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CSA Consultation Paper 25-401 – Potential Regulation of Proxy Advisory Firms

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Mergers & Acquisitions Bulletin

On June 21, 2012, the Canadian Securities Administrators (the "CSA") published Consultation Paper 25-401:  Potential Regulation of Proxy Advisory Firms (the "Consultation Paper") to provide a forum for discussion of certain concerns raised about the services provided by proxy advisory firms and their potential impact on Canadian capital markets and to determine if, and how, these concerns should be addressed by Canadian securities regulators.  The Consultation Paper includes an overview of the background of proxy advisory firms in Canada, an analysis of concerns raised and possible regulatory responses, the regulatory landscape in Canada and internationally, and a proposed securities regulatory framework to regulate proxy advisory firms, if deemed necessary.  In addition, the Consultation Paper requests comments from market participants in response to various questions, some of which are specifically directed to institutional investors, issuers or proxy advisory firms.


The Consultation Paper provides an overview of the variety of services that proxy advisory firms provide to their clients, including making vote recommendations to their clients (usually institutional investors), automatic vote execution services and consulting advisory services to issuers on corporate governance matters.  The Consultation Paper states that institutional investors have a duty to deal appropriately with the portfolio securities they hold for their clients or plan beneficiaries which typically require the institutional investors to vote the shares they hold.  The Consultation Paper also discusses the potential or perceived increased reliance on proxy advisory firms by institutional investors in fulfilling their voting duties.  The Consultation Paper suggests that the impact of proxy advisory firms may also extend beyond institutional shareholders to retail investors' voting choices and issuers' corporate governance policies, which due to the lack of regulation and sufficient competition in the proxy advisory industry could impact market integrity.  The Consultation Paper also notes that the proxy advisory industry in Canada is dominated by two firms: Institutional Shareholder Services Inc. and Glass, Lewis & Co.

Concerns with Lack of Regulation of Proxy Advisory Firms

The Consultation Paper identifies specific concerns with the lack of regulation of proxy advisory firms which could have an impact on the voting process and the integrity of Canada's capital markets.  The concerns set out in the Consultation Paper are as follows:

  1. Potential conflicts of interest – A proxy advisory firm could potentially be in a conflict of interest: (i) if a proxy advisory firm provides vote recommendations to institutional investors on corporate governance matters of an issuer to which it also provides consulting services; (ii) if an institutional client could be the proponent of a specific shareholder proposal that could be the subject of a favourable vote recommendation by the proxy advisory firm; and (iii) if there are conflicts of interest in the proxy advisory firm's ownership structure.
  2. Lack of transparency – Proxy advisory firms' recommendations are not publicly available and in addition the underlying analyses of such recommendations are not disclosed.
  3. Potential inaccuracies and limited opportunity for issuer engagement – Anecdotal information suggests that there often can be inaccuracies in the data used by proxy advisory firms to arrive at a vote recommendation and the issuer is given very little time (if any) to comment on a draft report prepared by the proxy advisory firm, which may lead to misinformed decision-making.
  4. Perceived corporate governance implications – Proxy advisory firms may indirectly become corporate governance "standard setters", without necessarily having the necessary expertise to set such standards.  Proxy advisory firms may influence the behaviour of the issuers about which they make recommendations, and certain issuers are compelled to adopt "one-size-fits-all" standards which not may not be suitable for their specific circumstances.
  5. Extent of reliance by institutional investors – The extent to which institutional investors in Canada rely on proxy advisory firms in making their voting decisions is unknown as there is limited Canadian information available in this regard; however, the extent could be as significant as complete reliance in certain circumstances, meaning that institutional investors cast an automatic vote in accordance with proxy advisory firms' recommendations.

Existing Securities Regulatory Frameworks Considered

The Consultation Paper analyzes existing securities regulatory frameworks that could be amended in order to provide for the regulation of proxy advisory firms.  The CSA is of the view that proxy advisory firms should not be: (i) required to register as "advisers" under Canadian securities legislation given that they are not in the business of advising in the purchase or sale of securities; nor (ii) captured within the definition of "solicit" because giving proxy voting advice is not actually soliciting proxies.  As a result, the Consultation Paper describes that amending National Instrument 31-103 – Registration Requirements: Exemptions and Ongoing Registrant Obligations or National Instrument 51-102 – Continuous Disclosure Obligations would be inappropriate because this legislation was not designed to apply to the business of proxy advisory firms and as such extensive amendments would be required.

The Consultation Paper also includes reference to other possible frameworks, such as the "designation framework" similar to the regulation of credit rating agencies, the "certification framework" requiring a person to certify compliance with a certain rule that would be established, the "comply and explain framework" requiring proxy advisory firms to comply with best practices guidelines that would be established and to explain if and why they have not complied with best practices guidelines, and the "best practices guidance" establishing best practices guidelines without providing securities regulators the ability to ensure and enforce compliance.

The Consultation Paper also provides an overview of the various regulatory frameworks and recent developments and initiatives in the United States and Europe.  The Consultation Paper notes that a public consultation process in the United States identified some of the same concerns identified by the CSA, such as potential conflicts of interest and lack of transparency.

New Securities Regulatory Framework Proposed

The Consultation Paper suggests that if the CSA determines that a securities regulatory response is required, then proxy advisory firms in the business of "making" vote recommendations on proposals put to a vote at shareholders' meetings of Canadian reporting issuers would become subject to a new stand alone securities regulatory instrument specifically designed with proxy advisory services in mind.

In order to respond to conflict of interest concerns, the potential new securities rules suggested in the Consultation Paper would require proxy advisory firms to: (i) have policies and procedures designed to identify and manage any potential conflicts of interest that arise in connection with the issuance of a vote recommendation, as well as employee and ownership conflicts; (ii) disclose on their website the procedures in place to mitigate or address conflicts and also possibly disclose a specific conflict in a vote recommendation; and (iii) separate their proxy voting services from the advisory or consulting services. 

In order to increase transparency in the activities of proxy advisory firms, the potential requirements proposed in the Consultation Paper would require proxy advisory firms to: (i) disclose internal procedures, guidelines, standards, methodologies, assumptions and sources of information supporting vote recommendations; (ii) implement policies (which would be disclosed on the firms' websites) that describe their processes to deal fairly with comments from issuers by allowing issuers an opportunity to review the reports and proxy advisory firms to respond to issuers' comments prior to the issuance of the report; and (iii) disclose on their websites the procedures they implement in developing their voting policy guidelines.

Request for Comments

The Consultation Paper sets out a variety of questions seeking comments from all market participants in respect of the concerns identified in the Consultation Paper and the proposed possible regulatory framework.  Additional questions specifically addressed to institutional investors relate to, among other things, the institutional investors' reliance on proxy advisory firms and measures taken to ensure reliability of proxy advisory firms' recommendations.  Additional questions specifically addressed to issuers relate to the issuer's overall experience or concerns with proxy advisory firms, the extent to which proxy advisory firms influence corporate governance practices, even when not appropriate, and whether the issuer has experienced material inaccuracies in a proxy advisory firm’s recommendations and how this situation resulted in an improper vote outcome.  The CSA also is seeking comments from proxy advisory firms regarding the possible regulatory approaches and their potential impact on a proxy advisory firm.

Comments on the Consultation Paper are due on or before August 20, 2012.

Fasken Martineau Experience

Fasken Martineau DuMoulin LLP is at the forefront of corporate governance and regularly advises issuers and institutional investors.  Stephen Erlichman, a co-author of this bulletin, is a senior partner at Fasken Martineau and Executive Director of the Canadian Coalition for Good Governance (whose members consist of most of the largest pension funds and other institutional investors in Canada which collectively manage approximately $2 trillion of assets).


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