This month, the House Financial Services Committee hosted two hearings investigating the role and influence that proxy advisors play in investors’ decision making. Members questioned witnesses about the lack of transparency in the proxy advisory process and arrived at bipartisan agreement that a duopoly exists in the industry. The hearings were welcome after a recent about-face by the U.S. Securities and Exchange Commission (SEC) to rein in the power of proxy advisors, organizations for hire that offer voting recommendations to investor clients about a variety of issues that appear on company proxy statements.
After nearly a decade of debate, the SEC in July 2020 voted to adopt long-awaited amendments to its rules governing shareholder proxy solicitations. At the time, those rules were designed to ensure that clients of proxy voting advisory businesses would have reasonable and timely access to more transparent, accurate, and complete information on which to make voting decisions. The amendments would have facilitated the ability of those who use proxy voting advice, primarily institutional investors managing millions of individual’s assets, to make informed voting decisions without imposing costs and delays that could adversely affect the timely provision of proxy voting advice.
The rules granted companies the right to respond directly to the recommendations made by the proxy advisers, pointing out any errors and omissions that might have existed between shareholder interests and the guidance provided by proxy advisors. The 2020 rules would have also ensured a mechanism by which investors would be informed of a company’s concerns about a proxy firm’s recommendations. But the current SEC voted to revoke them in 2021. This meant that the only way companies could raise disputes about proxy firm guidance was through a supplemental filing, imposing additional time and cost burdens on companies to dissect and refute faulty reasoning from proxy advisory firms.
At the same time, environmental, social, and governance (“ESG”) shareholder proposals continue to take center stage at company annual meetings, with an increasing number of shareholders compelled to vote on a variety of controversial issues that may not always be material to company business. A recent change made by SEC staff governing whether companies have to include certain proposals on their corporate proxies encouraged greater inclusion of ESG-related resolutions on a company ballot. Data shows that the trend is here to stay — an analysis published by the Harvard Law School Forum for Corporate Governance found that 90 percent of companies are already including some information about a variety of ESG topics on their proxy statements. The SEC’s final Climate Rule, forthcoming in the months ahead, is certain to amplify the number and nature of these shareholder proposals that proxy firms will need to address and handle, and to which companies will be compelled to respond.
Today, the rules requiring companies to submit supplemental filings to address inaccuracies in proxy recommendations remain problematic. Unless the SEC guidance reverts to the approach taken in the 2020 rules, supplemental filings and related compliance burdens that are already overwhelming will continue to grow in their numbers and scope, sapping the resources of both companies and the SEC along the way. While supplemental filings play a pivotal role in maintaining transparency and investor confidence, it is equally important to evaluate the materiality of shareholder requests, the information which is provided, and the ability to address and resolve questions quickly. Current SEC rules make that a difficult task.
The process can and must be fixed. Doing so requires confronting and accepting what’s broken. Without the 2020 proxy advisor rule in place, responding to questionable shareholder resolutions requires time-consuming and expensive supplemental filings with the SEC. In fact, in 2018, 2020 and 2021, the American Council for Capital Formation produced reports that reviewed companies’ supplemental filings with the SEC in response to proxy firm recommendations. The reports identified discrepancies between companies and proxy advisors from 2016 to 2021 proxy seasons. The analysis identified between 27 and 50+ annual instances where proxy advisors had formulated recommendations based on errors or analysis disputed by the companies themselves. With the SEC now considering additional changes to the recently updated shareholder proposal rule, those could potentially make the processes even more complicated, as it becomes easier to resubmit failed shareholder proposals year after year.
Therefore, it is crucial to establish a balance between investor needs, regulations, and the operational capabilities and challenges faced by companies. Current SEC rules lead to a circumvention of policymaking much better made by elected representatives. Accordingly, it is imperative that consideration also be given to the potentially adverse impacts that the current SEC rules could have on capital formation and the ability of U.S. companies to compete in the global capital markets.
The SEC should consider suggestions focused on the need for direct communication, reducing compliance burdens, enhancing the clarity and interpretation of resolutions, mitigating risks, and promoting timely and coordinated reporting. These improvements will better achieve a proxy management and reporting regime that is effective, efficient, and supportive of the growth of publicly held companies. Doing so will avoid adverse impacts on capital formation and investment, while safeguarding the interests of all stakeholders currently impacted by today’s cumbersome supplemental filings framework.
Kyle Isakower is the Senior Vice President of Regulatory & Energy Policy for the American Council for Capital Formation.