SEC Provides Clarification on Investment Advisers’ Proxy Voting Responsibilities and the Applicability of Proxy Rules to Voting Advice

On Aug. 21, 2019, the Securities and Exchange Commission (the SEC) voted 3–2 to publish new guidance on the proxy voting responsibilities of investment advisers under Rule 206(4)-6 under the Investment Advisers Act of 1940 (the Advisers Act) and Forms N-1A, N-2, N-3 and N-CSR under the Investment Company Act of 1940 (the Company Act), as well as interpretation and related guidance regarding the applicability of Rules 14a-1 and 14a-9 under the Securities Exchange Act of 1934 (the Exchange Act) to proxy voting advice. These new guidelines and interpretation come as a response to the increased criticisms charging that proxy advisory firms make “frequent and significant” errors in their voting recommendations, deviate from their own publicly announced methodologies and maintain inherent conflicts due to being paid by corporate issuers for governance advice.

Investment Advisers’ Proxy Voting Responsibilities

The SEC guidance provides clarification on how an investment adviser’s fiduciary duties and Rule 206(4)-6 under the Advisers Act relate to an investment adviser’s proxy voting authority on behalf of clients (whether these clients are individual investors, funds or institutional investors), particularly for investment advisers who retain a proxy advisory firm. The SEC guidance follows a question and answer format and provides practical examples to help facilitate investment advisers’ compliance with their proxy voting responsibilities.

The SEC guidance discusses the following topics:

• An investment adviser and its client, in establishing their relationship, may agree to limit the scope of the investment adviser’s authority and responsibilities to vote proxies on behalf of that client. The investment adviser is not required to accept voting authority for the client securities and may agree, subject to appropriate disclosure and informed client consent, on the scope of voting arrangements, including the types of matters for which the investment adviser will exercise proxy voting authority and those for which it will not.
  
  
• An investment adviser that assumes the authority to vote should take steps to demonstrate that it is making voting determinations in the client’s best interest and in accordance with the investment adviser’s proxy voting policies and procedures. The formulation and implementation of those policies should be reviewed at least annually. When an investment adviser has multiple clients, it should consider whether it should have different voting policies for some of these different clients, depending on the investment strategy and objectives of each client. The SEC adds that an investment adviser should also consider whether certain types of matters may necessitate that it conducts a more detailed analysis than what is provided in its general voting guidelines, to take into account factors that are particular to the issuer (such as size, governance structure, financial results and industry practices) or the voting matter under consideration.
  
  
• An investment adviser should take special considerations into account before retaining a proxy advisory firm to assist it, such as whether the proxy advisory firm has:
  
  
  • The capacity and competency to adequately analyze the matters for which the investment adviser is responsible for voting
    
    
  • An effective process for seeking timely input from issuers and proxy advisory firm clients
    
    
  • Adequately disclosed its methodologies in formulating voting recommendations
    
    
  • Policies and procedures regarding how such proxy advisory firm identifies and addresses conflicts of interest
    
    
• An investment adviser should plan steps 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 adviser’s voting determinations. The SEC notes that an investment adviser should adopt internal policies and procedures reasonably designed to ensure that its voting determinations are not based on materially inaccurate or incomplete information. The investment adviser should periodically  review its ongoing use of the proxy advisory firm’s research or voting recommendations and the effectiveness of the proxy advisory firm’s policies and procedures for obtaining current and accurate information on which to make recommendations, including its timely engagement with issuers to obtain their views on the recommendations. One of the dissenting SEC Commissioners identified this as a new substantive requirement.
  
  
• An investment adviser should evaluate the services of a retained proxy advisory firm, including any material changes in services or operations by the firm. The SEC notes that an investment adviser should adopt and implement policies and procedures to identify and evaluate a proxy advisory firm’s ongoing conflicts of interest, in addition to updating its assessment of the proxy advisory firm’s capacity and competency to provide voting recommendations or to execute votes in accordance with the investment adviser’s voting instructions.
  
  
• An investment adviser who has assumed voting authority on behalf of a client should address how it circumscribes its voting obligations, given that it is not required to exercise every opportunity to vote. The SEC notes that an investment advisor does not have to vote a proxy if (i) the matter to be voted on falls outside the scope of services that the client and the investment adviser agreed upon when establishing voting authority or (ii) voting on the proxy would not be in the best interest of the client.

Applicability of the Proxy Rules to Proxy Voting Advice Offered by Proxy Advisory Firms

The SEC interpretation and guidance examines when and how an advisory firm’s proxy voting advice constitutes a “solicitation” under the federal proxy rules, thereby subjecting the firm itself to provisions of those rules.  

Rule 14a-1(l) under the Exchange Act defines “solicitation” as, among other things, a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” The SEC interpretation states that communications that seek to influence the voting of proxies by shareholders are covered as solicitations, regardless of whether the person making them seeks authorization to act as a proxy and even if that person is indifferent to the vote’s ultimate outcome. Whether a particular communication is a solicitation often turns on “the purpose for which the communication was published – i.e., whether the purpose was to influence the shareholders’ decisions,” as evidenced by the substance of the communication and the circumstances under which it was transmitted. The SEC also notes that “the fact that proxy advisory firms typically provide their recommendations shortly before a shareholder meeting further enhances the likelihood that the recommendations are designed to and will influence the final stages of the investment advisers’ decision-making process on voting determinations,” hence making such recommendations “solicitations.”

However, Rule 14a-2(b) under the Exchange Act provides exemptions from the information and filing requirements of the federal proxy rules, if the Rule’s conditions are satisfied. Subsection (b)(3) specifically addresses “proxy voting advice” and requires that the advice be rendered in the ordinary course of the advisor’s business, without compensation from a person other than the recipients of the advice, not on behalf of a person soliciting proxies or an election participant; and with full disclosure of any significant relationship between the advisor and the issuer or another proponent of a vote or any material interest of the advisor in the outcome.

Finally, the SEC cautions that solicitations that are exempt from the federal proxy rules’ filing requirements remain subject to Rule 14a-9 under 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. As a result, the SEC notes that the proxy voting advisor should consider disclosing the methodology used to formulate advice, including when it deviates from previously-announced methodology; any third-party information sources, and the extent to which such materials were factored into the analysis; and any conflicts of interest the advisory firm has, explained in “reasonably sufficient detail.”

The guidance and interpretation will be effective upon publication in the Federal Register.

The SEC guidance on investment advisers’ proxy voting responsibilities is available here. 

The SEC interpretation and related guidance on the applicability of proxy rules to voting advice is available here.