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News September 24, 2018 Issue

SEC Withdraws Two No-Action Letters Regarding Use of Proxy Advisory Firms

The SEC on September 13 did something unexpected: It pulled two 2004 Division of Investment Management no-action letters concerning advisers’ use of proxy advisory firms in preparation for a planned November roundtable on the subject. What made the move unusual was not that the agency decided to supersede the letters, but that it did so by actually removing them, rather than simply issuing new guidance indicating a change of course.

The two letters in question, the May 27, 2004 Egan-Jones Proxy Services letter and the September 15, 2004 Institutional Shareholder Services letter, offer staff interpretations on how advisory firms are allowed to work with proxy advisory firms, and have been relied on since then by advisers. The Egan-Jones letter provides conditions under which it would be appropriate for an advisory firm to rely on voting recommendations from an independent third-party proxy advisory firm, while the Institutional Shareholder Services letter makes clear that one way to satisfy those conditions would be ensuring that a proxy firm has adequate procedures in place to avoid conflicts of interest.

Pickard Djinis & Pisarri partner Mari-Anne Pisarri, who wrote the request to the Investment Management staff that generated the Institutional Shareholder Services letter, said she was “troubled” by the removal of the letters from the SEC’s website. This not only raises questions for those that have been relying on the guidance for the past 14 years, she said, but raises questions about other agency documents that refer to them. For instance, she said, the SEC’s Staff Legal Bulletin 20 refers to the letters three times. “When readers then look for these letters and find that they no longer exist, what does that mean?”

“If the SEC disagrees with a particular no-action or interpretive position, it can simply direct the staff to issue a letter or other communication publicly withdrawing the prior position,” said Stradley Ronon partner Lawrence Stadulis.

“However,” he said, “removing prior letters from the SEC’s site that have been overturned or superseded is troubling for three reasons. First, and foremost, it seems inconsistent with a stated agency policy to increase regulatory transparency. Second, it creates potential regulatory confusion to the extent that the removed letters continue to be cited in other existing agency materials and, therefore, invite public review. Finally, it is, essentially, pointless given the fact that removed letters remain publicly accessible through other outlets, such as subscription-based legal databases.”

The use of proxy advisory firms by advisers has been a somewhat contentious subject over the years, and in fact was the subject of a 2013 SEC roundtable (ACA Insight, 12/16/13). One of those concerns addressed at the time, expressed in particular by then-commissioner Daniel Gallagher, was that there was an over-reliance by advisers on the recommendations of proxy firms, and that doing so might at times result in votes that were not in the best interest of clients. In addition, there was concern that two proxy advisory firms, Institutional Investor Services and Glass Lewis, dominate the field. Those two concerns, among others, still exist today.

The agency did address some adviser concerns in June 2014, when it issued guidance in the form of 13 questions and answers designed to help both advisers and corporations comply with Rule 206(4)-6, the Proxy Voting Rule (ACA Insight, 7/14/14). The questions answered include topics such as the steps advisers should take to demonstrate that proxy votes are cast in accordance with clients’ best interests, whether an adviser is required to vote every proxy, the considerations an adviser may wish to take into account if it retains a proxy advisory firm to assist it in its proxy voting duties, and whether an adviser has an ongoing duty to oversee a proxy advisory firm that it retains.

SEC chairman Jay Clayton, on the same day as the withdrawal of the two no-action letters, issued a “Statement Regarding SEC Staff Views,” in which he said that “all staff statements are nonbinding and create no enforceable legal rights or obligations of the Commission or other parties.” While it has long been known that agency staff guidance, letters, speeches, answers to frequently asked questions and more do not carry the force of law or of an official SEC Rule, advisers, their legal advisers and consultants have for years been relying on staff guidance to help stay in compliance with those laws and rules.

Cause and effect

What prompted Clayton’s statement and the decision to pull the two no-action letters? Perhaps it was an August 2 letter sent to the U.S. Government Accountability Office by six U.S. senators, seeking a determination on whether the two no-action letters in question constitute a rule under the Congressional Review Act (CRA). The senators’ letter points out that the CRA provides a broad definition of a rule that may include agency pronouncements “even if they are not subject to notice and comment rulemaking requirements.”

The key question involving staff letters that lies behind this issue, Stadulis said, is this: “At what point does an interpretive or no-action letter end and the substance of the letter become a de facto new rule that requires SEC approval, public notice and comment?”

Clayton’s statement appears to reinforce what has been common knowledge to many in the asset management community, that staff interpretative guidance, whatever its form, does not carry with it the force of a rule.

The effect on advisers

A more practical question that arises for advisers and others, and one that goes beyond the immediate issue concerning the use of proxy advisory firms, is this: What are advisers, their attorneys and consultants supposed to rely on now when seeking to stay in compliance, now that Clayton has reinforced the lesser status of staff guidance, and withdrawn two much-relied-upon no-action letters?

“I think it does a disservice to the regulated entities because in the past five years the Commission and the staff have done a great job of reaching out to assist registrants with their compliance efforts,” Pisarri said. “Of course staff guidance does not have the force of a statute or a regulation, but there are lots of ways in which a rule can be interpreted, and staff guidance is a valuable resource.”

“People have acted in compliance with these no-action letters for a decade and a half, and it hasn’t been an issue,” said Morgan Lewis partner John McGuire. “I think there’s a clear connection between the pulling of the no-action letters and chairman Clayton’s statement regarding SEC staff views. The SEC said, however, that the pulling of the letters was intended to spark a discussion at the roundtable.”

The roundtable

Announced by the agency on July 30, the roundtable is planned to cover a wide variety of topics concerning the proxy process, not just those of concern to advisory firms. For instance, other topics to be covered include the accuracy, transparency and efficiency in the proxy system as used by both companies and investors, and retail shareholder participation in votes.

Topics of interest to advisory firms include:

  • Whether various factors have resulted in investment advisers 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;"

  • Whether issuers are being given an appropriate opportunity to raise concerns if they disagree with a proxy advisory firm's recommendations; 
  • Whether there is “sufficient transparency” about a proxy advisory firm’s voting policies and procedures; 
  • Whether there are conflicts of interest, including with respect to related consulting services provided by proxy advisory firms; 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.”