Is the Pendulum Swinging? – SEC Commissioner Gallagher Expresses Concerns About Reliance on Proxy Advisors

by Dechert LLP

The role of proxy advisors has continued to attract attention from U.S. regulators and on Capitol Hill. Earlier this month, Commissioner Daniel M. Gallagher of the Securities and Exchange Commission (“SEC”)1 generated controversy when he expressed his view that the SEC should withdraw two 2004 no-action letters – issued to Egan-Jones Proxy Services and Institutional Shareholder Services, Inc.2 – that are credited with permitting advisers to rely on the recommendations of proxy advisory firms to vote shares on behalf of their managed accounts.

Commissioner Gallagher stated that, in his view, these no-action letters should be replaced by guidance indicating that advisers should be exercising their fiduciary duty in voting shares, “rather than engaging in rote reliance on proxy advisory firm recommendations.” Commissioner Gallagher indicated that, as a result of the no-action letters, investment advisers may “view their responsibility to vote on proxy matters with more of a compliance mindset than a fiduciary mindset.” Commissioner Gallagher’s comments, if implemented, could have a significant effect on those advisers that rely on proxy advisory firms.3


Annually, many advisers receive proxies relating to hundreds (or perhaps thousands) of companies held in their clients’ portfolios. In 2003, the SEC adopted Rule 206(4)-6 under the Investment Advisers Act of 1940 (“Advisers Act”), which requires registered advisers that have proxy voting discretion to adopt policies and procedures reasonably designed to ensure that they vote proxies in the best interests of their clients – and to disclose their policies, and how they actually voted for client accounts, to their relevant clients. At the same time, the SEC underscored its belief that one of an adviser’s fiduciary duties is to vote proxies.The SEC further noted that, although advisers may encounter conflicts of interest in voting proxies (for example, if they are asked to vote proxies with respect to affiliated companies), those conflicts could be avoided if the adviser has a pre-determined policy of delegating responsibility for voting proxies to an independent third party.  

In Commissioner Gallagher’s view, the Egan-Jones and Institutional Shareholder Services no-action letters issued by the SEC’s staff in 2004 broadened the scope of the SEC’s statement in the adopting release. These letters are widely followed by the industry and are viewed as essentially allowing advisers to determine, in accordance with the SEC’s statements in the proxy voting release and the terms of the letters, that voting in reliance on the independent proxy advisory firm’s voting recommendations as to proxy matters will insulate the voting decision from any conflicts of interest the adviser may have (and otherwise discharge the adviser's fiduciary duties and meet the requirements of the proxy voting rule that votes be cast in the client's best interest). Indeed, since 2004, many advisers have routinely relied on proxy advisory firms to avoid the substantial costs they might incur in undertaking an analysis of each and every proxy matter during proxy season.

Proxy Advisory Firms Face Continued Scrutiny

Underlying Commissioner Gallagher’s concerns has been the attention focused in recent years on the broader role of proxy advisory firms in corporate governance. Two firms, MSCI Institutional Shareholder Services, Inc. and Glass Lewis & Co., LLC, are cited as providing 97% of all proxy advisory services – together, they are estimated to account for the manner in which 38% of proxies are voted annually by institutional shareholders.5

The dominant role of proxy advisory firms in shareholder democracy, their opaque nature, and potential conflicts of interest have been the subject of SEC and Congressional inquiries recently. In 2011, the SEC issued the Proxy Concept Release,6 which inquired about the role of advisory firms. More recently, the House of Representatives Financial Services Subcommittee held hearings regarding the influence that the firms have on corporate governance through their analysis and voting recommendations.7

Issuers have complained loudly about the influence of proxy advisory firms. Echoing their concerns, Harvey L. Pitt, a former Chairman of the SEC, testified at the hearings on behalf of the U.S. Chamber of Commerce. He summarized the issues (consistently with Commissioner Gallagher’s more recent remarks), as follows:

Unfortunately, advice provided by ISS and Glass Lewis is not tailored to the interests of the shareholders of each firm’s investment portfolio manager clients, nor is it formulated with any consideration of the stated policies and purposes of the portfolios housing the equity securities to which the recommendations relate. Given the huge percentage of the vote likely controlled by ISS and Glass Lewis, the failure of an issuer to comply with those firms’ preferred policies saddles issuers with a large number of negative votes before voting has even begun. Proxy advisors, therefore, also can affect valuations and the ultimate outcomes of contests and specific transactional matters. As a result, ISS and Glass Lewis have become the de facto standard setters for corporate governance policies in the U.S. (Emphasis in original).8

Proxy firms have also been the subject of criticism for potential conflicts of interest that may be inherent in their business model.9 For example, some commenters have noted that clients of proxy firms include pension plans run by unions and politically motivated individuals that pursue social agendas that may be reflected in the firm's voting recommendations, even when not consistent with the economic interests of shareholders. In addition, proxy firms may also advise issuers on corporate governance issues, while also assigning the issuers corporate governance ratings and making recommendations to advisers on voting decisions that may relate to those same issuers.10


Many investment advisers rely heavily on proxy advisory firms to assist them in voting proxies, since it is often impractical to perform due diligence on every individual proxy measure. However, there is growing frustration among issuers that proxy advisory firms have become gatekeepers of corporate governance. This frustration has been exacerbated recently with the enactment of “say on pay” rules that require approval of corporate compensation practices – and have resulted in advisers placing increased reliance on proxy advisory firms. 

If Commissioner Gallagher’s comments become the views of the SEC, the pendulum may now be swinging in the other direction. Regardless of the extent to which regulation of corporate governance might be appropriate, concerns that the power to alter corporate practices effectively rests with a small group of largely unregulated private firms may be well-founded. Requiring advisers to devote additional resources to evaluate significant proxy matters could give issuers a greater opportunity to seek support for their proposals and lessen the influence of the proxy advisory firms. At the same time, however, any changes to the present system should seek to balance the costs that may be imposed on advisers and shareholders of undertaking individualized due diligence efforts on routine or immaterial proxy matters. These competing interests should be carefully weighed by the SEC, its staff, and Congress when considering further action on proxy voting issues.


1. Remarks of Commissioner Daniel M. Gallagher before the Society of Corporate Secretaries and Governance Professionals (July 11, 2013).

2. Egan-Jones Proxy Services, SEC No-Action Letter (May 27, 2004), available here;  and Institutional Shareholder Services, Inc., SEC No-Action Letter (Sept. 15, 2004), available here.

3. Commissioner Gallagher’s most recent comments echoed those he made in May of this year. See, Commissioner Daniel M. Gallagher, Remarks of at the 12th European Corporate Governance Law Conference (May 17, 2013) (expressing similar views and stating “I am concerned that unless these no-action letters are reviewed and possibly revisited, the SEC may find it difficult to ensure that fiduciaries are conducting proper due diligence with respect to proxy votes”), available here.

4. Proxy Voting by Investment Advisers Final Rule, Rel. No. IA-2106 (Mar. 10, 2003), available here.

5. See Chamber Statement, infra note 8, citing J. Glassman & J. Verret, How to Fix our Broken Proxy Advisory System, Mercatus Center, George Mason University (Apr. 16, 2013), available here, and  Ertimur, Yonca, Ferri, Fabrizio and Oesch, David, Shareholder Votes and Proxy Advisors: Evidence from Say on Pay, 7th Annual Conference on Empirical Legal Studies Paper (Feb. 25, 2013) (since updated), available here.

6. Concept Release on the U.S. Proxy System (July 14, 2010), available here.

7. Capital Markets and Government Sponsored Enterprises Subcommittee Hearing entitled “Examining the Market Power and Impact of Proxy Advisory Firms” (June 5, 2013), available here

8. Statement of the U.S. Chamber of Commerce (June 5, 2013) (footnotes omitted) (“Chamber Statement”). Along the same lines, Commissioner Gallagher noted in his speech:

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, especially given the fact that such recommendations are often not tailored to a fund’s unique strategy or investment goals…. I believe that the Commission should fundamentally review the role and regulation of proxy advisory firms and explore possible reforms, including, but not limited to, requiring them to follow a universal code of conduct, ensuring that their recommendations are designed to increase shareholder value, increasing the transparency of their methods, ensuring that conflicts of interest are dealt with appropriately, and increasing their overall accountability.

9. See e.g., Fixing the Broken Proxy System (April 23, 2013) (Bloomberg News), available here.   

10. Proxy firms, some of which are registered as investment advisers under the Advisers Act, have also drawn fire for having inadequate policies and procedures. In a recent administrative proceeding brought against a proxy firm that was a registered adviser, the SEC found that the firm had violated Section 204A of the Advisers Act by failing to establish and enforce policies and procedures reasonably designed to prevent the misuse of material, nonpublic proxy voting information provided to the firm by its institutional shareholder clients. See  Institutional Shareholder Services, Inc., Investment Advisers Act Rel. No. 3611 (May 23, 2013).


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