In amending Rule 14a-1(l), the SEC codified its view that proxy voting advice generally constitutes a “solicitation” within the meaning of Section 14(a) of the Exchange Act.
On July 22, 2020, the U.S. Securities and Exchange Commission (SEC) adopted amendments to its rules under the Securities Exchange Act of 1934 that exempt persons furnishing proxy voting advice from the information and filing requirements of the federal proxy rules. The most prominent proxy advisory firms that provide such proxy voting advice in the United States today are Institutional Shareholder Services (ISS) and Glass Lewis & Co. Pursuant to the amendments, the SEC codified its view that proxy voting advice generally constitutes a “solicitation,” imposed new conditions to exemptions under Exchange Act Rule 14a-2(b) and added examples of what may be “misleading” within the meaning of Exchange Act Rule 14a-9. The SEC also published supplemental guidance to assist investment advisers on assessing how to consider registrant responses to proxy voting advice in light of the new amendments to the proxy rules.
According to the SEC, it has adopted these amendments so that investors who use proxy voting advice receive more transparent, accurate and complete information on which to make their voting decisions, without imposing undue costs or delays that could negatively affect the timely provision of proxy voting advice. SEC Chairman Jay Clayton has underscored that these amendments are designed to facilitate informed decision-making by Main Street investors who participate in the public markets through intermediaries (i.e., mutual funds and ETFs) and by the investment professionals who vote on their behalf.
The amendments will become effective 60 days after publication in the Federal Register, but proxy advisory firms are not required to comply with the new conditions to the use of exemptions under Rule 14a-2(b)(9) until December 1, 2021. The supplemental guidance for investment advisers will be immediately effective upon publication in the Federal Register.
“Solicitation” Includes Proxy Voting Advice for a Fee
In amending Rule 14a-1(l), the SEC codified its view that proxy voting advice generally constitutes a “solicitation” within the meaning of Section 14(a) of the Exchange Act.
New paragraph (A) to Rule 14a-1(l)(1)(iii) specifies the circumstances in which persons who furnish proxy voting advice will be deemed to have engaged in a solicitation subject to the proxy rules. “Solicitation” includes any voting advice that makes a recommendation to a shareholder as to its vote, consent or authorization on a specific matter for which shareholder approval is solicited, and that is furnished by a person who markets its expertise as a provider of such advice, separately from other forms of investment advice, and sells that advice for a fee. In particular, the SEC views proxy advice formulated based on voting guidelines or a customer policy as a distinct solicitation under its final rule. However, this definition excludes any proxy voting advice furnished by a proxy voting firm only in response to an unprompted request, as it will be reflected in new paragraph (v) to Rule 14a-1(l)(2).
Conflicts of Interest Disclosure Requirements
Proxy advisory firms relying on exemptions under Rules 14a-2(b)(1)―which generally exempts solicitations by persons who do not seek the power to act as proxy for a shareholder and do not request any form of revocation, abstention or authorization―and 14a-2(b)(3)―which generally exempts the furnishing of proxy voting advice by an adviser to any other person with whom a business relationship exists―are required to satisfy the new conditions of new Rule 14a-2(b)(9). These firms must provide disclosures regarding conflicts of interest in their proxy voting advice or in an electronic medium used to deliver such advice. The rule requires that prominent disclosure of material conflicts of interests be included in the voting advice to ensure clients can readily access the information when they decide to vote. It does not, however, dictate the particular location or presentation of the disclosure in the advice or the manner of its conveyance. The disclosure required is for any information regarding an interest, transaction or relationship of the proxy advisory firm (or its affiliate) that is material to assessing the objectivity of the proxy voting advice in light of the circumstances of the particular interest, transaction or relationship.
The concept of materiality is at the core of the SEC’s disclosure requirements, which is illustrated by the following two examples. Consider a situation where a proxy advisory firm has been retained by a shareholder to provide advice regarding a registrant for which the proxy advisory firm once provided consulting services. In this scenario, if the proxy advisory firm has no business relationship with the registrant for some years and is not seeking a business relationship with the registrant, it is unlikely that the nature of the business’s relationship with the registrant would be deemed material. On the other hand, if a proxy advisory firm provides voting advice to its clients on proposals to be considered at the annual meeting of a registrant while the firm also earns fees (or is seeking to earn fees) from the registrant for providing advice on the corporate governance and compensation policies, such practice would likely be considered as a material conflict of interest.
The proxy advisory firms must also disclose those policies and procedures used to identify potential and actual material conflicts of interest as well as steps taken to address them. Proxy advisory firms may determine what information to disclose. Additionally, the final rule does not require detailed compliance manuals to be included in the proxy advice, or duplicative disclosures in both the proxy voting advice and the electronic delivery of such advice. By way of example, a proxy advisory firm can provide an active hyperlink or “click-through” feature on its voting platform to allow clients to quickly refer from the voting advice to the proxy advisory firm’s general policies and procedures.
Review and Response Mechanism and Safe Harbors
Proxy advisory firms relying on the Rules 14a-2(b)(1) and 14a-2(b)(3) exemptions are subject to new conditions imposed by Rule 14a-2(b)(9)(ii). This new rule requires proxy advisory firms to adopt and publicly disclose written policies and procedures reasonably designed to ensure:
- Registrants that are the subject of proxy voting advice have such advice made available to them at or prior to the time when such advice is disseminated to the proxy advisory firms’ clients (Rule 14a-2(b)(9)(ii)(A)), and
- The proxy advisory firm provides its clients with a mechanism by which they can reasonably be expected to become aware of any written statements regarding its proxy voting advice by registrants that are subject to such advice, in a timely manner before the shareholder meeting (or before the votes or consents, if no meeting) (Rule 14a-2(b)(9)(ii)(B)).
The new rules do not require the proxy advisory firms to provide the registrants with the opportunity to review the advice in advance of its distribution for a shareholder vote. Additionally, if the advice is later revised or updated, the SEC does not require a proxy advisory firm to make its advice available to registrants after the advice has been initially provided to clients. The SEC emphasizes these new conditions are intended to ensure proxy voting advice clients have access to more transparent, accurate and complete information.
To afford assurance to proxy advisory firms that their written policies and procedures satisfy the new requirements, the new rules include the following two nonexclusive safe harbors.
Providing Registrants with the Proxy Voting Advice
Under Rule 14a-2(b)(9)(iii), a proxy advisory firm will be deemed to satisfy the requirements of Rule 14a-2(b)(9)(ii)(A) if it has written policies and procedures that are reasonably designed to provide registrants with a copy of its proxy voting advice, at no charge, no later than the time it is disseminated to the proxy advisory firm’s clients. Such policies and procedures may include conditions requiring that such registrants have: (1) filed their definitive proxy statement at least 40 calendar days before the shareholder meeting, and (2) expressly acknowledged that they will only use the proxy voting advice for their internal purposes and/or in connection with the solicitation and it will not be published or otherwise shared except with the registrant’s employees or advisers.
If a registrant fails to comply with the conditions set forth by the proxy advisory firms (including the filing of definitive proxy statement at least 40 calendar days before the shareholder meeting), the registrant will not be able to take advantage of the review and response mechanism. Registrants will need to review carefully similar or additional conditions set forth in the proxy advisory firms’ policies and procedures to ensure that they are met.
In terms of methodology by which a proxy advisory firm may provide a copy of its advice to a registrant, it may do so by sending the registrant an email attaching an electronic copy of the report or including an active hyperlink to the report. In addition, it is not a condition of the safe harbor that the proxy advisory firm negotiate or otherwise engage in a dialogue with the registrant or revise its voting advice in response to any feedback from the registrant.
Informing Clients About the Registrant’s Additional Soliciting Materials
Under Rule 14a-2(b)(9)(iv), a proxy advisory firm will be deemed to satisfy the requirements of Rule 14a-2(b)(9)(ii)(B) if it has written policies and procedures reasonably designed to inform clients who have received proxy voting advice about a particular registrant in the event that such registrant notifies the proxy advisory firm that the registrant either intends to file or has filed additional soliciting materials with the SEC setting forth its views regarding such advice. A proxy advisory firm may provide the required notice that the registrant has filed or has informed the proxy advisory firm that it intends to file additional soliciting materials on the firm’s electronic client platform or, through email, or other electronic means.
This is an example of how the review and response mechanism may play out under the new rules if a registrant decides to respond to a proxy advisory firm’s voting advice:
- A registrant has filed its definitive proxy materials at least 40 calendar days before the shareholder meeting and acknowledges the limited use of the proxy voting advice.
- The proxy advisory firm sends an email attaching the voting advice or including a hyperlink to the voting advice to the registrant who is the subject of such advice at or prior to its dissemination to clients.
- The registrant reviews the voting advice and decides to file additional soliciting materials providing its views regarding the voting advice.
- A proxy advisory firm provides the required notice in an email to its clients that the registrant intends to file or has filed additional soliciting materials providing its views regarding the voting advice.
- If the proxy advisory firm revises its initial advice in light of the registrant's responses, there is no need to make its revised advice available to the registrant again.
Revised Anti-Fraud Provisions
The SEC modified Rule 14a-9 to require proxy advisory firms to disclose material information on proxy voting advice, including the proxy advisory firm’s methodology, source of information and/or conflicts of interest. According to the SEC, the amendment further clarifies that no solicitation (including proxy voting advice) may contain any statement that, at the time and in light of circumstances under which it is made, is false or misleading with respect to any material fact, or that omits to state any material fact necessary to make the statements not false or misleading. The SEC made clear that the failure to disclose material information about proxy voting advice, depending on the particular facts and circumstances, may constitute a potential violation of the antifraud provision under Rule 14a-9.
Courts have held that there is an implied private right of action under Rule 14a-9, meaning that private parties may sue for violations of Rule 14a-9 under certain circumstances. Although we would not typically expect registrants to bring a private action against a proxy advisory firm under normal circumstances, even for errors, we may see registrants sue proxy advisory firms in particularly adversarial proxy contests or where a proxy advisory firm ignores material facts. It is also possible that registrants could use the threat of litigation against a proxy advisory firm to obtain more meaningful engagement with the proxy advisory firm.
Investment Adviser Guidance
In conjunction with the adoption of the new amendments, the SEC issued supplementary guidelines to assist investment advisers on addressing how they should fulfill their proxy voting responsibilities in light of the new amendments to the proxy rules. The updated guidelines give special consideration to the use of automated proxy voting tools by the proxy advisory firms to allow the investment advisers to cast votes.
A proxy advisory firm’s electronic voting management system typically contains automated voting features. These features can pre-populate clients’ electronic ballots with a proxy advisory firm’s advice or automatically submit clients’ votes for counting. This creates the potential risk that clients would set up the system and forget to review, thus effectively allowing proxy advisory firms’ voting recommendations to become clients’ final decisions without further input from clients.
Under the new amendments to the proxy rules, a registrant may decide to file additional soliciting materials that contain its views regarding the proxy advisory firm’s voting advice. An investment adviser may become aware of such materials sufficiently in advance of the submission deadlines for proxies but after the investment adviser’s votes have already been pre-populated. If a registrant’s views regarding the proxy advisory firm’s voting advice could be reasonably expected to impact the investment adviser’s voting decision, the investment adviser would likely be obliged to consider such information prior to a final voting decision under its fiduciary duty to vote in the best interests of its clients.
In light of the above, an investment adviser that uses a voting management system that uses automated voting features should consider disclosing: (1) the extent of the use and under what circumstances the adviser uses automated voting, and (2) how the adviser’s policies and procedures address the use of automated voting in cases where the adviser becomes aware before the submission deadline for proxies to be voted at the shareholder meeting that a registrant intends to file or has filed additional soliciting materials with the SEC regarding a matter to be voted upon. Additionally, as a result of its duty of loyalty to clients, an investment adviser should disclose material facts related to the exercise of its voting authority with respect to client securities.
The SEC has posted its final rule and supplemental guidance.
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