On August 21, the Securities and Exchange Commission ("SEC") adopted (1) guidance on the proxy voting responsibilities of investment advisers under the Investment Advisers Act and related rules (the "Advisers Guidance") and (2) interpretation and guidance on the applicability to proxy voting advice of the rules on proxy solicitation under the Securities Exchange Act (the "Solicitation Guidance").
The SEC's guidance addresses a controversial element of the proxy voting process: for a very large portion of public company shares, voting decisions are made not by the beneficial owners but by their investment advisers, and a significant role in those decisions is played by two proxy advisory firms — ISS and Glass Lewis. Critics of these proxy advisory firms have called for regulatory action to limit their power, regulate their activities, make them more responsive to issuers, address conflicts of interest, and open up the market to other firms. But investment advisers have a real problem — they need to vote, generally without instructions from their clients, on complex issues at large numbers of companies; and they are in a market environment that rewards low fees and consequently low costs. Proxy advisors are useful to them.
The SEC's guidance will not satisfy the critics. The SEC proceeded cautiously, for the most part reinforcing regulatory positions it and its staff have taken in the past in a 2010 concept release (the "2010 Release") and in Staff Legal Bulletin No. 20 in 2014 ("SLB 20"), including:
- Clarifying the steps investment advisers should take to meet their fiduciary duties to clients in connection with proxy voting decisions, including oversight and evaluations of proxy advisory firms and the adequacy of their services and information;
- Confirming that proxy voting advice from proxy advisory firms generally constitutes a solicitation and would be subject to the applicable filing and disclosure requirements under the federal proxy rules unless otherwise covered by an exemption; and
- Setting forth disclosure considerations for proxy advisory firms, in connection with their ongoing compliance with the antifraud provisions of Rule 14a-9 under the proxy rules, relating to the accuracy and completeness of the information they use, the methodology by which they formulate voting recommendations and potential conflicts of interest.
Last week's guidance may impose some modest costs on proxy advisors and investment advisers, but it will not move the needle on the issue that most concerns public companies, which is whether the influence of the proxy advisors is too great. We do not expect the SEC's guidance to significantly alter the status quo or change the influence or the practices of the proxy advisory firms.
Advisers Guidance Elaborates on SLB 20 with Respect to the Oversight over Proxy Advisory Firms by Investment Advisers
Under the Investment Advisers Act, investment advisers owe a fiduciary duty to their clients, including with respect to proxy voting. Insofar as voting is based on the recommendations of a proxy advisory firm, the Advisers Guidance reiterates much of the guidance from SLB 20, including that the investment adviser should (a) consider evaluating the adequacy and quality of the proxy advisor's staffing and personnel prior to engaging the services of a proxy advisor, (b) ensure that voting recommendations from the proxy advisor are based on accurate information, and (c) implement policies and procedures for identifying and addressing the proxy advisors' conflicts of interest. The Advisers Guidance elaborates on these same topics, and it provides additional considerations about monitoring and evaluating any changes in the proxy advisor's (i) potential conflicts of interest, (ii) methodologies for formulating voting recommendations and (iii) process for collecting accurate and complete information, including whether the proxy advisor seeks issuer input and feedback on such information, methodologies and recommendations.
In connection with the investment adviser's obligation to ensure the reliability of the information it uses to guide voting decisions, the Advisers Guidance encourages proxy advisory firms to increase engagement with issuers by requesting investment advisers to evaluate proxy advisory firms on (x) whether they seek timely input from issuers with respect to their policies and voting methodologies, (y) whether they engage with issuers to ensure they have accurate and complete information (and their efforts to correct any discrepancies or deficiencies) and (z) whether they update their guidelines and recommendations in response to issuer feedback.
The Advisers Guidance also clarifies other considerations for investment advisers in exercising their fiduciary duties with respect to proxy voting, including (1) working with their clients to shape the nature and scope of the investment adviser's voting authority through full and fair disclosure and informed consent; (2) steps investment advisers should take to demonstrate that they are satisfying their duty to provide advice and make voting determinations in the best interest of the client, regardless of whether a proxy advisory firm has been retained; and (3) reviewing and possibly modifying their internal ongoing compliance programs.
Solicitation Guidance Confirms that the Provision of Proxy Voting Advice is a Solicitation and Elaborates on the Related Disclosure Requirements
The Solicitation Guidance formalizes the interpretation set forth in SLB 20 and the 2010 Release that proxy voting advice provided by a proxy advisory firm would generally constitute a "solicitation" under the federal proxy rules. It is therefore subject to all applicable information and filing requirements absent any available exemptions under Rule 14a-2. The SEC clarified that even exempted solicitations are subject to the antifraud provisions under Rule 14a-9, which prohibits a solicitation from containing any statements that may be false or misleading, or omitting any statements that would render the solicitation false or misleading. The SEC indicated that the steps and disclosure considerations set forth in the Solicitation Guidance may be required to avoid a potential violation. For example, proxy advisory firms should consider disclosure regarding (a) the methodology they use to formulate their voting recommendations, (b) the sources of the data and information they use in compiling their reports and analyses, particularly to the extent that such information is based on third-party information sources and may differ from the issuer's own public disclosures, and (c) consistent with SLB 20 and as alluded to in the 2010 Release, any potential or existing conflicts of interest that may arise (such as when a proxy advisory firm is providing voting recommendations to an investment adviser but is also retained by the issuer to consult on various related proposals or corporate matters).
The New Guidance is Unlikely to Meaningfully Change the Current Landscape, but the SEC May Adopt Further Changes¬
Given the limited nature of any additional obligations imposed on proxy advisory firms resulting from the Advisers Guidance and the Solicitation Guidance, it is unlikely that their methodologies and practices will be significantly altered. It is similarly unlikely that this guidance will change the extent of the proxy advisory firms' influence on proxy voting and their overall impact on public companies. To the extent the additional considerations relating to the investment advisers result in reducing the number of investment advisers that vote or the number of proposals on which they vote, this will only serve to further magnify the influence of some of the largest institutional investors.
Each of the Advisers Guidance and the Solicitation Guidance was adopted by a 3-2 vote, with Commissioners Jackson (D) and Lee (D) dissenting. The SEC continues to grapple with voting issues and in his closing remarks, Chairman Clayton promised that the work of the SEC in preparing this guidance was "just a first step" and that there were additional projects underway, including forthcoming amendments to the proxy rules (in particular, the definition of "solicitation" and the requirements for the applicability of the exemptions, which Chairman Clayton admitted "were adopted decades ago and [...] warrant a fresh look").
While the current guidance is not expected to meaningfully impact publicly traded companies, proxy voting remains at the forefront of the SEC's focus and future amendments to the rules (especially the availability of exemptions for proxy advisory firms' proxy voting advice) could provide an opportunity for the SEC to alter how services are provided by proxy advisory firms, which in turn could impact the nature and scope of their relationships with investment advisers and issuers.
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