Proxy advisory firms have provided valuable advice to companies and shareholders sorting through the deal mania of recent years—right until deal mania swept up the proxy firms themselves.
In the last six weeks, Institutional Shareholder Services dropped its venerable name in favor of RiskMetrics, the company that purchased ISS one year ago. Its chief rival, Glass, Lewis & Co., was sold to the Ontario Teachers Pension Plan, capping a tumultuous 10 months of ownership by a Chinese media group. And on Sept. 19 RiskMetrics filed documents for a possible initial public offering, which has some wondering how a publicly traded advisory firm can do its job independently.
“Obviously, it’s a field where companies have been successful at filling a need,” says Lynn Turner, former head of research at Glass Lewis and one-time chief accountant at the Securities and Exchange Commission. “When someone sees a company doing well, they want to get in there.”
The Ontario Teachers Fund paid $46 million to buy Glass Lewis from Xinhua Media, which owned the firm for barely a year. Xinhua had bought 19.9 percent of Glass Lewis in August 2006 and the rest in January 2007. Shortly after that January sale to Xinhua, questions were raised about the Shanghai-based company’s governance practices. That prompted several Glass Lewis executives—Turner among them—to resign.
The resignations came after published reports that Xinhua’s then-CFO had run afoul of the National Association of Securities Dealers and the SEC and had a long history of fraud and other sketchy investment activities.
Industry observers agree that the deal with the Ontario Teachers Fund will allow Glass Lewis to reassert its role as a reputable, independent proxy research firm. Indeed, Turner says, several large institutional investors had already been discussing the idea of forming their own proxy research firm or teaming up to make a bid for Glass Lewis.
Ferlauto
“This gives Glass Lewis stable ownership and the opportunity to compete head to head with RiskMetrics,” says Richard Ferlauto, director of pension and benefit policy for the American Federation of State, County, and Municipal Employees.
“The Ontario Teachers have a long-standing, respectful reputation,” adds Kent Hughes, president of governance research firm Egan-Jones. “They are not tainted by scandal.”
RiskMetrics, meanwhile, has been on a buying spree of its own. The company scooped up ISS at the end of last year for $542.6 million; in August, it acquired the Center for Financial Research & Analysis, which provides forensic accounting research, regulatory risk assessment, and similar services.
Now the company is seeking to capitalize on that momentum with an IPO. The registration statement it filed with the SEC notes that ISS had $103 million in revenues in 2006, up from $83 million the prior year and $66.6 million in 2004. Net income was $9 million last year, up from $7.4 million in 2005 and $6.8 million in 2004.
RISKY BUSINESS
Below is an excerpt of RiskMetric’s registration statement, outlining potential conflict-of-interest fears.
Any perceived conflicts of interest in our business could harm our reputation and business.
ISS’ institutional clients rely on us to provide them with informed vote recommendations, benchmark proxy voting guidelines, and unbiased analyses of companies’ environmental, social, and governance attributes. The institutional clients of both our RiskMetrics and ISS businesses, particularly hedge funds and more active institutional investors, may have material economic and other interests in the corporations on which we provide proxy analyses and ratings, which are the subject of our financial research and analysis products and services. In some cases these institutional clients pay us a significant amount of money for our RiskMetrics or ISS solutions and, accordingly, there may be a perception that we might advocate a particular position or provide research that supports a particular conclusion with respect to a corporation in order to satisfy the unique economic or other interests of a particular institutional client. As a result, institutional clients, competitors, and other market participants could raise questions about our ability to provide unbiased services, which could harm our reputation.
Through our ISS Corporate Services subsidiary, we provide products and services to corporate clients who often use our services to learn about and improve their governance practices. Accordingly, there may be a perceived conflict of interest between the services we provide to institutional clients and the services provided to certain corporate clients. For example, when we provide corporate governance services to a corporate client and at the same time provide proxy vote recommendations to institutional clients regarding that corporation’s proxy items, there may be a perception that we may treat that corporation more favorably due to its use of our services.
The safeguards that we have implemented may not be adequate to manage these apparent conflicts of interest, and clients or competitors may question the integrity of our services. In the event that we fail to adequately manage these perceived conflicts of interest, we could incur reputational damage, which could have a material adverse effect on our business, financial condition, and operating results.
Source
SEC Filing (Sept. 19, 2007).
The registration statement does not break down ISS’ revenue sources or identify how much money RiskMetrics hopes to raise in an IPO or the compensation of its top executives.
In the filing’s “Risk Factors” section, however, it does mention possible conflicts of interest. “Through our ISS Corporate Services subsidiary, we provide products and services to corporate clients who often use our services to learn about and improve their governance practices,” the filing states. “Accordingly, there may be a perceived conflict of interest between the services we provide to institutional clients and the services provided to certain corporate clients.”
RiskMetrics gave the example that when it provides corporate governance services to a company and at the same time advises institutional investors on that company’s proxy items, there may be a perception that RiskMetrics treats the company favorably because it is a customer. “The safeguards that we have implemented may not be adequate to manage these apparent conflicts of interest, and clients or competitors may question the integrity of our services,” the company frankly admits in its filings.
Overcoming Perception Hurdles
Turner
Turner is confident that both ISS and Glass Lewis are in good hands, after meeting the CEOs of both RiskMetrics and the Ontario Teachers fund. “Both are really confident, decent, highly ethical people,” he says. “Yet while both are very good organizations they each will have their conflicts to address.”
For example, 40 percent of the Ontario Teachers’ $106-billion pension fund is invested in stock markets in Canada and around the world—so what conflicts might arise between the Glass Lewis recommendations on proxy issues and the fund itself, which will have to vote on those same issues? The Ontario Teachers fund also submits proxy proposals, raising the question of how Glass Lewis will rate proposals its corporate parent submits.
In addition, the Ontario Teachers fund has a $16 billion portfolio that includes investments in private equity, venture capital, infrastructure, and timber. That prompts questions about whether Glass Lewis will offer an opinion on a pending acquisition by the Ontario Teachers’ private equity fund.
In an e-mailed statement, the Ontario Teachers fund said it will “continue to manage our own corporate governance and voting activities, separate from Glass Lewis. According to our normal practice for portfolio companies, we will be involved at the board of director level on strategic issues and will not be involved in Glass Lewis’ daily business.”
ISS is no stranger to charges of conflict-of-interest either. For years critics have said a large portion of ISS revenues come from consulting with companies on their corporate governance practices, while ISS rates and comments on companies’ governance practices for its institutional investor clients. Those concerns have continued under the RiskMetrics regime. An IPO, meanwhile, would also pressure RiskMetrics to satisfy investors and meet quarterly expectations.
Ferlauto, however, believes a RiskMetrics IPO could be a good thing: It will be seeking institutional ownership of its shares, which will provide those large investors—such as AFSCME—input into the company’s practices.
RiskMetrics also takes heart in a recent Government Accountability Report on the proxy advisory industry, which found that fears of conflict of interest were overstated. The GAO report also debunked criticism that ISS’s dominant position has created a barrier to competition, saying newcomers have plenty of access to SEC filings and other public documents that provide much of the information proxy advisory firms need.
RiskMetrics spokeswoman Sarah Cohn stressed that the company is a registered investment adviser, which puts it under strict SEC scrutiny to protect investors. “According to the GAO study, the SEC has found no major areas of concern in any of the registered proxy advisory firms,” she said. “We are also pleased our institutional clients told the GAO that they are comfortable with our business model and the comprehensive conflict management systems we have in place.”
In fact, the GAO noted, many large institutional investors use proxy advisory firms on a limited basis because they already do much of their research independently and only use proxy advisory firms’ recommendations to supplement their own efforts. That dynamic “could serve to limit the firms’ overall influence on proxy voting results,” the GAO added.
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