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Former SEC chief economist calls for enhanced accountability from proxy advisers

A former economist at Wall Street's top regulator is calling for enhanced oversight of the proxy advisory giants that have come to dominate a key part of the U.S. shareholder voting process.

In a June 13 report published by the Milken Institute, Chester Spatt, a finance professor at Carnegie Mellon University who worked as the SEC's chief economist from 2004 to 2007, urged proxy advisory firms to take a handful of steps that Spatt said will improve some of the concerns swirling around the proxy process.

Among those recommendations were calls for proxy advisory firms to improve their disclosures about possible conflicts of interests, to better explain their recommendations and to provide companies with time to respond to their suggestions. The report is the latest push to reform an industry that has faced mounting backlash, in part because of the amount of sway that a few select players — led by Institutional Shareholder Services Inc. and Glass Lewis & Co. LLC — have over the shareholder bases of companies across corporate America.

"The proxy advisers have tremendous influence," Spatt, also a senior fellow at the Milken Institute Center for Financial Markets, said in an interview. "[Proxy advisory firms] have lots of influence as arbiters in our system of corporate governance."

Proxy advisory firms operate at an increasingly important corner of the corporate governance process.

These companies issue research and recommendations to investors about individual corporations' shareholder votes. Much of the money management industry relies on these reports as their ability to conduct in-depth research internally on proposals ranging from executive compensation to carbon emission disclosures has been capped in an increasingly challenging operating environment. Proxy advisory firms have also gained momentum thanks to the rise of passive investment vehicles such as exchange-traded funds, with fund managers partially farming out their research on shareholder votes to such companies. Yet, executives and pro-business groups have bemoaned the amount of power that proxy advisory firms have in today's market, particularly as newfound issues such as gender pay equity and climate change have garnered more investor attention.

Within the report, Spatt raised concerns about a myriad of issues that he said warrant greater regulatory scrutiny. While other parts of the investment community are subjected to heavy regulatory demands from an alphabet soup of federal and state agencies, Spatt said, proxy advisory firms operate similarly to credit rating agencies and auditing firms, where regulation remains sparse even though conflicts of interests and biases can be prevalent within those companies' operations.

"It is important to understand the incentives and processes of these relevant decision makers who are at the heart of our system of corporate governance, potentially reinforcing the case for regulation," Spatt wrote in the report.

The SEC has signaled that it is exploring potential reforms to the proxy process, an effort led by SEC Commissioner Elad Roisman. The agency held a roundtable event with industry participants to discuss the proxy process in late 2018. Whether the SEC ultimately decides to move forward with reforming the proxy process remains unclear.

Still, Spatt believes that a handful of areas are ripe for reform in the proxy advisory business, with or without regulatory intervention.

Spatt specifically called out the considerations that proxy advisory firms use when making their recommendations. Citing a 2001 recommendation from ISS that shareholders approve a merger between HP and Compaq, even though there was declining value in HP when the transaction appeared more likely to be completed, Spatt said proxy advisory firms' recommendations often reflect other considerations that do not exclusively focus on maximizing shareholder value.

ISS pushed back on the claim that proxy advisory firms' recommendations reflect other considerations rather than shareholder value.

"As a registered investment adviser and fiduciary, ISS is committed and fully obligated to fulfilling our duty of loyalty and care, and to providing timely, accurate and insightful shareholder voting research and analysis to our clients," an ISS spokesperson said in an email. A spokesperson for Glass Lewis did not respond to a request for comment on Spatt's report.