For more than a decade, the SEC has been wrestling with whether and how to regulate the activities of the proxy advisory firms — principally ISS and Glass Lewis — that have come to play such an important role in shareholder voting at U.S. public companies. On July 22, 2020, the SEC adopted rules and interpretive guidance that, together, are probably as far as it will go.

Very generally, the main impact of last week's actions is that, beginning in the 2022 proxy season:

  • When a proxy advisory firm gives its clients voting advice about a typical shareholders' meeting, it will have to provide the advice simultaneously to the company
  • In case the company decides to respond to the proxy voting advice, the proxy advisory firm will need to develop procedures to alert its clients to the company's response before the vote is cast.
  • If the client is a registered investment adviser, it will need to have procedures to consider any company response.

This represents a step back from the SEC's November 2019 proposal, which would have prescribed a more complex interaction between the proxy advisory firm and the company.

Critics of the proxy advisory firms — already disappointed by the November 2019 proposal — will not be satisfied. On the other hand, the firms themselves and institutional investors, who generally opposed the proposal, were hoping it would be cut back further, or perhaps that it would expire unadopted in the peculiar circumstances of 2020. But now the current SEC has given the topic its best shot, and in the complicated eco-system that connects a public company with its shareholders — where asset managers play a decisive role and rely heavily on proxy advisory firms — this will provoke some adjustments but not fundamental change.

The SEC's July 2020 Action in Summary:1

The SEC has relied on two grounds in regulating proxy voting advice.2

  • First, the SEC has taken the position since 2010 that proxy voting advice may be "solicitation" subject to regulation under Section 14 of the Securities Exchange Act of 1934. Proxy advisory firms have, however, proceeded on the assumption that they are not subject to the information and filing requirements that apply to proxy solicitation under the federal proxy rules.
  • Second, many of the customers of the proxy advisory firms are themselves investment advisers, registered with the SEC under the Investment Advisers Act of 1940. If an investment adviser exercises voting authority, Rule 206(4)-6 under the Advisers Act requires it to adopt and implement written policies and procedures that are reasonably designed to ensure that it votes in the best interest of its clients. Since 2014, the SEC has emphasized to registered investment advisers that they should take these duties to clients into account when they rely on proxy advisory firms.

Building on this foundation, last week's SEC action included three main steps.

The SEC amended its definition of proxy solicitation to clearly include proxy voting advice. It also amended its antifraud rule for proxy solicitations to include, as an example of a false or misleading statement, failure to disclose material information regarding proxy voting advice.

  • The SEC adopted new conditions that a proxy advisory firm3 must meet in order to be exempt from the information and filing requirements that otherwise apply to proxy solicitations. These conditions include (1) conflict disclosures the proxy advisory firm must provide to its clients, (2) procedures to make proxy voting advice available to the company, at the latest when the advice goes to clients, and (3) a mechanism by which, if the company provides a written response to the voting advice, clients can reasonably be expected to become aware of the company's response in a timely manner.
  • The adopted Guidance to registered investment advisers that rely on proxy advisory firms. The Guidance addresses how an investment advisor should take account of the company's response to proxy voting advice, specifically where the investment adviser automatically follows the proxy advisory firm's recommendation — a practice sometimes referred to as "robo-voting."

The new rules will become effective 60 days after publication in the Federal Register, but there is an extended compliance date of December 1, 2021 for the new conditions applicable to the proxy advisory firms. As a result, the 2022 annual proxy season will be the first for which the new process and disclosure requirements are mandatory.

Background — the Road to the July 2020 Measures

The SEC's attention to proxy advisory firms has been building up for almost two decades. In 2004, the SEC staff issued two no-action letters that indicated that relying on a proxy advisory firm could be a way for an investment adviser to avoid conflicts of interest in the exercise of its voting responsibilities. In 2010, the increasing role of proxy advisory firms was one focus of a broader concept release on the proxy voting process generally. The SEC staff issued a Staff Legal Bulletin in 2014, cautioning investment advisers against over-relying on delegation to proxy advisory firms in carrying out their fiduciary duties with respect to their proxy voting responsibilities.

Footnotes

1 The SEC release adopting the final rules, "Exemptions from the Proxy Rules for Proxy Voting Advice" (the "Adopting Release") is available here. The SEC Guidance, "Supplement to Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers" (the "Guidance") is available at here.

2 The SEC has not relied on the argument that the proxy advisory firms themselves are subject to regulation under the Advisers Act. The proxy advisory firms have different analyses of their own regulatory status, with only ISS being registered as an investment adviser under the Advisers Act.

3 The SEC's new rules use the term "proxy voting advice business" to capture a person furnishing proxy voting advice as defined under the new rules. The Guidance uses the expression "proxy advisory firm," which we also use in this memorandum.

To view original article, please click here.

Originally published 31 July, 2020

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.