On June 30, the Securities and Exchange Commission’s Division of Investment Management and Division of Corporation Finance published Staff Legal Bulletin No. 20 (SLB 20), which offers guidance regarding investment advisers’ responsibilities in voting proxies and retaining proxy advisory firms, as well as the availability of two exemptions from federal proxy rules often relied upon by proxy advisory firms.

Investment Adviser Proxy Voting  

As a fiduciary, an investment adviser owes each of its clients a duty of care and loyalty with respect to services provided on the client’s behalf, including proxy voting. Moreover, Rule 206(4)-7 under the Investment Advisers Act of 1940 prohibits investment advisers from exercising voting authority with respect to client securities unless the adviser, among other things, adopts and implements written policies and procedures that are reasonably designed to ensure that the adviser votes proxies in the best interests of its clients (Proxy Voting Rule). SLB 20 provides examples of the steps an adviser can take to demonstrate its compliance with the Proxy Voting Rule, such as periodically sampling and reviewing proxy votes to ensure compliance with the adviser’s proxy voting policy and procedures, and assessing the adequacy of such policy and procedures at least annually to ensure that they are being implemented correctly and that proxies are voted in the best interest of clients. SLB 20 also clarifies that, while an investment adviser that assumes proxy voting authority for a client must do so in compliance with the Proxy Voting Rule, an investment adviser and its client may agree to limit the scope of the investment adviser’s obligation to exercise proxy voting authority in appropriate circumstances.   

SLB 20 also addresses investment advisers’ obligations in connection with the retention and oversight of proxy advisory firms. In considering whether to retain a proxy advisory firm, an investment adviser should ascertain whether the advisory firm has the capacity and competency to adequately analyze proxy issues. SLB 20 clarifies that, in evaluating a proxy advisory firm, an investment adviser could consider, for example, the adequacy and quality of the advisory firm’s personnel, as well as its policies and procedures for ensuring recommendations are based on current and accurate information and for addressing conflicts of interest.   

If a proxy advisory firm is retained, an investment adviser should adopt and implement policies and procedures that are reasonably designed to provide ongoing oversight of the proxy advisory firm to ensure that the investment adviser, through the investment advisory firm, continues to vote proxies in the best interests of its clients. The investment adviser also has a duty to monitor the effectiveness of the proxy advisory firm’s policies for addressing conflicts of interest and to take reasonable steps to address any factual errors upon which a proxy advisory firm’s recommendations may be based.   

Proxy Advisory Firm Exemptions from Proxy Rules 

SLB 20 also clarifies the Division of Corporation Finance’s interpretation of two exemptions from federal proxy rules upon which proxy advisory firms often rely. A proxy advisory firm is subject to federal proxy rules if it engages in a “solicitation,” which is defined under Rule 14a-1(l) under the Securities Exchange Act of 1934 (Exchange Act) to include “the furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” Rule 14a-2(b)(1) under the Exchange Act exempts from the information and filing requirements of federal proxy rules “any solicitation by or on behalf of any person who does not, at any time during such solicitation, seek directly or indirectly, either on its own or another’s behalf, the power to act as a proxy for a security holder and does not furnish or otherwise request, or act on behalf of a person who furnishes or requests, a form of revocation, abstention, consent or authorization.” Where, for example, a proxy advisory firm only distributes reports containing recommendations, but does not solicit proxies, the exemption under Rule 14a-2(b)(1) would be available. In contrast, SLB 20 clarifies that if a shareholder (such as an institutional investor) retains a proxy advisory firm to assist in the establishment of general proxy voting guidelines and policies, the exemption under Rule 14a-2(b)(1) would not be available to the proxy advisory firm where the proxy advisory firm is authorized to apply such guidelines to vote on the shareholder’s behalf because the proxy advisory firm would be viewed as having “solicited the power to act as a proxy” for its client. 

Rule 14a-2(b)(3) under the Exchange Act provides an additional exemption for furnishing information to a person with whom a business relationship exists, provided that the person furnishing the advice gives financial advice in the ordinary course of business; discloses to the recipient of the advice any significant relationship with the company or any of its affiliates, or a security holder proponent of the matter on which the advice is given, as well as any material interest of the person in such matter; receives no special commission for furnishing the advice from any person other than the person to whom the advice is given (and others who receive similar advice); and does not furnish the advice on behalf of any person soliciting proxies or on behalf of a participant in a contested election. SLB 20 clarifies that a relationship generally would be considered “significant,” or a “material interest” would exist, if knowledge of the relationship or interest would reasonably be expected to affect the recipient’s assessment of the reliability and objectivity of the adviser and the advice. SLB 20 further indicates that any such relationship or interest must be disclosed to the recipient of the advice (either publicly or between the proxy advisory firm and its client) and clarifies the type of information that must be disclosed.   

Click here to view the complete text of SLB 20.