What’s going on with the SEC’s proxy advisor rules?

For years, many companies and business lobbies, such as NAM and the Chamber of Commerce, repeatedly raised concerns about proxy advisory firms’ concentrated power and significant influence over corporate elections and other matters put to shareholder votes, leading to questions about whether these firms should be subject to more regulation and accountability. (See, e.g., this PubCo post, this PubCo post and this PubCo post.)  Whether and how to regulate proxy advisory firms has long been a contentious issue, with some arguing that their vote recommendations were plagued by conflicts of interest and often erroneous, while others saw no reason for regulation, given that the clients of these firms were satisfied with their services. Some have even thrown proxy advisory firms into the current culture wars over ESG, arguing that proxy advisors have a predisposition to view these ESG programs positively.

SEC backs out of appeal regarding proxy advisory recommendations as “solicitations”

In September 2019, the SEC, under Chair Jay Clayton, published in the Federal Register a new interpretation and guidance directed at proxy advisors confirming that their vote recommendations were considered to be “solicitations” under the proxy rules and subject to the anti-fraud provisions, and providing some “suggestions” about disclosures that would help avoid liability. (See this PubCo post.) Not surprisingly, the proxy advisory firms were none too happy with the new interpretation and guidance, leading one, ISS, to sue the SEC.  (See this PubCo post.)  But the SEC was, at the time, considering new rules on the topic, and the case was held in abeyance until that process was complete. Then, in 2020, the SEC adopted amendments to the proxy rules that codified the SEC’s interpretation regarding proxy advisors and “solicitations.” The 2020 rules added to the exemptions from those solicitation rules two significant new conditions, both viewed favorably by many companies and business organizations, such as NAM and the Chamber—one requiring disclosure of conflicts of interest and the second designed to facilitate effective engagement between proxy advisory firms and the companies that were the subjects of their advice.  (See this PubCo post.) The case was then reactivated and both parties filed for summary judgment.  

In June, soon after assuming his position as SEC Chair, Gary Gensler directed the staff to take another look at the 2020 rules, and the staff announced that it would decline to recommend enforcement in the interim. Once again, the Court held the case in abeyance as the SEC contemplated new regulatory action that could have narrowed or eliminated the issues raised. In 2022, the SEC adopted new amendments to the proxy advisor rules reversing some of those key company-favorable provisions governing proxy voting advice that were adopted in July 2020 (discussed further below). Importantly, however, under the 2022 amendments, proxy voting advice would still be considered a “solicitation” under the proxy rules and proxy advisors would still be subject to the requirement to disclose conflicts of interest.  (See this PubCo post.) Because, when the SEC ultimately took action, it did not change the definition of the term “solicitation” from the 2019 interpretation and guidance and the 2020 amendments, and the SEC’s interpretation of that term was the subject of Counts I and II of ISS’s amended complaint, the case was again reactivated.

In its amended complaint, ISS contended that the interpretation in the release and the subsequent rules were both unlawful for a number of reasons, including that the SEC’s determination that providing proxy advice is a “solicitation” is contrary to law, that the SEC failed to comply with the Administrative Procedure Act and that the views expressed in the release were arbitrary and capricious. NAM, which favored the 2020 amendments, intervened on the side of the SEC (and also became a defendant).  Over four years later, the D.C. District Court agreed, holding that the “SEC acted contrary to law and in excess of statutory authority when it amended the proxy rules’ definition of ‘solicit’ and ‘solicitation’ to include proxy voting advice for a fee.”

Opinion. After a lengthy examination of various historical dictionary and judicial definitions, the Court granted ISS’s motion for summary judgment, holding that, when the SEC amended the proxy rules’ definition of “solicit” and “solicitation” to include proxy voting advice for a fee, it acted “contrary to law and in excess of statutory authority.” Applying the Chevron test (which SCOTUS has now overruled, see this PubCo post), the Court held that “at Chevron step one, the ordinary meaning of ‘solicit’ at the time of Section 14(a)’s enactment does not reach proxy voting advice for a fee.  Nor does the Exchange Act’s history and purpose support the SEC’s reading.  The court therefore has no cause to move to Chevron step two and afford deference to the agency’s position.”  Although the Exchange Act does not define the term “solicit,” the Court said, the SEC “has long defined the terms ‘solicit’ and ‘solicitation’ to include a ‘communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.’” Moreover, according to the Court, the “ordinary meaning of those terms when Congress enacted the Exchange Act in 1934 did not encompass voting advice delivered by a person or firm with no interest in the outcome of the vote,” and none of the cases cited supported the SEC’s “position that proxy voting advice for a fee is ‘solicitation’ within the ordinary meaning of the term.”  In addition, the Court reasoned that “the casting of a client-shareholder’s vote does not turn the advisor’s advice into a ‘solicitation.’” The Court also concluded that ISS’s position “better reflects the purposes and history of Section 14(a).” (See this PubCo post.)

Appeal. In April, both NAM and the SEC (along with SEC Chair Gary Gensler) filed one-page notices of appeal, NAM first on April 16, with the SEC following a week later on April 23. Subsequently, the clerk of the D.C. Circuit filed an order consolidating the two appeals and setting out a schedule for various submissions by the parties.  Now, however, the SEC and Gensler have moved to voluntarily dismissed their appeal. Why? That remains a mystery: the SEC did not provide any reason. The SEC’s dismissal did not, however, impact NAM’s separate appeal as Intervenor-Appellant. But now NAM becomes the sole appellant in the case. In fact, NAM has moved for a 30-day extension of time to file its opening brief, citing as one reason that the SEC had just “abandon[ed] its defense of the regulation challenged by ISS,” and, as a result, NAM was “now the only party defending the SEC’s action on appeal” and needed “additional time to prepare its brief, given that its role has just changed materially.” In a statement to Bloomberg, a NAM representative said that NAM was “surprised and extremely disappointed that the SEC has chosen not to exercise its authority to defend America’s world-leading capital markets from the outsized and completely unregulated authority of proxy advisory firms.” Bloomberg reports that the SEC “didn’t immediately respond to a request for comment.”

Circuits collide on validity of 2022 amendments to proxy advisor rule

As noted above, under the 2022 amendments, proxy voting advice would still be considered a “solicitation” under the proxy rules and proxy advisors would still be subject to the requirement to disclose conflicts of interest; however, the new amendments rescinded the second central condition that was designed to facilitate engagement between proxy advisors and the subject companies—the notice-and-awareness provisions—which some might characterize as a core element of the 2020 amendments. (The amendments also rescinded an explanatory note to Rule 14a-9, also adopted as part of the 2020 rules, which provided examples of situations in which the failure to disclose certain information in proxy voting advice may be considered misleading. The SEC explained that the rescinded condition designed to facilitate engagement “did not ‘sufficiently justify the risks they pose[d]to the cost, timeliness, and independence of proxy voting advice on which many investors rely.’ And when rescinding Note (e), the SEC highlighted that Note (e) presented a ‘risk of confusion regarding the application of Rule 14a-9 to proxy voting advice.’”) (See this PubCo post.)

In the 5th Circuit. In July 2022, NAM filed a complaint against the SEC, asking that the 2022 amendments to the proxy advisor rules—which, as noted above, reversed the company-favorable condition that would have required company engagement—be set aside under the APA and declared unlawful and void.  In September, NAM filed a motion for summary judgment, characterizing the case as “a study in capricious agency action.” In its complaint, NAM had contended that the 2022 rules were “both procedurally defective and arbitrary and capricious.” The SEC, NAM argued, “has come to a completely opposite outcome to that reached only two years ago, and it has done so on the basis of the exact same factual record that drove the SEC to adopt the 2020 Rule in the first place. The SEC does not—no doubt because it cannot—offer any compelling justification for why the exact same factual record requires a different result this time around.” In NAM’s subsequent motion for summary judgment, NAM contended that the 2020 rules represented a rulemaking compromise that was the result of a  “decade of bipartisan policymaking”; new Chair Gensler, NAM argued, made “an abrupt about-face.” In December 2022, the Federal District Court for the Western District of Texas issued an Order granting summary judgment to the SEC and Gensler and denying summary judgment to NAM in that litigation. (See this PubCo post.) NAM appealed. In August last year, a three-judge panel of the 5th Circuit heard oral argument on NAM’s appeal, and it was apparent that the Court was none too sympathetic to the SEC’s case, with Judge Edith Jones mocking the SEC’s concern with the purported burdens on proxy advisors as “pearl-clutching.” (See this PubCo post.)

In an opinion by Judge Jones, issued in June this year, the 5th Circuit panel concluded “that the explanation provided by the SEC was arbitrary and capricious and therefore unlawful,” reversing the district court’s judgment and vacating the 2022 rescission and remanding it in part back to the SEC. Under the APA, the Court explained, courts are directed to “‘hold unlawful and set aside agency action’ that is ‘arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.’…’The APA’s arbitrary-and-capricious standard requires that agency action be reasonable and reasonably explained.’… Applying this standard entails considering whether ‘the agency has acted within a zone of reasonableness and, in particular, has reasonably considered the relevant issues and reasonably explained the decision.’” When a new administration comes into office, the Court continued, the SEC does have authority to rescind or change policies, but if the new policy is based on facts different from those underlying the prior policy, a more detailed explanation is required. Failure to explain its decision to rely on different facts can be arbitrary and capricious.

The 5th Circuit panel held that, in its rescission of the 2020 rule, the SEC was arbitrary and capricious “in two ways. First, the agency failed adequately to explain its decision to disregard its prior factual finding that the notice-and-awareness conditions posed little or no risk to the timeliness and independence of proxy voting advice. Second, the agency failed to provide a reasonable explanation why these risks were so significant under the 2020 Rule as to justify its rescission. These shortcomings require vacatur of the 2022 Rescission, but only to the extent it rescinded the notice-and-awareness conditions.” (For further discussion of this case, see this PubCo post.)

In the 6th Circuit. In July 2022, the Chamber of Commerce also filed a separate action in a federal district court challenging the 2022 amendments. The Chamber claimed that the SEC violated the APA’s procedural and substantive requirements when it adopted the 2022 amendments: it allowed only 31 days for public comment and, the Chamber alleged, the SEC’s explanation for the rule was arbitrary and capricious and failed to analyze the rule’s economic consequences. The District Court granted summary judgment to the SEC, and the Chamber appealed to the 6^th Circuit.  On Tuesday, in clear opposition to the decision of the 5th Circuit, the 6^th Circuit ruled in favor of the SEC on the 2022 amendments in a two-to-one decision.   

Reviewing the District Court’s decision de novo, the 6^th Circuit panel first took up the Chamber’s contention that the 2022 amendments were arbitrary and capricious and reached an entirely different conclusion than the 5th Circuit panel. According to the Court, the SEC “did not act arbitrarily merely because the 2022 Rescission immediately followed a change in administration. As the Supreme Court has recognized, an agency may rescind a prior rule based solely on a change in the agency’s policy preferences, so long as the change is reasonably explained…..Nor did the Commission err by relying on the same set of facts that gave rise to the 2020 Rule. Indeed, administrative agencies are free to reevaluate old facts to reach new policy conclusions….Accordingly, the SEC’s reliance on ‘precisely the same record’ was not arbitrary or capricious, particularly given that it explained why its reevaluation of the competing factors was more effective in 2022 than it had been in 2020.”

Citing FCC v. Fox Television Stations, Inc., the Court stated that, “[f]or an action representing a policy change to survive arbitrary-and-capricious review, the agency need not demonstrate that ‘the reasons for the new policy are better than the reasons for the old one.’… Instead, the agency must show that ‘that the new policy is permissible under the statute, that there are good reasons for it, and that the agency believes it to be better, which the conscious change of course adequately indicates.’…. The agency must also ‘display awareness that it is changing position.’” The Court found that the 2022 amendments satisfied those requirements: the SEC recognized that it was changing its position and thoughtfully explained the reasons for it, including that the SEC “was no longer convinced that the prevalence of errors in proxy voting advice justified the Notice-and-Awareness Conditions.”  Its explanation of these considerations was “hardly arbitrary and capricious.”  

In addition, the Court rejected the argument that, under Fox, the SEC would be required to provide a more detailed explanation for its decisions: the amendments neither threatened “the ‘serious reliance interests’ generated by a prior policy or ‘disregard[ed]’ the ‘facts and circumstances’ supporting an earlier regulation.” In this case, “neither of these concerns are at play.” In particular, the SEC “did not alter or disregard the factual findings underlying the 2020 Rule”; the changes in opinion were not changes in factual findings, but simply “differing judgments on the value of [proxy advisors’] self-regulation” and “adequately assessed the costs” of the rescission. An agency may “reevaluat[e]” its position, the Court said, “with respect to the weight it assigns to countervailing facts without making new factual findings,… and that is precisely what occurred here. The Commission struck a balance between regulatory burdens and benefits when it promulgated the 2020 Rule, and it thought better of that same balance when issuing the 2022 Rescission….The APA does not authorize us to second-guess that policy choice.”

The Court also determined that the Chamber’s contention that the SEC failed to adequately analyze the economic consequences of the 2022 amendments was “equally unfounded”: the SEC “adequately estimated the benefits of rescinding the Notice-and-Awareness Conditions.” With regard to the rescission of those conditions, “the SEC’s qualitative analysis of costs was sufficient because the potential costs that the plaintiffs identify are not easily quantified.”

Finally, with regard to the claim that the SEC’s thirty-one-day comment period for the proposed amendments was inadequate and “failed to provide interested parties with a meaningful opportunity to comment, as required under the APA,” the Court declined to vacate the 2022 amendments on that basis. The Court reasoned that “accepting this argument would require holding the Commission to an erroneously heightened procedural standard”: the “APA sets forth no minimum duration over which executive agencies must solicit public comment, instead requiring that the public’s opportunity to comment be a ‘meaningful’ one….. Under that standard, courts by and large accept thirty-day comment periods as procedurally sound absent extenuating circumstances.”

In addition, the Court agreed with the SEC that “the plaintiffs critique the thirty-one-day comment window accompanying the 2021 Proposed Rescission as insufficient without identifying a party that would have commented or a substantive argument that would have been made had the comment window been longer.” The Court likewise saw  “no merit to the plaintiffs’ contention that because ‘several parties requested that the Commission extend the comment period,’ the Commission’s failure to do so amounted to procedural error.”  In addition, the Court reasoned, “the plaintiffs’ contention that additional time would have yielded a quantitative analysis of the 2022 Rescission’s costs strains credulity where the lengthy and robust process accompanying the 2020 Rule notably failed to produce a quantitative analysis of the Rule’s benefits.” At bottom, the Court concluded, “highlighting the SEC’s refusal to extend the comment window without identifying how an extended comment period would have enhanced the substantive record is an empty gesture.” Accordingly, the 6^th Circuit panel affirmed. 

Will the Chamber or the SEC request en banc review of either of these two circuit decisions or, in light of the circuit split, seek to bring the matter before SCOTUS?  Time will tell.  Reuters reports that the Chamber “said it was considering its next steps. ‘We continue to weigh all legal options to challenge the SEC’s illegal rollback’ of the proxy rule, a spokesperson said.”

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