SEC Staff Legal Bulletin Addresses Use of Proxy Advisory Firms by Advisers and Reliance by Proxy Advisory Firms on Proxy Rules Exemptions

by Goodwin
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The SEC’s Divisions of Investment Management and Corporation Finance issued Staff Legal Bulletin No. 20 (the “Guidance”) which provides guidance from the Division of Investment Management to investment advisers on their responsibilities in voting client proxies, particularly regarding the use of proxy advisory firms, and guidance from the Division of Corporation Finance to proxy advisory firms on their ability to rely on certain exemptions from the information and filing requirements of the federal proxy rules provided by Rule 14a-2(b) under the Securities Exchange Act of 1934.  This article summarizes the Division of Investment Management’s guidance.

Voting Client Proxies – Adviser Duties 

The Guidance reiterates the SEC’s interpretation that Section 206 of the Investment Advisers Act of 1940 (the “Advisers Act”) imposes on an adviser a duty of care and loyalty with respect to proxy voting it undertakes on a client’s behalf.  The Guidance states that a registered adviser may demonstrate compliance with the written policies regarding proxy voting required of it by Rule 206(4)-6 under the Advisers Act (the “Proxy Voting Rule”) by, for example, (1) periodically verifying that action taken on a sample of proxy votes complied with the adviser’s policies, and (2) conducting targeted reviews of a sample of proxy votes on proposals that may require more analysis.  The Guidance also discusses reviewing proxy voting policies as part of an adviser’s annual review of its compliance program.

The Guidance notes that the Proxy Rule does not require an adviser to vote all client proxies and lists the following possible arrangements as illustrative of the flexibility afforded clients and advisers in determining the scope of proxy authority a client may grant to an adviser:

  • An adviser and its client may agree that the time and costs associated with the mechanics of voting proxies for certain types of proposals or issuers may not be in the client’s best interest.
  • An adviser and its client may agree that the adviser should exercise voting authority as recommended by management of the company or in favor of all proposals made by a particular shareholder proponent, as applicable, absent a contrary instruction from the client or a determination by the adviser that a particular proposal should be voted in a different way if, for example, it would further the investment strategy being pursued by the adviser on the client’s behalf.
  • An adviser and its client may agree that the adviser will abstain from voting any proxies at all, regardless of whether the client undertakes to vote the proxies itself.
  • An adviser and its client may agree that the adviser will focus resources only on particular types of proposals based on the client’s preferences.

Proxy Advisory Firms – Adviser Due Diligence and Oversight

The Guidance states that an adviser deciding whether to retain or continue retaining a proxy advisory firm to provide proxy voting recommendations should “ascertain, among other things, the firm’s capacity and competency to adequately analyze proxy issues” through the consideration of, “among other things:  the adequacy and quality of the proxy advisory firm’s staffing and personnel; the robustness of its policies and procedures regarding its ability to (i) ensure that its proxy voting recommendations are based on current and accurate information and (ii) identify and address any conflicts of interest . . . .”

The Guidance states that the Proxy Voting Rule requires an adviser to adopt procedures for overseeing a third party (such as a proxy advisory firm) that assists the adviser in fulfilling its proxy voting responsibilities and that these procedures should seek to verify on an ongoing basis that the arrangement with the third party continues to result in proxies being voted in the best interests of the adviser’s clients.  Noting that, after an adviser’s initial assessment, a proxy advisory firm’s business or policies regarding conflicts of interest could change in a manner that alters the effectiveness of the proxy advisory firm’s conflicts policies, the Guidance reiterates prior staff guidance stating that an adviser should take measures reasonably designed to identify and address on an ongoing basis potential proxy advisory firm conflicts, such as by requiring a proxy advisory firm to update the adviser of “business changes the investment adviser considers relevant  (i.e., with respect to the proxy advisory firm’s capacity and competency to provide proxy voting advice) or conflict policies and procedures.”

In discussing an adviser’s duty to oversee a proxy advisory firm, the Guidance addresses the situation where an adviser determines that a proxy advisory firm’s recommendation was based on a material factual error such that the adviser is led to question the process by which the proxy advisory firm develops its recommendations.   The Guidance states that an adviser faced with this situation “should take reasonable steps to investigate the error, taking into account, among other things, the nature of the error and the related recommendation, and seek to determine whether the proxy advisory firm is taking reasonable steps to seek to reduce similar errors in the future.”

Responding to the Guidance

The Guidance closes by noting the SEC staff’s expectation that any changes that may be needed in response to the Guidance will be made promptly, but in any event in advance of next year’s proxy season.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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