SEC Adopts 2019 Proxy Voting Amendments, Minus the Bite

Similar to the proposed amendments originally issued by the SEC in November 2019, the SEC’s adopting release echoes some of the concerns expressed by both issuers and investors regarding the lack of oversight of proxy advisory firms. Shortly before issuing the proposed amendments, the SEC issued guidance in August 2019 (the “2019 Guidance”) in which the SEC confirmed that proxy voting advice constitutes “solicitation” under the federal proxy rules and that, therefore, certain activities conducted by proxy advisory firms are subject to the proxy solicitation rules, and proxy advisory firms must depend on the exemptions from the information and filing requirements of the federal proxy rules. In October 2019, ISS brought a lawsuit against the SEC, challenging the 2019 Guidance and arguing that its activities were already comprehensively regulated under the Investment Advisers Act, and that the inclusion of proxy voting advice in the definition of “solicitation” under the Securities and Exchange Act of 1934 (the “Act”) would unnecessarily subject it to an additional regulatory regime. ISS further voiced concerns that the 2019 Guidance could be used or construed to impede ISS’s ability to deliver recommendations and research in an independent and timely manner. While ISS did not explicitly state why its ability to deliver recommendations timely and independently would be affected by interpretation of the 2019 Guidance, Allison Herren Lee, one of the dissenting SEC commissioners, said that “[the 2019 Guidance] introduces increased costs and time pressure into an already byzantine and highly compressed process,” and that “it calls for more issuer involvement in the process despite widespread agreement among institutional investors and investment advisers that greater involvement would undermine the reliability and independence of voting recommendations.” In January 2020, shortly after the SEC issued the proposed amendments, the lawsuit was stayed until the SEC adopted final rules.

Reactions to the amendments adopted on July 22, 2020 have been predictably mixed. Some commentators, including the Council of Institutional Investors, expressed relief that the SEC is walking back what they viewed as the more onerous aspects of the proposed amendments, while others thought the “principles-based” approach reflects a reasonable compromise allowing the SEC flexibility as the market continues to evolve.

The amendments will be effective 60 days after publication in the Federal Register. However, proxy advisory firms will not be required to comply with the amendments until December 1, 2021. Meanwhile, the ISS lawsuit is still pending in the D.C. District Court.

Pre-Existing Safe Harbor for Proxy Voting Advice

Proxy advisory firms such as ISS and Glass Lewis have traditionally been able to avoid solicitation disclosure requirements when issuing shareholder recommendations under the proxy rules by relying on two exemptions. The first, Rule 14a-2(b)(1) under the Act, exempts persons not seeking proxy authority from the information and filing requirements. The second, Rule 14a-2(b)(3) under the Act, exempts proxy voting advice to shareholders from certain advisors with whom shareholders have a business relationship. Together, these two regulations have served as a safe harbor for proxy advisory firms by exempting them from the rigorous and expensive information and filing requirements that apply to nearly all other “solicitations” under the federal proxy rules.

The Newly Adopted Amendments

The amendments adopted by the SEC generally provide for the following changes:

• Rule 14a-1(I) – The SEC broadened the definitions of “solicit” and “solicitation” under Rule 14a-1 to generally cover proxy voting advice, subject to the previously discussed exemptions. Further, the SEC established that in order to qualify for these exemptions, proxy advisory firms must now meet the following three conditions under Rule 14a-2(b)(9):
  • Proxy advisory firms must disclose specified conflicts of interests, including in particular, (1) any interest, transaction or relationship that is material to evaluating the proxy voting advice given the circumstances of the particular interest, transaction, or relationship and (2) any policies or procedures used to identify, and steps taken to address, any such material conflicts of interest arising from such interest, transaction, or relationship (Rule 14a-2(b)(9)(i));
  • Proxy advisory firms must adopt and disclose written policies and procedures that are reasonably designed to ensure that advice is made available to the registrant before or at the time it is made available to its clients (Rule 14a-2(b)(9)(ii)(A)); and
  • Proxy advisory firms must adopt and disclose written policies and procedures reasonably designed to ensure that their clients will be provided with a means reasonably expected to make them aware of any written responses to the proxy voting advice by the registrant in a timely manner (Rule 14a-2(b)(9)(ii)(B)).
• Rule 14a-9 – The SEC amended Rule 14a-9 to provide examples of when material omissions in proxy voting advice may be considered misleading. These include material information regarding the proxy voting advice business methodology, sources of information and conflicts of interest.

Final Amendments Less Impactful than 2019 Proposals

The final amendments adopted by the SEC are similar in many respects to those proposed in November 2019. However, certain modifications from the proposed amendments found in the final version significantly dilute their effect.

While the adopted amendments, like the proposed version, also codify the SEC’s 2019 Guidance by specifically including proxy voting advice in the definition of “solicit” and “solicitation” and by requiring certain conditions to be met for proxy advisory firms to utilize the exemptions discussed above, the proposed conditions were more detailed and specific than those adopted in the final amendments.

What this Means for the Proxy Process

Despite the principles-based approach ultimately adopted by the SEC, the new amendments to the proxy rules are likely to promote greater transparency for both issuers and investors and to better allow issuers and investors to review, respond to, and challenge recommendations set forth by proxy advisory firms.

Companies will need to carefully determine how best to deal with proxy voting recommendations given this new set of requirements. Since proxy advisors will have some flexibility in whether and how they provide advance notice of their recommendations prior to circulating the advice to their clients, companies may not always be able to anticipate how much time they will have to respond to proxy voting advice. In order to avoid confusing shareholders, the best strategy continues to be one of anticipating criticisms from proxy advisors in order to create the best disclosure and to best position the company to respond in the event an unfavorable recommendation is disseminated. Companies should focus on presenting a clear and consistent narrative when issuing any rebuttal to proxy voting advice.