On August 21, 2019, the Securities and Exchange Commission (SEC) issued guidance (Guidance) on the proxy voting and disclosure responsibilities of registered investment advisers under the Investment Advisers Act of 1940, as amended (Advisers Act).¹ The Guidance addresses how a registered adviser’s fiduciary duty and obligations under Rule 206(4)-6² of the Advisers Act relate to proxy voting on behalf of the adviser’s clients, particularly when engaging a proxy advisory firm.

The Guidance addresses the following matters, which are critical to understanding when a registered investment adviser (adviser) meets its fiduciary duties to its clients in connection with proxy voting:

1. Scope of the Adviser-Client Relationship. The Guidance states that, in the context of proxy voting, the specific obligations that flow from an adviser’s fiduciary duty depend upon the scope of the voting authority assumed by the adviser. The Guidance clarifies that an adviser (i) is not required to accept authority to vote client proxies³ and (ii) can tailor the scope of its proxy voting authority and responsibilities on behalf of a client with the informed consent of the client.⁴ The Guidance provides several examples of arrangements pursuant to which an adviser can limit its proxy voting authority for a client and therefore its proxy voting responsibilities to that client.

2. Making Voting Determinations that are in the Client’s Best Interests. According to the Guidance, when an adviser has assumed proxy voting authority on behalf of a client, it must have a reasonable understanding of the client’s objectives and must make voting determinations that are in the best interest of the client. To meet these standards, the adviser should conduct an investigation reasonably designed to ensure that its voting determinations are not based on materially inaccurate or incomplete information. The Guidance suggests that the adviser should also take into account other considerations, including:

• for an adviser to multiple clients, consideration of whether a uniform voting policy would be in each client’s best interests, particularly where client interests may differ due to client investment strategies and objectives;
• consideration of whether certain proxy matters may require more detailed issuer-specific analysis than prescribed by general voting guidelines and, if so, policies reflecting the factors it will consider in determining which proxy matters require such analysis;
• consideration of whether its votes are cast consistently according to its policies and procedures (including reasonable measures to test such activities); and
• for an adviser that retains a proxy advisory firm for voting recommendations or voting execution services, consideration of additional steps to evaluate voting determinations (for consistency with the adviser’s voting policies and procedures and the best interests of clients) before votes are cast.⁵

The Guidance stresses that in all cases an adviser should review and document the adequacy of its proxy voting policies and procedures annually to ensure they are reasonably formulated and effectively implemented.

3. Considerations when Retaining and Evaluating a Proxy Advisory Firm and its Services.⁶ The Guidance reflects the SEC’s belief that when an adviser retains a proxy advisory firm it should evaluate the firm’s capacity and competency to analyze the matters for which the adviser is responsible for voting. This evaluation by the adviser should include an assessment of the adequacy and quality of the proxy advisory firm’s personnel, technology and policies and procedures (including assessing whether the firm’s methodology, disclosures and operations are adequate for the adviser’s purposes). Because this assessment should not be static, the Guidance suggests that an adviser should consider whether the proxy advisory firm appropriately updates its methodologies, guidelines, and voting recommendations on an ongoing basis, including in response to feedback from issuers and their shareholders. And, importantly, the adviser should review the firm’s procedures for identifying, disclosing and addressing the firm’s conflicts of interest.

Following an initial assessment of a proxy advisory firm retained by an adviser, the adviser should perform periodic reviews of the firm. These periodic reviews should seek to identify and evaluate changes in the firm’s conflicts and business that are relevant to the firm’s capacity and competency to, as applicable, provide proxy voting advice and execute upon the adviser’s voting instructions.

4. Addressing Potential Errors and Weaknesses in a Proxy Advisory Firm’s Voting Analysis. The Guidance notes that, when it becomes aware of any potential errors or weaknesses in a firm’s voting analysis, an adviser should conduct a reasonable investigation of them. This coincides with statements in the Guidance that an adviser should have in place policies and procedures reasonably designed to ensure that its voting determinations are not based on materially inaccurate or incomplete information, including those that may be incorporated into a proxy advisory firm’s analysis and process. To this end, the Guidance suggests that an adviser should periodically review the research or voting recommendations made by its proxy advisory firms, assessing whether potential factual errors, potential incompleteness, or potential methodological weaknesses in the firm’s analysis materially affected the recommendations used by the adviser to vote client proxies.

5. Refraining from Voting. The Guidance clarifies that there are two limited circumstances in which an adviser with voting authority may refrain from voting proxies for a client. The first is when the adviser’s voting authority is limited by the client agreement. And, the second is when the adviser has determined that refraining from voting is in the client’s best interest, such as when the costs of voting exceed the expected benefit to the client. The Guidance cautions, however, that this latter determination should involve consideration of whether the adviser is fulfilling its duty to the client in light of the scope of services to which it and the client have agreed.

S&K Observations

Although the SEC has indicated that the Guidance does not create any new obligations for advisers, the matters and considerations set forth in the Guidance will require an adviser to revisit (i) its investment advisory agreements with respect to limiting or tailoring their proxy voting authority and (ii) its approach to considering the use of proxy advisory firms, particularly in the context of making voting determinations, and documenting those decisions. We therefore encourage each registered adviser to review its policies and procedures and its relationships with its proxy advisory firms in light of the Guidance.

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¹ Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Investment Advisers Act Release No. IA-5325; Investment Company Act Release No. IC-33605 (August 21, 2019), available at https://www.sec.gov/rules/interp/2019/ia-5325.pdf. In a companion release, the SEC also issued an interpretation and guidance on the application of proxy rules under the Securities Exchange Act of 1934, as amended, to voting advice provided by proxy advisory firms. See Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice, Exchange Act Release No. 34-86721 (August 21, 2019), available at https://www.sec.gov/rules/interp/2019/34-86721.pdf. This release clarifies that proxy voting advice provided by a proxy advisory firm typically constitutes a “solicitation” under Rule 14a-1 and therefore is subject to the anti-fraud provisions of the federal proxy rules.

² 17 C.F.R. § 206(4)-6. Rule 206(4)-6 requires an investment adviser that assumes proxy voting authority to adopt and implement policies and procedures that are reasonably designed to ensure it votes client securities in the best interest of clients. This typically involves a reasonable investigation into whether its voting determinations are in the best interest of the client.

³ The SEC reaffirmed its belief that an adviser’s responsibility for voting proxies is implied when the adviser has discretionary authority to manage the client’s portfolio and has not agreed to narrow the scope of its voting authority through fair and full disclosure and informed consent. See footnote 30 of the Guidance.

⁴ The SEC reiterated that, while an adviser may shape its voting authority with the client, an adviser that accepts proxy voting authority must exercise its responsibility in accordance with its fiduciary duty and in compliance with Rule 206(4)-6.

⁵ The Guidance provides examples of additional steps an adviser could use to evaluate its utilization of voting recommendations, including: periodic sampling of pre-populated votes, considering additional information regarding particular proposals and conducting a higher degree of analysis to assess whether votes are cast in a client’s best interest. In the context of an adviser’s conflicts of interest in voting proxy, the Guidance notes that while use of a proxy advisory firm’s voting recommendations may mitigate the adviser’s conflict, it does not relieve the adviser of its obligation to make voting determinations in the client’s best interest or its obligation to provide full and fair disclosure of the conflicts and obtain informed client consent.

⁶ The evaluation of a proxy advisory firm and its services by an adviser will depend on the scope of the adviser’s proxy voting authority and the services provided by the firm.