrangements the
proponent has with another person to provide any type of
benefit in relation to the submission of the proposal;
Whether the person has submitted the same or a
substantially similar proposal to another issuer and the
identity of such issuer(s);
In cases where the person submitting the proposal is acting
as a proxy or representative on behalf of someone else, the
beneficial owner of the shares should be required to make
similar disclosures; and
The SEC should define what it means to ``own'' shares in
the context of eligibility for submitting a proposal; this
would help ensure that a proponent has an economic interest in
the company.
We believe these are modest reforms to Rule 14a-8 that would
protect against abuse of the system while still preserving the ability
of retail investors to have their voice heard in corporate matters.
Retail investors would retain the ability to bring forward a proposal
at a company--or multiple companies if they feel it involves a
pervasive issue--but would have to comply with basic transparency
requirements and demonstrate that their idea can elicit a meaningful
level of support.
Universal Proxy
In October 2016, the SEC proposed a rule that would mandate the use
of a universal proxy ballot in contested director elections.\16\ The
proposal would ostensibly level the playing field for shareholders that
do not attend a company's annual meeting. In reality, the mandated use
of universal proxies would increase the frequency and ease of proxy
fights for dissident shareholders and empower special interests at the
expense of Main Street investors.
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\16\ Proposed Rule: Universal Proxy Release No. 34-79164; IC-32339,
October 26, 2016.
---------------------------------------------------------------------------
For decades, SEC rules have allowed a shareholder who is willing to
commit the necessary resources to conduct a proxy contest to seek a
change in board composition. If such a shareholder is able to nominate
credible, qualified candidates that gain the support of other
investors, the shareholder is sometimes able to alter the composition
of the board. If shareholders wish to split their votes among a
company's nominees and a dissident's nominees, they are able to attend
the annual shareholder meeting in order to cast a vote. This
longstanding system of voting for public company directors is well-
understood by the market and has been the foundation for numerous
orderly director elections over the years.
The mandated use of a universal proxy ballot would encourage proxy
fights by either individual or small groups of shareholders who do not
owe the same fiduciary duty to shareholders as the board of directors
and management do. Such dissident shareholders are not bound by the
company's corporate governance policies and may seek to nominate
directors to advance their own parochial interests without regard to
the broader best interests of the company and its shareholders as a
whole. Following this reasoning, in rejecting Rule 14a-11 (the SEC's
mandatory proxy access rule), the D.C. Circuit cited the SEC's failure
to assess the risk of giving special interest groups new powers to
pursue self-interested objectives rather than the goal of maximizing
shareholder value.\17\
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\17\ See Business Roundtable v. SEC, 647 F.3d 1144, 1152 (D.C. Cir
2011).
---------------------------------------------------------------------------
In addition to these fundamental flaws of a mandated universal
proxy ballot, the Commission's proposing release contained some
provisions that would further tilt the balance in favor of special
interests. For example, dissident shareholders would be permitted to
send proxy statements to shareholders representing only a majority of
the voting power of shares entitled to vote in an election. Because the
proposed rules would not require an insurgent to solicit all
shareholders, it stands to reason that retail investors would be
ignored, and the only investors solicited would be ones most likely to
favor the dissident slate. A dissident could even satisfy this
requirement by soliciting only a handful of a company's largest
institutional investors. Such an outcome would be detrimental to the
interests of investors as a whole, and particularly to retail investors
who would be left without a voice.
To be clear, we do not object if private ordering leads individual
companies voluntarily to elect to use a universal proxy card. Our
objection is only to an SEC mandate on the subject. As such, we believe
the SEC should abandon the universal proxy ballot rulemaking in its
entirety, and instead focus on other areas of reform for the U.S. proxy
system, which could be much more impactful in advancing the mission of
the SEC.
Increasing Retail Investor Participation--Client Directed Voting
As the Commission noted in its announcement for the roundtable,
retail investors have in recent years had very low participation rates
in the proxy process relative to institutions, with 29 percent of
retail shareholders voting their shares in 2018 (compared to 91 percent
of institutional investors voting their shares). The Chamber has long
been concerned that the failure to empower retail investors in the
proxy process creates unequal classes of investors with differing
abilities to provide input to public companies.
We continue to support implementation of the Client Directed Voting
model (``CDV'') as a means to boost retail investor participation. CDV
involves a process by which a retail shareholder can provide advance
voting instructions to an entity authorized to vote his or her shares,
while retaining the ability to change voting instructions in the
future. Adoption of the CDV model would provide an alternative to
examining every individual proxy issue, and instead allow retail
investors to establish standing instructions on proxy voting that are
in line with their investment philosophy and strategy. Furthermore,
advances in technology since CDV was last considered could likely
alleviate some of the concerns originally raised, which the SEC is well
suited to consider.
Allowing the use of a CDV model would give retail shareholders
access to the same mechanisms used by many institutional shareholders
who regularly provide standing proxy voting instructions. This
innovative change could allow for greater retail involvement in the
proxy process and create a more level playing field for all investors.
Conclusion
We appreciate the good work of the Senate Banking Committee in
finding ways to improve the competitiveness of our Nation's capital
markets. Reform of the U.S. proxy rules is a critical piece of
encourage more companies to go and stay public, and we look forward to
working with all Members of Congress and the SEC in order to modernize
an outdated system.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER FROM DANIEL M.
GALLAGHER
I am happy to provide the following written answers to the
additional questions submitted by Senator Warner. As requested
by Chairman Crapo in his letter of January 3, 2019, I have
repeated below each of Senator Warner's four questions,
followed in each case by my answer.
As was the case with my testimony, the answers below are
given in my personal capacity, including as a former
Commissioner of the Securities and Exchange Commission. I do
not speak for any employers or other associates, either past or
present.
Q.1. This hearing is about the proxy process, which is a key
way shareholders communicate their views on important issues to
boards and companies. But it is not the only way that
shareholders engage in a dialogue with boards and management.
Q.1.a. Can you describe what informal communication occurs
between shareholders or a particular shareholder and the board
or management?
A.1.a. Informal communications between shareholders and the
directors and management of the companies in which they invest
can occur throughout the year, often via email or phone calls
or at investor conferences or individual investor meetings.
Q.1.b. What topics are frequently discussed, and who is
involved in those conversations?
A.1.b. While the topics vary, common ones include corporate
strategy, corporate governance and executive compensation. The
participants from the company vary depending on the topic but
often include a member of the company's investor relations team
and other members of management. Some conversations may also
include one or more directors, including the chairman of the
board, the lead independent director or the chair of a relevant
board committee. I believe portfolio managers and/or members of
a shareholder's governance team (depending on the size and
structure of the shareholder) typically represent the
shareholder at those conversations.
Q.1.c. Do those communications sometimes lead to policy or
other changes at corporations?
A.1.c. Yes. Various companies have amended their governance
rules and documents, acted on recommendations about new
director nominations, revised their executive compensation
programs and enhanced their public disclosures, among other
changes, as a result of such communications.
Q.2. There are two main proxy advisory firms. What are the
barriers to entry in this space that prevent more competition?
A.2. Many institutional investors and pension funds have such
large portfolios that smaller proxy advisory firms--whose
coverage is more limited than that of the two main proxy
advisory firms--simply are not able to provide the scope and
breadth of coverage and services to those investors that the
two main proxy advisory firms can. In other words, costs and
limited resources prevent many smaller proxy advisory firms
from being able to enter the market and scale their business
offerings sufficiently to attract business from institutional
investors.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER FROM MICHAEL
GARLAND
Q.1.a. Can you describe what informal communication occurs
between shareholders or a particular shareholder and the board
or management?
A.1.a. There is a certain degree of formality involved in most
substantive communications between shareholders and a company,
regardless of whether the dialogue is initiated by the company
or its shareholders.
Shareholders generally initiate discussions by sending a
letter or submitting a shareholder proposal.
Separate from these more formal meetings and discussions,
there is very little informal communication. Informal
communication often occurs at investor conferences (some larger
companies with the capacity make an effort to participate in
events) and via phone or email, and may relate to a particular
shareholder question on something in the company's proxy
statement.
Q.1.b. What topics are frequently discussed, and who is
involved in those conversations?
A.1.b. Company-initiated discussions often occur in advance of
the company's annual meeting and revolve around the various
proposals subject to a shareholder vote at the annual meeting.
Many companies will initiate discussions with shareholders
following a negative voting recommendation from the proxy
advisors, often on management's say-on-pay proposal. Some
companies may also convene off-season discussions to hear
shareholder feedback on the company's disclosures, corporate
governance practices and policies and executive compensation.
Common topics of discussion include the company's corporate
governance policies and practices, including the structure of
the board and the independence of its leadership, as well as
executive compensation.
Shareholders often initiate engagements to gain a better
understanding of how the company is addressing a particular
risk, and whether and how the board is involved, or to advocate
for a particular corporate governance policy or practice, or
for enhanced disclosure.
Typical management participants include the Corporate
Secretary, Investor Relations and representatives with subject
matter expertise relevant to the shareholder's request or
concern, which could include someone from human resources to
discuss employment practices or executive compensation, or
someone involved in the company's sustainability program to
review environmental or supply chain risks and responses. It is
often helpful to have the participation of the Corporate
Secretary given their knowledge of, and access to, the Board of
Directors, whose approval of the request policy may be
required.
Corporate directors sometimes participate in discussions,
often in response to a specific request from shareholders, and
their participation is valued by investors. Directors can
provide shareholders with a window into how the board thinks
about and oversees a particular risk or practice, and
shareholders welcome the opportunity to make their case for
particular reforms directly to the directors, whose support and
approval is required, including for new shareholder rights or
company disclosures, that might be opposed by management. Some
topics are most appropriately discussed with independent
directors, rather than executives who may be accountable to the
CEO; these topics include the CEO's compensation and the
leadership of the board in instances where the CEO also serves
as board chairman.
Q.1.c. Do those communications sometimes lead to policy or
other changes at corporations?
A.1.c. Yes. While some shareholders may engage mainly for
informational purposes, the engagements initiated by the New
York City Comptroller and pension funds are most often to
advocate for a particular policy or practice, often
successfully. During 2018, companies responded to our
engagements by amending their bylaws to give shareholders the
right to nominate directors using the company's proxy statement
(``proxy access''), strengthening their executive compensation
clawback policies, and disclosing data on the race and gender
of their workforce, and whether they have a gender pay gap.
Most of these successful engagements were initiated with a
shareholder proposal. In our experience, shareholder proposals
are far more likely to result in policy changes than
engagements initiated in other ways.
Q.2. There are two main proxy advisory firms. What are the
barriers to entry in this space that prevent more competition?
A.2. I believe the primary barriers to entry are the required
economies of scale due mainly to the global nature of the
portfolios of large institutional investors, such as leading
asset owners like the New York City Pension Funds and leading
asset managers, who are the primary clients of the proxy
advisors. Given the paucity of competitors and new entrants, I
suspect that proxy advisory services are a low margin business.
As I stated in my written testimony, the New York City
Pension Funds use both of the main proxy advisors, ISS and
Glass Lewis. Our decision to add a redundant advisory service
followed (1) the enactment of the Dodd-Frank Act of 2010, which
mandated advisory vote on executive compensation at U.S.
companies, and (2) certain concurrent changes to our proxy
voting guidelines governing how we vote on individual director
candidates. Given the complexity of executive compensation and
the importance we attach to director elections, it is valuable
to have multiple research sources to enable us to apply our
proxy voting guidelines on executive compensation and director
elections.
While we would welcome the addition of qualified new
vendors to the market, such vendors would need to meet our
needs including providing sufficient coverage for our global
portfolio. For the year ending June 30, 2018, our office cast
71,000 individual ballots at 7,000 shareowner meetings in 84
markets around the world, each market with its own language,
governance norms and matters subject to shareowner voting. It
is therefore essential that our proxy advisors have local
market expertise. While smaller, market-specific vendors could
team up, either through partnerships or more formally through
mergers and acquisitions, to meet investors' global voting
needs, this can create particular challenges for investors like
us, who value receiving research reports in a standardized
format that enables our voting staff to quickly and easily
locate the information and metrics we need to apply our voting
guidelines.
I believe the inability to provide global coverage was
among the leading obstacles to the growth and success of Proxy
Governance, a new proxy advisory service established in 2004
with the explicit support of the then-chairman of the Business
Roundtable, which was then and now among the leading critics of
ISS and Glass Lewis. In a 2004 memo to BRT members, then-
chairman Henry McKinnell reportedly called on BRT members to
help Proxy Governance ``thrive in the marketplace'' by using
its services. Significantly, the BRT was reportedly Proxy
Governance's first subscriber, buying about 160 subscriptions
to its service for its members (see Morgenson, Gretchen,
``Pfizer and the Proxy Adviser,'' New York Times, April 21,
2006, a copy of which is enclosed).
According to the enclosed New York Times column, Proxy
Governance described itself ``as a new breed of advisory
service, providing advice that is ``completely free of conflict
and ``with the goal of truly building long-term shareholder
value, a formulation that appears to speak to the BRT's long-
standing critique of ISS and Glass Lewis.
In addition to its inability to provide clients with a
consistent global product, I understand that Proxy Governance's
initial practice of sharing advance copies of its research
reports to issuers was a source of concern to potential
investor clients, who were apparently concerned about potential
conflicts of interest or delayed receipt of research.
In light of the continuing attacks on the proxy advisors by
the U.S. Chamber of Commerce and the BRT, encourage the
Committee to examine the history and experience of Proxy
Governance. I have attached an April 2006 column, entitled
``Pfizer and the Proxy Adviser,'' by Gretchen Morgenson of the
New York Times, that describes Proxy Governance's history and
perceived conflicts of interest, which I would like included
for the record with my testimony and written responses to the
Committee's follow-up questions.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER FROM THOMAS
QUAADMAN
This hearing is about the proxy process, which is a key way
shareholders communicate their views on important issues to
boards and companies. But it is not the only way that
shareholders engage in a dialogue with boards and management.
Q.1.a. Can you describe what informal communication occurs
between shareholders or a particular shareholder and the board
or management?
A.1.a. The Chamber has long supported effective and ongoing
communication between shareholders, boards, and management.
Over the last 15 years, we have observed a marked increase in
both the level and quality of communication that occurs between
these groups. According to the Chamber's most recent annual
proxy survey, nearly 80 percent of companies report that they
have some type of year-round regular communication program with
institutional investors. Effective and transparent corporate
governance systems that encourage shareholder communication and
participation are critical for public companies to grow and
compete.
While some communications are more formal, like a letter
from a large asset manager to a company CEO, other
communications are more informal such as phone conversations or
meetings between investors and company executives or board
members. In the past, many institutional investors may have
only sought to engage on specific proxy issues that were up for
a vote in a given year. Today, however, investors are engaging
companies on a regular basis about the long-term strategy and
risk management companies employ to ensure long-term
profitability. Investors often communicate directly with the
company, either through their investor relations department or
directly with the board or management. Oftentimes,
institutional investors have a team in their investment
stewardship or governance team that handles engaging directly
with companies on these issues.
In recent years, many large institutional investors have
also started publicly announcing the largest topics they focus
on from a corporate governance standpoint, and will conduct
their conversations accordingly with companies. Because of
this, issuers are more aware than ever about the types of
baseline standards and practices investors are looking for, and
therefore are better prepared to meet the expectations of their
shareholder base.
Q.1.b. What topics are frequently discussed, and who is
involved in those conversations?
A.1.b. The Chamber hears consistently from company directors
and management that one of the top issues businesses face today
is the effect of technological disruption on long-term
performance. The rise of machine learning, artificial
intelligence, and the growing ``FinTech'' industry all present
challenges to established industries and companies, which must
remain nimble and competitive in an ever-changing environment.
Many institutional investors also engage on a number of
traditional corporate governance issues, such as board
composition, executive compensation, and management
performance. There is also an increase in investor interest and
engagement on environmental and social issues. As a result and
to be responsive to this interest, over 80 percent of S&P 500
companies now publish an annual sustainability report that
includes discussion of how companies handle environmental,
social, and governance (ESG) issues.
While shareholder engagement doesn't always lead to an
environmental or social proposal on the proxy statement,
according to the Manhattan Institute's Proxy Monitor report, 56
percent of shareholder proposals at Fortune 250 companies
during the 2017 proxy season dealt with social or policy
concerns. While the vast majority of these proposals have
failed to garner majority support of investors, they have shown
up on company ballots with increasing frequency over the last
decade.
Q.1.c. Do those communications sometimes lead to policy or
other changes at corporations?
A.1.c. In many instances, these communications can lead to
policy or other changes at corporations without having to be
settled through the proxy process. Many board members and
executives use shareholder engagement throughout the year to
learn where their shareholders stand on the strategic direction
of the company overall as well as key policy considerations
before getting to the annual meeting. This allows management to
gauge how patient and supportive their shareholder base is as
they implement long-term strategies at the company designed to
generate growth. Additionally, many asset managers use
shareholder engagement as a tool to seek policy changes at a
company, with a vote on a shareholder proposal or director
election used as a last resort. However, with some estimates
that proxy advisory firms can ``control'' up to 38 percent of
the shareholder vote, shareholder engagement often can only go
so far in working toward a constructive conclusion on a policy
matter in some cases.
Proactive steps taken by issuers can also result in better
communication and engagement between companies and issuers. For
example, the Edison Electric Institute (EEI) recently launched
an initiative that develops baseline standards for
sustainability reporting in the electric utility industry. This
project was the result of collaboration between both companies
and investors and has been positively received by many market
participants. EEI reported that as a result of the initiative
and increased communication, 17 shareholder proposals at its
member companies were withdrawn during the 2018 proxy
season.\1\ Since shareholder proposals are often submitted only
after a breakdown in communication between shareholders and
businesses, this should be viewed as a positive development and
way forward for other companies to manage expectations related
to ESG reporting.
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\1\ http://www.eei.org/issuesandpolicy/finance/Documents/
EEI%20ESG%20White%20Paper_
Nov2018.pdf.
Q.2. There are two main proxy advisory firms. What are the
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barriers to entry in this space that prevent more competition?
A.2. As has been mentioned, two firms--Institutional
Shareholder Services (ISS) and Glass Lewis--constitute roughly
97 percent of the proxy advisory firm market. Both companies
have significant conflicts of interest. ISS for instance
operates a subsidiary that
provides consulting services to businesses seeking favorable
vote recommendations on shareholder proposals, and Glass Lewis
is owned by an activist investor pension fund. Additionally,
the economic interests of proxy advisory firms are not always
aligned to ensure the best interests of the companies they are
rating. Given proxy advisory firms' for-profit business model,
this creates less incentives for them to make accurate
recommendations or to provide accountability throughout the
rating process. This limits competition among proxy advisory
firms by pushing them to make ``one-size-fits-all'' voting
recommendations and limiting the amount of due diligence they
can perform, thereby creating an ultimately inferior product.
Additionally, the sheer volume of vote recommendations
performed currently by proxy advisory firms represents a
significant barrier to entry. According to ISS, the firm covers
more than 20,000 companies around the globe and executes 9.6
million ballots representing over 3.7 trillion shares.
Additionally, as of June 2017, the ISS Global Research team
covered 40,000 shareholder meetings with approximately 270
research analysts and 190 data analysts. Glass Lewis purports
to analyze fewer issues but as fewer analysts to do so
(approximately 200 in 2014) ensuring that its analysts are
equally overwhelmed with their responsibilities in a short
period of time.
Attempts have been made to enter the market. In the late
2000s PGI and a few years ago Proxy Mosaic attempted with
varying levels of success. However, neither was successful over
a long period of time. The barriers to entry appear to be
somewhat similar to the Credit Ratings Agencies.
Additional Material Supplied for the Record
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