Following a 3-2 vote last week, the Securities and Exchange Commission has released two pieces of guidance related to the proxy voting process:
- Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers (the “IA Guidance”); and
- Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules (the “Proxy Rules Interpretation”).
The guidance is not subject to notice and comment and will become immediately effective upon publication in the Federal Register.
The guidance follows nearly a decade of engagement on the role and legal status of proxy advisory firms, including the 2010 Concept Release on the U.S. Proxy System, the issuance of Staff Legal Bulletin No. 20 (IM/CF) in 2014 regarding two exemptions from the proxy rules often relied upon by proxy advisory firms, the withdrawal of two no-action letters on which proxy advisory firms commonly relied regarding instances when a third-party proxy advisory firm may be considered independent under Advisers Act Rule 206(4)-61 and roundtable discussions in 2013 and 2018. Moreover, the proxy process remains on the SEC’s long-term agenda and could be an area for future rulemaking activity.
In thanking Commissioner Elad Roisman for leading the charge on both pieces of guidance, SEC Chairman Jay Clayton noted that these actions will “provide clarity to investment advisers regarding proxy voting responsibilities, and ultimately benefit their clients.” As the IA Guidance notes, the SEC encourages “investment advisers and proxy advisory firms to review their policies and practices in light of the guidance . . . in advance of next year’s proxy season.” Accordingly, companies will want to stay alert to any changes in proxy voting policies, particularly among their largest shareholders. Companies may also want to be alert for potential changes to voting recommendations from proxy advisory firms and may begin to see some additional disclosures from proxy advisory firms as to the bases underlying their voting recommendations, as described below.
For investment advisers, the IA Guidance describes ways in which investment advisers can engage with their clients to reach agreement on the investment adviser’s role in voting on behalf of the client. The IA Guidance also discusses how investment advisers should evaluate and utilize recommendations from proxy advisory firms. For instance, the IA Guidance offers a number of considerations that an investment adviser should take into account when retaining a proxy advisory firm to assist with proxy voting, including:
- The adequacy and quality of the proxy advisory firm’s staffing, personnel and/or technology;
- The proxy advisory firm’s processes for obtaining timely input from companies and proxy advisory firm clients regarding proxy voting policies, methodologies, and peer group constructions (e.g., for say-on-pay votes);
- How the proxy advisory firm takes account of unique characteristics regarding a company when constructing peer groups, including the company’s size, governance structure, industry and particular industry practices, history, and financing performance;
- Whether the proxy advisory firm has adequately disclosed its methodologies for formulating voting recommendations;
- The nature of third-party sources that the proxy advisory firm considers in developing voting recommendations;
- The effectiveness of the proxy advisory firm’s policies and procedures for obtaining current and accurate information underlying its voting recommendations; and
- The proxy advisory firm’s policies and procedures to address conflicts of interest.
Investment advisers are also reminded to have processes in place to follow up on potential factual errors, incompleteness or methodological weaknesses in the proxy advisory firm’s analysis.
For proxy advisory firms, the Proxy Rules Interpretation could prompt the application of additional scrutiny and diligence in the development of voting recommendations. Proxy advisory firms may also begin to provide additional disclosure regarding the facts underlying their voting recommendations or modify their existing practices for sharing reports with companies prior to publication. As the Proxy Rules Interpretation makes clear, proxy voting advice generally constitutes a “solicitation” under the proxy rules and, thus, is subject to 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.”2 Accordingly, to comply with Rule 14a-9, the Proxy Rules Interpretation suggests that “disclosure of the underlying facts, assumptions, limitations, and other information may be needed” with regard to “opinions, reasons, recommendations, or beliefs that are disclosed as part of a solicitation.” In this regard, the Proxy Rules Interpretation sets out the following three types of information that may need to accompany proxy voting advice:
- An explanation of the methodology used to formulate the voting advice on a particular matter (including any material deviations from 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 a company’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 company 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 proxy advisory firm’s client can assess the relevance of those conflicts.
1 The withdrawal took place shortly before the 2018 Roundtable on the Proxy Process, partly in an effort to prompt discussion on the topic. As the IA Guidance states, “Rule 206(4)-6 under the Advisers Act provides that it is a fraudulent, deceptive, or manipulative act, practice, or course of business for an investment adviser registered or required to be registered with the Commission to exercise voting authority with respect to client securities unless the adviser, among other things, adopts and implements written policies and procedures that are reasonably designed to ensure that the investment adviser votes proxies in the best interest of its clients.”
2 In the Proxy Rules Interpretation, the SEC pointed to the breadth of the definition of “solicitation” and concluded that unless it involves purely administrative or ministerial work, proxy voting advice generally will constitute a “solicitation” and thus trigger application of the federal proxy rules. While proxy voting advice will generally constitute a solicitation, the proxy advisory firms may continue to avail themselves of the exemptions from the information and filing requirements of the federal proxy rules. The two such exemptions most commonly relied upon are Exchange Act Rules 14a-2(b)(1) and (3).