SEC's Gallagher takes aim at proxy advisory firms

WASHINGTON Thu Jul 11, 2013 8:01pm EDT

WASHINGTON (Reuters) - The U.S. Securities and Exchange Commission has allowed proxy advisory firms to wield too much influence in the corporate election process and should take steps to mitigate potential conflicts, a top SEC official said on Thursday.

Daniel Gallagher, a Republican SEC commissioner, called for the agency to consider a raft of reforms for the proxy advisory industry in a speech due to be delivered in Seattle before the Society of Corporate Secretaries & Governance Professionals.

In particular, he said he fears that the SEC has enabled investment advisers to overly rely on proxy firms for advice when they cast corporate votes for clients, raising the risk they are not acting in the best interest of their customers.

"The last thing we should want is for investment advisers to adopt a mindset that leads to them blindly casting their votes in line with a proxy advisor's recommendations," said Gallagher in his prepared remarks.

"I believe that the Commission should fundamentally review the role and regulation of proxy advisory firms and explore possible reforms."

Mutual funds, pension organizations and other institutional investors often hire proxy advisory firms such as Institutional Shareholder Services to advise them on how to vote on important corporate issue such as executive compensation and board appointments.

But business groups such as the U.S. Chamber of Commerce have long complained about the influence of the firms on corporate elections.

Most recently, ISS urged JPMorgan Chase & Co shareholders to vote against the re-election of three board members, saying they failed to oversee the bank's risk-taking that led to $6.2 billion in losses from the "London Whale" trades.

The directors managed to hang onto their seats, but they received less than 50 percent of the vote.

Gallagher said problems first began in 2003 when the SEC adopted new rules regarding investment advisers' fiduciary obligations when they have authority to vote their clients' proxies.

Federal securities laws require advisers to put their clients' interests first.

But Gallagher said this rule essentially mandated the use of third party opinions by letting advisers rely on proxy advisory firms.

Things were exacerbated, he said, when proxy advisers convinced SEC staff to issue no-action letters which blessed the practice of letting investment advisers simply vote using the proxy advisory firms' recommendations.

No-action letters are generally granted by staff when companies are seeking permission for something without the fear of legal action by the agency.

Gallagher called for the staff no-action letters to be replaced with commission-level guidance, a move that would require a vote by all five SEC commissioners.

Guidance calling on institutional investors to take responsibility for their voting decisions "would go a long way toward mitigating the concerns arising from the outsized and potentially conflicted role of proxy advisory firms," he said.

He added that the SEC should also explore requiring proxy advisory firms to follow a universal code of conduct to make sure their recommendations increase shareholder value and that conflicts are mitigated.

"I realize that proxy advisors can provide important information to institutional investors and others," he said. "However ... changes need to be made."

In July 2010, the SEC released a 150-page request for comment about what, if any new regulations, should be imposed on the proxy advisory industry.

No additional action has been taken but in recent months the topic has surfaced again.

In May, the SEC let ISS, a unit of MSCI Inc, settle civil charges alleging that an employee of the firm shared non-public voting data in exchange for meals and concert tickets.

Then in June, a Republican-led House Financial Services Committee subcommittee held a hearing exploring various concerns about the regulatory scheme for proxy advisory firms.

Although Gallagher is a minority member of the SEC and does not set the agenda, his decision to call attention to proxy advisory firms could influence whether SEC Chair Mary Jo White decides to pick it up again at the SEC.

(Reporting by Sarah N. Lynch; Editing by Tim Dobbyn)

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