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From Securities Regulation Daily, March 1, 2018

Institutional investors oppose legislation regulating proxy advisory firms

By Amanda Maine, J.D.

The Council of Institutional Investors and several other investor organizations, including the heads of many public pension systems, have sent a letter to Sens. Mike Crapo (R-Idaho) and Sherrod Brown (D-Ohio) expressing their opposition to the Corporate Governance Reform and Transparency Act of 2017. The Act, which passed the House in December 2017, would require proxy advisory firms to register with the SEC and impose additional regulations, ostensibly to improve transparency.

According to the CII, the legislation would upend shareholder access to independent research by requiring proxy advisory firms to share their research reports and proxy voting recommendations with the subject companies before they are shared with the investors who pay the firms for the research. CII took issue with the premise that large institutional investors simply rubber stamp proxy advisory firm’s recommendations, advising that they vote their proxies according to their own guidelines to help manage issues accompanying over 38,000 annual shareholder meetings.

Right to review. Giving corporate management the "right to review" the proxy advisors’ work before the reports go to the investors who paid for it is unprecedented, CII explained. This requirement would create a dynamic that would encourage the firms to view management, and not investors, as their research clients, CII wrote.

The right to review would also add significant regulatory burdens that would increase the cost proxy advisory services, CII stated, costs that would be passed on to the firms’ clients. It would also result in less time for investors to digest the advisor’s reports in the context of their own proxy voting guidelines, especially during the busy spring proxy season.

SEC assessment of proxy advisory firms. Another concern CII expressed with the legislation is requiring firms to confidentially file information with the SEC on the adequacy of their financial and managerial resources and to file with the SEC and publish the methodology it used for making recommendations. This goes against free-market principles, CII stated, noting that the entities that are in the best position to make assessments about the contractual provisions negotiated with clients are the firms, not the government. The letter pointed out that the SEC issued guidance in 2014 reaffirming that investment advisors have a duty to maintain sufficient oversight of proxy advisory firms, and that there is no evidence that the guidance is not being followed.

Increased costs with no benefits. According to CII, the proposed heightened regulation of proxy advisory firms could result in costs rising substantially and possibly cause some or all proxy advisory firms to exit the industry due to this cost. CII believes that the cost estimate of the legislation provided by the Congressional Budget Office underestimates the costs the bill would impose. CBO should reassess the costs, taking into account what the effect of reduced competition and enhanced pricing power of a surviving firm, as well as the effect of all current firms exiting the market, forcing investors to use other resources not subject to the new regulations.

The letter also notes that the Treasury Department’s October 2017 report on the financial system found that institutional investors find the services of proxy advisory firms valuable for sorting through the lengthy disclosures contained in proxy statements. In addition, the report did not recommend any legislative changes governing proxy advisory firms, CII pointed out.

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