John Tuzyk

The Canadian Securities Administrators (the CSA) have requested comments from market participants on concerns raised about services provided by proxy advisory firms (such as Institutional Shareholder Services Inc. (ISS)), and their impact on Canadian capital markets and to determine if, and how, these concerns, should be addressed by Canadian securities regulators.

This consultation provides an opportunity to Canadian public company issuers which have concerns regarding their interactions with proxy advisory firms, notably ISS, with respect to voting recommendations provided by ISS on issuers’ governance matters such as the election of directors, approval of stock plans, and approval of M&A transactions, to comment to the Canadian securities regulators on whether, and how, proxy advisory firms such as ISS should be regulated.

This CSA request for comments is contained in CSA Consultation Paper 25-401: Potential Regulation of Proxy Advisory Firms dated June 21, 2012 (the Consultation Paper).

Objectives of Consultation
The Consultation Paper indicates the CSA would like to obtain information and views about the concerns raised by market participants regarding proxy advisory firms to further inform the CSA’s analysis before the CSA conclude whether there is a need to regulate such firms. The Consultation Paper outlines possible securities regulatory responses to the concerns raised and possible regulatory frameworks to implement those responses, and requests feedback on those.

Services Provided by Proxy Advisory Firms
As the Consultation Paper indicates, a proxy advisory firm is one which reviews and analyses matters (whether issuer or shareholder proposals) put for a vote at shareholders’ meetings, and makes voting recommendations on such matters to its clients, which are usually institutional investors. These matters range from the election of directors to M&A transactions that involve a voting decision.

The Consultation Paper notes that, in addition to providing proxy advisory and voting services to institutional investors, some firms also provide consulting and advisory services to issuers on corporate governance matters.

The Consultation Paper indicates that the proxy advisory industry in Canada is dominated by two firms: ISS and Glass, Lewis & Co. The Consultation Paper notes that, in recent years, the demand for services provided by proxy advisory firms has grown for a number of reasons, including enhanced continuous disclosure requirements as well as the number and complexity of matters to be voted upon at shareholders’ meetings.

The Consultation Paper notes that, while the potential or perceived influence of such firms on institutional and retail investors is a complex issue, it is the CSA’s understanding that institutional investors generally follow the policies and recommendations of proxy advisory firms.

The CSA notes that some market participants cite the potential influence of proxy advisory firms over vote outcomes and corporate governance, combined with the possible negative impact of conflicts of interest and lack of transparency, as support for greater regulatory oversight over proxy advisory firms. The Consultation Paper also notes that critics argue that possible risks to market integrity are greater because of limited competition in the proxy advising industry.

Concerns with Proxy Advisory Services
The Consultation Paper identifies the following concerns raised by market participants with respect to proxy advisory services.

1. Potential Conflicts of Interest. The Consultation Paper notes that a conflict of interest may exist if the proxy advisory firm provides voting recommendations to institutional investors for governance matters for which the same firm is providing consulting services to the issuer.

2. Lack of Transparency. The Consultation Paper also notes concerns about the lack of disclosure about how proxy advisory firms arrive at their voting recommendations and the lack of public disclosure of the actual report.

3. Inaccuracies and Issuer Engagement. The Consultation Paper notes concerns raised by some issuers with respect to inaccuracies in proxy advisors’ reports and that such inaccuracies may lead to misinformed decision-making, particularly in the case of complex, controversial voting matters (including M&A transactions) or “close vote” situations.

4. Development of Corporate Governance Standards. Another concern identified was that proxy advisory firms may have become de facto corporate governance standards setters, without necessary expertise and transparency, and that issuers are compelled to adopt “one-size-fits-all” standards which may not be suitable in specific circumstances.

5. Reliance by Institutional Investors. There are concerns that institutional investors may rely too much on the vote recommendations provided by proxy advisory firms.

Current Regulatory Landscape
The Consultation Paper states that proxy advisory firms are not currently subject to any form of Canadian securities regulatory oversight, noting that such providers are not “advisors” under the securities registration regime as they do not advise as to whether or not to buy securities, and the current proxy solicitation rules expressly carve out proxy voting services.

The Consultation Paper also describes the initiatives taken by other jurisdictions, such as the U.S. S.E.C. and the European Commission, with respect to regulating proxy advisory firms.

Possible Requirements
The Consultation Paper indicates that, based on the feedback received and evidence of the impact of the concerns on market integrity, the CSA may determine that a securities regulatory response is warranted to address any or all of the concerns raised. The Consultation Paper also indicates that, to the extent that the CSA conclude that a securities regulatory response is warranted with respect to proxy advisory firms, the CSA’s current preferred securities regulatory solution would be the creation of a new stand-alone securities regulatory instrument. The CSA say this would require that the CSA obtain clear legislative authority to regulate proxy advisory firms. The CSA currently believe the regulatory framework contained in National Instrument 51-102 Continuous Disclosure Obligations relating to proxy solicitation is not an appropriate securities regulatory framework for proxy advisors.

The Consultation Paper indicates that the potential requirements in a new securities regulatory framework for proxy advisory firms could require proxy advisory firms to have policies and procedures designed to identify and manage potential conflicts of interest and to separate proxy voting services from advisory and consulting services. The Consultation Paper suggests that the securities regulatory framework could also require increased transparency in the activities of proxy advisory firms, which would be required to disclose internal procedures, guidelines, standards, methodologies, assumptions and sources of information supporting vote recommendations and how proxy advisory firms would implement policies to deal fairly with comments received from issuers by allowing issuers an opportunity to review the reports and proxy advisory firms to respond to issuers’ comments prior to issuing a report.

While the Consultation Paper indicates that the preferred securities regulatory framework may be a stand-alone securities regulatory instrument, the CSA note they considered a “designation” framework, similar to that in place for credit rating organizations, a certification framework where an appropriate person would certify compliance with the specific requirements, a “comply or explain” framework which require proxy advisory firms to comply with specific best practices or explain if they have not so complied, and “best practices guidance” which would be the CSA policy providing guidance on best practices for proxy advisory firms.

Request for Comments
The Consultation Paper directs a number of questions to all market participants, including whether participants agree with the concerns identified in the Consultation Paper, whether participants have other material concerns with proxy advisory firms not identified and whether participants believe that proxy advisory firm activities should be regulated in some respect. It also contains specific questions relating to the existence and possible remedies for addressing potential conflicts of interest, remedies for the perceived lack of transparency in methodologies and analyses, changes to processes relating to engagement with issuers and addressing potentially inappropriate interference in corporate governance practices, and the proposed regulatory response and framework.

The Consultation Paper also contains specific questions for institutional investors, such as the extent and ways they rely on proxy advisory firm services and how the voting recommendations of these firms impact their decision-making process.

Specific questions addressed to issuers include what their overall experience has been with proxy advisory firms, whether the concerns identified have had a negative effect at voting outcomes at shareholders meetings (including specific examples), to what extent issuers have adopted corporate governance standards recommended by proxy advisory firms not appropriate for their organizations, and whether there have been instances where the issuer has identified potential inaccuracies in the proxy advisory firm’s recommendation, and whether these were material inaccuracies that would have resulted in a change of the proxy advisory firm’s vote recommendation.

The Consultation Paper also poses questions for proxy advisory firms, such as their views on the identified concerns and possible regulatory responses.
The CSA have requested comments in writing with respect to the Consultation Paper on or before August 20, 2012.

For further information, please contact John Tuzyk at 416-863-2918, john.tuzyk@blakes.com, or a member of our Corporate & Commercial Group.

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