The work of proxy advisory firms has been on the SEC’s radar for several years. Extensive consultations with market participants and research into the role of proxy advisory firms have culminated in the SEC publishing two sets of guidance–one directed at investment advisers and the other directed at proxy advisory firms such as Institutional Shareholder Services and Glass Lewis.
Investment advisers are fiduciaries
The SEC reminds investment advisers that they are fiduciaries and must make voting decisions in the best interests of their clients—including when using the services of a proxy advisory firm.
Investment advisers and clients may set the scope of their relationship
Investment advisers and their clients are free to set the scope of the adviser’s authority over the client’s securities, including the adviser’s responsibility to vote the securities on the client’s behalf. The client may authorize the adviser not to vote at all in some circumstances; or the adviser may sometimes determine that not voting is in the best interests of the client. A wide variety of fiduciary arrangements are possible, provided the client’s best interests always trump the adviser’s interests.
Investment advisers need to be diligent
The SEC’s guidance is extensive and detailed, suggesting numerous due diligence steps that investment advisers may take to help ensure that their proxy voting determinations are in their clients’ best interests. Not all steps need to be taken in all circumstances; the appropriate level of due diligence depends in part on the nature of the relationship between the investment adviser and client and the types of services, if any, that the investment adviser obtains from a proxy advisory firm.
Investment advisers should consider conducting self-assessments to help determine whether they are fulfilling their fiduciary obligations as outlined in the SEC’s guidance.
Sample due diligence questions
Examples of the types of due diligence questions that investment advisers may want to ask themselves:
- Is a uniform voting policy governing all client securities in the best interests of each individual client?
- Should we sometimes conduct a detailed, fact-specific proxy voting analysis instead of relying on our standard policies, e.g., in M&A transactions, contested director elections or other significant voting matters? The potential impact on the value of a client’s investments should be considered here.
- How do we deal with new information about voting matters, whether in additional definitive proxy materials or otherwise conveyed to us, that could reasonably be expected to affect our voting determinations?
Examples of due diligence questions if an investment adviser retains the services of a proxy advisory firm:
- Does the proxy advisory firm consider factors unique to a company or proposal when evaluating a voting matter?
- Does the proxy advisory firm have an effective process for seeking timely input from companies and clients on its proxy voting policies, methodologies and peer group constructions?
- What efforts does the proxy advisory firm make to correct any identified material deficiencies in its analysis?
- How do we access, in a timely and efficient manner, a company’s views about the proxy advisory firm’s voting recommendations?
- How do we respond when we become aware of potential factual errors, potential incompleteness, or potential methodological weaknesses in a proxy advisory firm’s analysis that could materially affect one or more of our voting determinations?
- Does the proxy advisory firm have adequate policies and procedures for identifying, disclosing and addressing actual and potential conflicts of interest?
- Do we have effective policies and procedures for monitoring the quality, adequacy and independence of the proxy advisory firm’s services on an ongoing basis?
The anti-fraud rules apply to proxy advisory firms’ activities
Proxy advisory firms market their expertise in researching and analyzing matters submitted to a shareholder vote to assist their clients in making voting decisions at shareholder meetings. The SEC’s view is that these activities constitute solicitations of proxies; however, exemptions are generally available for proxy advisory firms from the requirements to prepare and file a proxy circular in connection with a shareholders’ meeting.
The SEC cautions proxy advisory firms that their activities must not violate Rule 14a-9. That rule prohibits proxy solicitations from containing false or misleading statements about material facts or omitting material facts so as to render other statements false or misleading. Since the opinions, reasons and recommendations of proxy advisory firms may constitute material facts, the assumptions and limitations underlying them may need to be disclosed—otherwise Rule 14a-9 may be violated. Proxy advisory firms should consider disclosing
- their methodologies for formulating voting advice on particular matters,
- any reliance on third party information, especially if it deviates from a company’s public disclosures, and
- material conflicts of interest that arise in the course of giving proxy voting advice.
The SEC is considering going beyond guidance by making rule changes to improve the proxy voting system. In the meantime, SEC staff encourage investment advisers and proxy advisory firms to review their policies and practices before the 2020 proxy season and to contact the Division of Investment Management with any operational questions relating to the guidance.
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
For permission to republish this or any other publication, contact Janelle Weed.
© 2020 by Torys LLP.
All rights reserved.