Corporate Shareholder Meetings: Issues Relating to Firms That Advise Institutional Investors on Proxy Voting
Published: 2007-06-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: At annual meetings, shareholders of public corporations can vote on various issues (e.g., mergers and acquisitions) through a process called proxy voting. Institutional investors (e.g., mutual funds and pension funds) cast the majority of proxy votes due to their large stock holdings. In recent years, concerns have been raised about a group of about five firms that provide research and recommendations on proxy votes to their institutional investor clients. GAO was asked to report on (1) potential conflicts of interest that may exist with proxy advisory firms and the steps that the Securities and Exchange Commission (SEC) has taken to oversee these firms; (2) the factors that may impede or promote competition within the proxy advisory industry; and (3) institutional investors' use of the firms' services and the firms' potential influence on proxy vote outcomes. GAO reviewed SEC examinations of proxy advisory firms, spoke with industry professionals, and conducted structured interviews with 31 randomly selected institutional investors. GAO is not making any recommendations.
section_title: What GAO Found
paragraphs: Various potential conflicts of interest can arise at proxy advisory firms that could affect vote recommendations, but SEC has not identified any major violations in its examinations of such firms. In particular, the business model of the dominant proxy advisory firm--Institutional Shareholder Services (ISS)--has been the most commonly cited potential conflict. Specifically, 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. However, ISS officials said they have disclosed and taken steps to mitigate this potential conflict. For example, ISS discloses the potential conflict on its Web site and the firm's policy is to advise clients of relevant business practices in all proxy vote analyses. ISS also maintains separate staff who are located in separate buildings for the two businesses. While all institutional investors GAO spoke with that use ISS's services said they are satisfied with its mitigation procedures, some industry analysts continue to question their effectiveness. SEC conducts examinations of advisory firms that are registered as investment advisers and has not identified any major violations. Although new firms have entered the market, ISS's long-standing position has been cited by industry analysts as a barrier to competition. ISS has gained a reputation for providing comprehensive services, and as a result, other firms may have difficulty attracting clients. Proxy advisory firms must offer comprehensive coverage to compete and need sophisticated systems to provide the services clients demand. But firms interested in entering the market do have access to much of the information needed to make recommendations, such as publicly available documents filed with SEC. Competitors have attempted to differentiate themselves from ISS by, for example, providing only proxy advisory services and not corporate consulting services. While these firms have attracted clients, it is too soon to tell what their ultimate effect on enhancing competition will be. Among the 31 institutional investors GAO spoke with, large institutions reportedly rely less than small institutions on the research and recommendations offered by proxy advisory firms. Large institutional investors said that their reliance on proxy advisory firms is limited because, for example, they have in-house staff to assess proxy vote issues and only use the research and recommendations offered by proxy advisory firms to supplement such research. In contrast, small institutional investors have limited resources to conduct their own research and tend to rely more heavily on the research and recommendations offered by proxy advisory firms. The fact that large institutional investors cast the great majority of proxy votes made by institutional investors and reportedly place relatively less emphasis on advisory firm research and recommendations could serve to limit the firms' overall influence on proxy voting results.

section_title: Letter
paragraphs: Each year, publicly traded corporations hold shareholder meetings for  director elections and to consider management and shareholder proposals  that may have an effect on a corporation’s operations and value, such as  executive compensation, corporate governance matters, and proposed  mergers and acquisitions. Most shareholders typically do not attend these  meetings, opting instead to vote by mail or online, through a process  known as proxy voting. According to Automatic Data Processing, Inc.— one of the largest providers of transaction services to the financial  industry—most proxy votes are cast by or on behalf of institutional  investors, such as mutual funds and pension plans, given the level of  stocks they manage as compared to other types of investors.
In recent years, concerns have been raised about the proxy advisory  industry, which is comprised of five major proxy advisory firms that help  many institutional investors carry out their fiduciary responsibilities  relating to proxy voting. These proxy advisory firms may perform several  functions on behalf of their clients, such as offering research and  recommendations on particular proxy issues (e.g., whether to approve an  executive compensation plan) or casting the actual votes. Critics of proxy  advisory firms, including certain industry associations and academics,  contend that the proxy advisory industry suffers from significant conflicts  of interest and a lack of competition and that these firms have a  disproportionate influence on proxy voting. Others counter that the firms  provide a valuable service for institutional investors and note that such  clients are sophisticated market participants that are free to choose  whether and how to employ the services of proxy advisory firms.
Under the Securities Exchange Act of 1934, the Securities and Exchange  Commission (SEC) regulates the proxy solicitation process with respect to  publicly traded equity securities, and SEC regulates the activities of proxy  advisory firms that are registered with SEC as investment advisers under  the Investment Advisers Act of 1940. Under SEC rules, when soliciting  proxies, certain information must be disclosed in writing to shareholders,  and such disclosure, referred to as a proxy statement, must be filed with  the agency. These proxy statements must include important facts about  the issues on which shareholders are asked to vote. Under the Investment  Advisers Act and related SEC rules, registered investment advisers are  required to take a variety of steps designed to help protect their clients.  For example, an investment adviser must disclose information about its  business practices and potential conflicts of interest to clients and  potential clients. SEC monitors compliance with the laws and rules  through, among other means, periodic examinations of registered  investment advisers. Based on examination findings, SEC may send letters  to investment advisers requiring them to correct identified deficiencies.  SEC may also take enforcement actions for more serious violations, as  deemed appropriate, such as seeking civil fines in federal district court.
Because of your interest in helping to ensure the integrity of proxy voting,  you asked us to provide an overview of proxy advisory firms and SEC’s  oversight of this industry. This report (1) identifies potential conflicts of  interest that may exist with proxy advisory firms and the steps that SEC  has taken to oversee these firms; (2) discusses the factors that might  impede or promote competition in this industry; and (3) analyzes  institutional investors’ use of proxy advisory services to help vote proxies  and the influence proxy advisory firms may have on proxy voting.
To address these objectives, we conducted a literature review and  examined studies relating to the proxy advisory industry. In addition, we  identified and interviewed various professionals (experts, academics,  industry association representatives, and others) with knowledge of the  industry. To gain an understanding of SEC’s oversight of proxy advisory  firms, we reviewed relevant investment adviser regulations and  examination reports and interviewed agency officials. Further, we  conducted structured interviews with 31 institutional investors selected  randomly by type, including mutual funds, corporate pension funds,  government pension funds, and union pension funds, as well as some asset  management institutions, to gain an understanding of the ways in which  they use proxy advisory firms and the influence that such firms have on  proxy voting. Our sample was derived from Standard & Poor’s Money  Market Directories (January 2006), and consisted of a population of  institutional investors with over $1 billion in assets, including large and  small institutional investors from each type above this asset level. We  defined “large” and “small” institutional investors as the top and bottom 15  percent of each investor type. Large and small institutional investors  account for over 72 percent of the managed assets held by all of the  institutional investors with over $1 billion in assets. Although we randomly  selected these institutional investors, the size of the sample was small and  might not have been representative of the universe of institutional  investors. As a result, we could not generalize the results of this effort.
We conducted our work in Washington, D.C., between September 2006  and June 2007 in accordance with generally accepted government auditing  standards. See appendix I for more information on our scope and  methodology.
subsections: section_title: Background
paragraphs: According to ISS, over 28,000 publicly-traded corporations globally send  out proxy statements each year that contain important facts about more  than 250,000 separate issues on which shareholders are asked to vote.  Votes are solicited on a variety of key issues that could potentially affect  the corporations’ value, such as the election of directors, executive  compensation packages, and proposed mergers and acquisitions, as well  as other, more routine, issues that may not affect value, such as approving  an auditor and changing a corporate name. The proxy statement typically  includes a proxy ballot (also called a proxy card) that allows shareholders  to appoint a third party (proxy) to vote on the shareholder’s behalf if the  shareholder decides not to attend the meeting. The shareholder may  instruct the proxy how to vote the shares or may opt to grant the proxy  discretion to make the voting decision. The proxy card may be submitted  to the company via the mail or online.
The proxy advisory industry has grown over the past 20 years as a result of  various regulatory and market developments. The management of a  mutual fund’s or pension plan’s assets, including the voting of proxies, is  often delegated to a person who is an investment adviser subject to the  Investment Advisers Act of 1940. In a 1988 letter, known as the “Avon  Letter,” the Department of Labor took the position that the fiduciary act of  managing employee benefit plan assets includes the voting of proxies  associated with shares of stock owned by the plan. According to industry  experts, managers of employee retirement plan assets began to seek help  in executing their fiduciary responsibility to vote proxies in their clients’  best interests. Consequently, the proxy advisory industry—particularly  ISS, which had been established in 1985—started to grow. According to  industry experts, ISS’s reputation and dominance in the proxy advisory  industry continued to grow in the 1990s and early 2000s, fueled by the  growing fiduciary requirements of institutional investors and increased  shareholder activism. This increased shareholder activism has been  attributed in part to reaction by investors to the massive financial frauds  perpetrated by management of public companies, including the actions  that led to the bankruptcies of Enron and WorldCom. Many institutional  investors sought the services of proxy advisory firms to assist in their  assessments of the corporate governance practices of publicly traded  companies and to carry out the mechanics of proxy voting. Finally, in  2003, SEC adopted a rule and amendments under the Investment Advisers  Act of 1940 that requires registered investment advisers to adopt policies  and procedures reasonably designed to ensure that proxies are voted in  the best interests of clients, which industry experts also cited as a reason  for the continued growth of the proxy advisory industry.
Today, the proxy advisory industry is comprised of five major firms, with  ISS serving as the dominant player with over 1,700 clients. The other four  firms—Marco Consulting Group (MCG), Glass Lewis & Co. (Glass Lewis),  Proxy Governance, Inc. (PGI), and Egan-Jones Proxy Services (Egan- Jones)—have much smaller client bases and are relatively new to the  industry: Glass Lewis, PGI, and Egan-Jones were all created within the  past 6 years.
Founded in 1985, ISS serves clients with its core business, which  includes analyzing proxy issues and offering research and vote  recommendations. ISS also provides Web-based tools and advisory  services to corporate issuers through ISS Corporate Services, Inc. a  separate division established in 1997 which was spun-out into a wholly- owned subsidiary in 2006. RiskMetrics Group, a financial risk  management firm, acquired ISS in January 2007. RiskMetrics Group  provides risk management tools and analytics to assist investors in  assessing risk in their portfolios.
MCG was established in 1988 to provide investment analysis and advice  to Taft-Hartley funds and has since expanded its client base to public  employee benefit plans.
Glass Lewis, established in 2003, provides proxy research and voting  recommendations and was acquired by Xinhua Finance Limited, a  Chinese financial information and media company, in 2007.
Established in 2004, PGI offers proxy advice and voting  recommendations and is a wholly-owned subsidiary of FOLIOfn, Inc., a  financial services company that also provides brokerage services and  portfolio management technology for individual investors and  investment advisers.
Egan-Jones was established in 2002 as a division of Egan-Jones Ratings  Company, which was incorporated in 1992. Egan-Jones provides proxy  advisory services to institutional clients to facilitate making voting  decisions.
Of the five major proxy advisory firms, three—ISS, MCG, and PGI—are  registered with SEC as investment advisers and are subject to agency  oversight, while according to corporate officials, the other two firms are  not. In their SEC registration filings, the three registered firms have  identified themselves as pension consultants as the basis for registering as  investment advisers under the Investment Advisers Act. Although Glass  Lewis initially identified itself as a pension consultant and registered with  SEC as an investment adviser, it withdrew its registration in 2005.  According to SEC officials, an investment adviser is not required to  disclose a reason for its decision to withdraw its registration in the notice  of withdrawal filed with SEC. Officials from Glass Lewis and Egan-Jones  did not elaborate on their decisions not to be registered with SEC as  investment advisers, other than to note that their decisions were made  with advice from their respective counsel.
section_title: Potential Conflicts of Interest Exist among Proxy Advisory Firms That Could Affect Their Vote Recommendations, but SEC Has Not Identified Any Major Violations in Its Examinations of Registered Firms
paragraphs: In the proxy advisory industry, various conflicts of interest can arise that  have the potential to influence the research conducted and voting  recommendations made by proxy advisory firms. The most commonly  cited potential for conflict involves ISS, which provides services to both  institutional investor clients and corporate clients. Several other  circumstances may lead to potential conflicts on the part of proxy  advisory firms, including situations in which owners or executives of  proxy advisory firms have an ownership interest in or serve on the board  of directors of corporations that have proposals on which the firms are  offering vote recommendations. Although the potential for these types of  conflicts exists, in its examinations of proxy advisory firms that are  registered as investment advisers, SEC has not identified any major  violations, such as a failure to disclose a conflict, or taken any  enforcement actions to date.
subsections: section_title: ISS’s Business Model Has Been Identified as the Major Potential Conflict of Interest
paragraphs: Industry professionals and institutional investors we interviewed cited  ISS’s business model as presenting the greatest potential conflict of  interest associated with proxy advisory firms because ISS offers proxy  advisory services to institutional investors as well as advisory services to  corporate clients. Specifically, ISS provides institutional investor clients  with recommendations for proxy voting and ratings of companies’  corporate governance. In addition, ISS helps corporate clients develop  proposals to be voted on and offers corporate governance consulting  services to help clients understand and improve their corporate  governance ratings.
Because ISS provides services to both institutional investors and  corporate clients, there are various situations that can potentially lead to  conflicts. For example, some industry professionals stated that ISS could  help a corporate client design an executive compensation proposal to be  voted on by shareholders and subsequently make a recommendation to  investor clients to vote for this proposal. Some industry professionals also  contend that corporations could feel obligated to subscribe to ISS’s  consulting services in order to obtain favorable proxy vote  recommendations on their proposals and favorable corporate governance  ratings. One industry professional further believes that, even if  corporations do not feel obligated to subscribe to ISS’s consulting  services, they still could feel pressured to adopt a particular governance  practice simply to meet ISS’s standards even though the corporations may  not see the value of doing so.
ISS has disclosed and taken steps to help mitigate situations that can  potentially lead to conflicts. For example, on its Web site, ISS explains that  it is “aware of the potential conflicts of interest that may exist between   proxy advisory service … and the business of ISS Corporate Services,  Inc. .” The Web site also notes that “ISS policy requires every ISS  proxy analysis to carry a disclosure statement advising the client of the  work of ICS and advising ISS’s institutional clients that they can get  information about an issuer’s use of ICS’s products and services.” In  addition, some institutional investors we spoke with noted that ISS has on  occasion disclosed to them, on a case-by-case basis, the existence of a  specific conflict related to a particular corporation.
In addition to disclosure, ISS has implemented policies and procedures to  help mitigate potential conflicts. For example, according to ISS, it has  established a firewall that includes maintaining separate staff for its proxy  advisory and corporate businesses, which operate in separate buildings  and use segregated office equipment and information databases in order to  help avoid discovery of corporate clients by the proxy advisory staff. ISS  also notes on its Web site that it is a registered investment adviser and is  subject to the regulatory oversight of SEC. In addition, according to ISS’s  Web site, corporations purchasing advisory services sign an agreement  acknowledging that use of such services does not guarantee preferential  treatment from ISS’s division that provides proxy advisory services.
All of the institutional investors—both large and small—we spoke with  that subscribe to ISS’s services said that they are satisfied with the steps  that ISS has taken to mitigate its potential conflicts. Most institutional  investors also reported conducting due diligence to obtain reasonable  assurance that ISS or any other proxy advisory firm is independent and  free from conflicts of interest. As part of this process, many of these  institutional investors said they review ISS’s conflict policies and  periodically meet with ISS representatives to discuss these policies and  any changes to ISS’s business that could create additional conflicts.  Finally, as discussed in more detail later in this report, institutional  investors told us that ISS’s recommendations are generally not the sole  basis for their voting decisions, which further reduces the chances that  these potential conflicts would unduly influence how they vote.
Although institutional investors said they generally are not concerned  about the potential for conflicts from ISS’s businesses and are satisfied  with the steps ISS has taken to mitigate such potential conflicts, some  industry analysts we contacted said there remains reason to question the  steps’ effectiveness. For example, one academic said that while ISS is  probably doing a fair job managing its conflicts, it is difficult to confirm  the effectiveness of the firm’s mitigation procedures because ISS is a  privately-held company, thereby restricting information access. Moreover,  according to another industry analyst, because ISS’s recommendations are  often reported in the media, the corporate consulting and proxy advisory  services units could become aware of the other’s clients.
section_title: Other Potential Conflicts May Arise on the Part of Proxy Advisory Firms
paragraphs: In addition to the potential conflict of interest discussed above, several  other situations in the proxy advisory industry could give rise to potential  conflicts. Specifically:    Owners or executives of proxy advisory firms may have a significant  ownership interest in or serve on the board of directors of corporations  that have proposals on which the firms are offering vote  recommendations. A few institutional investors told us that such  situations have been reported to them by ISS and Glass Lewis, both of  which, in order to avoid the appearance of a conflict, did not make  voting recommendations.
Institutional investors may submit shareholder proposals to be voted  on at corporate shareholder meetings. This raises concern that proxy  advisory firms will make favorable recommendations to other  institutional investor clients on such proposals in order to maintain the  business of the investor clients that submitted these proposals.
Several proxy advisory firms are owned by companies that offer other  financial services to various types of clients, as is common in the  financial services industry, where companies often provide multiple  services to various types of clients. This is the case at ISS, Glass Lewis,  and PGI, and may present situations in which the interests of different  sets of clients diverge.
section_title: SEC Has Not Identified Any Major Violations in Its Oversight of Proxy Advisory Firms That Are Registered as Investment Advisers
paragraphs: SEC reviews registered investment advisers’ disclosure and management  of potential conflicts, as well as proxy voting situations where a potential  conflict may arise. Specifically, SEC’s Office of Compliance Inspections  and Examinations monitors the operations and conducts examinations of  registered investment advisers, including proxy advisory firms. An SEC  official stated that, as part of these examinations, SEC may review the  adequacy of disclosure of a firm’s owners and potential conflicts;  particular products and services that may present a conflict; the  independence of a firm’s proxy voting services; and the controls that are in  place to mitigate potential conflicts. As discussed previously, three of the  five proxy advisory firms (ISS, MCG, and PGI) are registered as investment  advisers while Glass Lewis and Egan-Jones are not. According to SEC, to  date, the agency has not identified any major violations of applicable  federal securities laws in its examinations of proxy advisory firms that are  registered as investment advisers and has not initiated any enforcement  action against these firms.
section_title: Analysts Cite ISS’s Long-standing Position in the Industry as a Potential Barrier to Competition, Although Firms Have Entered the Market in Recent Years
paragraphs: As the dominant proxy advisory firm, ISS has gained a reputation with  institutional investors for providing reliable, comprehensive proxy  research and recommendations, making it difficult for competitors to  attract clients and compete in the market. As shown below in table 1, ISS’s  client base currently includes an estimate of 1,700 institutional investors,  more than the other four major firms combined. Several of the  institutional investors we spoke with that subscribe to ISS’s services  explained that they do so because they have relied on ISS for many years  and trust it to provide reliable, efficient services. They said that they have  little reason to switch to another service provider because they are  satisfied with the services they have received from ISS over the years.  Because of ISS’s clients’ level of satisfaction, other providers of proxy  advisory services may have difficulty attracting their own clients. In  addition, because of its dominance and perceived market influence,  corporations may feel obligated to be more responsive to requests from  ISS for information about proposals than they might be to other, less- established proxy advisory firms, resulting in a greater level of access by  ISS to corporate information that might not be available to other firms.
Industry analysts explained that, in addition to overcoming ISS’s  reputation and dominance in the proxy advisory industry, proxy advisory  firms must offer comprehensive coverage of corporate proxies and  implement sophisticated technology to attract clients and compete. For  instance, institutional investors often hold shares in thousands of different  corporations and may not be interested in subscribing to proxy advisory  firms that provide research and voting recommendations on a limited  portion of these holdings. As a result, proxy advisory firms need to provide  thorough coverage of institutional holdings, and unless they offer  comprehensive services from the beginning of their operations, they may  have difficulty attracting clients. In addition, academics and industry  experts we spoke with said that new firms need to implement a  sophisticated level of technology to provide the research and proxy vote  execution services that clients demand. The initial investment required to  develop and implement such technology can be a significant expense for  firms.
Although newer proxy advisory firms may face challenges attracting  clients and establishing themselves in the industry, several of the  professionals we spoke with believed that these challenges could be  overcome. For example, while firms may need to offer comprehensive  coverage of corporate proxies in order to attract clients and although ISS  might have access to corporate information that other firms do not, much  of the information needed to conduct research and offer voting  recommendations is easily accessible. Specifically, anyone can access  corporations’ annual statements and proxy statements, which are filed  with SEC, are publicly available, and contain most of the information that  is needed to conduct research on corporations and make proxy voting  recommendations. Also, although developing and implementing the  technology required to provide research and voting services can be  challenging, various industry professionals told us that once a firm has  done so, the marginal cost of providing services to additional clients and  of updating and maintaining such technology is relatively low.
Some of the competitors seeking to enter the proxy advisory industry in  recent years that we spoke with have offered their services as alternatives  to ISS. Specifically, they have attempted to differentiate themselves from  ISS by providing only proxy advisory services to institutional investor  clients. ISS’s competitors have chosen not to provide corporate consulting  services in part to avoid the potential conflicts that exist at ISS. Proxy  advisory firms have also attempted to differentiate themselves from the  competition on the basis of the types of services provided. For example,  some firms have started to focus their research and recommendation  services on particular types of proxy issues or on issues specific to  individual corporations.
The institutional investors we spoke with had a variety of opinions about  the level of competition in the industry. Some questioned whether the  existing number of firms is sufficient, while others questioned whether the  market could sustain the current number of firms. However, many of the  institutional investors believe that increased competition could help  reduce the cost and increase the range of available proxy advisory  services. For example, some institutional investors said that they have  been able to negotiate better prices with ISS because other firms have  recently entered the market. While some of these newer proxy advisory  firms have attracted clients, it is too soon to tell what the firms’ ultimate  effect on competition will be.
section_title: Large Institutional Investors Reportedly Rely Less Than Small Institutional Investors on Advisory Firms, Limiting the Influence These Firms Have on Proxy Voting Results
paragraphs: We conducted structured interviews with 31 randomly selected  institutional investors to gain an understanding of the ways in which they  use proxy advisory firms and the influence that such firms have on proxy  voting. Of the 20 large institutional investors we interviewed, 19 reported  that they use proxy advisory services in one or more ways that may serve  to limit the influence that proxy advisory firms have on proxy voting  results (see table 2), while only 1 reported relying heavily on a proxy  advisory firm’s research and recommendations.
The following summarizes several of the reasons that large institutional  investors’ reliance on proxy advisory firms’ research and  recommendations is limited:    Most of the large institutional investors we spoke with (15 out of 20)  reported that they generally rely more on their own in-house research  and analyses to make voting decisions than on the research and  recommendations provided by their proxy advisory services providers.  These institutional investors tend to have their own in-house research  staffs, and their in-house research reportedly drives their proxy voting  decisions. They explained that they use the research and  recommendations provided by proxy advisory firms to supplement  their own analysis and as one of many factors they consider when  deciding how to vote.
In addition, many (14) of the large institutional investors we contacted  reported that they subscribe to a customized voting policy that a proxy  advisory firm executes on the institutions’ behalf. These institutional  investors develop their own voting policies and guidelines that instruct  the advisory firm how to vote on any given proxy issue. In such  instances, the proxy advisory firms simply apply their clients’ voting  policies, which then drive the voting decisions.
Further, 8 of the large institutional investors we contacted explained  that they subscribe to more than one proxy advisory firm to help  determine how to vote. These institutional investors said that they  consider multiple sets of proxy advisory firm research and  recommendations to gain a broader range of information on proxy  issues and to help make well-informed voting decisions.
We also interviewed representatives from 11 smaller institutional  investors, and the results of these interviews suggest that proxy advisory  firm recommendations are of greater importance to these institutions than  they are to the large institutional investors we spoke with. In particular,  representatives from smaller institutional investors were more likely to  say that they rely heavily on their proxy advisory firm and vote proxies  based strictly on the research and recommendations of their firm, given  these institutions’ limited resources. Consequently, the level of influence  held by proxy advisory firms appears greater with these smaller  institutional investors.
However, whether large or small, all of the institutional investors we  spoke with explained that they retain the fiduciary obligation to vote  proxies in the best interest of their clients irrespective of their reliance on  proxy advisory firms. Institutional investors emphasized that they do not  delegate this responsibility to proxy advisory firms and retain the right to  override any proxy advisory firm recommendations, limiting the amount of  influence proxy advisory firms hold. In addition, large and small  institutional investors reported that they tend to provide greater in-house  scrutiny to, and rely even less on, proxy advisory firm recommendations  about certain high-profile or controversial proxy issues, such as mergers  and acquisitions or executive compensation.
Institutional investors’ perspectives on the limited influence of proxy  advisory firms reflected what we heard from professionals that we spoke  with who have knowledge of the industry. Many of these industry analysts  and academics agreed that large institutional investors would be less likely  than small institutional investors to rely on proxy advisory firms, because  large institutions have the resources available to conduct research and  subscribe to more than one proxy advisory service provider. These  professionals also thought that large institutional investors would be likely  to use proxy advisory firms as one of several factors they consider in the  research and analysis they perform to help them decide how to vote  proxies. Further, several believed that small institutional investors would  be more likely to vote based strictly on proxy advisory firms’  recommendations, because they do not have the resources to conduct  their own research.
The results of our work suggest that the overall influence of advisory firms  on proxy vote outcomes may be limited. In particular, large institutional  investors, which cast the great majority of proxy votes made by all  institutional investors with over $1 billion in assets, reportedly place  relatively less emphasis on the firms’ research and recommendations than  smaller institutional investors. However, we could not reach a definitive  conclusion about the firms’ influence because the institutional investors  we contacted were not necessarily representative of all such investors.  Further, we could not identify any studies that comprehensively isolated  advisory firm research and recommendations from other factors that may  influence institutional investors’ proxy voting.
section_title: Agency Comments
paragraphs: We provided a draft of this report to SEC for its review and comment. SEC  provided technical comments, which we incorporated into the final report,  as appropriate. We also provided relevant sections of the draft to the  proxy advisory firms for a technical review of the accuracy of the wording  and made changes, as appropriate, based on the firms’ comments.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution of this report until 30  days from the report date. At that time we will provide copies of this  report to the Chairman and Ranking Member, Senate Committee on  Banking, Housing, and Urban Affairs; the Chairman, House Committee on  Financial Services; the Chairman, House Subcommittee on Capital  Markets, Insurance, and Government Sponsored Enterprises, Committee  on Financial Services; other interested committees; and the Chairman of  the Securities and Exchange Commission (SEC). We will also make copies  available to others upon request. In addition, the report will be available at  no charge on the GAO Web site at http://www.gao.gov. If you or your staffs  have any questions about this report, please contact me at (202) 512-8678   or jonesy@gao.gov. Contact points for our Offices of Congressional  Relations and Public Affairs may be found on the last page of this report.  Key contributors to this report are listed in appendix II.
section_title: Appendix I: Scope and Methodology
paragraphs: Our objectives were to (1) identify potential conflicts of interest that exist  with proxy advisory firms and the steps that the Securities and Exchange  Commission (SEC) has taken to oversee these firms; (2) review the factors  that might impede or promote competition in this industry; and (3) analyze  institutional investors’ use of proxy advisory services to help vote proxies  and the influence proxy advisory firms may have on proxy voting.
To determine the types of potential conflicts of interest that could arise in  the proxy advisory industry, we conducted a literature review and  examined studies relating to potential conflicts that may arise in this  industry. Further, we interviewed various professionals with knowledge of  the proxy advisory industry, including industry experts, academics,  industry association representatives, and proxy advisory firm  representatives, as well as institutional investors and officials at SEC. We  selected these professionals based, in part, on literature searches we  conducted on topics relating to proxy advisory and corporate governance  services, as well as referrals by several of the professionals we met with.  The professionals we spoke with represent a wide range of perspectives,  and include experts from academia, business, government, and  professional organizations. We did not attempt to assess any of the proxy  advisory firms’ conflict mitigation policies or procedures and, therefore,  did not come to any conclusions about the adequacy of these policies or  procedures. To gain an understanding of SEC’s oversight of proxy advisory  firms, we reviewed relevant investment adviser regulations and  examinations conducted by SEC since 2000 and interviewed agency  officials. We did not attempt to assess the adequacy of SEC’s oversight.
To identify the factors that might impede or promote competition in this  industry, we reviewed the relevant literature and examined studies  relating to the level of competition in the industry, and we spoke with  various industry professionals. We did not attempt to evaluate the level of  competition in this industry and, therefore, did not come to any  conclusions about the extent to which competition exists.
Finally, to explore institutional investors’ use of proxy advisory services to  help vote proxies and the influence proxy advisory firms may have on  proxy voting, we conducted structured interviews with 31 institutional  investors selected randomly by type, including mutual funds, corporate  pension funds, government pension funds, and union pension funds, as  well as asset management institutions. Our sample included several of the  largest institutional investors and was derived from Standard & Poor’s  Money Market Directories (January 2006). The sample consisted of a  population of mutual funds and pension funds with over $1 billion in  assets, and included large and small institutional investors from each  investor type. We defined “large” and “small” institutional investors as the  top and bottom 15 percent of each institutional investor type. In total,  these large and small institutional investors accounted for over 72 percent  of assets under management held by mutual funds and pension funds with  over $1 billion under management. Although we randomly selected these  institutional investors, the size of the sample was small and may not  necessarily be representative of the universe of institutional investors. As  a result, we could not generalize the results of our analysis to the entire  population of institutional investors.
We conducted structured interviews with 20 large and 11 small  institutional investors. Initially, we had contacted a total of 126 mutual  funds and pension funds that were randomly selected from our sample of  institutional investors and 20 (13 large and 7 small institutions) reported  using proxy advisory firm services and agreed to participate in our  structured interviews. The other 106 institutional investors we had initially  contacted declined to participate in the structured interviews for several  reasons. In particular, many of these institutions said that they do not vote  proxies themselves, but rather hire asset management institutions to both  manage their investment portfolios and vote proxies on their behalf. We  conducted interviews with 11 (7 large and 4 small institutions) of these  asset management institutions, which were referred to us by several of the  pension funds we had initially contacted. The results of these asset  manager interviews are included among the total of 20 large and 11 small  institutional investors that we interviewed. In addition, some of the 106  institutional investors declined to participate because they vote proxies  themselves or do not vote proxies at all, while others refused to  participate or could not be reached.
In our structured interviews with the 31 institutional investors, we spoke  with officials from the organizations who are responsible for proxy voting  activities. We asked these officials a variety of questions relating to their  institutions’ policies on proxy voting and use of proxy advisory firms.  Further, we asked the officials to comment on potential conflicts of  interest associated with proxy advisory firms, steps taken to mitigate such  potential conflicts, and the level of competition in the proxy advisory  industry.
Finally, we spoke with various industry professionals discussed earlier to  gain their perspectives on the influence of proxy advisory firms. We could  not identify any studies that comprehensively measured the influence that  these firms have on proxy voting.
We conducted our work in Washington, D.C., between September 2006  and June 2007 in accordance with generally accepted government auditing  standards.
section_title: Appendix II: GAO Contact and Staff Acknowledgments
subsections: section_title: Staff Acknowledgments
paragraphs: In addition to the above contact, Wes Phillips, Assistant Director; Emily  Chalmers; Rudy Chatlos; Eric Diamant; Fred Jimenez; Yola Lewis; and  Omyra Ramsingh made key contributions to this report.