In recent years, the role of proxy advisory firms in the Canadian capital markets has noticeably increased. Institutional investors, issuers and proxy advisory firms will be interested in the consultation paper of the Canadian Securities Administrators (CSA) published for comment in June 2012 regarding the potential regulation of proxy advisory firms. The consultation paper discusses concerns raised by certain market participants about the services provided by proxy advisory firms and the potential impact of those services on Canadian capital markets. This article summarizes these concerns and the potential implementation of related regulatory measures.
Proxy advisory firms typically review and analyze issuer or shareholder proposals put for vote at a shareholders’ meeting, then recommend that their client, usually an institutional investor, vote for or against such proposal. Currently, in Canada, proxy advisory firms are not subject to formal securities oversight.
The concerns discussed in the consultation paper are divided into five broad categories: (I) potential conflicts of interest; (II) perceived lack of transparency; (III) potential inaccuracies and limited engagement with issuers; (IV) potential corporate governance implications; and (V) the extent of reliance by institutional investors on the recommendations provided by proxy advisory firms.
I. Potential Conflicts of Interest
The CSA believes that potential conflicts of interest may compromise the independence of vote recommendations or create a perception that the independence of the vote recommendation has been compromised. A conflict of interest may exist if: (a) a proxy advisory firm provides vote recommendations to institutional investors on corporate governance matters for which the same firm has provided consulting services to the issuer; or (b) by virtue of the ownership structure of a proxy advisory firm.
The CSA recognizes that proxy advisory firms undertake certain measures to prevent conflicts of interest. However, it is not clear to what extent each proxy advisory firms’ policies and procedures are publicly available and whether making such policies publicly available would adequately address conflicts of interest. The CSA believes that a prohibition against a conflict of interest in the context of proxy advisory firm clients would only be appropriate where there is clear evidence of a material negative impact on market integrity. Further, the CSA suggests that proxy advisory firms be required to identify and control conflicts of interest through adequate organizational structures which are transparent to other market participants.
II. Lack of Transparency
According to the CSA, concerns regarding lack of transparency are a combination of: (a) the lack of disclosure about the procedures and criteria used to determine vote recommendations; and (b) lack of public disclosure of the actual report provided by the advisory firm to the client.
Because clients of proxy advisory firms pay a subscription fee for a vote recommendation, it may not be appropriate to require the reports prepared by an advisory firm for a particular client to be publicly disclosed. Accordingly, the CSA considers whether it would be more appropriate to require proxy advisory firms to disclose the internal procedures, guidelines, standards, methodologies, assumptions and sources of information supporting their vote recommendations.
III. Potential Inaccuracies and Limited Opportunity for Issuer Engagement
The CSA raises concerns with respect to inaccuracies in the underlying data used to prepare proxy advisory reports which may lead to potentially flawed decision-making analyses. In relation to these concerns, the CSA considers whether it would be appropriate to require proxy advisory firms to implement policies which address issuer comments on vote recommendations and the underlying analyses of such reports. Such policy would specify the process for issuer engagement and require that proxy advisory firms publicly disclose this process.
IV. Perceived Corporate Governance Implications
The CSA raises concerns that the current system grants to proxy advisory firms the de facto ability to set industry standards and, as a result, issuers are forced to adopt standards which may not suit their individual needs. The CSA cites a study conducted by the Center on Executive Compensation wherein 54% of survey respondents said they had changed or adopted a compensation plan, policy or practice in the past three years primarily to meet the standards of a proxy advisory firm. Moreover, the CSA states that some national corporate law firms actually instruct their issuer clients to consult the policies and guidelines of the major proxy advisory firms when devising corporate governance strategies and policies. To address these concerns, the CSA considers whether it is appropriate to require proxy advisory firms to implement fair and transparent procedures for developing corporate governance standards, which procedures would be publicly disclosed to market participants.
V. Extent of Reliance by Institutional Investors
The degree of reliance that an institutional investor places on the vote recommendation of a proxy advisory firm may range from complete reliance, which could include an automatic vote in accordance with the vote recommendation, or partial reliance, where institutional investors may conduct their own research and include a proxy advisor’s recommendations as part of their analysis. The consultation paper notes that there is very limited empirical information regarding the extent to which institutional investors rely on vote recommendations received from proxy advisory firms. As such, the CSA is currently considering the following: (a) how institutional investors view their voting obligations; (b) the extent to which various types of institutional investors rely on the services provided by proxy advisors; and (c) whether, and to what degree, institutional investors share the concerns described in the consultation paper.
We will continue to monitor and report developments in this area. If you have any questions about the potential regulation of proxy advisory firms and the impact that it may have on market participants, we encourage you to contact a securities lawyer in your local Miller Thomson office.