By Soyoung Ho
The Council of Institutional Investors (CII) and a coalition of investors told the SEC that they were concerned with its effort to regulate proxy advisory firms.
The SEC actions “may reduce investor participation in the corporate governance voting process, and is likely to undermine investor protection, upend efficiency in the critical arena of corporate governance and impair capital formation by diminishing corporate managerial accountability,” the groups wrote to SEC Chairman Jay Clayton and four other commissioners on October 15, 2019. Some of the organizations that signed the letter are New York City Comptroller, Boston Common Asset Management, and Trillium Asset Management, LLC.
The groups were referring to a split SEC decision in August to tighten the commission’s interpretation of rules that apply to proxy advisory firms and asset managers who use their services. (See Rule Reinterpretation to Bring Greater Scrutiny of Proxy Advisory Firms in the August 22, 2019, edition of Accounting & Compliance Alert .)
The action, which has been opposed by investor advocates, was made in response to long-running business complaints that proxy advisory firms—who provide voting recommendations on issues ranging from executive compensation to director elections during shareholder meetings—have too much unchecked power.
The commission has been worried that investment advisers might have outsourced their fiduciary duty when they rely on proxy advisory firms’ voting advice. The guidance clarifies how an asset manager’s fiduciary duty relates to proxy voting and provides a question and answer instruction along with examples to help with compliance.
Another guidance would require proxy advisers to be more transparent about its activities and how it comes up with voting recommendations, ranging from director elections and auditor ratification. This was in response to business complaints that they are not given an appropriate opportunity to raise concerns with the proxy adviser and shareholders if they disagree with a proxy adviser’s recommendations.
But asset managers who hold shares face logistical challenges in voting each proxy season, and supporters of proxy advisers say they provide efficient research on tens of thousands of vote recommendations. Some institutional investors say that they do not exclusively rely on the proxy firms but also do some independent analysis.
“We are disappointed that the SEC did not ask for public comment on its new Proxy Advisor Interpretation and Guidance before issuance,” the investor groups’ letter said. “We would ask that the SEC re-consider that interpretation and guidance, with appropriate opportunity for public comment.”
The SEC is also planning to propose a rule intended to address proxy advisers’ reliance on the proxy solicitation exemptions in Rule 14a-2(b) of the Securities Exchange Act of 1934. Proxy advisory firms are subject to the federal proxy rules when it engages in a “solicitation,” and the commission has stated furnishing proxy advice constitutes a “solicitation” subject to the information and filing requirements of the federal proxy rules.
However, Rule 14a-2(b)(1) provides an exemption from the SEC’s information and filing requirements for “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.”
Solicitations that are exempt from filing requirements must comply with rules that prohibit solicitation that contains any false or misleading statement.
“Should the SEC move ahead with the ‘Proxy Advisor Rulemaking,’ we ask that you not place requirements on proxy advisors that would reduce their independence and effectiveness or reduce competition,” the letter said. “It is commonplace throughout our economy that firms can freely pool their resources, including through third parties, where they consider it feasible to deliver what clients routinely expect from them. Funds’ retention of advisors to help ensure that proxies are voted in a cost-effective, timely and informed manner is no exception.”
Investors said proxy advisory firms provide market-based solutions, and the SEC policy initiatives have the potential to adversely affect the voluntary contracts between investors and their proxy advisors.
They said that they are further worried that the SEC has decided to tighten the rules on proxy advisory firms without showing evidence that it is needed.
“The case for government intervention into these private market activities has not yet been made,” the letter said. Moreover, they said proxy advisors maintain an open-door policy to companies that believe their report contains factual errors. Proxy advisers also routinely issue updates because their business model depends on factual accuracy.
“The vast bulk of issuers’ claims regarding errors in proxy advisors’ reports relate to proxy advisors’ analysis of executive compensation, a matter of personal importance to incumbent managers,” they said. “Issuers contest with many parts of this process.”
For example, as part of the compensation process, proxy advisors select a comparative peer group, investors said. Often, this peer group differs from the one an issuer has disclosed in its proxy statement.
“The consequence of proxy advisors’ bespoke analyses has, on occasion, revealed that some management teams have inflated compensation relative to truly comparable peers,” the investor groups said. “Separately, proxy advisors apply more rigorous compensation calculation models that, at times, reveal higher executive compensation amounts than those disclosed by issuers themselves.”
This difference, the groups said, is rarely due to factual errors but rather differences in analytical approaches and opinion.
“Some issuers’ disdain for proxy advisors and proxy advisors’ efficacy in helping investors hold management teams accountable is not a legitimate basis on which to justify regulatory intrusion on the voluntary, uncoerced, private contractual relationship between investors and the proxy advisors,” the letter said.
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