The Proxy Advisor Balance of Power May Be Shifting

This article has been updated.

The SEC’s Rules in a Nutshell
Implications for Executive Compensation
The SEC’s Core Issues
ISS’ Lawsuit Against the SEC

The Clayton SEC prioritized efforts to modernize the proxy voting system, focusing on proxy advisors, investment advisers, shareholder voting, and more. After a number of roundtables, economic analyses, and stakeholder discussions, in late 2019 the SEC introduced interpretive guidance and proposed rules on proxy matters. It followed up last summer by adopting final rules that define proxy advisors such as Institutional Shareholder Services (ISS) and Glass Lewis as proxy solicitors.

The SEC’s final release in 2020 marked the culmination of a decade-long effort to rein in the growing influence of proxy advisors. Then, on June 1, 2021, Chair Gensler hit the pause button. In response to the directive from Gensler, the Division of Corporation Finance issued a statement that they will revisit the prior guidance and, during that review process, will not recommend any enforcement action based on that content.

What will ultimately happen? It seems like this may become a partisan football. The two republican SEC commissioners issued their own response expressing skepticism to the sudden change given a rule-making process they said was “beyond reproach.” If this turns into a game of political one-upmanship, it’s hard to fathom where it will end as administrations come and go.

For now, we’ll unpack the SEC’s 2020 rule on the role and classification of proxy advisors as entities that are engaging in proxy solicitation. We’ll start with a brief introduction to the latest events. After that, we’ll go implications to executive compensation, then get into the details of the SEC’s rule-making and ISS’s decision to litigate the SEC over its final rule. Meanwhile, we’ll continue monitoring to see whether the Gensler SEC does choose to unwind the Clayton SEC’s final 2020 rule and what this could mean.


In August 2019, the SEC issued interpretive guidance clarifying that proxy advisors engage in the act of proxy solicitation and, therefore, are regulated under the proxy solicitation rules in the Securities Exchange Act of 1934 (“Exchange Act”). The SEC also issued interpretive guidance clarifying the extent to which investment advisors should rely on proxy voting advice relative to performing their own independent diligence.

Then—three months later, on November 5—the SEC issued two proposed amendments to the Exchange Act, one of which adjusts and formalizes the interpretive release on proxy advisors engaging in proxy solicitation. By that time, ISS, the largest proxy advisory firm, had already filed a lawsuit against the SEC in response to the August interpretive releases.

In January 2020, the SEC filed an Unopposed Motion to Hold Case in Abeyance, which puts the litigation on ice until the final rules are released. On July 22, 2020, the SEC released its final rules, which incorporated changes to the proposed rules while generally maintaining its stance on the central issues. The transition period to the new rules ends on December 1, 2021, which means we can expect the 2022 proxy season to look very different.

The comments submitted to the SEC during the comment period were unusually contentious. The Clayton SEC made various concessions in an effort to lend a conciliatory ear, but the 3-1 vote occurred along party lines.

With Democrats holding three of the five SEC seats, SEC staff has been directed to reassess the Clayton SEC’s final rule. Their options are to make no changes, unwind the entire rule, or take a middle-of-the-road approach.

As for ISS, the proxy advisor reactivated its lawsuit in August 2020, shortly after the SEC issued its final rule. Although that puts further pressure on the SEC, the SEC staff are not strangers to the courtroom and we can’t imagine this being a major reason to reassess the rules.

We’ll proceed to discuss the 2020 rule as if it does ultimately go into effect with no revision or only light revision by the SEC.

The SEC’s Rules in a Nutshell

Before we get into the details, let’s set the stage with the basics of what will change as a result of the final July 2020 release.

First, proxy advisors are now defined as engaging in proxy solicitation, which pulls them under the Exchange Act. This results in higher liability and expectations for accuracy.

Second, proxy advisors are subject to the information and filing requirements of the federal proxy rules unless they satisfy three exemption criteria:

  1. Any response published by corporations to a proxy advisor report must be shared in some capacity with the investment advisers subscribing to the proxy advisor reporting service.
  1. Corporations must be allowed to review the proxy advisor report.
  1. Proxy advisors must disclose any conflicts of interest.

The most significant of these is the first one because it provides a forced mechanism for proxy advisors to equip their clients with the corporate issuer’s rebuttal.

The third change is that proxy advisors must disclose and explain their methodology and assumptions to avoid triggering the antifraud provision in Exchange Act Rule 14a-9.

Finally, the SEC also published an interpretive release in August 2019 clarifying its expectations for investment advisers, namely that they must form their own perspectives and not robotically follow the recommendations of a proxy voting service they subscribe to.

Let’s now cover our prediction of what may happen in 2022 if the rule goes live.

Implications for Executive Compensation

We believe the executive compensation and proxy voting landscape could change materially under the SEC’s new rules. Here’s what may be in store:

A renewed opportunity for companies to tell their own narrative. The proposed rules create formal and direct feedback loops for companies to dispute statements made by proxy advisors and even include (via hyperlink) their counter-positions to proxy advisor reports. The current paradigm where ISS draws its conclusion with limited room for revision may be replaced by a marketplace of competing perspectives and ideas.

Corporate issuers are under no obligation to rebut the position, logic, or assumptions in a proxy advisor report, but they will soon have a podium they can use to rebut a one-sided story from a proxy advisor. This is a potential game-changer. The economics and logistics of proxy advisor shops force them into what our supply chain friends call “mass customization.” In contrast, an interested corporate issuer can deploy a dedicated team of internal and external experts to build a counter-story.

The SEC’s interpretive guidance from August 2019 encourages investment advisers to give that counter story due consideration. This seems very consequential.

What to do now:

  • Develop recurring analytical processes to harvest metrics of interest. Most compensation teams will run basic total shareholder return (TSR) calculations for the proxy, but not much more. For a company to share a story of its own, it must procure dozens of diverse data points to analyze. This includes mimicking ISS’ own calculations and developing firm-specific metrics that are arguably more meaningful than the generic lineup crunched by ISS.
  • Create a cross-functional team—think representatives from executive compensation, legal, investor relations, and outside consultants—to evaluate how active you should be in telling your own story. For instance, as consultants we can develop numerous models to tell a particular story, but how proactive you should be in telling that story is a much broader decision. (For an example of a very proactive messaging effort, see Abbott’s response to an ISS report from a few years ago.)

Audit and fact-checking. The new rules subject proxy advisors to Rule 14a-9, which prohibits materially misleading misstatements and omissions. The SEC’s rule amends Rule 14a-9 to explain how proxy advisors can avoid triggering a potential violation, such as by disclosing information sources and the methodology they used.

That adds transparency to many proxy advisor reports and should make it easier for companies to audit and fact-check them. Companies will receive report copies either before proxy advisor clients receive them or at the same time. Either way, there’s an opportunity to document errors and inconsistencies in the methodology. Investors will want to understand these errors to avoid being misled.

What to do now:

  • Engage internal resources or an external firm to develop recurring processes that replicate as many ISS calculations as possible, therefore simplifying the reconciliation exercise of tying out ISS reports. We develop these processes, and we know that any organization with data access and experience building financial models can do so as well.

More opportunities for shareholder engagement. As investment advisers take up the challenge to think critically about proxy advisors’ voting recommendations, a window will likely open to enhance the quality and rigor of shareholder dialogue. Lately, many of our clients have been complaining that shareholders rebuff offers to engage. Perhaps this will change.

What to do now:

  • Develop custom investor outreach materials that have a clearly defined purpose instead of just “getting together.” This is an important best practice, with or without changes in the proxy advisor landscape.
  • In your outreach, be explicit about what proxy advisor reports are missing. This is teeing off the interpretive guidance that warns against making investment decisions strictly on proxy advisors’ say-so.

More opportunities for diversity in plan design. For years, criticism has been building over homogenization in long-term incentive (LTI) design and the need for incentive awards to reflect and reinforce the business strategy. It’s been hard to respond to this criticism given the pressure to conform. However, if the power that proxy advisors hold is set to diminish—and the pressure is on to get more customized analyses from investment advisers—then the time couldn’t be better to bring more diversity to LTI awards.

What to do now:

  • Revisit LTI design with an eye to strategy, challenges, and opportunities in retaining and motivating executives, along with limitations in the current program architecture. This could entail different metrics, payout structures, and more.

The rise of new and increasingly subjective proxy advisor grading metrics. 2020 marks the first full year in which ISS’ new economic value added (EVA) measure will be in use. We expect its weighting to increase over time. Proxy advisors will also begin incorporating ESG metrics into their reviews.

Metrics like EVA are substantially more subjective and noisier than ones like TSR. As these new metrics crop up in proxy advisor methodologies (and those methodologies are more clearly disclosed), this paves the way for better fact-checking and negation where those methodologies simply don’t make sense.

What to do now:

  • Begin back-testing and producing your own EVA calculation processes so that if you do need to counter the story ISS tells, you’re ready.
  • Identify other metrics that are released and have subjective dimensions to them. Decide how to replicate them internally and form independent positions as to their veracity and fit.

Now let’s look at the issues the SEC weighed as it developed the proposed rules.

The SEC’s Core Issues

The SEC’s goal in its rule making is to ensure securities holders receive voting guidance that’s accurate, verifiable, and serves their best interest. The proxy advisory industry’s rapid growth has given it unprecedented weight over shareholder vote outcomes, making it more important than ever to reevaluate these entities’ role in the modern shareholder climate.

The new rules are currently in a transition period that will end on December 1, 2021, after which the rules will take effect. We’re expecting the 2022 proxy season to look much different.

Issue 1: Regulation of Proxy Advisors under the Exchange Act

Previously, proxy advisory firms were regulated by the Investment Advisers Act of 1940 (“Advisers Act”), which imposes a standard of fiduciary care. The proxy solicitation rules, which fall under the Exchange Act, set a much higher bar for information quality and accuracy. The proxy solicitation rules under the Exchange Act will materially expand the accountability imposed on proxy advisors for producing accurate information.

The SEC’s view is that the actions proxy advisory firms undertake are, in substance, solicitations that should fall under the purview of the Exchange Act. The Exchange Act defines solicitation as “a communication to security holders under circumstances reasonably calculated to result in the procurement, withholding, or revocation of a proxy.” Proxy advisors may not be engaging in this communication to empower themselves, but they’re certainly impacting proxy outcomes (or so the argument goes).

By adding language to 14a-1(1)(1)(iii) in a new paragraph (A), the SEC is looking to clarify that proxy voting advice falls within the scope of the Exchange Act and constitutes a solicitation. More specifically, the SEC wrote that it intends this new paragraph to state that

the terms ‘solicit’ and ‘solicitation’ include any proxy voting advice that makes a recommendation to a shareholder as to its vote, consent, or authorization on a specific matter for which shareholder approval is solicited, and that is furnished by a person who markets its expertise as a provider of such advice, separately from other forms of investment advice, and sells such advice for a fee.

As the SEC explains, “The purpose of Section 14(a) [of the Exchange Act] is to prevent ‘deceptive or inadequate disclosure’ from being made to shareholders in a proxy solicitation.” From a principles perspective, the SEC is saying it doesn’t care whether the proxy advisor is trying to consolidate power for itself (which is never the case) or simply impact proxy outcomes (which is the case), because both acts constitute solicitations as the Exchange Act defines them.

Issue 2: Exemptions to Information and Filing Requirements

Additionally, any entity or person engaging in a proxy solicitation faces certain information and filing requirements unless they can appeal for an exemption. The Exchange Act has two exemptions that exclude proxy advisors from this purview. Rule 14a-2(b)(1) exempts agents who are not seeking the power to act as a proxy for shareholders (ostensibly, ISS is just trying to sell advice). Meanwhile, Rule 14a-2(b)(3) exempts situations where advice comes from an “advisor.” Without this exemption, proxy advisors’ businesses would become almost impossible to run.

The SEC adopted Rule 14a-2(b)(9)(ii) as an additional condition for satisfying the exemptions. In short, the SEC is willing to allow proxy advisors to remain exempt from the information and filing requirements as long as certain concerns can be ameliorated. These concerns relate to potential conflicts of interest the proxy advisors have, the accuracy and completeness of the advice they give, and the need for recipients of proxy voting advice to receive counter information from the issuer in a timely fashion.

More specifically, Rule 14a-2(b)(9)(ii) requires proxy advisors to adopt and publicly disclose policies to reasonably ensure that:

  • Corporate issuers receive a copy of the proxy voting advice before or at the same time as when the proxy advisor’s clients receive it
  • Proxy advisors give their clients access to any response the corporate issuer may have to the proxy advisor’s initial voting advice, and to do so in a timely manner before an applicable shareholder meeting

This was an instance where the SEC walked back some of the requirements in the proposed rules in arriving at the final rules (which, again, demonstrates how key concessions were already made via a thoughtful commentary process).

One change in the final rule is that corporate issuers do not need to receive an advance copy of the report. In addition, the SEC revised the requirement to provide proxy advisor clients with a copy of a corporate issuer’s rebuttal so that it can be accomplished in a principles-based manner. The principle is to ensure that the clients of proxy advisors have access to the views and responses of corporate issuers with regard to the proxy voting advice. That creates an improved marketplace of information that can help the end investor make better decisions.

However, since the final rules don’t mandate a specific approach, the SEC offered a safe harbor to provide improved legal certainty to the proxy advisors that they are in compliance. The SEC describes two ways proxy advisors may notify their clients:

  • On their electronic client platform where the registrant has filed, or has informed the proxy advisor that it intends to file, additional soliciting materials (with an active hyperlink to those materials on EDGAR)
  • The same but through email or other electronic means

One potential concern is that the SEC’s new rules may motivate proxy advisors to delay releasing their reports, giving corporate issuers less time to rally shareholders to their side. We think this risk is real, but the principles-based nature of the rule makes it tough for proxy advisors to intentionally run down the clock.

In discussing factors relevant to the equation, the SEC wrote that it would consider “the extent to which the mechanism provided to clients is an efficient means by which they can reasonably be expected to become aware of the registrant’s written response, once it is filed, such that the client has sufficient time to consider such response in connection with a vote.” In this regard, the incentive might be offset by the proxy advisor’s desire to avoid any regulator perception that its end client lacked adequate time to review the corporate issuer’s rebuttal.

Issue 3: Materially False or Misleading Statements as per Rule 14a-9

While the SEC would like to give proxy advisors a way to avoid the information and filing requirements, they are not exempt from Rule 14a-9, which provides a liability framework for misleading misstatements and omissions in proxy solicitations. In other words, Rule 14a-9 is the punishment clause for releasing bad information and the exemptions described above do not apply.

To comply with Rule 14a-9, proxy advisors must make a good faith effort toward compliance and remediating noncompliance. The SEC has given examples of the types of information a proxy advisor could disclose to avoid a violation of Rule 14a-9. These include:

  • Explaining the methodology used to form the proxy voting advice
  • Disclosing the sources of information on which the advice is based
  • Disclosing material conflicts of interest that arise in connection with the advice

It remains to be seen how much information is provided as a result of this expanded guidance, but it at least raises the bar for accuracy and transparency.

Issue 4: Obligations of Investment Advisers

The final development that bears mentioning is an interpretive release the SEC published in August 2019 clarifying expectations for investment advisors and the extent to which they rely on proxy advisor firms to inform their voting decisions. The SEC released supplementary guidance in September 2020.

SEC is fundamentally worried about “robo-voting,” which describes the behavior of many institutional investors who automatically follow the voting recommendation of a proxy advisor. The guidance has six Q&A-style points that emphasize the importance of investment advisors customizing their frameworks and not overly relying on the judgment of proxy advisors.

The interpretive guidance is worth reading in its entirety, but the key point is that proxy advisors wield too much monopolistic influence and should be subject to greater controls among the entities that rely on their advice.

ISS’ Lawsuit Against the SEC

In response to the SEC’s interpretive August 2019 guidance, ISS on October 31 filed suit to declare the interpretive guidance unlawful. After the SEC released its proposed rules, ISS put its lawsuit on hold, only to reactivate it in August 2020 shortly after the SEC released its final rules.

We believe many of the concessions the SEC made in the final rules are at least partly to dampen the effect of ISS’ arguments. ISS’ complaint presents three reasons why the SEC’s guidance is illegal:

  1. ISS’ actions do not fall under the Exchange Act and the SEC does not have statutory authority to regulate them as such under Section 14(a) of the Exchange Act. It seems like ISS’ core argument is that they’re not a proxy solicitor, so it’s unlawful to put ISS under the purview of the Exchange Act when the Investment Advisers Act of 1940 is the appropriate governing regulation.
  1. The SEC exceeded their rulemaking authority by bypassing the notice-and-comment procedures of the Administrative Procedure Act.
  1. The rule is arbitrary and capricious. This argument attacks the SEC’s claim that it isn’t changing its position when, according to ISS, the change is non-trivial and there is no evidence that the regulatory framework in the Investment Advisers Act is insufficient.

In our view, the proposed rules from November 2019 short-circuit arguments two and three. The proposed rule is intended to follow the Administrative Procedure Act and has invited extensive commentary. Even more commentary, deliberation, and modification occurred between the proposed and final rule. The SEC also goes to great length to explain the basis for its position and why its position is consistent with historical actions taken to broaden and interpret proxy solicitation in a principles-based fashion.

leaves the first argument: ISS’ actions do not logically meet the definition of proxy solicitation. Here we’re also skeptical of ISS’ ability to prevail because it would require a court to effectively rule that the SEC can’t revise and amend the Exchange Act. In fact, the SEC has decades of precedent doing precisely that in response to evolving circumstances.

In any event, this lawsuit and the SEC’s intent to reassess the 2020 rules are likely to drag on for quite some time. We intend to monitor what happens.


In many respects, the SEC waited, planned, analyzed, and waited some more…before springing into action in late 2019 with a comprehensive series of interpretive releases and proposed rules. Then, it waited, planned, analyzed, and sprang into action again in July 2020 with final rules. This was not a slapdash process.

The Gensler SEC didn’t waste any time before hitting the pause button. While we don’t have a dogmatic position on the legal substance of the issues, we’re concerned that any effort to overturn the 2020 rule will eventually result in partisan reprisal. Too much back-and-forth is bad for markets and investors because it introduces uncertainty. Better to reach a compromise that gives both sides some of what they were after.

What’s most important to corporate issuers? We think it’s the opportunity to seize a louder bullhorn for communicating to investment advisers, paired with the incentive for investment advisers who previously put their voting on autopilot to now listen to a plurality of arguments and perspectives.

In the meantime, we encourage companies to shore up their internal processes to tie out proxy advisor values and, more importantly, to formulate their own narrative. If you would like to discuss how we could help in any of these capacities, please don’t hesitate to reach out.