SEC Chairman Jay Clayton said Tuesday the agency is investigating suspicious comment letters it received in support of proxy rule changes that the commission proposed last month over the objections of investor advocates.

“We’re having an investigation done of this issue, so I’m just going to leave the specifics of that,” Clayton said in response to a question from Sen. Tina Smith (D-Minn.) at a Senate Banking Committee oversight hearing.

“I am very interested in hearing directly from individual investors — in particular directly — not filtered, by groups,” Clayton added.

His announcement comes after two public interest groups sent multiple letters on Monday calling on agencies to investigate why Clayton referred specifically to the letters at the beginning of a Nov. 5 meeting called to consider the proposal, citing them to show that ordinary investors backed the changes.

A Bloomberg report revealed that some of those letters were signed by people who didn’t recall writing them. Several others were signed by relatives of a lobbyist for 60 Plus, an affiliate of the Main Street Investors Coalition, which is funded in part by the National Association of Manufacturers, according to the report.

Many companies favor the new rules since they rein in the power of proxy advisers, which make recommendations to shareholders on controversial proposals such as on climate change and corporate governance issues.

“I’m certainly glad to know that you’re investigating this, I think that that’s really important. And if you’re basing decisions about what to do on comments and public interactions that end up to be fueled by corporate advocacy groups, that I think is a problem,” Smith said.

Clayton came under withering criticism from Sen. Chris Van Hollen (D-Md.), who said the letter writers supporting the proxy changes had used him as a “vehicle” to deceive the public.

“I did not have a mainstream investor ever come to me and say that this is a concern of theirs,” Van Hollen said. “Now, if there are I look forward to it. But you got duped when you rolled out that statement.”

“I hope you will make it very clear that you find it outrageous that the people who hope you’re going to do this … you became the vehicle for their fraudulent attempts to make it sound like it was all about main street investors,” Van Hollen said.

“Regardless of this colloquy, I still believe we’re looking out for main street investors,” Clayton said in response to Van Hollen.

Clayton said he is “open for discussion” on the rules. “If people think what we are proposing is too onerous … I’m open,” he said.

Still, he wouldn’t commit to delaying the rules in any way related to the outcome of a lawsuit filed against the new rules by Institutional Shareholder Services, one of two firms that dominate the proxy advisory business.

In describing how the investigation came about, Clayton told Smith: “Very shortly after the Bloomberg article came out, we contacted our general counsel and the Office of Inspector General.”

But he didn’t directly answer another question from Smith as to whether the types of letters subject to the SEC investigation should be illegal.

“The comment process is an open process, to the extent things happen, I don’t think that — well, I’m just going to leave it at that for now, let’s see what happens with the investigation,” Clayton said.

U.S. Securities and Exchange Commission chairman Jay Clayton said Tuesday that the agency is investigating letters he cited in support of a controversial proposal to increase regulation of proxy advisory firms — letters that have since been reported to be dubious.

Clayton told the Senate Banking Committee that the matter has been turned over to the SEC’s general counsel and inspector general’s office. Clayton was responding to questions by Sen. Tina Smith, D-Minn., who was concerned “sham letters” were informing the agency’s thinking.

“We are having an investigation of this issue,” Clayton said, declining to delve into specifics.

The matter stems from rules the SEC proposed last month to increase regulatory scrutiny of proxy advisory firms, which sell research and advice to investors who vote on corporate ballots.

The proposal is under fire by shareholder groups, who argue the SEC is infringing their ability to hold companies accountable. Many business groups favor reining in proxy firms on grounds that such firms exercise vast influence over corporate governance with little oversight.

The SEC proposal would require proxy firms to improve disclosure of conflicts of interests, allow corporations to review and respond to proxy firm recommendations before a shareholders vote, and codify that proxy firms could be liable for fraud if they make materially misleading statements when attempting to influence votes.

The SEC approved submitting the proposal for public comment on Nov. 5 by a 3-2 vote, with Clayton in favor. Before voting on the matter, Clayton said he was struck by comment letters from “Main Street investors” that supported the action, including Army and Marine veterans, a police officer, a retired teacher, a single mother and a couple of retirees saving for retirement.

Smith cited a Bloomberg news report that found, among other things, that the retired teacher said she never wrote the letter and the military veterans cited by Clayton were the brother and cousin of the chairman of the 60 Plus Association, an advocacy group that was paid for by corporate supporters of the proposal.

“I am certainly glad to know that you are investigating this,” Smith said. “If you are basing decisions about what to do on comments and public interactions that end up to be fueled by corporate advocacy groups — that I think is a problem.”

The topic also led to an exchange between Clayton and Sen. Chris Van Hollen, D-Md., who said he was troubled that the SEC chairman sought to create an impression that reining in proxy firms is a priority for “Main Street” investors.

Van Hollen said no investor has expressed concern to him about proxy advisers. He described the SEC’s proposal as a “top priority of corporate CEOs who don’t want to be second guessed by proxy advisors.”

“You got duped when you rolled out that statement,” Van Hollen said.

Van Hollen further asked Clayton if he was aware that letters he cited came from relatives of the head of 60 Plus. Clayton said he was not previously familiar with 60 Plus.

A message to Virginia-based 60 Plus was not immediately returned Tuesday. Van Hollen described 60 Plus as a “dark money front group that corporations use for messaging.” The group describes itself as advocating for the interests of senior citizens through a “less government, less taxes approach.”

But Clayton stood by the SEC’s proposal, saying its intent is to ensure that investors have the most accurate mix of information available before they vote on matters.

“I am not backing away from the fact that we want to do what is in the interest of our long-term investors,” Clayton said.

The proxy matter and a related proposal that would raise thresholds on shareholders seeking to place an item for vote are now open for public comment through Feb. 3, after which the SEC may vote on final proposals. Clayton said he is interested in hearing from investors.

“During this comment period I encourage as many individual investors as they can to share their thoughts with us,” Clayton said, “and we will be doing town halls where they will have the opportunity to speak directly to me.”

Glass Lewis and Institutional Shareholder Services have a stranglehold on a booming industry: advising investors on how to cast their votes at companies’ annual meetings.

This has given the two privately owned companies considerable sway on everything from executive pay to environmental policies, just as issues of governance race up the corporate agenda.

Yet early next year, the two are likely to find themselves the subject of a Securities and Exchange Commission vote that is designed to cut them down to size, but which they warn risks damaging corporate governance across America.

US regulators are one step away from passing new rules governing proxy advisers, as Glass Lewis, ISS and their smaller competitors are known. They include forcing them to reveal their voting recommendations to a company’s management before they are sent to its shareholders.

The SEC vote would cap a lengthy fight that has simmered for several years but recently erupted. It pits proxy advisers and many large asset managers against some of America’s biggest companies, including ExxonMobil and Chevron, who claim the groups are too powerful and beset by conflicts of interest.

While heartening those who have championed the proposals such as the US Chamber of Commerce and the National Association of Manufacturers, the prospect of the new rules passing early in 2020 has galvanised some institutional investors who rely on proxy advisers.

“People are pretty agitated about this,” said Ken Bertsch, executive director at the Council of Institutional Investors, which is based in Washington and represents shareholders with $40tn in assets. “The SEC seems to be rushing to do this. It may be politically geared. The evidence [for the new rules] is very shaky.”

The rise of proxy advisers dates back to the turn of the century when a wave of corporate scandals, including Enron and WorldCom, turned the spotlight on the failings of shareholders in helping to police companies. Their influence was further strengthened after the SEC adopted a rule in 2003 that required investment advisers to have voting procedures in place on how to vote on the issues at AGMs.

ISS, which was founded in 1985, has been one of the biggest winners and was acquired by private equity firm Genstar Capital in 2017. It makes millions of voting recommendations a year, and its clients include large and small asset managers, including BlackRock, Allianz Global Investors and Legal & General Investment Management.

Glass Lewis, which was established in 2003, is owned by the Ontario Teachers’ Pension Plan Board and Alberta Investment Management Corporation.

However, their growing clout began to attract the scrutiny of US business lobby groups, as well as some of corporate America’s best-known leaders. In 2013, Jamie Dimon, chief executive of JPMorgan Chase, blasted shareholders who rely on proxy advisers as “lazy”, after Glass Lewis and ISS advised the bank’s investors to vote against his pay and to appoint an independent chairman.

Industry observers say the arrival of Donald Trump in the White House injected new momentum into the lobbying against proxy advisers, giving the SEC a more pro-business tilt.

The SEC’s commissioners split along political lines last month when they proposed the proxy adviser regulations — a prelude to the final vote next year.

To critics, such as those at the US Chamber of Commerce, the charge sheet against proxy advisers is simple. First, the proxy process at shareholder meetings has become far too costly for companies. Second, ISS and Glass Lewis both have conflicts of interest, they say, particularly as ISS sells consulting services through a subsidiary to public companies to help them improve their corporate governance. Finally, there are concerns about factual errors and misplaced accusations in the voting reports they produce.

Tom Quaadman, executive vice-president at the US Chamber of Commerce, said many private businesses had told him that the power wielded by ISS and Glass Lewis was one of the reasons private companies were reluctant to go public.

As the battle has intensified over the past 18 months, the US Chamber of Commerce and the NAM paid for a six-figure advertising campaign about the “growing risk” proxy advisers pose. NAM was also one of the founding members last year of Main Street Investors Coalition, a group that has been critical of proxy advisers.

The accusations are rejected by proxy advisers, who say that moves to tighten regulation stem from the uncomfortable spotlight their voting recommendations have put on executive pay as well as social and environmental issues.

“There would naturally be some tension between companies and organisations that write about them,” said Lorraine Kelly, head of governance solutions at ISS, but pay and environmental votes “seemed to galvanise lobby groups”.

Ms Kelly rebuts claims of a conflict of interest, arguing that there is a “very rigorous firewall” between the two divisions at ISS, while dismissing criticism that its reports are error-strewn.

Last year, a report commissioned by the American Council for Capital Formation, a non-profit, found 139 purported “proxy adviser errors” across 94 different companies. But in a letter to the SEC last month, the CII said that when it delved into the ACCF report, it found that “most of the claimed errors were actually disagreements on analysis and methodologies.”

A spokesperson for Glass Lewis said: “We believe the conditions the SEC is attempting to impose on proxy advisers are averse to the interests of shareholders.”

With the battle set to reach a climax early next year, some asset managers say it is the public whose savings are tied up in the stock market who will ultimately be the losers if the rules are passed.

“We think [the proposed rule] is not helpful to us as institutional investors when holding companies to account,” said Euan Stirling, head of stewardship at Aberdeen Standard Investments, the $669.1bn UK asset manager. “It will make the job more difficult and add costs. It will be the ordinary savers who have to pay the costs.”

It is a view echoed by Nell Minow, vice-chair of ValueEdge Advisors and a co-founder of ISS. She said SEC rules should be based on a cost-benefit analysis that the regulator has failed to provide in this case.

“It is completely counter to everything that the SEC should be doing. There is no benefit to investors whatsoever,” said Ms Minow.

In a statement, SEC spokeswoman Natalie Strom said the agency’s proposal “was designed to bring greater accuracy and transparency to investors who rely on proxy voting advice businesses”.

There is also concern that the higher costs that new regulations would bring will hurt smaller players such as Minerva and Pircharder, and deter new entrants to a market in need of competition. ISS and Glass Lewis have more than 90 per cent of the market.

With public consultation on the proposed rules open until early February, the next two months are expected to unleash a final frenzy of lobbying from both sides. Several big investors, such as the head of New York City’s $207bn retirement funds, have already petitioned the SEC to abandon its plans.

In a letter to the SEC last month, Scott Stringer, City of New York comptroller, said: “In light of the harm and costs that the Proposal is likely to impose on investors, and the benefits it will bestow upon the corporate management who have aggressively lobbied for it, investors are left to wonder as to the problems that the SEC is seeking to remedy with its proposal.”

Sarah Wilson, chief executive of Minerva, a UK-based proxy adviser, said: “It is now down to asset owners and asset managers who take governance seriously to voice their views.”

But business lobby groups are already quietly celebrating. “We anticipate this is going to be completed early next year,” said Mr Quaadman.

U.S. Securities and Exchange Commission Chairman Jay Clayton says his agency is investigating claims that a Virginia-based advocacy group was behind suspicious comment letters submitted in support of a rule change sought by large corporations.

“We’re having an investigation done of this issue,” Clayton said Tuesday in response to a question at a Senate Banking Committee hearing in Washington.

Lawmakers sought answers from Clayton on what the SEC was doing to address revelations in a Nov. 19 Bloomberg News story that some people whose names appeared on comment letters in support of changes to shareholder-voting rules said they hadn’t submitted them. A Democratic watchdog group last week called on the agency to investigate the role played by the 60 Plus Association, a Virginia advocacy group.

“Very shortly after the Bloomberg article came out, we contacted our general counsel and office of inspector general,” Clayton said in response to a question from Senator Tina Smith, a Minnesota Democrat.

Saul Anuzis, the president of 60 Plus, said last week that although his group helped draft and submit letters, all of the people whose names were used gave permission, “and they will be willing to sign an affidavit to testify as such.” He said people who told Bloomberg News that they didn’t know about their letters may have forgotten.

Clayton declined to respond when asked whether he thought it should be illegal for groups to submit comment letters in the name of individuals.

“The comment process is an open process,” he said. “Let’s see what happens with the investigation.”

Two groups of nuns, including one that puts living a life of peacemaking at the centre of its work, are gearing up for a fight with the US financial regulator over proposed shareholder rules.

The Ursuline Convent of the Sacred Heart in Toledo and the Dominican Sisters of Peace based in Columbus, Ohio, want the Securities and Exchange Commission to reverse its plans to introduce rules that would make it harder for smaller shareholders to submit proposals at annual meetings of public businesses in the US.

In a letter addressed to SEC chair Jay Clayton, Sister Barbara Kane, justice promoter at the Dominican Sisters of Peace, which has about $300m in assets, said: “Changing the rules governing shareholder resolutions is a solution without a problem.”

She added: “I understand that the SEC must balance the needs of shareholders with those of businesses but these changes are putting the scale on the side of business which puts our investments in danger.”

A divided SEC voted along political lines in November to require investors to hold more shares for longer before they can submit proposals. Currently shareholders must hold $2,000 worth of shares for a year, but the SEC plans to change this to a $25,000 holding for at least a year, declining to $2,000 for three-year holdings. It also wants to raise the thresholds for resubmitting unsuccessful proposals.

Sister Sandra Sherman, president of Ursuline Convent of the Sacred Heart in Toledo, which has an investment pot of about $20.6m, warned in a letter to the SEC that the proposed rule changes could leave congregations such as hers “without a voice” at corporate meetings.

She said the $2,000 ownership threshold enabled a variety of investors to have their voices heard. “These smaller investors have had great impacts on corporate practice throughout the history of the proposal process.”

She pointed out that small shareholders through their proposals have been instrumental in encouraging many companies to consider climate change, human rights assessments and governance reforms. “The proposed changes could prevent significant topics from even being suggested and considered, a loss to all shareholders,” said Sr Sherman. “We strongly urge the SEC to reconsider the proposed rule changes.”

According to data from the Interfaith Center on Corporate Responsibility, a coalition of investors with $400bn in assets, more than a third of ICCR members’ 277 proposals during the 2019 annual meeting season resulted in changes to corporate policies and practices.

The figures also show that of the 114 shareholder proposals that went to a vote this year, 10 achieved majority backing, while more than 60 per cent received at least 25 per cent support.

Sr Sherman said shareholders engaged on environmental, social and governance risks “precisely because we are concerned about the long-term health of the companies in which we are invested”.

“Engagement enables them to mitigate reputational, legal and financial risks, and build value. The filing of shareholders resolutions by investors big and small is a crucial part of the engagement process,” she said.

EPISODE SUMMARY

A common theme on our podcast is whether shareholders have too much power. But if we were going to redistribute that power, to whom should it go? Two recently proposed rule changes at the SEC would transfer more power to CEOs. But do we really want to empower managers to operate with less checks and balances? This week, Kate and Luigi sit down with SEC Commissioner Rob Jackson to talk through these issues and debate the proposed SEC rules.

The U.S. Securities and Exchange Commission’s proposed revisions to the shareholder voting process, including new regulations on proxy advisory firms and stiffer rules on corporate ballot proposals, are facing pushback from investor groups ahead of a potential showdown in 2020.

Both rule proposals, though separate, have in common an attempt by the SEC to reform key elements of the shareholder voting system that haven’t changed for decades. Whether the proposed changes are for better or worse is a question that divides market participants. Several shareholders groups worry the SEC’s efforts favor corporations at the expense of investors.

“We think both rule proposals undercut important shareholder rights and appear to be aimed at muffling the voice of investors at U.S. public companies,” said Amy Borrus, deputy director of the Council of Institutional Investors, which represents pension funds and other large investors.

By contrast, the SEC’s actions have received support from business interests who have argued that proxy firms have grown to become influential arbiters of corporate governance without regulatory oversight and that the shareholder proposal process is prone to abuse by small groups who don’t have a meaningful long-term commitment to a company.

The U.S. Chamber of Commerce and the National Association of Manufacturers have vocally supported both ideas, which a divided SEC proposed on Nov. 5 and may decide next year. NAM has lobbied the SEC to take action for years, saying it wants to “make the proxy process more responsible to Main Street investors and more reflective of business realities.”

“We intend to keep working with the SEC to ensure that both proposals are finalized and implemented appropriately in the weeks and months ahead,” Charles Crain, director of tax and domestic economic policy at NAM, said in a recent statement.

The push for action follows more than a decade of back and forth between regulators and market participants. The SEC in 2010 issued a concept release seeking comment on whether it should intervene to improve the proxy system, though it took no subsequent action.

SEC Chairman Jay Clayton revived interest in these topics. The agency hosted a roundtable on proxy issues last November and followed in August by publishing guidance stating its views on proxy-related matters, just months before releasing its latest rules proposals.

Both matters could be voted on in early 2020, sometime after the deadline for public comments.

But several market participants, including CII, New York City Comptroller Scott Stringer and other shareholder advocates, are concerned that regulators may be rushing. They are urging the SEC to double the time allowed for comments from the expected 60-day period to 120 days given the scope of both proposals, which total 320 pages and invite readers to respond to many questions.

“The two proposals are, in effect, a two-pronged attack on rights — proxy voting and shareowner proposals — that form the heart of the New York City Retirement Systems’ corporate governance program,” Stringer said in a Nov. 20 letter.

The SEC plans to allow 60 days of comments once the proposals are published in the Federal Register. Asked if it would consider extending that time frame, the agency declined to comment. As of Wednesday, the proposals had not been published in the Federal Register.

First, the SEC is proposing to increase scrutiny on proxy firms, which sell voting advice to institutional investors on matters like corporate elections, mergers, and executive pay. Proxy firms also provide voting advice on climate-change policies and other hot-button social issues.

The proxy advisory business has grown more influential given the outsize role that institutional investors — which own between 70 and 80 percent of the market value of U.S. public companies by some estimates — play in modern capital markets. As such, asset managers that own shares in hundreds or more public companies often rely on dominant proxy firms like Institutional Shareholder Services Inc. and Glass Lewis & Co. for advice on voting matters.

But business interests have argued that ISS and Glass-Lewis provide advice that is conflicted and error prone — criticism that the proxy firms and clients who rely on their advice dispute.

Among the SEC’s proposed revisions, proxy advisers will be required to increase disclosure about conflicts of interest if they wish to remain exempt from securities filing requirements.

Proxy advisory firms will also be required to give corporate management an opportunity to review and respond to the firms’ voting recommendations — provided that issuers file their proxy materials 25 days before a shareholder meeting. The proxy firms won’t be obligated to change their recommendations in accord with a corporation’s response.

Issuers will also be able to request that proxy firms include a hyperlink or some similar tool on their materials that directs readers to management’s response to its recommendations.

“From the issuer’s perspective, this is all reasonable,” said Simpson Thacher & Bartlett LLP partner Karen Hsu Kelley, who heads the firm’s public company advisory practice. “How can you argue with including disclosure of material conflicts of interest? And doesn’t it seem reasonable that companies should be given the opportunity to review and provide feedback, especially with respect to errors?”

CII says that its own analysis shows weak evidence for issuer’s concerns that proxy firms publish advice rife with errors, arguing that most claims of errors are actually methodological differences. CII also worries that allowing corporate managers to become more involved in the furnishing of proxy reports could hurt the ability of those firms to issue objective advice. Borrus called the SEC proposal an “unprecedented interference with the private market.”

“We think the rule proposals would bias proxy adviser reports and recommendations toward management,” Borrus said.

ISS is battling the SEC on its own front. The firm sued the agency in October, alleging that SEC guidance on proxy matters that was published in August just before the new rules proposals was “arbitrary and capricious” and could impede its ability to deliver independent research.

“It speaks volumes that the institutional investors which hire proxy advisers are not the ones calling for new, more onerous rules such as those now being contemplated,” ISS CEO Gary Retelny said in an emailed statement to Law360.

ISS insists that it manages conflicts of interest. The company has a subsidiary, ISS Corporate Solutions, which advises companies on how to improve their corporate governance and executive compensation policies. ISS maintains that its subsidiary’s business remains separate from the voting recommendations the parent company provides to shareholders.

Glass-Lewis, which is mostly owned by the Ontario Teachers Pension Plan, did not respond to requests for comment. The firm has said it manages and disclose conflicts and corrects errors when they happen.

The SEC has also codified in its proposal the agency’s prior interpretation that voting advice provided by proxy firms is considered a solicitation under federal proxy rules, meaning that such firms could be held liable if their advice is found to be false or misleading.

Separate from the SEC’s bid to regulate proxy firms is a proposal that would raise the bar on investors who want to submit items for vote at shareholder meetings. Among other things, the new proposal would toughen resubmission rules for ballot items that have failed by large majorities in prior votes.

Current rules require a proposal to gain at least 3% support to be resubmitted if voted on once, at least 6% support if voted on twice, and at least 10% support if voted on three times. The new proposal would respectively raise those resubmission requirements to 5%, 10% and 25%.

Business interests for years have argued that those thresholds should be raised on the premise that “zombie proposals” — meaning proposals that are continually rejected by large majorities of shareholders — are too easy to resubmit, costing companies and investors time and money.

The resubmission rules haven’t been updated since 1954, an era when most shareholders were retail investors. Clayton, who voted for both proposals, cited the market’s shift toward institutional investors as reasons for why be believes changes are needed.

“A lot of people see the resubmission threshold as ripe for updating,” said Covington & Burling LLP senior counsel David Martin, a former director of the SEC’s Division of Corporate Finance.

The SEC also wants to raise the minimum requirements for an initial shareholder proposal.

Shareholders are currently required to own at least $2,000 in company stock for one year before submitting a proposal for vote. Under the revision, shareholders who own $2,000 in company stock would have to wait three years before they could submit a proposal.

If a shareholder only owns company stock for two years, they would be required to own $15,000 worth of shares in order to submit a proposal, or $25,000 if they only owned stock for one year. The SEC said it wants to raise the initial criteria, which has not changed since 1998, to ensure proponents own a meaningful stake in a company or demonstrate a long-term commitment.

The SEC’s proposal also contains a “momentum” requirement that would let a company exclude a shareholder proposal even if it surpassed 25% support under certain conditions if the proposal’s support declined by 10% compared with the last time it was voted on.

The SEC’s two Democratic appointees, Robert Jackson and Allison Herren Lee, voted against both proposals regarding proxy firms and shareholder submissions, describing them as an affront to investor rights. Lee has called the new shareholder proposal requirements “stifling,” noting that many successful reforms to corporate governance take years to gain traction.

“While Chairman Clayton claims to be out to protect the Main Street investors, the proposed rules further disenfranchise us,” shareholder advocate James McRitchie said in a comment letter to the SEC.

Mayer & Brown LLP counsel Laura Richman, who advises public companies, described the SEC’s approach is balanced. She noted that submitting a proposal is an inexpensive way for shareholder proponents to publicize their issues while the company assumes the cost.

“Nobody is being silenced,” Richman said. “They [the SEC] are trying to update the threshold to modernize it.”

Clayton has said the proposal is meant to provide greater alignment between the proposing shareholders’ interests and the remaining shareholders, pointing to a 2018 study that said five individuals were responsible for 78% of all shareholder proposals between 2003 and 2014.

Clayton’s broader aim since taking the helm at the SEC has been to make capital markets more hospitable to public companies, which have dwindled in recent decades. Next year could represent the last opportunity for Clayton to shape the SEC’s agenda given the looming presidential election and potential for change in leadership in 2021.

However the proxy firm and shareholder proposals pan out, lawyers expect action next year.

“It’s clearly going to be on the SEC’s plate for 2020, both of these,” Richman said.