When significant decisions for public corporations are up for shareholder vote, institutional investors and shareholders or their registered investment advisors (meaning an individual or firm registered with the Securities and Exchange Commission (“SEC”) that is in the business of giving advice about securities in exchange for compensation (“RIAs”)) often rely on the voting recommendations of independent proxy advisory firms that conduct issue analysis, such as Egan-Jones Proxy Services, Institutional Shareholder Services and Glass Lewis & Co.  Issuers and regulators alike have become increasingly uncomfortable with the enormous influence that such proxy advisory firms wield on shareholder votes in corporate America. 

The SEC has held several roundtables on the topic of proxy advisory firms to consider whether additional regulation of proxy advisory firms is needed, and has now issued Staff Legal Bulletin No. 20 on this topic. The Bulletin takes the form of 13 Q&As and includes guidance from both the Division of Investment Management (which regulates, among others, RIAs) and the Division of Corporation Finance.  In light of the Bulletin, the SEC recognizes that RIAs and proxy advisory firms may want or need to make changes to their current policies and procedures.  It is expected that those changes will be made promptly, and in any case, in advance of the 2015 proxy season. 

In particular, the new guidance confirms that:

  • In using proxy advisory firms, RIAs have a duty to provide sufficient and ongoing oversight of those firms.  Before retaining such firms, RIAs may want to take into account, among other things, the robustness of such firms’ policies and procedures, including procedures to identify/address conflicts of interest, as well as whether the firms’ proxy voting recommendations are based on current and accurate information.  As fiduciaries, RIAs should seek to demonstrate that proxy votes are cast in accordance with a client’s best interests and with the RIA’s own internal proxy voting procedures; the means by which RIAs can demonstrate compliance include annually reviewing the adequacy of proxy voting policies and procedures to ensure effective implementation, and periodically sampling proxy votes to review whether they complied with the RIAs proxy voting policies and procedures.  RIAs and their clients have the flexibility to design the scope of the RIAs’ obligation to exercise proxy voting authority, so long as that authority is in compliance with proxy voting rules.
  • Proxy advisory firms are exempt from many of the SEC’s proxy rules under Exchange Act Rules 14a-2(b)(1) and 14a-2(b)(3).  The Rule 14a-2(b)(1) exemption is available to proxy advisory firms that only distribute reports containing voting recommendations and that do not solicit to act as a proxy for those receiving the recommendations, as long as the other exemption conditions are met.  Proxy advisory firms that provide services (e.g., consulting) to a company on a matter that is the subject of a voting recommendation, or that provide a voting recommendation to clients on a proposal sponsored by another client, may rely on the exemption under Rule 14a-2(b)(3) so long as (1) the exemption conditions are met, (2) the firm assesses whether it has any relationship with the company/any shareholder or has any material interest in the subject matter of the vote, and (3) discloses any such relationship or interest to the recipient of the voting recommendation.  Whether the relationship is significant, or whether the interest is material, will depend on the facts and circumstances.  Firms, however, should provide sufficient disclosure such that a client is able to understand the nature of the conflict, including any steps taken to mitigate the conflict, and assess the reliability or objectivity of the recommendation; such disclosure should be made at or around the same time that the client receives advice, and may be made publicly or only between the firm and the client.