The newest SEC Commissioner, Elad Roisman, who has reportedly gotten the nod to head up the SEC's efforts regarding proxy advisory firms, told the U.S. Chamber of Commerce in late March that he expects the SEC to issue new guidance, sometime after proxy season this year, regarding the use by institutional investors of proxy advisory firm recommendations, as reported in The Deal. And, according to the WSJ, Roisman has "also questioned whether it was appropriate for the SEC to exempt proxy advisers from some regulations on investment advice, including whether they can both advise a company and make recommendations to its shareholders at the same time." However, as discussed in this PubCo post, the question of whether proxy advisory firms, such as ISS and Glass Lewis, have undue influence over the voting process and should be reined in has long been something of a political donnybrook. With the issue of proxy advisory firm regulation so politically freighted, will the SEC limit the scope of its effort to guidance to institutional investors or, more controversially, go further and impose regulation on proxy advisors, as many companies have advocated?
In 2004, the staff of the Division of Investment Management issued two no-action letters, Egan-Jones Proxy Services (May 27, 2004) and Institutional Shareholder Services, Inc. (Sept. 15, 2004), which provided staff guidance about investment advisers' responsibilities in voting client proxies and retaining proxy advisory firms. Frequently disparaged (see this PubCo post), those two letters were withdrawn by the staff in September 2018, in anticipation of the SEC's proxy roundtable.
By way of background, as fiduciaries, investment advisers owe their clients duties of care and loyalty with respect to services provided, including proxy voting. Accordingly, in voting client securities, an investment adviser must adopt and implement policies and procedures reasonably designed to ensure that the adviser votes proxies in the best interest of its clients. The two now-withdrawn no-action letters indicated that one way advisers could demonstrate that proxies were voted in their clients' best interest was to vote client securities based on the recommendations of an independent third party—including a proxy advisory firm—which served to "cleanse" the vote of any conflict on the part of the investment adviser. Historically, investment advisers have frequently looked to proxy advisory firms to fill this role. As a result, the staff's guidance was often criticized for having "institutionalized" the role of—and, arguably, the over-reliance of investment advisers on—proxy advisory firms, in effect transforming them into faux regulators.
As discussed in this Cooley Alert, in response to frequently voiced criticisms that proxy advisory firms wielded too much influence—with too little accountability—in corporate elections and other corporate matters, in 2014, the SEC's Divisions of Investment Management and Corp Fin issued Staff Legal Bulletin No. 20, "Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms," which sought to reinforce the responsibilities of investment advisers as voters by reinvigorating their due diligence and oversight obligations with respect to any proxy advisory firms on which they relied. In that guidance, the staff indicated additional steps that an investment adviser could take to demonstrate that proxy votes were cast in accordance with clients' best interests. In addition, investment advisers were advised to "adopt and implement policies and procedures that are reasonably designed to provide sufficient ongoing oversight of the third party in order to ensure that the investment adviser, acting through the third party, continues to vote proxies in the best interests of its clients," including measures to identify and address the proxy advisory firm's conflicts on an ongoing basis. For example, the investment adviser was advised to ascertain, among other things, "whether the proxy advisory firm has the capacity and competency to adequately analyze proxy issues." However, the SLB left the two no-action letters in effect, and calls for regulation of proxy advisory firms have continued unabated. (See this PubCo post.)
In the staff statement, the staff indicated that the notice of withdrawal of the two letters was provided to facilitate the discussion at the SEC's 2018 Proxy Roundtable and that it intended to use information and feedback learned at the Roundtable in making recommendations to the SEC with respect to proxy advisory firms, including with regard to SLB 20 (discussed in the SideBar above). (Note that, in remarks yesterday to the SEC Speaks conference, SEC Commissioner Hester Peirce indicated that, with respect to those two no-action letters, in her view, "the letters should never have been issued, and it certainly is time to reassess the industry that grew up around those no-action letters with their purportedly limited reach.")
As it turned out, the panel's discussion at the Proxy Roundtable regarding the power of proxy advisors was remarkably tepid. Surprisingly, there did not seem to be much call for registration or other regulation of proxy advisors, possibly because of the fear of rising costs associated with registration and further regulation. (See this PubCo post.) (Note, however, that, legislators seem to regularly introduce legislation, to no avail, that would require the SEC to regulate proxy advisers. See, for example, the Corporate Governance Fairness Act, introduced in 2018.)
At the proxy roundtable, in addition to proxy advisory regulation, the discussion regarding proxy advisory firms addressed robo-voting, conflicts of interest and difficulty in correcting erroneous records. Investment advisors on the panel made the case, with regard to the recommendations of proxy advisors, that there was very little so-called "robo-voting." Asset manager State Street, for example, said that proxy advisors were used to execute State Street's own voting guidelines, as well as for research and operational ease. Others described a similar approach. ISS and Glass Lewis maintained that they do not drive voting decisions; rather, investors follow their own policies, and ISS and GL help execute votes in accordance with instructions. GL also noted that 80% of its voting was customized. An active fund manager indicated that it needed proxy advisors for its independent research function, workflow management and data aggregation. A smaller wealth manager advised that, from a practical perspective, it needed the help of proxy advisors to fulfill its duty of care and execute mechanics; without the assistance of proxy advisors, over time, its research department would spend more time on proxy research than on investment analysis. Its practice was first to perform due diligence on the benchmark standards and determine if they were consistent with the view of the firm.
With regard to conflicts of interest, the proxy advisors discussed how they address the standard proxy advisor conflicts of interest through disclosure and ethical walls. However, the representative of the American Enterprise Institute, former Senator Phil Gramm, had a novel take on the issue: in his view, the real conflict of interest lay in those organized special interest groups that, because they are unable to convince the legislature or the agencies to adopt laws or rules promoting their views, instead use "intimidation" to impose policies on corporate America regarding social issues that, in Gramm's view, are not in the interests of shareholders. The problem, as he saw it, arises out of the SEC's position that allowed index and other investment funds to fulfill their fiduciary responsibilities by following the advice of proxy advisors. He advocated that no investment advisor should be exempt from fulfilling its fiduciary duties and that the SEC reverse its position on Staff Legal Bulletin No. 20. (There was a lot more to it, including allusions to the Enlightenment and the flat-earth society. See this PubCo post.) The State Street representative agreed that it did have a fiduciary responsibility, but that it believed that ESG affects sustainable long-term economic value and shareholder returns and that its strategy involved taking these issues into account. Another issue discussed was the difficulty experienced by smaller companies in attempting to correct the record when errors are made in the proxy advisors' analyses.
Of course, beyond the Roundtable, others have expressed strong views advocating proxy advisor regulation. As discussed in the WSJ, lobbyists such as the U.S. Chamber of Commerce and the National Association of Manufacturers, as well as Nasdaq and the NYSE have "mounted a well-funded offensive against the industry." In addition, the WSJ reported, over 300 companies "signed on to a February Nasdaq, Inc. letter calling for the SEC to take 'strong action to regulate proxy advisory firms.'" These corporate groups, the WSJ reported, "are pushing the SEC to allow companies more leeway to address the firms' recommendations before they are sent to shareholders, a process that would also allow them to flag any errors in the recommendations. Some corporate groups, including NAM, want the SEC to consider new registration requirements for proxy advisers and add new disclosure requirements related to possible conflicts of interest."
There is, however, prominent opposition to that position. In remarks yesterday at the same SEC Speaks conference, Investor Advocate Rick Fleming identified proxy advisory firm regulation as one of ideas percolating at the SEC that he was "less enthusiastic about" (to put it mildly):
"I think it is fair to say that investors are wary about efforts to regulate proxy advisors. As many of you know, asset managers who hold shares in a wide range of companies face a logistical challenge in voting on numerous items each proxy season. Investment advisers are also required to vote shares in a way that is faithful to the fiduciary duties they owe their clients. To satisfy this obligation in a cost-effective way, many asset managers use the services of a proxy advisor. In addition to assisting with vote execution and regulatory reporting across markets globally, the advisors monitor the issues that are up for a vote, collect and analyze information and data, and give asset managers advice on how to vote their shares in accordance with the asset managers' expressed wishes.
"Some have criticized proxy advisors and allege that they have conflicts of interest in their business models, factual errors in their analytical processes, and a political agenda that supports social policies at the expense of investment returns. All of these things would cause me great concern, except for one thing—the investors who are paying for this service are not the ones who are expressing those concerns. Indeed, at the Roundtable on the Proxy Process that the Commission held last November, I think the investors made it pretty clear that they are relatively happy with the services they receive from proxy advisors. This is not to suggest that proxy advisors are perfect, but to the extent that any problems exist, it seems that their paying customers should be the ones to raise them....
"To be clear, some investors have expressed concerns that fund advisors may cast proxy votes in opposition to the stated objectives of the fund or in ways that are contrary to the interests of the investors in the fund. But, to the extent this is occurring, it involves a question of whether the fund adviser is satisfying its fiduciary duty to the investors in the fund, and the Commission already has authority to deal with that issue. It doesn't require additional oversight of the proxy advisors who generate advice in accordance with the fund adviser's instructions.
"So, if investors aren't calling for increased regulation of proxy advisors, what is driving the push for regulation?... In my view,... the simple fact of the matter seems to be that proxy advisors have given asset managers an efficient way to exercise much closer oversight of the companies in their portfolios, and those companies don't like it. That's understandable, and it is also understandable that companies, rather than directly asking the SEC to suppress shareholder voting or give companies more of a say in the advice that is given, would try to cloak their arguments under the mantle of investor protection. But the investors themselves—again, the ones paying for proxy advice—are not asking for protection. In fact, I keep hearing opposition from investors to proposals that might lead to interference in the proxy voting process."
Fleming's views echo those of SEC Commissioner Robert Jackson, who has indicated that he feared that the SEC's "efforts to fix corporate democracy will be stymied by misguided and controversial efforts to regulate proxy advisors." In effect, he was concerned that the focus on regulating proxy advisors was a shiny object that might well deflect attention from the serious problems affecting the corporate voting system. (See this PubCo post.)
According to The Deal, while the precise kind of guidance the SEC would issue is not yet known, the SEC "generally wants to make it easier for investors lacking resources to research voting topics at their portfolio companies, to be permitted not to vote altogether. In an interview with The Deal after his comments, Roisman suggested he was concerned about the use of proxy advisers by some investors, suggesting that some shareholders appear to be adopting policies set by proxy advisers, rather than coming up with their metrics....It is also possible that the SEC could move forward with a regulatory proposal imposing tougher restrictions on proxy advisers. The agency could require proxy advisers to provide draft recommendation reports to companies before publication for clients, so that businesses can submit comments and criticism, to accompany the initial recommendation report publication."
To address one of the complaints often raised about proxy advisors—and perhaps to deter regulatory action by the SEC—Glass Lewis has introduced a pilot for a new service, the Report Feedback Statement. The new service is designed to allow companies and proponents of shareholder proposals to provide feedback—unfiltered, provided that it complies with the RFS Etiquette Guide—about GL's analysis of their proposals directly to GL's "research and engagement team, which will in turn distribute them to clients within our research and voting platforms. Glass Lewis' investor clients will benefit by conveniently receiving unfiltered commentary on our analysis from subject companies and shareholder proponents. That real-time perspective will provide an additional dimension for their consideration and will be easily accessible, with reasonable time to review, even within the peak of proxy season." While there are some processes in place to address correction of factual errors (although many would argue about the effectiveness of these processes), the new service will allow comments to be submitted over differences of opinion, even when the facts are not in dispute.
GL advises subscribers to "limit their statements to their views on Glass Lewis' research, and...refrain from, directly or indirectly, commenting on the views, analysis and vote recommendations of other proxy advisors, and from providing a comparative analysis between the research published by Glass Lewis and the research published by another proxy advisor." In addition, subscribers are required to complete the following steps prior to submitting their Statements:
- "The subscriber has consulted with legal counsel to ensure the submission of its Report Feedback Statement complies with Regulation FD and any other regulatory requirements applicable to the subscriber and its disclosure of information.
- All information included in the Report Feedback Statement is 'publicly available' information, meaning the information has been disseminated in a manner making it available to investors generally as Glass Lewis will not consider, nor distribute material non-public information.
- A good faith effort has been made to ensure that all the information contained in the Report Feedback Statement is accurate.
- None of the statements included in the Report Feedback Statement defame, disparage, disrespect or offend Glass Lewis, its subsidiaries, owners, and employees, or any third party.
- The individual submitting the Report Feedback Statement is an authorized representative of the subscriber, with the authority to submit the Report Feedback Statement on behalf of the subscriber."
As reported in this post from FW Cook, the fees include the cost of acquiring a copy of the relevant Proxy Paper report (on a one-time basis or via subscription) and a distribution fee of $2000 for each Statement submitted. Time will tell whether the new service, and other efforts like it, will be enough to head off potential regulation from the SEC.
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