Amid growing scrutiny of proxy advisory firms and concerns about their influence over corporate governance matters and the potential for conflicts of interest, the Securities and Exchange Commission has issued new guidance. The slate of 13 questions and answers from the Division of Corporation Finance and Division of Investment Management addresses conflicts, the application of previous disclosure exemptions, and the use of these firms by investment managers voting on behalf of clients.

Proxy advisory firms, including market leaders ISS and Glass Lewis, have increasingly come under fire by business groups, notably the U.S. Chamber of Commerce, critical of what they see as outsized influence in governance matters and conflicts that may arise when they repackage and sell research (ISS also has a consulting arm that is separate from its advisory services). SEC commissioners Michael Piwowar and Daniel Gallagher have repeatedly raised similar concerns in public comments and speeches. In December, the Commission held a day-long roundtable where participants discussed these matters.

Among the matters addressed in the new guidance:

A proxy advisory firm is subject to federal proxy rules when it engages in a “solicitation.” Providing proxy voting advice constitutes a solicitation that is subject to disclosure requirements unless specified exemptions are met.

A disclosure exemption exists for providing proxy voting advice if the firm doing so gives financial advice in the ordinary course of business; discloses to the recipient of the advice any significant relationship with the company or affiliates; receives no special commission from anyone other than the recipient of the advice; and does not furnish the advice on behalf of anyone soliciting proxies or a participant in a contested election. In making these determinations, a proxy advisory firm should consider the type of service being offered, the amount of compensation it receives, and the extent to which the advice relates to the same subject matter as the transaction giving rise to the relationship with the company or security holder proponent. 

If a proxy advisory firm determines that it has a significant relationship, it must provide the recipient of its advice with a disclosure detailing that conflict. The SEC guidance cautions that “boilerplate language that such a relationship or interest may or may not exist” is insufficient. The disclosure should enable the recipient to understand the nature and scope of the relationship, including the steps taken, if any, to mitigate the conflict.  

The SEC imposes an affirmative duty to disclose significant relationships or material interests to the recipient of a proxy advisory firm's advice. Providing the information “upon request” would not satisfy that requirement. The SEC does not specify where the required disclosure should be provided; it may be made publicly or between only the proxy advisory firm and the client.

The guidance also addresses steps an investment adviser must take to demonstrate that proxy voting on a client's behalf is in their best interest. Compliance may be demonstrated by periodically sampling proxy votes to review whether they complied with the investment adviser's proxy voting policy and procedures. As part of an investment adviser's ongoing compliance program, it should review, at least annually, the adequacy of its proxy voting policies and procedures to make sure they have been implemented effectively and are in the best interests of clients.

When considering whether to retain a proxy adviser to provide voting recommendations, an investment adviser should ascertain whether the firm has “the capacity and competency to adequately analyze proxy issues.” This consideration should include: the adequacy and quality of staffing; policies to ensure recommendations are based on current and accurate information; and identifying and addressing any conflicts of interest.

If an investment adviser determines that a proxy advisory firm's recommendation was based on a material factual error, it should take reasonable steps to investigate the error and determine whether the proxy advisory firm is taking reasonable steps to seek to reduce similar errors in the future.