A Proxy Adviser's Two Sides

Some academics accused ISS of misusing its influence by creating a governance test and then selling the answers. "This starts to resemble the protection schemes of bullies," Jeffrey A. Sonnenfeld, a professor at the Yale School of Management, wrote in 2003.

And business groups said their members felt squeezed to buy ISS products out of fear of receiving unfavorable recommendations on crucial proxy votes. "The U.S. Chamber gets a number of calls from members who feel strong-armed," said David C. Chavern, vice president of the U.S. Chamber of Commerce.

Lately, some of ISS's clients have begun to object.

In one of his letters to ISS, Findlay, of the Missouri retirement system, compared ISS to the big accounting firms of a few years ago, which sold consulting services to corporations while at the same time auditing their books.

"I would have thought you might have reevaluated your business plan given the upheaval in the accounting community," Findlay wrote.

Last month, Millstein denounced ISS's business model at a conference celebrating ISS's 20th anniversary held at the Ronald Reagan Building and International Trade Center. "Anybody who can't see a conflict between consulting and standard-setting has trouble with their eyesight," Millstein said during a discussion with Connolly. "We who are on the other side are saying, 'How do they get away with this?' "

In the interview, Connolly said he had invited Millstein to the conference and was happy with the exchange of views. But he disagreed with the lawyer, a longtime advocate of better corporate governance who was legal adviser to the outside directors at General Motors Corp. in 1992 when they forced Chairman Robert C. Stempel to resign.

ISS executives noted that the company's corporate services sales division is physically separate from its shareholder research division, using separate office equipment and computer databases to prevent shareholder staffers from stumbling upon the names of corporate clients. Bonuses for those who provide research for institutional investors are calculated from a different pool than bonuses for those on the corporate sales side, Connolly said.

While Connolly acknowledged the failure of such "Chinese walls" in the accounting industry and on Wall Street, "we believe we've protected ourselves," he said.

He added that ISS, as a registered investment adviser, is regulated by the Securities and Exchange Commission, which he said has inspected its procedures and found no significant problems. In 2004, the SEC issued a legal ruling that said investment firms could rely on ISS and other proxy advisers if the firms properly checked out the advisers' conflict procedures. The agency, however, said it took "no position" on whether ISS's conflicts procedures were impartial.

ISS executives say that the heart of the company is good governance and that the cause is served both by its fee-based products and the amount of free governance resources for corporations that ISS provides. And some corporate executives, while not thrilled with the system, say they don't feel pressured to buy an ISS product to win its favor.

"I've never heard of a corporation that thought that paying for the consulting actually got them a better result," said Margaret M. Foran, senior vice president for corporate governance at Pfizer Inc. She said companies can improve their scores only by making changes, not by buying the ISS product.

The question keeps coming up.

Last month, at a meeting that included Connolly and McGurn, officials of a building-trades union accused ISS of retreating from full support of a union-backed shareholder measure that would make it easier to remove corporate directors, according to a source who spoke on the condition of anonymity because the meeting was supposed to be private. Union officials accused ISS representatives of compromising what had been a clear endorsement of the initiative, instead leaving open the possibility that ISS might approve corporate alternatives case by case.

"Are you going to charge for that?" asked Ed Durkin, director of corporate affairs for the United Brotherhood of Carpenters and Joiners of America, according to the source and later confirmed by Durkin.

McGurn, in an interview, said that the answer was an "unequivocal no" and that the company sells services for only matters, such as compensation plans and governance, that depend on written policies, not on the judgment of analysts. In any case, McGurn said, the union officials were mistaken. ISS had not changed its policy and would almost certainly back most of the unions' shareholder proposals, he said.

In an interview, Durkin said union officials "remain watchful" of ISS's stand on the question but are satisfied that "it isn't based on any consulting business that could raise conflicts."

"Is there a perception that there is a conflict?" Connolly said in an interview. "It sounds like there is. Can I assure you there is no conflict? Absolutely."