• The court vacated the last of the three conditions that were applied to proxy advisory firms as a result of the SEC’s 2020 regulation of Proxy Advisory Firms.
• As a result of this ruling, Proxy Advisory Firms are no longer required to disclose certain conflicts of interest.
• If the ruling stands, the SEC will not be able regulate the Proxy Advisory Firms through similar mechanisms in the future.

The United States District Court for the District of Columbia held on February 23, 2024 that the Securities and Exchange Commission “acted contrary to law and in excess of statutory authority” when it amended the proxy rules’ definition of "solicit" to include proxy voting advice for a fee.¹ With this decision, the court vacated the last of three conditions that applied to proxy advisory firms as a result of the SEC’s 2020 regulation of proxy advisory firms, meaning that proxy advisory firms are no longer required to disclose certain conflicts of interest. If the ruling stands, then the SEC in the future will not be able to regulate proxy advisory firms in a similar way through the proxy solicitation rules.

Background

The SEC had previously amended the proxy rules in September 2020 to interpret the term “solicitation” within Section 14(a) of the Securities Exchange Act of 1934 to include proxy voting advice issued by proxy advisory firms.² This interpretation built upon prior SEC interpretations of “solicitation” that included unsolicited proxy advice. The implication of the interpretation is that proxy advisory firms would have to file their proxy advice with the SEC as proxy solicitations without an exemption. These rule amendments provided this exemption, which included three conditions that proxy advisory firms relying on the exemption were required to comply with: the proxy advisory firm would have to (1) disclose conflicts of interest and the steps taken to address them; (2) adopt procedures to make proxy advice available to the public companies that are the subject of the advice at or prior to the time that the advice is disseminated to the proxy adviser’s clients; and (3) establish a mechanism to inform clients of the public company’s response to the advice before the applicable shareholder meeting. After the change of administrations in 2021, the SEC amended this rule in 2022 to rescind the latter two conditions.

Decision

The court held that the ordinary meaning of "solicit" at the time of Section 14(a)’s enactment does not reach proxy voting advice for a fee and that the Exchange Act 's history and purpose do not support the SEC's interpretation. The court held that the SEC thereby exceeded its statutory authority in this definition and vacated the applicable portions of the 2020 amendments. In its decision, the court cited investors’ growing reliance on proxy advisory firms as one of its primary considerations, with Judge Amit P. Mehta noting that “[r]eliance on proxy advisory firms, and their impact on vote outcomes, has steadily grown over the past 25 years.”³ Nonetheless, the court grounded its reasoning in a strict textual analysis of the statute.

The immediate, practical effect of the decision is to vacate the last remaining of the three original conditions to the exemption for proxy advisory firms in the 2020 amendments, the condition that required the firms to disclose conflicts of interest and the steps taken to address them. In the longer term, if the decision stands and/or is upheld on appeal,⁴ it will limit the ability of the SEC in the future to use the definition of proxy solicitation as a jurisdictional mechanism to regulate proxy advisory firms.

The authors would like to thank Sarah Yan for her contributions to this OnPoint.

1. Institutional Shareholder Services, Inc. v. SEC, (D.D.C. Feb. 23, 2024).
2. 17 C.F.R. § 240.14a-1(l)(1)(iii)(A).
3. See, Institutional Shareholder Services, Inc. at 2.
4. As of the date of this writing, the SEC has not appealed the decision in this case.