Former SEC Chair Pitt Says Two No-Action Letters Block SEC Review of Outsourcing Voting to Proxy Advisory Firms

In remarks at a Chamber of Commerce seminar on the role of proxy advisory firms, former SEC Chair Harvey Pitt said that, while the outsourcing of shareholder voting authority to proxy advisory firms is a breach of an existing fiduciary obligation, the chances of  SEC enforcement actions in this area are slim to none. This is because of two SEC no-action letters issued in 2004, Egan-Jones Proxy Services and Institutional Shareholder Services, which effectively encouraged  the outsourcing of voting authority to proxy advisory firms.

According to Mr. Pitt, when the SEC adopted Rule 206(4)-6 under the Investment Advisers Act, the hope was that institutional money managers would articulate a voting policy and then later people could see how well they lived up to that policy. But, in his view, the Egan-Jones Proxy Services no-action letter suggests that investment managers fearful of a conflict could adopt a policy saying that to avoid all conflicts they will obtain the views of a proxy advisory firm and vote in accordance with those views. The no-action letter says that if you do that you have then eliminated conflicts. Taken together, the former Chair noted, the two no-action letters create a regulatory environment in which portfolio managers believe that if they outsource the vote they have avoided major problems under Rule 206(4)-6 and their own fiduciary obligations.

The ISS no-action talked of whether there is a conflict between the proxy advisory firm and the investment adviser which, while relevant, is less significant than the issue of whether there is a conflict between the proxy advisory firm and the subject matter being voted on.

These no-action letters have the effect of rules, emphasized former Chairman Pitt, essentially revising an existing rule. Until these no-action letters are repealed, he noted, the SEC will be hard pressed to go after people who outsource their votes to proxy advisory firms.

The SEC has announced in its 2013 rulemaking agenda that it intends to review the issues around proxy advisory firms, observed former Chairman Pitt, but he added that there is no real assurance that this is anything more than an aspirational goal as opposed to a binding commitment on the part of the Commission. The SEC will eventually have to take action, he said, but that will mean confronting what the two no-action letters have achieved.