On July 22, 2020, the Securities and Exchange Commission (SEC) published an important new rule that affects proxy advisors and ratings agencies. Companies that provide proxy advice (primarily ISS and Glass Lewis) will now need to (1) make specific company recommendations available before investor votes are cast; and (2) disclose additional details regarding the reporting business’s methodology, sources of information, and conflicts of interest. Under this new rule, all companies, regardless of size, will have the opportunity to review proxy vote recommendations, respond to the analysis, and engage investors to advocate their position before the report is made widely available.
The rule is based on the SEC interpretation that proxy advice constitutes a “solicitation” as defined in the Securities and Exchange Act of 1934. According to the SEC’s new rule, proxy advisors must meet specific conditions to be exempt from disclosure and filing requirements of Federal proxy rules (including anti-fraud rules) starting December 1, 2021. These conditions include:
- Proxy advisors must distribute vote recommendations either simultaneously to both companies and investors – or in advance to all companies (not just S&P 500 companies)
- Proxy advisors must provide a mechanism by which investors can become aware of any written statements by companies that are subject to the proxy advice (aka, the Company’s response) in a timely manner in advance of the Company’s annual meeting
- Proxy advisors must provide specific conflict of interest disclosures within the medium delivering proxy reports to clients
Corporate advocacy organizations such as the Society for Corporate Governance and the National Association of Corporate Directors have publicly supported increased regulation of proxy advisory firms citing concerns surrounding transparency, data accuracy, and conflicts of interest.
The Council of Institutional Investors, however, advocated against the proposed regulations citing concerns that the new rules could delay the proxy voting process, drive up costs for investors, and jeopardize the independence of proxy advice:
“However, the new rules and guidance seem to effectively require investment advisors who vote proxies on behalf of investor clients to consider and evaluate any response from companies to proxy advice before submitting votes. That could cause significant delays in the already constricted proxy voting process. It also could jeopardize the independence of proxy advice as proxy advisory firms may feel pressure to tilt voting recommendations in favor of management more often, to avoid critical comments from companies that could draw out the voting process and expose the firms to costly threats of litigation.”
What does this mean?
In short, companies of all sizes will now be able to weigh-in on critical proxy issues before investor votes are cast. The newly adopted rules provide corporate issuers the opportunity to ensure proxy report data is accurate and respond to the proxy analysis before the annual meeting.
The recently adopted rule will likely also impact the timing of the overall proxy plumbing process. Investor votes may be delayed as some investors may choose to wait for the Company’s response before submitting a vote. Note, if the overall process is delayed, there may be less time for extensive engagement and remediation in the event of an unexpected vote recommendation.
How to Prepare
Companies should consider the following actions to best prepare for the changing proxy landscape:
- Proactively engage investors outside of proxy season to understand how top investment managers plan to respond to the new SEC rules and guidance
- Review proxy voting guidelines available from ISS and Glass Lewis to understand how current benchmark policies apply to your company
- Monitor all policy updates in advance of the 2021 and 2022 proxy season to ensure full understanding of updates to business methodology
- Put a team in place that is prepared to assess the accuracy of data in proxy reports and provide a response in 1-2 business days; this response will now be available to investors in advance of the annual meeting
- Strengthen proxy disclosures and rationale for potentially problematic compensation elements and/or hot topic environmental and social issues within the proxy
- Build a robust annual shareholder engagement program (outside of the approximate 2-3 week time period between the proxy report and annual meeting) that targets proxy stewardship teams and voting analysts at your top holders
The best way to avoid an unexpected vote outcome, is to engage investors early and often (generally during a Fall and Spring outreach) on the Company’s governance, compensation, environmental, and social strategy, goals, and performance relative to peers.
The SEC also provided supplemental guidance related to “robo-voting”, making it clear that investment advisors are obligated to conduct robust due diligence and oversight to ensure that proxy votes are carefully reviewed and cast in the best interest of clients. This could result in asset managers’ shoring up internal proxy voting teams to avoid breach of fiduciary duties through increased analysis of proxy votes as well as increased corporate stewardship engagements on proxy-related issues. These added steps may prove to be a hurdle for smaller firms.
What remains to be seen?
A few things remain to be seen in the 2021 and 2022 proxy season.
First, it remains to be seen how proxy advisors will respond to the SEC’s request for increased disclosure on information that could be materially misleading (i.e., business methodology, sources of information, and material conflicts of interest). While a lot of proxy advisory methodology is publicly available, there is not full transparency into all policy applications, benchmark calculations, and pay-for-performance modeling—especially in situations where a qualitative or case-by-case analysis determines a final vote recommendation.
Second, it is unclear how long corporate issuers will take to submit a response or supplemental filing in retort to proxy advisory reports. Companies should be prepared to thoroughly assess and respond to unexpected vote recommendations, as these responses will now be available to investors before they vote.
Third, it is unclear how increased disclosure of conflicts of interest will be implemented in practice, and how this disclosure will affect voting behavior. Some proxy advisory firms (ISS) offer consulting services to corporate issuers, and if this information becomes public it could impact the investor voting process as well as proxy advisory independence.
Last but not least, ISS filed a lawsuit last August against the SEC, challenging guidance put forth in 2019, and plans to re-file the lawsuit this year. It remains to be seen how ISS will proceed in light of the amended rules and ongoing litigation.
Additional Implications of Proposed Increase to Reporting Threshold for Institutional Investment Managers
Proposed changes to reporting rules for institutional investment managers may add further complexity to the proxy advisory and solicitation process for issuing companies. Recently, the SEC has proposed to update the reporting threshold for Form 13F reports, which would exempt 89% of investment managers currently required to file from these reporting mandates. This proposed rule would drastically reduce companies’ visibility to their respective shareholder bases, and as a result, could limit their ability to engage shareholders for proxy solicitation.
Should this proposed rule be codified, we could expect increased emphasis on engagement with large institutional investors as issuing companies will have reduced visibility into the smaller firms that constitute their shareholder voting base.
 “Exemptions from the Proxy Rules for Proxy Voting Advice,” 17 CFR Part 240 Release No. 34-89372 (July 22, 2020), available at http://www.sec.gov/rules/final/2020/34-89372.pdf.