A Proxy Adviser's Two Sides

Corporations complained that ISS imposed a "politically correct" governance model that had little to do with whether the corporations made money for shareholders. "You have centralized decision-making about what governance should look like," said Gary Lutin, principal of New York investment bank Lutin & Co. and a longtime ISS critic. "Who anointed these guys?"

Activist shareholders applauded. ISS supporters say the company has played a major role in defending shareholder interests against the worst corporate abuses -- insider deals, anti-takeover devices, excessive pay and cronyism. "It does a serious job on behalf of its clients," said Damon A. Silvers, associate general counsel for the AFL-CIO, which supports shareholder initiatives. "It has been a target of a long history of unfair attacks by various people acting on behalf of the corporate community."

By the end of the 1990s, ISS was a Goliath. Its current clients include the $1.1 trillion Fidelity Investments and hundreds of smaller funds, including the $48 billion Virginia Retirement System.

ISS has 500 employees, including 290 researchers who prepare reports on 33,000 corporations worldwide, including 8,000 in the United States. A plaque listing clients covers a wall in the reception area of ISS's headquarters.

ISS recommendations have been credited for tipping some blockbuster corporate battles, including Hewlett-Packard's Compaq acquisition and a vote in 2004 that forced Michael D. Eisner to quit the chairman's post at Walt Disney Co. ISS also provides recommendations for votes at small and mid-size companies, and for social initiatives pushed by activist shareholders -- such as whether corporations should be forced to abide by the Kyoto Protocol on global warming (ISS says generally yes) or be asked to label genetically modified foods (ISS says no).

Shareholders and executives alike puzzle over the influence of ISS recommendations on shareholder votes. Susan E. Wolf, vice president at Schering-Plough Corp. and chairman of the Society of Corporate Secretaries and Governance Professionals, said some organization members think ISS controls a third or more of their shareholder votes. Millstein agreed, adding: "That's scary."

A 2002 study published in the academic journal Financial Management found that ISS recommendations unfavorable to management were associated with lower vote totals of 14 to 21 percent, depending on the question.

ISS executives play down the influence of their recommendations. "ISS doesn't control any percent of the vote," said Martha L. Carter, ISS's director of research. "It's our clients who do."

In an interview, Connolly acknowledged that 15 to 20 percent of ISS clients use a service that automatically votes according to ISS recommendations, although the clients can override it. He said such clients represent a small portion of any shareholder vote. He said most of ISS's biggest clients vote according to their own criteria, using ISS to research whether companies measure up.

In 2001, a group led by New York merchant bank Warburg Pincus LLP bought the company, made a series of acquisitions and revved up the corporate business.

The next year, ISS began a long-planned service that sells information to corporations on how to improve governance ratings. A corporation's CGQ is stamped on the front of ISS's reports to money managers. A low rating is considered embarrassing. ISS sells corporations access to a Web site that shows how changing certain governance policies -- for example, eliminating related-party deals -- would boost their CGQs. Companies can find out free what their CGQs are and what changes would boost their scores but must pay for the Web-based tool that calculates the value of each change. They can also buy comparative data on corporate peers.

Another corporate product allows companies to calculate whether stock-based executive compensation plans exceed ISS standards.