The U.S. Securities and Exchange Commission (SEC) will be meeting on November 5, 2019, for an open meeting, at which the regulator is expected to vote on a proposal for new rules that could limit the role of proxy advisers and impact investors’ ability to engage with companies on environmental, social and governance (ESG) matters.
The meeting comes several months after the Commission issued a separate proxy voting rule interpretation which established that advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules. With the interpretation, the SEC has taken the stance that proxy advisory firms are, by providing their advice, not simply delivering objective information to a third party but are, in fact, appealing to the client to vote in a certain way. This in turn means the proxy voting firm must meet a set of specific responsibilities in terms of the accuracy, delivery and intention of its recommendations.
Sara Crovitz, a partner at Stradley Ronon who formerly served as Deputy Chief Counsel and Associate Director in Investment Management at the SEC, says retirement plan advisers and wealth managers should be paying close attention to these developments.
“During my time at the SEC, there was certainly some debate and evolution in terms of interpreting what a ‘solicitation’ means in the proxy voting context,” she explains. “Put simply, the core goal of the solicitation rule is to make sure someone isn’t trying to control your shares via proxy voting advice. However, the question about whether someone is giving advice or a solicitation to control your shares is a subtle one.”
By way of background, Crovitz recalls, the SEC created its main proxy voting standards framework back in 2003.
“When the SEC put out its rules in this area, it was actually in large part a response to a specific news event,” Crovitz says. “Your readers may recall the Hewlett Packard-Compact merger. In that case, an asset manager was found to have changed its proxy vote at the last minute, basically because HP said that if they wouldn’t vote to approve the merger, HP would not have its people do business with that asset manager in the future. So, the solicitation rule was definitely created at a time when there was some distrust and a certain tone hanging over this whole discussion about proxy voting.”
In a phrase, the presumption from the perspective of the SEC is that fiduciary advisers with the ability to exercise shareholder rights on behalf of clients should be engaged and should be casting votes. If the adviser is not going to vote, the SEC expects the adviser to have run a cost-benefit analysis demonstrating that it is not in the clients’ best interest to be voting on a particular matter.
“Under the Trump Administration, the SEC now seems to be suggesting that it is okay not to vote in various circumstances,” Crovitz says. “In my view, this is almost a meeting in the middle of the Department of Labor [DOL] and the SEC on this issue. The DOL’s stance is different, in that you have to do a cost-benefit analysis to prove that it is worth voting. The outlooks are really almost opposite, and for that reason it will be very interesting to track this issue as it unfolds across regulators in the coming years.”
George Michael Gerstein, partner and co-chair of the fiduciary governance team at Stradley Ronon, agrees with that characterization. He also says he expects the DOL could issue new guidance on this topic within the next few weeks. This expectation is based on the fact that, back in April, the White House issued an executive order stipulating that the Secretary of Labor should, within 180 days of the date of the order, “complete a review of existing DOL guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.”
“Technically there was no requirement in the order for new guidance to be issued, but we are nonetheless on the lookout,” Gerstein says. “From the perspective of the DOL, the real question is, how granular does the regulator expect any cost-benefit analysis of shareholder engagement activities to be? Republican and Democratic administrations have gone back and forth on this over the years.”
In his view, Gerstein says, the Bush Administration’s guidance in this area was too onerous. It required very careful and detailed analysis proving that shareholder activism would be beneficial to plan participants.
“Many parties thought the DOL’s stance was that a cost-benefit analysis was required on a vote-by-vote basis,” Gerstein says. “Then, under the Obama Administration, the step was taken to ‘clarify’ that it really didn’t have to be on a vote-by-vote basis. Plan fiduciaries could run a general analysis of the costs and benefits of shareholder engagement.”
Moving forward, Gerstein says, the DOL could go in a few different directions.
“I am concerned they could require a far deeper analysis of the calculation of the costs of exercising shareholder rights—going back to something similar to the Bush-era guidance,” Gerstein says. “That would prove particularly problematic in the context of the expanding use of ESG investing, in my view. If the DOL tightens the screws so much, it could potentially spook some fiduciaries into thinking they have to show some immediate benefit to the plan from any shareholder engagement activity they engage in. I think the DOL understands the opposite side of the coin from engagement is divestment, to be frank. So, the executive order’s original goal of energy infrastructure promotion could actually backfire if the DOL is too strict about shareholder engagement under ERISA. You could even see plan fiduciaries choosing to divest from energy companies rather than engage with those companies to help improve their long-term viability.”
*Editor’s note: PLANADVISER Magazine is owned by Institutional Shareholder Services (ISS). ISS has filed a lawsuit seeking to halt the implementation of the new proxy voting rules.