Paul Hodgson: As ISS sale enters final phase, the case for pension fund involvement

Private equity firms may be bidding up to $375m for proxy firm

Glass Lewis is owned by Canada’s Ontario Teachers’ Pension Plan and Alberta Investment Management Co. Institutional Shareholder Services (ISS) is currently up for sale. So how about if ISS were bought by a consortium of major pension funds?
It’s not such an outlandish idea. How would such an arrangement work? Clearly, getting a group of large pension funds to act in tandem would be akin to herding cats. But what if there were a single cat herder, who could manage the relationships between the investors at arm’s length from the investment? Such an arrangement might work. And, despite many claims to the contrary, I don’t believe such a situation would present any kind of conflict of interest. About which we shall hear more later.
But to go back to the beginning. In October last year, ISS’s parent MSCI announced that it was going to sell the division. Almost immediately there was understood to be interest from dozens of potential buyers. Sources associated with one of the potential buyers have indicated to me that there are now five or six private equity (PE) firms looking at a potential $325-$375 million price tag, and that a decision could be expected by the end of the month. One interesting aspect is that none of them are industry buyers – the likes of Thomson Reuters are not interested, apparently.
Some within the governance community are bemused by the interest of PE firms. There’s no doubt that ISS is a solid generator of revenue but it is hardly the kind of high growth business that PE firms are typically interested in. Clearly there is interest in solidity.
On the other hand, if the pension fund ownership model were followed, any hint of that nasty little thing called greed would be removed from the equation.
It is the opinion of many in the industry that ISS has not been well managed since Robert CS (Bobby) Monks, son of the founder Robert AG Monks, sold it to RiskMetrics. It was felt that RiskMetrics bought ISS because it needed the earnings and revenue it was generating to give it the legitimacy to launch a public offering. Little seemed to have changed when RiskMetrics was subsequently acquired by MCSI. Some have indicated that ISS has just been used as a cash cow. It retained its perceived autonomy but no serious independent management was appointed to drive it to improve itself.ISS has fully 10 years of stable and significant earnings but many feel that its product has been turned into a commodity. A senior figure in the governance community, who wished not to be named, told me: “Funds have to vote, they know in large part that it will have little or no effect whichever way they do vote, so none of them cares enough to pay a decent subscription for it.” The person added, referring to a controversial voting recommendation of a few years ago: “If you recommend a ‘no’ vote for the re-election of Warren Buffett to the Coke board because he owns companies that do business with Coke, which therefore represents a conflict of interest, that is enough to show every subscriber in the world that you are just pressing switches on a machine that is pumping out recommendations. If people baulk at buying such advice, it is hardly surprising. Yet, despite the potential cost implications, the kind of individual advice needed to override such recommendations is exactly what ISS and others need to provide.”
But these are not the only business problems facing ISS. In preparation for this article I listened to the Congressional hearings, by the Capital Markets and Government Sponsored Enterprises Subcommittee, on whether proxy advisory firms should be regulated or not. It made me wonder how some politicians ever get elected. Some of the claims by politicians on the committee in favour of regulation and by former SEC Chairman Harvey Pitt, the US Chamber of Commerce representative, were clearly grandstanding. Referring to ISS, there were allegations of: “serious conflicts permeat[ing] their activities”, “special interest agendas,” and that it “regularly gets together with unions”. At this point it almost felt like Joseph McCarthy was running the hearings.
Despite protestations from witnesses that companies like their shareholders, it almost seemed as if there was outright war between the two parties, and that ISS and its ilk were just caught in the middle. From others, ISS and its “many inaccuracies” was the problem, preventing a true and honest dialogue between companies and their investors.

With one criticism of ISS, though, I was in solid agreement. ISS Corporate Services – the division that provides consultative services to clients to improve their governance – presents a potential for conflict of interest. It should be sold off separately or subsequent to any deal, if for no other reason than it hands its enemies a stick to beat it with.
Bob (Robert AG) Monks told me he felt that it was a complete waste of congressional funds and SEC time to decide whether ISS and the other proxy advisory firms should be regulated. “The SEC has 10 years of Dodd-Frank regs to write and there’s Mary Jo White wasting her time listening to preposterous evidence.” He added: “ISS is simply selling a product. There is no obligation to buy it from ISS, so how does that create a situation where government needs to step in to regulate? The most important issue is not the monopoly situation, the real importance of proxy advisory firms is that they keep bringing out news and analysis of executive compensation and the Business Roundtable and the US Chamber of Commerce want to shut them up.”
Returning to the fear of a potential conflict of interest that might arise if ISS were bought by a consortium of large pension funds: we already have an exemplar of this situation at Glass Lewis. And indeed, a supposed conflict of interest between Glass Lewis and its majority owner, the Ontario Teachers fund, was brought up by some of the witnesses at the congressional committee hearing. Both the Chamber of Commerce and the Center for Capital Markets Competitiveness complained that Glass Lewis’ and Teachers’ recommendations for the election of directors at Canadian Pacific Railways’ 2012 annual meeting were identical and that it was obvious that Glass Lewis’ recommendations were influenced by its owners.But, as Glass Lewis indicated in a statement at the time, its recommendations were based on its own methodologies and differed “significantly” from Teachers’ actual votes: “While OTPP voted against all of the incumbent directors, Glass Lewis recommended supporting seven of the Company nominees.” Apart from the fact that Glass Lewis clearly discloses when any such conflict is apparent, the complaints were not even accurate. Thus, I do not believe, nor do many in the field, that any kind of conflict would exist were ISS owned by a hypothetical consortium of funds.
Nothing really emerged from the hearings. Proxy advisory firms are already registered investment advisors in the US, but this was not seen as sufficient oversight, and at one point a “unique regulatory framework” to deal with the industry was proposed. As Monks noted, this is nonsense.
Something does not feel right. Europe is largely regarded by the US as an over-regulator, but the reaction to these supposed conflicts and monopolies thus far from the European Commission has been to set up a working group to establish best practice standards; effectively for the industry to police itself. In contrast, the US is generally not keen to regulate. But corporations and their representatives, such as the US Chamber of Commerce and the Business Roundtable, to whom regulation is usually anathema, are those baying loudest for it. It makes one suspect that Monks’ accusation of ulterior motives is not without merit.
This threat of regulation is serious, and MSCI’s annual report lists these issues as risks associated with ISS’s business. It is certainly something which any serious buyer must account for in its offer price. What appears certain, however, is that we shall know who that buyer is within weeks. I vote for the consortium, but I’m not volunteering to be the cat herder.

Paul Hodgson is an independent governance consultant.