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. 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. 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.