On July 22, 2020, the U.S. Securities and Exchange Commission adopted amendments to the proxy rules, significantly impacting the duties of proxy advisors. The SEC voted 3-1 to adopt rules that will, among other things, (i) require proxy advisors to increase disclosure regarding material conflicts of interest, and, (ii) subject to certain exceptions, require proxy advisors to furnish issuers with their reports and allow such issuers to review and respond to any recommendations prior to the time ballots are cast. Proxy advisory firms will be required to comply with these enhanced requirements beginning December 1, 2021, which will therefore impact the 2022 proxy season. Further, the SEC formally codified the agency’s prior holding that the term “solicitation” under the proxy rules includes proxy advisor firm reports. Finally, the SEC issued supplementary guidance to its which provides the agency’s views on investment adviser obligations under the proxy rules.
(a) Formal Adoption of Proxy Advice as Solicitation: Codification of Proxy Voting Advice as a “Solicitation” per Rule 14a-1(I)(1)
The SEC amended Rule 14a-1(I)(1) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) to definitively provide 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. The amendment codifies earlier SEC guidance, released in September 2019, in which the staff of the SEC’s Division of Corporate Finance (the “Staff”) indicated that the proxy rules largely apply to reports furnished by proxy advisory firms (the “2019 Proxy Guidance”). The SEC’s adoptive release notes that the amendments’ codification of the SEC’s standing interpretation set forth in the 2019 Proxy Guidance is meant to further the purpose of Section 14(a) under the Exchange Act to prevent “deceptive or inadequate disclosure.”
As further discussed herein, the 2019 Proxy Guidance incited immediate, largely negative responses from leading proxy advisory firms, as well as institutional investors,1 and largely positive responses from public companies, and main street investor-focused trade associations2. In its adoptive release, the SEC reiterates that Section 14(a) grants the agency “broad authority to establish rules and regulations to govern proxy solicitations ‘as necessary or appropriate in the public interest or for the protection of investors.’” By expanding its interpretation of the breadth of the terms “solicit” and “solicitation,” the SEC has taken the position that statements in proxy voting advice fall squarely within the purview of Section 14(a), opening the door to potential SEC enforcement actions, private litigation and further regulation in the future.
(b)Increased Compliance Obligations for Proxy Advisory Firms: Expanded Disclosure and Notice Requirements per Rule 14a-2(b)
The SEC revised Rules 14a-2(b)(1) and (b)(3), which provide exemptions from the information and filing requirements of the proxy rules, such that any proxy advisory firm relying on such solicitation exemptions must now satisfy the following conditions pursuant to new Rule 14a-2(b)(9), requiring those firms to (i) provide specified conflicts of interest disclosure in their proxy voting advice or in an electronic medium used to deliver the proxy voting advice and (ii) adopt and publicly disclose written policies and procedures reasonably designed to ensure that (A) companies that are the subject of the 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’ clients, and (B) 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 companies who are the subject of such advice, in a timely manner before the meeting of security holders is held. While the SEC’s proposed rule contemplated that the proxy advisory firms provide all companies with a draft of its proxy voting report prior to its publication, the final rules refrained from imposing this requirement. The SEC noted in its adoptive release that it is aware of the risks of introducing new rules into a complex system like proxy voting and therefore adopted a more measured approach.
Notwithstanding the new requirements, not every subject company will enjoy the benefit of these amendments. The SEC has, in connection with the principles-based approach outlined above, adopted a non-exclusive safe-harbor, which clarifies that a proxy advisory firm will be deemed to have satisfied its obligations under the new rules if the firm provides (A) subject companies with its voting advice, free of charge, no later than when it is sent to its clients, but a firm may condition this obligation on the requirements that companies (i) file their definitive proxy statement at least 40 calendar days before the applicable shareholder meeting and (ii) use such advice only for their “internal purposes and/or in connection with the solicitation” and will not publish or otherwise share the advice except with the companies’ employees or advisers; and (B) notice on the firm’s electronic client platform or through email or other electronic means that the subject company has filed, or has informed the proxy voting advice business that it intends to file, additional soliciting materials setting forth the subject company’s statement regarding the advice (and include an active hyperlink to those materials on EDGAR when available).
These amendments have the potential to significantly impact the compliance burden for proxy advisors as well as important timing considerations for issuers that wish to take advantage of the requirement that proxy advisory firms make the subject issuer’s response available to the proxy advisory firms’ clients . One potential effect would be that an issuer’s response to proxy voting advice would become a widely adopted and expected practice, the result of which would further burden issuers with additional disclosures and proxy supplements filings. This potential burden would have its greatest impact on smaller issuers, many of whom are already strained during what is usually their busiest time of the fiscal year. However, these amendments also give issuers an incentive to respond in order to mitigate or overcome the effects on the voting of a prior unfavorable recommendation by a proxy advisor.
(c) Potential Increase in Liability for Proxy Advisory Firms: Expansion of “False or Misleading Statements” Due to Insufficient Disclosure per Rule 14a-9
As proxy advice is now codified as a “solicitation” under the proxy rules, such advice may fall under the anti-fraud provisions of Rule 14a-9. The SEC has amended Rule 14a-9 to include examples of when the failure to disclose certain material information in proxy voting advice could, depending upon the particular facts and circumstances, be considered misleading within the meaning of the rule. The list of potential disclosure shortcomings in the amendment is not exhaustive. The Note to Rule 14a-9 will not include a new paragraph (e) which provides that the failure to disclose material information regarding proxy advice “such as the proxy voting advice business’s methodology, sources of information, or conflicts of interest,” could be misleading within the meaning of the rule.
The list of potential disclosure shortcomings in the amendment is not exhaustive, and the new rules therefore create a potential direct window of liability for proxy advisory firms’ advice “[t]he amendment [to the proxy rules]… does not broaden the concept of materiality or create a new cause of action, as some have suggested.” Proxy advisory firms will likely be more sensitive to ensuring the accuracy and completeness of their reports given the codification of the Commission’s longstanding view could have some economic effects. Proxy voting advice has been and continues to be subject to Rule 14a-9 liability. This sensitivity may make proxy advisors more willing to engage with issuers prior to issuing their voting recommendations and enhance the ability of issuers to correct information they believe to be inaccurate or incomplete in advisers’ reports.
As we discussed in our client notice , the SEC approved two separate releases: (1) a policy statement that provides reasonably comprehensive guidance and interpretive advice on the proxy voting responsibilities of investment advisers under Rule 206(4)-6, the proxy voting rule, under the Investment Advisers Act of 1940; and (2) guidance declaring that the provision of proxy voting advice by proxy advisory firms is considered a solicitation under the federal proxy rules and provided new guidance about the availability of exemptions from the federal proxy rules as well as the applicability of the proxy anti-fraud rule to proxy voting advice.
On July 22, 2020, the SEC released supplementary guidance (the Supplemental Guidance), with the stated goal of “assist[ing] investment advisers in assessing how to consider issuer responses to recommendations by proxy advisory firms.” The Supplemental Guidance chiefly addresses the practice by certain investment advisers of utilizing electronic vote management systems which allow proxy advisory firms to populate ballots based on the firm’s recommendations, and/or automatically submit clients’ votes to be counted, in what the SEC deemed a “set it and forget it” approach in the adoptive release. The Supplemental Guidance, among other things, mandates certain disclosure obligations and affirmative client consent when an investment adviser utilizes certain automated services for voting, and states that an investment adviser must consider whether its policies and procedures address an eventuality where the adviser becomes aware that an issuer will file (or has filed) additional soliciting materials.
In addition to incorporating the considerations outlined above designed to clamp down on robo-voting by investment advisers, thereby steering advisers toward decisions made for the “benefit” of their clients, as a result of the amendments to Rule 14(a) described earlier in this notice, there may be more circumstances where subject companies file additional soliciting materials in response to the reports issued by proxy advisory firms. As a result, investment advisers will need to adopt policies and procedures to ensure compliance with this guidance.
The amendments to the proxy rules were approved along party-lines by the SEC commissioners, with Allison Herren Lee, the sole Democrat among the commissioners, dissenting. Ms. Lee stated, among other things, in her dissent, that the adopted rules were “unworkable” and that “[c]ompared to the status quo, these rules still raise all of the infirmities that investors identified, including that they increase issuer involvement, and impose significant new costs and delays.”
ISS previously filed suit against the SEC in federal district court in Washington, D.C. regarding the proposed amendments to Section 14(a) discussed in this notice. The suit was stayed until the earlier of (i) January 1, 2021 or (ii) the promulgation of final rules in the SEC’s proxy advisor rulemaking, following the SEC’s filing of an Unopposed Motion to Hold Case in Abeyance. On August 12, 2020, ISS published a press release announcing their intent to resume their suit against the SEC, and reiterated their belief that “[the SEC’s] stance [is] firmly inconsistent with the plain meaning of the federal securities laws.”3 The Council of Institutional Investors provided in a release that, while the CII was “relieved” that the SEC “dropped the most problematic aspects of its original proposals,” it further expressed disappointment that the SEC did not issue a revised proposal and draft guidance and seek public comment, and articulated its belief that the legal and factual bases for the SEC’s rulemaking are “fundamentally flawed.” Glass Lewis submitted comments regarding the proposed amendments to the SEC in February 2020, on August 6, 2020, published a press release describing the amendments, packaged as an advertisement for their compliance and regulatory product offerings for investment advisers. It remains to be seen whether CII, or other trade associations or groups will seek to take action against the SEC’s efforts in this area.
1. Council of Institutional Investors stated “ [t]he SEC has not established a compelling case to tighten regulation of proxy advisory firms, and we are concerned that it has adopted untested and unvetted requirements that could have adverse effects on investors’ ability to get the timely and unbiased proxy advice they need to act as stewards of the companies they own.” See: https://www.cii.org/july22_sec_proxy_advice_rules. Institutional Shareholder Services stated “The rule, passed today along party lines, is based on the view that the provision of proxy voting advice constitutes a solicitation, a premise which we believe is inconsistent with the plain meaning of the federal securities laws” and further that “[t]his issue was at the heart of the lawsuit which we initiated against the SEC last year and it continues to be of concern to ISS.” See: https://insights.issgovernance.com/posts/statement-from-iss-president-ceo-gary-retelny-on-todays-sec-actions/.↩
2. U.S. Chamber of Commerce stated that the “SEC…acted to protect investors, promote transparency, end conflicts of interest and boost U.S. competitiveness through oversight of proxy firms.” See: https://www.uschamber.com/press-release/us-chamber-commends-the-sec-reforming-proxy-advisory-firms. National Association of Manufacturers stated “[t]hese changes will protect the retirement savings of manufacturing workers and millions more American families from proxy firms’ errors and conflicts of interests.” See: https://www.nam.org/manufacturers-score-major-win-on-final-sec-proxy-advisory-firm-regulations-9894/?stream=series-press-releases.↩
3. See https://insights.issgovernance.com/posts/august-12-2020-statement-from-iss-president-ceo-gary-retelny/ ↩