SEC Issues Guidance On Proxy Advisory Firms
On August 29, 2019, the SEC issued anticipated guidance related to the application of the proxy rules to proxy advisory firms. Market participants have been very vocal over the years regarding the need for SEC intervention and guidance to rein in the astonishing power proxy advisor firms have over shareholder votes, and therefore public companies in general. The new SEC interpretation clarifies that advice provided by proxy advisory firms generally constitutes a “solicitation” under the proxy rules including the necessity to comply with such rules and the related anti-fraud provisions. On the same day, the SEC issued guidance on the proxy voting responsibilities of investment advisors, including when they use proxy advisory firms. This blog focuses on the guidance directly related to proxy advisory firms.
The SEC has been considering the role of proxy advisors for years. In 2010 it issued a concept release seeking public comment on the role and legal status of proxy advisory firms within the U.S. proxy system. In 2013, the SEC held a roundtable on the use of proxy advisory firm services by institutional investors and investment advisers and in 2014, it issued a Staff Legal Bulletin (SLB 20) to provide guidance about the availability and use of exemptions from the proxy rules by proxy advisory firms. Another roundtable was held in November 2018 on the subject. Although the current guidance is a good step in providing clarification, the SEC is also considering rule amendments directly related to proxy advisory firms.
The federal proxy rules can be found in Section 14 of the Securities Exchange Act of 1934 (“Exchange Act”) and the rules promulgated thereunder. Under Exchange Act Rule 14a-1(l), a solicitation includes, among other things, a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy,” and includes communications by a person seeking to influence the voting of proxies by shareholders, regardless of whether the person himself/herself is seeking authorization to act as a proxy. Under the SEC’s interpretation, proxy voting advice by a proxy advisory firm would fit within this definition of a solicitation.
Subject to certain exemptions, a solicitation of a proxy generally requires the filing of a proxy statement with the SEC and the mailing of that statement to all shareholders. Proxy advisory firms can rely on the filing and mailing exemption found in Rule 14a-2(b) if they comply with all aspects of that rule. However, solicitations that are exempt from the federal proxy rules’ filing requirements remain subject to Exchange Act Rule 14a-9, which prohibits any solicitation from containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact.
Rule 14a-1(l) – Solicitations
Exchange Act Section 14(a)9 applies to any solicitation for a proxy with respect to any security registered Section 12 and authorizes the SEC to establish rules and regulations governing such solicitations. As mentioned above, Exchange Act Rule 14a-1(I) defines a solicitation for purposes of compliance with the federal proxy rules. In particular, the terms “solicit” and “solicitation” include: (i) any request for a proxy whether or not accompanied by or included in a form of proxy; (ii) any request to execute or not to execute, or to revoke, a proxy; or (iii) the furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.
The terms do not apply, however, to: (i) the furnishing of a form of proxy to a security holder upon the unsolicited request of such security holder; (ii) the mailing out of proxies for shareholder proposals, providing shareholder lists or other company requirements under Rule 14a-7 related to shareholder proposals; (iii) the performance by any person of ministerial acts on behalf of a person soliciting a proxy; or (iv) a communication by a security holder who does not otherwise engage in a proxy solicitation stating how the security holder intends to vote and the reasons therefor. This last exemption is only available, however, if the communication: (A) is made by means of speeches in public forums, press releases, published or broadcast opinions, statements, or advertisements appearing in a broadcast media, or newspaper, magazine or other bona fide publication disseminated on a regular basis, (B) is directed to persons to whom the security holder owes a fiduciary duty in connection with the voting of securities of a registrant held by the security holder (such as financial advisor), or (C) is made in response to unsolicited requests for additional information with respect to a prior communication under this section.
The new SEC guidance, which is in Q & A format, indicates that solicitations by proxy advisors are reasonably calculated to “result in the procurement, withholding or revocation of a proxy” and, as such, fall within the definition of a solicitation. Finding that proxy advisor solicitations are covered by the rules is consistent with the SEC’s interpretations over the years that the definition is meant to be very broad. The SEC has also consistently stated that the federal proxy rules apply to any person seeking to influence the voting of proxies, regardless of whether the person himself/herself is seeking authorization to act as a proxy. To me it is clear that proxy advisor communications related to a particular vote are clearly solicitations as they both describe the specific proposals and make a voting recommendation.
Proxy advisors can exert a great deal of influence. Many investment advisers retain and pay a fee to proxy advisory firms to provide detailed analyses of various issues, including advice regarding how the investment adviser should vote on the proposals at the registrant’s upcoming meeting. Further proxy advisory firms recommend particular investment advisors based, at least in part, on that investment advisor’s voting history and criteria.
The courts have likewise interpreted the definition of a solicitation expansively. For example, courts have held that a report provided by a broker-dealer to shareholders of the target company in a contested merger constituted a solicitation because it advised the shareholders that one bidder’s offer was “far more attractive” than the other and therefore was a communication reasonably calculated to affect the shareholders’ voting decisions. Similarly, a letter from a shareholder to other shareholders in connection with an annual meeting asking them not to sign any proxies for the company was found to be a solicitation.
By maintaining a broad definition of a solicitation, the SEC can exempt certain communications, as it has in the definition and in Rule 14a-2(b) discussed below and through no-action relief, while preserving the application of the anti-fraud provisions. In that regard, the new SEC guidance specifically states that a proxy advisory firm does not fall within the carve-out in Rule 14a1(I) for “unsolicited” voting advice where the proxy advisory firm is hired by an investment advisor to provide advice. Proxy advisory firms do much more than just answer client inquiries but rather market themselves as having an expertise in researching and analyzing proxies for the purpose of making a voting determination. On the other hand, I note that when a shareholder reaches out to their financial advisor or broker with questions related to proxies, the financial advisor or broker would be covered by the carve-out for unsolicited inquiries.
Rule 14a-2(b) – Exemptions from filing requirements
Although a proxy advisory firm may be engaged in solicitations, they may be exempt from the information and filing requirements of the federal proxy rules under Rule 14a-2(b). Rule 14a-2(b)(1) provides an exemption from the information and filing requirements for “[A]ny solicitation by or on behalf of any person who does not, at any time during such solicitation, seek directly or indirectly, either on its own or another’s behalf, the power to act as proxy for a security holder and does not furnish or otherwise request, or act on behalf of a person who furnishes or requests, a form of revocation, abstention, consent or authorization.” A proxy advisory firm does not seek to vote on behalf of those they solicit or advise.
As an aside I note that the exemption in Rule 14a-2(b)(1) does not apply to affiliates, 5% or greater shareholders, officers or directors, or director nominees nor does it apply where a person is soliciting in opposition to a merger, recapitalization, reorganization, asset sale or other extraordinary transaction or is an interested party to the transaction.
Rule 14a2-(b)(2) provides an exemption from the information and filing requirements of the federal proxy rules when the number of persons being solicited is under 10. This would rarely, if ever, apply to a proxy advisory firm. Rule 14a2-(b)(3) provides an exemption from the information and filing requirements for financial advisors who provide voting advice to their clients subject to certain disclosures such as related party relationships and subject to certain conditions such as the lack of special commissions or compensation for furnishing the voting advice.
Rule 14a2-(b)(4) provides an exemption for certain limited partnership roll-up transactions. Rule 14a2-(b)(5) exempts broker-dealer research reports. Subject to certain timing limitations, Rule 14a2-(b)(6) provides an exemption for “any solicitation by or on behalf of any person who does not seek directly or indirectly, either on its own or another’s behalf, the power to act as proxy for a shareholder and does not furnish or otherwise request, or act on behalf of a person who furnishes or requests, a form of revocation, abstention, consent, or authorization in an electronic shareholder forum.” Finally, subject to certain conditions, Rule 14a2-(b)(7) provides an exemption for shareholders in connection with the formation of a nominating shareholder group.
Rule 14a-9 – Anti-fraud provisions
The SEC guidance affirms that solicitations that are exempt from the federal proxy rules’ information and filing requirements remain subject to Rule 14a-9, which prohibits any solicitation from containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact or omits to state any material fact necessary in order to make the statements therein not false or misleading.
Rule 14a-9 also extends to opinions, reasons, recommendations, or beliefs that are disclosed as part of a solicitation. To protect from Rule 14a-9 concerns, opinions and recommendations should disclose underlying facts, assumptions and limitations. The SEC guidance gives specific examples of information that proxy advisory firms should consider providing in respect to their recommendations, including:
- an explanation of the methodology used to formulate its voting advice on a particular matter (including any material deviations from the provider’s publicly announced guidelines, policies, or standard methodologies for analyzing such matters) where the omission of such information would render the voting advice materially false or misleading;
- to the extent that the proxy voting advice is based on information other than the company’s public disclosures, such as third-party information sources, disclosure about these information sources and the extent to which the information from these sources differs from the public disclosures provided by the company if such differences are material and the failure to disclose the differences would render the voting advice false or misleading; and
- disclosure about material conflicts of interest that arise in connection with providing the proxy voting advice in reasonably sufficient detail so that the client can assess the relevance of those conflicts.
Laura Anthony, Esq.
Anthony L.G., PLLC
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