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May 28, 2010
Proxy Advisory Services Come Under Increased Scrutiny
    by Robert Kropp

Pointing to the considerable proxy voting power and little oversight of companies such as RiskMetrics, critics call for increased regulation to avoid conflicts of interest.

When spoke earlier this month with Julie Tanner, Assistant Director of socially responsible investing (SRI) at Christian Brothers Investment Services (CBIS), she expressed disappointment in the recommendation to institutional investors by RiskMetrics Group’s proxy advisory service to vote against a shareowner resolution calling for the separation of CEO and chair at Goldman Sachs.

Tanner observed that the proposal, which nevertheless won a respectable 19% of the vote of shareowners, could have received as much as 15% more votes in approval if RiskMetrics had supported it. Two other major proxy advisory services did recommend a vote in favor of the proposal, but RiskMetrics, following its 2007 purchase of Institutional Shareholder Services (ISS) for $550 million, is by far the largest player in the field.

In a recent article posted on the website of
B usiness Ethics, author James Hyatt described the influence of RiskMetrics, which, he wrote, “by some estimates, advises half the world’s common stock.”

Hyatt continued, “RiskMetrics had $303 million of revenues in 2009; of that, almost half or $145 million came from the ISS segment. The company last year issued proxy and vote recommendations for more than 37,000 shareholder meetings in 108 countries and voted 7.6 million ballots representing over 1.3 trillion shares.”

“RiskMetrics in 2009 had 3,500 clients in 53 countries, including 70 of the 100 largest investment managers, 43 of the 50 largest mutual fund companies, and 42 of the 50 largest hedge funds,” Hyatt wrote.

However, RiskMetrics derives revenue from governance services that it provides to corporations as well. This year, following its acquisition of Innovest Strategic Value Advisors, an environmental, social and governance (ESG) investment research firm, RiskMetrics published its first list of top sustainable corporations, which it named the
Global ESG 100 Top-Rated Corporations.

Corporations contract with RiskMetrics for a service by which it advises them on how to improve their ESG rankings. As described in a
discussion draft published in March by the Shareholder Communications Coalition, RiskMetrics “provides corporate governance and executive compensation consulting services, in addition to providing voting recommendations on proposals submitted in shareholder elections.”

The draft continued, “Particularly as the SEC reviews its corporate disclosure requirements on these topics—and sustainability advocates increase their advocacy of specific shareholder proposals—this may create conflicts of interest between RiskMetrics' servicing of its institutional clients and the corporate consulting services it also provides.”

Another potential conflict of interest arises for RiskMetrics and other proxy advisory services when their institutional investor clients file a shareowner proposal on which the services will provide a voting recommendation.

RiskMetrics itself acknowledges a potential conflict of interest for its ISS subsidiary by stating, “We are also aware of the potential conflicts of interest that may exist between ISS’ proxy advisory service, which provides proxy analyses and vote recommendations to institutional investors, and the business of ISS Corporate Services, Inc. (“ICS”), which provides products and services to issuers consisting primarily of advisory and analytical services, self-assessment tools and publications.”

In March, the
Millstein Center for Corporate Governance and Performance published a Voti ng Integrity Policy Briefing, in which it recommended that proxy advisory services avoid conflict of interest by adopting “a code of professional ethics for the governance industry modeled on similar codes for other industries.”

However, calls for more stringent regulation are being heard as well. In its discussion draft, the Shareholder Communications Coalition recommended, at a minimum, that the Securities and Exchange Commission (SEC) require proxy advisory services to register as investment advisors. It also recommended that the SEC “require conflicts of interest disclosure for proxy advisory firms.”

Last November, Mary Schapiro, the Chairman of the SEC, said, “We'll be asking about the role of proxy advisory firms in corporate voting. Given the influence that these firms' recommendations have on corporate voting outcomes, we'll probe the need for rules to ensure that advisory firms are basing their research and recommendations on accurate and reliable information. And, that they are providing adequate disclosure of any conflicts of interest they may have in providing voting recommendations.”

In a Spring 2009 report entitled
The Case for Increased Oversight and Control, law professor Tamara Belinfanti argues for regulatory oversight of proxy advisory services that is analogous to that being developed by the SEC for regulation of credit rating agencies. Belinfanti also calls for the establishment of an oversight board for the industry, to “provide systematic accountability of proxy advisors.”

The questions that arise when considering the corporate activities of proxy advisory services are several. Can its ESG rankings of companies be accepted with full confidence by sustainability investors, when those rankings are often at odds with the ESG rankings of other investment research firms? Does the service RiskMetrics provides to guide a company to an improved ESG ranking guarantee a better ESG performance by that company?

Finally, when institutional investors and mutual funds outsource their proxy voting decisions to a third party, are they fulfilling their fiduciary duty to their clients, or should they engage more actively in the allocation of their votes?


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