July 2014
Practice Group:
Investment
Management, Hedge
Funds and
Alternative
Investments
SEC Staff Issues Guidance on Investment Adviser
Proxy Voting Responsibilities and Use of Proxy
Advisory Firms
By Mary Clarke-Pearson and Fatima S. Sulaiman
Executive Summary
On June 30, 2014, the staff of the Securities and Exchange Commission’s (the “SEC”)
Divisions of Investment Management and Corporation Finance issued Staff Legal Bulletin
No. 20, which provides guidance on investment advisers’ responsibilities in voting client
proxies and retaining proxy advisory firms. Using a question-and-answer format, the staff
legal bulletin appears to expand the oversight responsibilities of investment advisers that
retain proxy advisory firms to provide proxy voting recommendations by establishing an
ongoing duty to monitor these firms to ensure that they have the capacity and competency to
adequately analyze proxy issues. The staff guidance reiterates and builds upon positions
that the SEC staff has previously taken in no-action letters that investment advisers retaining
a proxy advisory firm should take reasonable steps to verify that the firm is independent and
can make proxy voting recommendations in an impartial manner and in the best interests of
the investment advisers’ clients.
According to the staff legal bulletin, an investment adviser that has retained a proxy advisory
firm should “adopt and implement policies and procedures that are reasonably designed to
provide sufficient ongoing oversight” of the proxy advisory firm. In the SEC staff’s view,
sufficient oversight would include “ascertaining whether the proxy advisory firm has the
capacity and competency to adequately analyze proxy issues.” More specifically, such
oversight could include:
• Assessing the adequacy and quality of the proxy advisory firm’s staffing and personnel;
and
• Assessing whether the proxy advisory firm has robust policies and procedures that enable
it to make proxy voting recommendations based on current and accurate information and
to identify and address conflicts of interest relating to its voting recommendations.
These specific oversight responsibilities are not mentioned in Rule 206(4)-6 of the
Investment Advisers Act of 1940, as amended (the “Advisers Act”), in the adopting release
for the rule or in prior staff no-action letters, and the public and the investment advisory
industry were not provided with the ability to provide input through the formal notice-andcomment process. In addition, to provide sufficient oversight, the SEC staff states that the
investment adviser’s own proxy voting policies and procedures should be reasonably
designed to identify and address the proxy advisory firm’s conflicts on an ongoing basis as
they arise, and not just at the time of the adviser’s initial assessment.
SEC Staff Issues Guidance on Investment Adviser Proxy
Voting Responsibilities and Use of Proxy Advisory Firms
The SEC staff expects that investment advisers will make any necessary changes to their
proxy voting systems and processes in response to the guidance “promptly, but in any event
in advance of next year’s proxy season.”
The staff legal bulletin also addresses proxy advisory firms’ compliance with certain
exemptive rules under the Securities Exchange Act of 1934 (the “Exchange Act”) that would
permit such firms to avoid the disclosure and filing requirements of the federal proxy rules.
The SEC staff states that a firm seeking to rely on one such exemptive rule has the
affirmative duty to disclose the nature of any material conflict of interest to its clients and that
“boilerplate” disclosure will not suffice.
Background
Rule 206(4)-6 under the Advisers Act was adopted in 2003 to address an investment
adviser’s fiduciary duties of loyalty and care to its clients when the adviser has the authority
to vote client proxies (the “Proxy Rule”). Under the Proxy Rule, it is a fraudulent, deceptive,
or manipulative act, practice, or course of business for an investment adviser to exercise
voting authority with respect to client securities, unless, among other things, the investment
adviser has adopted and implemented written policies and procedures that are reasonably
designed to ensure that the adviser votes proxies in the best interest of its clients. The
adopting release for the Proxy Rule emphasizes that the policies and procedures that an
investment adviser adopts must address how the adviser resolves any conflicts of interest
that could arise in voting client proxies1. In this regard, the adopting release states that an
adviser could demonstrate that a vote is not the product of a conflict by adopting a policy to
base its proxy voting upon the recommendations of an independent third party, such as a
proxy advisory firm2. Subsequent no-action relief from the SEC staff has supported the
position that an investment adviser’s reliance upon such recommendations may adequately
address its fiduciary duty under the Proxy Rule to resolve material conflicts of interest in
voting proxies on behalf of its clients3.
In the decade since the Proxy Rule was adopted, many investment companies and
institutional investors have become significant shareholders of public companies. To
manage the costly and time-consuming process of reviewing proxy solicitation materials and
conducting the necessary research to make voting decisions, many investment advisers with
the authority to vote client proxies have come to rely upon the assistance of third-party proxy
advisory firms. Critics have argued that this practice has resulted in a relatively small
number of proxy advisory firms with the potential to exercise considerable influence over the
outcome of proxies by providing recommendations upon which investment advisers rely.
In recent years, certain SEC Commissioners have voiced concerns over the reliance of
investment advisers on proxy advisory firms for recommendations on how to vote proxies on
behalf of clients4. In particular, Commissioner Daniel M. Gallagher has noted that relying on
1
See Proxy Voting by Investment Advisers, Exchange Act Release No. IA-2106, 68 Fed. Reg. 6585-01 (Feb. 7, 2003)
(Final Rule).
2
Id.
3
See Institutional Shareholder Services, Inc., SEC No Action Letter, 2004 WL 2093360 (Sept. 15, 2004) and Egan-Jones
Proxy Services, SEC No Action Letter, 2004 WL 1201240 (May 27, 2004).
4
See Daniel M. Gallagher, Commissioner, U.S. Securities & Exchange Commission, Remarks at the Society of Corporate
Secretaries & Governance Professionals (July 11, 2013) (available on SEC website) [hereinafter “Gallagher Remarks”]
and Michael S. Piwowar, Commissioner, U.S. Securities & Exchange Commission, Speech before U.S. Chamber of
Commerce: Advancing and Defending the SEC’s Core Mission (Jan. 27, 2014) (available on SEC website) [hereinafter
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SEC Staff Issues Guidance on Investment Adviser Proxy
Voting Responsibilities and Use of Proxy Advisory Firms
a proxy advisory firm’s recommendations may result in an investment adviser “blindly
casting” votes in accordance with the recommendations of the proxy advisory firm which may
not take into consideration a fund’s investment objectives or policies, and he has called into
question the quality of the research, the transparency, and the accountability of proxy
advisory firms5. Commissioner Gallagher has also questioned whether an investment
adviser that adopts a policy to rely on the voting recommendations of a third party without
taking any other measures to avoid conflicts of interest is in compliance with the Proxy Rule6.
In this regard, Commissioner Michael S. Piwowar has observed that an investment adviser
that engages a proxy advisory firm essentially “shifts” its fiduciary duties under the Proxy
Rule to the firm, which may face conflicts of interest of its own7. The staff legal bulletin
attempts to address these concerns, in a form of indirect regulation, by expanding
investment advisers’ duties under the Proxy Rule to include the ongoing oversight of proxy
advisory firms’ capacity, competency and impartiality. In addition, the staff legal bulletin
discusses the exemptions from the disclosure and filing requirements under the Exchange
Act that proxy advisory firms rely upon and the firms’ obligations to disclose certain conflicts
to their clients.
Investment Adviser Oversight of Proxy Voting
Summarized below are the SEC staff’s views, as set forth in the staff legal bulletin, regarding
the responsibilities of investment advisers that have the authority to vote client proxies,
including those investment advisers that rely on recommendations from third parties:
Voting Client Proxies. While many advisory clients, including investment companies,
fully delegate to their investment advisers the authority to vote proxies, the SEC staff
clarifies that clients and investment advisers have flexibility in determining the extent
to which investment advisers assume and exercise this authority. In this regard, the
SEC staff provides examples that illustrate the different proxy voting arrangements
that an investment adviser and its client may enter into, including instances where a
client may direct an investment adviser to follow the recommendations of company
management or vote in favor of all proposals made by a particular shareholder
proponent, absent a contrary client instruction or a determination by the adviser that
the proposal should be voted differently if, for example, it would further the
investment strategy the adviser is pursuing on the client’s behalf. Alternatively, an
investment adviser and its client may agree that the investment adviser will abstain
from voting any proxies at all or focus only on certain proposals based on the client’s
preferences. In none of these examples does the SEC staff state that an investment
adviser may refrain from voting a proxy without the agreement of the client.
“Piwowar Speech”]. See also Michael S. Piwowar, Commissioner, U.S. Securities and Exchange Commission, Opening
Statement at the Proxy Advisory Services Roundtable (Dec. 5, 2013) (available on SEC website) (noting that in July 2010,
the Commission sought public comment on the role of proxy advisory firms within a broad concept release on the proxy
system (see Concept Release on the U.S. Proxy System, Exchange Act Rel. No. 62495, 75 FR 42982 (Jul. 22, 2010))
and noting that a public comment file was opened in conjunction with the Roundtable to inform the SEC’s future decisionmaking regarding possible reforms). However, because the SEC did not formally propose the specific oversight
responsibilities set forth in the staff guidance, some may view the SEC staff guidance in the bulletin as rule-making
without an opportunity for public notice and comment.
5
Gallagher Remarks. See also Daniel M. Gallagher, Commissioner, U.S. Securities and Exchange Commission, Remarks
at Georgetown University’s Center for Financial Markets and Policy Event (Oct. 30, 2013) (available on SEC website).
6
Gallagher Remarks.
7
Piwowar Speech.
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SEC Staff Issues Guidance on Investment Adviser Proxy
Voting Responsibilities and Use of Proxy Advisory Firms
Selection of Proxy Advisory Firms. The SEC staff believes that when investment
advisers decide to select or continue to retain a proxy advisory firm, they should
evaluate the “capacity and competency” of the firm to analyze proxy issues
adequately. The SEC staff counsels investment advisers to consider, among other
things, the adequacy of the firm’s staff and the “robustness” of the firm’s policies
regarding managing conflicts of interest and ensuring the accuracy of information
upon which the firm’s voting recommendations are based.
Oversight of Proxy Advisory Firms and Conflicts. The staff legal bulletin builds on
investment advisers’ compliance obligations under the Proxy Rule by requiring them
to adopt written policies and procedures to address the ongoing oversight of proxy
advisory firms and the conflicts of interest that these firms may face. According to
the SEC staff, an investment adviser that relies on a proxy advisory firm must have
policies and procedures in place to ensure that the firm votes — and continues to
vote — in the best interest of the adviser’s clients. Similarly, the staff legal bulletin
counsels that investment advisers should establish and implement measures
reasonably designed to identify and address a proxy advisory firm’s conflicts of
interest. The SEC staff notes that an investment adviser’s initial assessment of a
proxy advisory firm’s conflicts of interest alone is not sufficient to ensure that conflicts
of interest do not exist. Rather, the SEC staff suggests that an investment adviser
has an ongoing duty to monitor conflicts that may arise as a result of changes to a
proxy advisory firm’s business or internal policies. The SEC staff notes that an
investment adviser could fulfill this duty by, among other things, requiring the proxy
advisory firm to provide updates on business changes or changes to its conflict
policies and procedures.
Evaluating Voting Recommendations. The SEC staff suggests that an investment
adviser evaluate a proxy advisory firm’s voting recommendations on an ongoing
basis to ensure that such recommendations are based on an accurate analysis of
relevant information. If an investment adviser determines that a proxy advisory firm’s
recommendation was based on a material factual error, the SEC staff states that the
investment adviser should investigate the error and evaluate whether the firm is
taking steps to mitigate making such errors in the future.
Proxy Advisory Firm Guidance
The staff legal bulletin also addresses the applicability of Exchange Act exemptive rules to
proxy advisory firms and the firms’ obligations to disclose to clients information about
potential conflicts of interest that they may encounter in making voting recommendations.
Exemptions from Proxy Solicitation Rules. The Exchange Act provides that entities
that engage in a proxy “solicitation” are subject to the filing and disclosure
requirements under the federal proxy rules. However, proxy advisory firms typically
rely on two rules under the Exchange Act that exempt their activities from the
definition of a “solicitation.” The staff legal bulletin clarifies that the exemption under
Exchange Act Rule 14a-2(b)(1), which exempts from the definition of a solicitation
"any person whether or not a shareholder, who conducts a solicitation but does not
seek proxy voting authority or furnish shareholders with a form of consent,
authorization, abstention, or revocation, and does not act on behalf of any such
person," is not available to proxy advisory firms that execute proxies or submit voting
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SEC Staff Issues Guidance on Investment Adviser Proxy
Voting Responsibilities and Use of Proxy Advisory Firms
instructions for a client based on pre-established guidelines and policies. However,
the SEC staff notes that a proxy advisory firm may rely on the exemption in
Exchange Act Rule 14a-2(b)(1) if it merely distributes reports containing
recommendations to a client, provided that it does not solicit the power to act as a
proxy to the client and complies with the other requirements of the exemption.
The staff legal bulletin also notes that proxy advisory firms may rely on the exemption
under Exchange Act Rule 14a-2(b)(3), which exempts entities that provide proxy
voting advice to persons with whom they have a business relationship, subject to
certain conditions. This exemption is available if, among other things, a proxy
advisory firm gives advice in the ordinary course of business; discloses to its clients
any significant relationship with the soliciting company or any of its affiliates, or a
security holder proponent of the matter on which advice is given, as well as any
material interests of the proxy advisory firm in such matter; receives no special
commission or remuneration for furnishing the advice from any person other than the
recipient of the advice and others who receive similar advice; and does not furnish
the advice on behalf of any person soliciting proxies for or on behalf of a participant
in a contested election.
Disclosure Requirements under Exchange Act Rule 14a-2(b)(3). The SEC staff
discusses a proxy advisory firm’s obligation, under Rule 14a-2(b)(3), to disclose to its
clients any significant relationship with a soliciting company or shareholder proponent
or material interest in a matter that is the subject of a voting recommendation. If, for
example, a proxy advisory firm provides consulting services to a company on a
proposal or provides a voting recommendation to its clients on a proposal sponsored
by another client, the SEC staff states that the proxy advisory firm would need to
assess whether its relationship with the company or security holder is significant or
whether it otherwise has any material interest in the matter that is subject to the
recommendation. If the proxy advisory firm determines, based on the facts and
circumstances, that it has a significant relationship or a material interest that requires
disclosure under Rule 14a-2(b)(3), the firm has the affirmative duty to disclose the
nature and scope of such a relationship, the steps taken to mitigate the conflict, and
the necessary information to allow a client to assess the objectivity of a voting
recommendation. The SEC staff notes that generalized “boilerplate” disclosure will
not satisfy the rule’s conditions. A proxy advisory firm is not, however, required to
make this disclosure public.
Authors:
Mary Clarke-Pearson
mary.clarke-pearson@klgates.com
+1.202.778.9458
Fatima S. Sulaiman
fatima.sulaiman@klgates.com
+1.202.778.9082
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SEC Staff Issues Guidance on Investment Adviser Proxy
Voting Responsibilities and Use of Proxy Advisory Firms
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