proxy advisers (ii)

Yesterday I wrote about the genesis of third-party proxy advisory firms as a result of SEC insistence that investment management firms fulfill their fiduciary duty to vote in the best interest of their shareholders at the annual meetings of portfolio holdings.

The media don’t really understand the function proxy advisory firms serve:  they’re low-cost insurance/evidence that the manager takes his proxy voting duties seriously.  As the de facto authority in this arena, the proxy advisor is the first line of defense if the SEC, the portfolio holding in question or clients have any questions.  Hiring the adviser also eliminates proxy voting as an administrative task for the investment manager, as well as as a source of internal friction among portfolio managers.

Jamie Dimon of JP Morgan should understand this as wel–but apparently doesn’tl.  Calling investment management firms lazy and irresponsible does him no good.   It seems to me his outburst will only serve to heighten the proxy advisers’ sense of mission in speaking out against high executive pay.

I do have one quarrel with the proxy advisers, though.  In an effort to grow, they’ve branched out into selling services to the corporations whose proxies they analyze.  To my mind, this is analogous to the pension consultants who also manage money or the accountants who have–to their regret–provided consulting services to audit clients.  In other words, it’s a conflict of interest.  They shouldn’t be doing this.

To see why, we only have to look at the sorry case of the accountants, whose consulting arms pressured their auditing colleagues to overlook problems with client firm’s accounts for fear of–or after threats of–losing lucrative consulting business if the auditors were too strict.

Even the possibility that this could take place with proxy advisers undermines their authority as pure ly objective sources.


proxy advisory firms–what they are and how they became powerful

Dimon’s outburst

Jamie Dimon, the CEO of JP Morgan, went on a rant last week about proxy advisers, saying that US institutional investors have been “lazy” and “irresponsible” in using third-party advice to cast votes at the annual meetings of publicly traded companies.

What’s this about?

Mutual funds and ETFs are specialized investment corporations that sell shares to the investing public.  When you or I buy shares of a mutual fund , we have a claim on a certain portion of the fund’s investment portfolio of stocks or bonds.  But we don’t hold the stocks or bonds directly.  That’s the beauty of the mutual fund/ETF structure–that we can easily and cheaply buy into a diversified portfolio of, say 100, 500, or more names with a single transaction.

But it creates complications when shareholders, as owners, are asked to vote on corporate matters.

For stocks, every year each company holds an annual meeting of shareholders.  It sends a package of materials to each holder in advance.  The package includes general information, details of top management compensation, and a list of proposals that will be voted on by shareholders at the meeting.  There’s also a form for shareholders to cast their vote if they’re not going to attend the meeting in person and want to vote by proxy.

 Who votes the shares that are held in mutual funds and ETFs?

In the old days, when I entered the industry, basically no one did.  Voting the shares held by institutions was haphazard at best.

By the early 1990s, however, the SEC had made it clear to professional investment managers of mutual funds that this was unacceptable.  Managers have a fiduciary obligation to vote the shares in their funds for the benefit of their shareholders.

This presented a set of practical problems:

–in a group of strong-willed, egotistic, opinionated portfolio managers (the norm), it was hard to obtain a consensus on how to vote

–if managers were split, say, 3/2 on a particular voting item, should all the firm’s shares be voted the way the majority thought, or just the shares in the portfolios managed by the 3?

–how would the firm protect itself against shareholder lawsuits if an apparently sensible, well thought out voting decision turned out to have severe negative consequences?

–should the firm use in-house lawyers for legal counsel on decision-making or use outside counsel?

What a hassle!  …an obligation, yes, but also a hassle.

proxy advisers to the “rescue”

Much in the way that person consultants serve institutional investors, proxy advisory firms arose to act as a form of insurance against lawsuits for investment managers.

Hiring one with experience, a large staff–including a bunch of in-house lawyers–also showed the SEC that you were taking your fiduciary duty on voting seriously.

It eliminated a lot of internal conflicts, as well.

Best of all, the proxy adviser could be paid in soft dollars.

More tomorrow.