RIA Compliance Blog
In what is turning out to be a busy summer at the SEC for issuing new rules and interpretations applicable to RIAs, the Commission has just released detailed guidance clarifying the proxy voting obligations of SEC-registered advisers. This latest release comes on the heels of the agency’s landmark package of releases issued on June 5th, which, for RIAs, included rules implementing the new Form CRS (a/k/a Form ADV, Part 3) and a major interpretive release clarifying the fiduciary duty owed to clients by all advisers. This latest release aims to clarify an adviser’s obligations arising under Advisers Act Rule 206(4)-6 (“the Proxy Rule”) relating to voting proxies for clients, specifically in the context of using the services of a “proxy advisory firm.”
The Proxy Rule provides that it is a “fraudulent, deceptive, or manipulative act” for an SEC-registered adviser to “exercise voting authority with respect to client securities” unless the adviser adopts and implements written policies and procedures designed to ensure that such voting is done in the “best interest of clients.” The Proxy Rule also requires certain disclosures be made to clients regarding any voting done for them. Notably, the Proxy Rule does not require advisers to vote client securities. Indeed, many advisers choose to escape the coverage of the Proxy Rule by simply not—in any instance—voting client securities. However, for advisers exercising any voting authority over client securities—even one share—the Proxy Rule swings into effect. Accordingly, all such advisers opting to vote client securities will need to be in full compliance with the Proxy Rule—and should pay close attention to the SEC’s new guidance on this matter.
The SEC’s new proxy guidance comes in Q&A format—six queries with detailed answers—which the SEC describes as “examples” and “not the only way” by which advisers can comply with the Proxy Rule and their fiduciary duty arising from the Advisers Act. That said, the SEC nonetheless cautions advisers to be sure to “review their policies and practices in light of the guidance below in advance of next year’s proxy season.”
Specifically, the SEC’s guidance can be summarized as follows (corresponding to the Q&A #s):
- Scope of the Adviser’s Proxy Voting Obligations. Again, as a threshold matter, advisers are under no mandate to accept proxy voting responsibilities. However, to the extent that the adviser does in fact accept voting obligations, it must be done in accordance with the adviser’s fiduciary duty. In turn, that fiduciary duty—while un-waivable—does allow the adviser-client relationship to be “shaped” subject to “full and fair disclosure and informed consent.” Accordingly, the SEC offered up “several non-exhaustive examples of possible voting arrangements,” including arrangements to: (i) vote along with corporate management’s direction; (ii) vote along with the direction of a particular shareholder bloc; (iii) not vote where the costs are excessive or large relative to client benefits; (iv) only vote on certain transactional matters (such as M&A activity); or (v) not vote where the vote would fail to have a “material effect on the value of the client’s investment.”
- Steps the Adviser Can Take to Demonstrate that it is Acting in Client’s Best Interest. The SEC reminds advisers of their fiduciary duty and corresponding need to “conduct a reasonable investigation into matters on which the adviser votes.” Part and parcel of this is considering the differing obligations that the adviser may have as to voting the same security for different clients or different types of clients (such as mutual funds, pooled investment vehicles, and individual investors). Moreover, even to the extent that an adviser utilizes a proxy advisory firm for assistance, it should still “consider additional steps” to ensure that the proxy advisory firm’s recommendations are “consistent with” its own voting policies and in that client’s best interest. The SEC then goes on to list a number of these “additional steps,” which basically amounts to double-checking and/or augmenting the proxy advisory firm’s analysis.
- Considerations for Advisers Retaining a Proxy Advisory Firm. For advisers using these firms’ services, such firms’ “capacity and competency” to deliver appropriate analysis as well as the “adequacy and quality” of their personnel and technology should be considered carefully. The SEC’s discussion reveals a belief that advisers need to vet proxy advisory firms thoroughly. Indeed, this vetting should apparently include investigation into the very basis for the proxy advisory firm’s voting recommendations; specifically, their proprietary methodologies as well as the external information sources utilized. Additionally, advisers should thoroughly review the proxy advisory firm’s policies and procedures for identifying and addressing their own material conflicts of interest (such as the proxy firm’s relationships with issuers being analyzed).
- Dealing with Errors, Incompleteness, or Weaknesses in the Proxy Advisory Firm’s Analysis. Again, here the SEC stresses the need for advisers to be able to form a reasonable belief that voting decisions are in a client’s best interest. In order to do this, the SEC suggests that advisers promptly conduct a reasonable investigation into any errors or other irregularities as they arise. This will by nature require effective communication and transparency with the proxy advisory firm and, in turn, the proxy advisory firm’s relationship with issuers.
- Evaluating Material Changes in Services or Operations of a Proxy Advisory Firm. The SEC implores advisers to have policies and procedures that will enable it to keep apprised of material changes at the proxy advisory firm, especially vis-à-vis conflicts of interest. The SEC encourages advisers to develop means of requiring the proxy advisory firm to update the adviser on all material changes.
- Need to Vote Every Proxy. The SEC poses the question of whether an adviser is “required to exercise every opportunity to vote” proxies for its clients, answering it in the negative. The SEC’s answer, however, is conditioned on (i) the adviser and client having explicitly agreed to limit voting, or (ii) the adviser refraining from voting where it has determined that such action is in the best interest of the client (see #1 above).
Our take on this new guidance is that while it technically may not change existing law, it adds a significant level of interpretation onto the Proxy Rule, which advisers will now need to take heed of and comply with. While the SEC may, on the one hand, refer to this guidance as “examples” and “not the only way” by which advisers can comply, rest assured that OCIE examiners will be conducting future audits with an eye towards the new guidance as a set of “best practices” at a minimum. Advisers failing to follow the “examples” set out in the guidance should be prepared to explain to OCIE why and how their policies and procedures are just as effective as the “examples” provided in the guidance. Indeed, small advisory firms that do currently vote client proxies may wish to revisit that practice entirely in the wake of the new guidance, as the benefits accruing to the adviser may be significantly outweighed by the new compliance obligations brought on.
The SEC’s new guidance is effective upon formal publication in the Federal Register—meaning that the new guidance is now in effect.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.