On July 22, 2020, the Securities and Exchange Commission (“SEC”) amended the Federal proxy voting rules (“Regulation 14A”) to require proxy advisory firms, such as ISS and Glass Lewis, to comply with additional disclosure and procedural requirements. The new requirements will take effect on December 1, 2021. The SEC’s Adopting Release can be found here.

Proxy advisory firms currently rely on two exemptions (Rule 14a-2(b)(1) and (b)(3)) to avoid the need to comply with the information and filing requirements of Regulation 14A generally applicable to proxy solicitations. To continue to rely on these exemptions, proxy advisory firms will need to comply with additional conflict of interest disclosure requirements and must implement procedures relating to a registrant’s review of the firm’s proxy voting advice and any subsequent written responses. The SEC also codified its existing guidance to clarify that proxy advisory services constitute a “solicitation” and are therefore covered by Regulation 14A. Lastly, the SEC amended Rule 14a-9, the anti-fraud provision, by adding an example, specific to proxy voting advice, of what may be considered misleading within the meaning of that rule.

The SEC’s aim in amending these rules was to ensure that proxy advisory firms’ clients receive more transparent, accurate, and complete information to consider when making voting decisions. As a result of increased institutional investor participation and intermediation in the voting process, proxy advisory firms have come to play an increasingly important role in the proxy voting process. Proxy advisory services are frequently used by investment advisors and institutional investors who vote on behalf of their clients.

The SEC issued its proposed amendments to Regulation 14A in November 2019 and, based on the comment letters received, adopted the rule amendments with certain modifications. The final amendments reflect a shift away from more prescriptive rules and instead take a principles-based approach intended to give proxy advisory firms more flexibility in complying with the new rules.

I. Codification of Proxy Voting Advice as a “Solicitation” Under Regulation 14A

The SEC’s longstanding view has been that proxy voting advice generally falls within the definition of “solicitation.” That stance is now codified in Regulation 14A as a new paragraph (A) to Rule 14a-1(l)(1)(iii). Specifically, a solicitation now includes:

“Any proxy voting advice that makes a recommendation to a security holder as to its vote, consent, or authorization on a specific matter for which security holder approval is solicited, and that is furnished by a person that markets its expertise as a provider of such proxy voting advice, separately from other forms of investment advice, and sells such proxy voting advice for a fee.”

Furnishing proxy voting advice only in response to an unprompted request does not constitute a solicitation, as per a new paragraph (v) to Rule 14a-1(l)(2). This exemption is also a codification of the SEC’s longstanding view on the matter.

The SEC’s Authority to Regulate Proxy Advisory Firms

During the comment period on the proposed rule amendments, some commenters asserted that the SEC does not have the authority to regulate proxy advisory firms under Section 14(a) or any other provisions of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The SEC rejected this argument, citing the structure of Section 14(a), which grants the SEC broad authority to regulate proxy solicitations “as necessary or appropriate in the public interest or for the protection of investors.”  The SEC further reasoned that the Exchange Act does not define the term “solicitation,” but does grant the SEC the power to define the term. The SEC also noted that Congress had considered adopting more specific proxy standards in Section 14(a) but ultimately rejected that approach, and that nothing in the text or legislative history of that section indicates that Congress intended to limit the scope of what constitutes a solicitation. Proxy advisory firms challenged the SEC’s rulemaking in court after the SEC proposed its amendments to Regulation 14A, and it is unclear whether proxy advisory firms will continue to fight the SEC in light of the final rules.

II. New Conflict of Interest Disclosure Requirement

The new amendments to Rule 14a-2(b) add certain conditions that a proxy advisory firm must satisfy in order to be exempt from the general proxy solicitation information and filing requirements. First, the proxy advisory firm must disclose:

• Any information regarding an interest, transaction, or relationship of the proxy advisory firm, or its affiliates, that is material to assessing the objectivity of the proxy voting advice in light of the circumstances of the particular interest, transaction, or relationship; and
• The policies and procedures used to identify and address any of such material conflicts.

This information must be prominently disclosed in the proxy voting advice or in an electronic medium used to deliver the proxy voting advice. The SEC made clear that boilerplate language such as “such relationships or interests may or may not exist” will not be sufficient. For the policies and procedures, an active hyperlink or “click through” feature on a client platform will satisfy the requirement.

By requiring a principles-based approach, the final rule is intended to give proxy advisory firms flexibility in determining the level of detail to be disclosed. Some of the specific conflict of interest scenarios that the SEC contemplated in its Adopting Release were:

• A proxy advisory firm that rates registrants’ corporate governance practices while at the same time, for a fee, provides consulting services to those registrants to increase their ratings.
• A proxy advisory firm that provides voting advice while affiliates of that firm hold a significant ownership interest in the registrant, sit on the registrant’s board of directors, or have relationships with a shareholder presenting a proposal covered by the proxy voting advice.
• A proxy advisory firm that provides voting advice on a matter on which it, or its affiliates, have provided advice to a registrant, a proponent, or other party regarding how to structure or present the matter or the business terms to be offered in such matter.

Some commenters were concerned that the new conflict of interest disclosure requirements would compromise the internal firewalls that proxy advisory firms already have in place to mitigate their risk of conflicts. In response to these concerns, the SEC modified the proposed amendment, which would have required the disclosures to be made in both the proxy voting advice and the electronic medium used to deliver the advice. This modification allows a proxy advisory firm to segregate the conflict disclosure information as necessary and ensure that only the intended recipients have access to such information.

• The proxy voting advice is based on custom voting policies that are proprietary to the proxy advisory firm’s client. “Custom policies” do not include a proxy advisory firm’s benchmark or specialty policies, even if adopted by the client as its own policy.
• The voting matter relates to merger and acquisition transactions or contested matters, such as contested director elections.

III. Registrant Review of the Proxy Voting Advice and Subsequent Response

The second condition that a proxy advisory firm must satisfy in order to be exempt from Regulation 14A information and filing requirements relates to registrant review of proxy voting advice and any subsequent written response. Specifically, a proxy advisory firm must adopt and publicly disclose written policies and procedures reasonably designed to ensure that:

• The proxy advisory firm’s voting advice is made available to the registrant either at or prior to the time when the advice is released to the proxy advisory firm’s clients; and
• The proxy advisory firm provides its clients with a mechanism by which they can reasonably be expected to become aware of any written statements made by the registrant in response to the proxy voting advice, in a timely manner before the shareholder meeting.

The rule as originally proposed would have required proxy advisory firms to implement a “review and feedback” process for registrants. This would have required proxy advisory firms to distribute a draft of the proxy voting advice to a registrant before it was released to the proxy advisory firm’s clients, thereby giving the registrant an opportunity to provide feedback and the proxy advisory firm an opportunity to make any revisions.

The final rule instead allows a proxy advisory firm to release the proxy voting advice to its clients and the registrant concurrently. This change was made to address several concerns expressed by commenters, such as compromising the independence of proxy advisory firms; providing an unfair advantage to company management in disputed proxy matters; increasing the risk of insider trading of material, non-public information; and incurring costs and delays in issuing proxy voting advice.

The SEC makes clear in its Adopting Release that a proxy advisory firm does not need to negotiate or engage in a dialogue with the registrant, and is not required to revise its voting advice in response to any feedback. Some of the factors that the SEC will consider in determining whether a proxy advisory firm has complied with the new rules are:

• The degree to which a registrant has time to respond and whether the policy ensures prompt conveyance of information to the registrant.
• The extent to which the mechanism provided to clients is an efficient means by which they can reasonably be expected to become aware of the registrant’s written response, once it is filed, such that the client has sufficient time to consider such response in connection with a vote.
• The reasonableness, based on facts and circumstances, of any fees charged by a proxy voting advice business to a registrant as a condition to receiving a copy of its proxy voting advice, and the extent to which such fees may dissuade a registrant from seeking to review and provide a response to such proxy voting advice.

Safe Harbor for Registrant Review

The amendment provides a non-exclusive safe harbor provision in Rule 14a-2(b)(9)(iii) for the registrant review requirement. A proxy advisory firm will be deemed to have satisfied the new requirement if:

• The proxy advisory firm has written policies and procedures that are reasonably designed to provide registrants with a copy of the proxy voting advice;
• The copy of the proxy voting advice is provided to the registrant no later than the time it is disseminated to the proxy advisory firm’s clients; and
• The copy of the proxy voting advice is provided to the registrant free of charge.

Proxy advisory firms may also, at their discretion, require that a registrant:

• File its definitive proxy statement at least 40 calendar days before the shareholder meeting; and
• Acknowledge that it will only use the proxy voting advice for internal purposes and/or in connection with the solicitation and the advice will not be published or otherwise shared except with its employees or advisers.

The SEC reiterates in its Adopting Release that the safe harbor is not the only means of satisfying the registrant review requirement.

Safe Harbor for Mechanism to Alert Clients to Registrant Response

The amendment also provides a non-exclusive safe harbor in Rule 14a-2(b)(9)(iv) for proxy advisory firms to comply with the requirement to implement a mechanism to alert clients to a registrant’s written response. A proxy advisory firm will be deemed to have satisfied the new requirement if it:

• Provides notice to its clients, either on its electronic platform, via email, or through other electronic means that the registrant either has filed, or intends to file, additional soliciting materials; and
• Includes an active hyperlink to those materials on EDGAR when available.

Like the safe harbor for registrant review, this is not intended to be the only means by which a proxy advisory firm can satisfy the new requirement.

Exclusions to the New Requirements

The registrant review and response requirements in Rule 14a-2(b)(9)(ii) do not apply in the following circumstances:

• The proxy voting advice is based on custom voting policies that are proprietary to the proxy advisory firm’s client. “Custom policies” do not include a proxy advisory firm’s benchmark or specialty policies, even if adopted by the client as its own policy.
• The voting matter relates to merger and acquisition transactions or contested matters, such as contested director elections.

IV. Amendment to Anti-Fraud Provision

The SEC also amended Rule 14a-9, the anti-fraud provision, which prohibits false or misleading statements with regard to any material fact in proxy solicitations. The rule was amended to include an example of what, depending upon particular facts and circumstances, may be misleading in the proxy advisory context. The new example states that failure to disclose material information regarding proxy voting advice, such as the proxy advisory firm’s business methodology, sources of information, or conflicts of interest, may be misleading under the anti-fraud rule.

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