The new rules
On July 22, 2020 the Securities and Exchange Commission (“SEC”) adopted final rules governing certain key aspects of the business of proxy advisory firms (the “Advisory Firms”) by a vote of 3-1. These rules are the culmination of the SEC’s lengthy efforts to review the regulatory framework applicable to Advisory Firms. These changes were first telegraphed by the SEC in its August 2019 guidance and first proposed in November 2019.
As expected, but not without controversy, the final rules codify the SEC’s 2019 guidance and 2019 proposed regulations that proxy voting advice (“Advice”) generally constitutes a “solicitation” within the meaning of the Securities Exchange Act of 1934, as amended. However, the SEC also codified its belief that Advisory Firms continue, subject to certain conditions, to be eligible for the exemptions from the information and filing requirements otherwise required for solicitations.
With this framework settled, the final rules also make changes to the nature of how Advice is used. In the 2019 proposed regulations, the SEC considered a robust and company-favorable set of required interactions, including a period of advance review by the company, before advice could be distributed by Advisory Firms to their clients (the “Firm Clients”) as well as the mandatory use of hyperlinked materials to disseminate issuer (“Target Company”) responses. The final rules represent a watered-down version of the 2019 proposed regulations; the final rules pivot towards a principles-based approach to allow Advisory Firms the opportunity to tailor their policies in a way that is efficient and cost-effective to serve Firm Clients. The final rules focus on two specific areas of the Advisory Firm business:
Conflicts of interest
Advice must include prominent disclosure of (a) information relating to any interest, transaction or relationship between an Advisory Firm and the Target Company that is material to assessing the objectivity of the Advice in light of the circumstances, (b) the Advisory Firms’ policies and procedures used to identify any such conflicts and (c) any steps taken by the Advisory Firm to address such conflicts.
Notice of advice and response
Advisory Firms must adopt and disclose written policies and procedures that are designed to ensure:
- Notice of proxy voting advice: Target Companies have Advice or reports made available to them at or prior to the time of the distribution to the Firm Clients.
- Notice of response: The Advisory Firms provides Firm Clients with a way they can reasonably be expected to become aware of Target Company reactions to the Advice before the meeting to which the Advice relates.
The SEC provided non-exclusive safe harbors that outlined the steps that would be deemed to per se comply with the rule:
- Notice of proxy voting advice: Written policies and procedures designed to provide Target Companies with the Advice without charge at or prior to the distribution to Firm Clients would be sufficient to comply.
- However, Advisory Firms may place conditions on Target Companies, including filing the definitive proxy statement at least 40 calendar days prior to the shareholder meeting and an acknowledgement from the Target Companies that receipt of the Advice is for internal use and will be shared with a limited group of the Target Company’s advisers and employees.
- Notice of response: Providing notice of a Target Company’s response to the Advice to its Firm Clients via either a notification on the Advisory Firm’s electronic client platform or an email informing Firm Clients of a Target Company’s filing of additional solicitation materials is sufficient to satisfy the rule, though not necessarily the only means of doing so.
- Although hyperlinks may, in the end, be the most common way of satisfying the new requirement, under the new rules Advisory Firms retain significant discretion as to how to meet the rule’s condition.
Consistent with the SEC’s codification that proxy voting advice is a solicitation, the SEC expanded the anti-fraud rules under Rule 14a-9 to include a failure to provide material information regarding Advice. Specifically, the rule mentions “methodology, sources of information or conflicts of interests” as types of disclosure for which the failure to provide material information could be misleading and give rise to liability under the rule.
The new rules will be effective beginning with the 2022 proxy season.
The table below sets out the position of the final rules, as compared to the proposed rules:
So, what will these new rules actually do?
Though less onerous than the proposed rules, Advisory Firms and their proponents are still likely to be disappointed by the increased regulation, especially as ISS in particular has sought to avoid regulation under the proxy solicitation regime entirely by asserting proxy voting advice should be regulated by the investment adviser regulatory framework. The SEC rejected this contention and has codified a regulatory framework that puts Advisory Firms clearly in the cross-hairs of SEC regulation.
On the other hand, a closer examination of the practical effects of the new rules shows they may have a minimal impact on Target Companies. If Target Companies had hoped that the 2022 proxy season would result in their relationships with Advisory Firms looking and feeling dramatically different, the fact that the SEC declined to provide for advance review of Advice may be the biggest source of disappointment. The 2019 proposed regulations’ strict choreography between Advisory Firms and Target Companies for the review and comment on Advice would have been a dramatic shift for Target Companies that have long argued that information is compiled, and voting recommendations are distributed, without a chance to review and provide some quality control over the content of Advice before it makes its way to the Firm Clients over which it has substantial influence.
By opting to provide for concurrent review by Target Companies and Firm Clients, the new rules essentially leave the balance of power at the status quo; the ability for companies to access Advice may be expanded (although will not look different for many companies), but the ability for companies to effectively reach Firm Clients, even to correct errors, before they vote is not a reality, and it remains to be seen whether the Advisory Firms that provide some limited advance review to certain Target Companies continue to do so. The reality of “robo-voting” undercuts the practical options for companies if Firm Clients receive Advice at the same time the Target Companies themselves receive the reports – it is well-known that many large Firm Clients vote within 24 hours of receiving Advice and are unlikely to change their votes, even if Target Companies choose to formally address Advice in updated proxy materials.
If Target Companies do choose to take advantage of the new rules’ tools to address Advice – not necessarily a foregone conclusion – doing so will likely require the filing of supplemental proxy materials with the SEC. Further, the new rules do not require Advisory Firms to distribute any additional materials – only that Firm Clients are reasonably likely to know they exist before the meeting. Target Companies will have to weigh whether the benefits of preparing additional materials are worth the costs to do so, including the potential for any such materials to continue to have a narrow reach.
There are likely to be some Target Companies that are compelled to correct information, or otherwise rebut recommendations, and while it is unlikely to have a significant effect on market practice, a slow but steady adoption of the Advice rebuttal procedure is possible. Given the robust discussion by the SEC of its reasoning for adopting the rules in the form they have selected, it seems unlikely that this topic will be revisited in the near term – the effects of these rules, whatever they may end up being, will likely have to be both learned and lived with by Target Companies and Advisory Firms for some time.