Senate Banking Committee Hearing on the Proxy Process
Senate Banking Committee
“Proxy Process and Rules: Examining Current Practices and Potential Changes”
Thursday, December 6, 2018
Key Topics & Takeaways
- Conflicts of Interest: Gallagher said there are two types of conflicts of interest: proxy advisory firms provide consulting services to the issuers they’re providing recommendations on; proxies can also provide advice to institutional investors, some who pay more in fees than others, which can cause an outsized influence by one investor over another.
- Need for Regulation: Gallagher said that there needs to be a role for the SEC in this space. Garland said it depends on what that regulation would look like, and they would oppose regulation that slows access to information, compromises independence, or imposes significant costs.
- Corporate Accountability: Garland explained that shareholder proposals ares a “critical tool,” calling accountability “key” for setting an appropriate tone for ethical conduct. Garland also highlighted the “up the ladder” provision, in which management can be held financially responsible for misconduct resulting from a supervisory failure, as a way of ensuring accountability.
Witnesses
- The Honorable Daniel M. Gallagher, Chief Legal Officer and Former Commissioner, Mylan N.V. and the U.S. Securities and Exchange Commission
- Michael Garland, Assistant Comptroller, Corporate Governance and Responsible Investment, Office of the Comptroller, New York City
- Thomas Quaadman, Executive Vice President, U.S. Chamber of Commerce Center of Capital Markets Competitiveness
Opening Statements
Sen. Mike Crapo (R-Idaho), Chairman
In his opening statement, Crapo noted a number of issues related to the proxy voting system that need to be addressed, including the role of proxy advisory firms, the shareholder proposal process, and retail shareholder participation. Crapo said that shareholder engagement is a hallmark of the public capital markets and called the proxy process a “fundamental” component of that engagement. Crapo commented that the existing rules on the issue have not been examined in decades, and in that time there has been a number of changes to the proxy environment. Crapo added there has also been a rise in the number of proposals pursuing an environmental, social, or political agenda, many of which have nothing to do with the company’s performance. Crapo noted that Securities and Exchange Commission (SEC) Chair Jay Clayton has expressed concern that the voices of long-term retail investors are being underrepresented or selectively represented in corporate governance, and that it is unclear if the current proxy rules promote the long-term financial interests of those investors.
Sen. Sherrod Brown (D-Ohio), Ranking Member
In his opening statement, Brown said too often corporate boards and executives focus on short-term profits instead of long-term investments in their companies and their workers. Brown said that many companies are not making decisions in the best interest of themselves, their customers, or their workers, necessitating more shareholder engagement, criticizing bills that would “undermine” shareholders’ oversight of the companies they own and make it harder for institutional investors to have timely access to research and analysis from proxy advisory firms that the investors have hired. Brown concluded that shareholders of all sizes deserve to have every tool available to hold executives accountable.
Sen. Jack Reed (D-R.I.)
In his opening statement, Reed discussed his legislation, S. 3614, the Corporate Governance Fairness Act, noting that it has bipartisan support. Reed said investors have been clear that continued access to proxy advisory firms is critical, and it is therefore important to ensure proxy advisory firms are appropriately regulated and held accountable.
Testimony
The Honorable Daniel M. Gallagher, Chief Legal Officer and Former Commissioner, Mylan N.V. and the U.S. Securities and Exchange Commission
In his testimony, Gallagher said that during his time at the SEC, few issues generated as much discussion or controversy as the proxy voting system, and that these issues have only become more pronounced. Gallagher said the intensity of the debates are evidence of the importance of the issue to the U.S. economy, and that many of the issues are the exact technical matters that independent agencies like the SEC were created to address. Gallagher added that despite the SEC’s “deep expertise” in proxy voting issues, they are operating in a “antiquated” statutory framework and the time is ripe for meaningful Congressional attention.
Michael Garland, Assistant Comptroller, Corporate Governance and Responsible Investment, Office of the Comptroller, New York City
In his testimony, Garland discussed how the Comptroller of New York utilizes proxy advisory firms in its role as the trustee and advisor to public pension funds. Garland said that the most cost-effective way they can protect and create shareholder value is to be an active owner, exercising their legal rights as shareowners, and actively vote their proxies. He added that their capacity to fulfill their fiduciary responsibilities relies on the timely receipt of expert independent proxy research and the ability to submit shareowner proposals. Garland said that additional regulation on proxy advisors would increase costs and delay research with no benefit to their process, and that critics of proposal rights and proxy advisors are seeking to solve a problem that does not exist.
Thomas Quaadman, Executive Vice President, U.S. Chamber of Commerce Center of Capital Markets Competitiveness
In his testimony, Quaadman noted there are three important issues related to proxy voting: a lack of oversight of the proxy advisory duopoly; the distraction of boards and inefficient use of company assets; and the disenfranchisement of retail investors. Quaadman added there are additional issues with proxy advisory firms, including their fiduciary obligations and conflicts of interest stemming from a lack of disclosure to the public if a shareholder proponent is also a consulting client of a firm. Quaadman expressed his support for a transparent process and dispensation of proxy advice, recommending that proxy advisory firms should certify recommendations are based on materially accurate information, should disclose conflicts, and should disclose to the public if a shareholder is also a proponent, saying it is time for the SEC and Congress to act.
Question & Answer
Role of Retail Investors
Crapo asked about the role of retail investors in this space. Gallagher said the retail investor voice has been largely lost, and is often different from the perspective of the institutional investor.
Environmental, Social, and Political Investing
In response to questions from Sens. Pat Toomey (R-Pa.), Brian Schatz (D-Hawaii) and Crapo about environmental, social, and political investing, Quaadman said these proposals make up over 50 percent of those submitted, yet almost none pass. He said those proposals are often not linked to economic return.
Corporate Accountability
Brown asked how shareholder proposals help hold management accountable. Garland explained that it is a “critical tool,” calling accountability “key” for setting an appropriate tone for ethical conduct. Garland also highlighted the “up the ladder” provision in which management can be held financially responsible for misconduct resulting from a supervisory failure, as a way of ensuring accountability. Asked if regulatory burdens on proxy advisory firms could limit investors’ ability to hold management accountable, Garland said it could compromise their independence, and noted that the timing of the receipt of proxy research is very important and should not be compromised.
Conflicts of Interest
Sen. John Kennedy (R-La.) asked if proxy advisory firms have conflicts of interest. Gallagher said there are two types: proxy advisory firms provide consulting services to the issuers they are providing recommendations on, and proxies can also provide advice to institutional investors, some who pay more in fees than others, which can cause an outsized influence by one investor over another. Garland agreed that the practice of selling services to companies they provide ratings on is a conflict of interest.
Disclosure
Sen. Catherine Cortez Masto (D-Nev.) asked if disclosing a conflict is enough to address it. Gallagher replied that is a premise of much of U.S. securities law, that disclosure is enough for investors to make an informed decision and disclosure “goes a long way.” Quaadman agreed, adding that under the current system, proxy advisory firms do not have to disclose all conflicts of interest, saying that disclosure also forces clients to manage those conflicts and ensure they are meeting the fiduciary duty they have to their own investors.
Need for Regulation
In response to a question from Cortez Masto about whether proxy advisory firms should be regulated by the SEC, Gallagher said that there needs to be a role for the SEC in this space. Quaadman agreed, saying there are flaws in the system that need to be addressed and there is a need for oversight. Garland said it depends on what that regulation would look like, and they would oppose regulation that slows access to information, compromises independence, or imposes significant costs.
Asked their top priorities for regulation, Quaadman said a disclosure of conflicts and an open and transparent process to ensure a level playing field. Garland and Gallagher echoed transparency with respect to conflicts and accountability. All stated their support for an explicit fiduciary responsibility.
Competition in the Market
Sen. Doug Jones (D-Ala.) asked about lack of competition in the proxy advisory market. Gallagher compared the issue to credit rating agencies, saying it is difficult to regulate without either regulating companies out of business or creating barriers to entry for new firms. Quaadman pointed out that two firms have tried to enter the market, but faced difficulties due to the power of the two large firms, saying that until another entrant is successful, the market needs regulation to level the playing field. Garland added that it is difficult for new firms to provide the tools needed to manage very large portfolios.
For more information about this hearing, click here.