SEC No-Action Letters Related to Proxy Advisory Firms

Cydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley publication by Ms. Posner.

You may recall that, in July, SEC Chair Jay Clayton announced that the SEC will be holding a Roundtable to discuss the proxy process, currently expected to be held in November. (See this PubCo post.) Among the potential topics identified was the role of proxy advisory firms and the question of whether investment advisers and others rely excessively on proxy advisory firms for information aggregation and voting recommendations. In anticipation of that roundtable, the staff of the Division of Investment Management has today issued a statement announcing that, in light of subsequent developments, the staff has withdrawn two frequently disparaged no-action letters, Egan-Jones Proxy Services (May 27, 2004) and Institutional Shareholder Services, Inc. (Sept. 15, 2004), which provided staff guidance about investment advisers’ responsibilities in voting client proxies and retaining proxy advisory firms.


SideBar

Amusingly, in light of this contemporaneous statement from Chair Clayton, the announcement states, in the first paragraph, that “Staff guidance is nonbinding and does not create enforceable legal rights or obligations.” And then, in case we missed it in the first paragraph, at the end of the five-paragraph announcement, it repeats that the update “does not constitute staff legal guidance and is not a rule, regulation, or statement of the Securities and Exchange Commission. The Commission has neither approved nor disapproved its content.” Message received. See this PubCo post.)

By way of background, as fiduciaries, investment advisers owe their clients duties of care and loyalty with respect to services provided, including proxy voting. Accordingly, in voting client securities, an investment adviser must adopt and implement policies and procedures reasonably designed to ensure that the adviser votes proxies in the best interest of its clients. The two now-withdrawn no-action letters indicated that one way advisers could demonstrate that proxies were voted in their clients’ best interest was to vote client securities based on the recommendations of an independent third party—including a proxy advisory firm—which served to “cleanse” the vote of any conflict on the part of the investment adviser. Historically, investment advisers have frequently looked to proxy advisory firms to fill this role. As a result, the staff’s guidance was often criticized for having “institutionalized” the role of—and, arguably, the over-reliance of investment advisers on—proxy advisory firms, in effect transforming them into faux regulators.

As discussed in this Cooley Alert, in response to frequently voiced criticisms that proxy advisory firms wielded too much influence—with too little accountability—in corporate elections and other corporate matters, in 2014, the SEC’s Divisions of Investment Management and Corp Fin issued Staff Legal Bulletin No. 20, “Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms,” which sought to reinforce the responsibilities of investment advisers as voters by reinvigorating their due diligence and oversight obligations with respect to any proxy advisory firms on which they relied. In that guidance, the staff indicated additional steps that an investment adviser could take to demonstrate that proxy votes were cast in accordance with clients’ best interests. In addition, investment advisers were advised to “adopt and implement policies and procedures that are reasonably designed to provide sufficient ongoing oversight of the third party in order to ensure that the investment adviser, acting through the third party, continues to vote proxies in the best interests of its clients,” including measures to identify and address the proxy advisory firm’s conflicts on an ongoing basis. For example, the investment adviser was advised to ascertain, among other things, “whether the proxy advisory firm has the capacity and competency to adequately analyze proxy issues.” However, the SLB left the two no-action letters in effect, and calls for regulation of proxy advisory firms have continued unabated. (See this PubCo post.)

In the announcement, the staff indicates that the notice of withdrawal of the two letters was provided to facilitate the discussion at the Roundtable and that it intends to use information and feedback learned at the Roundtable in making recommendations to the SEC with respect to proxy advisory firms, including with regard to SLB 20.

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