On July 22, the U.S. Securities and Exchange Commission (SEC) adopted controversial rule amendments that will impose additional disclosure and procedural requirements on proxy advisors like ISS and Glass Lewis as conditions for being able to continue relying on exemptions from the information and filing requirements of the federal proxy rules.1 In light of these amendments, the SEC also concurrently published supplemental guidance to assist investment advisers in fulfilling their proxy voting responsibilities, particularly when relying on proxy advisors for their advice and/or voting execution platforms.2
The final rules reflect a principles-based approach as opposed to the more prescriptive framework the SEC had proposed in November 2019.3 They give proxy advisors significant flexibility to determine the way in which they will satisfy their new obligations, including by leveraging their current practices and procedures.
The proxy solicitation rule amendments will make a proxy advisor’s reliance on the proxy rule exemptions contingent on the proxy advisor:
- Providing clients with enhanced disclosures about conflicts of interest.
- Adopting and publicly disclosing 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 before the time the advice is disseminated to the proxy advisors’ clients; and
- The proxy advisor provides its clients with a mechanism by which they can reasonably be expected to become aware of any written statements regarding 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).
The SEC also adopted rule amendments to:
- Codify its interpretation that the furnishing of proxy voting advice by proxy advisors generally constitutes a “solicitation” subject to the proxy rules.
- Clarify that the omission of certain information from proxy voting advice may, depending on the particular facts and circumstances, potentially violate the antifraud provisions of the proxy rules.
The rule amendments and supplemental guidance were each approved by a 3-1 vote, with Chair Clayton and Commissioners Peirce and Roisman voting in favor. Commissioner Lee dissented, arguing that the rule amendments are unwarranted, severely limit the ability of shareholders to hold company management accountable and make it more difficult and expensive for investors to vote in reliance on proxy voting advice.
The rule amendments will become effective 60 days following their publication in the Federal Register. The final rules provide for a one-year transition period after the publication of the final rules to give proxy advisors sufficient time to develop processes and systems to comply with certain aspects of the new rules. Specifically, proxy advisors will not be required to comply with the amendments to Exchange Act Rule 14a-2(b)(9) until December 1, 2021.4 The supplemental guidance will become effective upon publication in the Federal Register.
The amendments were informed, in part, by extensive feedback the SEC Staff received during its November 2018 roundtable on the proxy process and thousands of comment letters submitted since, including in response to the November 2019 proposing release. The final rules mark the culmination of a decade-long debate about the appropriate regulatory response to the role – and arguably outsized influence – of proxy advisors.
In our view, the rule amendments will have minimal impact on public companies and proxy advisors, in part because they give proxy advisors wide latitude to comply with the new obligations, which in some cases can be satisfied through existing policies and practices (see box below). To continue its efforts in reforming the U.S. proxy system, the SEC plans to adopt final rules relating to the use of universal proxies and procedural requirements and resubmission thresholds for shareholder proposals by October 2020.
Summary of Proxy Solicitation Rule Amendments
Conditions to Proxy Advisors Being Able to Rely on Proxy Rule Exemptions
Under the proxy rules, unless an exemption applies, a person engaging in a proxy solicitation must generally comply with certain filing and information requirements designed to ensure that shareholders solicited by the person receive materially complete and accurate information. Exchange Act Rule 14a-2(b) exempts certain types of proxy solicitations from the filing and information requirements of the proxy rules. Proxy advisors5 do not file their proxy voting advice as solicitation materials, in reliance on the exemptions set forth in Rule 14a-2(b)(1) and (b)(3). Indeed, to do so would significantly undercut their business models, which are based on subscriptions paid by their institutional investor clients. The SEC amended its rules to make such continued reliance subject to certain limitations and conditions described below.
Enhanced Conflict of Interest Disclosures
First, to continue relying on the exemptions, proxy advisors will be required to provide more detailed disclosures about material conflicts of interest to enable their clients to assess the objectivity and reliability of their proxy voting advice. Rule 14a-2(b)(9)(i) will require proxy advisors to include the following disclosures prominently in their proxy voting advice (or electronic medium used to deliver the advice):
- Any information regarding an interest, transaction or relationship of the proxy advisor (or its affiliate) 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.
Information regarding an interest, transaction or relationship that would be required to be disclosed may include disclosure about certain business practices in which the proxy advisor engages that might reasonably be expected to call into question the objectivity or independence of its proxy voting advice (examples provided in a footnote to the release include selectively consulting with certain clients before issuing a voting recommendation on a contested director election or a merger).6
The final rules provide a general framework for conflict of interest disclosure, but allow proxy advisors to use their discretion and particular knowledge of the circumstances to assess materiality and determine the appropriate level of detail to disclose (e.g., whether to provide dollar amounts or describe terminated relationships). The SEC warned that boilerplate language would not be sufficient to satisfy the new condition.
The rules also allow proxy advisors to use their judgment when deciding the manner in which they will provide conflict disclosures, which could include an active hyperlink or “click-through” feature from its electronic platform directing clients to a more comprehensive description of the proxy advisor’s policies and procedures governing conflicts of interest maintained on its publicly available website.
Concurrent Delivery of Proxy Voting Advice to Companies and Clients and Notice to Clients About Company Written Statements Regarding Proxy Voting Advice
To continue relying on the exemptions, a proxy advisor will have to satisfy two new principles-based requirements that advance the SEC’s objectives but have been tailored to reduce the burdens on proxy advisors. Each includes a safe harbor, or non-exclusive means by which a proxy advisor may satisfy these conditions to the exemptions.
New Rule 14a-2(b)(9)(ii)(A) will require a proxy advisor to adopt and publicly disclose written policies and procedures reasonably designed to ensure that companies that are the subject of proxy voting advice have access to such advice at or before the time the advice is disseminated to the proxy advisors’ clients.
A proxy advisor will be deemed to satisfy this rule if it has written policies and procedures reasonably designed to provide a company with a copy of the proxy advisor’s proxy voting advice, at no charge, no later than the time it is disseminated to the proxy advisor’s clients. These policies and procedures may include conditions requiring that:
- The company has filed its definitive proxy statement at least 40 calendar days before the date of the shareholder meeting (or if no meeting is held, at least 40 calendar days before the date the votes, consents, or authorizations may be used to effect the proposed action); and
- The company has acknowledged that it will use the copy of the proxy voting advice only for its internal purposes and/or in connection with the solicitation and it will not be published or otherwise shared except with the company’s employees or advisers.
The SEC does not prescribe the manner in which a proxy advisor must provide the company with its proxy voting advice, but provides as an example that a proxy advisor could send the company an email either attaching, or including an active hyperlink to, its proxy research report. To satisfy this requirement, the new rules clarify that a proxy advisor’s policies and procedures need not require it to provide a company with subsequently revised versions of its proxy voting advice for the same meeting (or vote, consent or authorization).
The final rules differ significantly from the proposed rules that would have provided companies with an opportunity to review and provide feedback on draft proxy voting advice before it is disseminated to the proxy advisors’ clients. The SEC acknowledges in the adopting release that ISS and Glass Lewis currently provide some of their clients an advance review opportunity and encourage them to continue that practice even though not required by the final rules.
New Rule 14a-2(b)(9)(ii)(B) requires a proxy advisor to adopt and publicly disclose written policies and procedures reasonably designed to ensure that the proxy advisor provides its clients with a mechanism by which they can reasonably be expected to become aware of any written statements regarding 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). The “timely manner” requirement will be met if the proxy advisor’s client has sufficient time to consider the company’s response in connection with a vote. The new rules do not condition the availability of the proxy rule exemptions on proxy advisors disabling or suspending pre-populated and automatic submission of votes in instances where a company indicates it intends to file or has filed a response to the voting advice as additional soliciting materials.
A proxy advisor will be deemed to satisfy this requirement if it has written policies and procedures reasonably designed to inform clients when a company that is the subject of proxy voting advice notifies the proxy advisor that it intends to file or has filed with the SEC additional soliciting materials setting forth the company’s statement regarding the advice, by notifying clients:
- On its electronic platform that the company intends to file or has filed such additional soliciting materials and including an active hyperlink to those materials on EDGAR when available; or
- Through email or other electronic means that the company intends to file or has filed such additional soliciting materials and including an active hyperlink to those materials on EDGAR when available.
The adopting release lists the following non-exclusive factors to consider when analyzing whether a proxy advisor has complied with the two principles-based requirements described in this section:
- 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.
- The reasonableness, based on facts and circumstances, of any fees charged by a proxy voting advice business to a company as a condition to receiving a copy of its proxy voting advice and the extent to which such fees may dissuade a company from seeking to review and provide a response to such proxy voting advice. (If a proxy advisor charges a fee to a company as a condition to receiving a copy of its proxy voting advice, it will not satisfy the safe harbor, which requires the advice to be provided to the company “at no charge.”)
These new concurrent delivery and notice to client conditions will not apply to proxy voting advice if it is based on custom voting policies that are proprietary to a proxy advisor’s client (although the enhanced conflict of interest disclosure rules will apply to such advice).7 The final rules also provide an exclusion for any portion of proxy voting advice that makes a recommendation to a security holder as to its vote, consent or authorization in a non-exempt solicitation involving certain M&A transactions or contested director elections, due to the accelerated timeframes at issue.
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Current Proxy Advisor Policies and Practices
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Proxy Voting Advice Generally Constitutes a “Solicitation”
In August 2019, the SEC published a new interpretation and guidance regarding the applicability of the federal proxy rules to proxy voting advice.10 It reiterated its longstanding view that the furnishing of proxy voting advice by proxy advisors generally constitutes a “solicitation” as defined in Exchange Act Rule 14a-1(l), which includes a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” The final rules codify this interpretation by explicitly adding to the definition of “solicitation” in Rule 14a-1(l) “[a]ny proxy voting advice that makes a recommendation to a security holder as to its vote, consent, or authorization on a specific matter for which security holder approval is solicited, and that is furnished by a person that markets its expertise as a provider of such proxy voting advice, separately from other forms of investment advice, and sells such proxy voting advice for a fee.” The SEC also amended Rule 14a-1(l)(2) to codify its view that proxy voting advice furnished only in response to an unprompted request would not constitute a “solicitation.” ISS and Glass Lewis had voiced strong opposition to this rule amendment, arguing that it could subject them to SEC enforcement or private litigation by companies based on matters of judgment, including their methodologies, opinions and recommendations. In October 2019, ISS filed suit asking a federal court to invalidate the August 2019 interpretation and guidance on substantive and procedural grounds – the parties agreed to stay the case until the earlier of (1) January 1, 2021 or (2) promulgation of these final rules.11
Examples of Information That May Be Misleading if Omitted From Proxy Voting Advice
Currently a note to Rule 14a-9 provides four examples of the type of information that a person engaged in a proxy solicitation may, depending on the particular facts and circumstances, need to disclose to avoid a potential violation of the antifraud provisions of the proxy rules. The SEC amended its rules to add as an example of information that could be misleading if omitted from proxy voting advice certain material information, such as the proxy advisor’s methodology, sources of information or conflicts of interest. The addition, which largely codifies current SEC guidance on the applicability of Rule 14a-9 to proxy voting advice, is designed to give proxy advisor clients greater insight as to the processes and methodologies proxy advisors use to formulate their proxy voting recommendations.
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Steps Public Companies Should Take When the
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Summary of Supplemental Guidance Regarding Investment Advisers’ Proxy Voting Responsibilities
Concurrent with adopting the proxy solicitation rule amendments, the SEC published a supplement to its August 2019 guidance to assist investment advisers in fulfilling their proxy voting responsibilities, particularly when relying on proxy advisors.
The new guidance is designed to help investment advisers in evaluating how to consider company responses to proxy advisor recommendations, which the SEC expects to become more readily available to proxy advisors and their clients in light of the proxy solicitation rule amendments. The guidance explains that a proxy advisor may assist an investment adviser with voting execution by using an electronic vote management system that allows the proxy advisor to (1) pre-populate the adviser’s ballots with suggested voting recommendations based on the investment adviser’s voting instructions to the proxy advisor and/or (2) automatically submit the adviser’s votes to be counted, known as automated voting or robo-voting.
The previous guidance outlined several steps an investment adviser can take to demonstrate it is making voting determinations in a client’s best interest, such as:
- Periodically sampling the pre-populated votes before they are cast; and
- Considering additional information that may become available regarding a proposal before the relevant votes are cast.
The new guidance provides that in addition to these steps, an investment adviser should consider whether its policies and procedures, including with respect to the automated voting of proxies, are reasonably designed to ensure that it exercises voting authority in its client’s best interest. The new guidance provides, as an example of a factor to consider, whether the investment adviser’s policies and procedures cover the scenario in which it learns that a company plans to file or has filed additional soliciting materials with the SEC after the investment adviser has received the proxy advisor’s voting recommendation but before the voting deadline. In that case, the guidance explains that, assuming the company files the additional information sufficiently in advance of the voting deadline and the information would reasonably be expected to affect the investment adviser’s voting determination, the investment adviser would likely need to consider such information before exercising voting authority to discharge its duty to vote in its client’s best interest. Because pre-populating and automated voting of proxies may result in proxy advisors possessing non-public information about how an investment adviser plans to vote a client’s securities, the guidance encourages investment advisers to review their agreements with proxy advisors to determine whether they would permit proxy advisors to use any such non-public information in a way that would not be in the best interest of an investment adviser’s client (e.g., can the proxy advisor share the information with third parties either on a stand-alone or aggregated basis?).
Under the new guidance, the SEC indicates that an investment adviser that uses automated voting should consider disclosing (1) when it uses automated voting and to what extent and (2) how its policies and procedures address the use of automated voting where it becomes aware that a company plans to file, before the voting deadline, additional soliciting material. Finally, the SEC encourages investment advisers to review carefully their disclosures of these matters to ensure that they are sufficiently detailed to enable a client to understand and provide informed consent with respect to the use of automated voting by an investment adviser as a means of exercising voting authority.
1 “Exemptions from the Proxy Rules for Proxy Voting Advice,” SEC Release No. 34-89372 (Jul. 22, 2020), available here.
2 “Supplement to Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers,” SEC Release No. IA-5537 (Jul. 22, 2020), available here. This guidance supplements the “Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers,” SEC Release No. IA-5325 (Aug. 21, 2019), 84 FR 47420 (Sep. 10, 2019), which was summarized in our Sidley Update titled “SEC Publishes New Guidance on Investment Advisers’ Proxy Voting Responsibilities and Reliance on Proxy Advisors” (Aug. 27, 2019), available here.
3 “Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice,” SEC Release No. 34-87457 (Nov. 5, 2019), available here, which was summarized in our Sidley Update titled “SEC Proposes Sweeping Changes to Proxy Solicitation and Shareholder Proposal Rules” (Nov. 8, 2019), available here.
5 New Rule 14a-2(b)(9) defines the term “proxy voting advice business” as “a person furnishing proxy voting advice covered by [Rule] 14a-1(l)(1)(iii)(A).” Although the proxy solicitation rule amendments use the new defined term, we refer to a proxy voting advice business colloquially as a proxy advisor in this Sidley Update.
6 In a footnote to the adopting release the SEC explained that this disclosure may be appropriate, in particular, where the proxy advisor consults with a client (e.g., an activist hedge fund) that is not directly involved as a party to the specific matter. This scenario could result in the consulted clients’ voting preferences influencing the proxy advisor’s voting recommendations given to other clients that were not consulted and without their knowledge.
8 See letter from Gary Retelny, President and CEO, Institutional Shareholder Services Inc. (Jan. 31, 2020), available here.
9 See letter from Kevin Cameron, Executive Chair, Glass, Lewis & Co., LLC (Feb. 3, 2020), available here.
11 ISS v. SEC et al., 1:19-cv-03275 (D. D.C. filed Oct. 31, 2019).
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