On June 30, 2014, the Division of Investment Management and the Division of Corporation  Finance of the Securities and Exchange Commission (the “SEC”) released Staff Legal Bulletin No. 20 (IM/CF) (“SLB No. 20”) providing guidance in the form of 13 questions and answers relating to proxy voting, investment advisers retaining proxy advisory firms and proxy advisory firms making voting recommendations to clients. This guidance does not address reforms that a number of public companies and issuer advocates have been pressing for relating to proxy advisory firms and their influence. A copy of SLB No. 20 is available here.

Investment Advisers' Responsibilities

Questions 1 through 5 address investment advisers’ obligations with respect to voting client proxies and retaining proxy advisory firms.

The SEC staff reminds investment advisers of their fiduciary duties of care and loyalty with respect to client services, including proxy voting, and that it is a fraudulent, deceptive or manipulative act, practice or course of business for a registered investment adviser to exercise voting authority over client securities unless it adopts and implements certain policies and procedures that are reasonably designed to ensure that the investment adviser votes proxies in the best interests of its clients (the “Proxy Voting Rule”).

The staff acknowledges that investment advisers and their clients have flexibility in determining the scope of the adviser's obligations to exercise proxy voting authority.

The staff suggests that investment advisers can demonstrate that their proxy votes are cast in compliance with their proxy voting policies and procedures by (1) periodically reviewing a sampling of proxy votes to confirm that they conformed with their proxy voting policies and procedures and (2) at least once a year, reviewing the adequacy of their proxy voting policies and procedures to determine whether they are effectively serving the best interests of their clients.

The staff notes that in connection with selecting a proxy advisory firm, an investment adviser should consider a number of factors, including whether the proxy adviser has the capacity and competency to adequately analyze proxy issues, the adequacy and quality of the firm’s staffing and personnel, and the robustness of the firm’s policies and procedures that address its ability to (1) ensure that proxy voting recommendations are based on current and accurate information, and (2) identify and address any conflicts of interest and other considerations that would be appropriate to consider.

The guidance confirms that investment advisers have an ongoing duty to oversee a proxy advisory firm they engage, and should implement policies and procedures that ensure such ongoing oversight. The staff highlighted conflict of interest policies and procedures in particular as requiring ongoing oversight and review, explaining that initial conflicts assessments of a proxy advisory firm may evolve during the term of its engagement.

The staff suggests that if an investment adviser determines that a proxy advisory firm made a recommendation based on a material factual error, the investment adviser has an obligation to (1) take reasonable steps to investigate the error, taking into account, among other things, the nature of the error and the related recommendation, and (2) seek to determine whether the proxy advisory firm is taking reasonable steps to seek to reduce similar errors in the future.

Applicable Exemptions for Proxy Advisory Firms

Questions 6-13 address the application of federal proxy rules to proxy advisory firms and certain exemptions from the rules that they may rely upon.

The guidance reiterates the staff’s view that a proxy advisory firm is subject to federal proxy rules when it engages in a “solicitation,” which generally includes the furnishing of proxy voting advice that is reasonably expected to result in the procurement, withholding or revocation of a proxy. Unless the proxy advisory firm is able to rely on an exemption, it will be subject to the federal proxy rules when engaging in a solicitation.

The staff notes that proxy advisory firms are permitted to rely on the exemption from proxy rules under Exchange Act Rule 14a-2(b)(1) if they only distribute reports containing recommendations and do not solicit the power to act as proxy for the clients receiving the recommendations. If the proxy advisory firm has any power to act as proxy, even for a client that sends the proxy advisory firm voting guidelines and policies in advance of a shareholder meeting (and the proxy firm’s voting recommendations with respect to such meeting), the proxy advisory firm may not rely on the exemption.

If the exemption under Rule 14a-2(b)(1) is not available, the staff suggests as an alternative the exemption under Rule 14a-2(b)(3), which exempts the furnishing of proxy voting advice by persons with existing business relationships, so long as the person furnishing the voting advice:

  • does so in the ordinary course of business,
  • discloses to the recipient conflicts of interest and other significant relationships with the public company or its affiliates or with a shareholder proponent of any matter on which the advice is given, or any material interest in such matter,
  • receives no special compensation for furnishing the advice from any person other than the recipient and others who receive similar advice, and
  • does not furnish the advice on behalf of any person soliciting proxies or on behalf of a participant in a contested election.

In the staff's view, if the proxy advisory firm has a relationship with a person on a matter subject to a voting recommendation, the proxy advisory firm has an affirmative obligation to disclose the relationship to the recipient of the recommendation, which should be more than the boilerplate language that such a relationship or interest may or may not exist and should enable the recipient to make an assessment about the reliability or objectivity of the recommendation. The disclosure need not be publicly available, but must be made in a manner that would allow the client to  assess both the disclosure and the proxy voting recommendation at or about the same time.  While the question of whether the proxy advisory firm has a “significant” relationship or “material interest” will be based on facts and circumstances, a relationship would generally be considered “significant” or a “material interest” would generally exist if knowledge of the relationship or interest would reasonably be expected to affect the recipient’s assessment of the reliability and objectivity of the proxy advisory firm or its advice.