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From Securities Regulation Daily, July 01, 2014

SEC staff issues bulletin on proxy rule responsibilities, exemptions

By Amy Leisinger, J.D.

The SEC’s Division of Investment Management and Division of Corporation Finance have provided guidance regarding proxy voting activities and applicable statutory and regulatory obligations. Specifically addressed in the staff legal bulletin are the responsibilities of investment advisers in proxy voting and hiring, retaining proxy advisory firms and guidance on the availability of exemptions from the federal proxy rules for proxy advisory firms.

Investment advisers. In order to exercise voting authority with respect to client securities, a registered investment adviser must adopt and implement written policies and procedures reasonably designed to ensure that proxies are voted in accordance with the best interests of clients and the adviser’s own proxy voting procedures. The staff recommends that, to ensure this, an adviser could periodically sample proxy votes to review compliance and should, on an ongoing basis, review its proxy voting policies and procedures to make sure they have been successfully implemented and continue to be effective to meet applicable requirements.

The proxy voting rule does not require advisers and clients to agree that the adviser will undertake all of the proxy voting responsibilities, the staff notes, and the parties may agree to various types of delegation arrangements based on issues such as resource allocation, management recommendations, and particular proposal types. An investment adviser and its client have flexibility in determining the scope of the obligation to exercise proxy voting authority, according to the staff.

In addition, when considering whether to hire or retain any particular proxy advisory firm to provide proxy voting recommendations, the staff believes that an investment adviser should take care to ascertain that the firm has the competency to adequately analyze proxy issues. This includes consideration of the proxy advisory firm’s staff and its ability to ensure that recommendations are based on accurate information and address potential conflicts of interest, the staff states. According to the staff, the adviser must also maintain ongoing oversight of the third party assisting with its proxy voting responsibilities to ensure that proxies continue to be voted in the best interests of its clients; business and operational changes may affect a proxy advisory firm’s competency to provide proxy voting advice or may create conflicts, the staff cautions, and an investment adviser should take measures to ensure that any and all potential issues or errors are addressed.

Proxy rules and exemptions. The staff notes that a proxy advisory firm is subject to the federal proxy rules when it engages in a “solicitation” or “the furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” The provision of recommendations to clients falls under this category, according to the staff, but certain exemptions from the information and filing requirements of the federal proxy rules are available under Rule 14a-2. Specifically, Rule 14a-2(b)(1) provides an exemption from most provisions of the federal proxy rules for solicitation by anyone who does not seek to act as proxy.  Thus, the staff states, to the extent that a proxy advisory firm limits its activities to distributing reports containing recommendations and does not solicit the power to act as proxy, the proxy advisory firm would be able to rely on the exemption under Rule 14a-2(b)(1).

In addition, Rule 14a-2(b)(3) provides an exemption for the furnishing of proxy voting advice when a person or firm: (1) gives financial advice in the ordinary course of business; (2) discloses significant relationships or material interests to the recipient of the advice; (3) receives no special remuneration for furnishing the advice from any person other than the recipient; and (4) refrains from furnishing advice on behalf of any person soliciting proxies. According to the staff, in assessing whether it has a significant relationship with the company or proponent or whether a material interest in the matter involved with the voting recommendation exists, a proxy advisory firm should consider services offered, compensation amounts, and connections between the advice given and the transaction giving rise to the relationship. According to the staff, a relationship would be considered “significant” or an interest would be considered “material” if knowledge of either would reasonably be expected to affect the recipient’s assessment of the advice.

The staff stated that it does not believe that providing this information upon request would satisfy applicable requirements and noted that boilerplate language that stated a significant relationship or material interest exists would not provide adequate notice. Disclosure should enable the recipient to understand the nature and scope of the relationship or interest, including the steps taken to mitigate conflicts and to provide information to allow adequate assessment of the objectivity of a recommendation, according to the staff. Rule 14a-2(b)(3) does not specify where the required disclosure should be provided, but the staff suggests that a proxy advisory firm provide the disclosure in manner that a client may assess both the advice provided together with disclosed relationship, either publicly or privately between the firm and the client.

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