In absence of federal action, states begin challenging the proxy duopoly

The two largest proxy advisors, Glass Lewis and Institutional Shareholder Services (ISS), have dominated the proxy voting market for the past 22 years. Following the recent DC Circuit opinion in ISS v. SEC, which held that proxy advisor advice did not constitute as a form of solicitation, and last year’s circuit split, courts remain divided over how these firms should be regulated at the federal level.

In absence of regulatory clarity, several states have begun cracking down on the firms’ promotion of politics over profits at annual shareholder meetings. With federal oversight in limbo, states like Texas, Florida, and Missouri are ramping up efforts to hold these firms accountable.

The proxy advisor duopoly owes much of its estimated 97 percent market dominance to a slew of flawed federal regulations. Chief among these are the Securities and Exchange Commission’s (SEC) 2003 Proxy Voting By Investment Advisers Rule, the Department of Labor’s (DOL) 1988 Avon Letter, and the DOL’s more recent 2022 Prudence and Loyalty Rule. These federal rules and guidances have stifled any meaningful competition among smaller, politically neutral, and right-of-center proxy firms.

This has also emboldened the duopoly to sidestep the financial interests of the companies they influence in favor of pursuing political goals. As a result, many institutional investors have embraced the advisors’ environmental, social, and governance (ESG) agenda. This is evidenced by the duopoly’s consistently pro-ESG recommendations and their persistent attacks against corporate directors who reject political influences (i.e., diversity quotas) in board composition.

Texas is currently the only state to pass a law, SB2337, requiring proxy advisors to disclose all nonpecuniary voting advice. The law went into effect on September 1, requiring advisors to report all proxy advice that is “not provided solely in the financial interest of the shareholders of a company.” This automatically covers all ESG-oriented advice, as well as any related to diversity, equity, or inclusion (DEI) or to social credit or sustainability scores. ISS and Glass Lewis have prioritized their promotion of environmental and social proposals (E&S), using their vote recommendations to propel the most promising proposals.

Each year, hundreds of E&S proposals have been validated and strengthened by the duopoly’s vote recommendations. Many activist shareholders craft their proposals in part based on the duopoly’s benchmark proxy voting guidelines. According to a 2012 Manhattan Institute report, a positive vote recommendation from ISS can increase shareholder support by roughly 15 percent.

Texas’s law is a welcome step toward proxy advisor transparency. The state rightfully targets the duopoly’s vague benchmark statements, serving as the foundation for its voting advice. This ambiguity often obfuscates whether a proxy advisor is acting in its clients’ best interests or offering advice to maximize capital returns.

To that end, the law effectively exposes how ISS and Glass Lewis offer vote recommendations on ESG matters without first disclosing the economic analysis they used. These advisors frequently fail to provide factual rationales grounded in sound economics or to offer financial analyses when recommending that companies incorporate ESG and DEI factors into business decisions.

According to the text of the law, “requiring proxy advisors to provide clear, factual disclosures when the advisors recommend casting a vote for nonfinancial reasons or provide conflicting advice to multiple clients who seek to maximize financial returns is necessary in order to prevent fraudulent or deceptive acts and practices.”

Such transparency is a reasonable expectation for proxy advisors to meet, especially those like ISS and Glass Lewis which also profit from selling ESG products. Proxy reporting will require firms to justify whether their advice is free of any conflicts and is offered in the best interest of their clients, primarily asset managers. Asset managers themselves have a fiduciary duty to safeguard and maximize their clients’ investments.

Texas’s law was partially inspired by two earlier measures pursued in Missouri. The 2024 Missouri laws required investment advisers and financial intermediaries to obtain consent from their customers prior to incorporating any ESG recommendations, including those from proxy firms. These laws were struck down last year in federal court over First Amendment concerns regarding compelled speech. In the court’s view, the laws were not perceived to be narrowly tailored to meet a compelling government interest to deter financial fraud.

Texas’s law appears to avoid Missouri’s mistakes, since they merely require basic transparency to deter fraudulent or deceptive practices in proxy advisement. The Texas law more clearly emphasizes the need for non-financial disclosure in the face of the sheer number of shareholder votes being affected by proxy recommendations.

Alongside Texas, Florida’s attorney general is actively investigating whether Glass Lewis and ISS have violated state antitrust laws. The investigation, conducted under the Florida Antitrust Act of 1980, will assess whether the proxy duopoly has collusively used “their overwhelming market power to advance partisan political agendas rather than maximizing shareholder value.”

This ongoing investigation follows a similar trajectory to Texas’s SB2337, cracking down on how politically motivated proxy firms may offer advice that is not within the best financial interest of shareholders. Florida’s investigation is likely motivated by a bombshell report from the House Judiciary Committee showing that the proxy duopoly facilitated the pressure tactics of Climate Action 100+ during shareholder review.

As courts remain divided and several promising proxy advisor reform bills stall in the House of Representatives, states are taking action to regulate the proxy duopoly. Depending on the outcome of Florida’s investigation, the state may pursue similar proxy reporting efforts like Texas or take separate legal action. In response to growing state action, Congress should afford greater consideration to the troubling role that Glass Lewis and ISS play in advancing political objectives before their institutional clients. This is a serious policy issue that can no longer be ignored, and one that deserves bipartisan attention.