As anticipated on November 5, 2019, the SEC issued two highly controversial rule proposals. The first is to amend Exchange Act rules to regulate proxy advisors. The second is to amend Securities Exchange Act Rule 14a-8 to increase the ownership threshold requirements required for shareholders to submit and re-submit proposals to be included in a company’s proxy statement. For a review of my blog on the Rule 14a-8 proposed amendments, see HERE. The new proposed rules are very controversial, but overdue and necessary. I am in support of both rules.
The SEC has been considering the need for rule changes related to proxy advisors for years as retail investors increasingly invest through funds and investment advisors where the asset managers rely on the advice, services and reports of proxy voting advice businesses. It is estimated that between 70% and 80% of the market value of U.S. public companies is held by institutional investors, the majority of which use proxy advisory firms to manage the decision making and logistics of voting for thousands of proposals within a concentrated period of a few months. Proxy voting advice businesses provide a variety of services including research and analysis on matters to be voted upon; general voting guidelines that clients can adopt; giving specific voting recommendations on specific matters subject to a shareholder vote; and handling the administrative process of returning proxies and casting votes. The administrative tasks are usually electronic and, at times, can involve an automated completion of a ballot based on programed voting instructions.
In 2010 the SEC 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 and in August 2019, the SEC issued new guidance clarifying that proxy advisors engage in “solicitations” within the meaning of the proxy rules.
This blog addresses the proposed rule changes related to the governance of proxy advisory firms. The proposed rules in essence codify the August 29, 2019 SEC guidance (see my blog HERE). In particular, the proposed rule changes the definition of “solicitation” in Exchange Act Rule 14a-1(l) to specifically include proxy advice subject to certain exceptions, provides additional examples for compliance with the anti-fraud provisions in Rule 14a-9 and amends rule 14a-2(b) to specifically exempt proxy voting advice businesses from the filing and information requirements of the federal proxy rules.
In addition, the proposed new rules enhance the quality of the disclosures about material conflicts of interest that proxy voting advice businesses provide their clients, provide that companies and other soliciting parties be given an opportunity to review and provide feedback to identify errors in the proxy voting advice, as long as the relevant definitive proxy materials have been filed 25 days or more in advance of a meeting, and add provisions to improve how investors are informed about differing views on advice.
Rule 14a-1(l) – Definition of “Solicit” and “Solicitation”
The fedederal proxy rules can be found in Section 14 of the Securities Exchange Act of 1934 (“Exchange Act”) and the rules promulgated thereunder and apply to any company which has securities registered under Section 12 of the Act. Exchange Act Rule 14(a) makes it unlawful for any person to “solicit” a proxy unless the follow the specific rules and procedures. Currently, 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. The SEC’s August guidance confirmed that proxy voting advice by a proxy advisory firm would fit within this definition of a solicitation.
The proposed amendments would amend Rule 14a-1(l) to specify the circumstances when a person who furnishes proxy voting advice will be deemed to be engaged in a solicitation subject to the proxy rules. In particular, the Rule would be amended to include “any proxy 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 such advice for a fee,“ within the definitions of “solicit” or “solicitation.”
The SEC provide for certain exemptions to the definition of a “solicitation” including: (i) the furnishing of a form of proxy to a security holder upon the unsolicited request of such security holder as long as such request is not to a proxy advisory firm; (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.
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 proposed SEC rules (and the August 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, 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 the Filing and Information Requirements
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. Currently, 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.” Rule 14a-2(b)(3) generally exempts voting advice furnished by an advisor to any other person the advisor has a business relationship with, such as broker-dealers, investment advisors and financial analysts.
Nevertheless, 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. Also, 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.
The proposed amendments would revise Rule 14a-2(b)(1) and 14a-2(b)(3) such that in order to rely on the exemption, a proxy voting advice business would need to: (i) include disclosure of material conflicts of interest in their proxy voting advice, including any reports, electronic platforms or other materials; (ii) provide companies and certain other soliciting persons with the opportunity to review and provide feedback on the proxy voting advice before it is issued, with the length of the review period depending on the number of days between the filing of the definitive proxy statement and the shareholder meeting; and (iii) allow companies and certain other soliciting persons to request that proxy voting advice businesses include a hyperlink or similar electronic link in their voting advice directing recipients to a written statement by the company or other soliciting person.
Conflicts of Interest
The rule release provides some good examples of conflicts of interest that would require disclosure, including: (i) providing proxy advice to voters while collecting fees from the company for advice on governance or compensation policies; (ii) providing advice on a matter in which one of its affiliates or other clients has a material interest, such as a transaction; (iii) providing voting advice on corporate governance standards while at the same time working with the company on matters related to those same standards; and (iv) providing voting advice related to a company where affiliates of the proxy advisory business hold major shareholder, board or officer positions.
The current rules do generally require disclosure of material interests, but the amended rules require a more specific and robust disclosure. In particular, the amended rules would require disclosure of: (i) any material interests, direct or indirect, of the proxy advisory firm or its affiliates in the matter or parties concerning which it is providing advice; (ii) any material transactions or relationships between the proxy advisory firm or its affiliates and the company, any other soliciting party, a shareholder proponent or in connection with the subject matter of the vote; (iii) any other information regarding the interest, transaction or relationship that is material to assessing the objectivity of the proxy voting advice; and (iv) any policies and procedures used to identify and steps taken to address material conflicts of interest.
The proposed amendments would permit proxy voting advice businesses to require companies and other soliciting persons to enter into confidentiality agreements for materials exchanged during the review and feedback period, and would allow proxy voting advice businesses to rely on the exemptions where failure to comply with the new conditions was immaterial or unintentional.
Review and Feedback on Proxy Advisory Materials
Although some of the largest proxy advisory firms such as ISS and Glass Lewis voluntarily provide S&P 500 companies with an opportunity to review and provide some feedback on advice, there is still a great deal of concern as to the accuracy and integrity of advice, and the need to formally allow all companies and soliciting parties an opportunity to review and provide input on such advice prior to it being provided to solicitation clients. The proposed amendments to Rule 14a2-(b) would require one standardized opportunity for timely review and feedback by companies of proxy voting advice before such advice is disseminated to clients, regardless of whether the advice is adverse to or agreeable to the company’s own position. The same opportunity must be provided to other soliciting parties only if the matter upon which they are soliciting is contested and to persons who intend to deliver their own proxy materials to voters.
The time for review depends on the timing of the definitive proxy statement compared to the meeting. If the definitive proxy statement is filed less than 45 but at least 25 calendar days before the meeting, the proxy advisory firm must provide a minimum of three business days for review and feedback. If the definitive proxy statement is filed more than 45 calendar days before the meeting, the proxy advisory firm must provide a minimum of five business days for review and feedback. If the definitive proxy statement is filed less than 25 calendar days before the meeting, the advisory firm has no obligation to provide a review and feedback period.
In addition to the review and feedback period, in order to rely on the exemptions in Rules 14a-2(b)(1) or (b)(3), a proxy voting advice business would be required to provide companies and certain other soliciting persons with a final notice of voting advice. This final notice must be provided no later than two business days prior to delivery of same to the proxy advisory firm’s clients. This final notice gives the company or other soliciting person a chance to decide whether or not to provide a written statement and request a hyperlink to that statement be provided by the proxy advisory firm. At the end of the two-day period, the proxy advisory firm has no further notice obligations.
Inclusion of Hyperlink to Written Statement
Under proposed Rule 14a-2(b)(9)(iii), as a condition to the exemptions found in Rules 14a2(b)(1) and 14a-2(b)(3), a proxy voting advice business must, upon request, include in its proxy voting advice and in any electronic medium used to deliver the advice a hyperlink (or other analogous electronic medium) that leads to the company’s statement about the proxy advisor’s voting advice. The hyperlink must be included upon request regardless of whether the voting advice is adverse to the company’s position. The written statement itself would be considered a solicitation and therefore subject to the filing and information requirements and anti-fraud rules. Like the notice and feedback rules, the proxy advisory firm is only require to provide a hyperlink for other soliciting parties only if the matter upon which they are soliciting is contested and to persons who intend to deliver their own proxy materials to voters.
Chart of Timing
The following chart included in the SEC rule proposal is helpful:
Person conducts solicitation exempt under
§ 240.14a-2 or submits shareholder proposal pursuant to Exchange Act Rule 14a-8
N/A. Proposed rules do not apply
Registrant and/or soliciting person conducts non-exempt solicitation and files definitive proxy statement for shareholder meeting N/A. Proposed rules do not dictate when the registrant and/or soliciting person files its definitive proxy statement
Proxy voting advice business provides the registrant and/or soliciting person with the version of the voting advice† that the business intends to deliver to its clients
[proposed Rule 14a-2(b)(9)(ii)]
Subject to the proxy voting advice business’s discretion, so long as it provides its voting advice to the registrant and/or soliciting person and complies with the required review and feedback and final notice periods in proposed Rule 14a-2(b)(9)(ii) prior to the distribution of such advice to the business’s clients
Review and feedback period:
Registrant and/or soliciting person has an opportunity to review and provide feedback, if any, on the proxy voting advice business’s voting advice [proposed Rules 14a- 2(b)(9)(ii)(A)(1) and (A)(2)]
· If definitive proxy statement is filed at least 45 calendar days before the date of the meeting, registrant and/or soliciting person has at least five business days to review and provide feedback; or
· If definitive proxy statement is filed less than 45 but at least 25 calendar days before the date of the meeting, registrant and/or soliciting person has at least three business days to review and provide feedback; or
· If definitive proxy statement is filed less than 25 calendar days before the date of the meeting, the proxy voting advice business is not required to provide its voting advice to registrant or soliciting person
Proxy voting advice business may revise its voting advice, as applicable N/A. Subject to the proxy voting advice business’s discretion
Final notice of voting advice:
Proxy voting advice business provides a copy of its voting advice that it will deliver to its clients to allow the registrant and/or soliciting person to assess whether or not to provide a statement with its response to the advice [proposed Rules 14a-2(b)(9)(ii)(B) and 14a-2(b)(9)(iii)]
No earlier than upon expiration of review and feedback period.
Registrant and/or soliciting person has at least two business days to provide a hyperlink (or other analogous electronic medium) with its response, if any
Registrant holds its shareholder meeting N/A
Rule 14a-9 – the Anti-Fraud Provisions
All solicitations, whether or not they 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. The proposed amendments would modify Rule 14a-9 to include examples of when the failure to disclose certain information in the proxy voting advice could, depending upon the particular facts and circumstances, be considered misleading within the meaning of the rule.
The types of information a proxy voting advice business may need to disclose could include the methodology used to formulate the proxy voting advice, sources of information on which the advice is based, or material conflicts of interest that arise in connection with providing the advice, without which the proxy voting advice may be misleading. Currently the Rule contains four examples of information that may be misleading including: (i) predictions as to specific future market values; (ii) information that impugns character, integrity or personal reputation or makes charges concerning improper, illegal or immoral conduct; (iii) failure to be clear as to who proxy materials are being solicited by; and (iv) claims made prior to a meeting as to the results of a solicitation.
The proposed rule would add to these examples the information required to be disclosed under 14a2-(b) including the failure to disclose the proxy voting advice business’s methodology, sources of information and conflicts of interest. Particularly the proxy advisor must provide 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). In its rule release, the SEC uses as an example a case where a proxy advisor recommends a vote against a director for the audit committee based on its finding that the director is not independent while failing to disclose that the proxy advisor’s independence standards differ from SEC and/or national exchange requirements and that the nominee does in fact meet those legal requirements.
Likewise, a proxy advisor must make disclosure 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.
Chair Jay Clayton supports the proposed amendments as part of the necessary modernization of the proxy process. Chair Clayton points out that the increased disclosures will improve transparency and trust during the proxy process without adding undue burdens or delays to the process.
Commissioner Roisman also supports the proposed rule changes. He is aware that some are debating that the SEC is regulating beyond its mission and authority but firmly pushes back on that argument noting that the SEC has always regulated disclosures and fraud in the proxy solicitation process. Proxy advisors are utilized by thousands of investment advisors and institutional investors. In light of the power they hold in the voting process, disclosures on methodologies and conflicts are not only proper but imperative. Commissioner Roisman’s statement is well thought out, pointing out both sides of the arguments, and concluding that the proposed rules find a workable middle ground after much thought and effort on the SEC’s part.
Commissioner Hester Peirce supports the rule changes but points out that they are only part of the overall solution to the problems in the proxy process. Ms. Peirce points out that there is a misperception that investment advisors have a fiduciary duty to vote all of their clients proxies. As the number of retail clients investing through advisors has grown dramatically, they have naturally turned to proxy advisory firms for assistance resulting in a voting process that may or may not take into account a particular client’s views or goals. She hopes that the proposed rules encourage investment advisors and institutional investors to do more due diligence on the proxy advisory firms they use and how they are voting on their clients’ behalf.
Commissioner Jackson is not in favor of the rule change believing it weakens the relationship between investment advisors and their proxy advisor business consultant. He also believes that the new process adds burdens to an advisor that recommends against a company proposal. I simply can’t agree. Requiring proper disclosure, just as a company is required to make proper disclosure, evens the playing field and prevents small private groups from putting forth undisclosed personal interests without any transparency.
Commissioner Allison Herren Lee also disagrees with the proposed rule. Although she agrees that proxy advice should be based on the most reliable accurate information, she thinks it already is and therefore no new rules, or burdens, should be added. She also believes that there is no basis for assuming that greater issuer involvement would improve proxy voting advice.