Editor: Explain why the Millstein Center's Policy Briefing No. 3 (Policy Briefing) focuses particularly on the proxy voting practices of institutional investors and the global proxy advisory industry.
Millstein: The answer is pretty simple, Al. The entire legitimacy of the corporate governance structure depends on effective oversight - shareholders oversee directors and directors oversee management. Shareholders are supposed to elect directors and directors to select management. The periodic election process is a reminder of the oversight role of shareholders and directors. The integrity of the voting system is critical. If it doesn't work right, the system suffers.
As we have learned in the past few years, you and I as individuals don't matter very much in this voting system. Our stock is in most instances not held in our name, so the vote is cast by intermediaries such as pension funds, mutual funds, banks, insurance companies and so on. We hope they vote in what is in our best interest, rather than theirs.
The integrity of the system depends on whether or not we feel comfortable that the intermediaries and their advisors are voting their shares in what is in our best interest rather than their own. This is why the Millstein Center decided to make the proxy voting issue a priority.
Editor: Why did the Center think that, given the current financial crisis, this was a good time to focus on the proxy voting issue?
Millstein: I think that what bothered the Center was that the crisis raised issues about the quality of decision making by intermediaries who were investing our money. The problem the crisis presents is that the intermediaries, mainly the pension and mutual funds, were risking our money by investing it in risky enterprises using very, very risky financial instruments. They did this because they were seeking greater returns - and there is nothing wrong with that. The question is whether or not they were taking enough care in investing what was essentially our money. Pension fund money fueled a lot of what was going on that contributed to the crisis. The beneficiaries - people like us - have a right to know whether the intermediaries understood the risks that they were taking with our money. I'm not sure they did. That raises questions about whether in voting the shares invested on our behalf, they are properly considering our long-term interests as the ultimate beneficiaries of those investments.
Editor: I have heard that some proxy advisors and institutional investors take a flat-out position that poison pills are bad and vote against any director who might ever have voted for a poison pill even where that vote involved a particularly vulnerable company where a takeover at that time might not have been in the long-term interest of shareholders.
Millstein: That is a possibility, but I don't think most rational people object to poison pills if they are used for the purposes of obtaining a better bid or protecting a corporation against low-balling. The original difficulty with them was their use to "just say no" to anything that threatened the tenure of entrenched management. More recently, courts have ruled that you can use a poison pill for defensive purposes to make sure that you are not being lowballed - to get the best price for shareholders.
Editor: Let me ask you about the Center's role in deciding to pursue issues related to voting. Why did it consider them so important?
Millstein: For the reasons I stated, it felt that the integrity of the voting system is critical to the legitimacy of corporate governance in general.
Editor: What role did you play in shaping the direction of the Policy Briefing in terms of its conclusions?
Millstein : It is very important to distinguish between shaping the Policy Briefing and determining the process followed. My role and that of Steve Davis, the Center's Senior Fellow, was to bring people together who we thought were the heart and soul of the industry - those representing shareholders, issuers, pension funds and proxy advisors headed up by Lynn Turner in whom we have a lot of confidence. Lynn, as you know, was the SEC's Chief Accountant for many years. We brought them together to discuss the issues at a one-day Roundtable. The Policy Briefing reflects a sense of the views they expressed that day rather than my view or Steve's view. The Roundtable was conducted under Chatham House rules so the participants know that they will not be directly quoted. That permits them to let their hair down and really tell us what they think is going on.
The recommendations are based on what we heard. If Steve or I had made the recommendations some of them might have been stronger, but they are not my or Steve's recommendations - they are recommendations that we think come within the bounds of what was discussed at the meeting. Remember, the purpose of the Center is to bring people together to discuss matters in depth that we think need to be discussed, and then to present recommendations based on those discussions. That is what we did.
Editor: Having sat in on the Roundtable discussions, should the voting recommendations of proxy advisors reflect the views of an issuer's shareholders with respect to its governance? Or, the views of the proxy advisor? Or, of independent consultants?
Millstein: All of the above. My view is that the broader the outreach the proxy advisors and institutional investors make, the better their recommendations will be. This includes talking to other proxy advisers and institutions and to issuers, beneficiaries and consultants and relevant others. Proxy advisors should disclose and make very clear who they are talking to and whose advice they are relying on.
Editor: One of the points that the Society of Corporate Secretaries & Governance Professionals (Society) made in response to an earlier draft of the Policy Briefing was that the issuer should have an opportunity to look at the recommendation before it goes public - not so much for the purpose of objecting, but for the purpose of assuring that the analysis is based upon facts, which in some cases may be known only to the issuer.
Millstein: That is a fair comment. The issuer ought to have the ability to look at it and comment. I think it would be healthy. I believe that when considered together, several provisions of the Center's Draft Code of Conduct for the Proxy Advisory Industry, under the heading of Quality of the Recommendation Process, should take care of the Society's concerns. A.2 provides that the proxy voting recommendations "should be subjected to some form of objective validation based on historic experience." A.8 states the "Advisor and its analysts should take steps to avoid issuing any recommendations or reports that contain any misrepresentations or are otherwise misleading." A.11 states furthermore that "The Advisor should implement a rigorous fact-checking process for its recommendations and set out how fact-checking is performed." Recommendation A.12 now provides that "The "Advisor should state whether it sends a draft copy of the recommendation to the issuer in advance for correction of any material errors. If this is part of the recommendation process, the issuer should be given a reasonable amount of time prior to the release of the recommendation to correct any errors. If the advisor does not send pre-release copies of recommendations to the issuer it should explain why." I think the Society should now be satisfied. Given the language I have quoted, I would think that any proxy advisor would be hard put to justify not sending pre-release copies to the issuer for fact checking.
Editor: How important is consistency; I know it was discussed in terms of the proxy advisor making recommendations.
Millstein: From the standpoint of impartiality, it is very important. You want to make sure that there are no hidden biases and that they are being consistent in what they recommend from one issuer to another. But there ought to be some flexibility as well to preserve balance. You ought to be able to take account of special situations.
Editor: The Society strongly commended the Policy Briefing for its call to action in addressing breakdowns in the voting chain.
Millstein: The part of the Roundtable discussion that surprised me the most was the universal concern with the voting chain and if you look at the Policy Briefing, you will see on page 13 that the diagram of the voting chain looks like a creation of Rube Goldberg. It is rife with the potential for the vote to be miscast, not voted or otherwise influenced. It's such an arcane structure that, like the Society, we've called on the SEC to address it. We think the best way to accomplish this would be for the SEC to convene a blue ribbon committee to consider the present complex and arcane voting chain and try to clean it up. The Center can't do that, it is only a private group. The voting chain can only be cleaned up by the SEC. We have been trying to get the attention of Mary Schapiro. I think when she gets done with some immediate things on her agenda, she will take this up.
Editor: The Policy Briefing included a proposed first industry-wide code of ethics applicable to proxy advisors. How has it fared?
Millstein: Apparently everybody subscribed to it other than RiskMetrics. I'm surprised at RiskMetrics's reaction and a little disappointed. However, I can understand why - it calls for the complete elimination of conflicts. RiskMetrics is a public company with its consulting practice built into its business model. They have taken steps to make sure that there is no contact between their analysts and the people doing the consulting. I just wish for their sake they would get out of the consulting business because they are an important part of the proxy voting process and are to be applauded for all the efforts they are making to make their voting process better and more open. Unfortunately for them, no matter what they try to do to eliminate the conflict, so long as they continue in the consulting business, the perception will never be erased.
Editor: Cary Klafter, who is the Corporate Secretary of Intel, in his interview on page 40 of this issue contrasts the SEC's ongoing concern about the conflicts of credit-rating firms and the fact that it has pretty much ignored those of the proxy advisory firms.
Millstein: The parallel is clear. Both of them are critical to the functioning of our whole system, both are privately held and both of them have conflicts that are at odds with their obligations to the investing public. Those industries won't really be credible until the conflict issue is dealt with. I agree with the Society.
Editor: Are there other features of the Millstein Center's proxy advisors' code that you would like to mention?
Millstein: I think we are missing one important element, and that is the criticism we heard of how the pension funds and institutional shareholders vote. That concern was eye-opening to me - although I had always expected that reaction, it was another thing to hear it articulated. The perception was that many of these institutional investors do not take voting very seriously.
Time after time you will hear institutional investors say, "Well, what is the point of voting, it doesn't have an impact on corporate governance." If that is true, then the whole system is crazy. To have faith in the system, you have to believe that someone out there is watching - that someone out there is exercising some degree of oversight over the corporation.
They are supposed to be the owners. Some don't believe their institutional votes have an effect. Others think it is too expensive to do the homework required to vote intelligently - so they don't devote time and energy in voting their proxies, in thinking through what is in their beneficiaries' best interest. They outsource voting to other people, which is not a happy result because owners are supposed to think about what they own, not base their judgments on what someone else thinks. It is fine to seek outside advice, but in the last analysis they should make up their own minds as to how they are going vote. That may be expensive, but that is the way the system is supposed to work.
The Policy Briefing is critical about the fact that, although the International Corporate Governance Network (ICGN) and the Stanford Institutional Investors' Forum Committee on Fund Governance (SIIFCFG) have proposed codes of best practices for fund owners; most of them just don't pay attention to it. Therefore one critical element of the whole system is missing, that is, that too many pension funds and other institutional investors are not operating in an intelligent and credible way to make sure that their votes are being cast in a way that reflects their beneficiaries' best interests, or at least that they think is in the best interest of their beneficiaries.
Editor: Do you have a closing comment?
Millstein: I hope that everybody will pay attention to the Policy Briefing because it is the first comprehensive critique of the whole proxy voting system that I know of. Coming from people who are actually involved in that system, it is worth reading because it will give you a very clear picture of what is currently wrong with the system and what needs to be corrected. On the proxy advisor side, we've already gotten a consensus sign-up to the Center's best practices code - the only holdout thus far being RiskMetrics. On the defects in the voting chain, I think in due course the SEC will pick that ball up and run with it. As far as pension plans and other institutional investors are concerned, my hope is that they will read the Policy Briefing and take its message to heart. A good first step would be the adoption and implementation of the ICGN or SIIFCFG codes by pension plans and other institutional investors.