The SEC’s Proxy Advisory Firm Disclosure Reforms
Updated January 25, 2023
The SEC’s Proxy Advisory Firm Disclosure Reforms
The boards of directors of public companies provide
such work to advisory firms. While they tend to conduct in-
strategic planning and oversight. The boards, in turn
house research, some larger investors such as BlackRock
respond to the views of shareholders and may vote on
also supplement their research through the use of advisory
proposed corporate changes if the proposals gain a majority
firms.
of affirmative shareholder votes at annual and special
shareholder meetings. Proposals may include issues
The advisory business is dominated by two firms, Glass
involving prospective mergers, executive compensation,
Lewis and Institutional Shareholder Services (ISS), jointly
environmental policy, corporate diversity, political
estimated to have about 97% of the advisory market share.
contributions, and executive management. Due to the large
In 2004, two SEC no-action letters indicated that
number and diverse array of issues in such proposals, proxy
institutional investment managers could show that their
advisory firms have emerged to provide proposal voting
proxies voted in the best interest of their clients through the
recommendations to institutional investors, who are large
use of voting policies formulated by independent third
shareholders in most public companies.
parties, such as proxy advisory firms. The development is
widely credited with helping to “institutionalize” demand
In July 2020, the Securities and Exchange Commission
for the advisory firms’ services.
(SEC) adopted controversial amendments to its proxy rules
implemented pursuant to the Securities Exchange Act of
Views on the Advisory Firms
1934 (1934 Act; P.L. 73-291) that require proxy advisory
Through the years, various academics and business
firms to disclose more information about themselves,
interests—including the U.S. Chamber of Commerce, the
including potential conflicts of interests. In July 2022, the
American Council for Capital Formation, the Society for
SEC reversed key parts of the 2020 rulemaking.
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
debate that has garnered mixed research findings.
being considered at shareholder meetings.
They have potential conflicts of interests that may bias
Approximately 70% of the outstanding shares in publicly
their recommendations and are not adequately disclosed.
owned domestic corporations are owned by institutional
For example, an ISS subsidiary earns fees from public
investors such as mutual funds, index funds, pension funds,
companies for advising them on corporate governance
and hedge funds. Institutional investors’ individual
and compensation policies.
portfolios may contain the securities of hundreds of
different public companies. As a consequence, for many of
Their research protocols are not transparent, and the
them, understanding the issues associated with multiple
research may be subject to problematic omissions and
public company board member elections and thousands of
methods and analytical flaws. These are said to be
shareholder proposals at corporate shareholder meetings
reinforced by the allegedly non-competitive nature of
can be both complicated and costly. Many medium and
the industry’s essentially duopolistic structure.
smaller-sized institutional investors often lack the necessary
size to cost-effectively conduct such research and outsource
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The SEC’s Proxy Advisory Firm Disclosure Reforms
Countering such criticisms, advisory firms and investor
The SEC amended Rule 14a-2(b) to adopt new
interests—including union-based pension plans, the Council
conditions that a proxy advisory firm must meet in order
of Institutional Investors (CII), the Consumer Federation of
to be exempt from the information and filing
America, and the SEC’s Investor Advisory Committee—
requirements otherwise applicable to proxy solicitations,
have argued the following:
including (1) conflict of interest disclosures advisory
firms must provide their clients, (2) procedures to make
While investors are guided by the advisor’s
advisory voting recommendations available to the target
recommendations, they make their own voting
firm either at or right before it is given to clients, and (3)
decisions, and the advisory firms wield little actual
a mechanism through which portfolio firm responses to
influence over client voting behavior.
advisory firm voting recommendations are readily
available to their clients before a corporate meeting; and
The firms have established conflict of interest disclosure
protocols and firewalls separating their proxy advisory
The SEC amended Rule 14a-9 to include examples of
work from their other services.
when the failure to disclose certain material information
on key elements involved in formulating proxy voting
The firms make an insignificant number of material
advice could be misleading and violate anti-fraud laws.
errors in their work, and client concerns over
inaccuracies are negligible.
The final rules generally duplicate the rules as proposed by
the SEC in November 2019—except they do not contain a
Robo-voting merely reflects investors’ needs for
requirement that advisory firms must give portfolio firms a
informational efficiencies as they navigate the plethora
chance to preview and respond to their voting
of proposals that confront them.
recommendations prior to submission to their clients.
Institutional investors were highly critical of that measure.
The ongoing demand for the firm’s services is a
reflection of generally positive client assessments of the
The U.S. Chamber of Commerce’s response to the final
value and the integrity of their work.
rules typified reactions from the business community. It
said that the rules would “protect investors, promote
An array of academic research has lent some credence to
transparency, end conflicts of interest and boost U.S.
both critical and supportive views.
competitiveness through oversight of … advisory firms.”
The CII’s response typified that in the institutional investor
The Regulation of Advisory Firms and
community: The rules “could result in delays in distribution
the 2020 Rules
of proxy advice, driving up costs for investors, impairing
Rule 14a-1(l) of the 1934 Act regulates shareholder proxy
the independence of proxy advice and causing uncertainty
solicitations—a shareholder’s request to authorize another
for institutional investors…. The SEC has not established a
entity to cast his or her vote at shareholder meetings.
compelling case to tighten [their] regulation.”
Historically, advisory firms resisted the notion that their
actions were subject to the SEC’s broad definition of proxy
The 2022 Rule Reversal
solicitation. However, critically, they typically relied upon
In June 2021, the newly established SEC chair, Gary
exemptions from the extensive information and filing
Gensler, said that the SEC would review and reconsider the
requirements conventionally required of those who solicit
2020 rule amendments, which were to take effect in
proxies. The exemptions derived from SEC determinations
December 2021. That same month, the SEC’s Division of
that investors did not require the protections provided by
Corporate Finance stated that it would not recommend
such information with respect to advisory firm involvement
enforcement of the 2020 proxy advisory firm rules while
in the proxy voting process.
they were under agency reconsideration.
In November 2021, the SEC commissioners proposed new
In August 2019, the SEC issued interpretive guidance
rules that reversed key parts of the 2020 rules. The rules
further clarifying its long-standing view that advisory firms
were finalized in July 2022 and took effect in September
are indeed subject to the federal proxy solicitation rules.
2022. In doing so, the SEC noted that advisory firm clients
had complained that under the 2020 rules, their compliance
On July 22, 2020, referencing the aforementioned concerns
costs had risen and “the independence and timeliness” of
over transparency, overreliance, inaccuracies, and conflicts
the advice on proxy voting had been undermined.
of interest, the SEC adopted controversial final rules that
amend various rules within the 1934 Act that require
Under the 2022 rules, proxy voting advice would still be
advisory firms to provide expanded disclosures. The rules
considered a “solicitation” under the proxy rules, and
went into effect on September 3, 2020, and are meant to
advisory firms would still have to disclose conflicts of
ensure that advisory firm clients “have reasonable and
interest. However, the new rules rescinded the 2020 rules
timely access to more transparent, accurate and complete
requiring proxy advisory firms to (1) make their advice
information on which to make voting decisions.” Major
available in advance to the subject companies, (2) make any
components of the final rules were as follows:
subject company response available to their clients; and (3)
provide examples of situations in which the failure to
The SEC amended its definition of proxy solicitation
disclose certain information in proxy voting advice might
under Rule 14a-1(l) to include advisory services
be misleading.
involving proxy voting.
Gary Shorter, Specialist in Financial Economics
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The SEC’s Proxy Advisory Firm Disclosure Reforms
IF11695
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