Over the past year, the U.S. SEC has been engaged in a thorough review of the entire proxy process, including the shareholder voting recommendations provided by proxy advisory firms such as Institutional Shareholder Services (ISS) and Glass Lewis. In the process of carrying out its review, the SEC will no doubt try and learn what it can from the experiences of other countries. For example, across the Atlantic, the United Kingdom has just implemented important new regulations to enhance the precision of a proxy advisor’s voting recommendations. I believe the substance of these regulations provides the SEC with important guidance in formulating its own oversight regime of proxy advisors and the disclosures it needs to require.
Under the Proxy Advisors (Shareholders’ Rights) Regulations 2019, which went into effect on June 10, 2019, Her Majesty’s Treasury now requires a proxy advisor to publicly disclose “information relating to” its “preparation of research, advice and voting recommendations.” In regard to voting recommendations, these disclosures are quite comprehensive and must include a description of: “the essential features of the methodologies and models applied;” information sources used; “the procedures” in place to make sure that the recommendations are “of an adequate quality” and are prepared by “qualified” staff; whether the analysis takes into account “national market, legal, regulatory and company-specific conditions” and how it does so; and “the extent and nature of the dialogue” it has with companies that are the object of its voting recommendations.
The new regulations also require a proxy advisor to promptly identify and disclose to its clients “any actual or potential conflict of interest or any business relationship that may influence” the creation of its voting recommendations. Moreover, it must provide these clients with “a statement of the action” on how it will resolve the actual or potential conflict of interest.
Most importantly, these new regulations will be enforced with financial penalties that will vary according to the seriousness of the breach of the regulations. In paragraph 7.11 of the explanatory memo that accompanied the new regulations, HM Treasury stated that the Financial Conduct Authority’s (the regulatory body enforcing compliance with the regulations) “investigative and enforcement powers relate solely to the scope of requirements on proxy advisors, namely that the required disclosures have in practice been made, and whether such disclosures have a basis in fact.” This means that proxy advisors will no longer be able to simply rely on publishing general codes of conduct, but will be required to demonstrate how day-to-day practice meets regulatory standards. Put another way, there are teeth to these regulations.
While there are additional provisions that should be included for purposes of satisfying the specific needs of the U.S. market, such as giving issuers sufficient time to review a proxy advisor’s draft recommendations prior to finalizing (comment letter from the National Association of Manufacturers to the SEC, March 5, pages 6-7), the substance of these new regulations appears to form a solid foundation for what the SEC needs to implement in order to adequately monitor the activities of proxy advisors.
One way the SEC can take advantage of this guidance within its own legal framework is to reaffirm the position it took in its 2010 Concept Release on the proxy process. In that Release (pages 109-110), the SEC specifically argued that proxy advisors are covered by the Investment Advisers Act of 1940 definition of investment adviser and therefore owe fiduciary duties to their clients. By taking this position, the SEC can then incorporate into the fiduciary duties of a proxy advisor the substance of what is described in the new U.K. regulations. This would provide the SEC with the authority to require a proxy advisor to make disclosures similar to what is described above. Moreover, to make unambiguous that proxy advisers are investment advisers under the Advisers Act and therefore have fiduciary duties, the SEC should require all proxy advisors that do business with U.S. issuers to be registered as investment advisers.
Investment advisers, such as T. Rowe Price, Fidelity, BlackRock, Vanguard, and State Street Global Advisors, have a fiduciary duty to vote in the best interests of their clients. In order to fulfill their fiduciary obligations, these advisers will likely rely on proxy advisors to provide them with informed voting recommendations. To make sure these voting recommendations are truly informed, proxy advisors must owe fiduciary duties as well – duties that are effectively described in the United Kingdom’s new regulations on proxy advisors.