SEC Clarifies RIAs’ Proxy Voting Responsibilities

On August 21, 2019, the SEC provided guidance to Registered Investment Advisers (“RIAs”) dealing with how they are able to fulfill their proxy voting responsibilities. The SEC’s guidance makes it clear that RIAs are permitted to establish a variety of different proxy voting arrangements with clients. The SEC’s release also discusses factors that firms should consider when engaging the services of a proxy advisory firm.

SEC examiners routinely scrutinize RIAs’ compliance with their fiduciary duty when voting proxies for their clients. Their examinations include reviews of risk areas pertaining to:

• Conflicts of interest;
• Proxy voting policies and procedures; and
• Oversight of proxy advisory firms.

An RIA’s breach of its fiduciary duty and the Proxy Voting Rule is likely to create serious compliance problems for an advisory firm.

Responsibilities under the Proxy Voting Rule

The Proxy Voting Rule is found in Rule 206(4)-6 under the Investment Advisers Act of 1940. The rule mandates that an RIA with discretion may not vote proxies for a client unless they first adopt and implement written policies and procedures. Those policies and procedures must be reasonably designed to ensure that proxies are voted in the client’s best interest. Although the Proxy Voting Rule does not require RIAs to vote proxies for clients, firms must fulfill a number of requirements once they agree to do so. RIAs’ policies and procedures, disclosure brochures, and advisory contracts should clearly articulate whether they will vote proxies for their clients.

The SEC’s guidance gives RIAs and their clients flexibility regarding proxy voting. The parties are permitted to define the scope of the RIA’s proxy voting obligations. Clients and RIAs may set parameters on the types of matters for which the firm will exercise voting authority. For example, advisers and clients may agree that the firm will not exercise voting authority where this action will impose costs on the client. The SEC pointed out that clients might incur opportunity costs resulting from the restricted use of securities for lending purposes in order to preserve the right to vote.

The SEC also cited an example where RIAs and clients agree to vote on a specific proposal in a different way to further an investment strategy being pursued by the adviser on behalf of the client. Another possibility is that clients and RIAs may agree that the firm will dedicate voting resources to particular types of proposals in accordance with the client’s preferences, such as ones involving mergers.

In this release, the SEC encourages RIAs to consider how their fiduciary obligations under Rule 206(4)-6 apply when the firm has multiple clients. Many RIAs provide service to multiple clients, including funds, other pooled investment vehicles, and individual investors, all of which may have different investment objectives and strategies. Therefore, an RIA should consider whether voting all of its clients’ shares in accordance with a uniform voting policy meets the fiduciary standard. Firms should consider whether they should have separate voting policies for some or all of those different clients.

Where RIAs and clients have previously agreed that the firm’s proxy voting authority is limited under certain circumstances, an adviser may refrain from voting if doing so is in the best interest of the client. Pursuant to that agreement, an RIA might not exercise voting authority if the cost is too high and the benefit to the client is too low. Voting may not be necessary where casting a vote would not reasonably be expected to have a material impact on the value of the client’s investment.

Even though RIAs and clients may shape the firm’s proxy voting authority through full and fair disclosure and informed consent, the SEC reiterated that advisers’ actions must be consistent with their fiduciary duty and compliant with Rule 206(4)-6.

Proxy voting advice provided by proxy advisory firms

Many RIAs elect to hire a proxy advisory firm to assist them with proxy voting for clients. When they rely on proxy advisory firms for research or voting recommendations, RIAs must take reasonable steps to ensure that their use of that advice is consistent with their fiduciary obligations.

For RIAs that retain proxy advisors, the SEC’s guidance discusses approaches RIAs can use to assess compliance such as:

• Periodically sampling the pre-populated votes provided by the proxy advisory firm;
• Implementing policies and procedures to ensure that additional information is considered when it becomes available, such as supplemental proxy materials; and
• Considering whether a more sophisticated analysis is necessary for a controversial proposal or matters that are not addressed by the RIA’s proxy voting policies and procedures.

When deciding whether to engage or retain a proxy advisory firm, an RIA should evaluate whether that entity has the capacity and competency to conduct a thorough analysis of proxy voting issues. Advisers should evaluate the quality and adequacy of the proxy advisory firm’s personnel and technology. RIAs should make certain that the proxy advisory firm’s recommendations are based upon data that is materially accurate. In addition, RIAs should consider requiring the proxy advisory firm to update them regarding relevant business changes that will impact the quality of voting recommendations.

RIAs should have policies and procedures in place to ensure that they are conducting effective oversight of their proxy advisory firm. Firms should consider conducting reviews to determine if there are potential factual errors, incompleteness, or methodological weaknesses in the proxy advisory firm’s analysis. RIAs must then ascertain what steps the proxy advisory firm is taking to correct the deficiencies in its analysis.

Conclusion

At least once per year, RIAs should review and document that they have evaluated their proxy voting policies and procedures. Policies and procedures for voting proxies should be designed to help mitigate any conflicts of interest, so clients are less likely to be harmed.

Rule 204-2 requires RIAs to maintain certain records relating to proxy voting. RIAs that exercise voting authority with respect to a client’s securities are required to make and retain copies of all policies and procedures related to proxy voting. RIAs should also retain a copy of any document that was material in deciding how to vote proxies on a client’s behalf or that articulates the rationale for their decision. In addition, RIAs should retain any written request from clients requesting that votes be cast in a particular manner or asking for information about how proxies were voted. RIAs must retain copies of their written responses, even if the client’s request was not in writing. If RIAs decide to hire a proxy advisory firm, they should retain books and records to substantiate that they conducted due diligence.

The SEC’s guidance is available at: https://www.sec.gov/news/press-release/2019-158. In addition to its guidance for RIAs, the SEC issued an interpretation that proxy advisory firms’ advice generally constitutes a “solicitation” under the federal proxy rules. The SEC also explained how the proxy antifraud rule applies to proxy voting advice¹.

¹ https://www.sec.gov/rules/interp/2019/34-86721.pdf

This article is not a solicitation of any investment product or service to any person or entity. The content contained in this article is for informational use only and is not intended to be and is not a substitute for professional financial, tax or legal advice.

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