Senate Bill on Proxy Advisors

Nichol Garzon is Senior Vice President and General Counsel at Glass, Lewis & Co. This post is based on a Glass Lewis memorandum by Ms. Garzon.

Just as the SEC convenes a Staff Roundtable to look at the proxy process as a whole, including the possible regulation of the proxy advisory industry, on November 14 six U.S. Senators introduced a bill that would amend the Investment Advisers Act of 1940 to require proxy advisory firms to register as investment advisers. The bill is a continuation of the legislative process that began with U.S. Senate Banking Committee inquiries and hearings held over the summer.

It’s the first time that Senators have introduced a bill addressing proxy advisory firms. Compared to existing legislation in the House, the Senate bill takes a narrower approach, and excludes some of the more controversial aspects of HR 5311 and HR 4015. Rather than creating a new regulatory framework tailored specifically to the proxy advisory industry, the bill seeks to fold proxy advisors, broadly defined to include firms providing ratings along with actual voting recommendations, into existing regulations and disclosure requirements aimed at investment advisers.

Despite the streamlined approach, the rationale for the Senate bill is questionable, possibly resting on a misunderstanding of how investors use proxy analysis and voting recommendations. Moreover, it’s not clear that requiring proxy advisory firms to register as investment advisers under the Investment Advisers Act of 1940, as the framework stands today, would provide any new meaningful protection to investors and issuers with respect to the areas of concern that have been raised.

The Investment Advisers Act was not originally designed to oversee and monitor the nuanced activities of a proxy advisory firm, but was tailored with the investment adviser in mind. Proxy advisors neither advise their clients whether to purchase, sell or hold securities nor do they manage client investments. The Investment Advisers Act is principally about disclosure, with only a few substantive requirements, most of which would not apply to proxy voting advice. Ultimately, this regulatory framework primarily requires that investment advisers disclose to their clients what services they will provide and that investment advisers actually perform the services agreed to.

A different approach could include validating the standards of conduct already implicitly enforced by the industry, coupled with a mechanism to monitor and ensure compliance. Such a plan could be a more appropriate way to address the issues around the role of proxy advisors, conflicts of interest, accuracy and reliability, transparency, and increased oversight.

We look forward to discussing these issues at the SEC Roundtable, and we will continue to engage all stakeholders to provide background.

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