The SEC has issued guidance regarding proxy advisory firms, in the form of 13 Questions and Answers, published in Staff Legal Bulletin No. 20 (“SLB 20”). The Staff’s guidance addresses, among other things, investment advisers’ responsibilities in voting client proxies and retaining proxy advisory firms. Such clients include mutual funds advised by an investment adviser.

In light of this guidance, mutual funds should re-evaluate their proxy voting policies and procedures and those of their investment advisers. In particular, mutual funds and advisers that use proxy advisory firms should carefully evaluate their oversight of such firms to ensure that they are complying with the SEC’s guidance.

As a fiduciary, an investment adviser owes its mutual fund clients a duty of care and loyalty with respect to proxy voting as well as other services undertaken on the client’s behalf. Further, Rule 206(4)-6 under the Investment Advisers Act of 1940 (the “Proxy Voting Rule”) provides that an investment adviser has an obligation to adopt and implement written policies and procedures that are reasonably designed to ensure that the investment adviser votes proxies in the best interest of its mutual fund clients.

SLB 20 provides guidance on an investment adviser’s responsibilities under the Proxy Voting Rule, including the following:

  • An investment adviser should review the adequacy of its proxy voting policies and procedures at least annually to confirm that they have been implemented effectively and continue to be in compliance with the requirements of the Proxy Voting Rule. In this regard, an investment adviser could demonstrate compliance with the Proxy Voting Rule by periodically sampling proxy votes to determine whether they complied with the investment adviser's proxy voting policy and procedures, or specifically reviewing a sample of proxy votes relating to proposals that may require additional analysis.
  • In most cases, mutual fund clients delegate all proxy voting authority to their investment advisers, the Staff clarified that the Proxy Voting Rule provides flexibility for an investment adviser and its client to determine the scope of the investment adviser’s proxy voting responsibilities. SLB 20 specifically notes that this may include, for example, arrangements where the adviser and its mutual fund clients determine: (1) that the time and costs associated with the mechanics of voting proxies with respect to certain types of proposals or issuers may not be in the client’s best interest; (2) that the adviser will abstain from voting any proxies; (3) that the adviser should vote proxies as recommended by the company’s management or in favor of all proposals made by a particular shareholder proponent; or (4) that the adviser will focus resources only on certain types of proposals depending on the client’s preferences.
  • In considering whether to retain or continue to retain a proxy advisory firm to provide proxy voting recommendations, an investment adviser should determine whether the firm has the “capacity and competency to adequately analyze proxy issues.” This could include consideration of the following factors: the adequacy and quality of the proxy advisory firm’s staffing and personnel; and 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.
  • In addition, an investment adviser that has retained a proxy adviser must provide sufficient ongoing oversight in order to ensure that the investment adviser continues to vote proxies in the best interests of its mutual fund clients.
  • With respect to an investment adviser’s duties relating to the material accuracy of the facts upon which the proxy advisory firm’s voting recommendations are based, the Staff reiterated that an investment adviser that receives voting recommendations from a proxy advisory firm should determine that the proxy advisory firm has the capacity and competency to adequately analyze proxy issues, including the ability to make voting recommendations based on materially accurate information. If, for example, an investment adviser determines that a proxy advisory firm’s recommendation was based on a material factual error that causes the adviser to question the process by which the proxy advisory firm develops its recommendations, the adviser should take reasonable steps to investigate the error, and seek to determine whether the firm is taking reasonable steps to reduce similar errors in the future.