Bill Clough, chief executive of CUI Global, was shocked to learn, out of the blue, that shareholders were voting one of his directors off the board.
Clough was told about this the week before the company — which supplies parts for power and energy companies — was set to hold its annual meeting in 2016. To him, it felt arbitrary, so he called around to his investors to better understand why.
They told him that they were voting off of the recommendation of something called Institutional Shareholder Services, or ISS. That’s the largest and among the oldest of the so-called proxy advisory firms, which make voting recommendations for shareholders on issues like acquisitions, board composition and executive pay.
So Clough called ISS. An analyst there told him that it urged shareholders to vote against one of his directors after Tualatin, Oregon-based CUI Global’s board had changed its bylaws to make it harder for smaller investors to run an activist slate.
But, the analyst told him, if he joins ISS for about $30,000 per year, the firm can help him better navigate these mishaps in the future. He was able to call his investors and get them to change their votes before the meeting, preserving the director for one more year (unlike political elections, shareholders are able to vote as many times as they would like up until the annual meeting).
Clough, who had been a cop for 16 years, said this reminded him of a protection racket, whereby a group uses the threat of violence to provide protection outside the confines of law enforcement. Ultimately, he said, he’ll have to pay for ISS’ protection.
“There’s really no way to fight this,” Clough said. “Ultimately, we will have to join because for us to go through this year after year just doesn’t make sense.”
Congress taking action
In the meantime, he’s hopeful for a piece of legislation that’s working its way through Congress called the Corporate Governance Reform and Transparency Act of 2017. The bill passed the House in December by a vote of 238-182 and is at the top of the agenda on Thursday for a Senate Banking Committee hearing on corporate governance.
The bill would require proxy advisory firms to register with the Securities and Exchange Commission and allow companies to fact-check the research before it’s distributed to investors.
Rep. Sean Duffy, R-Wis., who introduced the bill says this oversight is necessary to prevent any abuse of power by proxy advisory firms.
“They hold companies hostage and make them buy services,” Duffy said in an interview with CNBC. “It’s like Vinny down the street who says, ‘Hey look, I’ll protect your store and if you don’t pay, we’re going to come in at night and you know what happens.’”
ISS, however, believes this bill would “deprive shareholders of the independent proxy advice they need to have a meaningful say in corporate governance.” The firm says that even though institutional investors are the clients who pay for the research, the bill would give management “veto power,” an “unprecedented effort to stifle recommendations.”
“This legislation purports to take aim at proxy advisers,” said Patrick McGurn, special counsel for ISS, in an interview. “It really takes aim at individual investors.
Large investors oppose bill
Nearly 50 large investors, including the California State Teachers' Retirement System, or CalSTRS, and the New York state comptroller, signed onto a letter to Sen. Mike Crapo, R-Idaho, chairman of the Senate Banking Committee, opposing the bill.
The letter, which was put together by the Council of Institutional Investors, said proxy advisory firms play an important role in enabling effective and cost-effective independent research.
“If enacted, the proposed legislation would increase costs for pension plans and other institutional investors with no clear benefits,” the letter said.
But for Bill Clough, the hand-wringing continued. In 2017, CUI Global faced something like deja vu.
The company had deployed a director to temporarily take over one of its subsidiaries in the U.K. Clough says he ensured that this complied with Nasdaq and SEC regulations, but later learned the move did not match the standards of ISS.
This time, instead of going to shareholders, Clough said he went right to ISS. The firm recommended that shareholders vote against all of CUI’s independent directors.
“So I asked her what we should do because I didn’t want to have to go back to my shareholders and make it seem like we’re in a war,” Clough said.
Ultimately, CUI announced that it was appointing a new independent director and ISS changed its voting recommendation. Shortly thereafter, Clough recalls a similar proposition.
ISS told him, “If you were a member, you could avoid all this, it would really be a lot smoother,” Clough said.
He is anxiously awaiting the company’s next annual meeting in December.