Corporate Governance, who is guarding the guardians?

Mark Cobley
26 Nov 2007

Voting advisers to fund managers are under fire. The forthcoming stock market listing of RiskMetrics Group, a US portfolio risk analysis provider, has raised issues over the ownership and influence of proxy voting agencies.

Proxy agencies advise fund managers and pension funds how to vote at company meetings. As a result of stringent regulatory issues, they have always wielded great influence in the US but they are becoming more important in Europe because of growing cross-border voting driven by regulatory change.

RiskMetrics is backed by a private equity consortium led by General Atlantic Partners, Spectrum Equity Investors and Technology Crossover Ventures. It bought Institutional Shareholder Services, one of the most prominent proxy agencies, in January.

RiskMetrics has been criticised for not being sufficiently open in the run-up to its flotation. Bill Parish, an Oregon-based independent analyst and corporate governance specialist, has written to the US Securities and Exchange Commission asking it to suspend the listing because of insufficient disclosure on the part of RiskMetrics’ backers.

Parish said: “RiskMetrics owns the leading proxy firm and it is not being public about its ownership structure. Who is it that ultimately owns ISS? It is the investors in those private equity firms’ funds but we don’t know who they are.

“A public listing also raises questions. Why is it that no proxy adviser has done it before? There is a reason for that. What if some hedge fund came along and built a 20% stake in RiskMetrics?”

The big proxy voting agencies are privately owned, which makes them independent but critics argue that means they have no obligation to comply with the corporate governance standards to which they hold others.
The ownership of firms matters, as Glass, Lewis, a US competitor of ISS, has discovered.

Glass, Lewis, the second-biggest proxy agency, was bought by Xinhua Finance, a Shanghai-based financial information group, last December. Although privately owned, Xinhua Finance had a relationship with the Chinese state that proved controversial in the US, including a non-compete clause with state information outlet Xinhua.

Two Glass, Lewis directors resigned in May, with Jonathan Weil, former managing director, saying he was “uncomfortable and deeply disturbed by the conduct, background and activities of our new parent company”.

Xinhua sold the proxy agency in October for the same price it paid – $46m (€31m) – to Ontario Teachers’ Pension Plan, one of Canada’s largest retirement funds. The same month, the $52bn US Washington State Investment Board, which is a client of Glass, Lewis, cancelled its search for a new proxy adviser when Xinhua sold the agency. A spokeswoman for the fund’s board said the Ontario purchase of Glass, Lewis had “eased a lot of concern”.

Parish said a public pension plan was probably the best owner for a proxy firm, since they are accountable and transparent. However, Stephen Davis, a fellow at Yale University’s Millstein Center for Corporate Governance and Performance, said he did not consider the ownership issue so important. He said: “I am not convinced an IPO will make a difference to their commercial motivations. The bigger issues for the proxy firms are about how transparent they are and how they manage their conflicts of interest.”

Another criticism levelled at the agencies is one of market dominance. ISS is by far the biggest in the world, with more than 2,700 clients, 1,700 of which are in the US. The other four US firms – Glass, Lewis, Proxy Governance, Marco Consulting Group and Egan-Jones Proxy Services – have between 400 and 100 US clients each.

The main European competitors to ISS are Manifest, a UK agency, and the European Corporate Governance Service, a network of six agencies led by UK adviser Pirc, known for its activist voting recommendations. Both UK companies are privately owned.

The US agencies have been building their presence in Europe as European Union regulatory reform designed to encourage cross-border voting has resulted in the region becoming a growth market for proxy advice. The theory is that investors operating outside their home markets are more likely to buy advice and follow the agencies’ recommendations, potentially handing them more power.

Fund managers and governance specialists say the growing numbers of European investors operating outside their home markets may mean they are less familiar with local governance practices.

Only 27% of issued shares on the German Dax 30 are in German hands, while 46% of France’s CAC 40 is domestically owned, according to Manifest. Dutch investors own only 15% of the AEX, the Netherlands’ main index.

Manifest said US investors accounted for the biggest share of foreign ownership. Six of the largest 20 investment managers in Europe are of US origins, with Capital International taking the top spot.

Colin Melvin, chief executive of equity ownership services at UK asset manager Hermes, said there was a perception that US mutual fund managers stuck to their advisers’ line. US regulations mean mutual funds are obliged to vote, which Melvin said could lead to “unthinking” voting.

He said: “The proxy advisers have come in for criticism, particularly in the US. They are being done a disservice by their clients, who take their recommendations not as useful input but as the answer.”
However, this summer, following a nine-month investigation, the US Government Accountability Office gave the advisers a largely clean bill of health.

The report said: “The fact that large institutional investors cast the great majority of proxy votes … and reportedly place less emphasis than small institutions on research and recommendations could limit the overall influence advisory firms have on proxy voting results.”

Nevertheless, concerns have persisted. Australia-based remuneration consultancy Guerdon Associates said in October: “We were surprised at the conclusions of the report, which played down the influence of proxy advisers and the US firms’ conflicts of interest.”

Sarah Wilson, chief executive of Manifest, said there was tension between the US and European approaches to corporate governance, which could arise if US investors did not bend to local practice.

She said: “The SEC has a different approach to the European regulations. The US has no equivalent of the UK’s combined code on corporate governance. That means you get competition between the proxy advisory firms on policy issues. It becomes about whether one agency has a tougher governance policy than another agency. In Europe, the focus is more on execution – who has the better and faster service.”

Jean-Nicolas Caprasse, European managing director of ISS, said his company did not track how far its clients followed its voting recommendations but said about 60% in Europe insisted on having research tailored to their governance policies, suggesting they were forming their own opinions.

He said: “When we see our largest mutual fund clients in the US they are taking this much more seriously. Many have formed governance groups and we do a lot of education for them on European governance practices.”

Paul Hewitt, a researcher at Manifest, said: “We do not want to get to a position where the investors are not the ones that take the decisions. We have to ensure companies get involved in dialogue with investors, not proxy advisers.”

• The leading voting advisory firms in detail

ISS Governance Services
Founded: 1985
Based: New York

Ownership: RiskMetrics Group, backed by an investor consortium led by General Atlantic Partners, Spectrum Equity Investors and Technology Crossover Ventures

Chief executive: John Connolly, who is also president of RiskMetrics Group
Market reach: 2,750 clients worldwide, with more than $30 trillion of assets. Also incorporates Rrev, the UK corporate governance service founded in a joint venture with the National Association of Pension Funds and bought by ISS last year

Approach: Offers governance research with or without recommendations, and an electronic voting platform. It will also tailor research to clients’ policy preferences

Glass, Lewis
Founded: 2003
Based: San Francisco
Ownership: Acquired in October by the Ontario Teachers’ Pension Plan, one of the largest public funds in Canada
Chief executive: Katherine Rabin
Market reach: 350 US clients; worldwide clients with $13 trillion under management
Approach: Offers governance research and recommendations, with or without a voting platform

Egan-Jones Proxy Services
Founded: 2002
Based: Wynnewood, Pennsylvania
Ownership: Part of Egan-Jones Ratings Company
Chief executive: Sean Egan
Market reach: 400 US clients
Approach: Research, recommendations and voting services. Declines to provide consultancy services to company management, unlike its US competitors, on the grounds of conflicts of interest

Pensions & Investment Research Consultants
(Linked to European Corporate Governance Service)
Founded: Pirc 1986; ECGS 2002
Based: London
Ownership: Founders and principal directors
Chief executive: Alan MacDougall
Market reach: Pirc has 100 clients in Europe, with £75bn (€104bn) in assets. Its European partners are Proxinvest of France, DSW in Germany, Sustainable Governance in Switzerland, Dutch Sustainability Research in the Netherlands and Corporate Governance Services Spain. ECGS has 29 clients with about £80bn under management.
Approach: Research, recommendations and outsourced voting. Pirc’s background is in public-sector pension funds and it adopts a hawkish stance on corporate governance

Manifest
Founded: 1995
Based: London
Ownership: 55% owned by management; 27% by the Graphite Enterprise Trust, a private equity investment trust; and 18% by the HSBC Enterprise Fund
Chief executive: Sarah Wilson
Market reach: Undisclosed, though it is believed to be smaller than ISS in terms of European client reach, and of a similar size to Pirc
Approach: Governance research and a voting platform. Unusually, Manifest makes no voting recommendations in its research, choosing instead to flag issues and leave decisions to investors