Recent public statements by the Division of Investment Management of the U.S. Securities and Exchange Commission and by an SEC Commissioner have created uncertainty about the relationship between registered investment advisers and proxy advisory firms and whether the SEC will regulate proxy advisory firms. In late July, SEC Chairman Jay Clayton announced that the SEC intends to hold a Roundtable on the proxy process. Among many other topics, he indicated the Roundtable might consider whether investment advisers and others rely excessively on proxy advisory firms for information aggregation and voting recommendations.
On Thursday, September 13, the Division of Investment Management announced that it was withdrawing the no-action letters the SEC staff issued in 2004 to Egan-Jones Proxy Services and Institutional Shareholder Services, Inc. Those letters provided some guidelines by which an investment adviser could rely on a proxy advisory firm as an independent third party to make proxy voting recommendations in order to ensure that voting recommendations were made without a conflict of interest. The Division of Investment Management stated that the letters were being withdrawn in order to facilitate discussion at the SEC’s Roundtable on the Proxy Process, which is expected to be held in November 2018, including discussion regarding the staff guidance in Staff Legal Bulletin No. 20 (June 20, 2014). On Friday, September 14, Commissioner Robert J. Jackson Jr. issued a Statement on Shareholder Voting in which he expressed concern that the Commission’s efforts “to fix corporate democracy will be stymied by misguided and controversial efforts to regulate proxy advisors.” To date, no other SEC Commissioner has issued a statement in response to the Division of Investment Management’s September 13 announcement.
Rule 206(4)-6 of the Investment Advisers Act of 1940 requires registered investment advisers to implement written policies designed to ensure that their clients’ proxies are voted in the best interests of the clients and that material conflicts are addressed. In adopting the rule, the SEC indicated that an investment adviser could demonstrate that its vote of its clients’ proxies was not a product of a conflict of interest if the adviser voted the proxies in accordance with a pre-determined policy based on the recommendations of an independent third party. In the Egan-Jones and ISS letters, the Division of Investment Management indicated that a proxy advisory firm could be considered an independent third party for the purposes of providing voting recommendations, and thereby cleanse an investment adviser’s vote from conflict, even if the proxy advisory firm received compensation from the issuer for providing advice on corporate governance issues. Staff Legal Bulletin 20 expands on the Egan-Jones and ISS letters and addresses the proxy voting responsibilities of investment advisers and the availability of exemptions from the proxy rules for proxy advisory firms. The position articulated in those no-action letters was widely seen as an endorsement of investors’ reliance on proxy advisory firms. In addition, that position together with the 2014 guidance in Staff Legal Bulletin No. 20 effectively, although perhaps inadvertently, protected proxy advisory firms’ own conflicts of interest — specifically, the conflicts between their issuer consulting and proxy advisory services — and cleared the path to the increased influence of proxy advisory firms.
Questions about the role, independence and influence of ISS and other proxy advisory firms have been circulating for over a decade. In December 2017, the House passed (but the Senate has not voted on) the Corporate Governance Reform and Transparency Act of 2017. This bill would require proxy advisory firms to register with the SEC and disclose potential conflicts of interest, their methodologies for formulating proxy recommendations and analyses and their codes of ethics. In May 2018, six members of the Senate Banking, Housing and Urban Affairs Committee sent letters to ISS and Glass Lewis & Co. noting the level of their influence in the proxy process and requesting information on their independence, processes, and eligibility for exemption from the proxy rules. Both ISS and Glass Lewis responded to the Senate Committee defending their roles in the proxy process, and in June 2018, the Senate Committee held a hearing entitled “Legislative Proposals to Examine Corporate Governance,” which included, among other matters, discussions regarding the role of proxy advisory firms and the Corporate Governance Reform and Transparency Act.
In addition to the role of proxy advisory firms, the following topics are expected to be included in the SEC’s Roundtable agenda: (1) issues with the voting process (e.g., over- and under-voting, empty voting, voting transparency and accuracy, and the costs associated with proxy distribution); (2) retail shareholder participation; (3) shareholder proposals (including whether the current thresholds for minimum ownership and resubmission are appropriate); (4) the use of technology in the proxy process; and (5) the proposed amendments to the proxy rules to require the use of universal proxy cards. More details on the Roundtable agenda, including its date, are expected to be made public in the coming weeks.