On August 21, 2019, the Securities and Exchange Commission (the SEC) published two guidance releases regarding the proxy voting process. The first release is guidance to assist investment advisers (or fund managers) who assume voting responsibility on behalf of their clients, particularly with respect to the use of recommendations from proxy advisory firms, such as ISS and Glass Lewis (the Investment Advisers Guidance). The second release is an interpretation and guidance regarding the applicability of the federal proxy rules to voting recommendations made by proxy advisory firms (the Proxy Rules Guidance). The SEC approved both releases by a 3-2 vote, with Chairman Clayton and Republican Commissioners Peirce and Roisman forming the majority in each vote and Democratic Commissioners Jackson and Lee dissenting.
These releases follow years of engagement with the public by the SEC and its staff on the role of proxy advisory firms in the proxy voting process. The releases do not change the law or create new regulatory regimes for investment advisers or proxy advisory firms, but they do provide more formal guidance regarding the application of SEC rules to investment advisers and proxy advisory firms. The guidance contained in the releases is generally consistent with the guidance and interpretations previously issued by the SEC staff, although it does delve more deeply into the subject and offer more specific examples for implementation. Accordingly, investment advisers and proxy advisory firms should review their voting policies and practices in light of the guidance to determine if any changes should be made in advance of next year’s proxy season.
Investment Advisers Guidance
Investment advisers, who vote proxies for an increasing number of retail investors every year, and proxy advisory firms, who make voting recommendations to investment advisers, play a central role in the proxy voting process and the outcome of shareholder votes. The Investment Advisers Guidance begins with the premise that “[i]nvestment advisers are fiduciaries that owe each of their clients duties of care and loyalty with respect to services undertaken on the client’s behalf, including voting.” In this regard, the Investment Advisers Guidance provides the SEC’s views on how fiduciary duty and Rule 206(4)-6 under the Investment Advisers Act of 1940, as amended, relate to an investment adviser’s exercise of proxy voting authority on behalf of clients. The Investment Advisers Guidance acknowledges that, when making voting determinations on behalf of clients, many investment advisers retain proxy advisory firms for voting recommendations, among other services. The Investment Advisers Guidance discusses ways investment advisers can use the services of proxy advisory firms responsibly. The guidance, presented in a six Q&A format, is summarized below.
- An investment adviser and its client may, subject to full and fair disclosure and upon mutual, informed consent, agree on the scope of the investment adviser’s proxy voting responsibilities.
The Investment Advisers Guidance focuses on an investment adviser’s fiduciary duty, noting that “[t]he fiduciary duty follows the contours of the relationship between the investment adviser and its client, and the adviser and its client may shape that relationship by agreement, provided that there is full and fair disclosure and informed consent.” As such, an investment adviser has the ability to define the scope of its proxy voting responsibilities with each client and may decline to accept the authority to vote client securities altogether. An investment adviser that does assume voting responsibility on behalf of a client may, subject to the concepts of “full and fair disclosure and informed consent”, agree on a variety of arrangements for voting client securities, including the types of matters for which the investment adviser will exercise voting authority. The guidance provides several non-exhaustive examples of such possible voting arrangements to which a client and its investment adviser may agree, including the following:
- The investment adviser may exercise voting authority pursuant to specific parameters designed to serve the client’s best interest. For example, absent contrary instructions from the client, the investment adviser would vote in accordance with the recommendations of management of the issuer or in favor of all proposals made by particular shareholder proponents.
- The investment adviser would vote only on particular types of proposals based on the client’s preferences, such as proposals relating to M&A transactions or contested elections for directors.
- The investment adviser would not exercise voting authority in circumstances under which the cost of voting would be high, or the benefit to the client would be low.
Importantly, although an investment adviser may shape its voting responsibility with each client, the SEC emphasized that an investment adviser that assumes such responsibility must effect voting determinations in accordance with its fiduciary duty and in compliance with Rule 206(4)-6, which may result in some questions as to the ability of an investment adviser to fully customize, on a client-by-client basis, the nature of its proxy voting responsibilities.
- The investment adviser may exercise voting authority pursuant to specific parameters designed to serve the client’s best interest. For example, absent contrary instructions from the client, the investment adviser would vote in accordance with the recommendations of management of the issuer or in favor of all proposals made by particular shareholder proponents.
- An investment adviser should take steps to demonstrate that it is making voting determinations in a client’s best interest and in accordance with the investment adviser’s proxy voting policies and procedures.
The Investment Advisers Guidance provides the SEC’s views on the manner in which an investment adviser should exercise its fiduciary duty and obligations under Rule 206(4)-6 in the context of voting proxies for multiple clients, including different types of clients with differing investment objectives and strategies. An investment adviser should consider whether voting all of its clients’ shares in accordance with a uniform voting policy would be in the best interest of each of its clients. In shaping its voting policies, an investment adviser should consider whether certain types of matters may necessitate that the adviser conduct a more detailed analysis to consider factors particular to the issuer or the voting matter under consideration, such as M&A transactions or contested elections for directors.
An investment adviser that retains a proxy advisory firm to provide voting recommendations should consider additional steps to evaluate whether the investment adviser’s voting determinations are consistent with its polices and in the client’s best interest before the votes are cast. The guidance provides several examples of steps the investment adviser could use to evaluate its compliance, including the following:
- The investment adviser could consider policies and procedures that provide for consideration of additional information by the investment adviser that may become available regarding a particular proposal. This additional information may include subsequently filed definitive proxy materials or other information conveyed by an issuer or shareholder proponent to the investment adviser that would reasonably be expected to affect the investment adviser’s voting determination.
- Where the matter is highly contested or controversial, such as M&A transactions and contested director elections, the investment adviser could consider whether a higher degree of analysis may be necessary or appropriate to assess whether votes are cast in the client’s best interest.
- The investment adviser could consider policies and procedures that provide for consideration of additional information by the investment adviser that may become available regarding a particular proposal. This additional information may include subsequently filed definitive proxy materials or other information conveyed by an issuer or shareholder proponent to the investment adviser that would reasonably be expected to affect the investment adviser’s voting determination.
- An investment adviser should consider several factors if it retains a proxy advisory firm to assist in discharging its voting responsibilities.
An investment adviser, when deciding whether to retain a proxy advisory firm, should consider the firm’s “capacity and competency” to adequately analyze the matter for which the investment adviser is responsible for voting. This could include consideration of matters such as the adequacy and quality of the firm’s staffing, personnel and/or technology.
An investment adviser should also consider whether the proxy advisory firm has an effective process for seeking timely input from issuers and its own clients with respect to its proxy voting policies, methodologies, and peer group constructions, including for say-on-pay votes. The guidance states that “[w]here relevant, an investment adviser should also consider how the proxy advisory firm, in constructing peer groups, takes into account the unique characteristics regarding the issuer, to the extent available, such as the issuer’s size; its governance structure; its industry and any particular practices unique to that industry; its history; and its financial performance.”
An investment adviser should also consider whether a proxy advisory firm has adequately disclosed its methodologies in formulating voting recommendations, such that the investment adviser can understand the factors underlying the proxy advisory firm’s voting recommendations. In addition, the investment adviser should consider the nature of any third-party information sources that the proxy advisory firm uses as a basis for its voting recommendations. The investment adviser also should consider what steps it should take to develop a reasonable understanding of when and how the proxy advisory firm would expect to engage with issuers and third parties.
An investment adviser should reasonably review a proxy advisory firm’s policies and procedures regarding how it identifies and addresses conflicts of interest. For example, the investment adviser could assess whether the proxy advisory firm’s policies and procedures provide for adequate disclosure (i.e., context-specific, non-boilerplate disclosure) of actual and potential conflicts that is transparent and accessible, such as disclosure detailing whether the issuer has received consulting services from the firm, and if so, the amount of compensation paid to the firm.
- An investment adviser should take certain steps if it becomes aware of potential material factual errors, incompleteness, or methodological weakness in the proxy advisory firm’s analysis.
An investment adviser’s policies and procedures should be reasonably designed to ensure that its voting determinations are not based on materially inaccurate or incomplete information. In reviewing its use of a proxy advisory firm, an investment adviser should consider the effectiveness of a proxy advisory firm’s policies and procedures for obtaining current and accurate information relevant to matters on which it makes voting recommendations. As part of this assessment, the investment adviser should consider the following: the proxy advisory firm’s engagement with issuers, including its process for ensuring that it has complete and accurate information about the issuer and each particular matter; the proxy advisory firm’s efforts to correct any identified material deficiencies in its analysis; the proxy advisory firm’s disclosure regarding the sources of information and methodologies used in formulating voting recommendations; and the proxy advisory firm’s consideration of factors unique to a specific issuer or proposal.
- An investment adviser should evaluate the services of a proxy advisory firm on an ongoing basis.
An investment adviser should implement policies and procedures that are reasonably designed to sufficiently evaluate proxy advisory firms to ensure that the proxy voting is occurring in the best interest of the clients. In the context of such evaluations, an investment adviser should consider updating procedures, such as requiring the proxy advisory firm to update the investment adviser regarding relevant business changes and conflicts of interest, and also whether the proxy advisory firm appropriately updates its methodologies, guidelines, and voting recommendation on an ongoing basis, including in response to feedback from issuers and their shareholders.
- An investment adviser that has assumed voting authority on behalf of a client is not required to exercise every opportunity to vote a proxy for that client.
There may be times when refraining from voting a proxy on behalf of a client is in the best interest of the client, including where the adviser determines, in the course of fulfilling its fiduciary duty to its client, that the cost to the client of voting exceeds the expected benefit to the client. Additionally, if an investment adviser and its client have agreed in advance to limit the conditions of voting authority, the investment adviser need not vote if so contemplated by their agreement.
Guidance on Applicability of Federal Proxy Rules to Proxy Voting Advice
The Proxy Rules Guidance, presented in a two Q&A format, is summarized below.
- Proxy voting advice constitutes a solicitation under the federal proxy rules.
The SEC’s definition of a “solicitation” is broad and includes, among other things, a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” The guidance formalizes the SEC staff’s previous guidance that proxy voting advice provided by a proxy advisory firm constitutes a “solicitation” under the federal proxy rules. The guidance then goes on to provide robust reasoning for this position. The SEC specifically disagreed with the view advocated by ISS that voting advice provided by proxy advisory firms does not constitute a “solicitation” because it is not “unsolicited” voting advice. The SEC distinguished voting advice provided by proxy advisory firms from voting advice provided by financial advisors or brokers based on unsolicited inquiries from their clients. Because the proxy voting advice provided by proxy advisory firms “is invited by the proxy advisory firms themselves through the marketing of their expertise in researching and analyzing proxy issues,” the SEC concluded that such advice should not be viewed as “unsolicited” in a manner that would exclude it from the definition of “solicitation” under the federal proxy rules. The guidance notes that although proxy advice is a solicitation under the federal proxy rules, proxy advisory firms may avail themselves of the exemptions from the information and filings requirements of the federal proxy rules.
- Anti-fraud provisions of the federal proxy rules apply to proxy voting advice.
Solicitations that are exempt from the federal proxy rules’ information and filing requirement, such as proxy voting advice, remain subject to Exchange Act Rule 14a-9, which prohibits any solicitation from containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact. In addition, such solicitation must not omit to state any material fact necessary in order to make the statements therein not false or misleading.
Accordingly, a proxy advisory firm should consider whether it may need to disclose the following types of information in order to avoid a potential violation of Rule 14a-9:
- An explanation of the methodology used to formulate its voting advice on a particular matter (including any material deviations from the provider’s publicly-announced guidelines, policies, or standard methodologies for analyzing such matters) where the omission of such information would render the voting advice materially false or misleading;
- To the extent that the proxy voting advice is based on information other than the issuer’s public disclosures, such as third-party information sources,disclosure about these information sources and the extent to which the information from these sources differs from the public disclosures provided by the issuer if such differences are material and the failure to disclose the differences would render the voting advice false or misleading; and
- Disclosure about material conflicts of interest that arise in connection with providing the proxy voting advice in reasonably sufficient detail so that the client can assess the relevance of those conflicts.
As an example, the guidance specifically notes that, to the extent proxy voting advice is materially based on a methodology using a group of peer companies selected by the proxy advisory firm, the disclosure may need to include the identities of the peer group members used as part of its recommendation and the reasons for selecting these peer group members as well as, if material, why its peer group members differ from those selected by the registrant.
SEC Statements on Further Guidance and Oral Rule 14a-8 No-Action Requests
The SEC noted that the guidance discussed above is “just a first step” and in the near future it expects to consider proposed rules to amend the submission and resubmission thresholds for shareholder proposals under Exchange Act Rule 14a-8 and proposed rule amendments to address proxy advisory firms’ reliance on the proxy solicitation exemptions in Exchange Act Rule 14a-2(b). The SEC also indicated that it may in the longer-term consider actions to modernize the proxy system generally to promote greater efficiency and accuracy in shareholder voting, so called “proxy-plumbing.”
Shortly after issuing the Investment Advisers Guidance and the Proxy Rules Guidance, the SEC staff (Staff) announced that, as part of its consideration of how it could “most efficiently and effectively provide guidance on Rule 14a-8 no-action requests where appropriate,” it would modify how it responds to no-action requests involving shareholder proposals. Starting with the 2019-2020 annual meeting season, the Staff may respond to some no-action requests orally rather than in writing. In the future, the Staff stated that it will issue a response letter only in cases “where it believes doing so would provide value, such as more broadly applicable guidance about complying with Rule 14a-8.” This change is likely to have several practical implications for companies, proponents, and other involved parties, such as proxy advisory firms. For example, companies and proxy advisory firms will need to develop new practices to deal with cases where the Staff concurs orally with a company’s position that it can exclude a proposal, which will not provide a public written response to the company’s no-action request that the proxy advisory firm can evaluate. In practice, this announcement leads to more questions than it answers; the answers are likely to emerge only after the Staff begins to apply this change as the 2019-2020 proxy season begins.
Some Key Takeaways
In light of the SEC guidance, investment advisers should review their existing policies and practices, including their voting policies and practices for each of their clients, and consider whether any changes should be implemented.
The SEC guidance does not directly apply to issuers. However, it remains to be seen whether a renewed emphasis on potential liability for proxy advisory firms for misleading material statements and omissions in proxy voting communications may enhance the level of transparency in the proxy advisory firms’ reports and their responsiveness in communicating with issuers.