SEC Rule 206-4-6

The adopting release adds that nothing in the rule reduces or alters any fiduciary obligation applicable to an investment adviser or to a person associated with one. The rule sets a floor of procedure and disclosure beneath an obligation that exists independently of it, so an adviser with flawless procedures can still breach its fiduciary duty in the way it actually casts a vote.

The Fiduciary Duties Behind Proxy Voting

The adopting release began from scale. Registered advisers then had discretionary authority over some $19 trillion of client assets, and in most cases clients gave them authority to vote the related proxies, which gave advisers significant ability to affect the outcome of shareholder votes and the governance of corporations.

The federal securities laws do not specifically address how an adviser must exercise proxy voting authority. The Advisers Act nonetheless makes the adviser a fiduciary owing each client duties of care and loyalty with respect to all services undertaken on the client's behalf, proxy voting included, and the Commission located each part of the voting obligation in one of those duties.

The duty of care requires an adviser with voting authority to monitor corporate events and to vote the proxies. The 2019 guidance added that such an adviser must have a reasonable understanding of the client's objectives and should conduct an investigation reasonably designed to ensure that a voting determination is not based on materially inaccurate or incomplete information.

The duty of loyalty requires the adviser to cast votes consistently with the best interest of its client and not to subrogate client interests to its own, which is why conflicts of interest sit at the center of the rule.

Which Advisers the Rule Reaches

The rule applies to every Commission-registered adviser that exercises proxy voting authority over client securities. Commenters asked for exceptions, including one for smaller firms, and the Commission declined, finding no persuasive argument why an adviser that accepts voting authority should not have procedures to meet its fiduciary obligations. It observed instead that a smaller firm without financial industry affiliates is likely to have few or no voting conflicts, so its procedures could be much simpler.

Authority need not be explicit. The rule applies when the advisory contract is silent but voting authority is implied by an overall delegation of discretionary authority. An adviser that believes the rule should not apply to it can revise its contracts, or make other disclosure to clients, to make its responsibility or lack of responsibility for voting explicit.

The rule does not apply to an adviser that advises clients on how to vote proxies but has no authority to vote them. That adviser is not left unregulated: the Advisers Act's general anti-fraud provisions still require it to disclose any material conflict to the clients receiving the advice.

Agreeing the Scope of Voting Authority

The 2019 guidance, Release No. IA-5325, drew on the Commission's 2019 interpretation of the adviser's standard of conduct: the fiduciary duty follows the contours of the relationship, which adviser and client may shape by agreement, provided there is full and fair disclosure and informed consent. An adviser is therefore not required to accept authority to vote client securities, whether or not the client undertakes to vote the proxies itself. An adviser that accepts voting authority may agree with the client, on the same terms, on the scope of the arrangement, including the types of matters on which it will vote. However the scope is drawn, the relationship remains that of a fiduciary to the client.

Where an adviser has discretionary authority over a client's portfolio and has not agreed to a narrower scope of voting authority, the guidance said its responsibility for voting determinations is implied.

The guidance gave non-exhaustive examples of agreed arrangements. Absent a contrary client instruction or the adviser's determination that a different vote would serve the client better, the adviser may vote in line with the issuer's management's recommendations, or in favor of all proposals made by particular shareholder proponents. The adviser may focus its voting resources on particular types of proposal, such as mergers or contested director elections. Or it may not vote where voting would impose costs on the client, such as the opportunity cost of restricting securities lending to preserve the vote. Even then the duty of loyalty continues: an adviser deciding whether to retain a security and vote the proxy, or lend the security out, must make that choice in the client's best interest.

Writing the Policies and Procedures

The Commission did not prescribe the content of the policies and declined requests to publish a list of approved procedures. Registered advisers are so varied, it said, that a one-size-fits-all approach is unworkable, so each adviser may craft procedures suited to its business and the conflicts it faces.

Flexibility is not a license for boilerplate. Procedures that merely declare that all proxies will be voted in the best interests of clients do not meet the rule's requirements, because they state a goal without any means of reaching it.

The release suggested, without requiring, that policies address how the adviser will vote, or what factors it will weigh, on particular types of matter, such as changes in corporate governance structures, compensation plans including stock options, and matters involving social issues or corporate responsibility. An adviser that invests only in investment companies would address different matters, such as approval of advisory contracts, distribution plans and mergers.

Procedures can allocate responsibility without naming individuals. In a firm with few employees the roles of monitoring corporate actions, making voting decisions and submitting proxies on time may be self-evident, while a large firm may need to clarify which department has which responsibility in order to guard against non-compliance.

Nothing in the rule prevents an adviser from having different policies for different clients, and the board of directors of an investment company could adopt, and require its adviser to use, policies different from those the adviser uses for its other clients.

Identifying Material Conflicts of Interest

The adopting release listed the kinds of conflict that can affect a vote. The adviser or an affiliate may manage a pension plan, administer employee benefit plans, or provide brokerage, underwriting, insurance or banking services to the company whose management is soliciting proxies, so that a vote against management may harm the adviser's relationship with the company. An executive of the adviser may have a spouse or close relative who is a director of the company. The relationship may instead be with the proponent of a proposal, as where the adviser manages money for an employee group.

Whether such a relationship creates a material conflict depends on the facts and circumstances, but a conflict does not require anyone to lobby the adviser. Even in the absence of efforts by these parties to persuade the adviser how to vote, the value of the relationship to the adviser can itself create a material conflict.

Even the smallest firm can face a conflict. The release's example is an adviser solicited to vote client proxies approving an increase in the fees deducted from a mutual fund's assets under a 12b-1 plan: if those fees are a source of compensation for the adviser, it has a conflict with its clients invested in the fund, whatever its size.

Resolving Conflicts Before the Vote

An adviser's procedures should enable it to resolve material conflicts before voting. Clearly, the release said, a policy of disclosing the conflict to clients and obtaining their consent before voting satisfies the rule and, when implemented, fulfills the adviser's fiduciary obligations. The consent must be informed: the client must receive enough information about the matter and the nature of the adviser's conflict to decide, and boilerplate disclosure of generalized conflicts in a client brochure is inadequate. An adviser to an investment company satisfies its obligation if, before voting, it fully discloses the conflict to the fund's board or a board committee and obtains its consent or direction to vote.

Without client disclosure and consent, an adviser with a material conflict must take other steps designed to ensure that its vote was based on the clients' best interest and not the product of the conflict, and must be able to demonstrate that those steps produced that result. An adviser voting under a pre-determined policy could do so if applying the policy to the matter involved little discretion on its part. It could vote, under a pre-determined policy, on the recommendations of an independent third party. Or it could suggest that the client engage another party to decide how the proxies should be voted, which would relieve the adviser of the responsibility to vote them.

These methods have limits. A pre-determined policy must further the interests of clients rather than the adviser, so an adviser could not adopt a policy of voting in favor of the management of companies with which it does business. Nor can an adviser that has assumed voting responsibility resolve a conflict by simply refraining from voting, because proxies left unvoted for that reason are not voted in the clients' best interest. The effectiveness of any method turns on how well it insulates the voting decision from the conflict.

When an Adviser May Refrain From Voting

An adviser that fails to vote every proxy does not necessarily violate its fiduciary obligations. The 2019 guidance identified two situations in which an adviser with voting authority need not vote. The first is where adviser and client have agreed in advance to limit the conditions under which the adviser will vote. The second is where the adviser determines that refraining is in the client's best interest, as where the cost to the client of voting exceeds the expected benefit, and the costs weighed must be additional costs to the client. The adopting release's example is a vote on a foreign security that would require hiring a translator or traveling abroad to vote in person.

Neither situation allows an adviser to ignore the obligation it has assumed or to be negligent in fulfilling it. Before refraining on cost grounds, an adviser should consider whether it is fulfilling its duty of care in light of the scope of services it and the client have agreed.

The duty to vote does not make every adviser an activist. An adviser's fiduciary duties do not necessarily require it to solicit proxies or campaign for or against matters before shareholders; advisers decide whether to do so on the basis of the costs and expected benefits to clients.

Voting for Many Clients With Different Objectives

Many advisers vote for funds, pooled vehicles and individual investors whose strategies differ. The 2019 guidance said an adviser should consider whether voting all clients' shares under a uniform voting policy would be in the best interest of each client, and whether some clients should have different policies. Its example was a growth fund targeting companies with high growth prospects, which may view certain matters differently from an income fund seeking a stream of dividends or interest.

An adviser should also consider whether some matters, such as mergers and acquisitions, dissolutions or contested director elections, call for more detailed analysis than its general guidelines provide. In deciding whether to conduct an issuer-specific analysis, it should consider the potential effect of the vote on the value of the client's investment, and it should consider identifying in its policy the factors it will use to decide which matters require company-specific evaluation.

To check that it is in fact voting consistently with its policies, an adviser could sample the proxy votes it has cast as part of its annual review of its compliance policies and procedures under Rule 206(4)-7, including votes on proposals that call for issuer-specific analysis.

Retaining a Proxy Advisory Firm

Many advisers retain proxy advisory firms, whose services may be administrative, such as an electronic voting platform, or substantive: research, general voting guidelines, and recommendations on specific matters based on the firm's own guidelines or on custom guidelines the adviser has created.

An adviser with a conflict, for example because its interests in an issuer differ from those of some of its clients, may look to a proxy advisory firm's recommendation. That third-party input may mitigate the conflict, but it does not relieve the adviser of its obligation to vote in the client's best interest, or of its obligation to provide full and fair disclosure of the conflict and obtain the client's informed consent.

In deciding whether to retain or keep retaining a firm, an adviser should consider whether it has the capacity and competency to analyze the matters on which the adviser must vote, looking at the adequacy and quality of its staffing, personnel and technology, and whether it has disclosed its methodologies well enough for the adviser to understand the factors behind its recommendations. It should review how the firm identifies and addresses its own conflicts, such as consulting services the firm has provided to an issuer, or a shareholder proponent that is one of the firm's clients, and whether the firm's conflict disclosure is context-specific rather than boilerplate.

How far these steps go depends on the scope of the adviser's authority and the services retained. Some considerations matter less where a firm only executes votes on detailed instructions that leave it minimal discretion, but the adviser should still understand the firm's own procedures for implementing those instructions.

Errors, Incomplete Information and Ongoing Oversight

Where an adviser becomes aware of potential factual errors, incompleteness or methodological weaknesses in a proxy advisory firm's analysis, the 2019 guidance said its procedures should be reasonably designed to ensure that its votes are not based on materially inaccurate or incomplete information. One measure is a periodic review of the adviser's ongoing use of the firm's research or recommendations, assessing how far credible errors it became aware of affected what it relied on.

Oversight continues after the firm is hired. An adviser that has retained a third party to assist substantively with its voting should adopt and implement procedures reasonably designed to evaluate that third party sufficiently to ensure that votes are cast in clients' best interest. Because a firm's business or conflicts policies may change after the initial assessment, the adviser should consider requiring the firm to update it on business changes relevant to its capacity and competency, and whether the firm updates its methodologies and recommendations in response to feedback from issuers and their shareholders.

Pre-Populated and Automated Voting

In 2020 the Commission supplemented its guidance in Release No. IA-5547, issued alongside amendments to the Exchange Act proxy solicitation rules governing proxy voting advice. The supplement addressed electronic systems through which a proxy advisory firm populates each client's votes on its platform with the firm's recommendations based on that client's voting instructions, known as pre-population, and automatically submits the votes to be counted, known as automated voting. Both generally occur before the deadline for submitting proxies.

The supplement considered an issuer that, after votes have been pre-populated but before the deadline, files additional soliciting materials setting out its views on the firm's recommendation. If the issuer files sufficiently in advance of the deadline and the information would reasonably be expected to affect the adviser's voting determination, the adviser would likely need to consider it before voting in order to demonstrate that it is voting in its client's best interest.

Because pre-population may leave a proxy advisory firm holding non-public information about how an adviser intends to vote, the adviser should consider reviewing its agreements with the firm to determine whether they would let the firm use that information in a way not in the client's best interest, for example by sharing aggregated voting intentions with third parties.

An adviser that uses automated voting should also consider disclosing the extent of that use and the circumstances in which it occurs, and how its procedures deal with automated voting when it learns of an issuer's additional soliciting materials before the deadline. Without that disclosure a client may lack specific enough information to give informed consent to automated voting as a means of exercising voting authority.

Disclosure to Clients

Under paragraph (c), the adopting release said the description of the adviser's policies should be a concise summary of its proxy voting process rather than a reiteration of the policies themselves, and should indicate that a copy is available on request; if a client requests a copy, the adviser must supply it. Form ADV Part 2A, Item 17, separately requires an adviser that has, or will accept, authority to vote client securities to describe its voting policies briefly in its brochure.

Under paragraph (b), the Commission expected most advisers to say how clients can obtain their voting information in the written brochure required under Rule 204-3. The rule does not prescribe a client's right to that information, because the Commission considered a prescription unnecessary: a client already has a right, recognized in agency law, to information about how its own securities were voted.

Many investors urged the Commission to require advisers to disclose their votes publicly, and it declined. Public disclosure was unnecessary for an adviser to tell each client how it had voted that client's proxies, and public disclosure by some advisers would reveal client holdings and so betray client confidences. Registered investment companies, by contrast, were required by a companion release to disclose their proxy votes publicly, as a means of informing fund shareholders how the fund or its adviser voted.

Proxy Voting Records Under Rule 204-2

The same release amended Rule 204-2 so that an adviser that votes client proxies keeps records letting the Commission's examiners ascertain its compliance with Rule 206(4)-6: its proxy voting policies and procedures, proxy statements received regarding client securities, records of votes cast on behalf of clients, records of client requests for voting information, and documents it prepared that were material to a voting decision or memorialized its basis.

The Commission narrowed the proposal in response to comments on its burden. For client requests, an adviser need keep only written requests and any written response from the adviser, whether that response answered a written or an oral request. Instead of keeping its own copies of proxy statements, it may rely on those filed on the Commission's EDGAR system, and it may rely on proxy statements and vote records kept by a third party such as a proxy voting service, provided it has obtained the third party's undertaking to provide a copy promptly on request.

Records other than those held on EDGAR or by a third party must be kept in an easily accessible place for five years, the first two in an appropriate office of the adviser, the same period that applies to most other records under Rule 204-2.

Fund Proxy Voting Alongside the Rule

For a registered fund, the scope of the adviser's relationship is defined by the advisory agreement, and the fund board has authority to set the scope of voting authority in accordance with its own fiduciary duty. The 2019 guidance recorded the Investment Company Institute's observation that a fund board typically delegates its proxy voting duties to the fund's adviser.

Funds that invest in voting securities must disclose the policies they use to determine how to vote proxies on their portfolio securities. Open-end funds disclose them in their statements of additional information. Closed-end funds disclose them in their annual reports on Form N-CSR, because they do not offer shares continuously and so are generally not required to maintain an updated statement of additional information. Where an adviser uses different voting policies for different funds, those differences should be reflected in each fund's disclosure.

The two regimes were built in parallel: the 2002 adviser proposal was issued with a companion fund proposal, and the fund rules were adopted in Release No. IC-25922 at the same time as Rule 206(4)-6.

Common Errors and Exam Traps

Rule 206(4)-6 does not require an adviser to vote every proxy: it may limit its voting by informed agreement or refrain where refraining serves the client, but it may not neglect an obligation it has assumed or refrain merely to avoid a conflict.

The rule is not confined to contracts that expressly grant voting authority, and it does not reach an adviser that only advises clients on how to vote.

Reliance on a proxy advisory firm can mitigate a conflict but does not end the adviser's responsibility for best-interest voting, disclosure and oversight of the firm.

An adviser tells its clients how to obtain information about their own votes and need not publish its votes; registered funds disclose their votes publicly.

Procedures that merely promise best-interest voting fail the rule, and boilerplate brochure language about generalized conflicts does not support informed consent to a specific vote.

Examination Relevance and Key Takeaways

Rule 206(4)-6 is the procedural expression of the adviser's fiduciary duties of care and loyalty in one service, the exercise of voting authority over client securities. Its three conditions are written policies reasonably designed to ensure best-interest voting and addressing material conflicts, disclosure of how clients can obtain voting information, and a description of the policies with a copy on request, with the supporting records kept under Rule 204-2. The 2019 and 2020 guidance explains how those conditions apply where scope is limited by agreement, where clients have different objectives, and where an adviser relies on proxy advisory firms and automated voting.