Canada: Potential Regulation of Proxy Advisory Firms

Last Updated: July 6 2012

Edited by Martine Guimond

In this issue:

  • Potential Regulation of Proxy Advisory Firms


By: David Taniguchi and Tina Woodside

On June 21, 2012, the Canadian Securities Administrators (the "CSA") released CSA Consultation Paper 25-401: Potential Regulation of Proxy Advisory Firms (the "Consultation Paper").  The consultation process was established by the CSA in response to concerns raised by market participants with respect to the role of proxy advisory firms in the Canadian capital markets.  Proxy advisory firms are not currently regulated under the Canadian securities law regime.

Proxy Advisory Firms & Their Role in the Capital Markets

Proxy advisory firms analyze, and make vote recommendations in respect of, matters to be voted on at shareholders' meetings.  Proxy advisory firms also offer administrative services designed to assist their institutional investor clients in voting their shares.  In executing votes on behalf of a client, the client may instruct the proxy advisory firm to vote based either on the proxy advisory firm's  vote recommendation or on the voting guidelines or specific instructions of the individual client.

In addition to providing proxy advisory and voting services, some proxy advisory firms also have issuer clients, to which they provide consulting services relating to corporate governance, executive compensation or the development of proposals to be submitted to shareholders. 

In Canada, the industry is dominated by two proxy advisory firms, each of which is headquartered in the United States – Institutional Shareholder Services Inc. and Glass, Lewis & Co., LLC (which is a wholly-owned subsidiary of Ontario Teachers' Pension Plan).

The degree of influence which proxy advisory firms have in the capital markets is not fully understood, nor do market participants unanimously agree that the influence of such firms is necessarily negative.  The Consultation Paper aims to solicit information about matters such as the ways in which institutional investors actually use the services of proxy advisory firms, how much reliance institutional investors place on the recommendations made by such firms, and, in general, to what extent the current business model of proxy advisory firms threatens the integrity of the Canadian capital markets.  The CSA is also seeking feedback on some possible regulatory responses to the concerns raised.

Concerns Raised & Potential Regulation

The Consultation Paper identifies the following concerns which it notes have primarily been raised by issuers and their legal advisers.

Potential Conflicts of Interest

Conflicts of interest may arise in many situations, such as:

  1. when a proxy advisory firm has provided corporate governance advisory services to an issuer, and subsequently provides a vote recommendation on that issuer's corporate governance matters;
  2. when an institutional investor client of a proxy advisory firm is a proponent of a specific shareholder proposal, and the proxy advisory firm provides a vote recommendation on that proposal; and
  3. when an owner of the proxy advisory firm (such as Ontario Teachers' Pension Plan, in the case of Glass, Lewis & Co., LLC) is an investor in issuers, and the proxy advisory firm provides vote recommendations which may impact such investments.

It has been suggested that conflicts of interest, if not properly identified and managed, could negatively impact the integrity of the voting process.  The CSA is considering whether proxy advisory firms should be required, through regulation, to develop and implement conflict of interest policies and procedures, to disclose those policies and procedures on their websites, and to disclose specific conflicts in reports to their clients.  The CSA is also seeking feedback on whether proxy advisory firms should separate their proxy voting services from the advisory or consulting services they provide.

Perceived Lack of Transparency>

Proxy advisory firms provide their full proxy voting reports only to their clients, who have paid a subscription fee for such reports.  However, the vote recommendation of a proxy advisory firm (without the full report to support that vote recommendation) will, on occasion, be disclosed to the public by issuers or shareholders, usually for strategic reasons.  In addition, concerns have been raised about the lack of disclosure (within the reports or otherwise) as to how proxy advisory firms arrive at their vote recommendations.  Without full disclosure, market participants may not be able to properly evaluate the merits of the vote recommendations.

The CSA is considering whether proxy advisory firms should be required to disclose the internal procedures, guidelines, standards, methodologies, assumptions and sources of information supporting their vote recommendations.  However, the CSA notes that, in determining whether such disclosure should be mandated, the CSA will have to consider the commercially sensitive and proprietary nature of the information.

Potential Inaccuracies and Limited Engagement with Issuers

Issuers have suggested that there is no well-defined or reliable process for engaging with proxy advisory firms to correct inaccuracies in proxy voting reports.  A flawed analysis underlying a vote recommendation could impair the quality of the vote, to the extent that such recommendation, or the underlying inaccuracy, is relied upon by shareholders. 

The CSA is requesting feedback on whether proxy advisory firms should be required to have a publicly-disclosed process to deal with issuer comments on vote recommendations and the underlying analysis.  The CSA is also considering whether certain terms of such process should be prescribed (for example, the length of time during which issuers would be given the opportunity to review a draft vote recommendation).

Potential Corporate Governance Implications 

Each proxy season, proxy advisory firms develop recommended corporate governance practices or standards.  Certain market participants are concerned that issuers are pressured to adopt "one-size-fits-all" corporate governance standards set by the proxy advisory firms, whether or not those standards are necessarily the most appropriate for the particular issuer in the circumstances.  Further, some have questioned whether proxy advisory firms are in the best position to be setting the standards of corporate governance, particularly given the lack of competition in the proxy advisory industry.  To the extent that there is no competitive pressure on the proxy advisory firms which dominate the industry, there is some concern that the quality of the recommendations made by such firms will suffer.

The CSA believes that public disclosure of proxy advisory firms' procedures for developing corporate governance standards could improve market participants' confidence in the standards set by such firms.  It is considering whether proxy advisory firms should be required to publicly disclose those procedures.

Extent of Reliance by Institutional Investors on Recommendations Provided

The concern has been raised that institutional investors may rely too much on the vote recommendations of proxy advisory firms, and that such vote recommendations are having an increasing impact on voting results.

The CSA notes that it is unclear to what extent institutional investors rely on vote recommendations made by proxy advisory firms.  Further, if such reliance is placed, the CSA is asking for feedback as to the reasons why institutional investors have decided to follow vote recommendations.  The CSA does not make any specific suggestions in the Consultation Paper to address the general concern raised.  Rather, it asks questions of institutional investors in the hopes that information will be provided which might assist the CSA in establishing its views.

Potential for Regulation

It should be emphasized that the regulation of proxy advisory firms is not a foregone conclusion.  In the Consultation Paper, the CSA expressly recognizes that proxy advisory firms provide capital market benefits and serve a market need.  It is clear that the CSA is reluctant to impose any obligations or restrictions on proxy advisory firms which might jeopardize the value they provide, especially given the current lack of information as to the extent of the problem.  Further, the CSA recognizes that proxy advisory firms are, in many cases, already voluntarily addressing the concerns raised, without regulatory intervention.  We would expect to see a regulatory response only if the concerns raised are validated, and are found by the CSA to have a negative impact on the integrity of the Canadian capital markets.

Request for Comment

The CSA is seeking input from all market participants as it determines whether or not regulatory intervention is warranted and, if so, what form that intervention should take.  Submissions to the CSA must be made by August 20, 2012.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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