SEC Battles with Proxy Advisors to Limit Their Influence
The U.S. Securities and Exchange Commission proposed new rules affecting shareholder votes including the implementation of new regulations on proxy advisory firms to compel them to provide their voting recommendations to issuers such that these companies can review and respond prior to the proxy advisor releasing the recommendations to their clients - institutional investors. The SEC guidelines were drafted in response to the concern of the growing influence of these advisory firms, whose main focus is to provide recommendations to primarily institutional shareholders on how to vote.
Background
On August 21st, 2019 the SEC issued an interpretation of Exchange Act Rule 14a-1(l) that proxy voting advice offered by third party proxy advisory firms, such as Institutional Shareholder Services Inc. (“ISS”) and Glass, Lewis & Co. (“Glass Lewis”), should be regarded as a “solicitation” under the federal proxy rules, including related guidance regarding the application of the antifraud provisions in Exchange Act Rule 14a-9 to proxy voting advice. These federal proxy rules apply to any solicitation for a proxy with respect to any security registered under Exchange Act Section 12; and they authorize the SEC to establish regulations governing such solicitation “as necessary or appropriate to the public interest or for the protection of investors”.
Upon careful review, the Exchange Act 14a-1(l), states that a “solicitation” includes, among other things, “a communication to security holder[s] under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy” and includes communications by an entity seeking to influence the voting of proxies by shareholders, regardless of whether the entity itself is seeking authorization to act as proxy for such shareholder. Since the advice provided by proxy advisory firms provides a “vote recommendation” for each proposal on how a client should vote at an issuer’s shareholder meeting, the SEC believes that such advice constitutes a solicitation under the rules.
Furthermore, in August the SEC introduced interpretations that proxy advisory firms may need to disclose additional information to avoid issues under Exchange act Rule 14a-9, including:
A thorough explanation of the advisory firm’s methodology used to formulate its voting advice one particular matter;
Any non-public information sources and the extent to which the information from these sources differs from the publicly available disclosures; and
Any material conflicts of interest that arise in connection with providing the proxy voting advice, should be sufficiently disclosed in detail so that the client can assess the relevance of such conflicts.
To ensure avoiding materially false or misleading statements, or omitting material facts when providing such proxy voting advice, the SEC was proposing for the requirement of proxy advisory firms to submit their voting recommendations to companies for checking before distributing them to investors. The proposal pushed to allow companies a chance to review the proxy adviser’s reports two times before they are finalized and sent to investors.
This new issuer verification requirement would have a major impact on the business of proxy advisory firms as currently, companies are required to pay for these reports. By allowing companies to receive their report prior to publishing in order to confirm its accuracy, it would eliminate the need for companies to purchase these reports as they would be getting a copy prior to its release.
ISS Sues SEC Over New Rules
On October 31, 2019, ISS filed a lawsuit with the federal district court in Washington, D.C. against the SEC over the new guidelines intended to provide investors with better insight into how proxy advisory firms construct their voting recommendations.
Specifically, the ISS lawsuit filed against the SEC for its rule interpretation stated that the rule interpretation (which is binding on the business model of ISS) is not in accordance with the notice and comment guidelines of the Administrative Procedure Act and that the newly proposed rules were an arbitrary abuse of the agency’s power. If allowed to stand, the August interpretation and guidelines would effectively treat the advice proxy advisers provide to their clients in the same away that the SEC regulates proxy solicitations.
In response, the SEC has withdrawn the major component of its proposal requiring proxy advisers to verify their voting recommendations with companies before distribution to investors.
The Current Landscape
Currently ISS and Glass Lewis each offer unique ways for issuers to verify the accuracy of their reports. ISS allows for constituents of the S&P Composite Index to review a draft of their proxy report and provide feedback prior to it being released. Glass Lewis provides issuers who sign up on their website the ability to verify the quantitative data used in formulating their reports. Most recently, Glass Lewis has started including a new section in their reports called Report Feedback Statement (“RFS”). This additional section contains unedited company feedback from issuers or shareholder proponents regarding the research contained in Glass Lewis’ reports and is available for all annual and special meetings, including M&A transactions and proxy contests. After Glass Lewis has published their report regarding an issuer’s meeting, the issuer or a shareholder proponent that purchases the report, will now automatically have the right to submit an RFS. Will these type of issuer offerings from the proxy advisors evolve even further in an attempt to stop the SEC? We believe any further steps to promote transparency will be the basis for a resolution moving forward and create a satisfactory solution for both parties.