December 7, 2020
The SEC’s Proxy Advisory Firm Disclosure Reforms
The boards of directors of public companies provide
house research, some larger investors such as BlackRock
strategic planning and oversight. The boards, in turn
also supplement their research through the use of advisory
respond to the views of shareholders and may vote on
firms.
proposed corporate changes if the proposals gain a majority
of affirmative shareholder votes at annual and special
The advisory business is dominated by two firms, Glass
shareholder meetings. Proposals may include issues
Lewis and Institutional Shareholder Services (ISS), jointly
involving prospective mergers, executive compensation,
estimated to have about 97% of the advisory market share.
environmental policy, corporate diversity, political
In 2004, two SEC no-action letters indicated that
contributions, and executive management. Due to the large
institutional investment managers could show that their
number and diverse array of issues in such proposals, proxy
proxies voted in the best interest of their clients through the
advisory firms have emerged to provide proposal voting
use of voting policies formulated by independent third
recommendations to institutional investors, who are large
parties, such as proxy advisory firms. The development is
shareholders in most public companies.
widely credited with helping to “institutionalize” demand
for the advisory firms’ services.
On July 22, 2020, the Securities and Exchange Commission
(SEC) voted 3-1 to adopt controversial amendments to its
Views on the Advisory Firms
proxy rules under the Securities Exchange Act of 1934
Through the years, various academics and business
(1934 Act; P.L. 73-291) that require proxy advisory firms
interests—including the U.S. Chamber of Commerce, the
to disclose more information about themselves, including
American Council for Capital Formation, the Society for
potential conflicts of interests.
Corporate Governance, the Business Roundtable, the
NASDAQ Stock Exchange, and the National Association of
The Proxy Advisory Industry
Manufacturers (NAM)—have argued that, among other
State-based business incorporation laws give the states
things, advisory firms require additional regulation because:
substantial authority over companies that are incorporated
within a given state, including various aspects of
There tends to be an overreliance on them, said to be
shareholder voting. Under such laws, at annual and special
problematic because it diminishes the likelihood that
shareholder meetings, shareholders have the right to vote
investors will engage with portfolio firms. An extreme
their shares to elect directors, approve or reject a company’s
reliance is found in something called robo-voting
generally binding management proposals, and submit and
wherein investor clients vote immediately after
vote on generally non-binding shareholder proposals.
receiving advisory firm recommendations. A potential
downside of this is that it leaves portfolio firms with
Within the parameters of the state incorporation laws, under
little opportunity to assess the advice and respond.
Rule 14a-8 of the 1934 Act, the SEC oversees the types of
information shareholder proposals contain, who is eligible
Their voting recommendations can push a social and
to submit proposals for a vote, and how that information is
political agenda that some contend have little connection
disseminated to voters via a proxy statement. The proxy
to shareholder value. Chief among them are the
statement is an SEC-required document containing
pervasive so-called environmental, social, and political
information that companies provide to shareholders to
proposals whose contributions to shareholder value is a
enable them to make informed decisions about proposals
hotly debated question that has garnered mixed research
being considered at shareholder meetings.
findings.
Approximately 70% of the outstanding shares in publicly
They have potential conflicts of interests that may bias
owned domestic corporations are owned by institutional
their recommendations and are not adequately disclosed.
investors such as mutual funds, index funds, pension funds,
For example, an ISS subsidiary earns fees from public
and hedge funds. Institutional investors’ individual
companies for advising them on corporate governance
portfolios may contain the securities of hundreds of
and compensation policies .
different public companies. As a consequence, for many of
them, understanding the issues associated with multiple
Their research protocols are not transparent and the
public company board member elections and thousands of
research is subject to problematic omissions,
shareholder proposals at corporate shareholder meetings
methodological problems, and analytical flaws. These
can be both complicated and costly. Many medium and
are said to be reinforced by the allegedly non-
smaller-sized institutional investors often lack the necessary
competitive nature of the industry’s essentially
size to cost-effectively conduct such research and outsource
duopolistic structure.
such work to advisory firms. While they tend to conduct in-
https://crsreports.congress.gov
The SEC’s Proxy Advisory Firm Disclosure Reforms
Countering such criticisms, advisory firms and investor
The SEC amended its definition of proxy solicitation
interests—including union-based pension plans, the Council
under Rule 14a-1(l) to include advisory services
of Institutional Investors (CII), the Consumer Federation of
involving proxy voting.
America, and the SEC’s Investor Advisory Committee—
have argued that:
The SEC amended Rule 14a-2(b) to adopt new
conditions that a proxy advisory firm must meet in order
While investors are guided by the advisor’s
to be exempt from the information and filing
recommendations, they make their own voting
requirements otherwise applicable to proxy solicitations,
decisions, and the advisory firms wield little actual
including (1) conflict of interest disclosures advisory
influence over client voting behavior;
firms must provide their clients, (2) procedures to make
advisory voting recommendations available to the target
The firms have established conflict of interest disclosure
firm either at or right before it is given to clients, and (3)
protocols and firewalls separating their proxy advisory
a mechanism through which portfolio firm responses to
work from their other services;
advisory firm voting recommendations are readily
available to their clients before a corporate meeting; and
The firms make an insignificant number of material
errors in their work, and client concerns over
The SEC amended Rule 14a-9 to include examples of
inaccuracies are negligible;
when the failure to disclose certain material information
on key elements involved in formulating proxy voting
Robo-voting merely reflects investors’ needs for
advice could be misleading and violate anti-fraud laws.
informational efficiencies as they navigate the plethora
of proposals that confront them; and
The final rules generally duplicate proposed rules voted out
by the SEC in November 2019—except they do not contain
The ongoing demand for the firm’s services is a
a requirement that advisory firms must give portfolio firms
reflection of generally positive client assessments of the
a chance to preview and respond to their voting
value and the integrity of their work.
recommendations prior to submission to their clients.
Institutional investors were highly critical of that measure.
An array of academic research has lent some credence to
both critical and supportive views.
The U.S. Chamber of Commerce’s response to the final
rules typified reactions from the business community. It
The Regulation of Advisory Firms and
said that the rules would “protect investors, promote
the New SEC Rules
transparency, end conflicts of interest and boost U.S.
Rule 14a-1(l) of the 1934 Act regulates shareholder proxy
competitiveness through oversight of … advisory firms.”
solicitations—a shareholder’s request to authorize another
The CII’s response typified that in the institutional investor
entity to cast his or her vote at shareholder meetings.
community: The rules “could result in delays in distribution
Historically, advisory firms resisted the notion that their
of proxy advice, driving up costs for investors, impairing
actions were subject to the SEC’s broad definition of proxy
the independence of proxy advice and causing uncertainty
solicitation. However, critically, they typically relied upon
for institutional investors…. The SEC has not established a
exemptions from the extensive information and filing
compelling case to tighten [their] regulation.”
requirements conventionally required of those who solicit
proxies. The exemptions derived from SEC determinations
Litigation
that investors did not require the protections provided by
In 2019, ISS filed a complaint before the U.S. District
such information with respect to advisory firm involvement
Court for the District of Columbia (Institutional
in the proxy voting process.
Shareholder Services Inc. v. the Securities and Exchange
Commission and Walter Clayton, III). It alleged that the
In August 2019, the SEC issued interpretive guidance
final SEC rules exceed the agency’s statutory authority
further clarifying its long-standing view that advisory firms
because they unlawfully regulate proxy advice as proxy
are indeed subject to the federal proxy solicitation rules.
solicitation. In October 2020, NAM filed a motion with the
court to intervene in the case on behalf of the SEC.
On July 22, 2020, referencing the aforementioned concerns
Related Legislation
over transparency, overreliance, inaccuracies, and conflicts
In the 116th Congress, H.R. 7617 provides that no funds
of interest, in a 3-1 vote, the SEC adopted controversial
appropriated for the SEC could be used “to implement,
final rules that amend various rules within the 1934 Act that
administer, or enforce” the SEC’s proxy advisory rules. The
require advisory firms to provide expanded disclosures. The
bill passed the House on July 31, 2020. H.R. 5116 would
rules went into effect on September 3, 2020, and are meant
to ensure that advisory firm clients “have reasonable a
require advisory firms to register with the SEC, disclose
nd
conflicts of interest and ethics codes, and make their
timely access to more transparent, accurate and complete
information on which to make voting decisions.”
methodologies publicly available. In the 115th Congress, S.
3614 would have required advisory firms to register with
the SEC as investment advisers, who have fiduciary
Major components of the final rules are:
obligations to their clients. (ISS is registered as an
investment adviser; Glass Lewis is not.) H.R. 4015 would
have required advisory firms to register and to disclose
conflicts of interest, ethics codes, and their methodologies.
https://crsreports.congress.gov
The SEC’s Proxy Advisory Firm Disclosure Reforms
IF11695
Gary Shorter, Specialist in Financial Economics
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https://crsreports.congress.gov | IF11695 · VERSION 2 · NEW