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Coming off autopilot: The SEC issues guidance on investment advisers’ proxy voting responsibilities

After a November 2018 roundtable on the proxy process, the SEC has begun issuing guidance around the use of proxy advisors. This promises to be the beginning of the SEC’s scrutiny into proxy voting, not the end.

Prior to Jay Clayton assuming the Chairmanship of the Securities and Exchange Commission (“SEC”) in May 2017, proxy voting had been a periodic item of SEC interest that failed to garner significant attention.  A 2010 SEC concept release, 2013 roundtable, and 2014 staff legal bulletin generated little industry action.  That is changing now that Chairman Clayton made it a priority to review the role of proxy advisory firms in the voting process.  The review began in full with a November 2018 SEC roundtable and now has produced two SEC guidance releases.

On August 21, 2019, the SEC issued guidance on the proxy process through two releases; one covering the proxy voting responsibilities of advisers and the other covering the applicability of proxy voting rules to proxy voting advice.  Many in the industry have called the new guidance a win for publicly traded entities but a loss for shareholders and proxy advisory firms. The Council of Institutional Investors, in response to the releases, wrote to the SEC that the guidance “may make it unnecessarily difficult for proxy advisory firms to provide timely, independent and cost-effective research.” 

Proponents of the guidance note that researchers at George Mason University estimate that two firms, Institutional Shareholder Services (“ISS”) and Glass Lewis, control nearly 97% of the proxy voting advisory market.  In addition, SEC Commissioner Elad Roisman’s own comments express that “[t]he SEC is not in the business of picking winners and losers.”  Rather “it is our job as regulators to help ensure that such advisers vote proxies in a manner consistent with their fiduciary obligations.”  And therein the Commissioner’s statement lies the key term for all advisers: fiduciary.

The Best Interest Standard for Proxy Voting

As has been well established under federal law, an adviser has a fiduciary duty to its clients.  Until 2003, the proxy voting process was otherwise ungoverned by the SEC.  That changed when the SEC adopted Rule 206(4)-6 under the Investment Advisers Act of 1940 (“Rule 206(4)-6”), which requires an adviser to vote client securities in the best interest of its clients.  Specifically, advisers must:

  • adopt written policies and procedures to ensure they vote client securities in the best interest of clients;
  • disclose to clients how they voted; and
  • describe and furnish upon request a copy of its proxy voting policies.

Adviser Authority to Vote Proxies

 The current guidance states “an investment adviser is not required to accept the authority to vote client securities.”  The impracticality of refusing aside, advisers are affirmatively accepting a complex obligation when they accept the responsibility of voting client proxies.  In order to accept that authority, the adviser must first have: (i) an agreement as to the scope of the authority; (ii) full and fair disclosure of conflicts of interest; and (iii) informed consent from the client.

Agreement on Scope

As the adviser is both the acceptor of the obligation and a fiduciary, it is the client, the guidance states, who directs the scope of the adviser’s proxy voting authority by formal agreement.  The client may direct the adviser to vote all proxies or only on those proxies it considers vital, such as mergers and acquisitions or contested director elections.  The client may even prohibit the adviser from voting when doing so would generate costs, such as foreign translation fees, for the client.

In short, the agreement on scope can be nearly anything as long it meets two central requirements.  First, the scope is directed by the client.  Second, regardless of the agreement, the adviser “must make voting determinations consistent with its fiduciary duty and in compliance with Rule 206(4)-6.

Full and Fair Disclosure

The SEC relies on its own guidance from earlier this year to define what constitutes full and fair disclosure.  Full and fair disclosure “will depend upon, among other things, the nature of the client, the scope of the services, and the material fact or conflict. Full and fair disclosure for an institutional client can differ, in some cases significantly, from full and fair disclosure for a retail.”  As with many requirements, the SEC takes a holistic view, rather than prescribing specific requirements.

Informed Consent

The SEC provides less information on the requirement of informed consent.  The Agency refers readers again to its guidance from earlier this year.  This time, however, the SEC defines the requirements of informed consent in the negative.  Informed consent cannot occur in the absence of full and fair disclosure.  Informed consent does not have to “be achieved in a written advisory contract or otherwise in writing.”  What informed consent is, however, is left for advisers to determine based on their circumstances and relationship with their client.

Demonstrating the Best Interest Standard

Once delegated the authority to vote proxies on behalf of clients, the guidance makes clear that advisers must exercise that authority in the best interest of each client.  The guidance includes a non-exhaustive list of ways that advisers can demonstrate they are acting in a client’s best interest, including actions undertaken before and after the proxy vote is exercised.

Pre-exercise Investigations

Before exercising a proxy vote, an adviser must make a reasonable investigation into both the matter of the vote and what vote will be in the best interest of the client.  With potentially thousands of votes a year, an adviser will need to rely on the agreed policies and procedures it has established with the client to effectively manage the process.  The crux for advisers will be identifying those votes that require a more in depth analysis.  The SEC suggests potential factors for further analysis may include corporate events, those with a direct effect on the value of the client’s investment, and those matters requiring company specific evaluations.

Of note in the guidance is the SEC’s discussion of considerations for handling the best interest needs of multiple clients.  The SEC suggests a uniform voting policy may be okay for routine, non-controversial votes but may not fulfill the best interest standard for more difficult votes.  Further, it guides advisers to differentiate the needs of one set of investors from another.  As an example, it suggests an income fund’s best interest may require a different voting analysis than a growth fund.

Post-exercise Review

The guidance reminds advisers that it must review and document the adequacy of its voting policies and procedures at least annually.  One review method suggested is sampling proxy votes that relate to proposals requiring more issuer-specific analysis for consistency with policies and the client’s best interest.  For example, sampling votes on major acquisitions involving takeovers or contested director elections where a shareholder has proposed its own slate of directors.

Proxy Advisor Oversight

It is on the topic of proxy advisor oversight that the SEC takes its biggest step forward.  Under the guidance, the use of a new proxy advisor should result in substantial due diligence being performed by the adviser.  Initial due diligence on a proxy advisor should include:

  • whether the proxy advisor has the necessary capacity and competency;
  • the existence of an effective process by which the proxy advisor seeks timely input from issuers and clients;
  • what methodologies are utilized by the proxy advisor;
  • what third-party information sources are utilized by the proxy advisor; and
  • a reasonable understanding of when and how the proxy advisor will engage with issuers and third parties.

Notwithstanding the above named factors, the emphasis of the SEC’s guidance on proxy advisor due diligence is on the adviser’s reasonable review of the proxy advisor’s conflicts of interest.

The conflict of interest guidance asks an adviser to consider whether the proxy advisor has methods to:

  • identify conflicts of interest;
  • whether these conflicts are readily disclosed; and
  • whether the proxy advisor is using reasonable technology to address in the identification and disclosure process.

The guidance emphasizes that consulting services by proxy advisors to issuers are a prime example of a conflict that should be disclosed to the adviser.

After the initial due diligence, the SEC guidance reminds advisers to conduct at least annual reviews of its use of the proxy advisory firm, including a review of the adequacy of the proxy advisor’s voting procedures and policies.  This review should include additional measures than if the adviser was conducting its own internal review.

The SEC guidance states that the annual review of the proxy advisor requires “an investigation reasonably designed to ensure that the voting determination is not based on materially inaccurate or incomplete information.”  This assessment should identify “potential factual errors, potential incompleteness, or potential methodological weaknesses” that “materially affected” the proxy advisors research.  Plainly put, an adviser must now inspect and validate the methodology and output of the proxy advisor in its annual assessment.  If it cannot do so, then it should not delegate authority to the proxy advisor.

More to come

As part of the new guidance, the SEC is explicitly advising advisers “to review their policies and practices . . . in advance of next year’s proxy season.”  With 2020 fast approaching, advisers have increasingly little time to wait in beginning to assess their proxy voting processes.

Northern Trust continues to monitor the regulatory environment and commentary around proxy voting and is actively preparing to meet the ongoing administrative and operational needs of investment advisers.

To learn how Northern Trust’s team can support you, contact your Northern Trust representative or visit


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