It’s been six months since the Canadian Securities Administrators (CSA) put out consultation paper 25-401 Potential Regulation of Proxy Advisory Firms, which aims to address concerns about the services provided by proxy advisory firms (PAs) and their potential impact on Canadian capital markets. A mid-September deadline for comments has since passed and the CSA is now reviewing submissions on the issue of whether or not proxy advisory firms should be regulated. Last month, it gave Listed an update, noting, “The CSA has heard concerns about the role of proxy advisers in influencing shareholder voting and has solicited formal feedback on this issue. Sixty comment letters were received, which will help us analyze the facts behind the concerns raised and in assessing whether there is a need for securities regulation intervention.”
It’s a suitably dry characterization of a relationship that is in fact becoming increasingly contentious as demand for proxy advisory services—chiefly researching issuer proxies and making voting recommendations to shareholders—grows. The CSA sought and received feedback from issuers, institutional investors, the legal and academic community as well as the proxy advisory firms themselves. The responses were visceral and polarized.
The list of issuer respondents to the CSA’s request includes Canadian Tire, George Weston and Gildan Activewear. Collectively, they want regulation. Issuers worry that proxy advisory firms—specifically, Institutional Shareholder Services Inc. (ISS) and Glass, Lewis & Co.—wield significant influence yet have no accountability. There are concerns about potential conflict of interest in vote recommendations, lack of transparency, undo influence and inaccurate assessments with inadequate review. “Issuers are saying that proxy advisers have inaccuracies in their reports and, in many cases, these wouldn’t have been a problem if they had been given a chance to correct those inaccuracies before final voting recommendations by the PAs were made,” says Patricia Koval, a partner with Torys LLP in Toronto.
Large institutional investors, the proxy advisers’ main clients, say play on, insisting that the influence of PA firms is overstated. “We don’t believe in regulation,” says Bryan Thomson, vice-president, equity investments at BC Investment Management Corp. in Victoria, B.C., one of Canada’s largest institutional investors. “We use PA reports as a supplement when considering how to vote on an issue. If we disagree with the PA firm’s recommendation we don’t follow it.”
Part of the motivation behind the CSA’s move is the fact the United States and Europe are already considering regulatory action. “What happens in the U.S. and Europe in regards to PA firms will influence what will ultimately happen in Canada,” says P.M. Vasudev, an assistant law professor at the University of Ottawa. “The U.S. doesn’t seem to be talking about regulation yet—they’re just talking about the issue in general right now.”
Regulatory action would be a more straightforward issue if the questioning hinged less on issuer complaints and suspicions and more on clear-cut examples of proxy adviser transgression. “If you had a case of huge omission and conflict of interest, it would be different,” says Vasudev. “But there’s always an element of subjectivity in their recommendations.”
ISS’s own metrics show that, collectively, an ISS recommendation on a shareholder ballot increases votes for a proposal by 15% on average, while a thumbs-down from ISS leads to a 17% decline. It’s enough to make comfortable votes close and close votes less of a contest.“You can’t get away from the fact that the PAs are problematic,” says Vasudev, a proponent of some form of regulation. “The PAs certainly won’t do it themselves. It has to be done from the outside.”
Richard Leblanc, associate professor of law, governance and ethics at York University and a Listed columnist, agrees. “I’m not a proponent of regulation—at least, not as a first step,” says Leblanc. “But I think a soft hand by the CSA will enable gamesmanship. It will perpetuate lawyers that will draft guidelines to suit themselves. The prescription is a combination of passive disclosure mixed with some ironclad rules. The CSA has to find the sweet spot—soft, but with some backbone.”
A voice of moderation on the issuer side, Stan Magidson, president of the Institute of Corporate Directors acknowledges his members’ concerns but recommends a cautious hand. “Our members are complaining, but we want the issues dealt with pragmatically,” says Magidson. “Regulation is not a panacea.”
What would issuers ultimately like to see? PAs sharing their information and methodologies, especially in cases where a PA firm will be issuing negative recommendations that could play a significant factor in an important vote. “In those cases, we want to get the dialogue going between the PA and the issuer,” says Magidson. “That’s good due diligence. If, after that, the PA firm still wants to recommend contrary to the company’s board on an issue [as in the case of a takeover or company merger], then the issuer should be able to put their view in the PA’s recommendation report in writing. This gets to full and true disclosure and will get to the crux of the issuer’s concerns.”
The PAs seem to be listening. Both ISS and Glass Lewis submitted detailed comments to the CSA on the issue. And while ISS declined to comment to Listed, Glass Lewis (which is owned by the Ontario Teachers’ Pension Plan) was more open about its views. Specifically, Robert McCormick, chief policy officer with Glass Lewis, sees the importance of the CSA putting the issue out for open discussion. “We know we play a major role in providing voter decisions but the challenge for us is a philosophical one,” says McCormick. He explains that while PAs understand the issuers’ concerns for transparency and info on methodology, it’s difficult to review a recommendation with them before Glass Lewis gives it to a paying client. Errors can often be just a difference of interpretation of the facts. But he acknowledges that time constraints and huge workloads are also key issues. “We’re processing literally thousands of proxies—22,000 this year alone—that are 50 or 60 pages long each,” says McCormick. “It’s a challenge to get information out on time to a company, have them digest it and respond and get back to us, and then have us get back to the clients. And of course, there’s always the potential they may lobby us on our decision, because that happens now.”
To date, McCormick says Glass Lewis hasn’t seen a huge number of significant errors that are enough to warrant a change in the recommendations they give. “But we’re all human,” says McCormick. “It happens.” Right now, Glass Lewis—contrary to ISS—does not provide consulting services for public companies. “For us, it’s an insurmountable conflict,” says McCormick. “We don’t do consulting.”
So when is the CSA response expected? And what’s it likely to be? The consensus among market watchers is that the CSA will issue a recommendation sometime in the spring of 2013 and it will likely start out by recommending voluntary guidelines to resolve some of the key issues—codified standards short of regulation. The CSA will also likely defer to the SEC in the U.S. and European regulators to ensure a consistent approach. “I think the CSA will start with a soft-glove approach and evolve to more iron-hand in a few years,” says Paul Gryglewicz, managing partner of Global Governance Advisors, a Toronto firm that advises company boards and senior managers on corporate government and executive pay issues.
But it will be a challenge. “The PA firms will try to comply but the methodologies change,” says Gryglewicz. “The PAs have a statement of policy now but it’s a plug-and-play model. The challenge will be when you get to the nuts and bolts. But it’s a hugely important issue and having a third party such as the CSA involved will help guide that policy and keep the dialogue going. Really, it’s long overdue.”