Reclaiming Board of Directors’ Lost and Surrendered Accountabilities

As if Boards of Directors do not have enough to worry about. Between concerns over Cyber security, business model disruptions and disruptors, the US dollar and tariffs, Boards’ authorities are now being constantly challenged and undermined by the dominant proxy advisors, and mega public mutual funds. Lost and undermined are the individual investor’s voice, and U.S. public companies’ Boards’ governance duties and authorities, respectively. These fiduciaries are being overridden by two powerful consultants, and by sizeable wholesale investors.

“The proxy advisory firm duopoly is in serious need of reform and SEC attention. The market power of proxy advisory firms’ demands greater accountability for these firms’ actions and the information that they provide institutional investors,” said U.S. House Financial Services Committee Chairman Jeb Hensarling, R-Texas in Pensions & Investments. Equally in need of reform are the unfettered powers of large public mutual funds that vote their individual investors’ ownership shares according to the funds’ managers’ desires with no transparency and accountability. Mr. Hensarling and finally the SEC have directed their attention to the virtual veto powers that proxy advisers such as Glass Lewis and Institutional Shareholder Services (“ISS”) wield. These two firms control 97% of the advisory business, thus carrying a lot of weight with the SEC, and providing a pretext against investors’ lawsuits. According to The Wall Street Journal, “ISS issues recommendations on about 6,000 U.S. companies every year.“ The sheer power of these firms invites group think. Or, perhaps virtually no thinking, and just a follow-the-leader mentality?

Most recently, drug chain Rite Aid and supermarket chain Albertsons called off their prospective merger, after the all-powerful proxy adviser and large public investors nixed their seven-month-old proposed agreement to merge. This is despite compelling business reasons for the combination. Missed by the opponents are severe margin compression; the brutal competitive environment in both the drugstore and supermarket industries, and the entry of Amazon into the drug dispensing business with the acquisition of PillPack, as well as the sale of Targets’ pharmacies to the giant chain CVS. And ISS’s pretext for recommending against the Rite Aid-Albertsons combination was that the transaction would undermine Rite Aid’s share price, and that the deal “would introduce a new set of risks associated with the grocery business, and the combined leverage could limit investment in two evolving business environments, ” said ISS. Seriously? Although the objection to the transaction’s high leverage might be perfectly reasonable and understandable, Rite Aid’s very survivability as a standalone company provides a more pressing reason for the combination, as evidenced by continued losses at that chain and the sustained pressures from PBM companies.

The Rite Aid and Albertsons transaction is just one example of this emerged trend, which has accelerated and grown in the past two decades, all while neutering individual shareholders’ voting power and the very charges, accountabilities and fiduciary authorities Boards of Directors’ were granted by shareholders and regulators. If corporate management and Boards are accountable to shareholders and the SEC, to whom then are the proxy advisers firms with their oligopoly powers accountable to? Better yet, pray tell where is the transparency over the methodology utilized by these firms to make their recommendations?

The good news despite all of this is that last year the SEC started requiring these firms to register their decision-making methodology. Most recently, the SEC “waded into the dispute by rescinding a pair of roughly 15-year-old letters written by its staff. The letters had given mutual-fund managers greater assurance to rely on a consultant’s recommendations about matters up for a vote at a public company’s annual meeting,” said The Wall Street Journal. These staff 2003 and 2004 letters in fact “green lighted” the powerful influence of proxy advisers, and provided the very cover the fund managers needed to ward off potential investors lawsuits, left them vulnerable to outside influence, and relieved them of their responsibilities. Some of the credit for this recent reversal could go to the U.S. Chamber of Commerce, who has “pushed lawmakers and the SEC to quash the letters and more tightly regulate ISS and its main rival, Glass Lewis & Co.”

To the extent that the SEC’s rescission sticks, this may facilitate the expected November debates on regulation of the shareholder voting, and may force fund managers to adopt a more proactive, transparent, and widely accepted decision-making methodology.

Michael Zahaby

Bay Harbor Capital Advisors, LLC