On June 30, 2014, the Staff of the Securities and Exchange Commission’s Divisions of Investment Management and Corporation Finance issued guidance on the responsibilities of investment advisers in voting proxies and using proxy advisory firms and on the availability of two exemptions from the proxy rules frequently relied upon by proxy advisory firms. The guidance, which is in question-and-answer format, falls well short of the comprehensive rulemaking desired by those in the issuer community concerned with the influential proxy advisory industry, but it addresses (albeit timidly) some often-expressed concerns, including lack of accountability and conflicts of interest. Here is a link to the Staff Legal Bulletin containing the guidance.
Investment Adviser Proxy Voting Responsibilities and Use of Proxy Advisory Firms
The Bulletin confirms that it is a fraudulent, deceptive, or manipulative act, practice or course of business for a registered investment adviser to exercise voting authority unless, among other things, the adviser implements written policies and procedures that are reasonably designed to ensure that the adviser votes proxies in the best interests of the client. This is confirmation that uninformed, unmonitored reliance on proxy advisory firm voting recommendations for all voting decisions is not consistent with an adviser’s fiduciary duties to its clients.
Specifically, the Bulletin:
- Details steps that an investment adviser may take to demonstrate that votes are cast in accordance with the adviser’s policies and procedures, including periodic sampling of the adviser’s proxy votes to verify compliance and conducting a review, no less frequently than annually, of the adequacy of its proxy voting policies and procedures to ensure that they have been implemented effectively.
- Confirms that an adviser must actively and continuously evaluate and oversee proxy advisory firms used by the adviser. Notably, the Staff believes that an adviser, when determining whether to engage a proxy advisory firm, should ascertain whether the firm has the “capacity and competency to adequately analyze proxy issues.” Advisers “could consider” the adequacy and quality of the firm’s personnel as well as the “robustness” of its policies and procedures regarding its ability to (1) ensure that its proxy voting recommendations are based on current and accurate information and (2) identify and address any conflicts of interest. The Bulletin also confirms that investment advisers are not required to vote every proxy. Rather, advisers retain broad discretion to agree with their clients on the scope and extent of voting authority. For instance, an adviser may agree with its client (1) to completely abstain from voting, (2) that the time and costs of voting proxies with respect to certain types of proposals or issuers are not in the client’s best interests, (3) to focus resources only on particular subsets of proposals based on the client’s preferences or (4) to vote in accordance with the recommendations of the issuer’s board of directors or in favor of proposals by a particular shareholder proponent.
Proxy Advisory Firms and Federal Proxy Rule Exemptions
The Bulletin focuses on the applicability of two exemptions from the federal proxy rules commonly relied upon by proxy advisory firms. Proxy firms are subject to the proxy rules if they engage in a “solicitation,” which is defined in Rule 14a-1(l) of the Securities Exchange Act of 1934 (the “Exchange Act”) to include “the furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” The Bulletin confirms that, as a general matter, the SEC views furnishing proxy voting advice as a “solicitation.”
Exchange Act Rule 14a-2(b)(1), however, exempts “any solicitation by or on behalf of a person who does not, at any time during such solicitation, seek directly or indirectly, either on its own or another’s behalf, the power to act as a proxy for a security holder and does not furnish or otherwise request, or act on behalf of a person who furnishes or requests, a form of revocation, abstention, consent or authorization.” The Staff’s position is that this exemption is not available to a proxy advisory firm offering a service that allows the client to establish, in advance of receiving proxy materials, general guidelines or policies that the proxy advisory firm will apply to vote on behalf of the client. In that instance, the advisory firm would be viewed as having solicited the “power to act as a proxy” for the client. Alternatively, proxy firms may rely on the Rule 14a-2(b)(1) exemption if they limit their proxy voting activities to distributing recommendation reports.
If the 14a-2(b)(1) exemption is not available, proxy firms may look to Exchange Act Rule 14a-2(b)(3), which provides an exemption for the provision of proxy voting advice to a person with whom a business relationship exists if the advising person (1) “gives financial advice in the ordinary course of business,” (2) “discloses to the recipient . . . any significant relationship with the [issuer] or any of its affiliates, or a security holder proponent of the matter on which advice is given, as well as any material interests of the person in such matter,” (3) “receives no special commission or remuneration for furnishing the advice from any person other than the recipient of the advice and others who receive similar advice” and (4) “does not furnish advice on behalf of any person soliciting proxies or on behalf of a participant in a contested election.” The Bulletin’s guidance focuses primarily on the second prong of the exemption – evaluation and disclosure of conflicts of interest. The Staff highlights the following principles:
- Whether a relationship is “significant” or what constitutes a “material interest” will depend on the facts and circumstances, but a proxy advisory firm “would likely consider” (1) the type of service being offered to the issuer or security holder proponent, (2) the amount of compensation that the proxy advisory firm receives for those services and (3) the extent to which the advice given to the firm’s advisory client relates to the same subject matter as the transaction giving rise to the relationship with the issuer or security holder proponent. A “significant relationship” or “material interest” would 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 advisor and the advice.”
- Boilerplate disclosure that conflicts may or may not exist will not suffice. Rather, the Staff believes that “disclosure should enable the recipient to understand the nature and scope of the relationship or interest, including the steps taken, if any, to mitigate the conflict, and provide sufficient information to allow the recipient to make an assessment about the reliability or objectivity of the recommendation.”
- Advisory firms must voluntarily disclose conflicts without request at or about the same time the client receives the advice, either publicly or directly to the client, in a manner allowing the client to “assess both the advice provided and the nature and scope of the disclosed relationship or interest.”
The interpretive guidance does not address several of the common complaints about proxy advisory firms, including the inability of most companies to obtain draft reports from ISS, the quality of proxy advisory firm analyses and the refusal to make public the underlying methodologies on which the proxy advisory firms rely. Still, the Bulletin should promote more robust disclosure by proxy advisory firms and greater diligence by and autonomy of investment advisers relying on proxy advisory services. In the Bulletin, the Staff recognizes that investment advisers and proxy advisory firms may need to modify their current policies and practices, and states that the Staff expects necessary changes will be made “promptly, but in any event in advance of next year’s proxy season.” As a result, the impact of the Bulletin should be seen in the 2015 proxy season.