September 13, 2018
This morning, the Securities and Exchange Commission (SEC) announced the withdrawal of two letters that previously underpinned the outsized power and role of proxy advisors. The letters, issued in 2004 to two major proxy advisory firms – ISS and Egan-Jones, enabled proxy advisors to operate opaquely and shielded them from scrutiny over potential conflicts of interest.
The withdrawal is a win for advocates of proxy advisory reform. ISS and Egan-Jones penned their letters seeking clarification around Rule 206(4)-6, which forces advisors to act in the best interests of their clients. Arnold & Porter, a major international law firm, explains:
“The no-action letters made it easy for investment advisers to satisfy this requirement by relying on the voting recommendation of proxy advisory firms.”
Why are these letters being revisited now? In today’s statement, the SEC makes it clear that the upcoming Roundtable on the Proxy Process has prompted the re-evaluation of previous guidance about investment advisers’ responsibilities:
“Taking into account developments since 2004, the staff has determined to withdraw these letters, effective today. The staff is providing this notice of withdrawal of the letters in order to facilitate the discussion at the Roundtable and looks forward to receiving information and feedback from stakeholders with multiple perspectives at the Roundtable, including on the staff guidance in Staff Legal Bulletin No. 20 (June 30, 2014).”
These withdrawals didn’t come out of nowhere. Indeed, momentum has been building for years within the SEC to re-examine the role of proxy advisors and increase accountability and transparency. In 2013, then-SEC Commissioner Daniel M. Gallagher expressed concern over the outsized role of proxy advisors:
“I am very concerned that these letters have unduly increased the role of proxy advisory firms in corporate governance. I also have grave concerns as to whether investment advisers are indeed truly fulfilling their fiduciary duties when they rely on and follow recommendations from proxy advisory firms. It is troubling to think that institutional investors, particularly investment advisers, are treating their responsibility akin to a compliance function carried out through rote reliance on proxy advisory firm advice rather than actively researching the proposals before them and ensuring that their votes further their clients’ interests. The last thing we should want is for investment advisers to adopt a mindset that leads to them blindly casting their votes in line with a proxy advisor’s recommendations, especially given the fact that such recommendations are often not tailored to a fund’s unique strategy or investment goals.”
The withdrawal of these letters adds momentum to the rapidly growing proxy reform movement. This movement includes a 2018 report by the American Council for Capital Formation that recalls Commissioner Gallagher’s concerns regarding proxy advisory firms’ outsized and inappropriate regulatory influence. It also includes the Corporate Governance Reform and Transparency Act of 2017, a bipartisan legislative effort that calls for, among other things, the withdrawal these very letters. With this withdrawal action, the SEC has indicated that it, too, is on board with proxy reform.
The business and academic communities applauded today’s decision. The American Securities Association noted the positive impact for retail investors:
“The ASA applauds Chairman Clayton and the SEC for acting to put the interests of America’s retail investors before the often politically-motivated interests of the harmful proxy advisory mega-firms,” said ASA CEO Christopher Iacovella. “Today’s action will help investors better grow and protect their wealth as funds and institutions can no longer quickly turn to proxy advisors without conducting the necessary due diligence their fiduciary duty requires. We look forward to continuing to work with the SEC to modernize the proxy advisory process and to ensure Main Street investors have a seat at the table.”
Tim Doyle, Vice President and General Counsel of The American Council for Capital Formation, praised the withdrawal as a return to the fundamentals of what proxy advisors should do for their clients:
“It’s certainly a great first step toward genuine reform of the way these proxy advisory firms have exerted their influence over corporate governance matters. The conflicts of interests between offering both ratings and consulting services, coupled with a lack of allowable input from companies they rate and an overall lack of transparency, had given these firms unintended influence over the shareholder proposal process. Hopefully the withdrawal of these letters will refocus attention on the fiduciary duty owed to investors.”
The National Association of Manufacturers also cheered today’s actions, with CEO Jay Timmons commenting:
“The SEC’s action today is a major victory for manufacturers and Main Street investors. For far too long, proxy advisory firms have exerted undue influence over manufacturing companies, trying to force business decisions without any regard to investors’ best interests. This is a threat not only to manufacturing growth, but also to the savings of millions of American workers. The SEC has taken an important step to fix this unfairness, and we encourage them to continue working to ensure the voices of Main Street investors are not drowned out by third parties who have little stake in a company’s success. Manufacturers support increased SEC oversight over proxy advisory firms to restore fairness to the system.”
Bernie Sharfman, chairman of the advisory panel for Main Street Investors Coalition, summed up what this means for proxy advisors, and what could come next:
“All in all, it looks like the SEC, in seeking to significantly reduce the potential for proxy advisors generating recommendations that are influenced by conflicts of interest, wants to put more responsibility for the monitoring of these conflicts on the shoulders of the investment advisers, the ones ultimately responsible for shareholder voting. This seems very appropriate.”
As the Roundtable on the Proxy Process approaches, it is looking increasingly likely that the days of proxy advisory firms running rampant with little regard to their fiduciary duties will soon come to an end. This is welcome news for Main Street Investors.