SEC Withdraws Proxy Advisory Letters

On September 13, 2018, the staff (“Staff”) of the Division of Investment Management of the Securities and Exchange Commission (“SEC”) withdrew letters previously issued in 2004 to Egan-Jones Proxy Services and Institutional Shareholder Services, Inc. (“ISS”) under which the SEC had provided guidance on when an investment adviser could rely on a proxy advisory firm as an independent third party for purposes of making proxy voting decisions. This action by the Staff appears to be in response to the growing divide between public companies and proxy advisory firms due to public company concerns that two proxy advisory firms (ISS and Glass Lewis) have essentially cornered this market and as such have an overbearing influence on the voting process. Public companies and other interested observers have suggested that these firms are not held accountable for the conflicts of interest in their business of providing services to both investors and public companies, and that proxy advisers should be subject to additional regulation such as the proposed Corporate Governance Reform and Transparency Act of 2017, which would require proxy advisory firms to register with the SEC, to disclose potential conflicts of interest and whether they maintain a code of ethics, and to make publicly available their methodologies for formulating proxy recommendations and analyses. The Staff noted in its announcement of withdrawal of the 2004 guidance that it was doing so to facilitate discussion at the roundtable regarding the US proxy process the SEC staff will be hosting in November 2018.


Rule 206(4)-6 of the Investment Advisers Act of 1940 states that it is fraudulent and deceptive for investment advisers to exercise voting authority with respect to client securities unless, among other things, written policies and procedures are adopted to ensure that securities are voted in the best interests of clients. These procedures must state how conflicts between advisers and their clients are addressed. The SEC noted in its 2003 adopting release for Rule 206(4)-6 that investment advisers have a fiduciary duty of care and loyalty to their clients with respect to proxy voting. The SEC further explained that an “adviser may have a number of conflicts that can affect how it votes proxies. For example, an adviser (or its affiliate) may manage a pension plan, administer employee benefit plans, or provide brokerage, underwriting, insurance, or banking services to a company whose management is soliciting proxies. Failure to vote in favor of management may harm the adviser’s relationship with the company. The adviser may also have business or personal relationships with participants in proxy contests, corporate directors or candidates for directorships. For example, an executive of the adviser may have a spouse or other close relative who serves as a director or executive of a company.” The SEC went on to provide that an investment adviser could demonstrate that a vote of client securities was not, however, a conflict of interest if it voted in accordance with a pre-determined policy, based on the recommendations of an independent third party.

In the Egan-Jones letter, the Staff confirmed that despite receiving compensation from an issuer for providing advice on corporate governance issues that a third party proxy firm could still be considered independent, although the Staff listed additional requirements to be satisfied in such circumstances, including first ascertaining whether the proxy adviser (a) has the capacity and competency to adequately analyze proxy issues, and (b) can make such recommendations in an impartial manner and in the best interests of the adviser’s clients. Under the ISS letter, the Staff determined that a case-by-case evaluation of a proxy advisory firm’s potential conflicts of interest is not the exclusive mean by which an investment adviser may fulfill its fiduciary duty of care to its clients in connection with voting client proxies according to a firm’s recommendations. The Staff further noted that a thorough review of the voting proxy firm’s conflict procedures and the effectiveness of their implementation may be used to satisfy an investment adviser’s duties.


It is important to note that the while the Staff withdrew the 2004 letters referred to above, it did not withdraw Staff Legal Bulletin 20, which was jointly adopted in 2014 by the staffs of both the Division of Investment Management and Corporation Finance. The Bulletin cites the letters as authority and provides further guidance regarding the oversight of the conflicts that proxy advisory firms face. In addition, SEC Commissioner Robert J. Jackson, Jr., recently noted in a statement on the SEC website discussing the withdrawal of these letters that “the law governing investor use of proxy advisors is no different today that it was yesterday.” The true effect of the withdrawal of these letters should become more apparent after the SEC roundtable next month. It will be important to monitor whether these withdrawals signify a substantive change in the SEC’s views on proxy adviser issues. Reliance by investment advisers on these firms to satisfy the fiduciary duties of care and loyalty owed to their clients may be subject to significant alteration if the SEC upends the existing rules with respect to proxy advisory firms. A new regulatory approach could also have profound consequences for public companies regarding their engagement with proxy and investment advisers in connection with the proxy process and for shareholder engagement more generally. We will provide additional guidance as it becomes available.