U.S. SEC Adopts Rules to Regulate Proxy Advisory Firms

The U.S. Securities and Exchange Commission (the “SEC”) recently adopted amendments to the proxy rules to address proxy voting advice provided by proxy advisory firms such as Institutional Shareholder Services (“ISS”) and Glass, Lewis & Co.[1] The adoption of these final rules caps off a decade-long effort to address concerns with the proxy advisory firms.

Background

Over a decade ago, in the SEC’s proxy plumbing concept release,[2] the SEC addressed two concerns with proxy advisory firms:

• A lack of “adequate accountability for informational accuracy in the development and application of voting standards;” and
• Conflicts of interests that are “insufficiently disclosed and managed.” 

In addition, the SEC noted concerns about the influence that proxy advisory firms have over their clients, “without appropriate oversight” or “an actual economic stake in the issuer.” At the time, the SEC suggested a range of possible regulatory responses that included:

• Subjecting proxy advisory firms to the rules governing the solicitation of proxies;
• Amending Rule 14a-2(b)(3) under the Securities Exchange Act of 1934 (the “Exchange Act”) to include relevant provisions to address proxy advisory firms; or
• Amending the Investment Advisers Act of 1940 (the “Advisers Act”) to require registration for all proxy advisory firms. 

On August 21, 2019, the SEC provided guidance to assist investment advisers in fulfilling their proxy voting responsibilities.[3] This guidance discussed, among other matters, the ability of investment advisers to establish a variety of different voting arrangements with their clients and matters they should consider when they use the services of a proxy advisory firm. At the same time, the SEC issued an interpretation that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules and provided guidance about the application of Rule 14a-9, the proxy antifraud rule, to proxy voting advice.[4]

On October 31, 2019, ISS filed a lawsuit against the SEC and Chairman Jay Clayton in which it challenges the portion of the Interpretive Release indicating that the proxy solicitation rules govern the provision of proxy advice. The lawsuit alleges that the Interpretive Release:

• Exceeds the SEC’s statutory authority under Section 14(a) of the Exchange Act and is contrary to the plain language of the statute, because “the provision of proxy advice is not a proxy solicitation and cannot be regulated as such;”
• Constitutes a substantive rule that the SEC failed to promulgate pursuant to the notice‑and-comment procedures of the Administrative Procedure Act; and
• Must be set aside as arbitrary and capricious because, “even though it marks a significant change in the regulatory regime applicable to proxy advice, the SEC has denied that it is changing its position at all.”

The SEC has taken a position that the Interpretive Release is consistent with both Congress’s intent in adopting the Exchange Act and the plain meaning of the law. In January 2020, the court approved the SEC’s motion to stay the proceeding until the earlier of January 1, 2021 or the promulgation of final rules in the rulemaking discussed below.

On November 5, 2019, the SEC proposed rule amendments relating to the application of Exchange Act proxy solicitation rules to proxy advisory firms.[5] The comment period for these proposals ended on February 3, 2020.

The Final Rules

On July 22, 2020, the Commission adopted final rules governing proxy voting advice provided by proxy advisory firms.

Framework for Regulation

Exchange Act Rule 14a-1(l), which defines the terms “solicit” and “solicitation,” in the context of proxy solicitations subject to the SEC’s proxy rules. Any person engaging in a proxy solicitation is generally subject to filing and information requirements under the SEC’s proxy rules unless an exemption applies to that solicitation. Although certain types of solicitations are exempt from the filing and information requirements, Rule 14a-9 (the anti-fraud provision of the proxy rules) applies to all solicitations. Proxy advisory firms typically rely on the following exemptions to provide proxy voting advice without complying with the filing and information requirements of the proxy rules:

• Rule 14a-2(b)(1), which generally exempts solicitations by persons who do not seek the power to act as a proxy for shareholders and do not have a substantial interest in the subject matter of the communication beyond their interest as a shareholder; or
• Rule 14a-2(b)(3), which generally exempts proxy voting advice that is furnished by an advisor to any other person with whom the advisor has a business relationship.

The SEC’s final rule changes focused on these existing provisions of the proxy rules as a means for regulating the provision of proxy voting advice.

Definition of a Solicitation

Consistent with the Proposing Release, the SEC adopted an amendment to Exchange Act Rule 14a-1(l) to codify the SEC’s longstanding view (as described in the Interpretive Release) that when a person or entity furnishes proxy voting advice (which the SEC refers to as a “proxy voting advice business”), that proxy voting advice generally constitutes a “solicitation” under Section 14(a) of the Exchange Act. Absent an applicable exemption, any person providing proxy voting advice would be subject to the information and filing requirements in the proxy rules, including the obligation to file and furnish definitive proxy statements.

The SEC indicates that  a proxy voting advice business should be eligible to rely on an exemption from such information and filing requirements for their proxy voting advice, “but only to the extent that such exemption is appropriately tailored to their unique role in the proxy process and facilitates the transparency, accuracy, and completeness of the information available to those making voting decisions.”

Consistent with the Proposing Release, the SEC amended Rule 14a-1(l)(1)(iii) to add paragraph (A) to make clear that the terms “solicit” and “solicitation” include any proxy voting advice that makes a recommendation to a shareholder as to its vote, consent, or authorization on a specific matter for which shareholder approval is solicited, and that is furnished by a person who markets its expertise as a provider of such advice, separately from other forms of investment advice, and sells such advice for a fee. In doing so, the SEC rejected comments suggesting that the proposed amendment to Rule 14a-1(l)(1)(iii) conflicted with well-established practice in the proxy voting advice business industry and the SEC’s historical treatment of that industry.

In the final rules, the SEC recognized that proxy voting advice businesses may use more than one voting policy or set of guidelines in formulating their voting recommendations. For example, a proxy voting advice business may offer differing voting recommendations on a matter based on the application of its benchmark policy or various specialty policies. Under the final rule, the voting recommendations formulated under the benchmark policy and each of the specialty policies would be considered to be a separate communication of proxy voting advice under proposed Rule 14a-1(l)(1)(iii)(A). In addition to voting recommendations formulated pursuant to a proxy voting advice business’s benchmark and specialty policies, the SEC also included voting recommendations formulated pursuant to a proxy voting advice business’s client’s own custom policies within the scope of the term “solicitation,” consistent with its prior interpretation. The SEC rejected comments that suggested that these amendments exceed the SEC’s statutory authority to deem proxy voting advice as a proxy solicitation, noting that “[t]he Commission’s longstanding view that a ‘solicitation’ includes any communication reasonably calculated to result in the procurement, withholding, or revocation of a proxy—and that this encompasses the furnishing of proxy voting advice—accords with the text, history, and structure of Section 14(a) of the Exchange Act, as well as judicial precedent and our own rules.” The Adopting Release notes that, to the extent a business that provides proxy voting services “is not providing any voting recommendations and is instead exercising delegated voting authority on behalf of its clients, such services generally will not constitute ‘proxy voting advice’—and, therefore, not be a ‘solicitation’—under Rule 14a-1(l)(1)(iii)(A).”

The SEC also amended Rule 14a-1(l)(2) to add paragraph (v), which makes clear that the terms “solicit” and “solicitation” do not include any proxy voting advice provided by a person who furnishes such advice only in response to an unprompted request. This amendment “codifies the Commission’s historical view that such a communication should not be regarded as a solicitation subject to the proxy rules.”

Addressing Conflicts of Interest

The Adopting Release outlines certain circumstances that “create a risk that the proxy voting advice business’s voting advice could be influenced by the business’s own interests, which may call into question the objectivity and independence of its advice.” Examples of such circumstances include:

• A proxy voting advice business providing voting advice to its clients on proposals to be considered at the annual meeting of a company, while the proxy voting advice business also earns fees (or is seeking to earn fees) from that company for providing advice on corporate governance and compensation policies;
• A proxy voting advice business providing voting advice on a matter in which its affiliates or one or more of its clients has a material interest, such as a business transaction or a shareholder proposal put forward by or actively supported by that client or group of clients;
• A proxy voting advice business providing ratings to institutional investors of the corporate governance practices of companies while at the same time consulting for, or seeking to consult with, companies that are the subject of the ratings for a fee to help increase their corporate governance scores;
• A proxy voting advice business providing voting advice with respect to a company’s shareholder meeting while affiliates of the proxy voting advice business hold a significant ownership interest in the company, sit on the company’s board of directors, or have relationships with a shareholder presenting a proposal covered by the proxy voting advice; and
• A proxy voting advice business providing voting advice on a matter on which it or its affiliates have provided advice to a company, a proponent, or other party regarding how to structure or present the matter or the business terms to be offered in such matter.

The SEC considered comments that were both in favor of and opposed to disclosure concerning the existence of conflicts of interest. The SEC adopted amendments to Rule 14a-2(b) to require that persons who provide proxy voting advice in reliance on the exemptions in either Rule 14a‑2(b)(1) or (b)(3) must include, in their proxy voting advice to clients, the conflicts of interest disclosure that is specified in new Rule 14a-2(b)(9)(i).

The SEC adopted the conflict of interest disclosure requirement largely as proposed, with some modifications to clarify and streamline the requirement. The SEC indicates in the Adopting Release that Rule 14a-2(b)(9)(i) “establishes a principles-based requirement, based on a standard of materiality, that will apply to all proxy voting advice that is provided in reliance on the exemptions in Rules 14a-2(b)(1) and (b)(3),” which serves to enhance the conflicts of interest disclosures that proxy voting advice businesses currently provide in order to rely on the exemptions from the information and filing requirements.

Under the final rules, the exemption from the proxy disclosure and filing requirements in either Rule 14a-2(b)(1) or (b)(3) is conditioned on the proxy voting advice business including, in their voting advice (or in any electronic medium used to deliver the advice), prominent disclosure of:

• Any information regarding an interest, transaction, or relationship of the proxy voting advice business (or its affiliates) that is material to assessing the objectivity of the proxy voting advice in light of the circumstances of the particular interest, transaction, or relationship; and
• Any policies and procedures used to identify, as well as the steps taken to address, any such material conflicts of interest arising from such interest, transaction, or relationship.

Consistent with the suggestions of some commenters, the final rule text condenses proposed subsections (A), (B), and (C) of paragraph (b)(9)(i) into a single subsection (A) that requires disclosure of “any information regarding an interest, transaction, or relationship of the proxy voting advice business (or its affiliates) that is material to assessing the objectivity of the proxy voting advice in light of the circumstances of the particular interest, transaction, or relationship.”

As proposed, the rule would have required a proxy voting advice business to include conflicts of interest disclosure “in its proxy voting advice and in any electronic medium used to deliver the advice.” In response to commenters, the SEC adopted a final rule that gives a proxy voting advice business the option to include the required disclosure either in its proxy voting advice or in an electronic medium used to deliver the proxy voting advice, such as a client voting platform, “which allows the business to segregate the information, as necessary, to limit access exclusively to the parties for which it is intended.”

Notice of Proxy Voting Advice and Response

New Rule 14a-2(b)(9)(ii) requires, as a separate condition to the availability of the exemptions in Rules 14a-2(b)(1) and (b)(3), that a proxy voting advice business adopt and publicly disclose written policies and procedures reasonably designed to ensure that:

• Companies that are the subject of proxy voting advice have such advice made available to them at or prior to the time when such advice is disseminated to the proxy voting advice business’s clients; and

• The proxy voting advice business provides its clients with a mechanism by which they can reasonably be expected to become aware of any written statements regarding its proxy voting advice by companies that are the subject of such advice, in a timely manner before the shareholder meeting (or, if no meeting, before the votes, consents, or authorizations may be used to effect the proposed action).

As adopted, Rule 14a-2(b)(9)(ii)(A) leaves it to the proxy voting advice business “to choose how best to implement the principles embodied in the rule and incorporate them into the business’s policies and procedures.” The SEC notes in the Adopting Release that the rule as adopted does not require that proxy voting advice businesses provide companies or other soliciting persons with the opportunity to review proxy voting advice in advance of its dissemination to the proxy voting advice businesses’ clients, “although providing [companies] with the opportunity to review their proxy voting advice in advance would satisfy the principle and is encouraged to the extent feasible.” The final rule does not require proxy voting advice businesses to ensure that proxy voting advice is made available to companies after being initially provided to clients, given the fact that “such a requirement could be unduly burdensome given the timing constraints of the proxy process.”

Paragraph (iii) of Rule 14a-2(b)(9) as adopted includes a non-exclusive safe harbor provision that states a proxy voting advice business will be deemed to satisfy Rule 14a-2(b)(9)(ii)(A) if it has written policies and procedures that are reasonably designed to provide companies with a copy of its proxy voting advice, at no charge, no later than the time it is disseminated to the proxy voting advice business’s clients. Such policies and procedures may include conditions requiring that such companies have:

• Filed their definitive proxy statement at least 40 calendar days before the shareholder meeting; and
• Expressly acknowledged that they will only use the proxy voting advice for their internal purposes and/or in connection with the solicitation and it will not be published or otherwise shared except with the registrant’s employees or advisers.

Unlike the proposed rules, the safe harbor does not mandate the provision of draft proxy voting advice to companies before dissemination of the proxy voting advice business. Instead, compliance with the safe harbor requires that the proxy voting advice business provide its voting advice to companies no later than the time it is released to the proxy voting advice business’s clients. The SEC states in the Adopting Release that “[i]t is not a condition of this safe harbor, nor the principles-based requirement, that the proxy voting advice business negotiate or otherwise engage in a dialogue with the registrant, or revise its voting advice in response to any feedback,” however the SEC encourages “cooperation and an open dialogue.”

New Rule 14a-2(b)(9)(iv) provides a non-exclusive safe harbor pursuant to which proxy voting advice businesses will be deemed to satisfy the requirement of paragraph (ii)(B) of 14a-2(b)(9). This safe harbor provides that a proxy voting advice business must have written policies and procedures reasonably designed to inform clients who have received proxy voting advice about a particular company in the event that such company notifies the proxy voting advice business that the company either intends to file or has filed additional soliciting materials with the SEC setting forth its views regarding such advice. The safe harbor sets forth two methods by which the proxy voting advice business may provide such notice to its clients:

• Provide notice on its electronic client platform that the company has filed, or has informed the proxy voting advice business that it intends to file, additional soliciting materials (and include an active hyperlink to those materials on EDGAR when available); or

• Provide notice through email or other electronic means that the registrant has filed, or has informed the proxy voting advice business that it intends to file, additional soliciting materials (and include an active hyperlink to those materials on EDGAR when available).

The SEC states in the Adopting Release that “the inclusion of the hyperlink required under Rule 14a-2(b)(9)(iv) would not, by itself, make the proxy voting advice business liable for the content of the hyperlinked company’s statement.”

In the Adopting Release, the SEC indicates that whether a proxy voting advice business has complied with the requirements will be determined by the particular facts and circumstances of the proxy voting advice business’s adopted written policies and procedures, as well as whether such facts and circumstances support the conclusion that the particular policies and procedures are reasonably designed to ensure that:

• Companies that are the subject of the proxy voting advice have such advice made available to them at or prior to the time when such advice is disseminated to the proxy voting advice business’s clients; and
• The proxy voting advice business provides its clients with a mechanism by which they can reasonably be expected to become aware that companies have filed additional proxy materials that are responsive to the proxy voting advice in a timely manner before the shareholder meeting.

The Commission notes that some relevant factors include:

• The degree to which a company has time to respond and whether the policy ensures prompt conveyance of information to the company;
• The extent to which the mechanism provided to clients is an efficient means by which they can reasonably be expected to become aware of the company’s written response, once it is filed, such that the client has sufficient time to consider such response in connection with a vote; and
• The reasonableness, based on facts and circumstances, of any fees charged by a proxy voting advice business to a registrant as a condition to receiving a copy of its proxy voting advice and the extent to which such fees may dissuade a registrant from seeking to review and provide a response to such proxy voting advice.

The SEC indicates that these factors “are not exclusive and no single factor or combination of factors will control the determination of whether a proxy voting advice business has complied with the principles-based requirements.”

In accordance with Rules 14a-2(b)(9)(v) and (vi), proxy voting advice businesses do not need to comply with Rule 14a-2(b)(9)(ii) in order to rely on either the Rule 14a-2(b)(1) or (b)(3) exemption: (i) to the extent that their proxy voting advice is based on a custom policy; or (ii) if they provide proxy voting advice as to non-exempt solicitations regarding certain mergers and acquisitions or contested matters.

Amendments to Rule 14a-9

As proposed, the SEC adopted amendments to Rule 14a-9 to include examples of what may be misleading within the meaning of the rule. The amended Note to Rule 14a-9 now includes paragraph (e), which states that the failure to disclose material information regarding proxy voting advice, “such as the proxy voting advice business’s methodology, sources of information, or conflicts of interest” could, depending upon particular facts and circumstances, be misleading within the meaning of Rule 14a-9. The Commission did not adopt in new paragraph (e) the proposed clause “or use of standards that materially differ from relevant standards or requirements that the Commission sets or approves.”

Transition Period

Proxy voting advice businesses subject to the final rules will not be required to comply with the amendments to Rule 14a-2(b)(9) until December 1, 2021. This extended transition period does not apply to the amendments to Rule 14a-1(l) and Rule 14a-9 because these rule changes codify “existing Commission interpretations and guidance, and do not impose new obligations that necessitate significant time for preparation.” The amendments to Rule 14a-1(l) and Rule 14a-9 will go effective 60 days after publication of the Adopting Release in the Federal Register.

Supplemental Guidance for Investment Advisers

On July 22, 2020, the SEC supplemented its guidance regarding the proxy voting responsibilities of investment advisers in light of the Commission’s amendments to the proxy solicitation rules.[6] The SEC said that this supplemental guidance is intended to assist investment advisers in assessing how to consider additional information from issuers that may become more readily available as a result of the proxy solicitation rule amendments. The guidance also addresses circumstances where the investment adviser utilizes a proxy advisory firm’s electronic vote management system as well as disclosure and client consent obligations when investment advisers use these services for voting. 

[1] Release No. 34-89372, Exemptions from the Proxy Rules for Proxy Voting Advice (Jul. 22, 2020), available at: https://www.sec.gov/rules/final/2020/34-89372.pdf (the “Adopting Release”).

[2] Release No. 34-62495, Concept Release on the U.S. Proxy System (Jul. 14, 2020), available at: https://www.sec.gov/rules/concept/2010/34-62495.pdf (the “Concept Release”).

[3] Release No. IA-5325, Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers (Aug. 21, 2019), available at: https://www.sec.gov/rules/interp/2019/ia-5325.pdf.

[4] Release No 34-86721, Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice (Aug. 21, 2019), available at: https://www.sec.gov/rules/interp/2019/34-86721.pdf (the “Interpretive Release”).

[5] Release No. 34-87457, Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice (Nov. 5 2019), available at: https://www.sec.gov/rules/proposed/2019/34-87457.pdf (the “Proposing Release”).

[6] Release No. IA-5547, Supplement to Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers (Jul. 22, 2020), available at https://www.sec.gov/rules/policy/2020/ia-5547.pdf.