United States: SEC Applies Fiduciary Duties Analysis To Voting Obligations

On August 21, 2019, the Securities and Exchange Commission (SEC) voted 3 to 2 to adopt new interpretive guidance (the “Voting Interpretation”) applicable to investment advisers regarding their proxy voting responsibilities as a fiduciary.1 While the Voting Interpretation provides guidance that would be helpful for registered investment advisers in crafting their proxy voting policies, the Voting Interpretation is intended to apply to all investment advisers irrespective of their registered status. The following is a summary of the Voting Interpretation and a checklist to aid in updating compliance manuals to address these issues.

The Voting Interpretation restates and expands previous staff guidance2 regarding the scope of the voting obligations and considerations for the retention of proxy advisory firms in a manner consistent with the SEC’s final interpretation of investment adviser fiduciary duties3 (the “Fiduciary Interpretation”) adopted in the summer of 2019. Contemporaneously with the adoption of the Voting Interpretation, the SEC also adopted a separate interpretation that proxy advisory firms are making a “proxy solicitation” when they recommend votes to their clients and are subject to the antifraud requirements of Regulation 14A under the Securities Exchange Act of 1934.4

The Voting Interpretation states, “investment advisers are fiduciaries that owe each of their clients duties of care and loyalty with respect to services undertaken on the client’s behalf, including voting.” Investment advisers therefore must make voting determinations that are in the best interest of the client in light of a reasonable understanding of the client’s objectives and not place the investment adviser’s own interests ahead of the client’s interests. While retaining a proxy advisory firm would help mitigate potential conflicts of interest with its exercise of voting authority, the investment adviser would still have ultimate responsibility for making the voting investment decisions in the best interests of its clients, providing full and fair disclosure of potential conflicts of interest and obtaining informed consent from its clients.

Obligations When Voting

Duty of Care When Providing Advice

The Voting Interpretation suggests that investment advisers focus on material matters, such as mergers and contested elections, and the effect of those events on the value of its clients’ investments. Investment advisers should consider including the factors that it would consider in its votes on those material matters in its proxy-voting policies. In making voting decisions, investment advisers should ensure that that they are acting on information that is complete and accurate in all material respects.

Costs

As with the Fiduciary Interpretation, the Voting Interpretation requires investment advisers to consider the costs and the benefits of voting. For example, investment advisers must consider the costs of forgoing loan interest payments to recall shares when determining whether to vote. In addition, if the client would not expect any benefit for the vote (such as a client that typically does not hold long after the record date), the adviser and the client may wish to constrain the scope of voting activities.

Conflicts of Interests

Investment advisers should consider the interests of each client separately when making voting decisions and apply differing voting policies for clients with differing interests. Investment advisers facing a conflict of interest could also consider deferring to a proxy advisory firm or consulting the client.5

Considerations for Retaining a Proxy Advisory Firm

Required Diligence When Retaining Proxy Advisory Firms

As with other service providers, the SEC expects that investment advisers perform thorough diligence regarding whether the proxy advisory firm has the “capacity and competency to adequately analyze the matters for which the investment adviser is responsible for voting” by examining the adequacy and quality of the proxy advisory firm’s staffing, personnel, technology, processes and procedures.6 As part of the analysis, the investment adviser should assess (i) the factors that the proxy advisory firm uses in making voting recommendations, (ii) the third-party information that the firm utilizes, (iii) the firm’s interaction with issuers and third parties, and (iv) the firm’s processes for identification and addressing conflicts of interest.7 The investment adviser should also ensure that the proxy advisory firm makes specific disclosure regarding the conflicts of interest for the particular vote, such as whether the firm has provided advisory services to the subject of the vote and the amount of the compensation it received. The conflict may not be as relevant and the amount of diligence needed may not be as extensive if the proxy advisory firm is only performing administrative functions or voting according to a formula set by the investment adviser.

Supervision of Proxy Advisory Firm Votes

Investment advisers that have a retained proxy advisory firm must evaluate whether the firm’s recommendations are consistent with the investment adviser’s proxy voting policies before it casts votes. An investment adviser could fulfill its obligations by sampling the proxy advisory firm’s prepopulated votes, ensuring that the proxy advisory firm has policies and procedures to take into consideration subsequent information (such as a director vote becoming contested) and applying a higher level of analysis of the recommended vote for material matters. If the investment adviser becomes aware of proxy advisory firm relying on incorrect or incomplete information in making proxy recommendations, the investment adviser should conduct a reasonable investigation into the matter and the proxy advisory firm’s policies and procedures and consider the continued use of the proxy advisory firm.

Investment advisers must continue to evaluate the proxy advisory firm during the course of the relationship. To help satisfy its obligations, an investment adviser may require the proxy advisory firm to (i) notify the investment adviser of any business changes that the adviser has specified as material and (ii) update its methodologies, guidelines and voting recommendations on an ongoing basis.

Shaping Obligations

If an investment adviser has discretion over an investment account, the investment adviser would have implicit voting discretion. The Voting Interpretation, however, allows the investment adviser and its clients to shape the investment adviser’s voting responsibilities by agreement, so long as there is full and fair disclosure and informed consent to the voting arrangement. The Voting Interpretation lists several potential structures for voting advice, including but not limited to:

  • Preagreed voting determinations, such as a default vote in favor of management or shareholder proponents (potentially subject to conditions).
  • Agreeing not to vote if the act of voting would impose costs on the client without conferring a benefit.
  • Agreeing to focus exclusively on the high value events such as mergers and contested elections.

If an investment adviser has not limited its voting obligations by agreement, an investment adviser “should consider whether it is fulfilling its duty of care to its client in light of the scope of services to which it and the client have agreed” if it is not voting securities.

Appendix

Proxy Voting Policies Checklist

  • Written policies must be designed to ensure that votes are in the best interests of clients considered in light of the client’s interests and the investment adviser does not place the adviser’s interests ahead of the client’s.
    • Complete and accurate information. Investment advisers have the duty to ensure that their decisions are made based on complete and accurate information.
    • Costs considered. The costs, including opportunity costs, of voting should be considered in making voting decisions, including whether to recall securities.
    • Obligations scoped by agreement. Obligations may be limited by agreement to just vote as to particular items or not to vote.
  • Written policies must address how the adviser addresses material conflicts that arise.
    • Consider each client separately. Policies should address the interests of each client and consider adopting differing policies for each client to the extent that their interests differ, such as due to differing strategies and objectives.
    • Full disclosure of conflicts. Conflicts of interests should be fully and fairly disclosed to investors and consented to on an informed basis.
    • Potential outside source. An investment adviser may seek to mitigate conflicts through a third party, such as a proxy advisory firm.
  • Policies when investment adviser is voting.
    • Potential approaches
      • The investment adviser focuses on matters that would have a material impact on the value of the stock or other securities (such as contested elections or mergers for equity securities or amendments for debt securities) and votes with management on immaterial matters.
      • The investment adviser agrees not to vote if, for example, it has a short holding window and would not likely hold the stock on the date of the relevant vote.
      • The investment adviser discloses a predetermined voting policy with formulaic results.
    • Factors that would be considered in reaching voting decisions should be described.
  • Potential policies when using a proxy advisory firm.
    • Diligence on capabilities. Perform diligence on the proxy advisory firm with respect to its capacity and competency to analyze potential voting recommendations and its staffing, personnel, technology and procedures.
    • Policies for information assessment. An investment adviser must also ensure that the proxy advisory firm has adequate policies and procedures to ensure that the information relied upon is complete, accurate and up-to-date.
      • Specifically consider (either in policies or elsewhere documented):
        • The factors that the proxy advisory firm uses in making recommendations.8
        • The third-party information on which the proxy advisory firm relies.
        • Interaction between the proxy advisory firm and issuers and third parties.
        • The proxy advisory firm’s processes for identification, mitigation and specific disclosure of conflicts of interest.9
      • Evaluate recommendations in light of IA’s policies before voting. An investment adviser must evaluate whether the proxy advisory firm’s recommendations are consistent with the investment adviser’s proxy voting policies before it casts the recommended votes.
      • Follow up if concerns arise. An investment adviser must reasonably investigate the proxy advisory firm if it has reason to believe that the proxy advisory firm is relying on incomplete information.
      • Bring-down representations periodically. Consider requiring periodic representations from the proxy advisory firm regarding its policies, changes to its business and conflicts.

Footnotes

1.  “Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers,” Advisers Act Release 5325 available at https://www.sec.gov/rules/interp/2019/ia-5325.pdf.

2.  See Staff Legal Bulletin 20 available at http://www.sec.gov/interps/legal/cfslb20.htm.

3.  See our previous alert available at https://www.akingump.com/en/news-insights/sec-adopts-new-interpretation-of-fiduciary-duty.html.

4.  See SEC Interpretive Release, “Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice” Exchange Act Release 86721 (Aug. 21, 2019) available at https://www.sec.gov/rules/interp/2019/34-86721.pdf. Note, however, that proxy advisory firms are typically exempt from filing a proxy statement under Rule 14a-2(b)(3). See 17 C.F.R. § 240.14a-2.

5.  The SEC has previously brought an enforcement action when an investment adviser adopted proxy-voting policies that were friendly to union clients for all of its clients to help attract new clients. See Advisers Act Release 2872 (May 7, 2009) available at https://www.sec.gov/litigation/admin/2009/ia-2872.pdf.

6.  For example, an investment adviser may want to consider the proxy advisory firm’s methodologies for “say on pay votes” and how it constructs the peer group.

7.  Specific conflicts of interests to assess include, but are not limited to, (i) provision of services other than proxy voting recommendations or other proxy-related services or (ii) affiliations with persons who have taken a position on the vote, such as owners, lenders or significant sources of business.

8.  Proxy advisory firms typically publish these factors, which may be downloaded and retained on a periodic basis to document the file. Ensure that the correct list of factors is being retained. Also consider if the factors that are chosen are appropriate to the particular client or otherwise create a conflict of interest between the adviser and the client or between clients.

9.  Disclosure of conflicts of interest should be retained for files and should be assessed for whether to continue the relationship with the proxy advisory firm if the conflicts are material.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Cleary Gottlieb Steen & Hamilton LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Cleary Gottlieb Steen & Hamilton LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions