Clearhouse
Nasdaq Talks to Congressman Sean Duffy and Vitae Pharmaceuticals’ CEO Jeff Hatfield about Proxy Advisor Legislation and Short Selling Transparency
Publication Date: May 19, 2016

What motivates a Republican Congressman and a corporate biotech CEO to join forces in supporting additional regulation of U.S. capital markets? Nelson Griggs, Executive Vice President of Listing Services at Nasdaq, recently hosted a webinar discussion on corporate governance reforms with U.S. Representative Sean Duffy (R-WI) and Jeff Hatfield, President and CEO of Vitae Pharmaceuticals, Inc. (Nasdaq: VTAE). The topics discussed included Rep. Duffy’s proposed legislation to regulate proxy advisory firms and the need for timely disclosure of short selling positions.

Corporate Governance Reform and Transparency Legislation

Rep. Sean Duffy’s corporate governance reform and transparency legislation aims to ensure that proxy advice is issued in the best interest of shareholders. Congress understands the power and influence proxy advisory firms (PAFs) wield in our capital markets:

  • Institutional ownership of U.S. stocks has risen from 46% in the 1987 to approximately 75% today.
  • The two top PAF firms—Institutional Shareholder Services (ISS) and Glass, Lewis & Co.—control over 90% of the market, giving them outsized influence with respect to say-on-pay, mergers and acquisitions and director elections recommendations.
  • Many PAF firms also provide proxy battle consulting services to the corporations they issue recommendations on, potentially creating a serious conflict of interest.
  • The PAF industry is virtually unregulated and presents a significant opportunity for corruption and double-dealing.

As a result, there is an essential need for legislation that fosters accountability, transparency, responsiveness, and competition with the intent to protect investors and the market.

Duffy’s proposed bill, the Proxy Advisory Firm Reform Act of 2016 (the Act), would require, among other things, that PAFs:

  • Register with the SEC;
  • Employ ombudsman to handle complaints from listed companies about using inaccurate information to issue recommendations and such complaints must be resolved in a timely manner; and
  • Maintain a code of ethics to better manage conflicts of interest.

The Act also grants the SEC specific statutory authority to oversee PAFs.

During the Q&A segment of the discussion, Congressman Duffy also pointed out that the bill is co-sponsored by fellow Democratic Representative John Carney from Delaware -- so there is early bipartisan support for this effort. Rep. Duffy fielded a tough question about the idea of a Republican increasing regulation in the markets, and he stressed that while increased regulation may seem counterintuitive, in the case of PAFs where the market is so clearly dominated by a couple of firms, oversight is sorely needed.

Many public companies have raised concerns about the influence proxy firms have in shaping corporate governance. Congressman Duffy’s legislation would address this frustrating situation. You can voice your support by contacting Rep. Duffy’s Deputy Chief of Staff, Andy Taylor, at Andy.Taylor@mail.house.gov.

Impact of Unregulated PAFs on the Biotech Industry

The webinar provided context on the issue by focusing particularly on the effect and influence PAFs have on the biotech industry. Jeff Hatfield discussed his experience and concerns with PAFs and how the biotech industry would benefit from the bill. He explained that a new biotech company operates on a simple model, consisting of a small group of scientists working on first class breakthroughs on cures. This process takes decades to develop and costs billions to bring to market. There is no revenue earned for up to the first decade, so biotechs rely very heavily investors for cash flow and equity infusion (almost 40% of IPOs are biotech companies). Therefore, the influence of PAFs can be significant and detrimental at the same time.

PAFs don’t compare the size and revenues of the companies they influence, but rather recommend a one-size fits all approach on their recommendations throughout the market, which oftentimes does not accurately reflect the earnings potential and/or investment risk of a biotech model. Small companies find themselves aligning their policies and business models to satisfy proxy advisory firms, rather than making decisions in the best interest of the company’s long-term strategies and performance. Other issues involve the exposure of the draft reports and a noticeable conflict of interest. ISS will provide drafts of its reports to its larger companies (i.e., S&P companies) beforehand, while the smaller companies, like those in the biotech industry, will typically only get access to these reports once they are available to the shareholders. Additionally, there is an intrinsic conflict of interest, as PAFs provide consulting services on how to succeed in proxy fights that often result from the PAF’s own negative recommendations. The Act will provide some resolution to these types of issues.

Short Selling Transparency

The webcast discussion also covered the significant gap in the disclosure obligations of short sellers.

Transparency regarding short selling has long been an issue in the market. Nasdaq has taken a stance petitioning to require disclosure of short positions in parity with already-required disclosure of long positions. This is not a proposition for new restrictions, but rather to provide clarity and transparency to prevent abusive trading behavior that impacts companies and the longevity of shareholders.

While Hatfield supports short selling as it is critical to market liquidity, the information asymmetry gives rise to trade abuses. Additionally, as biotechs are thinly traded stocks with large gaps of time between major news, short selling can play a major factor in driving the stock during these periods. Short sales represent 13.2% of all biotech transactions, versus 1.6% of the market as a whole. The goal is to align short selling disclosure with parallel requirements to disclose long positions, which will give companies better insight into trading activity and provide adequate knowledge to answer investor questions and concerns.

In December, Nasdaq submitted a Petition to the SEC to adopt rules in this area. You can submit your comments to the SEC through the form here.

Listen to May 11th webinar >>

Read Nelson Griggs’ testimony before the House Financial Services Committee on these issues >>