This morning, at an actual uncancelled open (virtual) meeting, the SEC, by a vote of three to one (I wrote that part before the meeting), adopted new amendments to the proxy rules, modified from the original proposal issued in November last year, regarding proxy advisory firms (see this PubCo post). The amendments make proxy voting advice subject to the proxy solicitation rules and condition exemptions from those rules for proxy advisory firms, such as ISS and Glass Lewis, on disclosure of conflicts of interest and adoption of principles-based policies to make proxy voting advice available to the subject companies and to notify clients of company responses. The amendments also provide two non-exclusive safe harbors that satisfy the conditions to the exemptions. The SEC also voted by the same margin to publish new supplementary guidance to investment advisers addressing how advisers should consider company responses in light of the new amendments to the proxy rules. SEC Chair Jay Clayton observed that the final rules and guidance are the product of a 10-year effort—commencing with the SEC’s 2010 Concept Release on the U.S. Proxy System—which has led to “robust discussion” from all market participants. The original proposal issued in November generated substantial comment and criticism, and the SEC took much of it into account in developing the final rule, which now encourages what had been imperative in the proposal—namely that proxy advisors conduct a review and feedback process with issuers.
The amendments will become effective 60 days after publication in the Federal Register, but affected proxy advisors will not be required to comply with the Rule 14a-2(b)(9) amendments until December 1, 2021. The supplemental guidance for investment advisers will be effective upon publication in the Federal Register.
Many companies, as well as business lobbies such as the Business Roundtable and the National Association of Manufacturers, have repeatedly raised concerns about proxy advisory firms’ concentrated power and significant influence over corporate elections and other matters put to shareholder votes, which has led to questions about whether they should be subject to more regulation and accountability. (See, e.g., this PubCo post, this PubCo post and this PubCo post.) In particular, companies had expressed concerns that the analyses of proxy advisory firms were rife with factual errors, omissions and methodological weaknesses that “could materially affect the reliability of their voting recommendations and could affect voting outcomes, and that processes currently in place to mitigate these risks are insufficient.” What’s more, some companies contended that they did not have adequate opportunities to review the advice, engage with the firm and correct the errors on a timely basis. Although proxy advisory firms have taken some steps to share information with companies (see this PubCo post), those opportunities have been limited in some cases to larger companies, were not timely or were otherwise inadequate to address company concerns.
In response to these calls for action, in November last year, the SEC proposed rule amendments designed to build on market processes currently in place, providing a mechanism for enhanced engagement between proxy advisory firms and companies. The proposal clarified that the term “solicitation” includes any proxy advisor voting recommendations, and it conditioned exemptions from the filing and information requirements of the proxy rules for those solicitations on the proxy advisory firm’s making specified disclosures about conflicts of interest and compliance with an issuer review and feedback process regarding the firm’s advice. More specifically, the proposal required, as a condition to reliance on the exemptions, that the proxy advisory firm provide companies (and certain other soliciting persons) with at least two opportunities to review and provide feedback on the advice before dissemination to the firm’s clients, with the review time varying based on how far in advance of the shareholder meeting the definitive proxy is filed. (See this PubCo post.)
However, the proposal drew criticism from a number of quarters. The Council of Institutional Investors expressed concern that the requirement that proxy advisors share advance copies of their recommendations with issuers could interfere with the relationship between institutional investors and proxy advisory firms as their agents. In CII’s understanding, proxy advisory firms are agents of institutional investors, not of issuers. And, according to CII, there is no reason to believe that institutional investors feel the need for prior review by issuers of the work product of their agents, the proxy advisors. Rather, investors would prefer that the proxy advisory firms be completely independent of companies. The SEC’s Investor Advisory Committee recommendation also disparaged the proposal as unlikely to reliably achieve the SEC’s own stated goals, ultimately advising the SEC to rethink and republish the proposal. The committee contended that the proposal was almost futile without addressing in parallel more basic proxy plumbing issues (as the Committee had previously recommended) (see this PubCo post), and that none of the SEC’s actions at issue adequately identified the underlying problems that are intended to be remedied, provided a sufficient cost/benefit analysis or discussed reasonable alternatives that might have been proposed. (See this PubCo post.)
At the open meeting
At the open meeting, Clayton remarked that, given that approximately 72% of domestic stock market value is held by institutional investors (through which retail investors participate in the market), to the extent that investment professionals look to proxy advisors for advice “when voting the shares of Main Street investors, it is important that (1) they do so in a manner consistent with their fiduciary obligations, and (2) that they have access to transparent, accurate and materially complete information on which to make their voting decisions. By affirming and modernizing the implementation of these principles, today’s recommendations will help ensure that the interests of Main Street investors and the obligations of those who vote on their behalf will not only be better aligned, but better decisions will be made.”
Commissioner Elad Roisman, who has honchoed the proxy-process rulemakings through the SEC, said that there have been growing calls for the SEC to provide more oversight of proxy advisors as institutional ownership of the public markets has
“increased to unprecedented levels and rendered the voting advice sold by proxy voting advice businesses more widely consumed—and influential—than ever before….Advocates for reform have argued that new regulations are needed to address conflicts of interests, factual errors, and methodological biases in these businesses’ proxy voting advice. They have also called for the Commission to reaffirm the principle that asset managers may not rely on this advice wholesale and to address the practice of so-called ‘robo-voting.’ Of course, others have opposed any SEC action in this area, advocating instead that the SEC dismiss these persistent calls for reform and simply do nothing.”
In particular, he noted that it is universally acknowledged that proxy advisors “play a significant role in the proxy voting system,” and that their clients “believe their advice is material and market-moving.” He also highlighted the application of the new supplemental guidance regarding the fiduciary duties of investment advisers in the context of their use of “robo-voting,” features, which “(1) pre-populate clients’ electronic ballots with the businesses’ voting recommendations, and (2) automatically submit those ballots for counting. With the help of such features, a client could effectively ‘set-it-and-forget-it,’ allowing the proxy voting advice business to produce recommendations that determine the client’s vote, without further action by the client.”
Commissioner Hester Peirce approved of the final rules as a “measured” change, particularly the modifications to the original proposal that made the final rules more principles-based: “[t]hese principles-based procedural requirements provide proxy voting advice businesses flexibility to determine the best way to meet the rulemaking’s objectives, while respecting the value of the service that proxy voting advice businesses offer and the compressed time periods within which they operate. The safe harbors are just that—proxy voting advice businesses should not feel tethered to the safe harbors when developing their policies and procedures.” In her view, the “final rules achieve the Commission’s objective of ensuring that investors and their advisers who rely upon proxy voting advice are provided with more transparent, accurate, and complete information. The rules achieve this goal without imposing unduly burdensome requirements on proxy voting advice businesses given the significant time constraints of the proxy voting process.”
Commissioner Allison Lee, who dissented on both counts, objected to the rule changes and guidance as “unwarranted, unwanted, and unworkable.” According to Lee, the new rules will
“increase issuer involvement in what is supposed to be independent advice from proxy advisory firms. The release still wholly fails to explain how amplifying the views of issuers will improve the substance of proxy voting recommendations. The final rules will still add significant complexity and cost into a system that just isn’t broken, as we still have not produced any objective evidence of a problem with proxy advisory firms’ voting recommendations. No lawsuits, no enforcement cases, no exam findings, and no objective evidence of material error—in nature or number. Nothing.”
Lee also noted her objection to the codification of “a new interpretation of what it means to solicit a proxy under Exchange Act Section 14(a) that departs from the Commission’s historical interpretation of that term. The interpretation largely ignores the significance the Commission has traditionally given to the distinction between solicited and unsolicited advice.”
Although the final release reflects modifications in response to public comment (46 in favor, 159 in opposition), to Lee, all the changes do is make the rules less objectionable, but still don’t justify it; the final rules may be “less prescriptive in terms of issuer intervention,” but much of that flexibility “is abrogated by the safe harbors which, as is well understood, will become the de facto rules.” The release indicates that the rule changes will provide shareholders with “a more complete mix of information,” but that is not a good reason, in Lee’s view, to “justify the forced consideration of issuer views that these rules require, particularly over the objection of investors.” In addition investors, the purported beneficiaries of the rule changes, widely opposed the proposal. And, the final changes are so different from the proposal that it’s unclear from comments or economic analysis what the costs, delays and disruption are likely to be.
Finally, she asserts that, even if the rules no longer mandate company pre-review, the final rules still recommend it, introducing “delay and uncertainty by effectively requiring proxy advisors to provide their clients with notice of multiple events.” So, notwithstanding mitigation of some of the defects in the proposal, she contended, “the final rules will still make it harder and more costly for shareholders to cast their votes, and to do so in reliance on independent advice. That means it will be harder for shareholders to make their voices heard—and harder for them to hold management accountable. That’s less accountability on climate risk, less accountability on executive pay, less accountability on diversity, on human capital, worker safety, and the list goes on.”
Rule amendments related to proxy voting advice
As summarized in the press release, the following changes were adopted:
Rule 14a-1(l). The SEC amended the definition of “solicitation” in Rule 14a-1(l) “to codify its longstanding view that proxy voting advice generally constitutes a solicitation within the meaning of Section 14(a) of the Exchange Act.” A new paragraph describes when proxy advice involves a solicitation subject to the proxy rules, and another new paragraph codifies the SEC’s view that furnishing proxy voting advice “only in response to an unprompted request shall not be deemed to be a solicitation.”
Rules 14a-2(b)(1) and 14a-2(b)(3). These rules, which provide exemptions from the information and filing requirements of the proxy rules, are being amended to provide that proxy advisory firms can rely on the exemptions if they satisfy conditions set forth in new Rule 14a-2(b)(9):
- “They must provide specified conflicts of interest disclosure in their proxy voting advice or in an electronic medium used to deliver the proxy voting advice [Rule 14a-2(b)(9)(i)]; and
- They must have adopted and publicly disclosed written policies and procedures reasonably designed to ensure that:
- Registrants that are the subject of proxy voting advice have such advice made available to them at or prior to the time when such advice is disseminated to the proxy voting advice business’s clients [Rule 14a-2(b)(9)(ii)(A)]; and
- The proxy voting advice business provides its clients with a mechanism by which they can reasonably be expected to become aware of any written statements regarding its proxy voting advice by registrants who are the subject of such advice, in a timely manner before the security holder meeting [Rule 14a-2(b)(9)(ii)(B)].”
Safe harbors. The amendments also include two new safe harbors for proxy advisors with regard to the required written policies and procedures:
- First, with regard to dissemination of proxy advice, a proxy advisor will be deemed to satisfy the requirements of Rule 14a-2(b)(9)(ii)(A) if its written policies and procedures are reasonably designed to provide companies “with a copy of its proxy voting advice, at no charge, no later than the time it is disseminated to the business’s clients.” The policies and procedures may include conditions requiring companies “to (i) file their definitive proxy statement at least 40 calendar days before the security holder meeting and (ii) expressly acknowledge that they will only use the proxy voting advice for their internal purposes and/or in connection with the solicitation and will not publish or otherwise share the proxy voting advice except with the registrant’s employees or advisers.”
- Second, with regard to notification of clients, a proxy advisor “will be deemed to satisfy the requirements of Rule 14a-2(b)(9)(ii)(B) if its written policies and procedures are reasonably designed to provide notice on its electronic client platform or through email or other electronic means that the registrant has filed, or has informed the proxy voting advice business that it intends to file, additional soliciting materials setting forth the registrant’s statement regarding the advice (and include an active hyperlink to those materials on EDGAR when available).”
Rule 14a-9. The amendments modify Rule 14a-9 to include examples of when material omissions in proxy voting advice could be considered misleading within the meaning of the rule. These examples include material information about the proxy voting advice business’s methodology, sources of information or conflicts of interest.
Supplemental guidance regarding proxy voting responsibilities of investment advisers
In September 2019, the SEC issued Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, regarding how the fiduciary duty and rule 206(4)-6 under the Investment Advisers Act of 1940 relate to an investment adviser’s proxy voting on behalf of clients (see this PubCo post). The September guidance discussed the extent to which an investment adviser can “outsource” to proxy advisory firms and still fulfill its fiduciary duty to its clients by conducting reasonable due diligence, addressing conflicts and providing full disclosure. The guidance recommended that investment advisers satisfy their own fiduciary duties of care and loyalty and obligations to act in their clients’ best interests, in part, through careful oversight of proxy advisory firms (i.e., investment adviser as “enforcer”), such as by monitoring and analyzing the methodology and processes of proxy advisory firms, including their processes for engagement with companies and procedures to address errors.
The new supplemental guidance provides additional advice regarding how investment advisers should consider company responses to proxy advisor recommendations resulting from the new amendments to the solicitation rules, including robo-voting. For example, the supplemental guidance advises that policies and procedures should “address circumstances where the investment adviser has become aware that an issuer intends to file or has filed additional soliciting materials with the Commission after the investment adviser has received the proxy advisory firm’s voting recommendation but before the submission deadline. The supplemental guidance also addresses disclosure obligations and client consent when investment advisers use automated services for voting.”