SEC shouldn’t dismiss concerns about proxy advisers

It is easy to think of the stock market as the domain of hedge funds and investment conglomerates. In one sense, that is true. Some sources estimate that the percentage of U.S. equities held by institutional investors exceeds 80 percent.

Lurking behind that number, however, is the fact that most of the money in today’s stock market actually belongs to ordinary people hoping to put aside some money for retirement, their child’s education or to provide for future health care costs. These firefighters, police officers, teachers, pipefitters and auto workers place their trust in those who manage pension and 401(k) plans, believing these experts will do a better job than they could on their own. They expect professional money managers to spend their days poring over financial statements and company filings to make wise investment selections, and then carefully watch the companies in which they invest.

{mosads}Indeed, the law expects these institutional managers to not only carefully select investments, but to then thoughtfully vote on matters that come to shareholders for action each year.

Because these funds must vote on thousands of shareholder proposals each year, however, many have delegated their voting analysis to third-party companies known as proxy advisers — companies that have no relationship with, or duties to, those whose money is being invested.

Hundreds of these investment managers rely on the voting advice of proxy advisers almost all of the time. Further, they commonly do so almost immediately and electronically, and before taking the time to study the proxy advisers’ reports, or hear whether the companies subject to the reports have something to say in response. The effects of this practice, dubbed “robo-voting,” long have been reported, but have not been previously measured.

So, four major U.S. law firms — including my firm, Squire Patton Boggs — recently collaborated on a survey of public companies seeking information about the existence, size and nature of the robo-voting phenomenon when the proxy advisers recommended a vote contrary to the views of company management.

The survey responses show that almost 20 percent of votes are cast within three days of the issuance of an adverse recommendation by a proxy advisor. Yet, 60 percent of the respondents stated they would need as many as five days to communicate their side of the story to their institutional investors.

Perhaps that would all be well and good if the proxy advisers were always (or even almost always) right. However, an analysis of records filed with the Securities and Exchange Commission (SEC) tells another story.

Currently, the main remedy open to public companies who believe a proxy adviser has “gotten it wrong” is to submit a supplementary proxy filing with the SEC highlighting the error, hoping that investors will read their views before they vote.

We reviewed those filings from September 2016 through Sept. 31, 2018. During that period, 94 public companies identified 139 significant problems in their proxy adviser reports. These included a variety of factual and analytical errors. These filings are likely just the tip of the iceberg since many companies with objections decide not to make a supplemental filing, either because of a lack of time before votes are cast, or because they fear backlash from a proxy adviser in future years.

The outsized influence of proxy advisers and growing concerns over the quality of their guidance has attracted the attention of the SEC, which is holding a roundtable discussion on the proxy process this month. As the commission undertakes its investigation, it should assess the fact that institutional investors with fiduciary duties are voting rapidly and, in some cases, instantly, and on the basis of flawed guidance. This critical point of failure in our proxy voting system requires a fix.

Frank M. Placenti leads the U.S. governance practice at Squire Patton Boggs (U.S.) LLP. He serves as the founding president of the American College of Governance Counsel and as vice chair of the American Bar Association Corporate Governance Committee. The views expressed here are his own. The research referenced was included in a report commissioned by the American Council for Capital Formation.