The Director of the Securities Exchange Commission (“SEC”) Division of Investment Management (the “Director”) gave remarks this month regarding registered investment advisers (“RIAs”) and their proxy voting responsibilities in which he suggested, among other things, that RIAs revisit their proxy voting arrangements.1 There has also been a recent focus on proxy voting by the SEC and the current administration. As a result, RIAs may wish to re-assess their current proxy voting policies, procedures and practices.
Rule 206(4)-6 (the “Proxy Voting Rule”) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”) addresses an RIA’s fiduciary duties to its clients when the adviser has authority to vote client proxies. The Proxy Voting Rule requires an RIA to adopt and implement written policies and procedures reasonably designed to ensure that the adviser votes client securities in the best interest of its clients. The procedures must include how the RIA addresses material conflicts that may arise between the interests of the RIA and its clients.2 Additionally, an RIA must describe its proxy voting policies and procedures to clients (and upon request, furnish a copy to a requesting client) and disclose how clients may obtain information on how the RIA voted their proxies.
In his remarks, the Director brought up two important questions relating to proxy voting that RIAs should consider as they re-assess their proxy voting practices: first, must I vote client proxies and second, if so, how must I vote.
Question 1: Must I Vote Client Proxies?
The Director indicated that while the widespread view among RIAs is that an adviser must vote client proxies, he acknowledged that there are RIAs with certain mandates (i.e., quantitative and systematic managers that seek exposure to identified sources of alpha and index fund managers with passive strategies) where it may make sense not to vote. The Director further stated that RIAs who “determine proxy voting is not required by, or may even be inconsistent with, their investment program should not be afraid to take that position” while also recognizing that the determination must be consistent with client agreements, effectively disclosed to clients and satisfy the RIA’s fiduciary duties. The SEC has expressed this sentiment since the adoption of the Proxy Voting Rule in 2003, when it stated that it did “not suggest that an adviser that fails to vote every proxy would necessarily violate its fiduciary obligations.”3 The SEC acknowledged that there “may even be times when refraining from voting a proxy is in the client’s best interest.”4
Therefore, an RIA evaluating its proxy voting policies, procedures and practices should consider whether voting a proxy, or not voting a proxy, is in its clients’ best interest. In conducting this assessment, the adviser should be mindful of its obligations to clients concerning the voting of proxies, including the language included in its advisory contracts, client disclosures and the investment policies and objectives of its clients.
Question 2: How Must I Vote?
Many RIAs currently rely on proxy advisory firms to assist with the proxy voting process and satisfy their requirements under the Proxy Voting Rule. In his remarks, the Director indicated that while there is nothing inherently wrong with an RIA using a proxy advisor and recognized that they can provide valuable research, analysis and logistical support, he also cautioned that proxy voting should not be a “rote box-checking exercise” and was critical of the use of proxy advisory firms, particularly of their being viewed in the industry as a “de facto regulatory safe harbor.” He also directed RIAs with underlying investment mandates that seek passive exposure to think critically on whether their votes reflect the RIA’s or proxy advisor’s personal view or opinion on a social or political matter.
The Director also expressed his view that artificial intelligence (“AI”) can be a valuable tool to assist RIAs with proxy voting but cautioned that oversight and review by the RIA is still critical and advisers that use AI in proxy voting “would also need to take into consideration principles of transparency, auditability, and consistency with fiduciary duties.”
Regardless of whether an RIA uses a proxy advisor, AI or its own employees to determine how to vote its client securities, the RIA does not relinquish its fiduciary obligations to its clients.5 The SEC has stated that when an RIA has assumed authority to vote on behalf of a client, the RIA must have a reasonable understanding of the client’s objectives and make voting determinations that are in the best interest of its clients. To accomplish this, the SEC has stated that an RIA should conduct a reasonable investigation into an investment to avoid basing investment advice on incomplete or inaccurate information and make full and fair disclosures to clients about all material facts relating to the advisory relationship.6 In his remarks, the Director questioned whether an RIA is meeting its fiduciary duties if it routinely follows a proxy advisor’s recommendations without independent analysis or a tailored engagement. He also questioned situations when an RIA’s voting record for non-routine matters is “nearly identical” to a proxy advisor’s standard voting policies and procedures.
Given the Director’s recent remarks, RIAs should assess whether the methods they currently use for proxy voting are subject to policies and procedures that are reasonably designed to ensure that they are voting in their clients’ best interests. For example, an RIA that uses a proxy advisor should consider whether any changes to its use or oversight of the proxy advisor are necessary, particularly when the RIA’s voting record on non-routine matters does not vary (or does not often vary) from the proxy advisor’s standard voting policies and procedures. An RIA that is considering using, or already using, AI should make a similar assessment and discern how it will use and review its use of AI for voting its clients’ securities.
While RIAs should review their proxy voting practices each year in their annual review process, we encourage all RIAs to assess their proxy voting arrangements and policies and procedures in light of the recent focus on this area. This analysis should take into consideration the clients an RIA manages and their underlying investment mandates and strategies, keeping in mind the fiduciary duties owed to clients. In conducting this analysis, RIAs should also assess their use of third-party providers, if applicable. The Director’s comments may provide comfort to RIAs who have determined not to vote proxies considering their mandates and strategies or that wish to use technological advancements in proxy voting, such as AI tools. On the other hand, these remarks may lead RIAs that currently utilize proxy advisory firms to reconsider their current policies and procedures and arrangements with those firms.
If you have any questions regarding proxy voting or would like assistance in conducting a review of your proxy voting policies, procedures and practices, please contact an attorney in the Investment Management Group at Seward & Kissel LLP.