CII Comment Letter on Proposed Proxy Rules for Proxy Voting Advice

Kenneth A. Bertsch is Executive Director and Jeffrey P. Mahoney is General Counsel at the Council of Institutional Investors. This post is based on a CII letter to the SEC in response to request for comments on the proposed rule regarding proxy advisors (discussed in posts here and here).

The Council of Institutional Investors (CII), appreciates the opportunity to provide comments to the United States (U.S.) Securities and Exchange Commission (SEC or Commission) in response to proposed amendments to the federal proxy rules published on December 4, 2019, in SEC Release No. 34–87457, Amendments to Exemptions From the Proxy Rules for Proxy Voting Advice (Release).

CII is a nonprofit, nonpartisan association of U.S. public, corporate and union employee benefit funds, other employee benefit plans, state and local entities charged with investing public assets, and foundations and endowments with combined assets under management of approximately $4 trillion. Our member funds include major long-term shareowners with a duty to protect the retirement savings of millions of workers and their families, including public pension funds with more than 15 million participants—true “Main Street” investors through their pension funds. Our associate members include non-U.S. asset owners with about $4 trillion in assets, and a range of asset managers with more than $35 trillion in assets under management.

CII strongly opposes the Release in its entirety. We present a general summary of key issues in the Release, and then responses to the specific questions the SEC poses in the Release (page 6 of the complete letter).

We sought to provide as much response to the SEC’s questions as we could within the limited time provided for comments on the Release and the SEC’s proposal to limit shareholder proposals. (Both proposals were announced the same day and have the same limited comment period). We believe the two proposals together (1) are the most significant SEC attempt to limit shareholder rights since the Commission was created; (2) are fundamentally flawed and should be withdrawn so that the SEC can re-think key elements of the proposals and also spend time on credible cost-benefit analysis, should the Commission decide to re-propose changes; and (3) introduce substantial new complexity and micromanagement to proxy voting, while not addressing the major problems in the system.

The SEC poses a total of 345 questions in the two releases. We and 90 investors and investor organizations requested longer comment periods, but never received any response to these requests from the SEC. Therefore, we submit these comments now in anticipation of the February 3 comment deadline. We would note that SEC staff has told us they would welcome comments after February 3 but were equivocal about when might be too late; we may offer further comment at a later date.

In addition to this letter, we anticipate filing an additional letter in coming days focused particularly on unsubstantiated claims of errors by proxy advisors.

The following is a brief summary of our responses to some of the key issues raised in the Release.

Proposed Codification of the Commission’s Interpretation of “Solicitation” Under Rule 14a-1(1) and Section 14(a)

We do not support the proposed codification of the Commission’s interpretation of “solicitation.” It is unclear to us and many legal experts that the SEC has the authority to regulate proxy advisors as solicitors under Section 14(a) of the Exchange Act. We believe this issue ultimately will be decided by the courts.

We also note that the proposed codification undergirds a new proposed regulatory framework that disrupts the existing proxy advisory business model. Most institutional investor clients of proxy advisors do not support the framework; the framework is not based on reliable evidence; and its implementation would not benefit investors generally, including Main Street investors.

Conflicts of Interest

We generally support the proposed requirements to elicit disclosure of proxy voting advice businesses’ conflicts of interest to its clients. We agree that conflict of interest disclosure is important for all major participants in the securities markets, including proxy advisors’ businesses. We do not believe, however, that the SEC needs to create an elaborate and expensive (at least for investors) new regulatory structure to accomplish this.

We do not believe the Release provides reliable evidence indicating that the conflict of interest disclosures currently provided by proxy advisors are inadequate to meet the information needs of their institutional investor clients. Despite the lack of reliable evidence in the Release, we have historically supported and continue to support requiring proxy advisors to disclose details of potential conflicts in their research reports to clients. We generally believe the proposed requirements, subject to some modifications and enforced through existing SEC authority over registered investment advisors, could provide clients of proxy voting advice businesses with adequate and appropriate information about the proxy advisors’ conflicts of interest when making their voting determinations.

Registrants’ and Other Soliciting Persons’ Review of Proxy Voting Advice and Response

We oppose the proposed required review and notice periods of proxy voting advice and response. We believe the proposed requirements would significantly and negatively impact the ability of institutional investors to obtain independent, timely, and cost-effective research and advice from our proxy advisors.

We also believe the proposed requirements are largely premised on the incidence of factual errors and methodical weaknesses in proxy voting advice businesses’ analyses. The Release, however, fails to provide reliable evidence to support that premise.

Setting aside our strong principles-based objections, the rules as proposed are simply unworkable. If, despite our strong opposition, the Commission insists on a government-mandated review of proxy voting advice and response, we believe any requirements should include the following:

  • To be eligible for review of draft proxy voting advice and response an issuer shall:
    • File the definitive proxy statement at least 50 calendar days before the shareholder meeting
    • Reimburse the proxy advisor for reasonable expenses associated with the required review and response
  • The government mandate for the issuer management review and response period be limited to a maximum of two business days, with no “final notice” period (a proxy advisor could provide more time if it chooses)
  • The government mandate for provision in advance of draft reports to subject issuer management be limited to factual information and data only (a proxy advisor could provide more if it chooses, notwithstanding that doing so would be contrary to the FINRA rules for analysts)
  • The proxy advisor be permitted (if it chooses) to provide any such draft data report to clients at the same time it is provided to the issuer for review, as long as it is labeled a draft and as long as the proxy advisor and its clients subject to the SEC’s jurisdiction do not execute votes during the draft review period
  • The proxy advisor is eligible for a safe harbor from liability under Rule 14a-9 if it complies with the proposed

We believe a rule based on the stipulations above would produce far better outcomes than the rule as proposed in the Release. It would not worsen the very substantial time crunch challenges faced by our members and other investors in voting proxies (particularly during the spring proxy season), and would set a baseline for issuer review (as the Commission seeks in the Release), but leave room for firms to go beyond that baseline if there is market demand.

Proposed Amendments to Rule 14a-9

We do not support the proposed amendments to Rule 14a-9. We do not believe the Release provides a reliable basis for the assertion that proxy advice business reports lack clear disclosure when they use criteria that differs from the criteria approved or set by the Commission. We include three examples as appendices to this letter that support our view.

Transition Period

We support revising the proposed “one-year transition period after the publication of a final rule in the Federal Register” to at least an 18-month transition period after the publication of a final rule in the Federal Register. The proposed revision is intended to address concerns about limited time and resources for transition during the spring proxy season.

General Considerations

We support permitting, but not requiring, smaller proxy voting advice businesses from complying with the proposed amendments. More specifically, we would propose that proxy advisors that have annual gross receipts in an amount that is not more than $5,000,000, and/or that are 501(c)(3) organizations, be exempt from the proposed additional conditions to the exemptions.

Economic Analysis

We believe the provisions of the Release are anti-market, and would damage integrity and quality of proxy voting and impose a potentially substantial net cost on investors for at least four reasons.

First, CII staff performed a detailed review of the alleged errors in proxy voting advice business research reports and found a factual error rate on a report basis of 0.057 to 0.123%. We believe an error rate of that magnitude does not provide a reliable basis for imposing a costly new regulatory framework that will constrain competition.

We note that the only quantitative evidence presented in the Release on the reliability of voting advice is a table that provides data of registrant allegations of errors. SEC staff members told us that they made no effort to verify the company assertions. Even assuming the accuracy of company assertions and the SEC’s classification of complaints (about which the SEC declined to show its work), the number of possible factual errors identified by companies in their proxy supplements amounted to 0.3% of proxy reports. Despite repeated CII staff requests, the SEC declined to provide us and other market participants with all of the underlying information the SEC used to generate the table. Thus, we and other commentators are unable to judge the accuracy of the allegations as classified by the SEC (although we anticipate submitting a supplemental letter doing our best, with the limited information provided by the SEC, to examine SEC claims about issuer claims in 2018).

Second, even assuming the Commission believes a 0.3% error rate for proxy voting advice business research reports is too high and should be reduced, the proposed timeframe available for the proxy voting advice businesses to undertake their research and draft their recommendations, and, importantly, for institutional investor clients to review the advice, would generally decrease. Institutional Shareholder Services (ISS) estimates a decrease of nine to 13 calendar days; it says that on average it currently delivers reports just under 20 days in advance of meetings. We believe this shorter timeframe would reduce the reliability and completeness of voting advice, and substantially damage the ability of investors to consider proxy voting issues with the benefit of proxy voting advice that they pay for. The SEC also is proposing requirements for early filing of proxy statements ostensibly to create more time for review of proxy voting issues, but the SEC did not provide adequate justification for the dates it chose, and we believe this “incentive” will be ineffective as proposed by the Commission.

Third, the SEC rules will damage the independence of proxy voting advice. We note that the shorter time frame is largely created by the proposed requirements for proxy voting advice businesses to share draft research reports with companies for a review and feedback period. We believe that those requirements likely violate the First Amendment of the U.S. Constitution (the First Amendment). The requirements impair the independence of the proxy advisor research for at least two reasons: (1) the proxy advisor is required to seek review and receive feedback from the self-interested company before sharing the draft report with their own paying institutional investors clients; and (2) the proxy advisor advice to clients is subject to heightened liability to the issuer under SEC Rule 14a-9. We believe the impairment of the independence of the proxy advisor would reduce the reliability and completeness of voting advice.

Fourth, the highly prescriptive and expensive regulatory approach taken by the Commission is almost certain to damage the market for proxy voting advice, serving as a formidable barrier to entry and potentially putting out of business some firms identified by the SEC as existing proxy advisors. The market itself is an important source of pressure for accuracy and quality in proxy advisor reports. Our members generally would like to have more than two dominant providers, not fewer. The Release seems to entirely ignore the value of market-based solutions, and overvalues highly prescriptive regulation.

We do not possess the data necessary to determine all of the costs resulting from the proposed requirements of the Release. However, we understand that at least two of the proxy voting advice businesses have indicated that the SEC has substantially understated the costs. One of those businesses estimated that the burden imposed by the provisions would be 240x the Commission’s estimate.

The direct costs borne by proxy voting advice businesses resulting from the provisions of the Release would inevitably have to be passed on to their institutional investor clients and the beneficiaries of those client’s funds, including pension fund beneficiaries and other Main Street investors.

For those proxy voting advice businesses that do not currently have any issuer review procedures and processes in place, it is understandable that those businesses would be disproportionally affected by the provisions of the Release. We support measures to mitigate the effects on those businesses. For example, we would exempt businesses that do not routinely issue research reports to clients in advance of shareholder meetings.

Initial Regulatory Flexibility Analysis

We believe that there are a number of small proxy voting agents and research providers that have not been identified in the Release, but are likely to come within the broad sweep of the proposal. We also believe the cost to those firms as a result of the provisions of the Release will likely be significant and potentially cause some or all to exit the business. The SEC should have done additional analysis on smaller firms before making the proposal, including engaging with them about their business models and the impact on their business of potential regulatory schemes (which we understand the SEC did not do at all).

The complete publication, including footnotes, is available here.

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