Expected Effects of SEC Proposals on Public Companies & Proxy Advisors’ Dialogue

Last week, in a 3 to 2 vote in favor, the Securities and Exchange Commission’s (SEC) proposed regulations that would change how proxy advisory firms interact with public companies and their institutional investor clients regarding proxy voting recommendations. The headline for companies is that the SEC proposal would permit them more time to respond directly to proxy advisors with feedback on proposed voting recommendations.

This is the second action the SEC has taken regarding the proxy advisory process, and should be read together with that prior guidance as detailed in “Recent SEC guidance may affect how your company works with proxy advisors,” Executive Pay Matters, September 26, 2019.

The time frame for comments will differ depending on how many days before the annual meeting the company files its proxy. Those that file 45 calendar days or more before the shareholder meeting would have at least five business days to review the proxy voting advice and provide feedback, while those who file at least 25 but less than 45 calendar days before the meeting would have no fewer than three business days. The SEC expects that companies that want to use the five day comment period will file earlier than they have historically.

Timing: The proposed regulation would provide a one-year transition period after the publication of the final rule, although it is not entirely clear how the transition would work. For example, if we assume a Spring 2020 final rule, it is possible implementation would not take place for calendar year companies that file in early 2021, although this reading is far from certain. Comments are due 60 days after publication of the proposal in the Federal Register, which would make them due on or about January 12, 2020.

Discussion: As we detail the main elements of the proposal, keep in mind that the interactions between companies and the proxy advisors, and the recommendations provided to institutional shareholders, are still shared only between those parties and are not disclosed to the public. This reflects some SEC deference to the notion that its proposal seeks an improved process rather than an attempt to push proxy advisors to change their business models or ownership structures to avoid publicity about potential conflicts. The SEC has said as much in the proposal release:

“The focus of our rule proposal, however, is not on all aspects of proxy voting advice businesses’ role in the proxy process. Rather, it is on measures that, if adopted, would address certain specific concerns about proxy voting advice businesses and would help to ensure that the recipients of their voting advice make voting determinations on the basis of materially complete and accurate information. The proposed amendments are designed to achieve these purposes without generating undue costs or delays that might adversely affect the timely provision of proxy voting advice.”

Let’s take a quick look at the elements of the SEC proposal, accompanied by a few observations. Our scope will be narrow, focused on how companies will interact with proxy advisors. In tandem with the proxy advisor proposal, the SEC also proposed new rules that would govern when and which shareholders could offer proposals to be included on company proxies for a shareholder vote. That proposal is outside the focus of our summary.

The requirements listed below are a condition of the proxy advisory firms receiving exemptions from their proxy advice recommendations being considered as proxy solicitations, a hurdle we discussed in detail in our prior blog article (see link above). The issue of whether these communications are, in fact, proxy solicitations is a matter of litigation between one proxy advisor and the SEC. The SEC’s inclusion of this issue as part of the regulatory process raises a question about whether that pending litigation will move forward.

1. Proxy advisors must disclose conflicts of interest

The SEC proposal provides that proxy advisors must include in written or electronic proxy voting advice a detailed disclosure of potential conflicts of interest. Per the preamble, the SEC is concerned that “Given proxy voting advice businesses’ potential to influence the voting decisions of investment advisers and other institutional investors, who often vote on behalf of others, we are concerned about the risk of proxy voting advice businesses providing inaccurate or incomplete voting advice (including the failure to disclose material conflicts of interest) that could be relied upon to the detriment of investors.” The SEC mentioned this change would be in reaction to concerns that the conflicts disclosures provided by proxy advisors are vague or boilerplate and do not provide sufficient information about the nature of potential conflicts.

The proposal does not presume there are actual conflicts, but instead focuses on whether the proxy advisor has:

1. Any material interests in the matter or parties concerning which it is providing the advice
2. Any material transaction or relationship with the company, another soliciting person, shareholder proponent (or affiliates of the foregoing) connected with the matter covered by the advice
3. Other information pertaining to (a) or (b) that is material to assessing the objectivity of the proxy voting advice
4. Any policies and procedures used to identify, and steps taken to address, any material conflicts of interest arising from (a), (b) or (c)

Even though the SEC articulates that proxy advisors would apply a principles-based approach to compliance with these requirements, it notes that disclosures should be sufficiently detailed and cannot be boilerplate. Details may include the identities of the parties involved in the interest, transaction, or relationship triggering the proposed disclosure requirement, which might be more applicable to situations where the proxy advisor’s owner may be proponents of a shareholder proposal. In other circumstances, such as where the proxy advisor also provides consulting services to the company for whom it is providing a voting recommendation, details might include the approximate dollar amount involved in the interest, transaction or relationship. Under any circumstance, the proposal also would require a discussion of the material features of the policies and procedures used to identify and steps taken to address such potential and actual conflicts of interest.

Observations: The proposal would change the existing dynamic whereby institutional investors must actively obtain details of potential conflicts of interest, either by accessing links provided in reports or by reaching out to the proxy advisory firm. Instead, the proxy advisors would have an affirmative duty to provide disclosures of material relationships that could create conflicts of interest. The proposal also requires more details to be communicated regarding policies and procedures that might be in place to mitigate those conflicts. We expect proxy advisors would provide their clients a disclosure of fees for consulting services provided to the company for which it is making recommendations, which is a prevalent situation. Less prevalent, but perhaps more important, proxy advisors whose owners may be proponents of shareholder proposals would need to disclose these interests and how they believe providing voting recommendations on these matters are not material conflicts.

2. Expanding communications between companies and proxy advisors

The SEC proposes expanding companies’ ability to have a dialogue with proxy advisors beyond what currently exists. It stated it is reacting to concerns expressed by commentators and companies “that there could be factual errors, incompleteness, or methodological weaknesses” in how proxy advisors analyzed companies’ business, and how this information affected their voting advice. The SEC noted a perception that companies don’t have enough time to review the factual data and methodology behind the voting recommendations before institutional votes begin, particularly among smaller companies. It acknowledged that proxy advisors have expanded the opportunities for companies to comment over the past several years, but did not believe these steps were enough to permit companies a timely and effective way to express views contrary to the proxy advisor voting recommendation before shareholders cast their votes.

There are two parts to this element of the proposal:

A. Mandating a dialogue process between proxy advisors and companies

The proposed amendments to Rule 14a-2(b) would require a standardized process where companies can review and provide feedback on proxy advice before it is disseminated to institutional investors. As noted above, the length of time provided for the review will depend on how far before the annual shareholder meeting that the definitive proxy is filed. The SEC designed the rule to provide companies an incentive to file their proxy statements as far in advance of the meeting date as practicable, to permit more time for proxy advisors to formulate their recommendations and more time for companies to comment.

The time a company will have to review the proxy voting advice and provide feedback is proposed as follows:

• 45 calendar days or more before the annual shareholder meeting, at least five business days
• Less than 45 but at least 25 calendar days before the meeting, no fewer than three business days

The SEC expects that companies customarily filing their definitive proxies 35 to 40 calendar days in advance of a shareholder meeting would potentially file earlier to use the five business day rule.

Following the review and feedback period, the proxy advisor must provide a final notice of voting advice to the company and a copy of the proxy advice to be delivered to clients containing any revisions made in response to feedback. This final notice must be provided no later than two business days before voting advice delivery to clients.

B. Communicating company views on proxy voting advice

Once a company receives the final notice of voting advice, it could then choose to provide a statement in response to this advice and/or request that a hyperlink of its response be included in the voting advice delivered to institutional investor clients. This could be instead of, or in addition to, supplemental proxy materials companies might currently file in response to negative proxy voting recommendations. The difference here is that the company’s statement would not be available to all shareholders because it is sent only to the proxy advisor’s institutional investor clients. If the company wanted a statement to be more widely available to non-client shareholders, the SEC specifies it would be considered a proxy solicitation and would need to be filed as supplemental proxy material.

Observations: The proposal certainly would open the window for increased dialogue with proxy advisors and provide a more direct window for companies to offer their views to clients of these advisors. It also seems that this dialogue will permit companies to focus on the substance of existing proxy advisor policies and whether their application to specific business circumstances is appropriate to formulating a voting recommendation. We expect this will lead to lively discussions about whether these policies can and should be applied to all situations, and whether the policies themselves are properly designed to reflect the concerns of all institutional shareholders, regardless of their investment philosophies.

It is too soon to forecast how the proposal may change the proxy advisory process. The SEC is seeking comments on the potential implications of each aspect of the proposal, including whether the rules will accomplish the goals outlined, but also how these rules would affect how proxy advisors do business. Certainly, there will be staffing challenges for the advisors to respond to company feedback. Whether this moves them to a different, more scalable methodology to help establish their voting recommendations is a question that is balanced against the SEC’s prior guidance that voting recommendations should be better tailored to the needs of individual investors.