Proxy Music

The increasing sway of proxy advisors has prompted calls for greater regulation, reports Ben Power.

In 2017, the Australian Securities and Investments Commission (ASIC) held a roundtable meeting in Sydney on the topic of proxy advisors, the handful of powerful firms that advise big shareholders (who often do not attend the meetings) on how to vote shareholder resolutions, often voting on their behalf. Attending were representatives of institutional shareholders, industry associations, including the Australian Institute of Company Directors (AICD), and proxy advisors.

The ASIC meeting was a response to growing concern about the practices of proxy advisors. Harvey Norman’s Gerry Harvey had labelled them a “sore on corporate Australia”. South32 chair David Crawford AO FAICD criticised their “formulaic” approach and former Mortgage Choice chair Peter Ritchie AO accused them of being “closed-minded”. Some, including Tabcorp chair Paula Dwyer FAICD, had called for the regulation of proxy firms, echoing the statements of high-profile lawyers such as Jeremy Leibler.

Kathleen Conlon FAICD, a professional non-executive director who sits on the boards of REA Group, Aristocrat Leisure and Lynas Corporation, says the profession has an inherent conflict of interest.

“They need to be provocative,” she says. “If you always agree with companies, or agree the majority of the time, then why is somebody paying you to do the work?”

ASIC remains focused on the issue and continues to monitor proxy advisors, says ASIC Commissioner John Price. ASIC staff attended meetings during the 2017 AGM season and they’re scrutinising “against” recommendations in forensic detail. However, a regulatory regime for proxy advisors is likely to face opposition, not just by proxy advisors, who deny there is a problem, but also by their clients: powerful institutional shareholders. Some argue that rather than focus on regulation, directors should accept the role of proxy advisors and work to improve their own engagement with them.

“Directors or senior management who roll their eyes and say proxy advisors are the bane of their life remind me of the sort of people who, 20 years ago, rolled their eyes about journalists,” says Simon McKeon AO FAICD, who has chaired companies such as AMP and MYOB. “Just get over it. Act professionally in relation to this new profession.”

Louise Petschler MAICD, the AICD’s general manager of advocacy, says the institute recognises proxy advisors play a legitimate and influential role in the market. She also acknowledges there’ll always be tension when proxy firms recommend against board proposals. Still, she says, “the AICD continues to hear frustration from directors about challenges with engagement and accuracy”.

Directors complain about proxy firms’ reluctance to engage and the lack of time they have to respond to “No” recommendations on crucial issues such as remuneration packages. In the 2017 AGM season, some companies received copies of reports recommending No votes only two hours prior to the meeting, says Petschler.

There’s also growing concern around accuracy and the willingness of proxy advisors to correct mistakes. The Australasian Investor Relations Association (AIRA) recently surveyed 52 listed companies, including 46 in the ASX 200. One-third of respondents cited errors in reports written by proxy advisers. Of the 38 factual errors that were reported, only two had actually been corrected when reports were issued, according to the AIRA.

Many concerns centre on remuneration reports where proxy advisor recommendations have gained greater potency after the introduction of the “two strikes” rule. But one of the biggest complaints from directors is the tick-a-box approach of some proxy advisors. While boards put forward proposals they believe are in the best interests of the company, proxy advisors recommend a No vote because the proposals don’t fit their own narrow definitions, say some directors.

“You’re doing what’s right for the company, but the proxy advisors are saying you shouldn’t be doing that,” says Conlon. “There’s a disconnect between what companies are trying to achieve and what proxy advisors are trying to do. This is particularly an issue when investors vote blindly with the recommendations without spending the time to understand what the company is doing.”

Rules of engagement

“Australia differs from some other jurisdictions in not having rules of engagement for proxy advisory firms,” says Petschler. “Considering the role proxy advisors play in the market, they should be part of the same regulatory ecosystem as other players, particularly in relation to important areas such as conduct and conflicts.”

Formalising the rules would mean either self-regulation or greater regulation. Offshore jurisdictions have gone down different paths. In the US, a bill requiring the registration of proxy advisors is currently before Congress. The Canadian Securities Administrators has opted for guidance rather than regulatory reform, while proxy advisors in Europe have issued best-practice principles after regulators found there was no market failure in relation to the industry.

The AICD argued that an industry code of conduct with ASIC oversight would be a positive step if it addressed resourcing, competency, conflicts of interest and a framework for engagement — but proxy advisors are not in favour. Daniel Smith, general manager of proxy firm CGI Glass Lewis, says his firm already abides by the European code of conduct, which applies to its operations in Australia.

Price doesn’t believe an industry code of conduct is the solution, either. “There’s no agreement that a code of conduct is needed, no agreement as to what it would cover — and codes of conduct tend to be unenforceable,” he says.

Petschler says other options should be explored, such as extending Australian Financial Services (AFS) licensing to proxy firms. Proxy advisors do have AFS licences but, notes Price, they only cover advice about financial products. “AFSL regulation doesn’t cover advice about remuneration, board appointments or governance issues.”

Extending the AFSL to all proxy advisors’ activities may not be too onerous. Smith says his firm follows the licensing regime for all the advice it provides, not just financial advice. “There would be no administrative or operational burdens involved for formally extending the AFS licensing regime across our entire business.”

Swinging Voters

Proxy firms get the vote of director and philanthropist Simon McKeon FAICD.

Simon McKeon wanted to understand more about the role of proxy advisers, so when he was on the board of AMP, he shadowed one for a day. He says it gave him an intimate understanding of the challenges they face, particularly during busy periods. The time constraints were telling and he witnessed proxy advisors shut down meetings with companies — a source of frustration for many directors who want more time to argue their position.

McKeon also saw corners being cut because of the huge amount of information proxy advisors had to consider and the time pressure they were under to complete the report. And he saw “cock-ups”: one proxy firm got the companies mixed up, realising after five minutes that it had raised an issue with the wrong entity.

But McKeon says he couldn’t fault their motivation. “At certain times of the year, proxy advisors are run off their feet,” he says. “But they were trying to do the job to the best of their ability.”

”Any chairman who isn’t doing their darndest to win over proxy advisors simply isn’t doing their job.” Simon McKeon FAICD

McKeon, who is supportive of proxy advisors and believes they’re here to stay, says directors need to recognise the industry’s value and even develop empathy for it. “Any chairman who isn’t doing their darnedest to win over proxy advisors simply isn’t doing their job. You have to be focused on the proxy advisors and your major shareholders. You may well be in a situation where, frankly, every vote is important. Proxy advisors influence this whole group of professional investors — and sometimes they’re required by rules to have regard for them.”

McKeon says directors should try to connect as much as they can with proxy advisors outside of peak season. Directors won’t have a particular resolution they’re sensitive about discussing at the time and the proxy advisor will have more time to understand past recommendations that the director may have found unsatisfactory. It will also allow directors to get to know proxy advisors as individuals, which should improve relationships.

Differences of opinion

Many advisors are sceptical of increased regulation. “Do they want to devise specific regulation that covers four firms?” asks Martin Lawrence from proxy advisory service Ownership Matters. “That’s ridiculous.” Says McKeon, “My concern is that there will be another layer of bureaucracy that everybody is going to have to deal with.”

“I don’t think regulation solves the problem,” says Conlon, adding she does believe mechanisms for quality control need to be looked at, including the ability of directors and companies to give institutional investors feedback on the performance of their proxy advisors.

Others aren’t convinced there is a real problem, among them proxy advisors, who say director complaints reveal the unwillingness of corporate Australia to be criticised. “Every single person on the record complaining [about proxy advisors], I can point to an Against recommendation,” says Lawrence.

In their defence, proxy advisors cite increasing engagement with companies in recent years. Smith says CGI Glass Lewis held 283 meetings with 240 ASX-listed companies. “Our experience has been that the vast majority of those meetings were productive and professional,” he says. “We might agree to disagree on certain issues, but there’s a good-faith effort on both sides to see each other’s point of view and do the right thing by shareholders.”

Proxy advisers also reject assertions that accuracy is an issue. Lawrence labels the AIRA report a “grossly inaccurate survey, while Smith says that most “errors” are a difference of opinion. “Just because [companies] say it’s an error doesn’t necessarily mean it’s the case.” He says that if his firm makes a legitimate error, it republishes the report within 24 hours. “Why would that be considered a problem?”

As for the claim that proxy advisors simply tick boxes when assessing resolutions, Smith says this is “a tired argument that doesn’t reflect the nuance that goes into our analysis”. ASIC’s Price says regulation is ultimately a matter for government, but the commission will want factual evidence about the problem. He says ASIC receives very few complaints or reports of misconduct by proxy advisors. “We get a lot of anecdotal concerns, but in terms of people coming back to us with specific examples and documentation, not so much.” When it comes to mistakes, ASIC has been provided with examples, but “it seems to be more a difference of opinion rather than factual inaccuracies”, says Price.

ASIC research is focused on establishing the facts in areas such as proxy advisors’ willingness to engage with companies throughout the year and whether they are willing to correct factual inaccuracies. Another issue is whether it’s sensible for proxy advisors to adopt policies from markets like the US for use in Australia.

Smith says the fact his company is global has no bearing on the way it conducts research here. “What goes on in the US isn’t particularly relevant to us when evaluating a solely ASX-listed company,” he says, adding that policy guidelines are set with reference to the likes of Australian Council of Superannuation Investors guidelines and more than a decade of experience in the local market.

Greater engagement

Even if the government expands regulation, proxy advisors are here to stay because of their key role. Smith says the voice missing from the conversation is shareholders, who want and need proxy advisors. “Shareholders actually own those companies,” he says. Big shareholders, including First State Super, have said the system is not broken. The Association of Superannuation Funds also opposes regulation.

Proxy advisors point out that their industry has helped drive improvement in Australian corporate governance standards. “They play an important role,” says Price, “assisting investors in making voting decisions and promoting a focus on corporate governance issues relevant to shareholders.”

ASIC taking note

ASIC released its report on the 2017 AGM season on 29 January, noting that it was “less tumultuous” than the year before with fewer “strikes” on remuneration reports. A strong sense of shareholder input and engagement was evident, with some directors facing material “against” votes on their election.

The report shows that proxy advisory firm recommendations are influential, with resolutions that attracted “against” recommendations from proxy advisors receiving lower average “for” votes. However, in most cases, the average “against” vote for resolutions where at least one proxy advisor had recommended against a resolution, was not sufficient to alter the outcome.

Proxy Power

Australia’s proxy advisory firms — who’s who and what they do.

The growing influence of proxy advisors has accompanied the rise of institutional investors in Australia over the past two decades. Proxy advisors provide institutional investors with recommendations on how to vote on key shareholder proposals, including remuneration packages, director elections and corporate restructures.

Proxy advisors solve a key problem for institutions, according to Winthrop Professor Raymond da Silva Rosa from The University of Western Australia Business School. Institutions want a say in how companies are run, but if they get too close to companies, they lose liquidity (their share sales would trigger serious market concern). “Proxy advisors give them oversight of boards without necessarily compromising liquidity,” says da Silva Rosa. “The problem is that proxy advisors are [considered] outsiders.”

Despite their increasing influence, the Australian market has just four proxy advisory services. Two, Institutional Shareholder Services (ISS) and CGI Glass Lewis are large international firms. The Australian Council of Superannuation Investors, which advises 38 institutional investors, and Ownership Matters (formed in 2011 by former Melbourne employees of ISS Governance Services) are the locals.

Proxy advisors earn fees from services including proxy advice to institutional shareholders and vote execution and reporting services (helping investors manage workflow around voting). Some also sell reports to companies after they’ve been sent to institutional clients, while others provide bespoke research and data.

ASIC’s John Price says we need a greater understanding of how institutional investors, including foreign institutional investors, use proxy advisor reports.

“There’s a suggestion that institutional investors take things proxy advisors say on face value and don’t exercise independent judgement. I don’t think that’s right. Institutional investors in Australia have fiduciary duties that extend to how they vote. Based on my conversations, an independence of mind and rigour is brought to these [institutional investor] decisions.”

Daniel Smith of CGI Glass Lewis agrees: “Ultimately, institutional shareholders are calling the shots. We’re just inputs into that process.”