IN-DEPTH: SEC mixes signals on proxy adviser reform

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The leading figure in an effort to reshape proxy voting adviser regulations caused optimism and concern about the next stage of the process last week.

Few topics have rankled the investment community more than the Securities and Exchange Commission’s (SEC) plan to regulate proxy advisory firms. So, when SEC Commissioner Elad Roisman indicated he was “listening” to the concerns of market participants and considering at least one significant revision to the plan, it was welcomed, to a degree, by some shareholder activism insiders. On the other hand, Roisman’s subsequent statement about proxy advisory firms being used as cover for activists working as a group raised fears that the SEC is pursuing a new witch hunt against a problem that just doesn’t exist.

Rules proposed by the SEC on November 5 would, among other things, require that before a proxy adviser such as Institutional Shareholder Services (ISS) or Glass Lewis distributes its voting recommendations to clients, it must let the company holding the meeting review and comment on the recommendations before the reports are finalized.

The proposal has elicited a drumbeat of opposition from the investment community, especially shareholder activists. Third Point’s Daniel Loeb referred to it as an example of the Washington “swamp at its worst.” Carl Icahn called it a “recipe for disaster.”

Speaking last week in Washington, Roisman suggested he at least was open to “a contemporaneous review period for companies,” which would allow clients to see the report during the review period, as long as the proxy voting adviser passes on objections lodged by the issuer within a proposed two-day period.

“This is an alternative I am thinking about, and I thank commenters for suggesting it,” said Roisman, speaking at the Council of Institutional Investors (CII) spring conference in Washington, D.C.

Middle ground

ISS and Glass Lewis both declined to comment for this story. But others in the industry greeted it with reactions ranging from positive to a grudging welcome that the government was at least hinting at a willingness to consider alternatives.

“It is a middle ground,” Ken Bertsch, CII’s executive director told Activist Insight Online in an interview. “We are hearing about this from other places, so it looks there is a good probability that they could do it.”

Bruce Goldfarb, founder and CEO of proxy solicitation firm Okapi Partners, said that so long as it doesn’t slow the process, “Contemporaneous review is a much more efficient way to address the issue than the first proposal.”

Others were less sanguine. “It’s a welcome development that the SEC is willing to listen to the concerns of the real-world practitioners,” said Andrew Freedman, co-head of shareholder activism at law firm Olshan Frome Wolosky. However, he added that he felt the proposed rules were a bad idea from the outset. “Now to try to walk it back so it works in the real world of annual meetings and contested meetings doesn’t make things any better.”

Instead, Freedman said any changes to the process should take place early in the back-and-forth between boards and dissident shareholders to make sure the discussions are based on accurate information.

Speed bumps

A two-day waiting period raises technical issues. Some institutional shareholders allow proxy advisers to “pre-populate” their electronic ballots based on the adviser’s recommendations and automatically submit them for counting.

“Do these ‘set-it-and-forget-it’ mechanisms tie clients’ votes to the proxy voting advice businesses’ recommendations,” even if companies come back with objections or corrections, Roisman wondered, adding that proxy voting advisers might have to disable any automatic submission features for a period.

On the other hand, Goldfarb pointed out that the percentage of proxy advisory clients using automatic voting has declined in recent years, while those willing to hand control of the voting process over to the advisers may be more likely to accept a delay in the voting process.

There is also the issue of people with direct or indirect knowledge of any undisclosed recommendations trading on the information before it goes public. This would be especially tempting in contested merger situations, where large bets are made on the likelihood of a deal being completed. CII’s Bertsch suggested that proxy adviser be required to publicly disclose tentative recommendations to counter the issue, although this might increase volatility.

13D mystery

Roisman’s apparent willingness to seek a middle way on this one aspect of the proxy advisory controversy was overshadowed by his stated suspicion that activist investors were using the proxy voting advisers to coordinate voting activity, in violation of the Schedule 13D disclosure rules.

“I am concerned that some market participants have the mistaken impression that they can evade the disclosures required by our beneficial ownership rules by coordinating their voting decisions on important matters presented at a shareholder meeting through a proxy voting advice business,” he said, adding that he hoped to see the SEC explore whether further action is needed on this point.

The statements were met with both concern and confusion. “The speech seemed very conciliatory in the main, but then he added these comments that seem a bit off the wall,” said Bertsch. “It just doesn’t happen so not sure what they will do about something that’s not happening.”

Freedman was equally perplexed. “I have no earthly idea what he’s referring to, and if anyone should understand that it should be me,” said the securities lawyer, whose firm represents many of the leading shareholder activists.