New SEC guidance addresses proxy voting process

The releases are not subject to notice-and-comment, which was a sticking point for two of the Commissioners.

Specifically, the SEC issued an interpretation of Exchange Act Rule 14a-1(l) that proxy voting advice by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules and provided related guidance about the application of the proxy anti-fraud rule to proxy voting advice. Both these actions explain the Commission’s view of various non-exclusive methods entities can use to comply with existing laws or regulations or how such laws and regulations apply.

The other guidance “will provide clarity to investment advisers regarding proxy voting responsibilities and, ultimately, benefit their clients,” said SEC Chairman Jay Clayton. That guidance discusses, among other matters, the ability of investment advisers to establish a variety of different voting arrangements with their clients and matters they should consider when they use the services of a proxy advisory firm.

“The releases reiterate the Commission’s views on the importance of investment advisers’ voting responsibly on behalf of their clients and the applicability of our proxy rules to proxy voting advice,” Commissioner Elad Roisman said. “Advisers who vote proxies must do so in a manner consistent with their fiduciary obligations and, to the extent they rely on voting advice from proxy advisory firms they must take reasonable steps to ensure the use of that advice is consistent with their fiduciary duties. In addition, proxy advisory firms, to the extent they engage in solicitations, must comply with applicable law.”

Proxy advisory guidance

Proxy voting advice provided by proxy advisory firms generally constitutes a solicitation under Rule 14a-1(l) subject to the federal proxy rules. Rule 14a-9, however, provides proxy advisory firms an exemption from the federal proxy rules’ filing requirements, if the advisory firm complies with the exemption’s conditions. Rule 14a-9 “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.”

The Commission guidance explains what a person providing proxy voting advice should account for when considering the information it may need to disclose in order to avoid a potential violation of Rule 14a-9 where the failure to disclose such information would render the advice materially false or misleading.

Where proxy advisory firms market their expertise in researching and analyzing proxy issues for purposes of helping their investment adviser clients make proxy voting decisions by providing their voting recommendations “should be considered a ‘solicitation’ subject to the federal proxy rules because it is ‘a communication to security holders under circumstances reasonably calculated to result in the procurement, withholding, or revocation of a proxy,’ ” the Commission said.

Furthermore, the SEC believes “such analysis and advice regarding a voting determination generally should be considered a solicitation” even if the proxy advisory firm bases its recommendations on its client’s own tailored voting guidelines and even in circumstances where the client decides not to follow the proxy voting recommendations.

Anti-fraud rule exemption

The regulator further emphasizes in the Proxy Voting Advice guidance that solicitations exempt from the information and filing requirements of the federal proxy rules under Rule 14a-2(b)(1) remain subject to the anti-fraud provisions of Rule 14a-9. “Accordingly, any person engaged in a solicitation through proxy voting advice must not make materially false or misleading statements or omit material facts—such as information underlying the basis of its advice or which would affect its analysis and judgments—that would be required to make the advice not misleading,” the Commissioners said.

Notably, Rule 14a-9 also extends to opinions, reasons, recommendations, or beliefs that are disclosed as part of a solicitation. Where such opinions, recommendations, or similar views are provided, disclosure of the underlying facts, assumptions, limitations, and other information may be needed so these views do not raise concerns under the rule.

According to the Commission, proxy advisory firms may need to disclose the following types of information to avoid a potential violation of Rule 14a-9:

• An explanation of the methodology used to formulate its voting advice on a particular matter;
• Identities of non-public information sources used as part of its recommendation and the extent to which the information from these sources differ from those selected by the registrant; and
• Any 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.

Investment adviser guidance

Developed by the SEC’s Division of Investment Management, the Proxy Voting Responsibilities guidance is intended to assist investment advisers in fulfilling their proxy voting responsibilities, particularly where they retain the services of a proxy advisory firm. Rule 206(4)-6 under the Advisers Act requires an investment adviser who exercises voting authority with respect to client securities to adopt and implement written policies and procedures that are reasonably designed to ensure the investment adviser votes proxies in the best interest of its clients.

The guidance clarifies how an investment adviser’s fiduciary duty and Rule 206(4)-6 under the Advisers Act relate to an adviser’s proxy voting on behalf of clients, particularly if the investment adviser retains a proxy advisory firm. The guidance follows a question-and-answer format and provides examples to help facilitate compliance.

In particular, the guidance discusses, among other things:

• How an investment adviser and its client, in establishing their relationship, may agree upon the scope of the investment adviser’s authority and responsibilities to vote proxies on behalf of that client;
• What steps an investment adviser, who has assumed voting authority on behalf of clients, could take to demonstrate it is making voting determinations in a client’s best interest and in accordance with the investment adviser’s proxy voting policies and procedures;
• Considerations that an investment adviser should ponder if it retains a proxy advisory firm to assist it in discharging its proxy voting duties;
• Steps for an investment adviser to consider if it becomes aware of potential factual errors, potential incompleteness, or potential methodological weaknesses in the proxy advisory firm’s analysis that may materially affect one or more of the investment adviser’s voting determinations;
• How an investment adviser could evaluate the services of a proxy advisory firm that it retains, including evaluating any material changes in services or operations by the proxy advisory firm; and
• Whether an investment adviser who has assumed voting authority on behalf of a client is required to exercise every opportunity to vote a proxy for that client.

Dissenting votes

The Commissioners approved both guidance by a vote of 3-2, with Commissioners Robert Jackson and Allison Herren Lee dissenting. Both expressed concerns about the releases not being subject to a notice-and-comment period.

“It may be that some of these specific measures are warranted, but the Commission has made a substantive policy choice without formally seeking input, justifying that choice to the public, or even identifying any benefits for investors,” said Lee. Additionally, Lee expressed concern that more issuer involvement in the process “would undermine the reliability and independence of voting recommendations.”

Jackson in his dissent said the guidance “may alter the competitive landscape for the production and use of that advice—without addressing whether doing so might make it harder for investors to oversee management.” He noted that smaller institutions “may be less able to bear the costs” of taking the steps identified in the guidance to ensure their use of proxy voting advice complies with their fiduciary duties.

“If smaller investors respond to these costs simply by choosing to vote less, the result may be to give more influence to large institutions,” Jackson said. “We should carefully consider the consequences of that possibility before making policy in this area.”

“Similarly, the proxy-advisory industry itself is dominated by a small number of players, further concentrating voting influence into just a few hands,” Jackson added. Thus, the guidance “may make it more costly to run a proxy-advisory firm, encouraging even more concentration—rather than new entrants who can give investors more choices about how to vote,” he said.

Next steps

The guidance and interpretation will be effective upon publication in the Federal Register. “We encourage investment advisers to review their policies and procedures in light of the guidance in advance of next year’s proxy season,” the SEC said. “To the extent that firms identify operational or other questions in the course of that review, we encourage them to contact the staff of the Division of Investment Management.”

Additionally, the Commission indicated in the guidance that proposed rule amendments “to address proxy advisory firms’ reliance on the proxy solicitation exemptions in Exchange Act Rule 14a-2(b)” may be forthcoming. For now, however, attention will be focused on whether and to what extent investment advisers and proxy advisory firms adjust their practices in light of this guidance heading into the 2020 proxy season.