You may recall that, in July, SEC Chair Jay Clayton announced that the SEC will be holding a Roundtable to discuss the proxy process, currently expected to be held in November. (See this PubCo post.) Among the potential topics identified was the role of proxy advisory firms and the question of whether investment advisers and others rely excessively on proxy advisory firms for information aggregation and voting recommendations. In anticipation of that roundtable, the staff of the Division of Investment Management has today issued a statement announcing that, in light of subsequent developments, the staff has withdrawn two frequently disparaged no-action letters, Egan-Jones Proxy Services (May 27, 2004) and Institutional Shareholder Services, Inc. (Sept. 15, 2004), which provided staff guidance about investment advisers’ responsibilities in voting client proxies and retaining proxy advisory firms.
By way of background, as fiduciaries, investment advisers owe their clients duties of care and loyalty with respect to services provided, including proxy voting. Accordingly, in voting client securities, an investment adviser must adopt and implement policies and procedures reasonably designed to ensure that the adviser votes proxies in the best interest of its clients. The two now-withdrawn no-action letters indicated that one way advisers could demonstrate that proxies were voted in their clients’ best interest was to vote client securities based on the recommendations of an independent third party—including a proxy advisory firm—which served to “cleanse” the vote of any conflict on the part of the investment adviser. Historically, investment advisers have frequently looked to proxy advisory firms to fill this role. As a result, the staff’s guidance was often criticized for having “institutionalized” the role of—and, arguably, the over-reliance of investment advisers on—proxy advisory firms, in effect transforming them into faux regulators.
As discussed in this Cooley Alert, in response to frequently voiced criticisms that proxy advisory firms wielded too much influence—with too little accountability—in corporate elections and other corporate matters, in 2014, the SEC’s Divisions of Investment Management and Corp Fin issued Staff Legal Bulletin No. 20, “Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms,” which sought to reinforce the responsibilities of investment advisers as voters by reinvigorating their due diligence and oversight obligations with respect to any proxy advisory firms on which they relied. In that guidance, the staff indicated additional steps that an investment adviser could take to demonstrate that proxy votes were cast in accordance with clients’ best interests. In addition, investment advisers were advised to “adopt and implement policies and procedures that are reasonably designed to provide sufficient ongoing oversight of the third party in order to ensure that the investment adviser, acting through the third party, continues to vote proxies in the best interests of its clients,” including measures to identify and address the proxy advisory firm’s conflicts on an ongoing basis. For example, the investment adviser was advised to ascertain, among other things, “whether the proxy advisory firm has the capacity and competency to adequately analyze proxy issues.” However, the SLB left the two no-action letters in effect, and calls for regulation of proxy advisory firms have continued unabated. (See this PubCo post.)
In the announcement, the staff indicates that the notice of withdrawal of the two letters was provided to facilitate the discussion at the Roundtable and that it intends to use information and feedback learned at the Roundtable in making recommendations to the SEC with respect to proxy advisory firms, including with regard to SLB 20.
According to the WSJ, this action “came after a letter from six Republican senators who asked the Government Accountability Office last month to rule whether the SEC overreached in issuing the letters in 2003 and 2004.”
In a statement just posted on the SEC website on Friday, SEC Commissioner Robert Jackson called into question the impact of the withdrawal by the staff of the two no-action letters: “the law governing investor use of proxy advisors is no different today than it was yesterday.” The SEC, he argued, recognizes the important role that proxy advisors play “in the shareholder-voting process, and today’s statements do nothing to change that.” More significantly, however, he feared that the SEC’s “efforts to fix corporate democracy will be stymied by misguided and controversial efforts to regulate proxy advisors.” In effect, he was concerned that the recent renewed focus on regulating proxy advisors was a shiny object that might well deflect attention from the serious problems affecting the corporate voting system. In Jackson’s view, the push to regulate proxy advisors has been driven largely by “corporate lobbyists, who complain that advisors have too much power. There is, of course, little proof of that proposition, and the empirical work that’s been done in the area makes clear that that claim is vastly overstated. Rigorous review of the evidence shows that lobbyists are observing correlation in advisor recommendations and vote outcomes and confusing it for causation, providing no basis for the policy changes they seek. More generally, it’s hard to imagine that, upon a survey of all the problems that plague corporate America today, the Commission could conclude that investors receiving too much advice about how to vote their shares—advice they are free to, and often do, disregard—should be at the top of our list. In fact, the lack of competition among proxy-advisory firms is itself reason for pause, as regulation in the area risks further deepening the moat around the existing players—empowering the very firms that, some worry, already have too much influence.” Finally, he reiterated his plea “not to allow corporate lobbyists’ priorities to sidetrack our important work in fixing the American system for corporate voting.”