May 10, 2012

Proxy advisors: Who are these guys?

Yvan Allaire | Financial Post

ISS backed Pershing long before CP battle

The news that an American firm had come out in support of Pershing Square Capital’s slate of directors for the board of Canadian Pacific was ­received with bluster and fanfare in Canadian media.

There is something strange, even bizarre, in an American outfit making pronouncements about the fate of a Canadian company, the pronouncements received as the oracular output of impartial, independent and benign observers. But who are these guys?

They are “proxy advisors” doing a booming business advising institutional investors on whether to vote against some or all members of the board; they also advise their clients on whether to vote for or against the various proposals submitted to shareholders in the annual ritual of shareholders meeting.

ISS (Institutional Shareholders Services) is the largest “proxy advisor” by a wide margin, with Glass Lewis, owned by the Ontario Teachers’ Pension Fund, a distant second.

ISS is the same outfit that advised institutional investors to vote in favour of the egregious Magna deal with its founder; the same outfit that urged investors to agree to the takeover of Potash by foreign acquisitors — and the same outfit that recommended investors vote against the takeover of Casey’s chain of American convenience stores by Alimentation Couche-Tard!

ISS was bought in 2006 by Risk Metrics, a firm offering all kinds of consulting services to hedge funds, investors and companies. Then, in 2008, Risk Metrics became a publicly listed company with the usual imperatives to grow revenues and earnings per share. In 2010 Risk Metrics itself was bought by stock-market-listed MSCI, a firm offering multiple services to institutional investors.

How has it come to pass that an advisory firm wielding considerable influence could become part of a publicly traded entity, mixed in with other businesses offering all sorts of services on risk management, compensation, governance, mergers and acquisitions to clients who may benefit hugely from the voting recommendation of the proxy advisory division? Can’t anyone see the conflicts of interest lurking in this arrangement?

Indeed, many do, including the U.S. Securities and Exchange Commission, which issued a “concept release” in November 2009 requesting comments and suggestions on what to do about “proxy advisors.” The “concept release” singles conflicts of interest as the area of most concern, giving several examples of how such conflicts might arise, among them if a shareholder engages the proxy advisory firm for advice on voting recommendations in an effort to garner the firm’s support for its shareholder proposals. Moreover, the proxy advisory firm “might recommend a vote in favour of a client’s shareholder proposal in order to keep the client’s business.” (SEC, concept release, 2009.)

The SEC was deluged with informed comments, telling examples and drastic recommendations for action, but, overwhelmed by the implementation of the Dodd-Frank Act, has not taken any action yet.

In its submission to the SEC, U.S. law firm Wachtell, Lipton, Rosen and Katz writes that “at a minimum, proxy advisory firms should be required to disclose in their recommendations whether the advisor has, currently or within the recent past, been engaged by any participant in the relevant proxy contest, whether any of the interested parties in a contest subscribe to the proxy advisory firm’s services, and the aggregate fees paid by the interested parties to the proxy advisory firm.”

Pershing Square Capital has been involved in two bitter proxy contests over the last few years; in both ISS played a significant role.

In 2007, Pershing sought to get eight of its nominees on the board of Ceridian, a global business services company in the human resources, transportation and retail markets. ISS came out in support of several of the Pershing nominees, while other proxy advisors sided with management. The contest was settled with the election of four board members of the Pershing slate, but the company was quickly sold for $5.3-billion to a private-equity fund at considerable profit for Pershing.

Then, in 2009, Pershing engaged in a very acrimonious proxy fight to get its nominees on the board of Target, the huge American retail company with sales in excess of $60-billion and some 350,000 employees. Again, ISS basically supported Pershing’s stance when other proxy advisors recommended supporting the management of Target. The company issued a scathing rebuttal of the ISS report and shareholders overwhelmingly supported management, inflicting a huge loss on Pershing Capital.

Now, the Ontario Teachers’ Pension Plan has come out in favour of the nominees of Pershing Square Capital and so did, no surprise here, its subsidiary, proxy adviser Glass Lewis.

Indeed, why would institutional investors who claim to have the kind of resources needed to make wise investment decisions listen to the advice of an outfit like ISS on what’s best for their CP shares? Why give so much uncritical media coverage to the opinions of these outfits?