Institutional Shareholder Services Bucks Controversy, Says It's Changing

(Editor's Note: This is the third in a four-part series on proxy service firms. Read parts one and two.)

Institutional Shareholder Services has long been the Big Kahuna of proxy service firms. Founded more than 20 years ago, it helped define a new industry of providing institutional investors with ratings, recommendations and surveys of 3,500 companies in 50 countries.

Based in a leafy, campus-like setting in Rockville, Md., the firm saw its influence expand exponentially by the corporate scandals of the late 1990s as big institutions whetted their appetites for data regarding how well companies they were investing performed in corporate governance and transparency. By 2007, ISS was so successful that it was bought by New York-based RiskMetrics for about $450 million or roughly four times what it had been worth just a few years before.

Yet RiskMetrics/ISS has also become a lightening rod for complaints that proxy service firms are out of control and need to be reigned in. It is a constant butt of criticism by business columnists such as Gretchen Morgenson of The New York Times and has been the object of a recent, scathing study at Stanford. The firm has been accused of self-dealing by cross-selling both ratings and consulting to firms and by putting out funny numbers in its review of companies.

While not specifically addressing all the criticisms, a RiskMetrics/ISS official says that the firm is in the midst of a major transition. Since the merger, "we have been on a fairly transformational change agenda," Rick Leggett, head of RiskMetrics corporate governance, told me.

The firm has been expanding its capabilities across several fronts, including switching its research from just assessing issues to reviewing industrial sectors in the U.S. on a 365-day a year basis. It has beefed up its research team from 500 to 700 and has upgraded technology at its offices which span from the U.S. to Brussels, Paris, Tokyo and Manila.

Regarding accusations that his firm self-deals by simultaneously offering ratings and consulting, Leggett says the consulting side comprises a separate staff and works in a different building. It is a small part of RiskMetrics' total businesses with about $300 million in revenues. Leggett says that a report by the U.S. General Accountability Office last year found no conflict.

The Stanford study, Leggett says, misinterpreted some factors such as that ISS's ratings were never intended to be predictive about stock performance but are merely "an assessment tool." What's more, no Stanford researcher contacted ISS about their study, he says.

Rather than serve as merely a report card, RiskMetrics wants to expand into being a more interactive participant and has started an online outlet called "Governance Exchange" which is intended "to facilitate dialogue between directors and investors." The 24/7 exchange will marshal the firm's beefed-up analytical content and make it available to firms and the investment community via a secure portal provided by BoardVantage.

Also, RiskMetrics is one of the first proxy service firms along with ProxyGovernance to set up an outside advisory council as was recommended by the Milstein Governance Center at Yale School of Management. RiskMetric's 12-person board is headed by Arthur Levitt, Jr., who was chairman of the U.S. Securities & Exchange Commission from 1993 to 2001.

According to Leggett, the biggest thing on the plate of much-criticized RiskMetrics/ISS today is "engagement."

Next: How CEOs and boards should deal with proxy service firms.

(Image by Kyle Kesselring via Flickr, CC. 2.0)