A few weeks ago when Dan Loeb's fight with Sothebys' was running hot, Forbe's Agustino Fontevecchia noted the power ISS wielded in the fight:
Dan Loeb got the support of a heavy-hitter in the proxy-battle arena: Institutional Shareholder Services (ISS). The largest proxy services firm, reputed to be able to mobilize up to 30% of the vote in some cases, ISS agreed with Loeb’s claims on financial underperformance, lack of an online strategy, and fee-splitting, recommending two of Third Point’s three candidates for the board. ...
ISS is a for-profit advisory services firm that both provides research and consulting, but fails to disclose if a firm is a client, which could clearly lead to a conflict of interest and moral hazard. ...
In my book Corporate Governance after the Financial Crisis, I discuss at length the origins of ISS and its substantial power in shareholder voting. I note that "ISS is too rigid and mechanical in its advice."
Worse yet, as a 2007 GAO study noted, ISS' business model inherently creates massive conflicts of interest:
ISS advises institutional investors how to vote proxies and provides consulting services to corporations seeking to improve their corporate governance. Critics contend that corporations could feel obligated to retain ISS’s consulting services in order to obtain favorable vote recommendations.
The problem is not just that ISS' business model is based on a conflict of interest, however, as Fontevecchia explains:
According to research by Stanford Business School’s David Larcker, who heads a center focused on corporate governance, proxy advisory firms like ISS and rival Glass Lewis are opaque institutions that rely on limited data to make decisions that could result in billion dollars moves.
Larcker, along with researchers Allan McCall and Brian Tayan, question the limited number of participants in ISS’ surveys, from which they derive their general opinions on corporate governance and base their recommendations. ISS doesn’t adequately disclose the types of respondents, and their survey is flawed, the academics argue. Ultimately, they call into question whether the ISS is enhancing shareholder value, raising red flags as to how much sway these firms should really have.
The WSJ recently reported that the SEC is likely to require more disclosures from ISS and its ilk:
The guidance is expected to say that SEC staff don’t believe the current practice of requiring investors to contact an advisory firm for more information about potential conflicts conforms with the agency’s interpretation of an existing SEC rule, these people said. An SEC spokesman couldn’t immediately be reached for comment. ...
ISS, one of three primary U.S. proxy advisers, is the only firm to also provide consulting services. The company has said it maintains a strict separation between the two arms of its business, and discloses conflicts when asked.
The idea that ISS should get a pass because they disclose conflicts of interest "when asked" is a joke. Indeed, ISS would never approve of a corporation adopting a disclosure regime that tells shareholders about conflicts of interest only when they ask. After all, unless the party subject to the conflict affirmatively discloses the existence of the conflict, how would its clients know what to ask?
The question is whether disclosure is enough or whether some sort of substantive regulation?