Proposed Amendments To The Swiss Code Of Obligations On Proxy Advisors

The Swiss Federal Council has opened a consultation on targeted amendments to the Swiss Code of Obligations intended to enhance transparency regarding the involvement of proxy advisors in Swiss stock corporations.

The proposed amendments to the Swiss Code of Obligations are the result of a parliamentary motion in 2019/2020 requiring the Swiss government to propose a new regulation address ing the conflicts of proxy advisers for their potential dual role in advising institutional inves tors on voting recommendations and listed companies on corporate governance and com pensation. While the new regulation fell short of a direct regulation of (Swiss and/or non Swiss) proxy advisers, it places transparency obligations on the board of directors of Swiss companies.

1 INTRODUCTION

The Swiss Federal Council has initiated a con sultation on targeted amendments to the Swiss Code of Obligations (CO). The amend ments aim to enhance transparency regarding the involvement of proxy advisors in Swiss stock corporations. The proposal responds to parliamentary Motion 19.4122 Minder and fo cuses narrowly on potential conflicts of inter est that may arise where proxy advisors, or firms offering proxy advisory services, also provide services to companies whose share holders they advise. The legislative approach is deliberately minimalist addressing proxy advisors only indirectly through transparency obligations placed on the board of directors of Swiss companies rather than imposing di rect regulation on proxy advisors.

2 LEGISLATIVE BACKGROUND AND REGULATORY RATIONALE

Proxy advisors have gained considerable in fluence over shareholders' meetings, in partic ular at listed companies, by issuing voting rec ommendations that are often followed by in stitutional investors. While proxy advisors provide an important service to shareholders and can undoubtedly improve corporate gov ernance, conflicts of interest are structurally inherent in the business model of proxy advi sors who leverage the knowledge they acquire analyzing companies in view of providing proxy advisory services by also offering gov ernance consulting or ESG-related services.

This dual role creates a tension, as ties to listed companies may influence – or be perceived to influence – the independence of their analysis and recommendations. If a proxy advisor has been involved in structuring proposals sub mitted to the shareholders, it is highly unlikely to recommend voting against those pro posals. Boards of directors, on the other hand, may be inclined to align their proposals with the proxy advisor's guidelines or anticipated recommendations in order to secure share holder approval. This may deteriorate the quality of proposals submitted to the share holders because the voting policies are typi cally standardized and advice rendered by the proxy advisers based on their policies may not adequately reflect the company's specific cir cumstances. Such an alignment may also con flict with the boards of directors' duty to act in their company's interest, which may not al ways be aligned with the guidelines and rec ommendations of proxy advisors.

As two of the most influential proxy advisory firms in Switzerland, ISS and Glass Lewis, do not maintain a presence in Switzerland, it is difficult to establish an effective regulatory framework that would capture non-Swiss proxy advisors. In any case, direct regulation of ISS and Glass Lewis as most influential proxy advisory firms in Switzerland would have likely triggered allegations of extraterri torial reach. Switzerland is not in a position to simply replicate the EU regime, which requires member states to impose direct obligations on proxy advisors in relation to disclosures and potential conflicts of interest (including the obligation to publish a code of conduct). In the United States, the Securities and Ex change Commission of the United States (SEC) introduced rules for proxy advisors a few years ago with a view to enhancing the quality and transparency of proxy advisory services. However, these have basically been aban doned under the current administration. 

In addition, a significant proportion of inves tors in Swiss listed companies are based out side Switzerland. This makes it difficult to reg ulate proxy advisory services directly and helps explain why the initiative launched by economiesuisse in its Directive for Institu tional Investors for the Exercise of Their Par ticipation Rights in Stock Corporations (Richt linie für Institutionelle Investoren zur Ausübung ihrer Mitwirkungsrechte bei Ak tiengesellschaften) – which, among other things, calls on institutional investors to assess potential conflicts of interest affecting proxy advisors – has had only limited impact, as the directive was adopted solely by Swiss institu tional investors.

As a result, Switzerland has so far refrained from statutory regulation of proxy advisors. The present proposal reflects the political conclusion that a complete absence of statu tory rules is no longer appropriate, while at the same time rejecting a comprehensive reg ulatory framework for reasons of practicabil ity. The proposed solution aims at enhancing transparency ahead of and at shareholders' meetings, thereby strengthening shareholder decision‑making, without restricting contrac tual freedom or creating a burdensome, yet potentially ineffective, supervisory regime.

3. NEW DISCLOSURE REGIME

3.1 Scope and Trigger of the Disclosure Obligation

The proposal introduces a new article 700a CO establishing a disclosure obligation for the board of directors in connection with share holders' meetings. 

The obligation applies to all Swiss stock cor porations, whether listed or privately held. There is no threshold based on company size or the significance of the proxy advisor. How ever, proxy advisors are rarely engaged by companies whose shares are not listed. The new regime will therefore be largely relevant to listed companies only.

Rather than imposing regulatory duties or conduct rules on proxy advisory firm, the ob ligation applies exclusively at the level of the company. Potential conflicts are thus ad dressed through corporate transparency and shareholder information. The Federal Council refrained from addressing the underlying problem that is inherent in the business model of proxy advisors, citing concerns with restricting the contractual freedom of proxy advisors and practical difficulties of regulating service providers who, with the exception of Ethos, do not have a physical presence in Swit zerland and generally provide their services on a cross-border basis..

Disclosure is required only if the company it self, or another company within the same group, has obtained services in the current or preceding financial year from an undertaking that also offers proxy advisory services. It is not necessary that the undertaking issued voting recommendations regarding the com pany; it is sufficient that proxy advisory ser vices form part of the service provider's com mercial activities.

Proxy advisory services are broadly defined as the professional analysis of companies, in cluding research, for the purpose of inform ing, advising or issuing voting recommenda tions to shareholders in connection with shareholders' meetings.

3.2 Content and Timing of Disclosure

Where the disclosure obligation is triggered, the board of directors must include the re quired information in the invitation to the shareholders' meeting. The disclosure must identify the undertaking concerned (name and registered office) and describe the ser vices provided. This should enable sharehold ers to assess which agenda items are poten tially affected by the conflict of interest. The draft does not require disclosure of remuner ation or other commercially sensitive contrac tual details.

If the relevant services are obtained between the publication of the invitation and the shareholders' meeting itself, the information must be disclosed at the shareholders' meet ing. A disclosure in the minutes of the meeting is not required. In our view, this would have been desirable and may be a legislative over sight.

3.3 Exception

The board of directors may dispense with dis closure if the service provider confirms that it has not issued any voting recommendations on the agenda items of the shareholders' meeting. This is appropriate as there is argua bly no potential for conflicts of interest with respect to that proxy advisor and that specific shareholders' meeting.

In practice, companies may wish to obtain such confirmations in advance or even go one step further and require the adviser under the terms of its engagement not to provide any voting recommendations that would trigger a disclosure duty without informing the com pany in advance. In the absence of such an un dertaking, it may be advisable for the com pany to reconfirm, shortly before the relevant shareholders' meeting, that no voting recom mendations have been provided in the mean time.

3.4 Legal Consequences of Non‑Compli ance

The proposal does not introduce regulatory supervision or administrative sanctions. En forcement relies exclusively on existing com pany law mechanisms. A failure to disclose may lead to personal liability of board members under article 754 CO. However, the burden of proof for a successful claim of di rector liability would be high; in particular, a plaintiff would have to prove not only a breach of the disclosure duty but also that it caused damages. 

A failure to disclose may also render share holder resolutions challengeable under arti cle 706 CO where the undisclosed conflict of interest tainted the resolution. The consulta tion report does not discuss whether the breach alone suffices to set aside the resolu tions taken at the general meeting as is gen erally the case in case of an incomplete invita tion or if the claimant will need to prove that the breach affected the outcome of the deci sion-making process, under the more protec tive rule applicable to undue participation in a shareholders' meeting. The right to challenge lapses if the action is not brought within two months of the shareholders' meeting, at which time shareholders may not necessarily be aware that the company had retained the ser vices of a proxy advisor.

If the service provider provides wrong or mis leading information on a potential conflict of interest (i.e., wrongly confirms that it has not issued any voting recommendations), the members of the board should generally not incur liability, unless the board had actual knowledge of this fact or were negligent.

In practice, it is likely to be difficult to hold proxy advisors liable for misinforming Swiss companies, as proving recoverable damage in a civil court in such cases will generally be challenging. Moreover, shareholders will gen erally not have standing to sue against the proxy adviser.

4 TECHNICAL CORRECTIONS TO THE 2023 COMPANY LAW REFORM

The consultation draft also includes several minor technical corrections addressing draft ing oversights from the 2023 company law re form. These amendments are purely clarifica tory and are of limited practical relevance.

5 PRACTICAL IMPLICATIONS AND OUTLOOK

The proposed disclosure regime will be mainly relevant for listed companies that engage governance advisers or firms with proxy advi sory activities. Ahead of shareholders' meet ings, boards and legal teams will need to re view existing advisory relationships and assess whether any service provider falls within the scope of the new rules. However, the admin istrative burden for this as well as for any re quired disclosure itself is, overall, fairly light. And while the explanatory report does men tion potential additional risk of liability and challenges to corporate resolutions, we do not believe that the risk exposure of boards of directors changes significantly.

While we welcome the rather cautious step towards greater transparency, the proposal falls short of regulating a broader and more general problem: the quality of proxy advice. For example, the Swiss regulator could have decided for a more innovative regulatory framework giving Swiss listed companies the right to be heard before proxy advisers issue a recommendation to their clients or to have a statement of the Swiss listed company in cluded in the recommendation of the proxy advisers. The outcome of the consultation will determine whether the proposed minimalist model is maintained or whether further tight ening is pursued during the legislative pro cess.

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