Environmental, Social & Governance Briefs

On Governance: What Does the Latest SEC Guidance Mean for Proxy Advisors, Companies?

August 26, 2019

On Governance is a series of guest blog posts from corporate governance thought leaders. The series, which is curated by the Governance & Sustainability Center research team, is meant to serve to spark discussion on some of the most important corporate governance issues.

The SEC’s recent guidance releases have indicated that the agency is addressing the influence of proxy advisory firms on the shareholder proxy voting process.

First, without getting into the underlying merits, consider the complaints many public companies have had regarding proxy advisors, most of which were made during last fall’s SEC proxy voting process roundtable:

• They influence a substantial portion of director and shareholder proposals votes through their proxy voting recommendations;
• Their recommendations are sometimes based on inaccurate and incomplete information;
• They have conflicts of interest;
• They don’t regularly communicate with companies for which they issue the aforementioned voting recommendations.

Now, look at a description of the SEC’s two pieces of guidance it approved in a 3-2 vote on Aug. 21.

The guidance discusses, among other matters, the ability of investment advisers to establish a more stringent protocol when using the services of a proxy advisory firm. That protocol includes some of the following actions (to see the full protocol, click here):

• How an investment adviser and its client, in establishing their relationship, may agree upon the scope of the investment adviser’s authority and responsibilities to vote proxies on behalf of that client;
• Considerations that an investment adviser should take into account if it retains a proxy advisory firm to assist it in discharging its proxy voting duties;
• Steps for an investment adviser to consider if it becomes aware of potential factual errors, potential incompleteness, or potential methodological weaknesses in the proxy advisory firm’s analysis that may materially affect one or more of the investment adviser’s voting determinations;
• How an investment adviser could evaluate the services of a proxy advisory firm that it retains, including evaluating any material changes in services or operations by the proxy advisory firm.

In addition, the SEC issued an interpretation that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules and provided related guidance about the application of the proxy antifraud rule to proxy voting advice. While proxy advisors are generally exempt from federal proxy rules filing requirements, that does not include the anti-fraud provisions. The new guidance confirmed that.

Commissioner Elad Roisman, who headed up the guidance project, explained: “This guidance discusses ways [investment] advisers can use the services of proxy advisory firms responsibly.” That included the investment adviser’s decision to retain a proxy advisor, addressing potential errors or incompleteness in proxy advisor analysis, and the evaluation of the proxy services.

The U.S. Chamber of Commerce’s response to the SEC’s actions is worth reading.

“Proxy advisory firm reform is critical to reversing the decline of companies going and staying public in the United States and boosting American competitiveness in a global economy,” said Tom Quaadman, executive vice president of the U.S. Chamber’s Center for Capital Markets Competitiveness. “Proxy advisory firms have been riddled with conflicts of interest, failed to link advice with economic return or company-specific information, and lack process and transparency. We commend the SEC for taking a critical first step in bringing much-needed oversight to proxy advisory firms, and we hope the SEC and other regulators take further action to ensure that proxy advisory firms provide ‘decision-useful’ information to investors.”

The consensus is that the SEC’s recent clarification of investment advisers’ proxy voting responsibilities and the application of proxy rules to voting advice will drive up the cost of proxy advisors’ services.

Robert Lamm, a senior fellow of The Conference Board Governance & Sustainability Center and shareholder for Gunster Law Firm, addressed the guidance impact on proxy advisors.

“It looks like both the [proxy] advisors and their clients will need to adopt and implement some new policies and procedures, and that in some cases existing policies and procedures will need to be modified and/or documented,” he said. “If conventional wisdom is correct that the major proxy advisory firms would lose money but for corporate consulting, increased costs could be very painful.”

Another corporate governance expert who is a member of The Conference Board Governance & Sustainability Center believes the guidance will most likely lead to higher costs for proxy advisors and alter the behavior of investment advisors.

“Wednesday’s [Aug. 21, 2019] guidance will likely impose some modest costs on proxy advisors and investment advisers, but not move the needle on the issue that most concerns public companies, which is whether the influence of the proxy advisors on governance is too great today,” said Arthur Kohn, partner at Cleary Gottlieb Steen & Hamilton LLP. “That issue is affected in various ways by the economics of the proxy process – i.e., by the costs that must be incurred and the benefits that may be derived from a careful fiduciary approach to voting shares.”

One area Lamm sees challenging for proxy advisors is addressing the SEC’s focus on factual errors and omissions and methodological weaknesses in proxy advisor reports. “Given the concentration of shareholder meetings in the late first/second quarters, getting draft reports to companies and fielding their comments is already a struggle, even though only larger companies are currently favored with draft reports,” Lamm said. “If advisory firms have to provide drafts to every company, it’s not clear whether or how they will be able to do this.”

In a client memo, Wachtell Lipton Rosen & Katz stated: “These pronouncements increase pressure on investment advisers and proxy advisory firms in terms of what is expected of them and should alter the behavior of those that are not already following this guidance. The SEC is encouraging investment advisers and proxy advisory firms to review their policies and practices in light of the new guidance in advance of next year’s proxy season.”  

As for the impact the guidance will have on proxy advisors, Glass Lewis and Institutional Shareholder Services (ISS) are taking a wait-and-see approach before they comment on specifics. However, ISS President & CEO Gary Retelny did have one caveat: “We are deeply concerned that aspects of the guidance may significantly undermine our ability to deliver independent, timely and accurate data, research, insights and perspectives to aid in the discharge of our clients’ fiduciary duties.”

The views presented on the ESG Blog are not the official views of The Conference Board or the Governance & Sustainability Center and are not necessarily endorsed by all members, sponsors, advisors, contributors, staff members, others associated with The Conference Board or the Governance & Sustainability Center.