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Top Wall Street regulator rolls out new guidance on proxy advisory firms

Wall Street's top regulator is ramping up its review of the proxy advisory firms that have come to occupy a central role in corporate governance.

By a 3-2 vote, the SEC approved two new sets of guidance. The guidance addresses the regulation of proxy advisory firms such as Glass Lewis & Co. LLC and Institutional Shareholder Services Inc. and the increasingly prevalent roles such companies play in the U.S. corporate governance system.

The regulator outlined a series of steps that investment advisers should take when considering whether to use a proxy advisory firm to research and issue recommendations on proposals their clients will vote on at shareholder meetings. The SEC also clarified that voting advice from a proxy advisory firm is a form of solicitation. This means that those institutions could be penalized if their recommendations include any statement that is "false or misleading with respect to any material fact."

"Updating our guidance and providing additional interpretive clarity to address the realities of today's markets is appropriate and many would say overdue," SEC Commissioner Elad Roisman said at an Aug. 21 open meeting in Washington. Roisman has overseen the agency's ongoing review of the proxy process.

The SEC has been looking to modernize the proxy advisory industry since late 2018 when it began soliciting opinions about what one former commissioner called an "arcane" system.

Proxy advisory firms' reports and recommendations have become widely influential for shareholders. Companies such as Glass Lewis and ISS conduct research and analyses to develop recommendations for how shareholders ought to vote on proposals at companies' annual meetings. These proposals can range from their planned executive compensation packages to their strategies on a mix of different environmental, social and governance issues. Both big and small investment managers have long relied on Glass Lewis and ISS, which dominate the proxy advisory business. Most managers lack the time to dig into proposals in depth and so rely the firms' voting research. Still, executives, business groups and some former regulators have long argued that proxy advisory firms hold too much sway over the corporate governance process.

Critics say proxy advisory firms have allowed large asset managers and activist investors to push their social and political causes on to management teams even if those interests would not improve the companies' financial performances.

A 2018 analysis from BlackRock Inc. found that ISS supported more than 70% of shareholder proposals that were submitted to Russell 3000 companies between July 1, 2016, and June 30, 2017. But BlackRock also found that many large asset managers, including itself, supported only a fraction of those proposals. BlackRock supported 16% of the proposals. Fidelity Investments, Vanguard Group Inc. and State Street Global Advisors Inc. supported 14%, 15% and 33% of the proposals, respectively, according to the analysis.

The SEC's two Democratic commissioners — Robert Jackson Jr. and Allison Lee — dissented from their colleagues' vote to approve the guidance.

Jackson and Lee raised concerns at the meeting about the increased costs that investors could face from the guidance as a result of institutional investors having to ensure that their proxy advisory firm's recommendations comply with their fiduciary duties. That might lead smaller investors to not vote at all, leaving larger institutions with even more influence than before, Jackson said. He added that the new guidance could raise proxy advisers' operational costs as well.

"We should carefully consider the consequences of that possibility before making policy in this area," Jackson said. "A competitive market for voting advice benefits both investors and issuers by generating crucial accountability for companies and proxy advisers alike. I would have considered the effects of today's guidance on the competitive landscape more fully before taking these steps."

But the SEC is not likely done with reforming the proxy process.

Roisman said during the meeting that the commission would be considering new rules in the "near future." These rules could amend the submission and resubmission thresholds for shareholder proposals and address exemptions that proxy advisory firms widely use today. That likely signals that the SEC is looking to "bring reforms to the proxy advisory firms themselves," said Erik Rust, a director at the U.S. Chamber of Commerce's Center for Capital Markets Competitiveness, in an interview.

"This is a good first step," Rust said. "We anticipate and await further action on this from the SEC going forward."