[This post revises and updates my earlier post primarily to reflect the contents of the proposing release.]
At an open meeting on November 17, the SEC voted, three to two, to propose amendments to the proxy rules that would reverse some of the key provisions governing proxy voting advice that were adopted in July 2020. Those amendments had codified the SEC's interpretation that made proxy voting advice subject to the proxy solicitation rules. The intent was not, however, to cause ISS and other proxy voting advice businesses, which the SEC refers to as "PVABs," to file a slew of proxy statements. To address the real issue that the SEC was targeting, the 2020 rules added to the exemptions from those solicitation rules two significant new conditions—one requiring disclosure of conflicts of interest and the second calling for PVABs to engage with the companies that are the subjects of their advice. The proposed amendments would rescind that second central condition—which some might characterize as a core element, if not the core element, of the 2020 amendments. The proposal would also rescind a note to Rule 14a-9, adopted as part of the 2020 rules, that provided examples of situations in which the failure to disclose certain information in proxy voting advice may be considered misleading. According to SEC Chair Gary Gensler, PVABs "play an important role in the proxy process. Their clients deserve to receive independent proxy voting advice in a timely manner." The U.S. Chamber of Commerce had quite a different take on the proposal, contending that the "rules finalized by the SEC last year created a level playing field and ensured that investors would have access to high quality information free of bias. If the SEC decides to roll back these rules, it will signal that it is not serious about rooting out and eliminating misinformation and conflicts of interest in the proxy process and will instead place special interests at the head of the line, harming investors and markets. We will engage with the SEC to stop these misguided proposals from moving forward." The proposal will be open for public comment for 30 days after publication of the proposing release in the Federal Register.
Whether and how to regulate PVABs, such as ISS and Glass Lewis, has long been a contentious issue, with some arguing that their vote recommendations are plagued by conflicts of interest and often erroneous, while others see no problem so long as the institutional and other investors that are clients of these firms are satisfied with their services. (You might recall that both ISS and the National Association of Manufacturers have sued the SEC over these rules or their non-enforcement. See this PubCo post, this PubCo post and this PubCo post.) Many companies, as well as business lobbies such as the Business Roundtable and the National Association of Manufacturers, have repeatedly raised concerns about PVABs' concentrated power and significant influence over corporate elections and other matters put to shareholder votes, which has led to questions about whether they should be subject to more regulation and accountability. (See, e.g., this PubCo post, this PubCo post and this PubCo post.) In particular, companies had expressed concerns that the analyses by PVABs were rife with factual errors, omissions and methodological weaknesses that "could materially affect the reliability of their voting recommendations and could affect voting outcomes, and that processes currently in place to mitigate these risks are insufficient." What's more, some companies contended that they did not have adequate opportunities to review the advice, engage with the firm and correct the errors on a timely basis, impairing the accuracy, transparency and completeness of the information available to voters. Although PVABs had taken some steps to share information with companies (see this PubCo post), those opportunities were limited in some cases to larger companies, were later withdrawn, were not timely or were otherwise inadequate to address company concerns.
In response to these calls for action, in November 2019, the SEC proposed rule amendments designed to build on market processes then in place, providing a mechanism for enhanced engagement between PVABs and companies involving advance review by companies of proxy voting advice. Many companies supported the proposal, arguing that companies do not otherwise have a timely and effective method for conveying their views about proxy voting advice prior to voting. Nevertheless, the proposal drew fierce criticism from a number of quarters. Commenters complained that there was insufficient evidence of frequent errors or deficiencies on the part of PVABs to mandate this costly and time-consuming process. In addition, they contended that requiring advance review of proxy voting advice by companies would give those companies an unfair advantage by allowing them to influence the advice at a critical stage. Some also complained that the feedback framework was too rigid and not workable logistically and would impede PVABs' ability to provide their advice on a timely basis. Moreover, they said, some PVABs had already implemented feedback systems, and companies already have available other "counter-speech" measures. Some suggested that the requirement for a mandatory hyperlink was "compelled speech" in violation of the First Amendment. The Council of Institutional Investors expressed concern that the requirement that proxy advisors share advance copies of their recommendations with issuers could interfere with the relationship between institutional investors and PVABs as their agents. In CII's understanding, PVABs are agents of institutional investors, not of issuers. And, according to CII, there was no reason to believe that institutional investors feel the need for prior review by issuers of the work product of their agents, the proxy advisors. Rather, investors would prefer that PVABs be completely independent of companies. The SEC's Investor Advisory Committee recommendation also disparaged the proposal as unlikely to reliably achieve the SEC's own stated goals, ultimately advising the SEC to go back to the drawing board and republish a new proposal. (See this PubCo post.)
In July 2020, after making a number of adjustments that took many of the comments into account, the SEC adopted new amendments to the proxy rules designed to provide investors who use proxy voting advice with "more transparent, accurate, and complete information on which to make their voting decisions, without imposing undue costs or delays that could adversely affect the timely provision of proxy voting advice." The adopting release recognized—indeed underscored—the tremendous power and influence of PVABs: proxy voting advice "implicates interests beyond those of the clients who utilize it when voting." In what way? First, there are millions of retail investors whose shares are held and voted on their behalf by institutional investors. But perhaps more significantly, given the ability of institutional investors—the clients of PVABs—to "affect the outcome of the vote on a particular matter through their voting power, the proxy voting advice guiding the clients' votes potentially affects the interests of all shareholders of the registrant, the registrant, and the proxy system in general."
As noted above, in the 2020 amendments, the SEC revised the definition of "solicitation" in Rule 14a-1(l) to codify its "longstanding view that proxy voting advice generally constitutes a 'solicitation' under Section 14(a)." To the extent that proxy voting advice is a solicitation, in the absence of an exemption, PVABs would be subject to, among other things, the requirement to file and furnish definitive proxy statements. However, the SEC had a different goal in mind. To that end, the SEC crafted two new conditions applicable to exemptions from the proxy solicitation rules, "fashioned both to elicit adequate disclosure and to enable proxy voting advice businesses' clients to have reasonable and timely access to transparent, accurate, and complete information material to matters presented for a vote...." In addition, the SEC provided two non-exclusive safe harbors designed to "give assurance to PVABs that they have satisfied the conditions of Rules 14a-2(b)(9)(ii)(A) and (B)." Compliance with the new conditions was not required prior to December 1, 2021. (See this PubCo post). Then in June, Chair Gensler directed the staff to consider whether to recommend further regulatory action regarding proxy voting advice. As a result, Corp Fin issued a Statement indicating that "it will not recommend enforcement action to the Commission based on the 2019 Interpretation and Guidance or the 2020 Rule Amendments during the period in which the Commission is considering further regulatory action in this area." (See this PubCo post.)
In the proposing release, the SEC observes that it had "endeavored to tailor the 2020 Final Rules to avoid imposing undue costs or delays that could adversely affect the timely provision of proxy voting advice." Perhaps, however, that goal was not achieved? Since adoption, "institutional investors and other clients of PVABs have continued to express strong concerns about the rules' impact on their ability to receive independent proxy voting advice in a timely manner. Furthermore, PVABs have continued to develop industry-wide best practices and improve their own business practices to address the concerns that were the impetus for the 2020 Final Rules." As a result, the SEC decided that it was "appropriate to reassess the 2020 Final Rules, solicit further public comment and, where appropriate, recalibrate the rules to preserve the independence of proxy voting advice and ensure that PVABs can deliver advice in a timely manner without ultimately passing on higher costs to their clients."
The proposed amendments are "intended to be tailored adjustments in response to concerns and developments related to particular aspects of the 2020 Final Rules," with the goal of avoiding "burdens on PVABs that may impede and impair the timeliness and independence of their proxy voting advice and subject them to undue litigation risks and compliance costs, while simultaneously preserving investors' confidence in the integrity of such advice." The SEC believes that "the proposed amendments, in tandem with the unaffected portions of the 2020 Final Rules and other existing mechanisms in the proxy system, including certain policies and procedures that PVABs have adopted, strike a more appropriate balance."
Proposed amendments to Rule 14a-2(b)(9)(ii). As noted above, the 2020 rules added two conditions applicable to PVABs to the exemptions from the proxy solicitation rules—one requiring disclosure of conflicts of interest and the second, in Rule 14a-2(b)(9)(ii), regarding proxy advisor engagement with companies. More specifically, the condition in Rule 14a-2(b)(9)(ii) requires a PVAB to adopt and publicly disclose written policies and procedures reasonably designed to ensure that:
- companies that are the subject of proxy voting advice "have such advice made available to them" at or prior to the time when the advice is disseminated to the proxy advisor's client; and
- the PVAB provides to its clients "a mechanism by which they can reasonably be expected to become aware of any written statements regarding its proxy voting advice" from the subject companies, in a timely manner before the shareholder meeting.
The 2020 amendments also included two new, non-exclusive safe harbors for proxy advisors with regard to the required written policies and procedures intended to assure "PVABs that they have satisfied the conditions of Rules 14a-2(b)(9)(ii)(A) and (B)."
According to the proposing release, this new condition was designed, among other purposes, to "facilitate effective engagement between PVABs and registrants, help ensure that registrants are timely informed of proxy voting advice that bears on the solicitation of their shareholders and further the goal of ensuring that PVABs' clients have more complete, accurate and transparent information to consider when making their voting decisions." As characterized by the SEC, this condition was intended to "benefit the shareholders on whose behalf PVABs' clients may be voting" and provide "PVABs' clients with additional information that would assist them in assessing and contextualizing proxy voting advice."
While the SEC affirmed in the release that it "continues to believe that these goals are important," it nevertheless also believes in the appropriateness of reassessing its "policy judgment" regarding the Rule 14a-2(b)(9)(ii) conditions. Although, in the 2020 rules, the SEC made a number of adjustments in response to public comment, institutional investors and other clients of PVABs nevertheless continued to express "strong concerns," contending that the engagement condition would "impose increased compliance costs on PVABs and impair the independence and timeliness of their proxy voting advice and that such effects are not justified or balanced by corresponding investor protection benefits."
In addition, six PVABs, including ISS and Glass, Lewis, formed the Best Practice Principles Group and published Best Practice Principles for Providers of Shareholder Voting Research and Analysis, which relate to (1) service quality, (2) conflicts-of-interest avoidance or management and (3) communications policy. Compliance with those principles by PVABs is reviewed by an Oversight Committee, composed of "non-PVAB stakeholders in proxy voting advice, including representatives from the institutional investor, registrant and academic communities." In July 2021, the Oversight Committee reported that "all six firms met the standards established in the three best practices principles," including, for Glass Lewis, company advance review opportunities, feedback opportunities and processes to report errors. ISS, the biggest PVAB, on the other hand, just allows companies to request a copy of proxy voting advice upon dissemination and report errors; if ISS believes the advice contains an error, it will issue an updating Alert. ISS also provides its clients with access to a company's SEC filings through the platform used to deliver its proxy voting advice. Although companies can request engagement, "ISS does not provide draft proxy voting advice to any United States registrants," a cutback implemented in January 2021.
In light of the continued concerns expressed by the investors, as discussed above, the SEC is proposing to rescind Rule 14a-2(b)(9)(ii) as well as the related safe harbors and exclusions from those conditions. As proposed, proxy advice would continue to be a solicitation subject to the proxy rules; however, to rely on the exemptions, PVABs would need to comply only with the disclosure requirements regarding conflicts of interest. (See this PubCo post.) As part of its reassessment, although not the primary basis for its proposal, the SEC said that it took into account PVABs' efforts to develop and implement best practices, which the SEC believes "could address the concerns underlying the Rule 14a-2(b)(9)(ii)." And, "because PVABs developed these measures themselves," the SEC thinks the practices are "less likely to adversely affect the independence, cost and timeliness of proxy voting advice." In addition, the SEC believes that there are "market-based incentives for PVABs to adopt and maintain policies and procedures that provide some of the same benefits as those of the Rule 14a-2(b)(9)(ii) conditions without raising the concerns investors have expressed about those conditions." Rescission of the "Rule 14a2(b)(9)(ii) conditions would give PVABs, investors and registrants the flexibility to select mechanisms that best serve the needs of investors and other stakeholders and adapt to evolving market practices." In addition, observations from 2021 gave the SEC confidence in these mechanisms; the SEC will, however, continue to monitor the market.
In his remarks at the SEC's open meeting, Commissioner Elad Roisman, who honchoed the original proxy-process rulemakings through the SEC, seemed taken aback by the SEC's "unusual and surprising deference to self-created best practices." The industry group, he noted, has just recently been established and the oversight committee has conducted only one review. What's more, while the oversight committee was intended to be independent, the PVABs selected the committee members and funded the process. While he agreed that "these industry efforts to create and uphold standards appear positive, they are hardly well enough established for this Commission to consider them as replacements for key provisions of our recently adopted Final Rules.... Nor am I aware of meaningful precedent for the deference with which the proposal appears to discuss these nascent efforts at self-regulation. We have not historically allowed a consortium of market participants to make up their own rules—or principles and standards, in this case—to follow, with no Commission oversight or engagement." Similarly, Commissioner Hester Peirce also questioned the SEC's reliance on PVABs' efforts to develop industry-wide practices, noting that these efforts were well-known to the SEC at the time of the 2020 rulemaking, so they hardly constituted a reason for backtracking on the rules. "The only new piece of information" for the SEC to consider, she said, "is that one major PVAB [presumably ISS] is engaging less with issuers. That bit of news should only underscore the justification for the 2020 Final Rules."
Proposed Amendment to Rule 14a-9. The 2020 rules also modified Rule 14a-9, which prohibits false or misleading statements and material omissions, to add, in Note (e), examples of when material omissions in proxy voting advice could be considered misleading within the meaning of the rule. More specifically, the amendments provided that "failure to disclose material information regarding proxy voting advice, 'such as the [PVAB's] methodology, sources of information, or conflicts of interest' could, depending upon particular facts and circumstances, be misleading within the meaning of the rule." In connection with adoption of the 2020 rules, the SEC stated that the changes "were not intended to change the application or scope of Rule 14a-9 or create a new cause of action against PVABs" and that "the amendments do 'not make 'mere differences of opinion' actionable under Rule 14a-9.'"
Nevertheless, the SEC heard from PVABs, their clients and other investors that the examples in Note (e) could increase PVABs' litigation risks, which could increase costs that could ultimately be passed along. In addition, they contended, the examples could impair the "independence and quality" of PVAB's proxy voting advice if, for example, companies threatened litigation to compel more favorable advice and Rule 14a-9 was extended to impose liability for "mere differences of opinion" over the PVAB's vote recommendation or analysis, or simply because the PVAB declined to accept a company's suggested revisions.
To address the misperception that Note (e) altered the application or scope of Rule 14a-9 and to reduce any resulting uncertainty that could increase litigation risks, the SEC is proposing to rescind Note (e). In the proposing release, however, the SEC attempts to clarify when a PVAB's statement of opinion may subject it to liability under Rule 14a-9:
"A PVAB, like any other person engaged in solicitation, may, depending on the facts and circumstances, be subject to liability under Rule 14a-9 for a materially misleading statement or omission of fact, including with regard to its methodology, sources of information or conflicts of interest. That conclusion would not be altered by virtue of our proposed deletion of Note (e). We recognize, however, that the formulation of proxy voting advice often requires subjective determinations and exercise of professional judgment. We do not interpret Rule 14a-9 to subject PVABs to liability for such determinations simply because a registrant holds a differing view."
In support, the SEC cited SCOTUS's 2015 decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, which held that "a sincere statement of pure opinion is not an 'untrue statement of material fact'" even if, the SEC said, "the belief is wrong." (See this PubCo post.) Applying Omnicare, the SEC explained that a PVAB may be subject to liability under Rule 14a-9 for a statement of opinion that "'falsely describe[s]' its view as to the voting decision that it believes the client should make," if its advice contained "embedded statements of fact" that were materially false, or if it "'omits material facts about the [PVAB's] inquiry into or knowledge concerning [the] statement' and 'those facts conflict with what a reasonable investor would take from the statement itself.'" Accordingly, the SEC explained, "neither mere disagreement with a PVAB's analysis, methodology or opinions, nor a bare assertion that a PVAB failed to reveal the basis for its conclusions, would suffice to state a claim under Rule 14a-9." Use of discretion by a PVAB to "rely on a particular analysis, methodology or set of information" would not by itself subject a PVAB to 14a-9 liability in the SEC's view, nor would a decision not to accept a company's suggested revisions concerning these discretionary matters. "Instead," the SEC concludes, "a PVAB's potential liability under Rule 14a-9 turns on whether its proxy voting advice contains a material misstatement or omission of fact."
The discussion of this proposal at the SEC's open meeting was quite contentious, particularly the remarks from Roisman. He seemed perturbed by both the proposed "explicit attempt to peel back [investor] protections" and, in his view, the opaque and relatively abbreviated proposal process that could undo "nearly a decade's worth of work."
First, he highlighted the potential for PVABs' advice to have broad impact on a large number of matters up for a vote. The SEC, he said, has "stated that it is a matter of vital importance to ensure that the voting advice these firms provide is based on the most accurate information reasonably available and that the businesses providing such advice be sufficiently transparent with their clients about the processes and methodologies used to formulate their advice." To that end, he stressed, the SEC "engaged in a rulemaking process that was more extensive and thorough than is typical," including holding a roundtable and reviewing public comments received over a ten-year period and, in the final rule, tailoring its requirements to respond to public comments received on the 2019 proposed rules. (For more on the discussion at the 2018 roundtable, see this PubCo post.) In his view, it would not be "an exaggeration to say that [the 2020 rules] are the product of roughly a decade's worth of thinking and public feedback on how the Commission could promulgate regulations that would improve the quality of proxy voting advice available in our markets....Together, the conflict of interest disclosures and the engagement policies were intended to ensure that those who use proxy voting advice receive more transparent, accurate, and complete information on which to make their voting decisions. Sadly, the Final Rules were never permitted to take effect."
The proposal, he lamented, would nullify the important protections of the engagement policies imposed under the rules and "would replace this obligation with . . . nothing." Perhaps even more "troubling," he "found the proposal lacks many of the due process and procedural protections that usually guide Commission rulemakings. It does not squarely answer the question of why we would peel back our existing rules, which were the product of substantial Commission and staff work and which had undergone the rigor of the Administrative Procedure Act. Nor does the proposal answer the question why now, before these rules have even taken effect." He questioned whether the SEC might be inappropriately deferring to a small group of investors, and, as discussed in the SideBar above, to proxy advisors' own efforts at self-regulation, to the detriment of retail investors and the important protections provided by these rules.
In the end, Roisman believed that the final rules should be allowed to take effect and that the SEC should "rethink this rulemaking process.... Offering such little transparency into our process or reasoning for considering dramatic changes to recently adopted rules can lead people to worry about the efficacy and longevity of our rulemakings. This is poor precedent for our Commission to overturn thoughtfully developed regulation so lightly."
Although much less invested in the original rulemaking than Roisman, Peirce expressed similar views. She argued that the SEC "lacks a sound basis for seeking to amend a brand new rule. Nothing has changed since we adopted the rule, and we have not learned anything new. The release takes a stab at justifying the rewrite, but we might as well simply acknowledge that the political winds have shifted." She noted that the proposal attempts to justify "running away from these common-sense reforms" by pointing to "continued opposition to the 2020 Rules" by PVABs and their clients and to PVABs' efforts at developing industry-wide practices. However, she observed, the SEC was aware of all this in the first go-round; the "release fails to identify any new concerns." She also found the proposed amendment to Rule 14a-9 to be a "head-scratcher." Why delete Note (e) and then include the substance in guidance?
Commissioner Allison Herren Lee emphasized the importance of ensuring "that our rules do not interfere with the independence of proxy voting advice, introduce unnecessary cost and complexity into an already compressed proxy voting process, or otherwise burden the free and full exercise of shareholder voting rights." In her view, the "proposal represents a targeted reappraisal of only certain aspects of those amendments that generated substantial concern, particularly among investors (the intended beneficiaries of the changes), that [the SEC] didn't get the balance right in last year's final rules." In particular, she identified the inclusion of engagement mechanisms in the 2020 rules as "mechanisms to enhance management's influence over proxy voting advice...." And the addition of the example in Rule 14a-9 created "uncertainty regarding the scope of liability" for proxy advice. She maintains that these aspects of the 2020 rules "prompted considerable concern. Today's proposal responds to those concerns by proposing to eliminate the issuer access and response provisions, and clarify the scope of fraud liability for proxy advisors." In addition, she contends that, when considering the 2020 rules, the SEC never really met its burden to "establish that there was any need for those features of the rulemaking to begin with. In fact, it was quite clear then and now that the so-called 'error rate' with respect to proxy voting advice is vanishing to none."
With regard to process issues, she contends that, because the SEC "made fairly substantial modifications to the amendments from proposal to adoption," commenters never really had "an opportunity to weigh in on certain features of the rules in their final form until after adoption. But now they have. And investors in particular have explained that certain features of the final rules still include the same infirmities they had identified in the proposal, namely increased risk of impaired independence and significant new costs and delays." The SEC is simply responding to that feedback and, she argues, it is entirely consistent with SEC precedent "to review recent rules (sometimes even before their compliance date) in response to feedback from market participants."
Commissioner Caroline Crenshaw also observed that the proposal addresses concerns of those investors who rely on proxy voting advice that "the existing framework jeopardizes the independence of proxy voting advice and makes the conveyance of that proxy voting advice to investors costlier and subject to delay." By informing investors' voting decisions, "proxy voting advice is integral to our current system of corporate governance and shareholder democracy." Accordingly, "strengthening independence and ensuring that the costs of voting advice are not prohibitive are important objectives."
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