The SEC flexed its regulatory muscle Wednesday when it decided to spell out the responsibilities and limitations of investment advisors and proxy advisory firms that vote on investors’ behalf on corporate issues that range from executive compensation to climate change and gun safety issues.
SEC commissioners voted three to two in favor of publishing guidance on the proxy voting responsibilities of investment advisors under the Investment Advisers Act of 1940. The guidance covers the ability of advisors to establish various voting arrangements with their clients and what they should consider when they use the services of a proxy advisory firm.
By the same count, the commissioners also voted in favor of publishing an interpretation and guidance regarding the applicability of certain proxy advice rules under the Securities Exchange Act of 1934. The interpretation clarifies that proxy voting advice provided by proxy advisory firms generally constitutes a solicitation under the federal proxy rules.
The SEC’s actions generally favor companies and lobby groups, such as the U.S. Chamber of Commerce, that have been trying to curtail the influence of proxy advisory firms.
Proxy advisory firms, such as Institutional Shareholder Services Inc. and Glass Lewis & Co., increasingly have been exerting influence over shareholder voting even regarding contentious issues that aren’t part of the main businesses of a company, according to corporate lobby groups.
Gary Retelny, ISS president and CEO, says the company will review the guidance and consider further action.
“We are deeply concerned that aspects of the guidance may significantly undermine our ability to deliver independent, timely and accurate data, research, insights and perspectives to aid in the discharge of our clients’ fiduciary duties,” he says. “We will have more to say once we have the opportunity to closely study the guidance.”
FA-IQ also reached out to the U.S Chamber of Commerce and Glass Lewis to get their reactions on the SEC’s actions but did not receive a reply as of this writing.
Why is the SEC acting on proxy advisory voting?
At the Wednesday meeting, SEC Chairman Jay Clayton said the regulator prioritized tackling this issue because the proxy process has become increasingly complex over the past two decades and investment advisors have assumed a much greater role in shareholder-company engagement.
“Voting is a key component of shareholder engagement and investing more generally,” Clayton said, noting he expects the guidance to “provide clarity to investment advisors regarding proxy voting responsibilities, and ultimately benefit their clients.”
SEC Commissioner Elad Roisman, a Republican appointee and among those who voted yes on the two items, said the regulator’s actions reiterate its “views on the importance of investment advisors voting responsibly on behalf of their clients and the applicability of proxy rules to proxy voting advice.
“Advisors who vote proxies must do so in a manner consistent with their fiduciary obligations and, to the extent they rely on voting advice from proxy advisory firms they must take reasonable steps to ensure the use of that advice is consistent with their fiduciary duties,” he said. “Proxy advisory firms, to the extent they engage in solicitations, must comply with applicable law.”
SEC Commissioner Robert Jackson, Jr., who identifies as an independent and voted no on the two items, said he is worried that “if smaller investors respond” to additional costs related to the guidance and interpretation “simply by choosing to vote less, the result may be to give more influence to large institutions.”
Jackson said the actions may also discourage new entrants from setting up proxy advisory firms. He noted that “the entrance of new competitors has helped proxy advisors produce better and less-conflicted advice.”
Who’s right, who’s wrong?
The reaction to the SEC’s latest proxy voting actions has been mixed.
“Based on statements at the open meeting, we’re concerned that the new guidance adopted today will increase costs for advisors and also increase barriers to entry for proxy advisory firms,” says Investment Adviser Association general counsel Gail Bernstein.
“While the Commission stated at the open meeting that its actions do not create new obligations, we believe that as a practical matter they will for investment advisors. We are disappointed that the guidance was issued without the opportunity for public comment and without the benefit of an economic analysis,” she adds.
Will Martindale, director of policy and research for the Principles for Responsible Investment, an organization that lobbies for the incorporation of ESG issues into investment practice, hints the SEC appears to have succumbed to the wishes of companies resisting the power and influence of proxy advisory firms.
“The SEC is under pressure to issue onerous new regulations that would provide corporate management the ability to intervene in proxy advisors’ independent analysis and therefore greatly undermine investors who rely on their advice to integrate environmental, social and governance considerations and other matters that promote long-term financial stability,” Martindale says.
Like the IAA’s Bernstein, Martindale also questions how the SEC arrived at Wednesday’s vote.
“Instead of going through the notice and comment rulemaking process, which is legally required to make substantive policy changes, regulators are trying to cut corners by issuing guidance instead of a rule,” he says. “The rulemaking process is designed to be transparent and inclusive for a reason — voting to approve major policy changes without involving critical stakeholders undermines the SEC’s commitment to fair and transparent markets.”
In the SEC’s corner is the American Securities Association, which praised the SEC’s actions as a modernization of the proxy advisory process that would lead to more transparency for Main Street advisors.
The ASA says it “strongly supports” reforms that would subject the voting reports of proxy advisory firms to the anti-fraud provisions of the proxy solicitation rules; prohibit proxy advisors from offering rating and consulting services to issuers on any matter that they are also being paid by an investor to provide a voting recommendation; and update the resubmission thresholds for proposals that lose by wide margins.
Proxy voting responsibilities of investment advisors
In addition to publishing the guidelines, the SEC has released information in a fact sheet.
According to the SEC, investment advisors “owe each of their clients a duty of care and loyalty with respect to services undertaken on the clients’ behalf, including proxy voting.”
The Advisers Act requires an investment advisor who exercises voting authority on client securities to adopt and implement written policies and procedures that are reasonably designed to ensure that the vote “proxies in the best interest of its clients,” the SEC says.
The guidance covers the following issues when an investment advisor retains a proxy advisory firm to exercise the vote, according to the SEC:
- How an investment advisor and its client, in establishing their relationship, may agree upon the scope of the investment advisor’s authority and responsibilities to vote proxies on behalf of that client;
- What steps an investment advisor, who has assumed voting authority on behalf of clients, could take to demonstrate it is making voting determinations in a client’s best interest and in accordance with the investment advisor’s proxy voting policies and procedures;
- Considerations that an investment advisor should take into account if it retains a proxy advisory firm to assist it in discharging its proxy voting duties;
- Steps for an investment advisor to consider if it becomes aware of potential factual errors, potential incompleteness, or potential methodological weaknesses in the proxy advisory firm’s analysis that may materially affect one or more of the investment advisor’s voting determinations;
- How an investment advisor could evaluate the services of a proxy advisory firm that it retains, including evaluating any material changes in services or operations by the proxy advisory firm; and
- Whether an investment advisor who has assumed voting authority on behalf of a client is required to exercise every opportunity to vote a proxy for that client.
Applicability of the federal proxy rules to proxy voting advice
The federal proxy rules apply to any solicitation for a proxy with respect to any security registered under the Exchange Act, according to the SEC.
A solicitation includes, among other things, a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy” and includes communications by a person seeking to influence the voting of proxies by shareholders, regardless of whether the person is seeking authorization to act as a proxy, the SEC explains.
The SEC says its interpretation that the proxy advisory firm's vote is subject to the federal proxy rule doesn’t affect the ability of those firms to continue to rely on the exemptions from the federal proxy rules’ filing requirements, as long as there is compliance with the exemption’s conditions.
Solicitations that are exempt from the federal proxy rules’ filing requirements remain subject to the Exchange Act, which prohibits any solicitation from containing any statement which — at the time and in the light of the circumstances under which it is made — is false or misleading with respect to any material fact, the SEC says.
The SEC guidance also explains what a person providing proxy voting advice should consider about information it may need to disclose to avoid a potential violation of the Exchange Act rule that says failure to disclose would render the advice materially false or misleading.
The guidance and interpretation will be effective upon publication in the Federal Register.