On November 5, 2019, the Securities and Exchange Commission (“SEC”) proposed amendments to the federal proxy rules that would enhance the SEC’s regulation of proxy advisory firms.1 The proposed amendments to Rules 14a-1, 14a-2 and 14a-9 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), involve two major changes:
- definition of "solicitation": the proposed amendments would amend the definition of "solicitation" in Rule 14a-1(l) to cover specifically the voting recommendations of proxy advisory firms, thereby codifying recent SEC guidance that proxy advisory firm recommendations are "solicitations" and subject to the federal proxy rules; and
- requirements for use of exemptions: the proposed amendments would impose additional requirements on proxy advisory firms for them to be able to rely on the existing exemptions from the information and filing requirements of the federal proxy rules (the "information and filing requirements").
Most notably, the proposed rules would require proxy advisory firms to provide all public companies subject to the federal proxy rules with an opportunity to review and comment on the advisory firms’ draft voting recommendations in order to avoid filing such recommendations publicly with the SEC as soliciting material.2 In the proposing release, the SEC noted that its proposed amendments are “designed to enhance the accuracy, transparency of process and material completeness of the information provided to clients of proxy voting advice businesses.” The SEC further acknowledged the existence of a wider public debate about the role and impact of proxy advisory firms, but noted that its focus was on certain specific concerns, rather than on all aspects of proxy voting advice business’ role in the proxy process.
Proposal to Amend Definition of “Solicitation” to Specifically Cover the Voting Advice of Proxy Advisory Firms
The proposed amendments would modify Exchange Act Rule 14a-1(l) to clarify that the term “solicitation” includes “any proxy voting advice that makes a recommendation to a security holder as to its vote, consent, or authorization on a specific matter for which security holder approval is solicited and that is furnished by a person who markets its expertise as a provider of such advice, separately from other forms of investment advice, and sells such advice for a fee.”3 This language is intended to clarify explicitly that the voting recommendations of proxy advisory firms do, indeed, constitute a “solicitation” that is subject to the federal proxy rules.4
In proposing this change, the SEC noted that the furnishing of proxy voting advice by proxy advisory firms is the type of activity that raises concerns about inadequate or materially misleading disclosures that the proxy rules are intended to address, and further noted that the regulatory framework of the proxy rules, with their focus on the information received by shareholders as part of the voting process, is “well-suited to enhancing the quality and availability of the information” that the investor clients of proxy advisory firms consider when they vote.
New Conditions for Proxy Advisory Firms to Rely on Exemptions from Information and Filing Requirements
Overview
Given the SEC’s position that voting recommendations constitute a “solicitation” under the federal proxy rules, proxy advisory firms need to rely on exemptions from the information and filing requirements to avoid filing their voting recommendations publicly with the SEC.
Proxy voting advice businesses typically rely on exemptions (in Exchange Act Rules 14a-2(b)(1) and 14a-2(b)(3))5 to provide voting advice without complying with the information and filing requirements. The SEC proposed additional conditions that proxy advisory firms would have to meet in order to take advantage of these exemptions and thereby avoid filing their voting recommendations publicly with the SEC.6
- Disclose Material Conflicts of Interest: Proxy advisory firms would need to provide specified disclosures about their material conflicts of interest and include these disclosures in the reports they provide to investor clients with their voting recommendations.
- Provide Companies with Opportunity to Review Draft Voting Advice: In a change from their current practice, proxy advisory firms would need to provide all public companies subject to the federal proxy rules with an opportunity to review and provide feedback on the proxy advisory firm’s voting advice before disseminating it to these companies’ investors.
- Provide Companies with Final Notice and Opportunity to Include Response in Proxy Voting Advice: Proxy advisory firms would need to provide companies with a final draft of their proxy voting advice at least two business days prior to disseminating the advice to investor clients. Furthermore, upon request from a company, a proxy advisory firm would need to include in its voting advice a hyperlink to the company’s statement in response to the firm’s advice. If the company opts to make this request, the company would still need to file its own statement (without the proxy advisor’s voting advice) as additional soliciting material with the SEC by the date that the proxy advisory firm first sends, publishes or gives its advice to its investor clients.
Each of these additional requirements is subject to limitations and detailed requirements in the proposed amendments, as summarized below.
Summary of New Conditions for Proxy Advisory Firms to Rely on Exemptions from Filing Requirements Under the Federal Proxy Rules
Disclose Material Conflicts of Interest
In order for proxy advisory firms to be exempt from the information and filing requirements, proxy voting advisers would be required to include “prominent disclosure” of material conflicts of interest in the reports disseminated to investor clients with their voting recommendations that is “sufficiently detailed so that [investors] can understand the nature and scope of the interest, transaction, or relationship to appropriately assess the objectivity and reliability of the proxy voting advice they receive.” Boilerplate language that a conflict “may” exist would be insufficient.7 In the proposing release, the SEC noted that imposing an affirmative duty on proxy advisory firms to provide disclosures of material conflicts of interest is “consistent with obligations to disclose potential conflicts of interest in other contexts,” such as information about related party transactions required by Item 404 of Regulation S-K.
Provide Companies with Opportunity to Review Draft Proxy Voting Advice
In order for proxy advisory firms to be exempt from the information and filing requirements, the proposed amendments would require one standardized opportunity for companies to review and provide feedback on draft voting recommendations before the firms disseminate them to their investor clients.8 The length of time provided to companies for review of the draft voting recommendations would depend on how far in advance the company files its definitive proxy statement. As proposed:
- If a company files its definitive proxy statement 45 calendar days or more before its shareholder meeting, the proxy advisory firm would be required to provide the company at least five business days to review the proxy voting advice and provide feedback.
- If a company files its definitive proxy statement less than 45 but at least 25 calendar days before the date
of its shareholder meeting, the proxy advisory firm would need to provide a company with at least three
business days to review the voting recommendations. - In the event that a company files its definitive proxy statement less than 25 calendar days before its
meeting, the proxy advisory firm would have no obligation to provide its draft voting recommendations to a
company.
Currently, ISS offers only companies in the S&P 500 with an opportunity to review a draft ISS report on a “best efforts” basis, prior to their issuance to its clients. Glass Lewis provides companies an opportunity to review the data used for its voting advice, but does not allow companies the ability to preview the actual voting recommendations.9 Accordingly, this mandated review period under the proposed rules would open up the opportunity to review the draft proxy advisory firm reports and suggest revisions to all public companies filing definitive proxy statements with the SEC, including the vast majority of mid- and smaller-cap public companies outside of the S&P 500, and to a wider array of circumstances, including special meetings and contested solicitations. The proposed rules would not, however, require proxy advisory firms to accept any suggested revisions from companies to their voting recommendations. In fact, the information in ISS and Glass Lewis reports would remain within the firms’ discretion, including, most importantly, their influential voting recommendations.
Provide Companies with Final Notice and Opportunity to Include Response in Proxy Voting Advice
Following the review period described above, in order to be exempt from the information and filing requirements, a proxy advisory firm would be required to provide a company with a final notice of voting advice with its final voting recommendations at least two business days prior to their delivery to proxy advisory firm clients. The notice would be required even if a company did not comment on the advisor’s draft report. To allow proxy advisors to maintain control over the dissemination of their voting advice and minimize the risk of
unintentional or unauthorized disclosures, the proposed rule would allow a proxy advisory firm to require companies (or other soliciting persons) to agree to keep the draft recommendations confidential and refrain from commenting publicly on them, as a condition of receiving the draft report and final notice of voting advice.
As noted by the SEC in the proposing release, this two-business-day window period would allow a company to determine whether to provide its own statement in response to the proxy advisory firm’s voting advice and request that the proxy advisory firm provide a hyperlink to any such company response in the voting advice delivered to proxy advisory firm clients. To take advantage of this, however, companies would be required to provide the hyperlink with their response to the proxy advisory firm no later than the expiration of the final, two-business day notice period. In addition, as noted above, if the company opts to make this request, the company would still need to file its own statement (without the proxy advisor’s voting advice) as additional soliciting material with the SEC by the date that the proxy advisory firm first sends, publishes or gives its advice with the hyperlink to its clients.
Safe Harbor for Immaterial or Unintentional Compliance Failures by Proxy Advisory Firms
The proposed amendments would provide proxy advisory firms with a safe harbor allowing them to take advantage of the exemption from the information and filing requirements if they experience an “immaterial or unintentional” failure to comply with the new conditions of Rule 14a-2(b)(9) described above.
Specifically, the proposed amendments provide that such a failure to comply with the new conditions would not result in the loss of their filing exemptions so long as (i) the proxy advisory firm made a “good faith and reasonable effort to comply” and (ii) “to the extent that it is feasible to do so, the proxy advisory firm uses reasonable efforts to substantially comply with the condition as soon as practicable after it becomes aware of its noncompliance.” Moreover, the SEC noted that the failure of proxy advisory firms to comply with these additional new conditions does not create a new private right of action for companies against proxy advisory firms.
Proposed Amendments to Anti-Fraud Provision in Rule 14a-9 to Address Proxy Advisory Firms
As noted in the proposing release, solicitations that are exempt from the information and filing requirements are still subject to the anti-fraud provisions of Rule 14a-9, which generally prohibits any proxy solicitation from containing false or misleading statements and may provide the basis for a private right of action by a shareholder. The SEC clarified that this would continue to be the case for the voting recommendations of proxy advisory firms, which would still be subject to the anti-fraud provision of Rule 14a-9, despite their exemption from the information and filing requirements.
Currently, the text of Rule 14a-9 provides four examples of what may be misleading in a solicitation within the meaning of the federal proxy rule. The SEC proposed to amend this list of examples in Rule 14a-9 to also list a proxy advisory firm’s failure to disclose information such as the firm’s “methodology, sources of information, conflicts of interest or use of standards that materially differ from relevant standards or requirements that the [SEC] sets or approves,” as examples of what may be misleading under the federal proxy rules.
In proposing this language, the SEC recognized concerns that proxy advisory firms make negative voting recommendations based on their evaluation that a company’s disclosure is inadequate, even though such disclosure meets existing SEC requirements. This is routine for proxy advisory firm recommendations because they are based on proxy advisory firms’ own policies and guidelines (including with respect to director independence and compensation disclosure) that are generally stricter and more burdensome on public companies than SEC rules. Depending on the facts and circumstances, the proposed rule would consider it misleading if a proxy advisory firm fails to make clear to its clients that it is making a negative voting recommendation based on its own disclosure criteria, which materially differ from the SEC requirements. The SEC emphasized, however, that including this as an example of what may be misleading in Rule 14a-9 is not meant to imply that it would be inappropriate for a proxy advisory firm to use its own standards; rather, the amended rule is meant to focus on disclosure and ensure that proxy advisory firm recommendations are not materially misleading with respect to their underlying bases.
Proposed Transition Period
The SEC notes in the proposing release that, if adopted, the amendments would require proxy advisory firms to develop new processes and systems to comply with the new proposed conditions. Accordingly, the SEC proposed to provide a one-year transition period after the publication of a final rule to give proxy advisory firms sufficient time to comply with the proposed new requirements. With respect to the new review period requirement, the SEC noted that there may be existing providers readily available to support the proposed review process, but there may also be a need for new services and providers to satisfy demand for effective market solutions, including third party service providers that emerge to coordinate the review process.
Conclusion
The proposed amendments come on the heels of a series of SEC roundtables and a recent SEC interpretive release on proxy advisory firms,10 and represent long-awaited rulemaking in an area where the SEC has tended only to issue broad guidance.11
Overall, the proposed changes would not fundamentally alter the significant influence of proxy advisory firms over the proxy voting process. However, the changes could address certain specific concerns expressed by the issuer community in recent years. Giving every public company in the United States an opportunity to review a draft ISS or Glass Lewis report would be a change for mid-cap and small-cap companies in particular, since these companies would, for the first time, have visibility into proxy advisory firm voting recommendations before they influence their annual meeting voting results.
At this stage, these are only proposed amendments and will not affect the upcoming proxy season. Moreover, criticism and comments from proxy advisory firms and their backers will likely be forceful. ISS has already filed a lawsuit12 against the SEC seeking injunctive and declaratory relief, arguing that prior SEC guidance exceeds the SEC’s statutory authority, is procedurally improper and is “arbitrary and capricious” because it lacks reasoned explanations for the SEC’s actions.
Comments on the Proposed Rule are due 60 days following publication in the Federal Register.
1 The proposing release is available here.
2 As noted in our Prior Alert, proxy advisors’ business models are premised significantly on their ability to provide voting recommendations and related analysis of a subject company on a subscription basis to their investment adviser and other clients. The ability of proxy advisors to avoid filing their voting recommendations publicly is critical to their subscription business model.
3 The SEC proposed one carve-out to this definition such that proxy voting advice furnished by a person only in response to an “unprompted request” would not constitute a solicitation. In proposing this carve-out, the SEC noted that it continues to believe that “providing voting advice to a client where the client’s request for the advice has been invited and encouraged by the person’s marketing, offering, and selling such advice should be distinguished from advice provided by a person only in response to an unprompted request from its client.”
4 As noted in our Prior Alert, the SEC guidance issued in August 2019 had already affirmed this as the view of the SEC, and this proposed amendment would explicitly codify this view in the federal proxy rules.
5 Rule 14a-2(b)(1) generally exempts solicitations by persons who do not seek the power to act as proxy for a shareholder and do not have a substantial interest in the subject matter of the communication beyond their interest as a shareholder. Rule 14a-2(b)(3), generally exempts proxy voting advice furnished by an advisor to any other person with whom the advisor has a business relationship.
6 See Rule 14a-2(b)(9) on page 138 of the proposing release.
7 This would be a shift from current Rule 14a-2(b)(3), which requires that proxy advisers disclose “any significant relationship” with a company, company affiliate or stockholder proponent, along with any “material interests” in the subject of their advice, as well as from current Rule 14a-2(b)(1), which does not have any requirement to disclose conflicts of interest. Moreover, it would be an expansion of SEC guidance governing conflicts of interests in situations when proxy advisers provide their voting advice to investment advisers.
8 The proposed rules would also extend the opportunity to review and respond to persons who are conducting non-exempt solicitations through the use of a proxy statement and a proxy card, such as dissident shareholders in contested elections, but not to proponents who submit Rule 14a-8 shareholder proposals or other shareholders that campaign about ballot items through exempt filings, such as in “just vote no” campaigns.
9 See ISS policies regarding draft review process for US issuers here. See Glass Lewis policies on issuer data report review here. Under the respective proxy advisory firm’s guidance, to be eligible to receive the draft materials from either ISS or Glass Lewis, the company must have filed its definitive proxy statement at least 30 days in advance of the company’s annual meeting.
10 For more information, see our Prior Alert.
11 The efforts of the SEC in this area came to the forefront nearly a decade ago in 2010, when the SEC issued what is commonly known as the “proxy plumbing release” (see the Concept Release on the US Proxy System, Release No. 34-62495 (Jul. 14, 2010)), which is frequently cited in this proposing release.
12 The full complaint is available here.
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