Texas Hold ‘Em: New Law Requires Proxy Advisors to Show Their Cards if “Nonpecuniary” Factors Guide Voting Recommendations

SB 2337 appears to take aim at the purported “duopoly” of the largest proxy advisors, namely ISS and Glass Lewis, that are perceived to have outsized sway on proxy voting decisions of major institutional investors. Such proxy advisors have, in recent years, been an influential component of corporate issuers developing and disclosing factors that are not always clearly financial in nature (opponents may call them “non-pecuniary,” proponents may call them “pre-pecuniary”), but nonetheless have been driving voting decisions at major investors, which, in turn, have accelerated action at corporate issuers. Matters, such as the setting of climate targets, development of diversity, equity and inclusion (“DEI”) commitments or other topics that have recently become particularly polarizing and to which it can be difficult to ascribe a specific monetary value, appear to be the primary focus of the new law.

While SB 2337 most directly affects the two largest proxy advisors, it also applies to any person providing proxy advisory services to shareholders or persons with authority to vote on behalf of shareholders at a company that is either a Texas entity, a foreign entity seeking to reincorporate in Texas, or that has its principal place of business located in the state. “Proxy advisory services,” as defined under the new law, include any research, analysis or recommendations relating to company and shareholder proposals, any rating or research on corporate governance or any default proxy voting policies and recommendations.

Proxy advisors subject to SB 2337 will be required to make certain disclosures in connection with any proxy advisory services which are “not provided solely in the financial interest of shareholders.” Under the law, problematic advisory services include:

• voting recommendations wholly or partly based on any commitment, initiative, policy, target or subject standards relating to (i) ESG, (ii) DEI, (iii) social credits and sustainability factors or (iv) memberships in or commitments to any organization that bases its assessment of a company’s value, in whole or in part, on nonfinancial factors;
• recommendations not based solely on financial factors which subordinate the financial interests of shareholders to other objectives, including sacrificing investment returns or undertaking additional investment risk to promote nonfinancial factors;
• recommendations on shareholder proposals that are inconsistent with management’s recommendation, unless a “written economic analysis” supporting the firm’s position is included; and
• recommendations to vote against directors, unless the proxy advisor affirmatively states its reason is based on the financial interest of the company’s shareholders.

Under SB 2337, proxy advisors whose advice falls into the categories of nonfinancial proxy advisory services must:

• Disclose to each shareholder (or entity acting on behalf of the shareholder):
  • the proxy advisory service is not made solely in the financial interest of the company’s shareholders due to one or more financial factors; and
  • explain with particularity the reasoning for the proxy advisor’s advice for making such recommendations, and that its advice subordinates the financial interests of the shareholder, including sacrificing investment returns, to promote the nonfinancial factors.
• Provide a copy of the notice to the company about which the recommendations are being made.
• Conspicuously disclose on the homepage of its website that the proxy advisory services include advice and recommendations not based solely on pecuniary factors.

Where proxy advisors provide “materially different” advice to their various clients on company or shareholder proposals or nominees for director of a company, the proxy advisor must give notice about the conflicting recommendations to each shareholder receiving the advice (or entity receiving advice on behalf of the shareholder), along with the Texas attorney general and the company about which the recommendations are being made. Proxy advisors giving conflicting recommendations must also comply with the disclosure requirements for nonfinancial proxy advisory services, to the extent applicable. Additionally, the language of this section suggests that if the advisor makes any recommendation inconsistent with management recommendations, the proxy advisor must provide a specific economic analysis of the financial impact to shareholders.

One prominent proxy advisor, Glass Lewis, sent a letter to the Texas House Committee in response to SB 2337. Glass Lewis noted that the disclosure requirements under the new law would be “costly, disruptive, and could breach a proxy advisor’s duty of confidentiality to its client.” Glass Lewis went on to note that a majority of its clients have custom voting policies, which the law would undermine by effectively forcing proxy advisors to pick a “correct viewpoint,” and is inconsistent with existing guidance from the U.S. Securities and Exchange Commission about the subjective nature of shareholder voting. The letter argues that under the law, the definitions of “proxy advisor” and “proxy advisor service” are overly broad, and could potentially pull in other parties not typically considered proxy advisors. The letter by Glass Lewis also asserts that it is a dubious position to believe that good governance is a non-pecuniary issue, when there are innumerable examples of significant financial impacts resulting from poor governance, such as the lack of environmental or safety processes that have proven to result in significant harms to a business as a result of a major environmental disaster or safety incident. Glass Lewis cites that it would be inconsistent with the views of their clients (highly sophisticated institutional investors that use proxy advisor recommendations as part of a mosaic of information for the investor’s own custom voting policies) to ignore these types of risks, even if they are difficult to quantify in advance.

SB 2337 and other recent Texas laws reflect a desire by the Lone Star State to blaze a new trail for companies looking for lower operational burdens and perhaps reincorporate or move primary operations to Texas. While the new Texas corporate laws may encourage companies to take a look at reincorporation, relisting, or moving to the greener pastures of Texas, companies should be aware that there could also be unintended consequences from the new law. For instance, the new law may chill proxy advisor recommendations for Texas companies and, as a result, impede shareholder engagement or analysis of such companies. Consequently, voting results by proxy advisory clients (i.e., institutional investors) may become more opaque and harder to discern.

Vinson & Elkins is closely watching developments in this area as they may affect companies with a nexus to Texas. Please reach out to your V&E team to discuss the potential effects of these developments on your company.