The Proxy Problem: Using Nonprofits to Solve Misaligned Incentives in the Proxy Voting Process
Authors: Duncan Leah 
Published: June 2020

Proxy advisory firms and their influence on the proxy voting process have recently become the subject of great attention for the Securities and Exchange Commission (“SEC”) among other constituencies. A glance at recent proxy season recaps and reports, many of which devote space to discussing proxy advisory firm recommendations, reveal the significance of this influence on institutional voting. As Sagiv Edelman puts it, “proxy advisory firms exist at the nexus of some of the most high-profile corporate law discussions—most notably, the shareholder voting process, which has recently been the subject of much scholarly and legal debate.” The SEC has responded by announcing that it intends to reform the regulations, or lack thereof, surrounding proxy advisory firms.

Recently, the SEC issued proposed amendments to Exchange Act Rule 14(a)-1 which would effectively codify their earlier interpretation of solicitation under this rule. The proposed amendment would “condition the availability of certain existing exemptions from the information and filing requirements . . . for proxy voting advice businesses upon compliance with additional disclosures and procedural requirements.” Furthermore, the amendments would clarify when a lack of disclosure of certain information in proxy voting advice compromises the accuracy of the advice and misleads within the meaning of the rule. The SEC believes that these extra requirements will “help ensure that investors who use proxy voting advice receive more accurate, transparent, and complete information on which to make their voting decisions.” Based on this proposal, it is apparent that the SEC is intent on rectifying some of the problems of transparency and conflicts of interest associated with proxy advisory firms.

Given the increasing influence of proxy advisory firms, the misalignment of incentives between proxy firms and the institutional shareholders who use proxy firm services is troubling. This Note identifies inherent problems and concerns with proxy advisory firms and offers solutions to these issues with a focus on eliminating conflicts of interest. Using Henry Hansmann’s theory of ownership, this Note argues that nonprofit ownership of proxy advisory firms eliminates both information asymmetry and conflicts of interest inherent to the current ownership structure.

Part I provides a brief overview of the problems and concerns associated with proxy advisory firms. Part II suggests two potential solutions: that Rule 206(4)-6 of the Investment Adviser Act of 1940 should be repealed or alternatively, that nonprofit ownership through investment company associations is a more effective way for investment management companies to comply with their fiduciary duties. Because profit incentive has created conflicts of interest that lead to proxy advice that may not always be in the best interest of investment manager clients, nonprofit ownership promotes transparency that allows parties who rely on the advice to make more independent decisions. Part III argues that nonprofit ownership is the most viable alternative to the status quo.