SEC’s Proposed Proxy Process Amendments Would Give ISS a Taste of Its Own Medicine
V&E SEC Update, November 13, 2019
On November 5, 2019, a divided Commission voted on two proposed rule amendments: Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice (the “Proxy Advisory Proposed Rules”) and Procedural Requirements and Resubmission Thresholds under Exchange Act Rule 14a-8 (the “Rule 14a-8 Proposed Rules”). If adopted, the rule amendments proposed by these two releases could have a meaningful impact on the current proxy process by (i) establishing significant regulatory hurdles that proxy advisory firms will have to comply with before they issue voting recommendations, and (ii) changing the ownership threshold for shareholder proponents to submit proposals and altering their ability to use representatives and resubmit failed proposals.
I. The Proxy Advisory Proposed Rules.
If adopted, the rule amendments included in the Proxy Advisory Proposed Rules seek to address concerns regarding the lack of oversight of proxy advisory firms that have been raised by companies and governance practitioners for years. Specifically, the proposed amendments would:
- Codify proxy advisory firms’ business model into the concept of what constitutes “solicitation” under the federal proxy rules. Under long standing law, it is illegal for anyone to solicit votes with respect to publicly-held securities without complying with the SEC’s rules and regulations regarding proxy solicitation. The federal securities laws do not contain a bright-line definition of “solicitation” and the SEC’s interpretation of the concept has traditionally been quite broad. Engaging in proxy solicitation triggers certain information and filing requirements under the federal proxy rules, absent the application of an exemption. In August 2019, the SEC issued the Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice, which clarified, and arguably expanded, the degree to which the Commission views proxy advisory firms’ advice to be “solicitation” under the federal securities laws. Under the proposed rules, the SEC is seeking to codify that interpretation into the definition of solicitation contained in Rule 14a-1 of the Exchange Act. Specifically, the proposed amendments would revise Rule 14a-1 to include in the definition of “solicit” and “solicitation” any proxy voting advice that makes a recommendation to a shareholder as to its vote, consent, or authorization on a specific matter for which shareholder approval is solicited, and that is furnished by a person who markets its expertise as a provider of such advice, separately from other forms of investment advice, and sells such advice for a fee. This inclusion of this definition in Rule 14a-1 would, for the first time, result in the regulation of the voting advice routinely issued by ISS and Glass Lewis.
What does it mean? By amending Rule 14a-1 to include the proxy advisory firms’ traditional business model, the SEC is establishing a firm footing on which to (1) curb the ability of proxy advisory firms to issue voting recommendations with little to no Commission oversight, and (2) require proxy advisory firms to provide certain information and comply with certain restrictions in issuing their voting recommendations.
- Qualify proxy advisory firms’ ability to rely on exemptions to the detailed filing and information requirements that are triggered by engaging in “solicitation.” As mentioned above, engaging in “solicitation” triggers information and filing requirements under the federal proxy rules, absent the application of an exemption. Traditionally, ISS and Glass Lewis and their counterparts have been able to rely on two exemptions from these requirements, even though many of their communications were arguably included in the SEC’s definition of solicitation. The first of these two is contained in Rule 14a-2(b)(1) of the Exchange Act, which exempts persons not seeking proxy authority from the information and filing requirements, and the second is contained in Rule 14a-2(b)(3) of the Exchange Act, which exempts proxy voting advice to shareholders from certain advisors with whom the shareholders have a business relationship. While these exemptions are subject to certain limitations and conditions, collectively they have provided proxy advisory firms with a long-standing safe harbor from complying with the detailed (and expensive) information and filing requirements applied to substantially all other solicitations.
Now the SEC is proposing that in order for ISS, Glass Lewis and their counterparts to continue relying on these exemptions, two prerequisites must be met:
- Meaningful disclosure regarding their conflicts of interest. The proposed amendments would revise Rules 14a-2(b)(1) and (b)(3) to specify that these exemptions are only available to proxy advisory firms if they provide specified disclosures regarding material conflicts of interest in issuing their proxy voting advice. Boilerplate language indicating that certain relationships or interests may or may not exist would be insufficient, and a discussion of the policies and procedures, if any, used to identify and steps taken to address such potential and actual conflicts of interest would be required.
What does it mean? Much has been written about proxy advisory firms’ ability to profit from their advice on how to improve scores and voting recommendations when they also are the source of those scores and voting recommendations—the word “blackmail” has come up more than once at corporate governance conferences. Proxy advisory firms have traditionally had wide latitude to engage in transactions that, at a minimum, give rise to the appearance of conflicts of interest, without having to provide any meaningful, specific disclosures regarding those conflicts or potential conflicts. The SEC’s proposed rule changes would require proxy advisory firms to be significantly more transparent regarding potential conflicts, or risk losing their exemption.
- A meaningful opportunity for companies to review proxy voting advice. The proposed amendments would revise Rule 14a-2(b) of the Exchange Act to require a standardized opportunity for timely review and feedback by companies (and, as discussed in more detail below, other soliciting persons, including some activists) of proxy voting advice before the advice is disseminated. Specifically, the new rules would require, as conditions to the exemptions in Rules 14a-2(b)(1) and (b)(3), that proxy advisory firms provide companies and soliciting persons with:
What does it mean? As governance professionals, we often see ISS and Glass Lewis reports, and it is not unusual for those reports to contain errors. But in the past, if companies have been provided any opportunity to review reports before they are disseminated, the review period has frequently been 24 hours or less. Under the proposed rules, companies would have a meaningful period of time to review and comment on those reports, as well as the opportunity to provide an explanation for any matters cast in a negative light by the proxy advisory firm.
- No fewer than five business days (if the company files its definitive proxy statement at least 45 calendar days before the date of its shareholder meeting), or no fewer than three business days (if the company files its definitive proxy statement less than 45 but at least 25 calendar days before the date of its shareholder meeting) to review any proxy advisory advice and provide feedback. In the event a company files its definitive proxy statement less than 25 calendar days before its shareholder meeting, the proxy voting firm would have no obligation to provide a review and feedback period as a condition of the exemption.
- A final notice of their voting advice two business days prior to dissemination.
- The opportunity to include in the proxy voting advice a hyperlink or similar medium directing the recipient of the advice to a written statement prepared by the company (or other soliciting person) that sets forth its views on the advice.
- Require proxy advisory firms to disclose when they are using “secret sauce.” Even solicitations that are exempt from the federal proxy rules’ information and filing requirements are subject to the prohibition against false and misleading statements contained in Rule 14a-9 of the Exchange Act. While the advice of proxy advisory firms has historically been subject to this prohibition, the proposed amendments would add real teeth by including as examples of what may be “misleading” under Rule 14a-9 the failure to disclose the proxy voting firm’s methodology, sources of information and conflicts of interest, and the failure to disclose the use of standards or requirements that materially differ from the relevant standards or requirements set by the SEC or the exchanges.
What does it mean? ISS and Glass Lewis both have publicly available voting policies. However, if you have ever become frustrated trying to understand how they have arrived at a particular score or voting recommendation given those policies, you are not alone. The SEC’s proposed rules would, for example, require ISS to clarify that it applies its own definition of “independence” when making recommendations regarding director elections, and could require ISS to be more transparent with respect to its infamously complex equity compensation plan evaluation methodology.
In late October, ISS filed a lawsuit against the SEC for the guidance the Commission issued in August making many of the points underlying the proposed rule changes discussed above. ISS’s complaint alleges that the SEC’s August guidance would chill proxy advisory firms’ protected speech. We will be watching this suit closely.
The Proxy Advisory Proposed Rules Could be a Gamechanger for Proxy Fights
In addition to the potential impact on proxy advisory firms’ ability to make recommendations in “peace time,” the Proxy Advisory Proposed Rules could change the balance of power during proxy fights. Specifically, if adopted as is, the Proxy Advisory Proposed Rules could result in:
- Longer proxy fights. If the new rules regarding providing companies (and activists) with meaningful opportunities to review recommendations in advance are adopted, the amount of time proxy advisory firms need to engage with companies and activists before issuing final recommendations could nearly double.
- Greater litigation risk for proxy advisory firms. The new rules could provide companies and activists with greater opportunity and stronger bases on which to sue proxy advisory firms if a company or activist believes a proxy advisory firm provided a harmful and faulty recommendation.
- Increased costs for proxy advisory firms. In both peace time and war time, the new rules will likely increase costs for proxy advisory firms as they stretch to meet administrative and reporting requirements. It is possible that there could be consolidation of proxy advisors if smaller firms are unable to manage the material additional costs.
- A more formulaic approach to proxy advisory firms’ recommendations. Proxy advisory firms may start relying more on established formulas, rather than considering companies’ unique circumstances, in an attempt to avoid additional costs and litigation risks.
- Earlier settlements during the initial period of unpredictability following adoption. Until it is clear how proxy advisory firms will adjust to the new regulation, final rules could result in earlier settlements between companies and activists as they seek to avoid the uncertainty.
The comment period for the Proxy Advisory Proposed Rules will expire 60 days after they are published in the Federal Register.
II. The Rule 14a-8 Proposed Rules.
The Rule 14a-8 Proposed Rules would provide a long-awaited recalibration of certain requirements in Rule 14a-8 of the Exchange Act. As a reminder, Rule 14a-8 provides shareholders with the opportunity to have a proposal included alongside management’s proposals in the company’s proxy materials. The rule is old, and aspects of it are long overdue for updating. The proposed amendments would make the following changes:
- Update the ownership threshold for submitting proposals. The current ownership thresholder under Rule 14a-8 ($2,000 or 1% of the company’s securities entitled to vote) was last reviewed and updated in 1998. Particularly given that the 1% standard is rarely utilized, the effective ownership threshold is quite low. Under the proposed amendments, the ownership threshold would be revised to require continuous ownership of (i) $2,000 of the company’s securities entitled to vote on the proposal for at least three years, (ii) $15,000 of the company’s securities entitled to vote on the proposal for at least two years, or (iii) $25,000 of the company’s securities entitled to vote on the proposal for at least one year.
- Effectively limit “proposals by proxy” by:
- Requiring certain information from shareholders using representatives to submit proposals. In 2017, the Division of Corporation Finance issued Staff Legal Bulletin 14I (“SLB 14I”) addressing some of the challenges and concerns raised by “proposal by proxy,” the term used to describe a shareholder’s use of a representative to submit a proposal on the shareholder’s behalf. Perhaps in part because SLB 14I is only Staff guidance, and therefore does not actually alter or amend Rule 14a-8, it has had limited impact in practice as many proponents continue to submit proposals on behalf of their client-shareholders without clear documentation regarding their authority to do so. In contrast, the proposed amendments would formerly amend Rule 14a-8 to require shareholders who use a representative to submit a proposal to provide enumerated documentation attesting that the shareholder supports the proposal and authorizes the representative to submit the specific proposal on the shareholder’s behalf.
- Amending the “only one proposal per shareholder” requirement to actually mean only one proposal. Current Rule 14a-8(c) provides that “each shareholder may submit only one proposal to a company for a particular shareholders’ meeting.” In practice, however, it has not been unusual for shareholder proponents to submit one proposal in their own name and simultaneously serve as a representative to submit different proposals on behalf of other shareholders. This practice has been the modus operandi of activist investor John Chevedden—one of a small group of investors responsible for the majority of Rule 14a-8 proposals submitted to companies each year. The proposed amendments would prohibit a person from relying on the securities holdings of another person for the purpose of meeting the eligibility requirements and submitting multiple proposals for a particular shareholders’ meeting.
- Require shareholder proponents to disclose their willingness to engage with the company. The proposed amendments would require shareholder proponents to make a statement regarding their availability to meet with the company in person or via teleconference no less than 10 calendar days, nor more than 30 calendar days, after submission of the shareholder proposal.
- Increase the resubmission thresholds. Under Rule 14a-8(i)(12) of the Exchange Act, a company is not required to include a proposal in its proxy statement if substantially the same proposal was submitted to shareholders recently and it failed to receive a specific level of support. The proposed amendments would replace the current resubmission thresholds as follows:
|Current Rule ||Proposed Rule|| |
| Less than 3%|| Less than 5%||If proposed once within the preceding 5 calendar years|
| Less than 6%|| Less than 15%||If proposed twice within the preceding 5 calendar years|
| Less than 10% || Less than 25%||If proposed three or more times within the preceding 5 calendar years|
In addition, a new provision would allow companies to exclude proposals that have been submitted three or more times in the preceding five years if they received more than 25%, but less than 50%, of the vote and support declined by more than 10% from the last time substantially the same subject matter was submitted for a vote. The Commission notes in its proposing release that it would expect that under the proposed 15%/25% thresholds, there would be 14%/27% more proposals excludable under Rule 14a-8(i)(12).
The comment period for the Rule 14a-8 Proposed Rules will expire 60 days after they are published in the Federal Register.
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