See below for a discussion of HR 4015, the “Corporate Governance and Reform and Transparency Act of 2017.” The bill. which originated in the US House Financial Services Committee, was approved by the US House of Representatives in December 2017 and sent to the US Senate. The US Senate Committee on Banking, Housing, and Urban Affairs held a hearing on the bill in June 2018.
The goal of H.R. 4015 is to improve transparency in the proxy system and enhance shareholder access to investment information by requiring proxy advisory firms to register with the SEC, disclose potential conflicts of interest and codes of ethics, and make publicly available their methodologies for formulating proxy recommendations and analyses.
Each year, public companies hold shareholder meetings at which the company’s shareholders vote for the company’s directors and on other significant corporate actions that require shareholder approval. As part of this annual process, the SEC requires public companies to provide their shareholders with a proxy statement before shareholder meetings. A proxy statement includes all important facts about the matters to be voted on at a shareholder meeting, including, for example, information on board of director candidates, director compensation, executive compensation, related party transactions, securities ownership by certain beneficial owners and management, and eligible shareholder proposals. The information contained in the statement must be filed with the SEC before soliciting a shareholder vote on the election of directors and the approval of other corporate actions.
Solicitations, whether by management or shareholders, must disclose all important facts about the issues on which shareholders are asked to vote. In general, state corporate law governs shareholder voting rights, including the types of corporate actions that require shareholder approval. However, Section 14 of the Securities Exchange Act of 1934 (Exchange Act) authorizes the SEC to promulgate rules governing the solicitation of proxies for most public companies. SEC Regulation 14A governs proxy solicitations and sets forth the categories of information that must be disclosed in proxy solicitations. Regulation 14A also provides for shareholder access to certain information in connection with proxy solicitations, sets forth when a company must include a shareholder’s proposal in its proxy statement, and prohibits the making of materially false and misleading statements or omissions in connection with a proxy solicitation.
Institutional investors, including investment advisers to mutual funds and pension funds, typically hold shares in a large number of public companies. Each year, the investment advisers to these funds vote billions of shares on behalf of their clients, on thousands of proxy ballot items. In 2003, the SEC adopted a rule under the Investment Advisers Act of 1940 requiring an investment adviser that exercises voting authority over its clients’ proxies to adopt policies and procedures designed to ensure that the investment adviser votes those proxies in the best interests of its clients. The SEC’s release adopting the rule clarified that “an adviser could demonstrate that the vote was not a product of a conflict of interest if it voted client securities, in accordance with a pre-determined policy, based upon the recommendations of an independent third party.” As a result, institutional investors increased their reliance on proxy advisory firms to help them decide how to vote their shares. In 2004, the SEC staff issued, without a Commission vote, two no-action letters, which SEC Commissioner Daniel M. Gallagher described in a 2013 speech as “effectively blessing the practice of investment advisers simply voting the recommendations provided by a proxy adviser.”
Largely as a result of the SEC’s regulations, proxy advisory firms now wield outsized influence in the U.S. proxy system. Studies have shown that the two largest proxy advisory firms–Institutional Shareholder Services (ISS) and Glass Lewis & Co.–collectively make up approximately 97% of the proxy advisory industry and can control a significant percentage of shareholder votes in corporate elections, sometimes as high as 40%. This outsized influence raises important public policy concerns.
In particular, regulators, market participants, and academic observers have highlighted potential conflicts of interest inherent in the business models and activities of proxy advisory firms. For example, as indicated above, proxy advisory firms may feel pressured by their largest clients– many of whom are activist investors–to issue vote recommendations that reflect those clients’ specific agendas.
In addition, proxy advisory firms often provide voting recommendations to investment advisers on matters for which they also provide consulting services to public companies. According to a Mercatus Center study, “these consulting services are designed precisely to facilitate managers’ obtaining favorable recommendations.” Some proxy advisory firms also rate or score public companies on its governance structure, policies, and practices, which provides another avenue for proxy advisory firms to influence corporate governance practices.
Given the major role proxy advisory firms play in the U.S. proxy system through their ability to influence corporate governance standards–by supplying voting recommendations and other services despite the risk conflicts of interest, such as those described above–proxy advisory firms have become the subject of greater scrutiny. The Committee is aware of numerous instances whereby the two largest proxy advisory firms have issued vote recommendations to public company shareholders that include errors, misstatements of fact, and incomplete analysis.
Some proxy advisory firms’ recommendations have been made without any contact to the public company, and these same proxy advisory firms encourage companies to join their service in order to have the privilege to “influence” an advisory firm’s recommendations.
Regulators, market participants, and academics have argued that rather than using shareholder votes to maximize shareholder value, proxy advisory firms have instead aligned themselves with single-issue, narrow-issue shareholders, activist shareholders or unions to push social and political initiatives unrelated–and in many cases antithetical–to increasing shareholder returns. In turn, corporate governance decisions occur that are not in the best interest of shareholders and the company. Critics of proxy advisory firms attribute this hijacking of the proxy system to proxy advisory firms generally having no financial interest in a public company’s performance and owing no duty to shareholders.
In response to these concerns, on June 30, 2014, the SEC’s Division of Corporate Finance and the Division of Investment Management jointly issued a staff legal bulletin entitled “Proxy Voting: Proxy Voting Responsibilities of Investment Advisers and Availability of Exemptions from the Proxy Rules for Proxy Advisory Firms.” (“Bulletin”) The Bulletin clarifies that an investment adviser and its clients “have flexibility in determining the scope of the investment adviser’s obligation to exercise proxy voting authority” and that SEC rules do not require investment advisers to vote every proxy. The Bulletin also states that, in considering whether to obtain the assistance of a proxy advisory firm, an investment adviser should ascertain the proxy advisory firm’s “capacity and competency to adequately analyze proxy issues” and “identify and address any conflicts of interest.” The Bulletin adds that, in order to comply with SEC rules, investment advisers should adopt policies and procedures “reasonably designed to provide sufficient ongoing oversight of . . . third party [proxy advisers]” in order to ensure that proxies are voted in the best interest of the investment adviser’s clients. Finally, the Bulletin describes the exemptions available to proxy advisory firms from the filing and disclosure requirements of the SEC’s proxy rules, and clarifies that, in order to rely on these exemptions, proxy advisers must make certain disclosures regarding significant relationships and material interests, including material conflicts that may arise from consulting services or client relationships.
The Corporate Governance Reform and Transparency Act of 2017 addresses these issues in a manner that provides greater accountability and transparency in regards to the proxy advisory industry, thereby helping to ensure that the voting recommendations that proxy advisory firms provide are in fact in the interests of long-term shareholders. By requiring proxy advisory firms to disclose any potential conflicts of interest that may impact their voting recommendations, the amount of impartial information provided to investors actually will be increased, as investors for the first time can be certain that they understand the biases that may be affecting the partiality of the information they are reviewing.
Section-by-Section Analysis of the Legislation
Section 1. Short title
This Section cites H.R. 4015 as the “Corporate Governance Reform and Transparency Act of 2017.”
Section 2. Definitions
This section amends Section 3(a) of the Exchange Act by defining the term “proxy advisory firm” to mean any person registered under section 15H who is engaged in the business of providing proxy voting research, analysis, or recommendations to clients, which constitutes a solicitation; by defining “person associated with” to mean any partner, officer, employee, director or controller or under control of a proxy advisory firm.
Section 3: Registration of proxy advisory firms
This section amends the Exchange Act by inserting Section 15H. This new section states that a proxy advisory firm must file an application for registration with the Commission and disclose any potential conflicts of interest and code of ethics. Specifically, when applying for registration the proxy advisory firm must include the following information: a certification that the firm has the financial and managerial resources to provide proxy advice; the procedures and methodologies that the firm uses in developing proxy voting recommendations; the organizational structure of the firm; whether or not the firm has a code of ethics; any potential or actual conflict of interest; policies and procedures to manage conflicts of interest; and any other information that the Commission deems necessary. The Commission is directed to issue final rules regarding the form in which such information must be filed with the Commission. The Commission also is directed to issue final rules to prohibit or require the management and disclosure of any conflicts of interests related to the offering of proxy advisory services by a registered proxy advisory firm. This section further sets forth that the Commission shall issue final rules to prohibit any act that they believe is unfair, coercive, or abusive relating to the offering of proxy advisory services, as well as make publicly available all information that was provided to them by the proxy advisory firms.
Section 4: Commission annual report
This section requires that the Commission publicly release an annual report that describes the methodologies that they used for formulating proxy recommendations and analyses.
Mr. Woessner’s bio appears here.