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On August 21, 2019, the Securities and Exchange Commission (the “SEC”) issued guidance1 relating to the proxy voting responsibilities of investment advisers (the “Proxy Voting Guidance”). This guidance follows the SEC’s withdrawal last year of the No-Action Letters issued in 2004 to Egan-Jones Proxy Services (May 27, 2004) and Institutional Shareholder Services, Inc. (September 15, 2004) regarding proxy advisory firms and conflicts of interest2. The Proxy Voting Guidance does not appear to provide the hoped-for explanation of the specific policy changes which necessitated the withdrawal of the 2004 No-Action Letters, but instead focuses on the fiduciary obligations that investment advisers owe their clients. Specifically, the Proxy Voting Guidance stresses that investment advisers are fiduciaries who owe their clients duties of care and loyalty with respect to actions taken on their client’s behalf, including the voting of clients’ securities by proxy. In addition, while the Proxy Voting Guidance does not offer specific comment on whether, or how, the engagement of proxy voting advisers can mitigate conflicts of interest of the investment manager with respect to particular proxy votes, it does speak generally to the relevance of proxy voting advisory firms to an investment advisor meeting its fiduciary duties.
Division of Investment Management Guidance
Rule 206(4)-6 under the Investment Advisers Act of 1940 (the “Advisers Act”) provides that it is a fraudulent, deceptive, or manipulative act, practice, or course of business for an investment adviser registered or required to be registered with the SEC to exercise voting authority with respect to client securities unless the adviser, among other things, adopts and implements written policies and procedures that are reasonably designed to ensure that the investment adviser votes client securities in the best interest of its clients. The Proxy Voting Guidance serves to provide insight into the ways that investment advisers can address these potential issues, particularly with regard to the engagement of proxy advisory firms, through a question and answer format designed to facilitate compliance with investment advisers’ fiduciary obligations and Rule 206(4)-6.
Q&A 1 Determining an agreed-upon scope of authority with respect to proxy voting.
The first question addresses how the investment adviser and its client may agree upon the scope of authority which the investment adviser may agree to accept with respect to proxy voting. The SEC is clear in stating that an investment adviser is not obligated to accept the authority to vote client securities; however, the response notes that having discretionary authority to manage a client’s portfolio will imply having the authority to vote client proxies unless such authority has been otherwise limited through full and fair disclosure and consent to the client. An investment adviser may, of course, vary the scope of its proxy voting authority through full and fair disclosure to its client. The Proxy Voting Guidance provides several examples of situations and ways in which an investment adviser and its client may agree to limited proxy voting authority. While an investment adviser and its client may shape the voting authority through full and fair disclosure and informed consent, it is important to note that when an investment adviser does assume proxy voting authority on behalf of its client, the adviser must make voting determinations that are consistent with its fiduciary duties and that are in compliance with Rule 206(4)-6.
Q&A 2 How an investment adviser can demonstrate that voting determinations are made in the best interests of its clients.
The second question addresses the actions that an investment adviser can take to demonstrate that it is making voting determinations in the best interest of its clients and in accordance with its own proxy voting policies and procedures. The SEC notes that an investment adviser owes fiduciary duties to each of its clients, and questions how a uniform proxy voting policy may apply to differently situated clients. Given the unique circumstances of each client, an investment adviser may be best served by having different proxy voting policies with respect to different clients, or integrating these differences into its overall investment policy. The SEC states that advisers should consider whether certain types of matters, such as contested elections for directors, may necessitate a more detailed analysis than what the adviser normally undertakes pursuant to its voting guidelines. This detailed analysis would allow the adviser to better consider specific factors particular to the issuer or the voting matter under consideration. In addition, the SEC states that where an investment adviser retains a proxy advisory firm, it should take additional steps to evaluate whether the proxy adviser’s recommendations are consistent with the investment adviser’s proxy voting policies and procedures and the individual client needs. Finally, the SEC noted that the investment adviser must review and document as a part of its ongoing compliance review, on a no less than annual basis, the adequacy of its voting policies and procedures to ensure that they are reasonably designed to ensure that the investment adviser casts votes on behalf of its clients in the best interest of each client.
Q&A 3 Factors investment advisors should consider when retaining proxy advisory firms.
The third question deals directly with the considerations that an investment adviser should examine if it retains a proxy advisory firm to assist in its proxy voting duties. Prior to engaging a proxy advisory firm, investment advisers should consider the adequacy and quality of the proxy advisory firm’s staffing, personnel, technology, whether the proxy advisory firm has a process for seeking comment from issuers, and whether it has adequately disclosed its methodologies in formulating voting recommendations. The investment adviser should carefully review and consider the proxy advisory firm’s policies and procedures prior to entering into any engagement, particularly with regard to how it identifies and addresses conflicts of interest.
Q&A 4 Steps investment advisors should take when becoming aware of analytical deficiencies in its proxy advisory firm’s analysis.
The fourth question concerns the steps that an investment adviser should take when it becomes aware of potential factual errors, potential incompleteness, or potential methodological weaknesses in its proxy advisory firm’s analysis. The SEC notes that an investment adviser engages a proxy advisory firm, it should ensure that the investment adviser’s proxy voting policies and procedures are reasonably designed to ensure that its voting determinations are not based on materially inaccurate or incomplete information. The Proxy Voting Guidance provides insight into various topics that an investment adviser may wish to discuss with its proxy advisory firm, which include the proxy advisory firm’s efforts to correct identified material deficiencies in its analysis, and a discussion of the proxy advisory firm’s disclosure to an investment adviser regarding sources of information and methodologies it uses in formulating voting recommendations.
Q&A 5 Evaluating the services provided by a proxy advisory firm.
The fifth question touches on how an investment adviser can evaluate the services of a proxy advisory firm. The SEC states that, consistent with Rule 206(4)-6, an investment adviser that retains a proxy advisory firm must implement policies and procedures to periodically review its proxy advisory firm to ensure that the investment adviser is casting votes in the best interest of its clients. In particular, these policies and procedures should identify and address any potential conflicts of interest that the proxy advisory firm may have, and continue to evaluate the proxy advisory firm’s capacity to provide the required services.
Q&A 6 Investment advisers have discretion to decide whether, and how, to vote a client’s securities.
The final question addresses whether an investment adviser is required to exercise every opportunity to vote a client’s securities if it has proxy voting authority. The SEC provided clear guidance on this point that an investment adviser is not required to exercise every opportunity to vote a client’s securities. The decision whether, and how, to vote a client’s securities is subject to the investment adviser’s fiduciary duty, and as such determinations must be made on a case by case basis. The principal underlying this determination is that the investment adviser must always act in the best interest of its client, and a bright line rule on whether to vote may not always be consistent with such duty.
Division of Corporation Finance Guidance
In addition to the Proxy Voting Guidance issued by the Division of Investment Management, the Division of Corporation Finance concurrently issued an interpretive release3 providing guidance on the applicability of the SEC’s proxy rules to proxy voting advice provided by proxy advisory firms, such as ISS and Glass Lewis (the “Corp. Fin. Guidance”). The Corp. Fin. Guidance provides two questions and answers, in similar format to the Proxy Voting Guidance discussed above.
Q&A 1 The advice provided by a proxy advisory firm constitutes a solicitation under federal proxy rules.
The first question directly addresses whether proxy voting advice provided by a proxy advisory firm constitutes a solicitation under the federal proxy rules. The SEC is clear in its response that recommendations will typically be viewed as solicitations whether or not the proxy advisory firm is using custom tailored guidelines, whether or not the advice was solicited, and regardless of whether the client ultimately takes the proxy advisory firm’s advice.
Q&A 2 Exchange Act Rule 14a-9 applies to proxy voting advice.
The SEC is clear in its response that solicitations that are exempt from the federal proxy rules’ information and filing requirements remain subject to the Exchange Act Rule 14a-9. The SEC goes on to clarify that Exchange Act Rule 14a-9’s anti-fraud rules prohibit any solicitation from containing false or misleading statements. Proxy advisory firm recommendations and reports may not include statements which are, at the time made, false or misleading as to any material fact, may not omit to state any material fact which is necessary in order to make the statements therein not false or misleading or which is necessary to correct any earlier communication with respect to the solicitation of a proxy which has become false or misleading. The Corp. Fin. Guidance recommends that proxy advisory firms consider including disclosure of material conflicts of interest, third-party information underlying their recommendation, and the methodology used in determining their voting recommendations. The SEC specifically recommends that proxy advisory firms include disclosure regarding the sources of information used in formulating their recommendation, with particular emphasis on highlighting where the information that they are relying on deviates from an issuer’s public disclosures.
As we have in the past, we will continue to monitor these issues and will provide future client updates. This QuickStudy is for guidance only and is not intended to be a substitute for specific legal advice. If you would like more information on the matters discussed here, please contact the authors.