Proxy advisory firms are continuing to make headlines in Canada, the United States and abroad. As shareholder activism increases, the role of proxy advisers, such as Institutional Shareholder Services Inc. (ISS) and Glass Lewis & Co., and their potential influence on the outcome of corporate governance initiatives and M&A transactions have been brought sharply into focus. Earlier this month, Glass Lewis defended itself against allegations of conflicts of interest in respect of its voting recommendations in the Canadian Pacific Railway proxy contest. ISS was also accused of issuing a misleading report on Canadian Pacific. Against the backdrop of heightened criticism of proxy advisers, Canadian securities regulators are now considering whether, and to what extent, the legal regulation of proxy advisers is appropriate.
The Canadian regulators have released a consultation paper to open the discussion, citing the following concerns surrounding the operations of proxy advisory firms and their role in Canada’s capital markets:
- Proxy advisory firms may face conflicts of interest in making voting recommendations that support an institutional investor client or that relate to a matter for which they provided consulting services to an issuer.
- There is a perceived lack of transparency concerning the way proxy advisory firms arrive at their voting recommendations.
- The reports produced by proxy advisory firms may include inaccuracies, and issuers have limited opportunities to engage with these firms to address these issues.
- Proxy advisory firms are perceived as having become de facto setters of corporate governance standards.
- Some institutional investors may rely too heavily on the recommendations of proxy advisory firms.
At this stage, the regulators are focusing on fact-finding to assess the validity of these concerns. The overall tone of the paper reflects the regulators’ primary objective that any new legal regime governing proxy advisory firms should be consistent with the regulators’ mandate to promote the integrity of Canada’s capital markets. As justification for their cautious approach, the regulators cite the legitimate contractual nature of the relationship between proxy advisory firms and their institutional investor clients; the potential value of proxy advisory services in light of the ever-increasing volume and complexity of matters on which shareholders vote; and the need for better empirical evidence of the actual influence of proxy advisory firms on voting behaviour.
In considering potential approaches to regulation, the Canadian securities regulators’ preferred approach would be to create a new, stand-alone regulatory instrument tailored to proxy advisory firms, rather than require these firms to register as advisers under National Instrument 31-103 or bring them within the framework of the existing proxy solicitation regime under National Instrument 51-102. A new instrument might include requiring proxy advisory firms to
- develop policies and procedures to identify and mitigate conflicts of interest;
- separate their proxy voting services from their advisory or consulting services;
- disclose the internal methodologies and procedures they use to establish voting policy guidelines and recommendations; and
- implement policies for engaging fairly with issuers, including allowing issuers to review and comment on proxy advisory firms’ reports.
The Securities and Exchange Commission has undertaken a similar initiative, beginning with its 2010 concept release on the U.S. proxy system. In response to feedback on that release, the SEC is now preparing to provide guidance on how proxy advisory firms could be regulated under U.S. federal securities laws. However, the timing of U.S. regulatory action is unclear.
The regulators have requested comment on the consultation paper from all market participants and are especially encouraging institutional investors, issuers and proxy advisory firms to give feedback.
To the extent that proxy advisory firms have significant influence over the outcome of shareholder votes on contested matters and capital markets participants perceive there is an uneven playing field, the focus of many comments is likely to be on whether there is a need for proxy advisory firms to engage more openly with issuers and be accountable for their recommendations.
Comments on the consultation paper are due by August 20, 2012.
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