SEC Staff Releases Guidance Regarding Proxy Advisory Firms

July 1, 2014

On June 30, 2014, the staff of the Securities and Exchange Commission’s (the "Commission") Division of Investment Management and Division of Corporation Finance (the "Staff") issued much-anticipated guidance regarding proxy advisory firms, in the form of 13 Questions and Answers.  Published in Staff Legal Bulletin No. 20 ("SLB 20"), available at http://www.sec.gov/interps/legal/cfslb20.htm, the Staff’s guidance addresses both (1) investment advisers’ responsibilities in voting client proxies and retaining proxy advisory firms (Questions 1-5), and (2) the availability and requirements of two exemptions to the proxy rules often relied upon by proxy advisory firms (Questions 6-13).

SLB 20 includes an acknowledgement that investment advisers and proxy advisory firms may determine or need to make changes to their current systems and processes in light of its guidance.  Accordingly, the Staff "expects any necessary changes will be made promptly, but in any event in advance of next year’s proxy season."  However, the guidance is unlikely to affect public companies’ interaction with proxy advisory firms. 

This alert provides an overview of SLB 20, focusing on information that public companies should know about the new Staff guidance. 

I.          Proxy Advisory Firms and the SEC’s Proxy Solicitation Rules

The Staff of the Division of Corporation Finance explained that a proxy advisory firm is subject to the federal proxy rules when it engages in a "solicitation," and the Commission has stated, as a general matter, that the furnishing of proxy advice constitutes a "solicitation" subject to the information and filing requirements of the federal proxy rules.  However, Rule 14a-2(b)(1) under the Securities Exchange Act of 1934 (the "Solicitation Exemption") provides an exemption from the SEC’s information and filing requirements (but not from the anti-fraud rules) for "any 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 a 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." 

SLB 20 provides the Staff’s views on the scope of the Solicitation Exemption.  Specifically, the Solicitation Exemption is not available for a proxy advisory firm offering a service that allows the client to establish, in advance of receiving proxy materials for a particular shareholder meeting, general guidelines or policies and then authorize the proxy advisory firm to execute a proxy or submit voting instructions on its behalf, with discretion to apply the guidelines to determine how to vote on particular proposals.  In this instance, the proxy advisory firm would be viewed as having solicited the "power to act as a proxy" for its client, even if the authority is revocable by the client.  

The Staff further explains that even if the Solicitation Exemption is not available, Rule 14a-2(b)(3) under the Securities Exchange Act of 1934 (the "Business Relationship Exemption") may be available.  The Business Relationship Exemption exempts the furnishing of proxy voting advice by any person to another person with whom a business relationship exists, but only if:  (1) "the person gives financial advice in the ordinary course of business;" (2) "discloses to the recipient of the advice any significant relationship with the company or any of its affiliates, or a security holder proponent of the matter on which advice is given, as well as any material interests of the person in such matter;" (3) "receives no special commission or remuneration for furnishing the advice from any person other than the recipient of the advice and others who receive similar advice;" and (4) "does not furnish the advice on behalf of any person soliciting proxies or on behalf of a participant in a contested election."

SLB 20 provides the following guidance on when a proxy advisory firm may rely on the Business Relationship Exemption:

• If a proxy advisory firm provides consulting services to a company on a matter that is the subject of a voting recommendation or provides a voting recommendation to its clients on a proposal sponsored by another client, it must assess, based on the facts and circumstances, whether this relationship with the company or security holder proponent is "significant" or whether it has any "material interest" in the matter that is the subject of the voting recommendation.  SLB 20 states that, in making this determination, a proxy advisory firm likely would consider "the type of service being offered to the company or security holder proponent, the amount of compensation that the proxy advisory firm receives for such service, and the extent to which the advice given to its advisory client relates to the same subject matter as the transaction giving rise to the relationship with the company or security holder proponent."  A "significant" relationship or a "material interest" generally would exist if knowledge of the relationship or interest would "reasonably be expected to affect the recipient’s assessment of the reliability and objectivity of the advisor and the advice."
• If a proxy advisory firm determines that it has a "significant relationship" or "material interest" that requires disclosure, it must disclose to the recipient of the advice information that "should enable the recipient to understand the nature and scope of the relationship or interest, including the steps taken, if any, to mitigate the conflict" and "allow the recipient to make an assessment about the reliability or objectivity of the recommendation."  In this regard, SLB 20 states that boilerplate language that such a relationship or interest may or may not exist would not be considered sufficient, nor is it sufficient to state only that such information will be provided upon request.
• A proxy advisory firm may make disclosure of "significant" relationships and "material interests" only to the client or may make such disclosure publicly available.  While a proxy advisory firm is not required to include the disclosure in the report about a company or in another document that conveys a voting recommendation or advice, the disclosure should be provided in a manner that would "allow the client to assess both the advice provided and the nature and scope of the disclosed relationship or interest at or about the same time that the client receives the advice."

II.        Investment Advisers’ Proxy Voting and Use of Proxy Advisory Firms

The Staff of the Division of Investment Management explained that, as a fiduciary, an investment adviser owes its clients a duty of care and loyalty with respect to proxy voting as well as other services undertaken on the client’s behalf.  Further, Rule 206(4)-6 under the Investment Advisers Act of 1940 (the "Proxy Voting Rule") provides that an investment adviser registered or required to be registered with the Commission has an obligation to adopt and implement written policies and procedures that are reasonably designed to ensure that the investment adviser votes proxies in the best interest of its clients.

SLB 20 provides guidance on an investment adviser’s responsibilities under the Proxy Voting Rule, including the following:

• An investment adviser should review the adequacy of its proxy voting policies and procedures at least annually to confirm that they have been implemented effectively and continue to be in compliance with the requirements of the Proxy Voting Rule.  In this regard, an investment adviser could demonstrate compliance with the Proxy Voting Rule by periodically sampling proxy votes to determine whether they complied with the investment adviser’s proxy voting policy and procedures, or specifically reviewing a sample of proxy votes relating to proposals that may require additional analysis.
• While SLB 20 indicates that, in most cases, clients delegate all proxy voting authority to their investment advisers, the Staff clarified that the Proxy Voting Rule provides flexibility for an investment adviser and its client to determine the scope of the investment adviser’s proxy voting responsibilities.  SLB 20 specifically notes that this may include, for example, arrangements where the adviser and its clients determine: (1) that the time and costs associated with the mechanics of voting proxies with respect to certain types of proposals or issuers may not be in the client’s best interest; (2) that the adviser will abstain from voting any proxies; (3) that the adviser should vote proxies as recommended by the company’s management or in favor of all proposals made by a particular shareholder proponent; or (4) that the adviser will focus resources only on certain types of proposals depending on the client’s preferences. 
• In considering whether to retain or continue to retain a proxy advisory firm to provide proxy voting recommendations, an investment adviser should determine whether the firm has the "capacity and competency to adequately analyze proxy issues."  This could include consideration of the following factors:  the adequacy and quality of the proxy advisory firm’s staffing and personnel; and the robustness of its policies and procedures regarding its ability to (1) ensure that its proxy voting recommendations are based on current and accurate information and (2) identify and address any conflicts of interest.
• In addition, an investment adviser that has retained a proxy adviser must provide sufficient ongoing oversight in order to ensure that the investment adviser continues to vote proxies in the best interests of its clients.
• With respect to an investment adviser’s duties relating to the material accuracy of the facts upon which the proxy advisory firm’s voting recommendations are based, the Staff reiterated that an investment adviser that receives voting recommendations from a proxy advisory firm should determine that the proxy advisory firm has the capacity and competency to adequately analyze proxy issues, including the ability to make voting recommendations based on materially accurate information.  If, for example, an investment adviser determines that a proxy advisory firm’s recommendation was based on a material factual error that causes the adviser to question the process by which the proxy advisory firm develops its recommendations, the adviser should take reasonable steps to investigate the error, and seek to determine whether the firm is taking reasonable steps to reduce similar errors in the future. 

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