A Proxy Adviser's Two Sides

In November, the board of the $34 billion Colorado Public Employees' Retirement Association terminated its contract with ISS after 16 years and hired Glass Lewis, noting in a statement that the San Francisco firm, among other things, "was free of any appearance of conflict."

ISS executives say the concerns are unwarranted. President and chief executive John M. Connolly said in an interview that the company has no conflicts and goes to great lengths to separate the sales of services to corporations from the researchers who issue recommendations. He said ISS does not consult but offers access to tools and research data to corporate clients.

"Everything we do is for the interests of institutional clients," Connolly said in an interview. "We are not here to grow at any cost." The services ISS sells help further the cause of shareholders by helping companies improve their governance, he said. The sales account for only 15 percent of ISS's revenue, he said.

Connolly said that despite 30 client defections, ISS had a 94 percent renewal rate by its customers last year and added 424 clients.

In some ways, the scrutiny of ISS is a result of its remarkable rise. Its roots date to the once-scruffy shareholder-rights movement of the late 1960s and early 1970s, when campus protesters pushed universities to justify investments in companies involved in nuclear power, weapons, and apartheid-ruled South Africa.

The corporate landscape at the time was dominated by imperial chief executives and rubber-stamp boards. Most institutional investors -- including pension funds, foundations and mutual funds -- either routinely sided with management in corporate votes or didn't vote at all. Shareholder activists were seen as gadflies or pie-in-the-sky economists.

ISS founder Robert A.G. Monks, a former money manager who once ran for the Republican nomination for U.S. Senate from Maine, said he was inspired to start the company in the late 1970s by a paper company polluting the Penobscot River. After a stint in the Reagan administration as head of the Labor Department's Pension and Welfare Benefits Administration, he founded ISS in 1985 to help shareholders exert more control over the companies they owned.

In 1988, Monks's former office at the Labor Department ruled that pension-fund managers who ignored proxy votes exposed themselves to legal risk. The edict -- the first in series of government mandates requiring money managers to pay closer attention to proxy votes -- boosted the fledgling proxy advisory business.

ISS took off in the mid-1990s after Canadian media giant Thomson Corp. bought the company and invested heavily in an electronic system to cast institutions' ballots. The ISS "agency voting" system collects ballots, marks them (with ISS recommendations, if the client chooses) and delivers them to vote-tabulation companies without money managers having to see them.

"That's where the explosion came from," said ISS's executive vice president, Patrick S. McGurn, who worked at an ISS rival before joining ISS in 1996.

ISS, meanwhile, rode the rise in the power of the institutional investor. In the 1980s and 1990s, tens of millions of Americans invested in stocks for the first time, mostly through pension plans and mutual funds. In 1985, institutional investors controlled 46 percent of a U.S. stock market worth $2.2 trillion; today institutions control 63 percent of a market worth $17 trillion, according to the Federal Reserve.

With institutions demanding a more systematic approach to proxy voting, ISS over the years drew up policies that defined good corporate governance. Its Corporate Governance Quotient, or CGQ, includes 63 features that all corporations should have, including some now considered commonplace: that boards include formal nominating and compensation committees, that boards be controlled by a majority of independent directors and that "independence" be strictly defined.