Last week, the SEC voted (by a vote of three to two) to propose amendments to the proxy rules to add new disclosure and engagement requirements for proxy advisory firms, such as ISS and Glass Lewis. The proposal is part of the third phase of the SEC’s efforts to address perceived problems in the proxy voting system, the first phase being the proxy process roundtable (see this PubCo post) and the second phase being the SEC’s recently issued interpretation and guidance (see this PubCo post). Of course, not everyone perceives the same problems in the system or perceives them the same way—a disparity that was plainly evident at the open meeting as the proposal’s advocates and critics were hardly reticent in expressing their views. (For a discussion of the goings-on at the open meeting, see this PubCo post.) The proposal is subject to a 60-day comment period and, if adopted, the rules would be subject to a one-year transition period.
The SEC observes that institutional investors today own between 70% and 80% of U.S. public market value and frequently look to proxy advisory firms for help in making voting determinations and performing related research and analysis, especially smaller institutions that are more resource constrained. As a result, the SEC noted, “it is vital that proxy voting advice be based on the most accurate information reasonably available and that the businesses providing such advice be sufficiently transparent with their clients about the processes and methodologies used to formulate the advice.” In light of concerns expressed regarding the “accuracy and soundness of the information and methodologies used to formulate proxy voting advice businesses’ recommendations as well as potential conflicts of interest that may affect those recommendations,” the SEC is proposing “amendments to the federal proxy rules that are designed to enhance the accuracy, transparency of process, and material completeness of the information provided to clients of proxy voting advice businesses when they cast their votes, as well as amendments to enhance disclosures of conflicts of interest that may materially affect the proxy voting advice businesses’ voting advice.”
Many have raised concerns about proxy advisory firms’ concentrated power and significant influence over corporate elections and other matters put to shareholder votes, which has led some to question whether they should be subject to more regulation and accountability. (See, e.g., this PubCo post, this PubCo post and this PubCo post.) While acknowledging “the existence of a wider public debate about the role and impact of proxy voting advice businesses in the proxy voting system,” the SEC has declined to address any issues in this proposal beyond its sweet spot: ensuring that disclosure is accurate and complete. The SEC has positioned the proposal not as an effort to placate companies or regulate the agency relationship between institutional investors and proxy advisory firms, but rather as narrowly focused on protection of investors: “The focus of our rule proposal, however, is not on all aspects of proxy voting advice businesses’ role in the proxy process. Rather, it is on measures that, if adopted, would address certain specific concerns about proxy voting advice businesses and would help to ensure that the recipients of their voting advice make voting determinations on the basis of materially complete and accurate information. The proposed amendments are designed to achieve these purposes without generating undue costs or delays that might adversely affect the timely provision of proxy voting advice.” Whether other process participants necessarily buy into that perspective is, of course, another question.
The second phase of the SEC’s effort to address the proxy voting process, adopted in August, consisted of two components: guidance directed at investment advisors that revisited the extent to which an investment adviser can “outsource” to proxy advisory firms and still fulfill its fiduciary duty to its clients by, as Chair Jay Clayton summed it up, conducting “reasonable due diligence, reasonably identifying and addressing conflicts, and full and fair disclosure.” And an interpretation and guidance directed at proxy advisory firms confirming that their vote recommendations are “solicitations” under the proxy rules and subject to the anti-fraud provisions, and providing some “suggestions” about disclosures that would help avoid liability. (See this PubCo post.)
Below is a summary of the proposal:
Proposed Codification of the SEC’s Interpretation of “Solicitation” Under Rule 14a-1(l) and Section 14(a)
Under Exchange Act Section 14(a), it is unlawful for any person to “solicit” any proxy with respect to any security registered under Section 12 in contravention of SEC rules. While the Exchange Act does not define “solicitation,” it gives the SEC broad authority to establish rules governing solicitations for the protection of investors. Over time, the SEC has used that authority to expand the definition, providing exemptions where the SEC considered it unnecessary to apply the requirements to that particular form of solicitation, while retaining the application of the antifraud provisions. As noted above, the SEC has previously advised that proxy voting advice may come within the definition and enumerated a number of factors that would indicate a “solicitation” subject to SEC rules. The SEC has said that proxy voting advice could well be a solicitation “even if the proxy advisory firm is providing recommendations based on the client’s own tailored voting guidelines, and even if the client chooses not to follow the advice.”
The proposal would codify that interpretation by adding “paragraph (A) to Rule 14a-1(l)(1)(iii) to make clear that the terms ‘solicit’ and ‘solicitation’ include any proxy voting advice that makes a recommendation to a shareholder as to its vote, consent, or authorization on a specific matter for which shareholder approval is solicited, and that is furnished by a person who markets its expertise as a provider of such advice, separately from other forms of investment advice, and sells such advice for a fee.” From the SEC’s perspective, that type of activity “raises the investor protection concerns about inadequate or materially misleading disclosures that Section 14(a) and the Commission’s proxy rules are intended to address.” To address concerns that a broker-dealer or investment adviser that received unprompted requests for voting advice from a client could fall under the definition, the proposal would also amend Rule 14a-1(l)(2) by adding proxy voting advice furnished only in response to an unprompted request to the current lists of activities and communications that are not considered solicitations.
Proposed Amendments to Rule 14a-2(b)
The SEC has adopted a number of exemptions from the filing and information requirements of the proxy rules, subject to various conditions, where those requirements are not necessary for investor protection. To enable shareholders to freely communicate with other shareholders, the SEC adopted Rule 14a-2(b)(1), which “generally exempts solicitations by persons who do not seek the power to act as proxy for a shareholder and do not have a substantial interest in the subject matter of the communication beyond their interest as a shareholder.” Similarly, to remove an impediment to the provision of advice to shareholders from their advisors, such as financial analysts, investment advisers and broker-dealers, the SEC adopted Rule 14a-2(b)(3),which “generally exempts proxy voting advice furnished by an advisor to any other person with whom the advisor has a business relationship.” Proxy advisory firms have typically relied on those exemptions in providing their recommendations.
However, as noted above, concerns have been raised about “(i) the adequacy of disclosure of any actual or potential conflicts of interest that could materially affect the objectivity of the proxy voting advice; (ii) the accuracy and material completeness of the information underlying the advice; and (iii) the inability of proxy voting advice businesses’ clients to receive information and views from the registrant, potentially contrary to that presented in the advice, in a manner that is consistently timely and efficient.” Accordingly, the proposal would add new conditions to the exemptions in Rules 14a-2(b)(1) and 14a-2(b)(3) applicable to “persons furnishing proxy voting advice that constitutes a solicitation within the scope of proposed Rule 14a-1(l)(1)(iii)(A).” The proposed amendments are intended to improve “disclosures of conflicts of interests that would reasonably be expected to materially affect their voting advice, (ii) establish effective measures to reduce the likelihood of factual errors or methodological weaknesses in proxy voting advice, and (iii) ensure that those who receive proxy voting advice have an efficient and timely way to obtain and consider any response a registrant or certain other soliciting person may have to such advice.”
Conflicts of Interest. Proxy advisory firms sometimes engage in activities that could result in conflicts that cause their interests to diverge from those of their investor clients, such as providing advice on governance or compensation matters to a company while advising their investor clients on the company’s proxy proposals or providing voting advice on a matter in which their affiliates have a material interest, such as a business transaction. Accordingly, the proposal would amend the exemptions to require the following disclosures in sufficient detail to convey the nature and scope of the interest:
- “Any material interests, direct or indirect, of the proxy voting advice business (or its affiliates) in the matter or parties concerning which it is providing the advice;
- Any material transaction or relationship between the proxy voting advice business (or its affiliates) and (i) the registrant (or any of the registrant’s affiliates), (ii) another soliciting person (or its affiliates), or (iii) a shareholder proponent (or its affiliates), in connection with the matter covered by the proxy voting advice;
- Any other information regarding the interest, transaction, or relationship of the proxy voting advice business (or its affiliate) that is material to assessing the objectivity of the proxy voting advice in light of the circumstances of the particular interest, transaction, or relationship; and
- Any policies and procedures used to identify, as well as the steps taken to address, any such material conflicts of interest arising from such interest, transaction, or relationship.”
Proposed Rule 14a-2(b)(9)(i) would specify that the enhanced disclosure about material conflicts must be included in the proxy voting advice provided to clients. that proposed rule also requests disclosure of any other information regarding the interest, transaction, or relationship that would be material to a reasonable investor’s assessment of the objectivity of the proxy voting advice. In addition, the proposed amendments would require a discussion of any policies and procedures “used to identify and steps taken to address such potential and actual conflicts of interest.”
Registrants’ and Other Soliciting Persons’ Review of Proxy Voting Advice and Response. Companies have expressed concerns that the analyses of proxy advisory firms are 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 contend that they don’t 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, those opportunities are limited in some cases to larger companies, are not timely or are otherwise inadequate to address company concerns.
The proposal would build on market processes currently in place, providing a mechanism for enhanced engagement between proxy advisory firms and companies (and, as discussed below, certain other soliciting persons, such as dissident shareholders engaged in a proxy contest). The SEC believes that this process could be helpful for investors by providing these other views and potentially improving accuracy, transparency and completeness of the information provided to voters, even where the proxy advisor’s recommendation is not adverse and there are no errors in the analysis underlying the advice. In addition, disagreements may extend beyond accuracy, and voters may benefit from access to these differences of opinion. Accordingly, the proposal is designed to facilitate dialogue and provide for communication of views by companies prior to dissemination of the advice.
Proposed new Rule 14a-2(b)(9)(ii) would require, as a condition to reliance on the exemptions, that, subject to certain conditions, the proxy advisory firm provide companies (and certain other soliciting persons) a length of time to review and provide feedback on the advice (regardless of whether that advice is adverse) before it is disseminated 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. In light of the narrow timeframes typically applicable for delivery of advice, the proposal is structured to incentivize companies to file early. If the company files its definitive proxy at least 45 days before the meeting, the company would have at least five business days to review the advice and provide feedback, but definitive filings between 25 and 45 days in advance would have a minimum of only three business days to review. Filings after that time would not be entitled to any review. (Most companies tend to file between 35 to 40 days in advance, so companies might end up accelerating their schedules to obtain the full benefit of the five-business-day period.) Although proxy advisory firms are not required to accept any suggested revisions, the SEC emphasizes that it is “equally important” to recognize that the advice is subject to liability under Rule 14a-9, even if exempt under Rule 14a-2(b).
As another condition, the proxy advisory firm would have to provide the company (and certain other soliciting persons) with a final notice of voting advice, regardless of whether the company provided feedback, at least two business days prior to delivery of the advice to clients. This notice must contain a copy of the proxy voting advice as it will be sent to clients, including any revisions made as a result of the review and feedback period, allowing companies to see any changes resulting from feedback. A company would also be allowed, within the two-business-day period, to provide a statement in response to the advice and to request that a hyperlink to its written response be included in the voting advice. To prevent unintentional or unauthorized release, proxy advisory firms could require companies to sign confidentiality agreements until dissemination of the advice, but these agreements “could be no more restrictive than similar types of confidentiality agreements the proxy voting advice business uses with its clients.”
In addition, under proposed Rule 14a-2(b)(9)(iii), as noted above, another condition to the exemptions requires each proxy advisory firm to include, upon request, in its proxy voting advice and in any electronic medium used to deliver the advice, a hyperlink that links to the company’s (and certain other soliciting persons’) statement about the proxy advisor’s voting advice, even if not adverse. Although companies can file supplemental proxy materials, given the high incidence of voting shortly after the voting advice is delivered, according to the SEC, these supplemental responses may not be very effective. The link is expected to be more efficient and timely, improving the overall mix of information. The company’s statement would, however, constitute a “solicitation,” be subject to the anti-fraud prohibitions of Rule 14a-9 and the filing requirements of Rule 14a-12 (as supplemental proxy materials). The company must provide the hyperlink within the two-business-day final notice period. The proposal includes a handy chart summarizing the various proposed requirements and their timing. The SEC observes that, in light of the need to resolve a number of implementation details, “effective coordination between proxy voting advice businesses and registrants (and certain other soliciting persons, as applicable) would be needed.”
The review-and-feedback process would not be available for persons conducting exempt solicitations (under Rule 14a-2) or to proponents of shareholder proposals; the process would be available only to registrants and to soliciting persons who are contesting the registrant’s solicitation and intend to deliver their own proxy statements and proxy cards to shareholders.
Because failure to comply with the conditions of the exemptions, even as a result of unintentional problems, could be have a significant adverse effect, the proposed amendments would provide a good faith safe harbor: the proxy advisory firm will not lose the benefit of the exemptions so long as the firm “made a good faith and reasonable effort to comply” and, to the extent feasible, the firm “uses reasonable efforts to substantially comply with the condition as soon as practicable after it becomes aware of its noncompliance.” In addition, failure to comply would not create a private right of action.
In advance (and perhaps in anticipation) of this proposal, the Council of Institutional Investors submitted two comment letters to the SEC (available here and here) taking issue with the SEC’s interpretation and guidance. In the first letter, in addition to a number of other assertions, CII expresses its concern that the anticipated rulemaking may get in the middle of the relationship between institutional investors and proxy advisory firms as their agents: CII understands that the new rulemaking “may contemplate a direct requirement that proxy advisors share advance copies of their recommendations with issuers.” In the view of CII, “[p]roxy advisors are agents of institutional investors, not of issuers. There is no evidence that the bulk of institutional investors believe a mandatory requirement of prior review by issuers of the work product of their agents, the proxy advisors, would be desirable or helpful to the proxy voting process. Indeed, it is abundantly clear that institutional investors, the principals in the relationship, fervently desire that the proxy advisors be wholly independent of issuers and that their reports and recommendations not be subject to prior review or influence by issuers.”
In his statement at the meeting, Commissioner Elad Roisman explained that the proposed new process giving companies an opportunity to engage with proxy advisory firms and respond to their final voting advice simply reflects an expansion of successful current market practices—the type of opportunity that ISS has made available to the largest companies and the more recent practice of Glass Lewis to obtain feedback from issuers on the data underlying their reports and the reports themselves. The proposal makes these types of opportunities available on a general basis, he said.
Proposed Amendments to Rule 14a-9
As noted above, the SEC makes plain its view that proxy voting advice that is exempt under Rules 14a-2(b)(1) and (b)(3) is still subject to the anti-fraud provisions of Rule 14a-9. The SEC’s earlier interpretation and guidance identified some types of information that a proxy advisory firm may need to disclose. (See this PubCo post.) Consistent with that guidance, the proposal would add to the text of Rule 14a-9 examples highlighting the types of information that may need to be disclosed, such as the “methodology used to formulate the proxy voting advice, sources of information on which the advice is based, or material conflicts of interest that arise in connection with providing the advice, without which the proxy voting advice may be misleading.” In addition, the proposal would add as an example, “the failure to disclose the use of standards or requirements that materially differ from relevant standards or requirements that the Commission sets or approves.”
Where the proxy advisory firm provides an adverse recommendation based on application of its own standards, if “the use of the criteria and the material differences between the criteria and the applicable Commission requirements are not clearly conveyed to proxy voting advice businesses’ clients, there is a risk that the clients may make their voting decisions based on a misapprehension that a registrant is not in compliance with the Commission’s standards or requirements [or that] the unique criteria used by the proxy voting advice businesses were approved or set by the Commission.” The SEC emphasizes, however, that the proposal does not mean that it would be inappropriate for the firm to use different standards.
Even before this proposal was issued, ISS felt compelled to file suit against the SEC and its Chair, Jay Clayton, contending that the SEC’s interpretation and guidance is unlawful and that its application should be enjoined for a number of reasons, including that the SEC’s determination that providing proxy advice is a “solicitation” is contrary to law, that the SEC failed to comply with the Administrative Procedures Act and that the views expressed in the guidance were arbitrary and capricious. (See this PubCo post.) In its complaint, ISS contends that it should not be subject to the interpretation because it is instead subject to a comprehensive regulatory framework under the Investment Advisers Act of 1940, which imposes on ISS fiduciary standards of care and loyalty. Proxy voting advice should be regulated under Advisers Act, not the Exchange Act, ISS claimed.
The proposal could undermine at least some of ISS’s arguments in the complaint, especially given that much of the interpretation and guidance would now be codified in rulemaking and subject to APA procedures, including notice and comment. In addition, in a note to the proposing release, the SEC contends that “it is not unusual for a registrant under one provision of the securities laws to be subject to other provisions of the securities laws when engaging in conduct that falls within the other provisions. Given the focus of Section 14(a) and the Commission’s proxy rules on protecting investors who receive communications regarding their proxy votes, it is appropriate that proxy voting advice businesses be subject to applicable rules under Section 14(a) when they provide proxy voting advice.” The SEC also observed that “not all proxy voting advice businesses are registered as investment advisers.