Professor Asaf Eckstein of Tel Aviv University-Buchmann Faculty of Law examined the potential implications of proxy advisory firm regulation and public expectations in his paper Great Expectations: The Peril of an Expectations Gap in Proxy Advisory Firm Regulation. Eckstein feels that, based on the suggestions and comments for proxy advisor regulation, such regulation in reality would likely fall short of expectations and would not give the SEC “much real control over the advisors’ operations,” thus creating an “Expectations Gap.” Eckstein defines the term in this context as “the difference between a regulation’s perceived and actual efficacy.”
Applied to proxy advisors, the public would believe that action by the SEC would mean “that proxy advisory firms are being supervised on an ongoing basis, and that their voting recommendations to institutional investors are based on the best possible research and support, and promote the economic interests of investors.” According to Eckstein, the gap would result in increased confidence in the ability of the advisors based on a perceived “seal of approval,” while the advisors themselves would then be able to deflect a measure of responsibility to the SEC. Additionally, institutional investors would feel more comfortable relying more heavily on advice of proxy advisors, and Eckstein believes that this would lead institutional investors to be less rigorous in their analysis of recommendations.
Eckstein takes no position on what type of regulation would be most effective, nor even if regulation should be enacted in the first place. He does, however, recommend four methods to reduce the effect of an expectations gap in the proxy advisory sphere and elsewhere. For each new regulation, he advocates that the SEC:
· Include an analysis of the potential for an expectations gap,
· Include a disclaimer in an attempt to minimize unrealistic expectations by the public,
· Develop a plan to test the effectiveness of the regulation and detail the plan in the adopting release, and
· Have a third party (such as the OMB) monitor communications to the public by agencies and public officials to reduce the amount of inflationary rhetoric.
The full text of Eckstein’s article can be accessed here.