Paul Hodgson: SEC proxy advisor regulations – “unwarranted, unwanted, and unworkable”

Observers say the rules will enable companies to intimidate proxy advisors and blunt shareholder activism with the threat of litigation

No one involved wanted them – neither the firms offering the advice nor the customers paying for it – but the US Securities and Exchange Commission (SEC) has issued new regulations for proxy advisors anyway. The intent behind the rules seems to be to open up avenues for companies to sue proxy advisors if they disagree with their advice.

Approved along party lines, with the Republican commissioners supporting the rules that have been described as a solution in search of a problem, and the Democratic commissioners opposing them, some of the regulations are very different from those initially proposed.

So what is going to be implemented?

The SEC has adopted a ‘principles-based approach’, so that proxy advice is made available to companies at least at the same time as investors instead of days in advance; a so-called ‘soft speed bump’.

Advisors must also provide a mechanism to notify their clients of company feedback. The new rules also codify the current SEC’s view that proxy advice is considered a “solicitation”; in other words, a campaign to get investors to vote a certain way, rather than advising them. As such, the advice is not exempt from the requirements that solicitations are subject to (see Litigation, Litigation, Litigation below). 

It also amended the proxy solicitation antifraud rule so that a failure to disclose the proxy advisor’s “methodology, sources of information, or conflicts of interest” could be defined as “misleading” and subject to litigation.

The first parts of the new rules are, actually, in place at most proxy advisors already; an example would be Glass Lewis’ Research Feedback Statement, which allows companies to post unedited commentary on GL’s proxy advice.

In a public statement, Gary Retelny, CEO of ISS, the largest US proxy advisor, said: “the new rules, coupled with the new guidance for investment advisers, will hinder investors’ ability to vote in a timely, cost-effective, and objective manner.” 

While it has not made a public statement, Glass Lewis also focused on the new guidance for investment advisers in a client release, saying: “the new rules and guidance seem to effectively require investment advisors who vote proxies on behalf of investor clients to consider and evaluate any response from companies to proxy advice before submitting votes. That could cause significant delays in the already constricted proxy voting process.”

“The Commission pissed on our leg and told us it is raining but we all know the difference between rain and piss.” – James McRitchie

SEC Commissioner Allison Herren Lee  was scathing in her condemnation of the rules; her quotation headlines this article. 

Her speech at the SEC open meeting on the issue said that the SEC shouldn’t be wasting its time on this and doesn’t know how the new rules will work nor how much they are going to cost.

Most of the proxy advisors provided detailed estimates of how much time it would have taken to comply with the originally proposed rules. 

But then the SEC switched the rules, saying that the old ones would have cost a lot, but now they won’t. 

John Coates, Harvard Law School professor and member of the SEC’s Investor Advisory Committee, was condemnatory in a Tweet about the lack of costing.

“We are unable to provide quantitative estimates of these direct costs on proxy voting advice businesses because the facts and circumstances are unique to each proxy voting advice business…” he quotes the rule release as saying in a string of tweets. He then goes on to say that the SEC provides the potential costs to businesses, but not for proxy advisors… it’s too difficult, it claims. “Glib and baseless assertions that quantification is not possible, when partial quantification is demonstrably possible, is a marker of bad faith and arbitrary rulemaking,” he said.

James McRitchie, the shareholder activist, was more forthright on social media: “The Commission pissed on our leg and told us it is raining but we all know the difference between rain and piss. The rules do not create more fertile ground. They make it harder for proxy advisors to keep costs low and to concentrate on gathering and reporting the information investors want.”

Statements from shareholder representatives on the rules follow the same line of complaint as Commissioner Lee. 

Amy Borrus, the new executive director of the Council of Institutional Investors, said in a statement: “It also could jeopardize the independence of proxy advice as proxy advisory firms may feel pressure to tilt voting recommendations in favor of management more often, to avoid critical comments from companies that could draw out the voting process and expose the firms to costly threats of litigation.”

Lisa Woll, CEO of US SIF: The Forum for Sustainable and Responsible Investment, said: “Today’s vote is a blow to the independence of research provided by proxy advisors to investors. The proxy advisor rule shifts power to corporate management and away from investors by allowing corporations to inappropriately influence proxy voting advice and intimidate proxy advisors with the threat of litigation.”

Litigation, litigation, litigation.

By opening up liability for materially misleading statements or omissions, these rules simply open up an avenue for litigation for companies to sue over proxy advice. If they find some ‘error’ in the process, alleging that a proxy advisor didn’t announce that it was going to put out further material from the company, for example, because they have reclassified proxy advice as proxy solicitation, it is no longer exempt. 

Failure to disclose enough about methodology or sources of information could also put a proxy advisor on the wrong side of the anti-fraud rule; even if the information is not inaccurate it could still be the basis for an anti-fraud claim. 

As one insider put it to me: “It’s a terrible dynamic to put in this space when advisors are issuing thousands of reports a year and trying to be independent.”

There is, in effect, no purpose for this rule change except to open up this avenue for companies to sue proxy advisors just because they disagree with their proxy advice. In fact, companies can simply threaten a lawsuit in an attempt to intimidate the advisor into changing their advice. Many of the things that companies get upset about – such as peer group construction – are subjective; they are opinions, not facts. Companies can still sue over them, however.

It’s almost as if the Republican commissioners said: we couldn’t regulate in exactly the way we wanted so we are going to make the job of offering proxy advice as difficult as we can make it in whatever way we can…companies have complained enough so we have to give them something. But this is not the way a public servant should approach their job. The complaints have to have some substance, and the number of actual errors, rather than disagreements about opinions, is vanishingly small.

ISS’ lawsuit challenging the SEC’s contention that proxy advice is proxy solicitation is still out there; it was suspended until the final rules were issued. ISS would not comment publicly on this, but it seems unlikely that it will not pursue the case.

And finally, for some reason, the new rules, which have not been issued for public comment, are not going to be implemented until December 2021. 

An awful lot can happen before then…