Proxy Advisors

Proxy advisors consult to investors about how to vote on the range of matters that require shareholder approval at the public corporations in an investor portfolio. They have become a critical stop on the road show when management and activists contest these matters, such as over electing directors.

An activist investor that seeks to elect directors to a company board, or to approve a resolution at the annual meeting, inevitably will need to persuade one or more proxy advisor to recommend the activist’s position over management’s. Below is a checklist of items to consider in engaging with a proxy advisor.

For those unfamiliar with proxy advisors, some history may help (others can skip down to the checklist right away). While US corporations have submitted matters to a vote of shareholders for many decades, until the mid-1970s in most situations investors did not take these votes seriously, and frequently did not even bother to vote on these corporate matters.

In 1974 the ERISA law changed all that - it requires pension plans to vote responsibly on all such matters. Pensions plans, and shortly thereafter most other institutional investors, started to review carefully the board candidates, shareholder proposals, and other matters at dozens, hundreds, or even thousands of portfolio companies. But, with so many portfolio companies, investors found this difficult. As happens so often, a clever entrepreneur stepped in, and created a firm, Institutional Shareholder Services (ISS), to advise investors about how to vote.

In the U.S., two firms have emerged as the principal proxy advisors: ISS and Glass Lewis. A third, Manifest, tends to focus on European votes. There’s not much difference between the firms, although ISS is the oldest and largest, and thus tends to carry a bit more weight with its decisions. An activist investor usually needs to solicit the endorsement from both ISS and Glass Lewis (in the US) for a slate of corporate director candidates, supporting various shareholder proposals, and for other matters for which the activist needs the votes of other shareholders.

These endorsements can matter a great deal. Except in the most controversial situations, most large institutional investors, including pension funds, endowments, and mutual funds, usually follow proxy advisor recommendations when voting their shares. These investors have way too many companies to follow to do anything but, and besides, that’s why they pay the considerable fees to these firms.

It’s worth noting that proxy advisors evaluate a given activist investor’s proposal (for example, which director candidates to endorse) with respect to a set of their own policies or guidelines. So (continuing with the example), if ISS requires incumbent directors to attend 75% of the board and committee meetings in the past year, and an incumbent failed to do that, ISS will usually recommend that investors not support that incumbent, and support an activist investor’s candidate. The proxy advisors spend a considerable amount of effort reviewing, refining, and updating these policies, since they allow firms simply to compare a given proposal to the existing policy, rather than evaluate each proposal individually. These policies also allows each proxy advisor to render consistent advice across proposals and companies.

How does an activist investor go about obtaining support from proxy advisors? The process resembles meetings with debt rating agencies or equity analysts, with some nuances related to the matters at hand. Corporations and investors alike cultivate relationships with analysts at each of the three firms, who usually specialize in one or another industry sector. In contested matters, such as a competitive director election or controversial shareholder proposals, corporate executives and portfolio managers will meet (separately, of course) with those analysts, making the case for their side of the story.

You might find this checklist useful as you solicit support from proxy advisors.

✓Determine which analyst at each firm covers the company in question. It’s a easy as contacting each firm and asking.
✓Review each firm’s policies and guidelines, and identify which policy(ies) pertains to the matter(s) in question at the company.
✓Identify for the analyst which specific subject on which they will need to advise their clients. The analyst renders an opinion on a particular matter, say whether the firm’s clients should support an activist investor’s director candidate or an incumbent director. While other issues might be of interest to the analyst, say the company’s poor financial performance or management’s competence, the analyst really needs to know what, specifically, the matter on which his or her clients will need to vote.
✓Schedule and prepare for a formal presentation of the specific subject, the activist investor’s position, and the rationale for supporting that position. Expect the meeting to take about ninety minutes, with the first half on the presentation, and the second on discussion.
✓Make the case for the activist investor’s position on the specific subject or issue in question.
✓Spend more effort on the case for the activist investor’s position, and less effort criticizing management’s position.
✓Proxy advisors care more about how the matter affects the governance at the company, and less about overall business performance, so, don’t complain to the analyst about a depressed share price, but instead show ow your position is consistent with the firm’s policies, and advances the governance of the company.
✓Obtain past recommendations that the proxy advisor has made on matters that the company has considered.
✓Ask other investors that support the activist investor position to contact the analyst and voice that support.
✓A partial endorsement from proxy advisors is usually better than no endorsement at all, and can form part of an activist investor’s presentation strategy. Lately proxy advisors have recommended some of an activist investor’s director nominees, rather than all of them, or one shareholder proposal among several.