Government consults about whether to regulate proxy advisers
15 June 2021
In brief
In a move that has been perceived as controversial by some, the Government has consulted with industry stakeholders about whether there should be greater regulation of proxy advisers in Australia. The issues raised by the consultation include how to:
- ensure accuracy of advice provided;
- better regulate proxy advisers, including through licensing; and
- manage conflicts of interest of the proxy adviser.
In this alert, we consider each of the issues that the Government is seeking to address through the consultation paper, how these issues have been dealt with by other global regulators such as the United States, United Kingdom, Europe and Canada and what regulation (if any) is required in Australia.
In detail
Why is the Government consulting about further regulating proxy advisers?
Proxy advisers have the potential to exert significant influence over listed entities. They are often engaged by institutional investors (such as superannuation funds) to provide recommendations about how to vote on proposed resolutions at a company’s annual general meeting.
In Australia, superannuation funds hold significant voting power in listed entities through their investments. The consultation paper notes that as at 31 December 2020, of the $443.7 billion worth of securities listed on the Australian Stock Exchange, 20% were held by superannuation funds with more than 4 members. Therefore, proxy advisers advising institutional investors can influence the decision making of significant shareholders. Further, there are only four major proxy advisers operating in Australia, meaning that the power to advise institutional investors is concentrated in relatively few hands.
Regulators in other jurisdictions have also recently grappled with the issue of whether to better regulate proxy advisers, so it is unsurprising that this issue is also on the Australian Government’s radar.
Ensuring accuracy of proxy advice
Regulators are seeking to ensure that proxy advice is accurate and reliable.
Misleading or deceptive conduct prohibited
Under Australian law, proxy advisers have an obligation to ensure that they do not, in relation to a financial product or financial service, engage in conduct that is misleading or deceptive or likely to mislead or deceive. If a proxy adviser engages in such conduct, a person who suffers loss or damage from the conduct may bring an action against the proxy adviser to recover the amount of loss or damage suffered. Therefore, proxy advisers have an obligation to ensure that they do not circulate misleading or deceptive advice about an issuer entity to their client.
Similarly, in the United States the Securities and Exchange Commission (SEC) recently formalised their longstanding view that proxy advice constitutes a ‘solicitation’ within the meaning of section 14(a) of the Exchange Act of 1934. This means that proxy advice is subject to the Federal proxy rules and that, depending on the circumstances, failure to disclose certain information in proxy voting advice may be considered materially misleading in breach of the antifraud provision of the proxy rules. The ruling by the SEC brings the position at law in the United States in line with the position in Australia, generally prohibiting proxy advice from being misleading.
In practice, it may be difficult for an issuer company to know whether proxy advice contains misleading or deceptive information because it is not mandatory for issuer companies to receive a copy of such advice. Accordingly, regulators in the United States, Canada and Australia have contemplated whether to mandate that an issuer company should be entitled to receive a copy of the proxy advice, and whether they should also have a right of reply.
Access to proxy advice and right of reply
The SEC has introduced rules (which require compliance by 1 December 2021) requiring proxy firms seeking to rely on exemptions from the information and filing requirements of the proxy rules to adopt and publicly disclose their policies to:
make their advice available to issuer companies prior to, or at the time of, dissemination to their clients; and
provide their clients with a mechanism to become aware of any rebuttal by the issuer company.
The SEC initially proposed to mandate a standardised period within which issuer companies would be required to review and provide feedback in response to a proxy adviser report. However, the SEC received feedback that this was too intrusive as it may cause delays in shareholders receiving timely voting advice from proxy advisers and that giving companies access to draft advice ahead of publication may compromise the objectivity of proxy advice as advisers might be swayed to issue more favourable advice. With respect to the proposed right of reply, stakeholders expressed concerns to the SEC about who would bear the costs of making the issuer company’s response available to clients. Ultimately, the SEC decided to adopt a less prescriptive and more principles-based approach, leaving it to the proxy adviser to implement a policy stipulating exactly when and how they will make their advice available to the issuer company, as well as the mechanism by which shareholders can access the issuer company’s response.
In Canada, the Capital Markets Modernisation Taskforce (Taskforce) recently recommended that issuing companies should be given a right of reply to reports prepared by proxy advisers when the recommendation is to vote against management’s recommendation. The Taskforce recommended that the issuer should be given access to the proxy advice at no cost, and that if a company intends to exercise its right of rebuttal then the management information circular should be filed at least 30 days before the applicable meeting. This recommendation is more prescriptive than that adopted by the SEC in the United States and it is not yet known whether this recommendation will be codified by the Canadian Government.
On the other hand, the United Kingdom and European Union merely require proxy advisers to disclose to the public information relating to the preparation of research, advice and voting recommendations (including their methodologies in preparing the advice and the main sources of information). Issuer companies in these jurisdictions do not have an express right to obtain a copy of a proxy adviser’s report or a right of rebuttal.
While it may not have the full force of the law, a framework exists in Australia to enable issuer companies to obtain copies of proxy advice. Firstly, fund managers are required to disclose their use of proxy advisory services to the market. Further, each of the four major proxy adviser firms in Australia have policies in place detailing how they engage with issuer companies to remedy any errors in their reports. In ASIC Report 578: ASIC review of proxy adviser engagement practices, ASIC analysed these engagement policies and found that all four major proxy advisers had policies to make their final advice available to issuer companies for fact-checking after the report had been distributed to their clients. The proxy advisers had varying practices, with one proxy adviser charging a fee for the issuer company to access the final report while another was open to provide draft advice to issuing companies for fact checking prior to dissemination of the final report to clients (time permitting).
If the Government seeks to mandate that proxy advisers must furnish issuer companies with their reports, it will have to balance complex considerations, such as:
whether a copy of the proxy advice should be made available to the issuer company for free;
whether it will require proxy advisers to provide draft advice;
whether it will require issuer companies to respond within a defined timeframe; and
whether this will impact their objectivity.
Regarding the issue of whether issuer companies should be given a right of reply, the Government will need to consider who will be responsible for circulating the company’s response and who bears the cost of making the rebuttal available to clients of proxy advisers. In the United States, the SEC did not make a call on any of these complex issues and left it to the proxy adviser to decide their engagement policies. The practical effect of the developments in the United States is that proxy advisers may each adopt their own engagement policies and are required to disclose their engagement policies to the market. In substance, we consider this to be similar to the current position in Australia. Although not mandated by law, each of the four major proxy advisers has adopted and made publicly available their policies for engaging with issuer companies and correcting errors in their reports.
Regulating proxy advisers through licensing
In Australia, a proxy adviser only requires an Australian Financial Services Licence (AFSL) where the voting advice relates to dealings in financial products. This includes, for example, advice about whether to vote in favour of a share buy-back resolution or whether to accept a takeover bid where the consideration offered is a financial product such as shares. An AFSL holder is subject to general obligations under s912A of the Corporations Act 2001 (Cth) (Corporations Act) including (amongst other things):
the obligation to do all things necessary to ensure that financial services covered by the licence are provided efficiently, honestly and fairly;
have in place adequate arrangements for management of conflicts of interest; and
compliance with the licence conditions.
For voting advice which does not relate to financial products (such as, for example, voting advice relating to director elections and remuneration reports), a proxy adviser is not presently required to be licensed. If the AFSL regime was extended to such advice, then the general obligations noted above would extend to advice that does not relate to financial products.
The four major proxy advisers in Australia already hold an AFSL to carry on a financial services business to provide general financial product advice only for interests in managed investment schemes (excluding investor directed portfolio services) and securities to wholesale clients. The practical effect of extending the AFSL regime to advice not relating to financial products is that:
those proxy advisers already holding an AFSL would need to apply to ASIC to vary their existing licence to cater for a broader range of services including proxy voting advice that does not relate to financial products; and
those proxy advisers who do not hold an AFSL would need to apply for one with ASIC.
The effect of such a change is that the cost of compliance will increase for proxy advisers (including the cost of obtaining legal advice as well as ASIC lodgment fees).
There is presently no requirement for proxy advisers to be registered to provide their services in the United States. Two Bills have been introduced in the U.S. Senate in the last 5 years to require the registration of proxy advisers with the SEC, and the progress of both Bills has stalled. If a licensing requirement is introduced for proxy advisers in Australia, this would be the first of its kind as compared to the United States, Canada, the United Kingdom and Europe.
We query whether the AFSL regime should be extended or is in fact an appropriate regime through which proxy advice should be regulated. The question remains whether extended coverage under the AFSL regime would have any positive impact on the standard of proxy advice particularly when the four major proxy advisers already hold an AFSL for financial product related advice (and therefore are already subject to the general obligations of a licensee in this regard) and given that advice which does not relate to financial products is already regulated by the misleading and deceptive conduct prohibition as outlined above.
Managing conflicts of interest
The Government also consulted about whether proxy advisers should be meaningfully independent from a superannuation fund. This is to ensure that advice is being provided on an arm’s length basis. The rationale behind this proposal is that where a proxy adviser or its affiliate also holds a significant ownership interest in the issuing entity in respect of which it is providing proxy voting advice, the independence of the advice may be compromised. This is arguably one of the most controversial proposals, because mandating that proxy advisers be meaningfully independent from their clients could affect the structure of existing proxy adviser businesses in Australia where the proxy adviser is comprised of entities that are also institutional owners.
Other jurisdictions have dealt with the issue of independence by requiring proxy adviser firms to identify and disclose any actual or potential conflicts of interest to their clients and to have a policy on how the conflict will be eliminated, mitigated or managed. Such an approach has been adopted by the SEC in the United States, as well as the European Union and the United Kingdom. This approach allows proxy adviser businesses to apply judgement in determining the materiality of conflicts that might pose a risk to the independence of its advice. In Canada, the Taskforce recommended that the Government implement a framework to address conflicts of interest where proxy adviser firms provide consulting services to issuers in respect of which they also provide voting recommendations to their clients. However, the Taskforce did not provide recommendations about the contents of that framework.
We consider that a similar approach to the United States, United Kingdom and European Union should be adopted in Australia. Proxy advisers should not be precluded from giving advice merely because of any relationship they may have with the issuer company. However, advisers should be required to identify any relationships and provide details of steps taken to address any such material conflicts. This approach will allow proxy advisers to exercise their business judgment in dealing with conflicts of interest.
Let's talk
As noted in this alert, each of the four major proxy advisers in Australia already have policies in place that deal with how they engage with issuer companies. Further, they each hold an AFSL and, to the extent that they are providing advice that does not relate to financial products, must ensure that such advice is not misleading or deceptive or likely to mislead or deceive in accordance with the Corporations Act. Accordingly, we consider that proxy advisers are robustly regulated in Australia and that at this stage no further regulation is required.
The Government’s consultation closed on 1 June 2021. We will provide regular updates regarding this matter as further developments unfold. If you are an institutional investor, proxy adviser or company, and you would like to discuss the matters that the Government is consulting about, please contact us.