SEC Publishes Guidance on Investment Adviser's Proxy Voting Responsibilities and Recommendation of Proxy Voting Advice

The Securities and Exchange Commission ("SEC") published guidance on August 21, 2019 to assist investment advisers in fulfilling their proxy voting responsibilities, particularly where those firms use a proxy advisory firm. The guidance is intended to ensure that investment advisers understand their fiduciary duties when using proxy voting advisory service recommendations. The SEC's interpretive guidance is based in part on the concern that some investment advisers may have been taking recommendations from proxy advisory firms and not reviewing those recommendations sufficiently or not reviewing those recommendations in light of a client's individual interests and priorities.

The use of proxy advisory firms by investment advisers has become more widespread in recent years. The SEC has increased its scrutiny of proxy advisory firms as their use by investment advisers has increased. In recent years, the SEC has issued a concept release seeking public comment on proxy advisory firms and had multiple roundtable discussions on those firms. In 2018, the SEC hosted its most recent roundtable on the use of proxy advisory firms and sought public input on the role those firms play in proxy voting recommendations provided to investment advisers. Based on the feedback from those roundtables and the public feedback provided, the SEC published updated guidance for investment adviser firms that rely on proxy advisory firms when making proxy voting determinations for advisory clients.

Investment advisers are "fiduciaries that owe each of their clients duties of care and loyalty with respect to services undertaken on the client’s behalf, including voting." To satisfy the investment adviser's fiduciary duty and duty of care and loyalty when making proxy votes for clients, the adviser must make every determination in the best interest of that individual client. An adviser must have, amongst other things, a reasonable understanding of the client's objectives and make voting decisions in the best interest of every client. Forming a reasonable basis for a decision minimally requires the adviser conduct a review to determine that any vote is not based on inaccurate or incomplete information. Rule 206(4)-6 of the Investment Advisers Act of 1940 ("Advisers Act") requires that every investment adviser with proxy voting authority adopt policies and procedures that are reasonably designed to ensure the investment adviser making proxy voting determinations is in the best interests of each client.

Many investment advisers rely on proxy advisory firms that make proxy voting recommendations for investment adviser clients. Those proxy advisory firm recommendations can be based on a number of things, including internal policies of the proxy advisory firm and/or custom voting guidelines provided by the investment adviser. Investment advisers also rely on proxy voting recommendations where the investment adviser has a conflict of interest in the voting matter. Regardless of the reason the investment adviser relies on the proxy voting recommendations, or how narrowly tailored the voting guidelines provided by the investment adviser are, the investment adviser's fiduciary obligation and duty of care and loyalty are neither diminished nor modified. 

The SEC's updated guidance is in the form of an extended question and answer. Those questions and a summary of the answers are below.

Question 1: How may an investment adviser and its client, in establishing their relationship, agree upon the scope of the investment adviser’s authority and responsibilities to vote proxies on behalf of that client?

The SEC's guidance provides that an agreement between a client and an investment adviser can give the adviser a spectrum of possible voting authority. The key requirement is that there is full and fair disclosure of the investment adviser's role, any possible conflicts of interests, and potential costs involved to the client. As long as the investment adviser is making full and fair disclosure to the client, making voting determinations in line with the investment adviser's fiduciary duty and duty of care and loyalty, and has policies and procedures in place to be in compliance with Rule 206(4)-6 of the Advisers Act, then the investment adviser may have as little or as much authority as the client is willing to provide.

Question 2: What steps could an investment adviser, who has assumed the authority to vote proxies on behalf of a client, take to demonstrate it is making voting determinations in a client’s best interest and in accordance with the investment adviser’s proxy voting policies and procedures?

In light of an investment adviser's obligations to clients and requirements under Rule 206(4)-6, an investment adviser should consider whether voting all of its client's securities in accordance with a uniform policy is in any client's best interest. Investment advisers have a wide variety of clients including individuals, funds, pooled investment vehicles, etc. While it may be that voting an entire block of proxy votes uniformly for all clients is in each client's best interest, an investment adviser should ensure that each vote meets that investment adviser's obligations to the individual client and the investment adviser is in compliance with Rule 206(4)-6 when making a proxy vote. There may be circumstances where an extensive review of the proxy advisory firm's recommendations must be undertaken by the investment adviser for a client. It is also possible that the investment adviser finds the proxy voting recommendations are contrary to a specific client's interests or that the investment adviser needs to make further disclosures to the client about a possible conflict of interest before a proxy vote is made.

Question 3: What are some of the considerations an investment adviser should take into account if it retains a proxy advisory firm to assist it in discharging its proxy voting duties?

The SEC's guidance provides a non-exhaustive list of things an investment adviser engaging a proxy advisory service should consider, including:

1. Does the proxy advisory firm have the capacity and competency to adequately analyze the issues the investment adviser is responsible for voting?
2. Are the proxy advisory firm's staffing, personnel, and technology sufficient to provide the services they claim to provide?
3. Does the proxy advisory firm have an effective process for seeking timely input from investment advisers and issuers with respect to issues related to a specific proxy vote?
4. Has the proxy advisory firm disclosed to the investment adviser its vote formulation methodologies sufficiently for the investment adviser to be able to understand those methodologies? 
5. What third-party information services does the proxy advisor firm use?
6. Has the investment adviser reviewed the general policies and procedures of the proxy advisory firm in sufficient detail to be able to understand them?
7. What conflicts of interest exists with the proxy advisory firm on any particular vote, if any? Are those conflicts sufficiently disclosed?

Question 4: When retaining a proxy advisory firm for research or voting recommendations as an input to its voting determinations, what steps should an investment adviser consider taking when it becomes aware of potential factual errors, potential incompleteness, or potential methodological weaknesses in the proxy advisory firm’s analysis that may materially affect one or more of the investment adviser’s voting determinations?

An investment adviser has to have a reasonable basis that its voting recommendations are in the best interest of every client. The investment adviser should review and understand the proxy advisory firm's recommendations and procedures sufficiently to be able to determine when that proxy advisory firm has made a recommendation that is based on materially inaccurate or incomplete information. If an investment adviser finds an issue with the manner in which a proxy advisory firm made a recommendation, that investment adviser should review the voting issue independently to make its own recommendation or allow the client to review and vote.

Question 5: How can an investment adviser evaluate the services of a proxy advisory firm it retains, including evaluating any material changes in services or operations by the proxy advisory firm?

From the guidance, "[i]n order to act consistently with Rule 206(4)-6, an investment adviser that has retained a third party (such as a proxy advisory firm) to assist substantively with its proxy voting responsibilities and carrying out its fiduciary duty should adopt and implement policies and procedures that are reasonably designed to sufficiently evaluate the third party in order to ensure that the investment adviser casts votes in the best interest of its clients." Specifically, an investment adviser should have policies and procedures in place to regularly evaluate and identify any potential conflict of interest that may exist for the proxy advisory firm as well as the competency and recommendation process of that proxy advisory firm. 

Question 6: If an investment adviser has assumed voting authority on behalf of a client, is it required to exercise every opportunity to vote a proxy for that client?

No. There are a variety of circumstances where an investment adviser and client may limit voting authority for certain proxy votes. There may also be situations where an investment adviser has a conflict of interest or determines the client's needs are better served by the client voting themselves.

The SEC's updated interpretive guidance can be found here. 

Please contact Erik Hansen, Matt Fornshell or another member of our Business Group if you have any questions.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.