On August 21, 2019, in a 3-2 vote along party lines, the Securities and Exchange Commission (SEC) issued guidance to investment advisers regarding their voting responsibilities, in particular when engaging proxy advisory firms such as Institutional Shareholder Services (ISS) and Glass Lewis. Although the SEC appears to be issuing a warning to proxy advisory firms about potentially opaque evaluation methodologies, inaccurate conclusions, and conflicts of interest, the lack of specific requirements in the guidance is not likely to result in significant change. Rather, the Commission puts the onus on investment advisers to develop and maintain policies and procedures to ensure they are fulfilling their fiduciary duties to their clients (e.g., the duty to provide advice that is in the best interests of the client). Dissenting commissioners worry that the guidance will increase costs that could discourage new proxy advisory firms from entering the market and lead smaller investors to vote less frequently, thereby increasing the impact of votes by larger funds.
On the same date, the SEC also issued interpretive guidance to proxy advisory firms confirming that their voting advice constitutes a “solicitation” under the federal proxy rules and is subject to the anti-fraud rule prohibiting any solicitation from containing false or misleading statements with respect to any material fact. This guidance raises several questions, including whether firms like ISS will need to open their “black box” and disclose the methodologies underlying their voting recommendations.
The SEC’s “Guidance Regarding Proxy Voting Responsibilities of Investment Advisers” outlines considerations an investment adviser should take into account when retaining a proxy advisory firm, such as:
- The proxy advisory firm’s “capacity and competency to adequately analyze” the relevant voting matters, including “the adequacy and quality” of the firm’s employees and technology.
- The proxy advisory firm’s process for gathering input from issuers, clients, and third parties on voting policies and methodologies for developing vote recommendations, and whether the proxy advisor adequately discloses such policies and methodologies and any third-party information sources used.
- As an example of one such methodology, the guidance discusses the development of peer groups used in comparative evaluations of performance and pay, which often form the foundation of the proxy advisor’s vote recommendation for “Say-on-Pay.” Peer group construction is often a major sticking point, and the guidance suggests that investment advisers consider the manner in which the proxy advisor takes into account the issuer’s unique characteristics, governance structures, history and financial performance, etc.
- The proxy advisory firm’s policies and procedures for identifying and addressing conflicts of interest, and the firm’s disclosure of such conflicts. Examples of potential conflicts identified in the guidance include:
- A proxy advisory firm providing services to issuers in addition to the services provided to investment advisers, and
- A third party, such as a major shareholder of the proxy advisory firm, taking a position on a particular voting issue.
The guidance also discusses “potential factual errors, potential incompleteness, or potential methodological weaknesses” in the proxy advisory firm’s analysis. Here the guidance recommends investment advisers implement policies and procedures to ensure vote determinations are based on accurate information, but again no specific actions are mandated.
In “Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice,” the SEC confirmed that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” subject to federal proxy rules, and that even solicitations that are exempt from filing and information requirements (as is commonly the case with proxy advisory firm voting advice) are subject to the rule prohibiting any solicitation from containing false or misleading statements with respect to any material fact.
- Where opinions and recommendations are provided in solicitations, “disclosure of the underlying facts, assumptions, limitations, and other information may be needed” to comply with the federal proxy rules. As examples, the SEC noted that proxy advisory firms should consider whether to disclose:
- The methodology used to formulate voting advice,
- Any third-party information sources, if not publicly available, or
- Any material conflicts of interest that arise in connection with providing proxy advice.
The guidance and interpretation issued on August 21, 2019 are first steps in the SEC’s review of the proxy process. The staff is also considering amendments to the exemptions from the federal proxy rules’ filing requirements commonly relied upon by proxy advisory firms.
Managing Director & Head of Chicago Office
Cimi Silverberg has twenty-two years of consulting experience, nineteen focusing solely on executive compensation. Cimi’s clients include both public and private organizations in a variety of industries and company size categories. She is a frequent writer and speaker on the topic of executive compensation and a strong contributor to the firm’s technical papers and studies.
Jeffrey M. Kanter
Jeff Kanter joined the firm in 1985 and is a member of the firm’s Board of Directors. He has a legal background with specialization in taxation. Jeff works with both private and public companies of all sizes, and among all industries throughout the world on the design of short- and long-term incentive and related compensation programs. He has a particular specialization in transactional consulting, such as corporate and financial restructurings, IPOs, acquisitions and divestitures and employment arrangements.
Dina Bernstein has extensive experience advising on all aspects of executive compensation, working with companies on an ongoing basis, as well as in the context of mergers and acquisitions, spin-offs, initial public offerings, and other corporate events. Dina provides guidance to private and public companies across various industries regarding cash and equity incentive compensation arrangements, employment, severance and change in control agreements, overall compensation program design, pay governance practices, taxation, stock exchange listing requirements and securities regulation compliance.