The Securities and Exchange Commission has rescinded two guidance letters from 2004, a move that may reduce the influence proxy advisers have on say-on-pay and other shareholder votes.

The guidance letters informed investment management firms that outsourcing their proxy-voting decisions to proxy advisers would satisfy their fiduciary obligations to vote their shares, while avoiding potential conflicts of interest with regard to companies whose funds they manage.

For example, if an investment manager (like Vanguard) has proxies to vote on behalf of a company in one of its index funds, and also manages that company’s pension fund, it could conceivably be influenced to vote with management on the proxy matters, points out compensation and governance consultancy Farient Advisors.

By essentially delegating to proxy advisers the votes on its shares in that company, the investment manager would be “cleansed” of potential allegations of conflict, based on the 2004 letters.

Now, with that guidance rescinded, investment managers can choose to vote according to their determination of the merits of each proxy resolution, which may or may not correspond to proxy-adviser recommendations.

“Critics of the SEC guidance letters have argued that they effectively institutionalized proxy advisory firms, especially Institutional Shareholder Services (ISS), as de facto regulators without the oversight required of actual regulators,” Farient says. “The critics also have contended that over-reliance on such firms may not be in investors’ best interests.” (In addition to ISS, the other major proxy adviser is Glass Lewis.)

ISS’s business model is arguably built largely on regulatory requirements, especially the SEC’s 2003 rule mandating that investment managers disclose their proxy voting policies (and votes) and the 2010 Dodd-Frank Act, which mandated say-on-pay.

Many of the larger institutional investors have built internal governance expertise to guide voting decisions, using ISS data to help them screen companies to target. Smaller funds have generally found it more cost effective to essentially outsource their votes to ISS, according to Farient.

The larger funds, however, have outsourced many of their votes as well. That’s due partly to the 2004 guidance letters, “because they are more likely to sell investment management to the companies that they also invest in,” Farient says.

Research indicates that ISS has gained significant influence over shareholder voting and, consequently, over corporate governance policies.

“As its influence has grown, ISS’s dominance has been increasingly challenged by public companies and certain governance critics who have focused on ISS’s own potential conflicts of interest and the quality of the research and standards behind their recommendations,” says Farient.

Following more recent SEC guidance for casting their votes in clients’ best interests should provide investment managers a strong basis for defending their voting decisions, even as they reduce their reliance on proxy advisers, according to Farient.

“The impact of this rescission is not expected to be very significant in terms of how investors generally oversee compensation governance,” Farient says. “But it does portend continued push-back on ISS’s influence as the SEC prepares for its November roundtable on potential regulation of proxy advisers.”

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