Department suggests that the narrow interpretation of investment advice may no longer afford
sufficient protections to plan participants and their beneficiaries. The Department expresses particular
concern about plan advisers who operate with undisclosed and unmitigated conflicts of interest.®

The Department proposes to address these concerns by broadening the circumstances under which a
person would be deemed to render investment advice for purposes of ERISA section 3(21)(A)(ii).
Under the amended version of the rule, the statutory definition would generally be met if the person
performs at least one of three specified functions and satisfies at least one of four specified conditions.
Of particular interest to ISS is the proposal to include as one of the triggering functions providing
advice or recommendations as to the management of securities or other property; according to the
Department, this would include “advice and recommendations as to the exercise of rights appurtenant
to shares of stock (e.g., voting proxies)".'° Also of interest is the proposal to include as one of the
qualifying conditions being an investment adviser within the meaning of section 202(a)(11) of the
Advisers Act."'

ISS understands the need to ensure that ERISA regulations keep pace with changes in the retirement
plan community and the financial markets, and ISS appreciates the Department's concern that some
parties who render investment advice to plans and participants may not be acting in their clients' best
interests. Nevertheless, ISS is concerned that the current proposal could ultimately harm, rather than
protect, plans and their participants.

Unintended Consequences of the Current Proposal

As a registered investment adviser, ISS already owes fiduciary duties of care and loyalty to its
clients.’2 Therefore, we see no impediment to imposing ERISA's affirmative fiduciary duties on proxy
advisers to the extent those duties are relevant.'? On the other hand, imposing ERISA's prohibited
transaction provisions on proxy advisers could harm plans and their participants if the Department were
to consider a proxy vote to be a "transaction." Problems also could arise if the Department were to
deem a corporation's interests to be "adverse" to the interests of its shareholders, or if it were to deem
issuers and shareholders to "deal" with each other in connection with a proxy vote.

Section 406(b) of ERISA forbids a fiduciary to act in any transaction involving the plan on behalf of a
party, or to represent a party, whose interests are adverse to the interests of the plan or its participants
or beneficiaries. This section also prohibits a fiduciary from receiving any consideration for his personal
account from any party dealing with the plan in connection with a transaction involving plan assets.

ISS submits that a proxy vote is not a "transaction" as that term is used in Section 406, and that
providing advice in connection with a proxy vote does not constitute “acting in a transaction" within

° id, 75 Fed. Reg. at 65265, 65272.

10 Id., 75 Fed. Reg. at 65266, describing proposed Section 2510.3-21(c)(1)(i(A)(3).

'l Proposed Section 2510.3-21(c)(1)(ii)(C).

2 See Proposing Release at note 15 and accompanying text.

'3 Certain duties enumerated in Section 404 of ERISA, such as the duty to diversify investments,
would be irrelevant to a fiduciary whose function is limited to analyzing governance issues and

making proxy vote recommendations.


Furthermore, pursuant to the Dodd-Frank Act, the SEC has recently undertaken a general study of the
legal and regulatory standards of care applicable to investment advisers and broker-dealers.'® Among
other things, this study examines the fiduciary duty imposed on registered advisers when they vote
proxies for their clients.'? The study also explores whether the fiduciary standards applicable to
investment advisers should be extended to certain broker-dealer activities as well. Both the Concept
Release and the Dodd-Frank study may be followed by rulemaking.

ISS urges the Department to co-ordinate its rulemaking regarding the application of fiduciary standards
under ERISA with the SEC's current regulatory initiatives. ISS believes that such a comprehensive
approach will lead to more sensible regulation and better and more consistent protections for all
investors, including employee benefit plans and their participants and beneficiaries.

Conclusion
ISS appreciates the Department's efforts to modernize and improve its fiduciary regulations. However,
ISS asks the Department to be sensitive to the potential for unintended consequences and to recognize
the benefits of inter-agency co-ordination in this area.
We would be happy to supply the Department with additional information regarding any of the matters
discussed herein. Please direct any questions about these comments to the undersigned or to our
outside counsel, Mari-Anne Pisarri of Pickard and Djinis LLP. She can be reached at 202-223-4418.

Respectfully submitted,

Steven E. Friedman
General Counsel

18 SEC Staff, “Study on Investment Advisers and Broker-Dealers as Required by Section 913 of
the Dodd-Frank Wall Street Reform and Consumer Protection Act,” (January 2011).

18 Id, at 39 (“The duty of care requires an adviser with proxy voting authority to monitor
corporate events and to vote the proxies To satisfy its duly of loyalty, the adviser must cast the
proxy votes in a manner consistent with the best interest of its client and must not subordinate
client interests to its own.")(citation omitted).

ISS | Institutional Shareholder Services Inc


O Disclosure Regarding Potential Conflicts

ISS provides its investor clients with an extensive array of information to ensure that they are fully
informed of potential conflicts and the steps ISS has taken to address them. In addition to making full
disclosure in the Form ADV brochure it delivers to each client, ISS supplies a comprehensive due
diligence compliance package on its Web site* to assist clients and prospective clients in fulfilling their
own obligations regarding the use of independent, third-party proxy voting firms. This package
includes a copy of ISS' Code of Ethics, a description of other policies, procedures and practices
regarding potential conflicts of interest and a description of the ICS business.

Moreover, each proxy analysis and research report ISS issues contains a legend indicating that the
subject of the analysis or report may be a client of or affiliated with a client of ISS, ICS or another
MSCI subsidiary. Each analysis and report also notes that one or more proponents of a shareholder
proposal may be a client of ISS or one of its affiliates, or may be affiliated with such a party. Clients
who wish to learn more about the relationship, if any, between ICS and the subject of an analysis or
report are invited to contact ISS' Legal and Compliance Department for relevant details. This process
allows ISS' proxy voting clients to receive the information they need without revealing the identity of
ICS clients to research analysts as they prepare vote recommendations and other research.

ISS believes that these extensive measures provide employee benefit plans and other clients with a
high degree of comfort that ISS has eliminated or is effectively managing the potential conflicts of
interest its business entails.

The Department's Proposal

The Definition of "Fiduciary" Under ERISA

ERISA generally defines a “fiduciary” to include a person who renders investment advice for a fee or
other compensation with respect to moneys or other property of an employee benefit plan, as well as
any person who has authority or responsibility to do so.° In its current proposal, the Department seeks
to amend a thirty-five year old rule that establishes the circumstances under which a person is deemed
to render "investment advice" within the meaning of ERISA's fiduciary definition.’ In proposing this
change, the Department notes that the existing regulation is narrower than the statute and hampers
regulatory efforts to police the conduct of persons who advise plans about their investments.® Due to
changes in the retirement plan industry and the financial marketplace since the rule was adopted, the

+ www.issgovernance.com/practices.

5 In 2004, the SEC staff issued guidance to registered investment advisers concerning their due
diligence obligations with respect to the use of third-party proxy voting firms. See Institutional
Shareholder Services (September 15, 2004); Egan-Jones Proxy Services (May 24, 2004). See also,
SEC Release Nos. IA-2106 (January 31, 2003)(Adopting Advisers Act Rule 206(4)-6), and IC-25922
(January 31, 2003) {adopting Rule 30b-1-4 under the Investment Company Act of 1940).

8 ERISA, Section 3(21)(A)(ii). The term also includes anyone who exercises discretion over the
management of the plan or its assets, as well as anyone who has discretionary authority regarding the
administration of the plan.

7 29 CFR 2510.3-21(c).

® Proposing Release, 75 Fed. Reg. at 65264-65.

ISS | Institutional Shareholder Services Inc


the meaning of that provision. A contrary reading of the statue could deprive employee benefit plans
and their participants of access to critical professional guidance regarding their voting decisions.

As noted above, ISS helps many of its clients develop custom proxy voting policies and makes vote
recommendations based on clients' specific voting guidelines. Some of these guidelines focus solely
on economic factors, while others emphasize environmental, social, faith-based or other issues.
Because ISS' advice is tailored to the specific needs and preferences of its clients, ISS may recommend
that some clients support a proxy proposal while advising other clients to reject that same proposal. If
the proxy vote is deemed to be a "transaction" and rendering advice about that vote is deemed to be
"acting in a transaction," Section 406(b) could effectively preclude ISS from offering its services to any
client covered by ERISA, because there might not be a way to operate the proxy advisory service
without engaging in a prohibited transaction.

Employee benefit plans and their participants also could be harmed if Section 406(b) were read to
preclude a proxy adviser from directly or indirectly providing services to issuers. Educating
corporations about best practices relating to executive compensation and other governance issues
ultimately benefits those corporations' shareholders. If proxy votes are "transactions" and if issuers’
interests are presumed to be "adverse" to the interests of shareholders, or if issuers are deemed to
"deal" with shareholders in connection with proxy votes, proxy advisers could be forced either to stop
providing advice to ERISA plans and their beneficiaries or to stop educating issuers about corporate
governance. Neither course would benefit plans or their beneficiaries in the long run.

Indeed, an overly broad reading of the terms used in ERISA Section 406(b) could limit plans’ ability to
use any proxy advisory firm, including even those firms that do not provide customized vote
recommendations and/or that do not directly or indirectly provide services to issuers. An adviser that
makes a vote recommendation regarding an issuer that owns one of the adviser’s institutional clients,
or regarding a contested solicitation or shareholder proposal involving an institutional client, could find
itself engaging in a prohibited transaction, if the proxy vote is a “transaction” and the issuer is deemed
to be “adverse to” or “dealing with” the adviser’s other shareholder clients.

The complexity of relationships among parties in the proxy voting chain means that the potential for
conflict of interest is always present for all proxy advisory firms. A broad prohibition of these
relationships would essentially make it impossible for plans to receive advice of any kind. For this
reason, ISS submits that should the Department decide to amend Section 2510.3-21(c), it must do so
in a way that ensures that plans continue to have access to professional guidance regarding their proxy
votes. The Department could achieve this goal by confirming -- either in the rule itself or in an
adopting release -- that a proxy vote is not a "transaction" for purposes of ERISA Section 406(b). In
the alternative, the Department could issue a class prohibited transaction exemption
contemporaneously with the adoption of the amendment, to permit proxy advisers to continue to serve
the employee benefit plan community.

ISS is also concerned about the potential unintended consequences of tying fiduciary status under
ERISA to a party's status as an investment adviser under the Advisers Act. At this time, not all proxy
advisers are registered as investment advisers, even though the SEC has opined that proxy firms act as
such when they provide their clients with advice designed to enable clients to maximize the value of
their investments."* Including investment adviser status as one of the conditions that might cause a
party to be deemed an ERISA fiduciary could create opportunities for regulatory arbitrage, allowing

“ soy Release No. IA-3052 (July 14, 2010) at 109-110, 75 Fed. Reg. 42981, 43010 (July 22,
2010).



Filed Electronically
February 2, 2011

Office of Regulations and Interpretations
Employee Benefits Security Administration
Attn: Definition of Fiduciary Proposed Rule
Room N-5655

U.S. Department of Labor

200 Constitution Ave., N.W.

Washington, D.C. 20210

Re: RIN 1210-AB32, Definition of the Term "Fiduciary" Under ERISA
Dear Madam or Sir:

Institutional Shareholder Services Inc. (ISS) appreciates the opportunity to comment on the
Department's proposal to amend 29 CFR 2510.3-21(c).' This rule defines the circumstances under
which a person rendering investment advice to an employee benefit plan or a plan's participants is
deemed to be a "fiduciary" for purposes of section 3(21)(A)(ii) of the Employee Retirement Income
Security Act of 1974 (ERISA). While ISS generally supports the Department's efforts to review this
regulation, ISS is concerned that the current proposal could have unintended consequences that will
harm, rather than protect, participants in employee benefit plans and their beneficiaries by depriving
them of access to critical professional guidance regarding their proxy voting decisions. ISS also
believes that the Department should co-ordinate its rulemaking in this area with the Securities and
Exchange Commission (SEC), which is currently studying similar issues.

Background

ISS, an indirect, wholly-owned subsidiary of MSCI Inc.,? is a federally registered investment adviser
with more than 25 years of experience in helping institutional investors meet their fiduciary
responsibilities related to proxy voting. More than 1,300 clients -- including employee benefit plans,
investment managers, hedge funds and mutual funds -- rely on ISS' expertise to help them make more
informed proxy voting decisions, manage the complex process of voting their shares, and report their
votes to their stakeholders and regulators.

Governance Research and Recommendations

Through its governance research and proxy voting recommendations, ISS helps institutional investors
understand corporate governance policies and practices at their portfolio companies and take these
practices into account in their proxy voting. ISS offers a wide range of proxy voting policy options to
institutional investors, including vote recommendations based on a client's specific customized voting
guidelines. In addition, ISS provides enhanced analysis of contentious meetings (M&A and proxy

1 “Definition of the Term 'Fiduciary'," 29 CFR Part 2510, RIN 1210-AB32 (October 13, 2010),
75 Fed. Reg. 65263 (October 22, 2010) ("Proposing Release").

2 MSCI is a provider of investment decision support tools to investors globally. MSCI's products
and services include indices and portfolio risk and performance analytics tools.



proxy advisory firms that refuse to characterize themselves as investment advisers to escape
regulatory oversight by the Department under ERISA as well as by the SEC under the Advisers Act.
Such a situation would be enormously harmful to plans and their participants and beneficiaries.

In its recent Concept Release on the U.S. Proxy System, the SEC had this to say about the substantial
client protections afforded by the Advisers Act and related rules:

Proxy advisory firms that are registered as investment advisers with the Commission are
subject to a number of additional regulatory requirements that provide important protections to
the firm's clients. For example, registered investment advisers have to make certain
disclosures on their Form ADV. Among other things, these disclosures include information
about arrangements that the adviser has that involve certain conflicts of interest with its
advisory clients. In addition, proxy advisory firms that are registered investment advisers are
required to adopt, implement, and annually review an internal compliance program consisting of
written policies and procedures that are reasonably designed to prevent the adviser or its
supervised persons from violating the Advisers Act. Every registered proxy advisory firm that
is registered as an investment adviser also must designate a chief compliance officer to
oversee its compliance program. This compliance officer must be knowledgeable about the
Advisers Act and have authority to develop and enforce appropriate compliance policies and
procedures for the adviser. A proxy advisory firm that is registered as an investment adviser
also is required to establish, maintain, and enforce policies and procedures reasonably designed
to prevent the misuse of material non-public information. Proxy advisory firms that are
registered as investment advisers also are required to create and preserve certain records that
our examiners review when performing an inspection of the adviser.’

Compliance with the Advisers Act and related rules substantially eliminates the type of unmitigated and
undisclosed conflicts of interest that motivated the Department to take this regulatory action. In our
opinion, the simple disclosure of potential conflicts is inadequate in the absence of a concrete, written
and examined compliance program. The Department therefore should withdraw proposed Section
2510.3-21(c)(1)(ii)(C) in order to remove the incentive for proxy advisers to avoid subjecting
themselves to the Advisers Act's robust regulatory regime.'®

Co-ordinating the Department's Rulemaking with SEC Iniatives

Among the issues the SEC considered in its Concept Release on the U.S. Proxy System are the role
and legal status of proxy advisory firms.’ In connection with this review, the Commission has sought
public comment on the appropriate regulatory treatment of proxy advisers, including the application of
the Advisers Act registration provisions to such firms and whether oversight of proxy advisers
registered under the Advisers Act should be improved, especially the area of conflicts of interest.

15 Id,, at 113-114, 75 Fed. Reg. at 43011 (citations omitted).

16 In this regard, the Department also might consider conditioning any relief it provides regarding
the prohibited transaction issue discussed above on the proxy adviser's being registered as an
investment adviser under the Advisers Act or similar state laws.

17 See note 14, supra.

3S | Institutional Shareholder Services Inc


contests) as well as governance data and analytics through its Governance Risk Indicators (GRid)
product.

Voting Services

ISS' ProxyExchange application and experienced account managers provide end-to-end management of
the proxy voting process. ISS clients can control their voting policy and final vote decisions while
outsourcing the processing and data management elements to an experienced service provider. To this
end, ISS receives clients' proxy ballots, works with custodian banks, executes votes on clients! behalf,
maintains vote records and provides comprehensive reporting. By outsourcing the administrative tasks
associated with the voting process, our clients free themselves to devote their internal resources to
making more informed investment decisions.

Disclosure and Other Services for Institutional Investors

In addition to developing proxy voting policies, making vote recommendations, and processing votes,
ISS also offers a Vote Disclosure Service to help investment companies comply with their regulatory
disclosure obligations. Other ISS offerings include corporate governance services focusing on
environmental and sustainability issues.

Services Provided to Issuers

Apart from ISS' core business of analyzing the proxies of corporate issuers and making vote
recommendations for the benefit of institutional investors, ISS' wholly-owned subsidiary, ISS Corporate
Services, Inc. (ICS), serves the corporate issuer community by providing products and services that
enable issuers to undetstand and implement corporate governance best practices. These products and
services include web-based tools, advisory services and publications that assist issuers with executive
and director compensation modeling, capital structure planning and other governance issues.

1SS' Approach Regarding Conflicts of Interest

As an investment adviser registered under the Investment Advisers Act of 1940 (Advisers Act), ISS
fully appreciates the fiduciary duties of care and loyalty it owes to its clients. It also understands that
these duties entail a responsibility to eliminate potential conflicts of interest where possible and to
manage and disclose those conflicts that cannot reasonably be avoided. To this end, ISS takes a
number of steps to safeguard the integrity of the research and services it provides to institutional
investors so that it can fulfill its important role in the dialogue between corporations and their
shareholders. .

O Policy-Based Approach

At its core, ISS is a transparent policy-based organization; its use of a series of published voting
policies provides a very practical check and balance that ensures the integrity and independence of
ISS' analyses and vote recommendations. While these policies allow analysts to consider company-
and market-specific factors in generating vote recommendations, the existence of a published
analytical framework, coupled with the fact that vote recommendations are based on publicly-available
information, allows ISS clients to continuously monitor the integrity of ISS’ advice.°

3 Each ISS analysis includes a URL for a direct hyperlink to ISS' summary voting guidelines for
easy access by users of our research.



O Compliance Program: Code of Ethics, Training, Monitoring and Firewall

In addition to the practical check and balance supplied by the policy framework, the independence and
integrity of ISS' proxy advice is further ensured by the comprehensive compliance program the
company maintains pursuant to the Advisers Act and related rules. One of the primary components of
this program is a Code of Ethics that prescribes standards of conduct for ISS and its employees.

The Code of Ethics affirms ISS' fiduciary relationship with its clients and obligates ISS and its
employees to carry out their duties solely in the best interests of clients and free from any
compromising influences and loyalties. The Code also contains restrictions on personal trading
designed to prevent employees from improperly trading on, or benefiting from, inside information, client
information and/or 1SS' voting recommendations. The Code emphasizes the requirement that all
research for clients be rendered independently of employees’ personal interests.

In order to ensure compliance with the Code of Ethics, ISS conducts periodic training sessions for
employees and requires employees to affirm their commitment to compliance on an annual basis.
Furthermore, ISS regularly monitors the sufficiency of the Code and the effectiveness of its
implementation.

Another critical component of the ISS compliance program is the firewall it maintains between its
institutional business and the corporate services performed by its ICS subsidiary. This firewall includes
the physical and functional separation between ICS and ISS, with a particular focus on the separation
of ICS from the ISS Global Research team. A key goal of the firewall is to keep the ISS Global
Research team from learning the identity of ICS' clients, thereby ensuring the objectivity and
independence of ISS' research process and vote recommendations.

The firewall mitigates potential conflicts via several layers of separation:
1. ICS is a separate legal entity from ISS.
2. ICS is physically separated from ISS, and its day-to-day operations are separately managed.
3. ISS Global Research works independently from ICS.

4. ICS and ISS staff are prohibited from discussing a range of matters, including the identity of
ICS clients.

5. Institutional analysts' salaries, bonuses and other forms of compensation are not linked to
any specific ICS activity or sale.

6. ICS explicitly tells its corporate clients that ISS will not give preferential treatment to, and is
under no obligation to support, any proxy proposal of an ICS client. ICS further informs its
clients that ISS' Global Research team prepares its analyses and vote recommendations
independently of, and with no involvement from, ICS.

As is the case with the Code of Ethics, ISS maintains a robust training and monitoring program
regarding the firewall. This program includes quarterly tests of the firewall's integrity, new-hire
orientation, and review of certain marketing materials and disclosures. In addition, there is an ethics
hotline available to both ICS and ISS staff for reporting issues of potential concern.