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News August 6, 2018 Issue

Proxy Advisory Firms Again Come Under the SEC Spotlight

Advisers’ use of proxy advisory firms, including the degree to which advisers follow proxy advisers’ recommendations when they vote, will again come before the SEC, as part of a planned roundtable on the proxy process this fall. Whether any changes will result is another matter.

The roundtable, a precise date for which has yet to be determined, was announced by SEC chairman Jay Clayton July 30. While the role of proxy advisory firms and other issues that affect investment advisers will make up a significant segment of the session, much of the roundtable will be devoted to proxy issues that involve corporations, according to a list of topics that Clayton issued and asked the agency staff to consider as they create an agenda.

The roundtable may have been prompted in part by letters from six U.S. senators in May 2018 to Glass Lewis and Institutional Shareholder Services, which the letters said constitute 97 percent of the proxy advisory services nationwide. In those letters, the senators expressed concerns and asked questions about how each firm conducts its proxy advisory process. In addition, a recent white paper from Stanford University, "The Big Thumb on the Scale – An Overview of the Proxy Advisory Industry," published the same month, discussed the degree of influence that proxy advisory firms have on proxy voting and whether such influence serves shareholder interests.

"The roundtable agenda may address the issues that the senators highlighted in the letters," said Sidley Austin partner Holly Gregory. "These include whether proxy advisory firm voting systems function in a manner that is and should be exempt from the proxy solicitation rules, the accuracy of proxy adviser reports and the ability for companies to review draft recommendations and reports, and proxy adviser conflicts of interest and appropriate handling of such conflicts."

Past concerns

The role of proxy advisory firms in working with advisers was something of a hot issue in 2013 and 2014, when then-commissioner Daniel Gallagher and others raised the question of whether advisers were relying too much on proxy advisory firms’ recommendations. During a roundtable on the subject in December 2013, he and other commissioners, as well as the heads of the two largest proxy advisory firms and others offered their views in a somewhat contentious four-hour meeting (ACA Insight, 12/16/13).

The result of that roundtable was the issuance of new guidance jointly issued by the Division of Investment Management and the Division of Corporate Finance, in the form of 13 questions and answers, to help both advisers and corporations comply with Rule 206(4)-6, the Proxy Voting Rule, when they cast proxies for clients, as well as when they retain and work with proxy advisory firms. The new guidance, while viewed as helpful in that it further articulated and clarified the SEC’s views on the use of proxy advisers, was not seen as breaking much new ground, however (ACA Insight, 7/14/14).

"It reminds advisers of their watchdog role," said Gregory at the time. "It highlights the fact that while it’s fine to retain the services of a proxy advisory firm, a discretionary investment adviser cannot simply delegate away its obligation to oversee the proxy voting process."

"If an investment adviser retains a proxy adviser," she said, "it must determine that the proxy adviser has the capacity and competence to vote proxies consistent with the best interests of its clients and continually monitor that proxy adviser’s performance. As with any fiduciary, an investment adviser has a responsibility to provide ongoing oversight."

Topics likely to be covered

While the final agenda for the coming roundtable is not yet set, among the topics that Clayton said he would like to see covered are the following relating to proxy advisory firms, which he said "provide a number of services related to proxy voting, which include aggregating and standardizing information, providing platforms for managing votes, and providing voting recommendations."

The following five areas within the topic of proxy advisory firms "warrant particular attention," he said.

Whether various factors, including legal requirements, have resulted in investment advisers to funds and other clients relying on proxy advisory firms for information aggregation and voting recommendations to a greater extent than they should, and whether the extent of reliance on these firms is in the best interests of investment advisers and their clients, including funds and fund shareholders;

  • Whether issuers are being given an appropriate opportunity to raise concerns if they disagree with a proxy advisory firm’s recommendations, including, in particular, if the recommendation is based on erroneous, materially incomplete, or outdated information;
  • Whether there is sufficient transparency about a proxy advisory firm’s voting policies and procedures so that companies, investors, and other market participants can understand how the advisory firm reached its voting recommendations on a particular matter, and whether comparisons of recommendations across similarly situated companies have value;
  • Whether there are conflicts of interest, including with respect to related consulting services provided by proxy advisory firms, and, if so, whether those conflicts are adequately disclosed and mitigated; and
  • The appropriate regulatory regime for proxy advisory firms and whether prior staff guidance about investment advisers’ responsibilities in voting client proxies and retaining proxy advisory firms should be modified, rescinded, or supplemented.

"There is someone, the adviser or the fund board, charged with a fiduciary duty to make sure the proxy service is voting in a way that is in the best interests of the client/fund," said Morgan Lewis partner John McGuire. "While I think it is an interesting question, I think it is hard for someone to second guess what is in the best interest of the client and the ultimate answer is, the SEC already requires that funds disclose their proxy voting record. If a shareholder does not agree with the way his fund (through ISS or Glass) is voting proxies, the shareholder can sell the fund and move his money elsewhere."

More input from individual shareholders

While most of the remaining topics that Clayton proposed appear to address issues more tied to corporations than to advisers, one area listed under the topic of "retail shareholder participation" would be of interest to advisers, said Mayer Brown partner Adam Kanter. Specifically, that area is:

  • How existing rules or market practices affect the ability of individuals who invest in the public markets through investment vehicles such as mutual funds and pension funds to participate in the governance of public companies in which they have an interest. For example, some have suggested that fund shareholders should have a means of providing input into how the fund adviser votes its portfolio securities.

Just how the SEC might address the issue of gaining more direct input from individual shareholders in the governing of public companies, rather than do so through advisers at mutual funds or pension funds, might be problematic, Kanter said. "It would seem impractical to poll every shareholder on every topic that might come up for a proxy vote."

Whether some specific actions, or just actions of little consequence, result from the roundtable, he said, "advisers should pay attention to what’s going to happen here because you should always know what the SEC thinks in regard to these issues."