SEC Issues Proxy Guidance

Art by Tim Bower

On August 21, the Securities and Exchange Commission (SEC) issued an interpretive release titled “Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers,” directed at all advisers registered under the Investment Advisers Act of 1940. The SEC focused on three broad categories of Adviser Act compliance as to proxy voting activity: 1) when and to what extent the act applies; 2) the standard of conduct that applies to advisers who engage in proxy voting activities; and 3) the responsibilities of advisers who utilize the services of third-party proxy voting services.

During the advisory relationship, a number of opportunities will arise with regard to voting securities held by an adviser’s clients. The fiduciary requirements under the Adviser Act apply to the extent that the adviser agrees with the client to assume responsibilities for proxy voting. In other words, the adviser need not assume any responsibility for voting proxies, may assume only limited responsibility, or may assume complete responsibility for voting proxies. However, the SEC requires the adviser to obtain from his client “full and fair disclosure and informed consent” in connection with how the advisory relationship is shaped.

In its release, the SEC provides a number of examples showing different degrees to which the adviser vs. the client can handle the voting responsibilities and says the two parties have a great deal of discretion in defining what each one’s role will be.

The release also makes clear that an adviser acts as a fiduciary to the extent that he assumes voting responsibilities. Therefore, he should consider how he will meet his fiduciary duties and obligations under Rule 206(4)-6. This means he must act in the best interest of the client and, to that end, establish appropriate proxy voting policies and procedures.

Notably, the release states, an adviser should consider whether to apply a uniform proxy voting policy to every client, or to tailor the policy to the client or groups of clients. The answer to this question will largely depend on the extent to which he has agreed with each client to provide proxy voting services and whether his clients all have the same investment strategies or objectives.

The SEC also noted that an adviser should consider whether his proxy voting policies and procedures should require that he conduct a more detailed analysis when more complicated or significant events are at issue. Such events include, for example, mergers and acquisitions (M&As), dissolutions, conversions, consolidations and contested board of directors elections, rather than more routine matters, such as a change to an issuer’s auditors, that require a vote.

The policies should identify such complex situations and detail how those versus the routine  matters, will be addressed. The release also says all of the adviser’s proxy voting policies and procedures should be disclosed in his statements of additional information or on Form N-CSR and that he should test whether he complies with the procedures he has established.

Finally, the SEC explains in considerable detail how an adviser should comply with the act when he engages third-party proxy voting firms to help conduct voting activities. Importantly, the release stresses that hiring a third party does not absolve the adviser of compliance with his fiduciary duties and obligations under Rule 206(4)-6.

When an adviser engages a third-party proxy voting service, that service must take steps to assure that the adviser’s voting determinations are consistent with his policies and procedures and with his fiduciary duties. But there may be situations where the adviser should not simply accept the recommendations of the third party such as when he has pertinent additional information that the third party lacks.

According to the SEC, the Adviser Act also requires the adviser to enter into a rigorous due diligence process when hiring a third-party proxy firm. The firm must be adequately qualified to perform the services for which it is engaged. The adviser should review the firm’s policies and procedures, including those intended to address potential conflicts of interest on the part of the firm and to address potential factual errors, potential incompleteness, or potential methodological weakness in the firm’s analysis.

By making even modest changes to policies and procedures, advisers may be able to find, and remedy, shortcomings before the SEC spots them during an examination.

David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers. He served on the DOL’s ERISA Advisory Council from 2012 through 2014.