ISS Comment Letter on Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice

Subodh Mishra is Executive Director at Institutional Shareholder Services, Inc. This post is based on a recent comment letter from ISS President & CEO Gary Retelny to the SEC in response to request for comments on the proposed rule regarding proxy advisors (discussed in posts here and here).

Institutional Shareholder Services Inc. (ISS) submits these comments in response to the above-referenced proposal to regulate proxy advice as a proxy solicitation under the Securities Exchange Act of 1934 (Exchange Act). [1]

Over the past several years, proxy advisers have become surrogates in the debate over how much say shareholders should have in the companies they own. On one side of this debate are shareholders and their representatives, who see proxy voting as an integral part of their fiduciary responsibilities and a duty of good corporate citizenship and who believe proxy advisers play a critical role in aggregating and synthesizing the vast array of data found in proxy statements and providing independent research, analysis and advice that help shareholders make well-informed voting decisions. On the other side are certain corporate representatives who appear to resent shareholders’ ability to disagree with management and who have launched a volley of attacks against proxy advisers based mostly on anecdote, faulty reasoning and the occasional fabricated news. In issuing the current rule proposal, the SEC has put its finger firmly on the issuers’ side of the scale, a departure from its stated mission. Distilled to its essence, the proposal would give the managers of U.S. public companies an unprecedented and unconstitutional editorial role in the production of the research and vote recommendations that institutional investors engage proxy advisers to provide.

The proposal has three core components.

The first is a definitional component. Here, the Commission proposes to amend Exchange Act Rule 14a-1(l) to classify expert proxy voting advice, including advice rendered by investors’ fiduciaries, as a “solicitation” subject to the Exchange Act proxy rules, depending on how the adviser markets its services and structures its fees. The proposed changes to Rule 14a-1(l) would codify a modified version of the new definition of solicitation the SEC adopted this past August when it issued an “Interpretation and Guidance” regarding proxy advisers. [2] Concluding that the SEC lacks the authority to regulate proxy voting advice as though it were a solicitation, ISS has asked a federal court to invalidate the Interpretation and Guidance on both substantive and procedural grounds. [3]

The second component of the proposal is exemptive. Here, the Commission proposes to amend two exemptions from the information and filing requirements of the proxy solicitation rules. One exemption, found in Rule 14a-2(b)(1), was originally designed for certain shareholders and other parties who do not seek to act as a proxy for a security holder and who have a limited interest in the outcome of a shareholder vote, consent or authorization. The other exemption, found in Rule 14a-2(b)(3), was designed for certain financial advisors who voluntarily supply proxy voting advice to parties who have not asked for it, which the SEC traditionally has called “unsolicited” advice. Under the current proposal, a proxy adviser seeking to rely on either exemption would be required to provide the subject of its advice with a review and feedback right, the timing of which would vary depending on when the company files its definitive proxy statement. In addition, no later than two business days prior to delivery of the proxy advice to its clients, the proxy adviser would be obliged to provide the subject of the research and advice with a final notice of voting advice, which would have to contain a copy of the proxy voting advice that will be delivered to its clients. If the subject of the advice is not satisfied with the proxy adviser’s finished product, it could force the adviser to include in the proxy advice (and on any electronic medium used to distribute the advice), a hyperlink directing the recipient of the advice to the subject’s views on the advice. The adviser would effectively be barred from responding to the subject’s statement, regardless of how objectionable, baseless or inaccurate it might be. These review, feedback and content-insertion benefits would be guaranteed to issuers of securities registered under Section 12 of the Exchange Act and certain other parties engaging in a solicitation, but not to shareholder proponents of ballot proposals.

The Commission also proposes to duplicate the substance of proxy advisers’ existing conflict of interest disclosures, but with additional twists: Now advisers would have to disclose the new conflicts created by the unprecedented editorial rights the proposal would grant to the subjects of the proxy voting advice. In addition, the prescriptive requirements in the proposal for how disclosure is made do not align with the disclosure requirements in existing regulations.

The third aspect of the SEC’s proposal is a litigation risk component. In this regard, the SEC seeks to build on the new liability theory it adopted in the Interpretation and Guidance with regard to Exchange Act Rule 14a-9, which prohibits material misstatements or omissions of fact in proxy solicitations. There, the Commission said that proxy advisers’ “opinions, reasons, recommendations, or beliefs” can be “statements of material facts” actionable under 14a-9. [4] In a nod to those public companies who do not want to be judged by anything other than the lowest standards required by law, the Commission now proposes to force proxy advisers to make granular disclosure about how the voting guidelines their clients create or select differ from minimum market standards the SEC sets or approves.

ISS submits that there is no legal basis for any aspect of the proposal and that Congress never authorized the SEC to regulate either proxy advisers or proxy advice under the Exchange Act proxy rules. ISS further submits that the proposal to grant public companies and certain other solicitors the right to review, comment on and insert content into the advice proxy advisers render to their clients is unconstitutional, since it infringes on advisers’ First Amendment rights of free speech. By forcing proxy advisers to give their intellectual property to the subjects of their advice, the proposal also violates the Takings Clause of the Fifth Amendment of the Constitution and destroys ISS’ reliance interests in maintaining the independence and integrity of its adviser-client relationships.

Furthermore, the proposal rests on the erroneous assertion that there are problems with the accuracy and integrity of proxy voting advice and ignores statements by the consumers of proxy advice that contradict that baseless assertion. The reality is that we at ISS go to great lengths to ensure the accuracy of the information that underpins our proxy research and recommendations and it is clear to us—after looking at the unsupported claims of “evidence” of pervasive errors— that most “errors” are actually differences over subjective interpretations or differing opinions on methodological frameworks.

The proposal is also unworkable. The suggested review, feedback and response-insertion provisions would severely impede proxy advisers’ ability to deliver research and voting recommendations for U.S. corporations to investor clients in a timely fashion. We estimate that the review and feedback rights provided to registrants and certain other soliciting parties alone could reduce our report delivery time by between 45 and 65 percent, thus reducing the time available for shareholders to make the well-informed decisions that the proposals purport to encourage.

The proposal arbitrarily fails to explain why investors cannot be adequately protected under the fiduciary regime established under the Investment Advisers Act of 1940 (Advisers Act); nor does the proposal acknowledge, as it should have, that the suggested amendments to the proxy rules would duplicate, overlap and conflict with applicable Advisers Act rules.

The proposal’s cost/benefit analysis is also seriously deficient. Among other things, it selects as a baseline the Interpretation and Guidance that the Commission adopted last August without undertaking any cost-benefit analysis, and without assessing the proposal’s effect on competition. The proposal underestimates the operational costs of complying with the revised proxy rule exemptions and fails to calculate the costs to proxy advisers and their clients of managing and monitoring the new requirements resulting from the review, feedback and content-insertion provisions. The proposal also ignores the costs to proxy advisers of having to defend baseless lawsuits by disgruntled registrants under Rule 14a-9. With regard to impact on the capital markets, the proposal fails to recognize the likely diminution of competition and loss of diverse thought among proxy advisers, and the increased insider trading risks caused by proxy advisers’ forced disclosure of material nonpublic information to registrants and certain other solicitors. On the other hand, the proposal’s benefits, which are largely illusory, are grossly overstated.

The attached appendix examines these legal, factual, and economic deficiencies in detail. Because of these deficiencies, ISS strongly urges the Commission to withdraw this flawed proposal.

Download the full comment letter here.

Endnotes

1Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice, Exchange Act Rel. No. 87457 (Nov. 5, 2019), 84 Fed. Reg. 66518 (Dec. 4, 2019), available at https://www.sec.gov/rules/proposed/ 2019/34-87457.pdf.(go back)

2Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice, Exchange Act Rel. No. 86721 (Aug. 21, 2019), 84 Fed. Reg. 47416 (Sept. 10, 2019), available at https://www.sec.gov/rules/interp/2019/34-86721.pdf (Interpretation and Guidance).(go back)

3ISS v. SEC et al., 1:19-cv-03275 (D. D.C. filed 10/31/19). This case has been held in abeyance until the earlier of January 1, 2021 or the promulgation of final rules in this rulemaking.(go back)

4Interpretation and Guidance, supra note 2, at 11, 84 Fed. Reg. at 47419.(go back)

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