We focus on SEC oversight since 2007 later in this report. Increased Demand for Proxy Advisory Firms’ Services Stems from Rise of Institutional Investing and Requirements for Shareholder Voting

The market for proxy advisory firms has grown over the last 30 years as  institutional investors have relied more on firms to provide research,  analysis, and vote recommendations. Studies and Market Participants Agreed That Proxy Advisory Firms Influence Voting and Corporate Governance, but Had Mixed Views about Extent of Influence

Recent studies, market participants, and other stakeholders agree that  proxy advisory firms have influence on shareholder voting and corporate  governance practices, but had mixed views about the extent of their  influence. Most of the 13 institutional investors,11 corporate issuers, 4  proxy solicitors, and 8 industry association representatives with whom we  spoke stated that proxy advisory firms (more specifically, ISS and Glass  Lewis—the two firms with the largest number of institutional investor  clients) have influence on shareholder voting. According to large institutional investors and a few investor association  representatives that we spoke to, some smaller institutional investors who  do not have their own in-house research staffs to analyze the many proxy  voting issues and companies in their portfolio will obtain such services  from proxy advisory firms and rely more on the research and  recommendations proposed by the firms. Proxy Advisory Firms Have Increased Engagement with Market Participants and Stakeholders in the Vote Recommendation Process

Proxy advisory firms develop their general voting policies and update  them through an iterative process involving analysis of institutional  investor and corporate issuer input, industry practices, and discussions  with other stakeholders. Proxy  advisory firms have taken steps to communicate with corporate issuers  when developing voting recommendations and have allowed some to  review proxy reports for accuracy before they are final. While some  corporate issuers said they still do not understand the bases for some  vote recommendations and would like to have a dialogue about the proxy  reports, proxy advisory firms said that to maintain objectivity and satisfy  research reporting timelines for clients they have to limit the breadth of  such discussions. Some corporate issuers we interviewed said that both ISS and Glass  Lewis recently have made more of an effort to engage market participants  in the general policy development process unlike in the past when their  outreach was less frequent or formal. Also, Glass Lewis officials said that they work with an  independent advisory council that provides guidance in the development  and updating of its voting policies. According to market  participants, the increased rise of shareholder activism also saw  increased attention on the issue of proxy access. Corporate issuers we interviewed expressed concern that firms applied  these policies in a one-size-fits-all or rules-based manner. SEC Oversight Activities of Proxy Advisory Services Have Included Information Gathering, Guidance, and Examinations

Since 2007, SEC oversight of proxy advisory firms and the services they  provide has included information gathering on issues relating to the firms,  issuance of guidance, and examinations of firms registered as investment  advisors and of registered investment companies or investment advisers  using proxy advisory services (see fig. 5). The 2010 concept release discusses, among other  things, concerns that had been raised by corporate issuers and industry  participants about the level of accuracy and transparency in how proxy  advisory firms formulate voting recommendations and potential conflicts  of interest. In December 2013, SEC held a roundtable to discuss  issues facing the proxy advisory industry. The roundtable discussed the use of proxy advisory firms in general and  also reviewed key topics of interest, including potential conflicts of interest  for proxy advisory firms and users of their services, the transparency and  accuracy of the recommendations the firms make, and what the nature  and extent of institutional investor reliance on proxy advisor  recommendations is and should be. Examinations. SEC staff efforts on this  priority were incorporated into an ongoing Never-Before-Examined  Investment Company Initiative that launched in April 2015. Appendix I: Objectives, Scope, and Methodology

This report discusses (1) the demand for proxy advisory services and the  extent to which firms may influence proxy voting and corporate  governance practices, (2) how proxy advisory firms develop and apply  voting policies to make vote recommendations and efforts to increase  transparency, and (3) Securities and Exchange Commission’s (SEC)  oversight since 2007 related to proxy advisory firms and the services they  provide. In selecting institutional  investors for our interviews, we obtained information from the Council for  Institutional Investors and the Investment Company Institute to  judgmentally select a mix of 13 institutional investors (based on asset  size) and type (mutual fund companies and pension funds). We  reviewed the transcript and comments on a roundtable SEC held about  the proxy advisory industry in 2013.
Why GAO Did This Study

As institutional investment has grown over the last 30 years, institutional investors increasingly have relied on proxy advisory firms. The proxy advisory industry in the United States consists of five firms—two of which are the largest and most dominant proxy advisory firms. Some members of Congress, industry associations, and academics have raised issues about proxy advisory firms' influence on voting and corporate governance, the level of transparency in their methods, and the level of regulatory oversight.
GAO was asked to review the current state of the proxy advisory industry. This report discusses (1) the influence proxy advisory firms may have on voting and corporate governance, (2) how firms develop and apply policies to make vote recommendations, and (3) SEC's oversight activities. GAO reviewed literature; analyzed the proxy advisory firms' policies and SEC policies and examinations; and interviewed the 5 proxy advisory firms, 13 institutional investors, 11 corporate issuers, SEC officials, and industry stakeholders. GAO randomly selected corporate issuers from Standard and Poor's indexes and judgmentally selected institutional investors (based on size and type of investor) from industry associations' information.
GAO makes no recommendations in this report. GAO provided a draft to SEC for its review and received technical comments, which were incorporated as appropriate.

What GAO Found

Institutional investors, such as pension plans and mutual funds, hire proxy advisory firms to obtain research and vote recommendations on issues, such as executive compensation and proposed mergers that are addressed at shareholder meetings of public corporations (corporate issuers). Market participants and other stakeholders with whom GAO spoke agreed that with the increased demand for their services, proxy advisory firms' influence on shareholder voting and corporate governance practices has increased. But recent studies, market participants, and stakeholders had mixed views about the extent of the influence. For example, some said influence can vary based on institutional investor size (there is less influence on large institutional investors that often perform research in-house and have their own voting policies).
Proxy advisory firms, specifically Institutional Shareholder Services and Glass Lewis & Company—the two largest firms—develop and update their general voting policies through an iterative process, involving analysis of regulatory requirements, industry practices, and discussions with market participants. Corporate issuers and institutional investors told GAO that unlike in the past, the firms have made more of an effort to engage market participants in the development and updating of voting policies, such as criteria for assessing the independence of board directors and executive compensation packages. According to the firms, they apply these general voting policies to publicly available company information to develop vote recommendations, which also are based on institutional investor voting instructions and criteria that firm analysts determine are applicable to the issue being voted on. Firms have taken steps to communicate with corporate issuers and allow review of data used to make vote recommendations before they are finalized. However, some corporate issuers told GAO that firms continue to apply policies in a one-size-fits-all manner, which can lead to recommendations not in the best interest of shareholders. Corporate issuers also stated that they often do not understand the rationale for some vote recommendations and would like to discuss them before they are finalized. Proxy advisory firms told GAO that to maintain objectivity and satisfy research reporting timelines for clients, they limit the breadth of such discussions.
Securities and Exchange Commission (SEC) oversight of proxy advisory firms and the services they provide has included gathering information, issuing guidance, and examining proxy advisory firms and use of the firms by investment companies, such as mutual funds. In 2010, SEC summarized concerns that market participants raised about conflicts of interest, accuracy, and transparency of proxy advisory firms and requested comments on potential regulatory solutions. In December 2013, SEC held a roundtable to discuss issues facing the proxy advisory industry, and issued guidance in June 2014 on disclosure of conflicts of interest, among other things. According to SEC, it also has continued to address concerns surrounding proxy advisory firms through its examinations of investment advisers and investment companies that retain their services. SEC made these examinations a priority in 2015 and an area of focus in its ongoing initiative for registered investment companies that had not been examined by SEC.