Heat on proxy advisers could raise costs for mutual fund clients

Tue Dec 3, 2013 4:59pm EST

BOSTON/WASHINGTON Dec 3 (Reuters) - Are proxy advisory firms giving mutual funds too much help with their homework?

That question is due for airing at a event in Washington on Thursday focused on the role of proxy advisers like Institutional Shareholder Services and Glass, Lewis & Co. that help funds decide how to vote at corporate annual meetings.

The U.S. Securities and Exchange Commission could ultimately use points raised by industry critics and other participants at the session to set new rules - such as disclosure requirements - on the proxy advisers. The agency is hosting the session, billing it as a roundtable discussion with leaders of the advisers, fund firms, companies and academics.

With contentious proxy battles becoming more common, skeptics have zeroed in on the role of mutual funds and other clients of the proxy advisers. Critics, some aligned with business groups like the U.S. Chamber of Commerce, say they worry that big investors have effectively outsourced their voting to the advisers to save money without concern for companies' best interests.

It is a sore point for mutual fund firms, especially smaller ones with less staff to evaluate voting at the thousands of companies whose stocks they own.

The funds' costs could rise, depending on what new rules emerge, said Jill Fisch, a University of Pennsylvania law professor. The current system, she said, "is an incredibly low-cost way of collecting a huge amount of information for many large institutional investors. The alternatives are likely to be less efficient and more expensive."

One debate is how many strings the proxy advisers pull. Fund companies such as Dimensional Fund Advisors, Invesco Ltd and Wells Fargo & Co's asset management arm voted as much as 99 percent of the time with the proxy advisers on executive pay questions, a study led by Stanford University professor David Larcker recently found.

But another recent paper, published in the Harvard Business Law Review by Penn's Fisch and others, found voting by big fund firms like Fidelity differed "substantially" from ISS on director elections. The authors wrote that "more funds seem to blindly follow management recommendations than blindly follow ISS."

Representatives for Dimensional, Wells Fargo, Fidelity and other fund firms did not make executives available to comment. Invesco said in a statement that its investment teams treat proxy adviser research "as one of many research tools in determining how to vote a proxy."

BLIND VOTING

The focus on funds marks a new twist after years of complaints about proxy advisers, often from businesses that are the target of negative vote recommendations, such as on executive pay or director elections.

SEC Commissioner Daniel Gallagher warned in July that the SEC had created a regulatory environment that has allowed investment advisers to adopt a mindset in which they blindly vote in line with proxy adviser recommendations.

Gallagher, a Republican, said in the speech that he has "grave concerns as to whether investment advisers are indeed truly fulfilling their fiduciary duties when they rely on and follow recommendations from proxy advisory firms."

Speaking at a corporate-governance conference on Tuesday, Gallagher also acknowledged differences between larger and smaller fund firms when it comes to proxy voting. One solution might be to revise rules that now compel smaller firms to cast votes.

"Why are we making everyone vote on every vote?" he asked.

Another critic has been Nasdaq OMX Group General Counsel Edward Knight. He said this fall that the proxy advisers "exert outsized influence from the shadows."

Speakers at Thursday's SEC event will include executives from BlackRock Inc., and Charles Schwab Corp.

The SEC has done little in the area since a report in 2010 that noted how proxy advisers face potential conflicts such as when they provide both voting recommendations and consulting services to corporations seeking help with proposals. Another complaint is that the firms say too little on how they decide their voting recommendations.

The SEC sought public opinions on solutions it outlined - but did not act upon - in the 2010 report, such as regulating proxy advisers like credit-rating agencies, or having them disclose more about how they handle complaints.

It is not clear if the five-member SEC will take any action. Speaking to reporters on Tuesday at the conference where Gallagher appeared, SEC Chair Mary Jo White did not take a position on the proxy advisers and said Thursday's event will help in "identifying what the problems are and whether further market or regulatory responses are needed and if so, what the responses should be."

The advisers have defended their records. K.T. Rabin, chief executive of closely held Glass Lewis, said similarities between how investors vote and her company's recommendations only show their similar concerns. Top asset managers, "despite what some misguided academics suggest, are not shirking their fiduciary responsibilities," she said via e-mail.

In an e-mailed statement, ISS said it helps clients make sense of governance issues that are "voluminous and complex, and ISS works hard to ensure that clients have all the tools they need to make informed voting decisions." ISS of Rockville, Maryland, is a unit of MSCI Inc but is up for sale

Proxy adviser clients also include hedge funds and endowments, but mutual fund firms get the most heat because their voting records are public.

Jack Zwingli, CEO of Incentive Lab LLC, a Scottsdale, Arizona, compensation analysis firm, said one outcome could be that big investors would have to buy research from multiple proxy advisers - expenses that would hit smaller firms harder.

"It would be painful for them," Zwingli said.

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