Last week, the U.S. Securities and Exchange Commission (SEC or Commission) published (i) guidance to assist investment advisers in fulfilling their proxy voting responsibilities, particularly when relying on proxy advisors such as ISS or Glass Lewis (the Investment Advisers Release), and (ii) a new interpretation and related guidance regarding the applicability of the federal proxy rules to proxy voting advice furnished by proxy advisors (the Proxy Rules Release). The new guidance was approved by a 3-2 vote along party lines at an open meeting on August 21, 2019.
The new guidance was informed by extensive comments received since the SEC Staff held a roundtable in November 2018 to assess whether the SEC should update its rules governing proxy voting mechanics and the shareholder proposal process and strengthen the regulation of proxy advisors. These issues had been under consideration since the SEC solicited public comment on the proxy system through the “proxy plumbing” concept release in 2010. In 2014, the SEC’s Division of Investment Management and the Division of Corporation Finance jointly published Staff Legal Bulletin No. 20 (SLB 20) which addressed investment adviser responsibilities related to proxy voting and issues investment advisers should consider with respect to the retention and oversight of proxy advisory firms. The new Commission-level guidance updates and supplements some of the previous Staff-level guidance provided in SLB 20.
According to SEC Commissioner Elad Roisman, the new guidance “would not change the law or create a new regulatory regime for proxy advisory firms, but reiterate[s] longstanding Commission rules and positions that remain applicable and very relevant in today’s marketplace.” The Investment Advisers Release provides several examples of actions investment advisers can take to ensure that they are meeting their fiduciary duties to their clients with respect to proxy voting. These examples are not meant to be prescriptive mandates. The release specifically states that the examples provided “are not the only way by which investment advisers could comply with their principles-based fiduciary duty imposed on them by the Advisers Act.” Nevertheless, both investment advisers and proxy advisors are likely to view the new guidance as imposing additional expectations on them.
This Sidley Update summarizes the new guidance, which will become effective once published in the Federal Register. The SEC encourages investment advisers and proxy advisors to review their policies and practices in light of the guidance before the 2020 proxy season.
Investment Advisers’ Proxy Voting Responsibilities
The Investment Advisers Release provides guidance to investment advisers about their proxy voting responsibilities, especially when relying on proxy advisors. The new guidance, which was recommended by the SEC’s Division of Investment Management and provided in the form of six Q&As, is summarized below.
The guidance underscores a prior SEC statement that “[a]n investment adviser is a fiduciary that owes each of its clients duties of care and loyalty with respect to all services undertaken on the client’s behalf, including proxy voting.” It also re-emphasizes that using a proxy advisor to assist with voting in no way relieves an investment adviser of its fiduciary duty to serve its client’s best interest.
1. An investment adviser and its client may agree on the scope of the investment adviser’s proxy voting authority and responsibilities.
Investment advisers that assume proxy voting authority may establish a variety of voting arrangements with their clients, subject to full and fair disclosure and informed consent. The Investment Advisers Release provides a non-exhaustive list of potential arrangements for voting client securities, including:
- The investment adviser votes according to specified parameters designed to serve the client’s best interest (e.g., in favor of all management proposals or in favor of all proposals made by a specified shareholder proponent).
- The investment adviser does not vote if it would impose costs on the client (e.g., opportunity costs from retaining a security and voting versus lending out the security).
- The investment adviser votes only on certain types of proposals (e.g., relating to significant corporate events or contested director elections) based on the client’s preferences.
- The investment adviser does not vote on certain types of proposals “where the cost of voting would be high, or the benefit to the client would be low” (e.g., if the cost exceeds the expected benefit or voting would not reasonably be expected to have a material effect on the value of the client’s investment).
The Investment Advisers Release reiterates that, regardless of the agreed-on voting arrangement, an investment adviser that assumes proxy voting authority must make voting determinations consistent with its fiduciary duty and in compliance with Rule 206(4)-6.
2. An investment adviser can take several steps to demonstrate it is making voting determinations in accordance with its proxy voting policies and procedures and in a client’s best interest.
The Investment Advisers Release provides the following examples of actions an investment adviser can take to ensure that it is voting consistently with its voting policies and procedures and in its client’s best interest.
- If an investment adviser votes proxies on behalf of multiple clients with diverse investment goals (e.g., funds, other pooled investment vehicles and individual investors), it should consider whether applying a uniform voting policy to all such clients would be in each of their best interests or whether different voting policies should apply. If mutual funds use distinct, tailored voting policies, they should disclose this in their statements of additional information (SAI) or Form N-CSR, as applicable.
- An investment adviser should also consider applying a more detailed company-specific analysis (as opposed to applying general voting guidelines) for certain types of proposals, such as significant corporate events or contested director elections.
- An investment adviser should consider annually reviewing a sampling of the proxy votes it casts on behalf of its clients. For investment advisers that retain proxy advisors, the Investment Advisers Release provides the following examples of approaches an investment adviser could use to assess compliance:
- Periodically sampling the “pre-populated” votes shown on the proxy advisor’s electronic voting platform before such votes are cast.
- Adopting policies and procedures that provide for consideration of additional information (e.g., the filing of supplemental proxy materials by the company or shareholder proponent) that may become available regarding a proposal.
- Considering whether a higher degree of analysis may be required or appropriate for highly contested or controversial proposals or matters not covered by the investment adviser’s voting policies and procedures.
- Finally, an investment adviser should review and document at least annually that its voting policies and procedures are reasonably designed to ensure that the adviser votes in its clients’ best interests.
3. An investment adviser should consider several factors if it retains a proxy advisor to assist it in discharging its proxy voting duties.
The Investment Advisers Release provides a non-exhaustive list of factors the SEC believes an investment adviser should consider when deciding whether to retain (or continue to retain) a proxy advisor, including:
- Whether the proxy advisor has the ability to adequately analyze the matters for which the investment adviser is responsible for voting, including the adequacy of the proxy advisor’s staffing and personnel and its use of technology.
- Whether the proxy advisor has an effective process for incorporating input from companies and clients with respect to its proxy voting policies, methodologies and peer group constructions.
- Whether the proxy advisor has sufficiently informed the investment adviser about its methodologies in formulating voting recommendations and the nature of third-party information sources it used as a basis for its voting recommendations.
The SEC also believes an investment adviser should review a proxy advisor’s conflict of interest policies and procedures and assess whether they:
- Adequately identify and address actual and potential conflicts of interest (whether related to the provision of proxy voting services or otherwise as well as conflicts arising from certain affiliations).
- Provide for “context-specific, non-boilerplate” disclosure of the proxy advisor’s actual and potential conflicts with respect to the services provided to the investment adviser, which could include details about any consulting services provided by the proxy advisor to the company and related fees.
- Use technology (e.g., an online portal) to convey conflicts disclosures that are readily accessible.
The Investment Advisers Release acknowledges that the steps taken may vary based on (i) the scope of the investment adviser’s voting authority and (ii) the nature of the services the proxy advisor is performing for the investment adviser.
4. An investment adviser should consider taking certain steps if it becomes aware of potential factual errors, incompleteness or methodological weaknesses in a proxy advisor’s analysis that may materially affect the investment adviser’s voting determinations.
An investment adviser that retains a proxy advisor must have in place policies and procedures reasonably designed to ensure that its voting determinations are not based on materially inaccurate or incomplete information. According to the guidance, an investment adviser should periodically review its ongoing use of the proxy advisor’s research or voting recommendations, including whether any potential factual errors, incompleteness or methodological weaknesses in the proxy advisor’s analysis materially affected the research or recommendations used by the investment adviser.
An investment adviser should also consider whether the proxy advisor’s policies and procedures are effective for obtaining current and accurate information relevant to its research and voting recommendations. This should include considering (and potentially discussing with the proxy advisor) the proxy advisor’s (i) engagement with companies, including its process for ensuring that it has complete and accurate information about the company and each proposal, and its process (if any) for investment advisers to access the company’s views about the proxy advisor’s voting recommendations in a timely and efficient way; (ii) efforts to correct any identified material deficiencies in its analysis; (iii) disclosure to the investment adviser regarding the sources of information and methodologies used in formulating its voting recommendations or executing voting instructions; and (iv) consideration of factors unique to a specific company or proposal when evaluating a matter subject to a shareholder vote.
5. An investment adviser should consider evaluating a proxy advisor’s services on an ongoing basis.
Because circumstances could change after an investment adviser’s initial assessment and retention of a proxy advisor, investment advisers should consider evaluating proxy advisors on an ongoing basis. In particular, investment advisers may consider whether any conflicts of interest have arisen and whether the proxy advisor is appropriately updating its proxy voting guidelines and methodologies. They also may consider requiring the proxy advisor to provide updates regarding relevant business changes, such as those that may affect the proxy advisor’s ability to provide independent voting advice and execute the investment adviser’s voting instructions.
6. Even if an investment adviser has assumed voting authority on behalf of a client, it is not required to exercise every opportunity to vote a proxy for that client.
An investment adviser need not exercise its voting authority in the following situations:
- If the investment adviser and its client agreed in advance to limit the conditions under which the investment adviser would cast a vote.
- Where the investment adviser has determined that refraining from voting is in the client’s best interest (e.g., the cost exceeds the expected benefit), after considering whether it is meeting its duty of care to its client in light of the agreed-on scope of the investment adviser’s services to the client.
Applicability of the Federal Proxy Rules to Proxy Voting Advice
The Proxy Rules Release provides a new interpretation and related guidance regarding the applicability of the federal proxy rules to proxy voting advice provided by proxy advisors. The Staff of the SEC’s Division of Corporation Finance recommended the interpretation and guidance in connection with its overall review of the proxy process. The new guidance, provided in the form of two Q&As, is summarized below.
1. Proxy voting advice provided by a proxy advisor generally constitutes a “solicitation” under the federal proxy rules.
The Proxy Rules Release reiterates that the furnishing of proxy voting advice by proxy advisors generally constitutes a “solicitation” as defined in Exchange Act Rule 14a-1, which includes a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” This guidance echoes prior SEC statements that “the federal proxy rules apply to any person seeking to influence the voting of proxies by shareholders” and is consistent with the broader interpretation of the term “solicitation” by the SEC and courts over time. The Proxy Rules Release clarifies that a proxy advisor generally will be deemed to be engaging in a solicitation (i) even if the proxy advisor applies a client’s own voting guidelines and (ii) even if a client does not follow the proxy advisor’s advice.
2. The anti-fraud provisions in Exchange Act Rule 14a-9 apply to proxy voting advice.
Exchange Act Rule 14a-2(b)(3) exempts proxy advisors from the information and filing requirements of the federal proxy rules if specified conditions are met. The Proxy Rules Release makes clear that nothing in the guidance is meant to restrict the ability of proxy advisors to continue to rely on those exemptions. However, such exempt solicitations remain subject to the prohibition on false and misleading statements or omissions in Exchange Act Rule 14a-9.
Because a proxy advisor’s opinions, recommendations and similar views may be deemed statements of material facts for purposes of Exchange Act Rule 14a-9, a proxy advisor must not make materially false or misleading statements or omit material facts, such as information underlying the basis of its advice or that would affect its analysis and judgments, that would be required to make the advice not misleading. The Proxy Rules Release advises that a proxy advisor should consider the need to disclose the following types of information to avoid potential Rule 14a-9 violations:
- An explanation of the methodology used to formulate its voting advice, including any material deviation from its proxy voting policies or standard methodologies. (As an example, a footnote to the Proxy Rules Release notes that disclosure may be necessary if the proxy advisor used a group of peer companies it selected rather than using the peer group selected by the company.)
- A description of any third-party information sources (e.g., research, publications, databases or rankings) on which the proxy advisor based its voting advice and any material differences between the information from these sources and the company’s public disclosures.
- Details about material conflicts of interest arising from providing the proxy voting advice so that the client can assess the relevance of those conflicts.
SEC Chair Jay Clayton described the guidance as “just a first step” and noted that the Staff is also considering recommending that the SEC propose amendments to Exchange Act Rule 14a-2(b) to address the ability of proxy advisors to rely on certain exemptions from the federal proxy rules’ information and filing requirements. He also asked the Staff to consider whether the current definition of “solicitation” should be amended to codify the new interpretation.
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