The Securities and Exchange Commission adopted new rule amendments and an interpretation concerning the proxy advisory industry on July 22. According to the Commission’s three-member majority, the changes are “to ensure that clients of proxy voting advice businesses have reasonable and timely access to more transparent, accurate and complete information on which to make voting decisions.” Critics of the rule, such as Commissioner (and lone dissenter) Allison Herren Lee, see the measures as “unwarranted, unwanted, and unworkable.”
Proxy Advisor Rule Changes
The rule amendments are based on the Commission’s characterization that proxy voting advice constitutes a “solicitation” under the proxy rules. With proxy advice defined as a solicitation, proxy advisors would be required to comply with burdensome disclosure requirements absent an exemption. The rule changes modified the existing exemptions available to proxy advisors under Exchange Act Rules 14a-2(b)(1) (for persons who do not seek to act as proxy for a shareholder) and 14a-2(b)(3) (for persons who furnish proxy voting advice to other persons with whom the advisor has a business relationship), imposing specific conditions on those provisions.
In order to qualify for the exemptions, proxy advisors must provide specified conflicts-of-interest disclosures. Advisors also must have adopted written policies and procedures to provide that subject companies have access to proxy advisor reports at the time they are issued to clients. The policies and procedures must also require that proxy advisor clients are made aware of any written responses to the advice by companies. The rule includes nonexclusive safe harbors applicable to advisors.
The Commission also amended Rule 14a-9, the general proxy anti-fraud provision. The change added language to the rule’s current list of actions that could be misleading. As amended, the rule will provide that the failure to disclose material information regarding proxy voting advice, such as the advisor’s “methodology, sources of information, or conflicts of interest,” could be a violation.
The SEC did not include the most contentious provision of the proposal package in its final rules. The Commission did not require proxy advisors to provide subject companies with an opportunity to pre-review draft reports or to deliver final reports to subject companies at least two days before advisors were to send the materials to clients. Critics had argued that this requirement could have delayed the delivery of proxy advice to clients for up to two weeks, and could have adversely impacted the independence of the advisor.
The amendments will become effective 60 days after Federal Register publication, but affected proxy advisors will not be required to comply with the amendments until Dec. 1, 2021.
Guidance for Investment Advisers
In addition to the proxy rule amendments, the SEC issued a policy statement regarding investment advisors and their proxy voting responsibilities. The interpretation deals with cases in which the investment adviser utilizes a proxy advisory firm’s electronic vote management system that “pre-populates” the adviser’s ballots with suggested voting recommendations, and an issuer intends to file or has filed additional soliciting materials regarding the voting recommendations. According to the SEC, “the investment adviser would likely need to consider such information prior to exercising voting authority in order to demonstrate that it is voting in its client’s best interest.” The supplemental guidance also addresses disclosure obligations and client consent when investment advisers use automated services for voting.
Commissioner Lee’s Dissent
Commissioner Allison Herren Lee began her dissent by stating that the rule changes will “harm the governance process and suppress the free and full exercise of shareholder voting rights.” While she noted that the Commission backed away from its most prescriptive proposal on advance issuer review, she stated that “making the final rules less objectionable than the proposal does not relieve the Commission of its fundamental obligation to identify the need for this rulemaking and to explain how the rules we are adopting will meet this need.”
According to Commissioner Lee, the majority largely changed their justification for the rulemaking from the proposing rationale. The proposal was based on a claim of widespread errors and inaccuracies in proxy advisor reports, while the final rules stress the need for “a more complete mix of information,” including issuer input. She noted that the consumers of proxy advice, large institutional investors, have strongly opposed the measures. Finally, she concluded that the measures are unworkable, as they introduce delays, uncertainty and additional costs into the process. She stated that the rule changes effectively require proxy advisors to provide their clients with notice of multiple events concerning issuer actions, and “notice of, and a hyperlink to, any actual issuer response, regardless of whether the proxy advisor considers the response to add any new information, and regardless of whether it may contain errors or misstatements.”
I spoke with Nicolas Grabar, a partner in Cleary Gottlieb’s New York office, about the impact of the rulemaking. He indicated that in the long run, he did not see the amendments as a “big deal.” The rules, which he described as principles-based, will not have a significant impact on the operations of the proxy advisory business. While issuers will receive proxy advice reports roughly in real time, the final rules largely avoided the “fundamental beef” that issuers have with proxy firms on the content of the advice and advance access to the reports. The rules did little to disrupt the “complicated dance” between issuers, proxy advisors and institutional investors. Proxy advisors will continue to thrive as a utility, providing essential services to investment advisers that compete with regard to fees, returns and stewardship. Institutional investors need the efficiency provided by proxy firms, he noted.
Grabar also doesn’t anticipate a successful challenge to the rules in court. The removal of the prescriptive advance notice requirements largely mitigated the First Amendment concerns, while in his view, there is adequate support in the adopting release to survive an administrative procedure challenge. The rules as adopted, he noted, are not sufficiently different from the proposals as to require a re-proposal process.
Nell Minow, Vice Chair of ValueEdge Advisors and a co-founder and former president of Institutional Shareholder Services Inc. (ISS), takes a different view on the proxy advisor rules. She told me that the rulemaking procedure is deficient in several different ways, and could be subject to court challenge. Initially, the Commission acted without proper regard for supporting evidence, she stated, and did not conduct any realistic review of the implications of the impacts or costs of the changes. Proxy voting advice will become more expensive and less independent, in her view, and the SEC failed to consider these factors. She also noted that the rulemaking was based in part on the rescission of no-action letters issued by the Division of Investment Management in 2004 to Egan-Jones Proxy Services and ISS concerning proxy advisor independence. She claimed that the Commission has no available documentation supporting the process for this decision.
First Amendment issues may also be actionable, Minow said, with regard to the rules impinging on the ability of proxy advisors to publish information when and where they wish. She also thinks that the Commission should have reproposed the rules, as the provisions adopted differ significantly from the initial proposals. Much of the comments on the 2019 proposals involved the mandatory advance notice requirement, which was not adopted. Commenters did not have the opportunity to examine the safe harbor provisions adopted by the Commission prior to adoption.
Finally, Minow sees the rules themselves as unnecessary. For example, more than 90% of all ISS recommendations align with management directives. She noted that the SEC currently has ample authority to enforce any violations of fiduciary duties by investment advisers, rendering the rulemaking superfluous.
The proxy advisor rulemaking marks a key step in a long-run regulatory battle. Rule proponents see the rules as a measured response to a significant problem of interest conflicts and erroneous reporting, while critics see the action as a solution in search of a problem. The rulemaking will not be the final word, however. Advisory firms will likely challenge the Commission’s actions in court, making both constitutional and administrative procedure arguments.
The proxy advisor rules also do not clear the Commission’s proxy agenda. Changes to the shareholder proposal process and the daunting challenge posed by “proxy plumbing,” the technical and mechanical underpinning of the entire proxy process, still await SEC action after years of debate and discussion.