Proxy Advisory Services Come Under Increased Scrutiny - SRI World Group, May 28, 2010

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May 28, 2010

Proxy Advisory Services Come Under Increased Scrutiny



    by Robert Kropp

Pointing to the considerable proxy voting power and little oversight of
companies such as
RiskMetrics, critics call for increased regulation to avoid conflicts of
interest.

SocialFunds.com --

When SocialFunds.com spoke earlier this month with Julie Tanner,
Assistant Director of
socially responsible investing (SRI) at Christian Brothers Investment Services
(CBIS), she expressed
disappointment in the recommendation to institutional investors by RiskMetrics Group’s
proxy advisory service to vote against a
shareowner resolution calling for the separation of CEO and chair at
Goldman Sachs.



Tanner
observed that the proposal, which nevertheless won a respectable 19% of
the vote of shareowners,
could have received as much as 15% more votes in approval if RiskMetrics
had supported it. Two
other major proxy advisory services did recommend a vote in favor of the
proposal, but RiskMetrics,
following its 2007 purchase of Institutional Shareholder Services (ISS)
for $550 million, is by far
the largest player in the field.



In a recent article posted on the website of B
usiness Ethics, author James Hyatt described the influence of
RiskMetrics, which, he wrote, “by
some estimates, advises half the world’s common stock.”



Hyatt continued, “RiskMetrics had
$303 million of revenues in 2009; of that, almost half or $145 million
came from the ISS segment.
The company last year issued proxy and vote recommendations for more
than 37,000 shareholder
meetings in 108 countries and voted 7.6 million ballots representing
over 1.3 trillion shares.”



“RiskMetrics in 2009 had 3,500 clients in 53 countries, including 70
of the 100 largest
investment managers, 43 of the 50 largest mutual fund companies, and 42
of the 50 largest hedge
funds,” Hyatt wrote.



However, RiskMetrics derives revenue from governance services that
it
provides to corporations as well. This year, following its acquisition
of Innovest Strategic Value
Advisors, an environmental, social and governance (ESG) investment
research firm, RiskMetrics
published its first list of top sustainable corporations, which it named
the Global ESG
100 Top-Rated
Corporations.



Corporations contract with RiskMetrics for a service by which it
advises
them on how to improve their ESG rankings. As described in a discussion
draft published in March by the Shareholder Communications
Coalition, RiskMetrics
“provides corporate governance and executive compensation consulting
services, in addition to
providing voting recommendations on proposals submitted in shareholder
elections.”



The
draft continued, “Particularly as the SEC reviews its corporate
disclosure requirements on these
topics—and sustainability advocates increase their advocacy of specific
shareholder proposals—this
may create conflicts of interest between RiskMetrics' servicing of its
institutional clients and
the corporate consulting services it also provides.”



Another potential conflict of
interest arises for RiskMetrics and other proxy advisory services when
their institutional investor
clients file a shareowner proposal on which the services will provide a
voting recommendation.



RiskMetrics itself acknowledges a potential conflict of interest for
its ISS subsidiary by
stating, “We are also aware of the potential conflicts of interest that
may exist between ISS’
proxy advisory service, which provides proxy analyses and vote
recommendations to institutional
investors, and the business of ISS Corporate Services, Inc. (“ICS”),
which provides products and
services to issuers consisting primarily of advisory and analytical
services, self-assessment tools
and publications.”



In March, the Millstein Center for Corporate
Governance and Performance
published a Voti
ng
Integrity Policy Briefing, in which it recommended that proxy
advisory services avoid
conflict of interest by adopting “a code of professional ethics for the
governance industry modeled
on similar codes for other industries.”



However, calls for more stringent regulation are
being heard as well. In its discussion draft, the Shareholder
Communications Coalition recommended,
at a minimum, that the Securities and Exchange Commission (SEC) require
proxy advisory services to
register as investment advisors. It also recommended that the SEC
“require conflicts of interest
disclosure for proxy advisory firms.”



Last November, Mary Schapiro, the Chairman of the
SEC, said, “We'll be asking about the role of proxy advisory firms in
corporate voting. Given the
influence that these firms' recommendations have on corporate voting
outcomes, we'll probe the need
for rules to ensure that advisory firms are basing their research and
recommendations on accurate
and reliable information. And, that they are providing adequate
disclosure of any conflicts of
interest they may have in providing voting recommendations.”



In a Spring 2009 report
entitled The
Case for Increased Oversight and Control, law professor Tamara
Belinfanti argues for regulatory
oversight of proxy advisory services that is analogous to that being
developed by the SEC for
regulation of credit rating agencies. Belinfanti also calls for the
establishment of an oversight
board for the industry, to “provide systematic accountability of proxy
advisors.”



The
questions that arise when considering the corporate activities of proxy
advisory services are
several. Can its ESG rankings of companies be accepted with full
confidence by sustainability
investors, when those rankings are often at odds with the ESG rankings
of other investment research
firms? Does the service RiskMetrics provides to guide a company to an
improved ESG ranking
guarantee a better ESG performance by that company?



Finally, when institutional investors
and mutual funds outsource their proxy voting decisions to a third
party, are they fulfilling their
fiduciary duty to their clients, or should they engage more actively in
the allocation of their
votes?