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SEC Proxy Rules and the Need for Further Analysis

This post is the third in a series on corporate governance, guest-authored by experts from around the country, and intended to elevate differing perspectives and new ideas. The Bipartisan Policy Center recently launched a corporate governance project which is exploring the role of corporations in today’s ever-evolving society.

Job Title: Associate Professor of Finance and Giuriceo Family Faculty Fellow

Current Employer: Boston College

Bio: Nadya Malenko is an Associate Professor of Finance and Giuriceo Family Faculty Fellow at the Carroll School of Management at Boston College. Her research examines shareholder voting, the design of corporate boards, shareholder activism, and the allocation of authority in organizations. Her papers have been published in the Journal of Finance, American Economic Review, Review of Financial Studies, and Journal of Financial Economics. Professor Malenko received her Ph.D. in Finance from Stanford University. She is an Associate Editor at the Journal of Finance, Review of Financial Studies, and Journal of Corporate Finance, and is a member of the board of directors of the Finance Theory Group, Financial Intermediation Research Society, and Midwest Finance Association.

Over the past 18 months, there has been significant debate in corporate governance circles surrounding the role of proxy advisors, their influence on companies’ corporate governance practices, and their interaction with institutional investors. In August 2019, the U.S. Securities and Exchange Commission (‘SEC”) published guidance on the use of proxy advisors by investment advisors and, shortly after in November, issued a proposed rule amending exemptions from the proxy rules for proxy voting advice.

I have spent significant time studying shareholder voting and proxy advisors. Together with my colleagues Yao Shen and Andrey Malenko, I have published separate papers that found, respectively, that recommendations from Institutional Shareholder Services (ISS) can have a significant influence over shareholder voting; and that how beneficial proxy advisors’ recommendations are in informing shareholder voting depends on the firm’s ownership structure.

When contributing to the SEC’s Roundtable on the proxy process in November 2018, both pieces of research were submitted in order to aid the SEC’s considerations. In submitting our paper, Andrey Malenko and I made the point that any action from the SEC should carefully consider the effects any rule would have on two aspects of the proxy advisor industry:

  • institutional investors’ incentives to perform independent governance research; and,
  • proxy advisors’ incentives to produce high-quality recommendations.

Having reviewed the rule proposed by the SEC, I recognize there are benefits to its formulation. There remain issues around transparency and conflicts of interest in the proxy advisor industry and, in combination with the guidance issued in August, disclosure of potential conflicts of interests and enhancements to report accuracy are positive steps.

Nonetheless, as with the introduction of any piece of legislation or regulation, there is a balance to be struck between the benefits and costs. The detail and explanation of the proposed rule appears to have focused on the benefits that will accrue to market participants, without necessarily weighting the potential costs of its imposition. As part of proposing a significant change to the operation of a hugely influential segment of corporate governance and capital markets, I believe there could be a more rigorous discussion and quantitative analysis as to the costs of the regulation.

In addition to the comment letter noting concern with two specific aspects of the rule, I believe that greater analysis of the following areas would serve to enhance the final rule or allay the concerns voiced by a number of stakeholders:

  1. The extra burdens and timing required for a review period of five business days may place significant pressure on investors and might inhibit their ability to thoroughly evaluate proxy advisors’ reports.
  2. Given the change in exemptions, further analysis of the impact of removing the exemptions on proxy advisors’ incentives to offer potentially controversial recommendations would be welcome.
  3. As things stand, the overly concentrated proxy advisor market may be preventing better service being provided to institutional investors. Given that the new regulation may place additional costs on any future market entrants, the proposed rule may further entrench the two current large advisors.

In addition, over the past number of years, proxy advisors have made efforts to ‘self-regulate’ and attempt to achieve higher standards in terms of allowing issuer input and ensuring accuracy of reports. ISS provides issuers with draft reports prior to publication – albeit just to the S&P 500 – while Glass Lewis has implemented a number of services to promote greater engagement between issuers, themselves, and investors.

Therefore, as things stand, further analysis may be needed to ensure the benefits of the proposed regulations clearly outweigh the negatives, or, to demonstrate how the rule will be superior to the steps taken by major proxy advisors themselves. This is particularly true of the removal of exemptions for proxy advice and the introduction of a five-day review period for reports. That is not to say that the evidence justifying the implementation of these aspects of the rule does not exist; however, my view is that more time and analysis is necessary to justify such changes. By conducting such analysis, the SEC would provide assurances to all stakeholders that the trade-offs are necessary and provide the most effective way to achieve the aims of modernizing and improving the efficiency of proxy advisors’ impact on corporate governance and capital markets.

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