On June 30, 2014, the SEC issued Staff Legal Bulletin No. 20 (IM/CF) (SLB No. 20), providing guidance to investment advisors on their proxy voting responsibilities and the use of proxy advisory firms, and setting forth conflict-of-interest disclosure obligations for proxy advisory firms. SLB No. 20 includes 13 Q&As that touch on many of the concerns raised in the SEC’s proxy advisory firm roundtable in December 2013. 

One of the concerns addressed in the roundtable was the unintentional incentive the SEC created for investment advisors to retain proxy advisory firms when, in 2003, it adopted Rule 206(4)-6 under the Investment Advisors Act of 1940. Rule 206(4)-6 requires investment advisors to adopt and implement written policies and procedures that are reasonably designed to ensure that the investment advisor votes proxies in the best interest of its clients. The Q&As provide that this obligation requires investment advisors, among other things, to review, no less frequently than annually, the adequacy of their proxy voting policies and procedures to ensure that they have been implemented effectively and are reasonably designed. The Q&As provide that an investment advisor and its client have broad scope to delineate the extent to which the investment advisor will vote proxies, and Rule 206(4)-6 does not require investment advisors to vote each proxy. These Q&As help negate any implication under Rule 206(4)-6 and subsequent no action letters that blind reliance on proxy advisory firm recommendations for all voting decisions is an effective way for advisors to satisfy their duties to vote proxies in the best interest of their clients.

Moreover, the Q&As also provide specific guidance on the duties of investment advisors when using proxy advisory firm services. The Q&As provide that when considering whether to engage or retain a proxy advisory firm, investment advisors should consider factors such as whether the proxy advisory firm has the capacity and competency to adequately analyze proxy issues, including the adequacy and quality of its staffing and personnel, and the robustness of its policies and procedures to ensure voting recommendations are based on current and accurate information, and address any conflicts of interest. The Q&As provide that investment advisors have an ongoing duty to oversee a proxy advisory firm, including for purposes of addressing conflicts of interest, and must take reasonable steps to investigate material inaccuracies in proxy advisory firms’ reports. 

The remaining eight Q&As address obligations of proxy advisory firms, as opposed to investment advisors. Proxy advisory firms generally avoid the costs and burdens of compliance with the information and filing requirements under the proxy rules through either of two exemptions to the definition of “solicitation.” The Q&As clarify that the exemption under Exchange Act Rule 14a-2(b)(1) for solicitations by a person who does not seek the power to act as a proxy is not available if the proxy advisory firm is “offering a service that allows the client to establish, in advance of receiving proxy materials for a particular shareholder meeting, general guidelines or policies that the proxy advisory firm will apply to vote on behalf of the client.” By contrast, if the proxy advisory firm just distributes proxy voting recommendation reports, the exemption would be available. As indicated in the roundtable, proxy advisory firms often provide the type of service that would render them ineligible to rely on Rule 14a-2(b)(1). 

The other “solicitation” exemption, Rule 14a-2(b)(3), exempts the furnishing of proxy voting advice pursuant to a business relationship where certain conditions are satisfied, such as disclosure to the advice recipient of any significant relationship with the company or a security holder proponent of the matter on which advice is given, and of any material interests in the matter. The Q&As provide that if the proxy advisory firm provides consulting services to a company on a matter that is the subject of a voting recommendation, or a voting recommendation to its clients on a proposal sponsored by another client, the firm would have to evaluate whether a “significant relationship” or “material interest” existed. If so, the firm should provide disclosure that enabled the advice recipient “to understand the nature and scope of the relationship or interest, including the steps taken, if any, to mitigate the conflicts, and provide sufficient information to allow the recipient to make an assessment about the reliability or objectivity of the recommendation.” The disclosure must be specific and not boilerplate, and must be affirmatively disclosed, either publicly or between the proxy advisory firm and its client, and not merely disclosed upon request. 

SLB No. 20 is merely interpretative relief under existing rules and falls far short of the more comprehensive rulemaking that many in the issuer community advocated. Given the SEC’s current workload, comprehensive reform so soon after the roundtable was never a realistic possibility. The SEC stated that it expects investment advisors and proxy advisory firms to conform their systems and processes in advance of next year’s proxy season. The 2015 proxy season should therefore be an important test of the impact of SLB No. 20.