The Securities and Exchange Commission (SEC) recently issued guidance clarifying the proxy voting responsibilities of investment advisers (IA Proxy Release). On the same day, August 21, the SEC issued a separate release related to Rule 14a-1(l) under the Securities Exchange Act of 1934, as amended (Proxy Release), which provides an interpretation of and guidance on the applicability of the proxy rules to proxy voting advice provided by proxy advisors. This client alert addresses the IA Proxy Release; a separate client alert addressing the Proxy Release is forthcoming.
Guidance to investment advisers
Under the Investment Advisers Act of 1940, as amended (Advisers Act), investment advisers owe a fiduciary duty to their clients, which is interpreted to include the duty to vote proxies if expressly or impliedly included within the scope of the client relationship. As a fiduciary, if an investment adviser accepts responsibility for voting proxies, it is required to exercise its authority to vote proxies in a client's best interest.
The IA Proxy Release provides guidance regarding investment advisers' proxy voting responsibilities, particularly when relying upon proxy advisory firms (Proxy Advisors) to discharge some or all of the adviser's proxy voting responsibilities. While the use of Proxy Advisors can be helpful to investment advisers, the IA Proxy Release emphasizes that using such firms is not, in and of itself, sufficient to discharge an investment adviser's fiduciary duty to act in the best interests of its clients. The SEC's guidance, which is provided through the use of detailed examples in a Q&A format, is summarized below.
- An investment adviser may agree with clients to tailor the scope of its proxy voting authority and responsibilities. An investment adviser may agree to a variety of voting arrangements with its clients, including an agreement not to have responsibility for voting proxies, subject to full and fair disclosure and informed consent. Whatever voting arrangement is agreed upon, an investment adviser must make voting decisions under that arrangement consistent with its fiduciary duty and its proxy voting policies and procedures. Possible voting arrangements discussed in the IA Proxy Release include:
- voting according to specific parameters designed to serve a particular client's best interests (eg, in favor of management proposals, subject to certain conditions)
- refraining from voting in circumstances that would impose costs on the client or the benefit of voting is outweighed by the costs and
- focusing voting responsibilities only on particular kinds of proposals (eg, M&A transactions or contested directors' elections).
- Advisers should consider ways to demonstrate that voting decisions are made in accordance with their policies and clients' best interest. Examples of actions that an investment adviser can take in this regard include:
- applying different voting policies for clients with different investment goals, rather than applying a uniform policy (eg, based on an informed understanding of each client's investment objectives)
- conducting a company-specific analysis (rather than using general voting guidelines) for certain types of proposals and identifying in its policies factors that the adviser will consider to determine whether a company-specific analysis is required
- conducting annual reviews of a sampling of proxy votes cast on behalf of clients to ensure consistency with its policies
- when Proxy Advisors are used, considering additional steps to determine that the Proxy Advisor's votes or recommendations are consistent with the investment adviser's proxy voting polices and in its clients' best interest. These steps might include sampling pre-populated votes and conducting a higher degree of analysis, particularly for controversial proposals, that the votes cast by Proxy Advisors are in its clients' best interest.
- Investment advisers should carefully consider any Proxy Advisors they retain. Possible considerations include:
- evaluating the adequacy and quality of the Proxy Advisor's staffing, personnel and/or technology
- determining whether the Proxy Advisor has an effective process for seeking input from issuers and its clients regarding proxy voting policies, methodologies and peer group constructions
- considering whether adequate disclosure has been given by the Proxy Advisor regarding its methodologies for formulating voting recommendations, including the factors underlying the recommendations and
- engaging in reasonable review of the Proxy Advisor's procedures regarding the identification, disclosure and resolution of conflicts of interest.
- Investment advisers should consider remedial steps if they become aware of potential factual errors, incompleteness or methodological weaknesses in a Proxy Advisor's voting analysis or inputs. An investment adviser's policies and procedures should be reasonably designed to ensure that its voting determinations (whether based on recommendations from a Proxy Advisor or votes that are cast by a Proxy Advisor) are not based on factual or procedural errors. Such policies and procedures should provide for a periodic review of the ongoing use of a Proxy Advisor, including an assessment of the extent to which potential factual errors, potential incompleteness in information or potential methodological weaknesses in the Proxy Advisor's analysis materially affected its research or recommendations to the investment adviser. An investment adviser should also consider whether the Proxy Advisor's policies are effective for obtaining current and accurate information relevant to its research and voting recommendations.
- Investment advisers should evaluate a Proxy Advisor's services on an ongoing basis. An investment adviser's policies and procedures should include processes to periodically evaluate the Proxy Advisor to ensure that votes are cast in the best interests of its clients. Such an evaluation should include on an ongoing basis:
- identification and evaluation of the Proxy Advisor's conflicts of interest (including, for example, with respect to the Proxy Advisor's affiliates)
- review of the Proxy Advisor's competence to provide voting recommendations and execute votes
- requiring the Proxy Advisor to update the investment adviser regarding relevant changes to the Proxy Advisor's business and
- a determination of whether a Proxy Advisor appropriately updates its methodologies, guidelines and voting recommendations on an ongoing basis (eg, in response to feedback from issuers and shareholders).
- An adviser that has voting authority is not required to exercise every opportunity to vote under certain circumstances. The SEC clarified that an adviser need not exercise voting authority if:
- it is agreed in advance with a client to limit the conditions under which the investment adviser would cast a vote and
- where the adviser has determined that not voting is in the client's best interest, such as where the cost of voting outweighs the benefit, subject to a determination that refraining from voting is consistent with the adviser's fiduciary duty in light of the agreed upon voting arrangement.
The guidance provided in the IA Proxy Release is intended to be non-binding and the SEC states that the examples described in the release are not the only way that advisers can discharge their fiduciary duty with respect to proxy voting. Investment advisers should, however, view the IA Proxy Release as a strong indication that the SEC expects advisers to focus on their proxy voting policies and procedures and improve those policies and procedures as necessary. In addition, investment advisers that utilize Proxy Advisors should be diligent about overseeing them and investigate issues that arise to ensure that the services received from such Proxy Advisors result in proxy voting that is in the best interests of their clients. Advisers should document their oversight efforts consistent with their internal policies.
We anticipate that the SEC's examination staff will review investment advisers' proxy voting procedures in the examination process within the context of the guidance provided in the IA Proxy Release. Accordingly, investment advisers should carefully consider the guidance provided in light of their business practices and compliance programs and adjust their proxy voting policies and procedures as necessary. Investment advisers should also consider whether it is advisable to clarify the scope of their proxy voting responsibilities in their investment advisory agreements.
Learn more about the IA Proxy Release by contacting any of the authors or your usual DLA Piper lawyer.