As I noted the other day, the GAO released its report on proxy advisory services (GAO-07-765: Proxy Advisory Services). Like many who rush through all the mail that piles up, I didn’t really say much about the report, other that to quote a few passages that implied the SEC did not identify any major violations, even with potential conflicts of interest, and that large institutional investors aren’t totally reliant on such services in voting their proxies.

P&I appears to have gone a little overboard in an article entitled GAO: Proxy advisory firms’ influence overblown. (Compare with Is This the Most Influential Man on Wall Street?, SmartMondy.com, 10/16/02. Has ISS really gotten less powerful in the last five years?) Thankfully, this morning I woke up to a much more thoughtful read under the heading GAO Report on Proxy Advisors: No Smoking Guns at TheCorporateCounsel.net Blog (8/1/07). In it Broc Romanek poses six questions the GAO should have asked. Of the six, the most interesting to me is the following:

“4. Lack of investigative research - A big flaw in the report was taking at face value that many of these institutional investors said they make independent decisions. Yes, some do. But how many of them, when asked, would be expected to say: “Yep, most of the time I just vote the way they tell me.” Not any of the smart ones, because they have a fiduciary duty to vote.

Remember that most of these investors hold positions in thousands of companies; it would be a monumental task to conduct independent research about each item for each issuer’s ballot. To do so, an investor would have to have a staff along the lines of a proxy advisor to adequately do the job. The reality is that investors are trying to keep their expense ratios down - and even the larger investors typically have only a few employees dedicated to vetting voting issues.”

Romanek gets to fundamentals by pointing out that even the largest institutional investors only have a few staff devoted to researching proxy issues for thousands of companies. Therefore, they really are more dependent on ISS than they would like to acknowledge. However, a brief analysis of ISS by Mark Latham doesn’t provide much solace to those of us who worry about how much focus is actually given to proxies and how shareowners vote.

Latham quotes ISS, “Comprehensive analyses of proxy issues and complete vote recommendations for more than 10,000 U.S. companies are delivered by ISS’s seasoned U.S. research team consisting of more than 20 analysts.” He then goes on to observe:

We can thus estimate about four hours of analysis per proxy, costing perhaps $2000 including ISS infrastructure costs. Considering the amount of money we shareowners pay CEOs and boards of directors who are elected and compensated based on our voting, and the amount of capital at stake in the typical company they manage for us, we should be spending more than $2000 to guide our voting.

I agree, that’s why I have long supported Latham’s notion that “all shareowners of a company can solve the freerider problem by paying for voting advice as a group instead of one investor at a time. If we can pay with company funds, then all are paying together in proportion to the number of shares owned, thus in proportion to any benefit in share value from improved voting.” Of course, “the trick is to keep the advisor selection and payment procedure free of influence from the board of directors” and to come up with an easy and expeditious way for shareowners to select a proxy advisor for more in-depth coverage. (Proxy Voting Brand Competition, Journal of Investment Management, First Quarter, 2007)

So far, Latham has been more successful in applying his model of brand competition to university than to corporate elections. (see VoterMedia.org) Of course, the students of today will be the CEOs, directors, and fiduciaries of tomorrow. Just as there were early proxy access adopters, such as Apria Healthcare (2003) and Comverse Technology (2007), innovative companies will soon acknowledge the increased credibility an independent analysis of their proxy can provide. Just as all hire an “independent” auditor, they will soon begin funding proxy monitors. To ensure true independence, they should be asking shareowners to vote on their selection.