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Blog > Regulatory Roundup: The New Frontier of Proxy Reporting

Regulatory Roundup: The New Frontier of Proxy Reporting

Mastering Form N-PX Compliance
New Frontier of Proxy Reporting

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The SEC’s revisions to Form N-PX significantly enhance transparency and accountability in corporate governance and shareholder rights. As the proxy season unfolds, these changes are set to redefine the landscape of proxy voting reporting, bringing forth a new level of clarity to the decisions made by institutional investors. Arootah Advisor Michele McGurk navigates the complexities of the updated Form N-PX, dissecting the implications for investment managers and outlining the steps necessary for seamless compliance.

Unlocking Transparency: Understanding the Changes to Form NPX

As the 2024 U.S. proxy season kicks off, a significant transformation is underway in the realm of institutional investor transparency. Amidst the buzz of proxy contests and shareholder proposals, the Securities and Exchange Commission (SEC) has ushered in a new era of disclosure through revisions to Form N-PX, a document utilized by U.S. funds for proxy voting reporting for over 20 years. The changes to the annual filing requirements are based on the SEC’s new rule 14Ad-1 adopted in November 2022, under the Exchange Act, with an effective date of July 1st, 2024. The first filing under the new rule is due August 31, 2024, covering the most recent twelve-month period ended June 30, 2024. This article provides a comprehensive guide to the noteworthy changes to Form N-PX, offering investment managers insights into the implications and best practices for compliance.

Understanding the Changes
The SEC’s amendments to Form N-PX apply to all investment managers who file Form 13F, regardless of whether they are based in the US. The adoption of the new rule ushers in two categories of changes and is relevant to both registered funds and institutional investment managers. The definition of “institutional investment manager” under the new rule is defined as an entity that either invests in or buys and sells, securities for its account. The term also includes a natural person or an entity that exercises investment discretion over the account of any other natural person or entity (for example, an investment adviser).

First, as required by Dodd-Frank, all institutional investment managers subject to Form 13F reporting requirements are now mandated to disclose their “Say-on-Pay” votes, or those votes where they “exercised voting power”. The “Say-on-Pay” votes include (1) votes on executive compensation approval, (2) the frequency of such votes, and (3) golden parachute compensation related to mergers and acquisitions. The disclosure requirement isn’t new, but the new rule has standardized the format and practices of the mandate. Under the new rule, it’s important to understand that “exercising voting power” extends to situations where institutional investment managers opt not to vote, even including the decision not to recall and vote securities that are on loan. Even if managers abstain from voting on any reportable matter during the specified period, they are still obligated to file. However, this filing requirement is streamlined for cases where no votes were cast, necessitating only a notice report confirming the absence of voting activity.

The second major change is in the revised Form N-PX itself, which is an enhanced version that requires new disclosures and alters the reporting format to adopt a standardized and modernized reporting framework which will allow for greater comparability. Although registered funds have traditionally used Form N-PX to report proxy votes over the past twenty years, the adoption of the new rule requires both 13F institutional investor filers and registered funds to use the same amended Form N-PX.

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Key Modifications to Form N-PX
The revised Form N-PX introduces several significant changes, including:

    1. Categorization of Votes: Funds are required to categorize all proxy votes into 14 distinct categories, ranging from director elections to environmental and diversity matters. Funds will need to select one or more categories for each vote recorded.
    2. Disclosure of Shares Loaned: The new form mandates disclosure of both the number of shares voted and the number of shares loaned but not recalled before the voting record date.
    3. Adoption of Structured Data Language: Form N-PX filings will now utilize a custom XML structured data language, enhancing data standardization and accessibility. As a result of the new standardized XML format, will provide an opportunity to summarize and analyze proxy voting across funds.

The standardized format of the new Form N-PX contains three sections:

(1) “Form N-PX Cover Page” which includes information on the reporting person/entity, address, report period, SEC 13F Filer number, CRD number, LEI, whether the amendment is a restatement or adds new proxy voting entries, and for registered management investment companies, the report type as either Fund Voting Report (held one or more securities and required to vote), or Fund Notice Report (if didn’t hold any securities it was entitled to vote and therefore does not have any proxy votes to report).

(2) “Form N-PX Summary Page” which requires disclosure information on the institutional managers’ reports (e.g. name, 13F filer number, CRD number, LEI, SEC file number), information about the series relevant to the report.

(3) “Form N-PX Proxy Voting Record” which includes an Item 1 Voting Record and will contain information such as the name of the issuer security, CUSIP, ISIN or FIGI(optional), identification of the matter voted on, categories of applicable matters, number of shares voted and shares loaned and not recalled and whether the votes were against one management’s recommendation.

Compliance Imperatives for Institutional Investors
For affected institutional investors, compliance with the revised Form N-PX is critical. The SEC estimates that over 8,000 managers across various institutional investor types will be subject to the new reporting requirements. As the reporting deadline approaches this summer, investors need to establish strong internal compliance procedures and effectively collaborate with service providers to smoothly navigate the new reporting requirements. Implementation mandates the establishment of effective coordination and oversight mechanisms, especially for funds reporting “Say-on-Pay” votes on behalf of multiple entities.

Best Practices for Implementation
To navigate the changes effectively, investment managers should consider the following best practices:

  • Review and Align Policies: Conduct a comprehensive review of existing proxy voting policies and align them with Form N-PX requirements.
  • Maintain Detailed Records: Maintain comprehensive records of all proxy voting activities, including shares voted and shares loaned.
  • Collaboration and Coordination: Collaborate with custodians and service providers to ensure the availability of requisite share lending information and streamline reporting processes.

Key Takeaways
The revised Form N-PX is poised to reshape proxy voting dynamics by enhancing transparency, fostering informed decision-making, and promoting shareholder engagement. Additionally, the disclosure of say-on-pay votes may influence corporate governance practices, fostering alignment between executive compensation policies and shareholder interests. As institutional investors prepare for the 2024 proxy season, understanding and adapting to these changes is crucial. The adoption of the new Form N-PX rule is expected to offer valuable insights to investors, aiding in identifying market risks and opportunities for making informed investment decisions. By embracing transparency and adhering to compliance best practices, investment managers can confidently navigate the evolving regulatory landscape, fostering greater accountability and stewardship in proxy voting activities.

Updates to the SEC Marketing Rule FAQs: Insights on Gross and Net Performance Reporting

In the ever-changing regulatory environment, investment managers must remain vigilant to comply with evolving standards. Notably, recent updates to the SEC Marketing Rule FAQ offer important insights into effectively implementing the Marketing Rule, a focal point of recent investment adviser exams.

Below, we delve into the key aspects of the updates, discuss their impact on investment managers, and offer practical insights on how to revisit policies and procedures to ensure compliance and adherence to best practices.

Understanding the SEC Marketing Rule FAQs
The SEC issued updates to its Marketing Compliance FAQs initially on January 11, 2023, and most recently on February 6, 2024, as it relates to the Marketing Rule (Rule 206(4)-1) which went into effect November 4, 2022. The most recent FAQ updates shed further light on the methodology and calculation requirements for presenting gross and net performance returns, offering valuable insights for investment advisers to ensure compliance and transparency in their marketing practices.

Extracted Performance
One key question addressed in the FAQs concerns the display of gross performance for individual investments or groups of investments from private funds. The SEC Staff is clear in asserting that presenting such performance falls within the domain of “extracted performance” as defined in the Marketing Rule. This provision is designed to prevent potentially misleading presentations of performance, thereby safeguarding investor interests. Consequently, advisers must comply with stringent requirements, including disclosing net performance alongside gross performance. This ensures a fair and balanced representation of investment returns, aligning with regulatory objectives and fostering transparency in marketing communications.

Harmonizing Gross and Net Performance
In the February 2024 FAQ update, the SEC Staff further elaborated on the alignment of gross and net performance in advertisements, emphasizing the importance of consistency in methodology and calculation. While the Marketing Rule doesn’t prescribe specific methodologies, it requires that gross and net performance be calculated over the same time-period and using the same return type and methodology. This requirement underscores the need for accuracy and comparability in performance reporting, enabling investors to make informed decisions.

The FAQs highlight a scenario commonly encountered by private fund advisers, where the gross internal rate of return (Gross IRR) is calculated from the time of investment, excluding the impact of subscription facilities, while the net internal rate of return (Net IRR) reflects the impact of such subscription facilities (i.e. the date the investor capital calls were made to fund the investments or pay back borrowings, as applicable). It is important to note that fund-level subscription facilities encompass various financial arrangements obtained by a private fund, typically secured by the unfunded capital commitments made by the investors of the private fund.

The SEC Staff emphasizes that presenting Gross IRR without accounting for the impact of capital calls while simultaneously presenting Net IRR that includes such impact violates regulatory standards. These discrepancies result in inconsistent performance calculations across different periods, potentially misleading investors and contravening the provisions of the Marketing Rule.

Compliance Implications and Prohibitions
The FAQ clarifies the compliance implications associated with misaligned gross and net performance reporting. Advisers risk violating the general prohibitions of the marketing rule if they present only Net IRR inclusive of subscription facilities without providing comparable performance data or relevant disclosures. Such practices could mislead investors, undermining trust and confidence in the investment process. Investment advisers must navigate the regulatory landscape diligently and with integrity, adhering to best practices and ensuring compliance with regulatory standards.

Key Takeaways for Investment Managers
In conclusion, the SEC’s FAQ updates on gross and net performance reporting offer invaluable insights for investment advisers navigating the complexities of performance disclosures. By adhering to regulatory requirements and best practices, advisers can elevate transparency, mitigate compliance risks, and uphold investor trust. Investment firms must review their marketing practices considering these updates, fostering a culture of compliance and integrity in performance reporting. Below is a sample self-examination questionnaire investment managers can utilize as part of a self-assessment of marketing rule compliance instead of the FAQ updates. Through proactive measures and adherence to regulatory standards, advisers can fortify investor confidence and contribute to a robust and resilient investment landscape.

Sample Self Examination Questionnaire for Marketing Rule Compliance
1. Are gross and net performance calculations consistently applied across advertisements and marketing materials?
2. Do presentations that reflect performance include all relevant disclosures to ensure investor understanding?
3. Are gross and net performance returns calculated over the same time-period and using the same methodology?
4. Is performance reporting presented in a fair, balanced, and transparent manner, in line with regulatory requirements?
5. Have internal policies and procedures been reviewed and updated to ensure alignment with SEC guidelines on performance reporting?
6. Is there ongoing monitoring and review of performance reporting practices to ensure compliance with evolving regulatory standards?
7. Is there documented evidence demonstrating our review and approval of marketing materials to ensure compliance with all Marketing Rule requirements?

Lessons from the Latest SEC Enforcement Action on Recordkeeping Failures

In light of recent SEC enforcement actions targeting widespread failures in recordkeeping requirements, investment managers are once again confronted with the urgent need to uphold stringent compliance practices, particularly regarding the preservation of electronic communications. The SEC’s announcement on February 9, 2024, exposed charges against 16 firms, culminating in combined penalties exceeding $81 million to resolve the associated charges.

The SEC’s crackdown on firms’ inadequate preservation of electronic communications underscores the regulatory imperative for meticulous recordkeeping, serving as another stark reminder of the severe consequences that non-compliance can entail. The charges imposed against these firms, spanning broker-dealers, dually registered broker-dealers, and investment advisers, underscore the pervasive and longstanding nature of failures to maintain and preserve electronic communications. The SEC’s investigations unveiled a common practice of utilizing unapproved communication methods, such as personal text messages, for business-related discussions, resulting in a breach of recordkeeping provisions of the federal securities laws.

Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, underscored the significance of recordkeeping requirements, stating, “Today’s actions against these 16 firms result from our continuing efforts to ensure that all regulated entities comply with the recordkeeping requirements, which are essential to our ability to monitor and enforce compliance with the federal securities laws.”

These enforcement actions underscore the need for investment managers to conduct comprehensive self-assessments of their compliance practices to proactively identify and rectify any deficiencies. Some practical steps investment managers can take to ensure robust compliance include:

    1. Review and Update Policies and Procedures: Regularly review and update policies and procedures concerning electronic communications to ensure they are comprehensive, clearly articulated, and aligned with regulatory requirements.
    2. Implement Monitoring and Oversight Mechanisms: Establish robust monitoring and oversight mechanisms to effectively detect and prevent unauthorized communication channels. Utilize technology solutions and surveillance tools for compliance monitoring.
    3. Employee Training and Awareness: Conduct routine training sessions to educate employees on the importance of compliance with recordkeeping requirements. Enhance awareness about the risks associated with using unapproved communication methods for business-related discussions, such as personal text messages, which can result in a breach of federal securities laws.
    4. Enhance Technology Infrastructure: Invest in technology infrastructure to facilitate compliant electronic communication practices. Deploy secure messaging platforms and archiving solutions to ensure the preservation of electronic communications is in line with regulatory standards.
    5. Conduct Regular Audits and Reviews: Conduct ongoing reviews of electronic communications and audits of retention practices to identify and remediate any compliance gaps or deficiencies. Engage independent third-party auditors, if necessary, for objective assessments of compliance practices.
    6. Promote a Culture of Compliance: Foster a culture of compliance within the organization by emphasizing the importance of adhering to regulatory requirements. Encourage open communication and transparency regarding compliance issues.

The Bottom Line

By proactively enhancing compliance practices, investment managers can mitigate the risk of encountering similar recordkeeping failures and facing enforcement actions by regulatory authorities. Compliance should not only be seen as a regulatory obligation but also as a critical element in maintaining the trust and integrity of the financial industry.

In conclusion, the recent SEC enforcement actions serve as a poignant reminder for investment managers to prioritize compliance with recordkeeping requirements, especially concerning electronic communications. By implementing robust policies, procedures, and oversight mechanisms, investment firms can demonstrate their commitment to regulatory compliance and safeguard against potential fines and reputational damage. Compliance is an ongoing journey, and investment managers must remain vigilant in their efforts to uphold the highest standards of integrity and accountability. If you’re seeking further guidance to support your team’s needs, learn more about Arootah’s coaching and advisory support tailored to your organization. Also, sign up for the Capital Returns newsletter for more updates and upcoming events.

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Disclaimer: This article is for general informational purposes only and does not constitute legal, investment, financial, accounting, or tax advice, or establish an attorney-client relationship. Arootah does not warrant or guarantee the accuracy, reliability, completeness, or suitability of its content for a particular purpose. Please do not act or refrain from acting based on anything you read in our newsletter, blog, or anywhere else on our website.

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