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Advise Institutional Investors on Proxy Voting' which was released on 
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Report to Congressional Requesters: 

United States Government Accountability Office: 

GAO: 

June 2007: 

Corporate Shareholder Meetings: 

Issues Relating to Firms That Advise Institutional Investors on Proxy 
Voting: 

GAO-07-765: 

GAO Highlights: 

Highlights of GAO-07-765, a report to congressional requesters 

Why GAO Did This Study: 

At annual meetings, shareholders of public corporations can vote on 
various issues (e.g., mergers and acquisitions) through a process 
called proxy voting. Institutional investors (e.g., mutual funds and 
pension funds) cast the majority of proxy votes due to their large 
stock holdings. In recent years, concerns have been raised about a 
group of about five firms that provide research and recommendations on 
proxy votes to their institutional investor clients. 

GAO was asked to report on
(1) potential conflicts of interest that may exist with proxy advisory 
firms and the steps that the Securities and Exchange Commission (SEC) 
has taken to oversee these firms; (2) the factors that may impede or 
promote competition within the proxy advisory industry; and (3) 
institutional investors’ use of the firms’ services and the firms’ 
potential influence on proxy vote outcomes. 

GAO reviewed SEC examinations of proxy advisory firms, spoke with 
industry professionals, and conducted structured interviews with 31 
randomly selected institutional investors. 

GAO is not making any recommendations. 

GAO provided a draft of this report to SEC for its review and comment. 
SEC provided technical comments, which GAO incorporated, as 
appropriate. 

What GAO Found: 

Various potential conflicts of interest can arise at proxy advisory 
firms that could affect vote recommendations, but SEC has not 
identified any major violations in its examinations of such firms. In 
particular, the business model of the dominant proxy advisory 
firm—Institutional Shareholder Services (ISS)—has been the most 
commonly cited potential conflict. Specifically, ISS advises 
institutional investors how to vote proxies and provides consulting 
services to corporations seeking to improve their corporate governance. 
Critics contend that corporations could feel obligated to retain ISS’s 
consulting services in order to obtain favorable vote recommendations. 
However, ISS officials said they have disclosed and taken steps to 
mitigate this potential conflict. For example, ISS discloses the 
potential conflict on its Web site and the firm’s policy is to advise 
clients of relevant business practices in all proxy vote analyses. ISS 
also maintains separate staff who are located in separate buildings for 
the two businesses. While all institutional investors GAO spoke with 
that use ISS’s services said they are satisfied with its mitigation 
procedures, some industry analysts continue to question their 
effectiveness. SEC conducts examinations of advisory firms that are 
registered as investment advisers and has not identified any major 
violations. 

Although new firms have entered the market, ISS’s long-standing 
position has been cited by industry analysts as a barrier to 
competition. ISS has gained a reputation for providing comprehensive 
services, and as a result, other firms may have difficulty attracting 
clients. Proxy advisory firms must offer comprehensive coverage to 
compete and need sophisticated systems to provide the services clients 
demand. But firms interested in entering the market do have access to 
much of the information needed to make recommendations, such as 
publicly available documents filed with SEC. Competitors have attempted 
to differentiate themselves from ISS by, for example, providing only 
proxy advisory services and not corporate consulting services. While 
these firms have attracted clients, it is too soon to tell what their 
ultimate effect on enhancing competition will be. 

Among the 31 institutional investors GAO spoke with, large institutions 
reportedly rely less than small institutions on the research and 
recommendations offered by proxy advisory firms. Large institutional 
investors said that their reliance on proxy advisory firms is limited 
because, for example, they have in-house staff to assess proxy vote 
issues and only use the research and recommendations offered by proxy 
advisory firms to supplement such research. In contrast, small 
institutional investors have limited resources to conduct their own 
research and tend to rely more heavily on the research and 
recommendations offered by proxy advisory firms. The fact that large 
institutional investors cast the great majority of proxy votes made by 
institutional investors and reportedly place relatively less emphasis 
on advisory firm research and recommendations could serve to limit the 
firms’ overall influence on proxy voting results. 

[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-765]. 

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Yvonne Jones at (202) 512-
8678 or jonesy@gao.gov. 

[End of section] 

Contents: 

Letter: 

Results in Brief: 

Background: 

Potential Conflicts of Interest Exist among Proxy Advisory Firms That 
Could Affect Their Vote Recommendations, but SEC Has Not Identified Any 
Major Violations in Its Examinations of Registered Firms: 

Analysts Cite ISS's Long-standing Position in the Industry as a 
Potential Barrier to Competition, Although Firms Have Entered the 
Market in Recent Years: 

Large Institutional Investors Reportedly Rely Less Than Small 
Institutional Investors on Advisory Firms, Limiting the Influence These 
Firms Have on Proxy Voting Results: 

Agency Comments: 

Appendix I: Scope and Methodology: 

Appendix II: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: Overview of the Major Proxy Advisory Firms: 

Table 2: Reliance of Large Institutional Investors on Proxy Advisory 
Firms: 

Abbreviations: 

Egan-Jones: Egan-Jones Proxy Services: 

Glass Lewis: Glass Lewis & Co. 

ICS: ISS Corporate Services, Inc. 

ISS: Institutional Shareholder Services, Inc. 

MCG: Marco Consulting Group: 

PGI: Proxy Governance, Inc. 

PWBA: Pension Welfare Benefits Administration: 

SEC: Securities and Exchange Commission: 

United States Government Accountability Office: 
Washington, DC 20548: 

June 29, 2007: 

The Honorable Spencer Bachus: 
Ranking Member: 
Committee on Financial Services: 
House of Representatives: 

The Honorable Deborah Pryce: 
Ranking Member: 
Subcommittee on Capital Markets, Insurance, and Government Sponsored 
Enterprises: 
Committee on Financial Services: 
House of Representatives: 

The Honorable Richard Baker: 
House of Representatives: 

Each year, publicly traded corporations hold shareholder meetings for 
director elections and to consider management and shareholder proposals 
that may have an effect on a corporation's operations and value, such 
as executive compensation, corporate governance matters, and proposed 
mergers and acquisitions. Most shareholders typically do not attend 
these meetings, opting instead to vote by mail or online, through a 
process known as proxy voting. According to Automatic Data Processing, 
Inc.--one of the largest providers of transaction services to the 
financial industry--most proxy votes are cast by or on behalf of 
institutional investors, such as mutual funds and pension plans, given 
the level of stocks they manage as compared to other types of 
investors. 

In recent years, concerns have been raised about the proxy advisory 
industry, which is comprised of five major proxy advisory firms that 
help many institutional investors carry out their fiduciary 
responsibilities relating to proxy voting.[Footnote 1] These proxy 
advisory firms may perform several functions on behalf of their 
clients, such as offering research and recommendations on particular 
proxy issues (e.g., whether to approve an executive compensation plan) 
or casting the actual votes. Critics of proxy advisory firms, including 
certain industry associations and academics, contend that the proxy 
advisory industry suffers from significant conflicts of interest and a 
lack of competition and that these firms have a disproportionate 
influence on proxy voting. Others counter that the firms provide a 
valuable service for institutional investors and note that such clients 
are sophisticated market participants that are free to choose whether 
and how to employ the services of proxy advisory firms. 

Under the Securities Exchange Act of 1934,[Footnote 2] the Securities 
and Exchange Commission (SEC) regulates the proxy solicitation process 
with respect to publicly traded equity securities, and SEC regulates 
the activities of proxy advisory firms that are registered with SEC as 
investment advisers under the Investment Advisers Act of 1940.[Footnote 
3] Under SEC rules, when soliciting proxies, certain information must 
be disclosed in writing to shareholders, and such disclosure, referred 
to as a proxy statement, must be filed with the agency.[Footnote 4] 
These proxy statements must include important facts about the issues on 
which shareholders are asked to vote. Under the Investment Advisers Act 
and related SEC rules, registered investment advisers are required to 
take a variety of steps designed to help protect their clients. For 
example, an investment adviser must disclose information about its 
business practices and potential conflicts of interest to clients and 
potential clients. SEC monitors compliance with the laws and rules 
through, among other means, periodic examinations of registered 
investment advisers. Based on examination findings, SEC may send 
letters to investment advisers requiring them to correct identified 
deficiencies. SEC may also take enforcement actions for more serious 
violations, as deemed appropriate, such as seeking civil fines in 
federal district court. 

Because of your interest in helping to ensure the integrity of proxy 
voting, you asked us to provide an overview of proxy advisory firms and 
SEC's oversight of this industry. This report (1) identifies potential 
conflicts of interest that may exist with proxy advisory firms and the 
steps that SEC has taken to oversee these firms; (2) discusses the 
factors that might impede or promote competition in this industry; and 
(3) analyzes institutional investors' use of proxy advisory services to 
help vote proxies and the influence proxy advisory firms may have on 
proxy voting. 

To address these objectives, we conducted a literature review and 
examined studies relating to the proxy advisory industry. In addition, 
we identified and interviewed various professionals (experts, 
academics, industry association representatives, and others) with 
knowledge of the industry. To gain an understanding of SEC's oversight 
of proxy advisory firms, we reviewed relevant investment adviser 
regulations and examination reports and interviewed agency officials. 
Further, we conducted structured interviews with 31 institutional 
investors selected randomly by type, including mutual funds, corporate 
pension funds, government pension funds, and union pension funds, as 
well as some asset management institutions, to gain an understanding of 
the ways in which they use proxy advisory firms and the influence that 
such firms have on proxy voting.[Footnote 5] Our sample was derived 
from Standard & Poor's Money Market Directories (January 2006), and 
consisted of a population of institutional investors with over $1 
billion in assets, including large and small institutional investors 
from each type above this asset level. We defined "large" and "small" 
institutional investors as the top and bottom 15 percent of each 
investor type. Large and small institutional investors account for over 
72 percent of the managed assets held by all of the institutional 
investors with over $1 billion in assets. Although we randomly selected 
these institutional investors, the size of the sample was small and 
might not have been representative of the universe of institutional 
investors. As a result, we could not generalize the results of this 
effort. 

We conducted our work in Washington, D.C., between September 2006 and 
June 2007 in accordance with generally accepted government auditing 
standards. See appendix I for more information on our scope and 
methodology. 

Results in Brief: 

Various potential conflicts of interest exist among proxy advisory 
firms that could affect vote recommendations, but SEC has not 
identified any major violations in its examinations of such registered 
firms. In particular, the business model of the dominant advisory firm-
-Institutional Shareholder Services, Inc. (ISS)--has been cited by 
industry participants and analysts as creating a significant potential 
conflict of interest. ISS advises institutional investor clients on how 
to vote their proxies and at the same time provides consulting services 
to help corporations develop management proposals and improve their 
corporate governance. Because it provides both types of services, ISS 
could, for example, help a corporate client develop an executive 
compensation proposal to be submitted for shareholder approval while at 
the same time making a recommendation to investor clients on how to 
vote for this proposal. ISS's critics also contend that this could lead 
corporations to feel obligated to retain ISS's consulting services in 
order to obtain favorable proxy vote recommendations. However, ISS 
officials said that they have disclosed and taken steps to help 
mitigate this potential conflict. For example, ISS publicly discloses 
information about the potential conflict on its Web site and firm 
policy requires relevant disclosures to its institutional investor 
clients. In addition, ISS officials explained that the proxy advisory 
and corporate consulting businesses have separate staff, operate in 
separate buildings, and use segregated office equipment and information 
databases. While all institutional investors we spoke with that use 
ISS's services said they are satisfied with the steps ISS has taken to 
mitigate this potential conflict, some industry analysts we contacted 
said there remains reason to question the steps' effectiveness. We also 
identified other potential conflicts associated with proxy advisory 
firms. For example, owners or executives of proxy advisory firms may 
have a significant ownership interest in or serve on the board of 
directors of corporations that have proposals on which the firms are 
offering vote recommendations. In its oversight capacity, SEC conducts 
examinations of proxy advisory firms that are registered as investment 
advisers, including, among other things, assessing compliance with 
requirements of the Investment Advisers Act and related rules, 
including the requirement that investment advisers identify, disclose, 
and mitigate conflicts of interest. To date, SEC has not identified any 
major violations and has not initiated any enforcement action against 
proxy advisory firms. 

ISS's long-standing position in the proxy advisory industry has been 
cited as a potential barrier to competition in this industry, although 
new firms have entered the market in recent years. Since it began 
operating in 1985, ISS has gained a reputation with institutional 
investors for providing comprehensive proxy voting research and 
recommendations. Consequently, other providers may have difficulty 
attracting ISS's institutional client base of over 1,700 firms. 
According to industry participants, proxy advisory firms must offer 
comprehensive coverage of public companies in order to compete, because 
institutional investors may not be interested in subscribing to limited 
service offerings. Firms also need to develop sophisticated information 
systems to provide the research and vote-processing capabilities 
clients demand. But industry analysts also explained that firms 
interested in entering the market do have access to much of the 
information needed to conduct research, including the annual and 
quarterly reports companies file with SEC. In addition, various 
academics told us that once a firm has acquired the necessary 
technology and research processes, the marginal cost of providing 
services to additional clients and of updating and maintaining these 
services is relatively low. Competitors that have entered the market in 
recent years have attempted to differentiate themselves from ISS by, 
for example, emphasizing that they provide only proxy advisory services 
and not corporate consulting services. While these firms have attracted 
institutional clients, it is too soon to tell what their ultimate 
effect will be on enhancing industry competition. 

Among the 31 institutional investors we spoke with, large institutions 
reportedly relied less than small institutions on the research and 
specific recommendations offered by proxy advisory firms to help decide 
how to vote proxies. Specifically, large institutional investors 
reported that their reliance on proxy advisory services is limited 
because these institutional investors (1) conduct their own research 
and analyses to make voting decisions and use the research and 
recommendations offered by proxy advisory firms only to supplement such 
analyses; (2) might develop their own voting policies, which the 
advisory firms would be responsible for executing; and (3) might 
contract with more than one advisory firm to gain a broader range of 
information on proxy issues. In contrast, small institutional investors 
reported that they have limited resources to conduct their own research 
and tend to rely more heavily on the research and recommendations of 
proxy advisory firms. Like large institutional investors, however, 
representatives of small institutions said that they are ultimately 
responsible for proxy voting decisions and retain the right to override 
recommendations made by advisory firms. While the institutional 
investors we contacted might not have been representative of all 
institutional investors, many industry analysts we spoke with agreed 
that large institutions would place less emphasis than small 
institutions on proxy advisory firms' research and recommendations when 
deciding how to vote. The fact that large institutional investors cast 
the great majority of proxy votes made by institutional investors and 
reportedly place less emphasis than small institutions on such research 
and recommendations could serve to limit the overall influence advisory 
firms have on proxy voting results. 

We provided a draft of this report to SEC for its review and comment. 
SEC provided technical comments, which we incorporated, as appropriate. 
We also provided relevant sections of the draft to the proxy advisory 
firms for a technical review of the accuracy of the wording and made 
changes, as appropriate, based on the firms' comments. 

Background: 

According to ISS, over 28,000 publicly-traded corporations globally 
send out proxy statements each year that contain important facts about 
more than 250,000 separate issues on which shareholders are asked to 
vote. Votes are solicited on a variety of key issues that could 
potentially affect the corporations' value, such as the election of 
directors, executive compensation packages, and proposed mergers and 
acquisitions, as well as other, more routine, issues that may not 
affect value, such as approving an auditor and changing a corporate 
name. The proxy statement typically includes a proxy ballot (also 
called a proxy card) that allows shareholders to appoint a third party 
(proxy) to vote on the shareholder's behalf if the shareholder decides 
not to attend the meeting. The shareholder may instruct the proxy how 
to vote the shares or may opt to grant the proxy discretion to make the 
voting decision. The proxy card may be submitted to the company via the 
mail or online. 

The proxy advisory industry has grown over the past 20 years as a 
result of various regulatory and market developments. The management of 
a mutual fund's or pension plan's assets, including the voting of 
proxies, is often delegated to a person who is an investment adviser 
subject to the Investment Advisers Act of 1940.[Footnote 6] In a 1988 
letter, known as the "Avon Letter," the Department of Labor took the 
position that the fiduciary act of managing employee benefit plan 
assets includes the voting of proxies associated with shares of stock 
owned by the plan.[Footnote 7] According to industry experts, managers 
of employee retirement plan assets began to seek help in executing 
their fiduciary responsibility to vote proxies in their clients' best 
interests. Consequently, the proxy advisory industry--particularly ISS, 
which had been established in 1985--started to grow. According to 
industry experts, ISS's reputation and dominance in the proxy advisory 
industry continued to grow in the 1990s and early 2000s, fueled by the 
growing fiduciary requirements of institutional investors and increased 
shareholder activism. This increased shareholder activism has been 
attributed in part to reaction by investors to the massive financial 
frauds perpetrated by management of public companies, including the 
actions that led to the bankruptcies of Enron and WorldCom. Many 
institutional investors sought the services of proxy advisory firms to 
assist in their assessments of the corporate governance practices of 
publicly traded companies and to carry out the mechanics of proxy 
voting. Finally, in 2003, SEC adopted a rule and amendments under the 
Investment Advisers Act of 1940 that requires registered investment 
advisers to adopt policies and procedures reasonably designed to ensure 
that proxies are voted in the best interests of clients, which industry 
experts also cited as a reason for the continued growth of the proxy 
advisory industry.[Footnote 8] 

Today, the proxy advisory industry is comprised of five major firms, 
with ISS serving as the dominant player with over 1,700 clients. The 
other four firms--Marco Consulting Group (MCG), Glass Lewis & Co. 
(Glass Lewis), Proxy Governance, Inc. (PGI), and Egan-Jones Proxy 
Services (Egan-Jones)--have much smaller client bases and are 
relatively new to the industry: Glass Lewis, PGI, and Egan-Jones were 
all created within the past 6 years. 

* Founded in 1985, ISS serves clients with its core business, which 
includes analyzing proxy issues and offering research and vote 
recommendations. ISS also provides Web-based tools and advisory 
services to corporate issuers through ISS Corporate Services, Inc. a 
separate division established in 1997 which was spun-out into a wholly- 
owned subsidiary in 2006. RiskMetrics Group, a financial risk 
management firm, acquired ISS in January 2007. RiskMetrics Group 
provides risk management tools and analytics to assist investors in 
assessing risk in their portfolios. 

* MCG was established in 1988 to provide investment analysis and advice 
to Taft-Hartley funds and has since expanded its client base to public 
employee benefit plans.[Footnote 9] 

* Glass Lewis, established in 2003, provides proxy research and voting 
recommendations and was acquired by Xinhua Finance Limited, a Chinese 
financial information and media company, in 2007. 

* Established in 2004, PGI offers proxy advice and voting 
recommendations and is a wholly-owned subsidiary of FOLIOfn, Inc., a 
financial services company that also provides brokerage services and 
portfolio management technology for individual investors and investment 
advisers. 

* Egan-Jones was established in 2002 as a division of Egan-Jones 
Ratings Company, which was incorporated in 1992. Egan-Jones provides 
proxy advisory services to institutional clients to facilitate making 
voting decisions. 

Of the five major proxy advisory firms, three--ISS, MCG, and PGI--are 
registered with SEC as investment advisers and are subject to agency 
oversight, while according to corporate officials, the other two firms 
are not. In their SEC registration filings, the three registered firms 
have identified themselves as pension consultants as the basis for 
registering as investment advisers under the Investment Advisers 
Act.[Footnote 10] Although Glass Lewis initially identified itself as a 
pension consultant and registered with SEC as an investment adviser, it 
withdrew its registration in 2005. According to SEC officials, an 
investment adviser is not required to disclose a reason for its 
decision to withdraw its registration in the notice of withdrawal filed 
with SEC. Officials from Glass Lewis and Egan-Jones did not elaborate 
on their decisions not to be registered with SEC as investment 
advisers, other than to note that their decisions were made with advice 
from their respective counsel. 

Potential Conflicts of Interest Exist among Proxy Advisory Firms That 
Could Affect Their Vote Recommendations, but SEC Has Not Identified Any 
Major Violations in Its Examinations of Registered Firms: 

In the proxy advisory industry, various conflicts of interest can arise 
that have the potential to influence the research conducted and voting 
recommendations made by proxy advisory firms. The most commonly cited 
potential for conflict involves ISS, which provides services to both 
institutional investor clients and corporate clients. Several other 
circumstances may lead to potential conflicts on the part of proxy 
advisory firms, including situations in which owners or executives of 
proxy advisory firms have an ownership interest in or serve on the 
board of directors of corporations that have proposals on which the 
firms are offering vote recommendations. Although the potential for 
these types of conflicts exists, in its examinations of proxy advisory 
firms that are registered as investment advisers, SEC has not 
identified any major violations, such as a failure to disclose a 
conflict, or taken any enforcement actions to date. 

ISS's Business Model Has Been Identified as the Major Potential 
Conflict of Interest: 

Industry professionals and institutional investors we interviewed cited 
ISS's business model as presenting the greatest potential conflict of 
interest associated with proxy advisory firms because ISS offers proxy 
advisory services to institutional investors as well as advisory 
services to corporate clients. Specifically, ISS provides institutional 
investor clients with recommendations for proxy voting and ratings of 
companies' corporate governance. In addition, ISS helps corporate 
clients develop proposals to be voted on and offers corporate 
governance consulting services to help clients understand and improve 
their corporate governance ratings. 

Because ISS provides services to both institutional investors and 
corporate clients, there are various situations that can potentially 
lead to conflicts. For example, some industry professionals stated that 
ISS could help a corporate client design an executive compensation 
proposal to be voted on by shareholders and subsequently make a 
recommendation to investor clients to vote for this proposal. Some 
industry professionals also contend that corporations could feel 
obligated to subscribe to ISS's consulting services in order to obtain 
favorable proxy vote recommendations on their proposals and favorable 
corporate governance ratings. One industry professional further 
believes that, even if corporations do not feel obligated to subscribe 
to ISS's consulting services, they still could feel pressured to adopt 
a particular governance practice simply to meet ISS's standards even 
though the corporations may not see the value of doing so. 

ISS has disclosed and taken steps to help mitigate situations that can 
potentially lead to conflicts. For example, on its Web site, ISS 
explains that it is "aware of the potential conflicts of interest that 
may exist between [its] proxy advisory service … and the business of 
ISS Corporate Services, Inc. [ICS]." The Web site also notes that "ISS 
policy requires every ISS proxy analysis to carry a disclosure 
statement advising the client of the work of ICS and advising ISS's 
institutional clients that they can get information about an issuer's 
use of ICS's products and services." In addition, some institutional 
investors we spoke with noted that ISS has on occasion disclosed to 
them, on a case-by-case basis, the existence of a specific conflict 
related to a particular corporation. 

In addition to disclosure, ISS has implemented policies and procedures 
to help mitigate potential conflicts. For example, according to ISS, it 
has established a firewall that includes maintaining separate staff for 
its proxy advisory and corporate businesses, which operate in separate 
buildings and use segregated office equipment and information databases 
in order to help avoid discovery of corporate clients by the proxy 
advisory staff. ISS also notes on its Web site that it is a registered 
investment adviser and is subject to the regulatory oversight of SEC. 
In addition, according to ISS's Web site, corporations purchasing 
advisory services sign an agreement acknowledging that use of such 
services does not guarantee preferential treatment from ISS's division 
that provides proxy advisory services. 

All of the institutional investors--both large and small--we spoke with 
that subscribe to ISS's services said that they are satisfied with the 
steps that ISS has taken to mitigate its potential conflicts. Most 
institutional investors also reported conducting due diligence to 
obtain reasonable assurance that ISS or any other proxy advisory firm 
is independent and free from conflicts of interest. As part of this 
process, many of these institutional investors said they review ISS's 
conflict policies and periodically meet with ISS representatives to 
discuss these policies and any changes to ISS's business that could 
create additional conflicts. Finally, as discussed in more detail later 
in this report, institutional investors told us that ISS's 
recommendations are generally not the sole basis for their voting 
decisions, which further reduces the chances that these potential 
conflicts would unduly influence how they vote. 

Although institutional investors said they generally are not concerned 
about the potential for conflicts from ISS's businesses and are 
satisfied with the steps ISS has taken to mitigate such potential 
conflicts, some industry analysts we contacted said there remains 
reason to question the steps' effectiveness. For example, one academic 
said that while ISS is probably doing a fair job managing its 
conflicts, it is difficult to confirm the effectiveness of the firm's 
mitigation procedures because ISS is a privately-held company, thereby 
restricting information access. Moreover, according to another industry 
analyst, because ISS's recommendations are often reported in the media, 
the corporate consulting and proxy advisory services units could become 
aware of the other's clients. 

Other Potential Conflicts May Arise on the Part of Proxy Advisory 
Firms: 

In addition to the potential conflict of interest discussed above, 
several other situations in the proxy advisory industry could give rise 
to potential conflicts. Specifically: 

* Owners or executives of proxy advisory firms may have a significant 
ownership interest in or serve on the board of directors of 
corporations that have proposals on which the firms are offering vote 
recommendations. A few institutional investors told us that such 
situations have been reported to them by ISS and Glass Lewis, both of 
which, in order to avoid the appearance of a conflict, did not make 
voting recommendations. 

* Institutional investors may submit shareholder proposals to be voted 
on at corporate shareholder meetings. This raises concern that proxy 
advisory firms will make favorable recommendations to other 
institutional investor clients on such proposals in order to maintain 
the business of the investor clients that submitted these proposals. 

* Several proxy advisory firms are owned by companies that offer other 
financial services to various types of clients, as is common in the 
financial services industry, where companies often provide multiple 
services to various types of clients. This is the case at ISS, Glass 
Lewis, and PGI, and may present situations in which the interests of 
different sets of clients diverge. 

SEC Has Not Identified Any Major Violations in Its Oversight of Proxy 
Advisory Firms That Are Registered as Investment Advisers: 

SEC reviews registered investment advisers' disclosure and management 
of potential conflicts, as well as proxy voting situations where a 
potential conflict may arise. Specifically, SEC's Office of Compliance 
Inspections and Examinations monitors the operations and conducts 
examinations of registered investment advisers, including proxy 
advisory firms. An SEC official stated that, as part of these 
examinations, SEC may review the adequacy of disclosure of a firm's 
owners and potential conflicts; particular products and services that 
may present a conflict; the independence of a firm's proxy voting 
services; and the controls that are in place to mitigate potential 
conflicts.[Footnote 11] As discussed previously, three of the five 
proxy advisory firms (ISS, MCG, and PGI) are registered as investment 
advisers while Glass Lewis and Egan-Jones are not. According to SEC, to 
date, the agency has not identified any major violations of applicable 
federal securities laws in its examinations of proxy advisory firms 
that are registered as investment advisers and has not initiated any 
enforcement action against these firms.[Footnote 12] 

Analysts Cite ISS's Long-standing Position in the Industry as a 
Potential Barrier to Competition, Although Firms Have Entered the 
Market in Recent Years: 

As the dominant proxy advisory firm, ISS has gained a reputation with 
institutional investors for providing reliable, comprehensive proxy 
research and recommendations, making it difficult for competitors to 
attract clients and compete in the market. As shown below in table 1, 
ISS's client base currently includes an estimate of 1,700 institutional 
investors, more than the other four major firms combined. Several of 
the institutional investors we spoke with that subscribe to ISS's 
services explained that they do so because they have relied on ISS for 
many years and trust it to provide reliable, efficient services. They 
said that they have little reason to switch to another service provider 
because they are satisfied with the services they have received from 
ISS over the years. Because of ISS's clients' level of satisfaction, 
other providers of proxy advisory services may have difficulty 
attracting their own clients. In addition, because of its dominance and 
perceived market influence, corporations may feel obligated to be more 
responsive to requests from ISS for information about proposals than 
they might be to other, less-established proxy advisory firms, 
resulting in a greater level of access by ISS to corporate information 
that might not be available to other firms. 

Table 1: Overview of the Major Proxy Advisory Firms: 

Firm: Institutional Shareholder Services (ISS); 
Founded: 1985; 
Estimated number of employees: 630; 
Estimated number of clients: 1,700;
 Estimated clients' equity assets (dollars)[A]: 25.5 trillion. 

Firm: Marco Consulting Group (MCG); 
Founded: 1988; 
Estimated number of employees: 70; 
Estimated number of clients: 350; 
Estimated clients' equity assets (dollars)[A]: 85 billion. 

Firm: Glass Lewis & Company (Glass Lewis); 
Founded: 2003; 
Estimated number of employees: 70; 
Estimated number of clients: 300; 
Estimated clients' equity assets (dollars)[A]: 15 trillion. 

Firm: Proxy Governance, Inc. (PGI); 
Founded: 2004; 
Estimated number of employees: 31; 
Estimated number of clients: 100; 
Estimated clients' equity assets (dollars)[A]: 1 trillion. 

Firm: Egan-Jones Proxy Services (Egan-Jones); 
Founded: 2001; 
Estimated number of employees: Not available; 
Estimated number of clients: 400; 
Estimated clients' equity assets (dollars)[A]: Not available. 

Source: GAO presentation of information provided by proxy advisory 
firms. 

[A] Clients' equity assets refers to the total assets under management 
by the firms' institutional investor clients. There is overlap between 
proxy advisory firms' clients' equity assets since, as will be 
discussed later in this report, some clients use the services of 
several proxy advisory firms. 

[End of table] 

Industry analysts explained that, in addition to overcoming ISS's 
reputation and dominance in the proxy advisory industry, proxy advisory 
firms must offer comprehensive coverage of corporate proxies and 
implement sophisticated technology to attract clients and compete. For 
instance, institutional investors often hold shares in thousands of 
different corporations and may not be interested in subscribing to 
proxy advisory firms that provide research and voting recommendations 
on a limited portion of these holdings. As a result, proxy advisory 
firms need to provide thorough coverage of institutional holdings, and 
unless they offer comprehensive services from the beginning of their 
operations, they may have difficulty attracting clients. In addition, 
academics and industry experts we spoke with said that new firms need 
to implement a sophisticated level of technology to provide the 
research and proxy vote execution services that clients demand. The 
initial investment required to develop and implement such technology 
can be a significant expense for firms. 

Although newer proxy advisory firms may face challenges attracting 
clients and establishing themselves in the industry, several of the 
professionals we spoke with believed that these challenges could be 
overcome. For example, while firms may need to offer comprehensive 
coverage of corporate proxies in order to attract clients and although 
ISS might have access to corporate information that other firms do not, 
much of the information needed to conduct research and offer voting 
recommendations is easily accessible. Specifically, anyone can access 
corporations' annual statements and proxy statements, which are filed 
with SEC, are publicly available, and contain most of the information 
that is needed to conduct research on corporations and make proxy 
voting recommendations. Also, although developing and implementing the 
technology required to provide research and voting services can be 
challenging, various industry professionals told us that once a firm 
has done so, the marginal cost of providing services to additional 
clients and of updating and maintaining such technology is relatively 
low. 

Some of the competitors seeking to enter the proxy advisory industry in 
recent years that we spoke with have offered their services as 
alternatives to ISS. Specifically, they have attempted to differentiate 
themselves from ISS by providing only proxy advisory services to 
institutional investor clients. ISS's competitors have chosen not to 
provide corporate consulting services in part to avoid the potential 
conflicts that exist at ISS. Proxy advisory firms have also attempted 
to differentiate themselves from the competition on the basis of the 
types of services provided. For example, some firms have started to 
focus their research and recommendation services on particular types of 
proxy issues or on issues specific to individual corporations. 

The institutional investors we spoke with had a variety of opinions 
about the level of competition in the industry. Some questioned whether 
the existing number of firms is sufficient, while others questioned 
whether the market could sustain the current number of firms. However, 
many of the institutional investors believe that increased competition 
could help reduce the cost and increase the range of available proxy 
advisory services. For example, some institutional investors said that 
they have been able to negotiate better prices with ISS because other 
firms have recently entered the market. While some of these newer proxy 
advisory firms have attracted clients, it is too soon to tell what the 
firms' ultimate effect on competition will be. 

Large Institutional Investors Reportedly Rely Less Than Small 
Institutional Investors on Advisory Firms, Limiting the Influence These 
Firms Have on Proxy Voting Results: 

We conducted structured interviews with 31 randomly selected 
institutional investors to gain an understanding of the ways in which 
they use proxy advisory firms and the influence that such firms have on 
proxy voting. Of the 20 large institutional investors we interviewed, 
19 reported that they use proxy advisory services in one or more ways 
that may serve to limit the influence that proxy advisory firms have on 
proxy voting results (see table 2), while only 1 reported relying 
heavily on a proxy advisory firm's research and 
recommendations.[Footnote 13] 

Table 2: Reliance of Large Institutional Investors on Proxy Advisory 
Firms: 

Number of large institutional investors (out of 20 interviewed)[A]; 
Use proxy advisory firm to supplement in-house research: 15; 
Use proxy advisory firm to execute customized voting policy: 14; 
Subscribe to several proxy advisory firms: 8. 

Source: GAO analysis of structured interviews with 20 large 
institutional investors. 

[A] Many of the large institutional investors we spoke with explained 
that, although they subscribe to a customized voting policy, they may 
also continue to use their proxy advisory firm to supplement their own 
in-house research, subscribe to several proxy advisory firms, or both. 
This results in overlap among the three categories of how these 
institutional investors use proxy advisory firms, as shown in the 
table. 

[End of table] 

The following summarizes several of the reasons that large 
institutional investors' reliance on proxy advisory firms' research and 
recommendations is limited: 

* Most of the large institutional investors we spoke with (15 out of 
20) reported that they generally rely more on their own in-house 
research and analyses to make voting decisions than on the research and 
recommendations provided by their proxy advisory services providers. 
These institutional investors tend to have their own in-house research 
staffs, and their in-house research reportedly drives their proxy 
voting decisions. They explained that they use the research and 
recommendations provided by proxy advisory firms to supplement their 
own analysis and as one of many factors they consider when deciding how 
to vote. 

* In addition, many (14) of the large institutional investors we 
contacted reported that they subscribe to a customized voting policy 
that a proxy advisory firm executes on the institutions' behalf. These 
institutional investors develop their own voting policies and 
guidelines that instruct the advisory firm how to vote on any given 
proxy issue. In such instances, the proxy advisory firms simply apply 
their clients' voting policies, which then drive the voting decisions. 

* Further, 8 of the large institutional investors we contacted 
explained that they subscribe to more than one proxy advisory firm to 
help determine how to vote. These institutional investors said that 
they consider multiple sets of proxy advisory firm research and 
recommendations to gain a broader range of information on proxy issues 
and to help make well-informed voting decisions. 

We also interviewed representatives from 11 smaller institutional 
investors, and the results of these interviews suggest that proxy 
advisory firm recommendations are of greater importance to these 
institutions than they are to the large institutional investors we 
spoke with. In particular, representatives from smaller institutional 
investors were more likely to say that they rely heavily on their proxy 
advisory firm and vote proxies based strictly on the research and 
recommendations of their firm, given these institutions' limited 
resources. Consequently, the level of influence held by proxy advisory 
firms appears greater with these smaller institutional investors. 

However, whether large or small, all of the institutional investors we 
spoke with explained that they retain the fiduciary obligation to vote 
proxies in the best interest of their clients irrespective of their 
reliance on proxy advisory firms. Institutional investors emphasized 
that they do not delegate this responsibility to proxy advisory firms 
and retain the right to override any proxy advisory firm 
recommendations, limiting the amount of influence proxy advisory firms 
hold. In addition, large and small institutional investors reported 
that they tend to provide greater in-house scrutiny to, and rely even 
less on, proxy advisory firm recommendations about certain high-profile 
or controversial proxy issues, such as mergers and acquisitions or 
executive compensation. 

Institutional investors' perspectives on the limited influence of proxy 
advisory firms reflected what we heard from professionals that we spoke 
with who have knowledge of the industry. Many of these industry 
analysts and academics agreed that large institutional investors would 
be less likely than small institutional investors to rely on proxy 
advisory firms, because large institutions have the resources available 
to conduct research and subscribe to more than one proxy advisory 
service provider. These professionals also thought that large 
institutional investors would be likely to use proxy advisory firms as 
one of several factors they consider in the research and analysis they 
perform to help them decide how to vote proxies. Further, several 
believed that small institutional investors would be more likely to 
vote based strictly on proxy advisory firms' recommendations, because 
they do not have the resources to conduct their own research. 

The results of our work suggest that the overall influence of advisory 
firms on proxy vote outcomes may be limited. In particular, large 
institutional investors, which cast the great majority of proxy votes 
made by all institutional investors with over $1 billion in assets, 
reportedly place relatively less emphasis on the firms' research and 
recommendations than smaller institutional investors. However, we could 
not reach a definitive conclusion about the firms' influence because 
the institutional investors we contacted were not necessarily 
representative of all such investors. Further, we could not identify 
any studies that comprehensively isolated advisory firm research and 
recommendations from other factors that may influence institutional 
investors' proxy voting.[Footnote 14] 

Agency Comments: 

We provided a draft of this report to SEC for its review and comment. 
SEC provided technical comments, which we incorporated into the final 
report, as appropriate. We also provided relevant sections of the draft 
to the proxy advisory firms for a technical review of the accuracy of 
the wording and made changes, as appropriate, based on the firms' 
comments. 

As agreed with your office, unless you publicly announce the contents 
of this report earlier, we plan no further distribution of this report 
until 30 days from the report date. At that time we will provide copies 
of this report to the Chairman and Ranking Member, Senate Committee on 
Banking, Housing, and Urban Affairs; the Chairman, House Committee on 
Financial Services; the Chairman, House Subcommittee on Capital 
Markets, Insurance, and Government Sponsored Enterprises, Committee on 
Financial Services; other interested committees; and the Chairman of 
the Securities and Exchange Commission (SEC). We will also make copies 
available to others upon request. In addition, the report will be 
available at no charge on the GAO Web site at http://www.gao.gov. If 
you or your staffs have any questions about this report, please contact 
me at (202) 512-8678: 

or jonesy@gao.gov. Contact points for our Offices of Congressional 
Relations and Public Affairs may be found on the last page of this 
report. Key contributors to this report are listed in appendix II. 

Signed by: 

Yvonne D. Jones: 
Director, Financial Markets and Community Investment: 

[End of section] 

Appendix I: Scope and Methodology: 

Our objectives were to (1) identify potential conflicts of interest 
that exist with proxy advisory firms and the steps that the Securities 
and Exchange Commission (SEC) has taken to oversee these firms; (2) 
review the factors that might impede or promote competition in this 
industry; and (3) analyze institutional investors' use of proxy 
advisory services to help vote proxies and the influence proxy advisory 
firms may have on proxy voting. 

To determine the types of potential conflicts of interest that could 
arise in the proxy advisory industry, we conducted a literature review 
and examined studies relating to potential conflicts that may arise in 
this industry. Further, we interviewed various professionals with 
knowledge of the proxy advisory industry, including industry experts, 
academics, industry association representatives, and proxy advisory 
firm representatives, as well as institutional investors and officials 
at SEC. We selected these professionals based, in part, on literature 
searches we conducted on topics relating to proxy advisory and 
corporate governance services, as well as referrals by several of the 
professionals we met with. The professionals we spoke with represent a 
wide range of perspectives, and include experts from academia, 
business, government, and professional organizations. We did not 
attempt to assess any of the proxy advisory firms' conflict mitigation 
policies or procedures and, therefore, did not come to any conclusions 
about the adequacy of these policies or procedures. To gain an 
understanding of SEC's oversight of proxy advisory firms, we reviewed 
relevant investment adviser regulations and examinations conducted by 
SEC since 2000 and interviewed agency officials. We did not attempt to 
assess the adequacy of SEC's oversight. 

To identify the factors that might impede or promote competition in 
this industry, we reviewed the relevant literature and examined studies 
relating to the level of competition in the industry, and we spoke with 
various industry professionals. We did not attempt to evaluate the 
level of competition in this industry and, therefore, did not come to 
any conclusions about the extent to which competition exists. 

Finally, to explore institutional investors' use of proxy advisory 
services to help vote proxies and the influence proxy advisory firms 
may have on proxy voting, we conducted structured interviews with 31 
institutional investors selected randomly by type, including mutual 
funds, corporate pension funds, government pension funds, and union 
pension funds, as well as asset management institutions. Our sample 
included several of the largest institutional investors and was derived 
from Standard & Poor's Money Market Directories (January 2006). The 
sample consisted of a population of mutual funds and pension funds with 
over $1 billion in assets, and included large and small institutional 
investors from each investor type. We defined "large" and "small" 
institutional investors as the top and bottom 15 percent of each 
institutional investor type. In total, these large and small 
institutional investors accounted for over 72 percent of assets under 
management held by mutual funds and pension funds with over $1 billion 
under management. Although we randomly selected these institutional 
investors, the size of the sample was small and may not necessarily be 
representative of the universe of institutional investors. As a result, 
we could not generalize the results of our analysis to the entire 
population of institutional investors. 

We conducted structured interviews with 20 large and 11 small 
institutional investors. Initially, we had contacted a total of 126 
mutual funds and pension funds that were randomly selected from our 
sample of institutional investors and 20 (13 large and 7 small 
institutions) reported using proxy advisory firm services and agreed to 
participate in our structured interviews. The other 106 institutional 
investors we had initially contacted declined to participate in the 
structured interviews for several reasons. In particular, many of these 
institutions said that they do not vote proxies themselves, but rather 
hire asset management institutions to both manage their investment 
portfolios and vote proxies on their behalf. We conducted interviews 
with 11 (7 large and 4 small institutions) of these asset management 
institutions, which were referred to us by several of the pension funds 
we had initially contacted. The results of these asset manager 
interviews are included among the total of 20 large and 11 small 
institutional investors that we interviewed. In addition, some of the 
106 institutional investors declined to participate because they vote 
proxies themselves or do not vote proxies at all, while others refused 
to participate or could not be reached. 

In our structured interviews with the 31 institutional investors, we 
spoke with officials from the organizations who are responsible for 
proxy voting activities. We asked these officials a variety of 
questions relating to their institutions' policies on proxy voting and 
use of proxy advisory firms. Further, we asked the officials to comment 
on potential conflicts of interest associated with proxy advisory 
firms, steps taken to mitigate such potential conflicts, and the level 
of competition in the proxy advisory industry. 

Finally, we spoke with various industry professionals discussed earlier 
to gain their perspectives on the influence of proxy advisory firms. We 
could not identify any studies that comprehensively measured the 
influence that these firms have on proxy voting. 

We conducted our work in Washington, D.C., between September 2006 and 
June 2007 in accordance with generally accepted government auditing 
standards. 

[End of section] 

Appendix II: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

Yvonne D. Jones, (202) 512-8678 or jonesy@gao.gov: 

Staff Acknowledgments: 

In addition to the above contact, Wes Phillips, Assistant Director; 
Emily Chalmers; Rudy Chatlos; Eric Diamant; Fred Jimenez; Yola Lewis; 
and Omyra Ramsingh made key contributions to this report. 

FOOTNOTES 

[1] See Proxy Voting by Investment Advisers, 68 Fed. Reg. 6585 (2003) 
(final rule) (codified in various sections of 17 C.F.R. Part 275), 
which requires registered investment advisers to adopt policies and 
procedures reasonably designed to ensure that they vote proxies in the 
best interests of their clients. Similarly, the Employee Retirement 
Income Security Act of 1974 (ERISA) has been interpreted as imposing 
fiduciary obligations on persons authorized to vote proxies associated 
with equity securities owned by ERISA plans. See 29 C.F.R. § 2509.94-2 
(2006). 

[2] 15 U.S.C. §§ 78a et seq. 

[3] Most, but not all, of the major proxy advisory firms have 
registered as investment advisers with SEC, as will be discussed in 
this report. 

[4] See section 14 of the Securities Exchange Act of 1934 (codified as 
amended at 15 U.S.C. § 78n) and related rules. 

[5] For purposes of this report, the term "institutional investor" 
refers to both the institution that owns the securities as well as an 
asset manager delegated the authority to vote proxies on behalf of the 
investors as the context requires. 

[6] To the extent a mutual fund or pension plan has delegated the 
voting of its proxies to an asset manager, the proxy voting process is 
subject to the Investment Advisers Act of 1940 and the Employee 
Retirement Income Security Act of 1974 (ERISA). For purposes of this 
report, the term "asset manager" is used to refer both to investment 
advisers of registered investment companies, as well as to managers of 
pension plan assets. Registered investment companies are also required 
to disclose the policies and procedures that they use to determine how 
to vote proxies relating to portfolio securities and must file with SEC 
an annual report on its proxy voting record. See 17 C.F.R. § 270.30b1- 
4 and SEC Forms N-1, N-2, N-3 and N-CSR (adopted under the Investment 
Company Act of 1940 (codified as amended at 15 U.S.C. § 80a-1 et 
seq.)). 

[7] The Deputy Assistant Secretary of the Pension Welfare Benefits 
Administration (PWBA, now known as the Employee Benefits Security 
Administration) issued the Avon letter to Mr. Helmuth Fandl, Chairman 
of the Retirement Board of Avon Products, Inc., on February 23, 1988. 
Current U.S. Comptroller General David M. Walker was the Assistant 
Secretary of Labor for the PWBA from 1987 to 1989. The Department of 
Labor subsequently issued Interpretative Bulletin No. 94-2 (codified at 
29 C.F.R. § 2509-94-2), which, among other things, set forth the 
department's interpretation of ERISA as it applies to the voting of 
proxies on securities held by employee benefit plan investment 
portfolios. The bulletin essentially restates the views set forth in 
the Avon Letter. 

[8] See Proxy Voting by Investment Advisers. 

[9] The Labor Management Relations Act, also known as the Taft-Hartley 
Act, allows for the establishment of multiemployer trust funds, known 
as Taft-Hartley funds, for the purpose of providing pension and welfare 
benefits to employees and their families. Act of June 23, 1947, ch. 
120, 61 Stat. 136 (1947) (codified as amended at 29 U.S.C. §§ 141 et 
seq.) These funds, or benefit plans, are financed in whole or part by 
employer contributions and are administered jointly by labor and 
management. These funds are subject to ERISA and regulated by the U.S. 
Department of Labor. Accordingly, managers of Taft-Hartley fund assets 
have a fiduciary obligation to protect plan assets as required by 
ERISA. 

[10] Section 203A of the Investment Advisers Act prohibits state- 
regulated investment advisers who have less than $25 million in assets 
under management from registering with SEC, unless the person is an 
investment adviser to a registered investment company, like a mutual 
fund. SEC Rule 203A-2(b), exempts certain pension consultants from this 
general prohibition and permits them to register with SEC. 17 C.F.R. § 
275.203A-2(b). An investment adviser is a pension consultant for 
purposes of Rule 203A-2(b), if he or she provides investment advice 
relating to assets of certain employee benefit plans having an 
aggregate value of at least $50 million. 

[11] We did not attempt to assess the adequacy of these examinations. 

[12] We cannot disclose the specific results of examinations because of 
SEC confidentiality considerations. 

[13] Of the 20 large institutional investors we spoke with, 7 were 
asset management institutions that vote proxies on behalf of their 
clients. Many large and small institutional investors we initially 
attempted to contact reported that they do not vote their own proxies. 
Instead, these institutional investors said that companies that provide 
asset management services also vote proxies on their behalf. We added 
these asset management institutions, which were referred to us by 
pension funds, to our sample in order to understand the extent to which 
they rely on proxy advisory services. 

[14] We identified a study--"The Role of Advisory Services in Proxy 
Voting," by Cindy R. Alexander, Mark A. Chen, Duane J. Seppi, and 
Chester S. Spatt (Dec. 14, 2006)--that examined the extent to which 
recommendations can influence vote outcomes and stock prices by 
focusing on recommendations made by ISS that were reported in the 
media. The authors documented "significant stock price movements around 
recommendation dates, indicating that proxy advice brings new 
information to the market," as well as "a robust association between 
recommendations and contest outcomes after controlling for differences 
in contest characteristics, voting rules, dissidents, and incumbents." 
As the authors note, "although not all ISS recommendations are reported 
in the media, restricting attention to the newsworthy cases ensures 
that our sample consists of contests in which the underlying issues are 
significant and the recommendation is most likely to play an important 
role." However, most of the institutional investors we spoke with 
reported that they tend to provide greater in-house scrutiny to, and 
rely even less on, proxy advisory firm recommendations about high- 
profile or controversial proxy issues, which are the recommendations 
that would be more likely to appear in the media. 

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