US regulator draws internal criticism for pressure over proxy firm influence

The Securities and Exchange Commission has drawn criticism
from within its own ranks after pushing investment managers to question and
probe the influence proxy voting firms on have on their decisions.

The guidance, voted through on a 3-2 pass on August 21,
examines the relationship between investment managers and proxy advisory firms
and how one takes influence from the other. It suggests investment managers
take a much deeper look into how these advisers are run and why they might be
making such recommendations.

A recently appointed commissioner has called out the US
financial regulator’s decision to publish guidance on managers’ fiduciary
responsibility to their clients, with a specific focus on their acceptance of
recommendations made by proxy firms.

The action follows several conflicts between the SEC and
large US proxy voting firms.

A survey of the 2018 voting season, which was carried out by
Nasdaq and
the US Chamber of Commerce’s Center for Capital Market Competitiveness,
outlined numerous issues with proxy advice firms. These included “rampant
conflicts of interest”, a “one-size-fits-all approach to voting
recommendations” and a “lack of willingness to constructively engage with
issuers, particularly small and midsize issuers that are disproportionately
impacted by proxy advisory firms”.

The report also cited a “lack of transparency throughout the
research and development of voting recommendations” along with “frequent and
significant errors in analysis and an unwillingness to address errors”.

However, rather than direct the proxy firms themselves to
make changes, the SEC outlined how investment managers should take their
directions.

It highlighted that a manager did not have to accept the
authority to vote on its client’s behalf, but if it was to do so, it was
responsible to carry out due diligence checks on the proxy voting firm that was
making recommendations.

These checks would include assessing several of the elements
raised by the aforementioned report by Nasdaq.

However, Commissioner Allison Herren Lee, who voted against
publishing the guidance, aired her grievances with the move immediately after
vote was announced.

“There can be no doubt that investment advisers have and
retain important fiduciary duties with respect to proxy voting,” Herren Lee
said. “Today’s proxy voting release, however, creates significant risks to the
free and full exercise of shareholder voting rights.”

The commissioner was appointed to the SEC in July after a
multi-decade-long career in securities law.

“First, it introduces increased costs and time pressure into
an already byzantine and highly compressed process,” she said. “Second, it
calls for more issuer involvement in the process despite widespread agreement
among institutional investors and investment advisers that greater involvement
would undermine the reliability and independence of voting recommendations.”

Herren Lee added that although the SEC guidance was not
legally binding, the examples it outlined would be seen as something managers
“should” do and “a regulated entity ignores such direction at its peril”.

“Today’s release will have the practical effect of
enshrining these examples in the policies and procedures of many, if not most,
investment advisers and thereby increase costs for both investment advisers and
proxy advisory firms,” she concluded.

She added that “significantly” the guidance had been issues
without justifying the choices made to the “affected parties and the public,
and without weighing the costs and benefits of the chosen course”.

Herren Lee outlined numerous unintended consequences of this
quasi-legislation and warned of these knock-on effects to the investment
sector.

“We don’t have investment advisers clamouring for advice or certainty on how to meet their fiduciary duties, and we don’t have those who use them—institutional investors—complaining that investment advisers are breaching those duties,” she said.

“So, what exactly are we fixing by calling for increased issuer input and injecting costs into the process? These are the questions we should be asking and answering before we act.”