SEC Issues Rule on Proxy Advisors; Companies to Finally Get Their Say

Good things often take time. On July 22, the US Securities and Exchange Commission (SEC) approved a rule on Exemptions from the Proxy Rules for Proxy Voting Advice. The new rule is in response to more than a decade’s worth of complaints about the role of proxy-voting advisors such as Institutional Shareholder Services (ISS) and Glass, Lewis & Co. These advisors were perceived as having an outsized influence on how proxies were being voted, large enough to sway votes on proxy-voting matters such as director elections and executive compensation (say on pay).

The rule will be effective December 1, 2021, in time for the spring 2022 proxy season, but earlier compliance is possible.

The SEC’s new rule (issued along with supplemental guidance) builds on the Commission’s 2019 guidance clarifying the applicability of the federal proxy rules to proxy-voting advice, as well as related 2019 guidance regarding the proxy-voting responsibilities of proxy-voting advisors. (For more on those developments, see NACD Washington Review, Q3 2019.) Those documents in turn reflected views from a major 2018 SEC roundtable on the proxy process, as well as an earlier 2013 roundtable on proxy advisory services—all building on the 2010 Concept Release on the US Proxy System.

The SEC’s long-awaited rule sets some new conditions that proxy advisors must meet in order to be exempt from certain federal disclosure and filing requirements. (The exemptions are necessary because the SEC has declared that proxy-voting advice constitutes a “solicitation” of shares under securities laws.)

To gain exemption from the rule that would normally apply to a solicitation, proxy-voting advisors must disclose any conflicts of interest. Specifically, the new rule reads that proxy advisors must include in their voting advice to investors “any information regarding an interest, transaction, or relationship of the proxy-voting advice business (or its affiliates) that is material to assessing the objectivity of the proxy-voting advice” and “explain steps taken to address any such material conflicts of interest.”

In its comment letter on the new rule before it became final, the Business Roundtable expressed concerns about commercial conflicts at ISS (which provides consulting) and ownership conflicts at Glass Lewis (which is owned in part by a labor union owner).

Under the new rule, proxy advisors must also adopt certain written policies and procedures “designed to ensure” certain outcomes for companies that file early enough (at least 40 calendar days before the annual meeting).

First, companies need to get timely notice of what the advisors plan to recommend—getting access to the recommendation at or before the time the proxy advisor client gets it. Second, the proxy advisor must give its clients (key shareholders of the company in question) “a mechanism by which they can reasonably be expected to become aware of any written statements regarding its proxy voting advice by registrants that are the subject of such advice, in a timely manner before the shareholder meeting.” In other words, companies will now have a chance to rebut the claims of the advisor.

For example, suppose a proxy advisor plans to recommend a vote against reelecting all compensation committee members, alleging that they fail to link pay to performance. The company would be able to see the advice in advance and respond, and the advisor would need to provide some way (such as a web link) for the client to see the company’s response. This clearly expands the information available to the shareholder.

The new rule, however, does not require the proxy advisor to “negotiate or otherwise engage in a dialogue with the registrant” or “revise its voting advice in response to any feedback.”

Finally, the rule explains how the failure to disclose certain information in proxy-voting advice may violate the antifraud provision of the proxy rules.

The new rule is not effective until late next year, but it is likely to have an impact on the upcoming 2021 proxy season. As proxy advisors begin putting these future requirements into place, dialogue is bound to occur and possibly even improve.

This positive change has been a long time coming. In an early comment letter responding to the SEC’s historic 2010 concept release, NACD outlined the concerns of our members on this score. “NACD recommends more transparency and independence: Companies should be able to understand the standards by which they are being judged, and advisors should be free from any conflicts of interest.” Now, 10 years later, these two important goals are more likely to be met.