On September 13, 2018, the SEC’s Division of Investment Management issued IM Information Update 2018-02 entitled “Statement Regarding Staff Proxy Advisory Letters.” The purpose of this Update is to notify advisers of its withdrawal of two 2004 no-action letters related to proxy voting. This Update follows the Commission’s July 2018 announcement of its plans to host a Roundtable with market participants (now scheduled for November 2018) to address proxy voting topics including the voting process, retail shareholder participation and the role of proxy advisory firms.
Over the past decade the SEC has consistently conveyed concern in public discourse and in adviser examinations regarding the growing reliance by advisers on proxy consultants. In 2010 the Commission sought public comment on the issue due to concern that the SEC’s own guidance permitted advisers to fulsomely rely upon the recommendations of proxy consultants. After reviewing this condition, the SEC has determined that over-reliance by advisers on proxy consultants may introduce a conflict of interest wherein the investment adviser fiduciary duty to provide objective investment advice is jeopardized.
This determination has resulted in an unusual but by no means unprecedented regulatory intervention wherein the SEC re-examined and subsequently withdrew (effective September 13, 2018) no-action letter guidance addressing adviser proxy voting services. This regulatory guidance was issued to Egan-Jones Proxy Services (May 27, 2004) and Institutional Shareholder Services, Inc. (Sept. 15, 2004). This guidance clarified that voting in reliance on a proxy consultant’s voting recommendations will insulate an investment adviser from any conflicts of interest and otherwise support the discharge of the investment adviser’s fiduciary duties.
However, the Egan Jones letter also issued a warning that the adviser should not conclude that it is appropriate to follow the voting recommendations of an independent proxy voting firm without first ascertaining, among other things, whether the proxy voting firm (a) has the capacity and competency to adequately analyze proxy issues; and (b) can make such recommendations in an impartial manner and in the best interests of the adviser’s clients.
As to the withdrawal of its 2004 no-action letter guidance, the Commission has stated that it has done so to facilitate the forthcoming roundtable discussion wherein the Commission will solicit and consider input from various market participants and stakeholders, i.e., public companies, public funds, investors, proxy advisors, and registered firms, among others, on all matters related to proxy voting.
Staff Legal Bulletin No. 20 (Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms), issued by the Division of Investment Management in June 2014, remains in force, and provides guidance to advisers about their responsibilities in voting client proxies and retaining proxy advisory firms (including a reiteration of the Egan Jones capacity, competency, and impartiality standards).
The regulatory regime requires advisers to implement risk-based policy and procedure that is reasonably designed to ensure compliance with securities statutes. The rescindment of the referenced no-action guidance makes this risk management objective more problematic for advisers that retain proxy voting authority.
Advisers that retain voting authority are required to fulfill the fiduciary standard of care when voting proxies, as referenced in the Egan Jones letter. The Commission views proxy voting as a vital component of the investment decision making process. Proxy advice and decisions must be disinterested and objective in nature to ensure that client interests prevail in all voting decisions.
Furthermore, advisers must monitor proxy policies and procedures and fully document and retain all related input utilized to formulate, execute, and assess voting decisions in much the same manner as the adviser does investment decisions for clients. Legal Bulletin No. 20 provides a helpful Question & Answer format to assist advisers in stress testing their proxy voting policies and procedures.
The proxy consultant industry has grown exponentially since advisers were first required to register with the SEC in 2004. This growth, and adviser reliance upon this industry, exerts considerable pressure upon advisers to evince through documentation that proxy consultants are but one source of input rather than the sole source.
Valuable Information Sources
IM Information Update 2018-02: https://www.sec.gov/divisions/investment/imannouncements/im-info-2018-02.pdf
To view the SEC’s public statement about its actions with regard to the proxy letters, follow this link: https://www.sec.gov/news/public-statement/statement-regarding-staff-proxy-advisory-letters
Staff Legal Bulletin No. 20 is available here: https://www.sec.gov/interps/legal/cfslb20.htm