U.S. changes affecting your business: ISS and SEC battle over appropriate regulation of proxy advisory firms

The appropriate level of regulation of Institutional Shareholder Services (ISS) and other proxy advisory firms has been on the SEC’s radar for several years. The debate has now led to ISS suing the SEC over the SEC’s recently published interpretation of the application of federal proxy rules to ISS. Five days after ISS launched its lawsuit, the SEC published proposed rules that would impose substantially stricter regulations on proxy advisory firms.

The SEC’s guidance

On August 21, the SEC published Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice (guidance). Publications like the guidance, while technically not binding, are considered by capital markets participants to be highly persuasive. The SEC staff expressed the following views in the guidance:

• When proxy advisory firms such as ISS and Glass Lewis provide proxy voting advice to their investor clients, they are engaging in proxy solicitations.
• Accordingly, the opinions, reasons and voting recommendations provided by proxy advisory firms to their clients are subject to the securities law prohibitions on making false or misleading statements or omissions.
• Proxy advisory firms should therefore consider:
  • explaining their methodology for formulating voting advice on particular matters;
  • disclosing any third-party information sources; and
  • disclosing material conflicts of interest.
• The activities of proxy advisory firms may, however, continue to fall within one of the exemptions from the proxy solicitation disclosure and filing requirements.

The SEC staff encouraged proxy advisory firms to review their policies and practices before the 2020 proxy season in light of the guidance. The guidance also indicated that the staff were considering recommending changes to the SEC’s proxy rules to reflect the above views.

The ISS lawsuit

In response to the guidance, ISS took the significant step of suing the SEC on October 31, relying on the following main allegations:

• The guidance is effectively rule-making in disguise; the SEC should have followed the formal notice-and-comment protocol for enacting rules.
• The SEC’s view that proxy voting advice constitutes solicitation is incorrect under securities laws because ISS’ clients seek and pay for ISS’ advice and ISS does not have an interest in the outcome of any shareholder vote.
• Proxy advisory firms are regulated as investment advisors and adhere to a fiduciary standard of conduct towards their clients; additional regulation under the SEC’s proxy solicitation rules is inappropriate.

The SEC’s proposed new rules

On November 5, five days after ISS sued, the SEC took the formal step of publishing proposed rule amendments to codify its interpretative guidance. Under the proposed rules, the definition of “solicitation” would include proxy voting advice that:

• makes a recommendation to a shareholder as to a vote, consent or authorization on a specific matter for which shareholder approval is being solicited;
• is furnished by a person who markets its expertise as a provider of such advice, separately from other forms of investment advice; and
• is sold by the provider of such advice for a fee.

Proxy advisory firms’ reliance on the exemption from the proxy disclosure and filing obligations would be conditioned on proxy advisory firms:

• disclosing in their proxy voting reports any material conflicts of interest, including fees paid to them by the subject company and any significant ownership in the subject company;
• allowing subject companies and other soliciting parties a period of time to review and provide feedback on proxy voting reports before they are given to investors; and
• if requested by a company, including in the proxy voting report a link to a statement from the company expressing the company’s views about the report.

Proxy advisory firms would be able to require companies to enter into confidentiality agreements for materials exchanged during the review and feedback period.

Comments on the SEC’s proposed rule amendments are due by approximately the first week of January 2020. We expect the SEC to receive a voluminous number of letters from market participants. The appropriate level of regulation of proxy advisory firms is a contentious question that now stands to be addressed both in the courts and in the comment process. Until any new rules are adopted, it remains unclear what the impact will be on the 2020 proxy season.

With lawyers across capital markets, M&A, private equity, financing, tax, infrastructure and litigation, Torys New York has decades of experience advising on complex and high-profile U.S. work.