October 25, 2021

NAM sues SEC over decision not to enforce proxy advisory firm rules

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For years, many companies and business lobbies, such as the National Association of Manufacturers, 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.) In July 2020, the SEC adopted, by a vote of three to one, new amendments to the proxy rules regarding proxy advisory firms. At the time of adoption of the new rules, then-SEC Chair Jay Clayton observed that the final rules were the product of a 10-year effort—commencing with the SEC’s 2010 Concept Release on the U.S. Proxy System—which led to “robust discussion” from all market participants. Commissioner Allison Herren Lee, who dissented, objected to the rule changes as “unwarranted, unwanted, and unworkable.” When new SEC Chair Gary Gensler was confirmed, he asked the SEC staff to take another look at the rule amendments, and Corp Fin stated that, during the reconsideration period, it would not recommend enforcement action. Now, as reported on thecorporatecounsel.net blog, NAM has just announced that it has filed suit in federal court against the SEC for failure to enforce its final rules on proxy advisory firms.

Whether and how to regulate proxy advisory firms, such as ISS and Glass Lewis, 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. In September 2019, the SEC published in the Federal Register a new interpretation and guidance directed at proxy advisory firms 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.) The proxy advisory firms were not happy with the new interpretation and guidance, leading one, ISS, to sue the SEC. (See this PubCo post.) Then, in 2020, the SEC adopted amendments to the proxy rules that codified the SEC’s interpretation regarding proxy advisory firms and “solicitations.” In addition, the SEC adopted two new conditions to the exemptions from those rules for proxy advisory firms, which requires disclosure of conflicts of interest and adoption of principles-based policies to make proxy voting advice available to the subject companies and to notify clients of company responses. The original proposal generated substantial comment and criticism, and the SEC took much of it into account in developing the final rule, which only “encourages” what had been imperative in the proposal—namely that proxy advisors conduct a review and feedback process with issuers. Compliance with the new conditions was not required prior to December 1, 2021. (See this PubCo post).

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At the time of adoption of the new rule amendments, Commissioner Elad Roisman, who had honchoed the proxy-process rulemakings through the SEC, said that there had been growing calls for the SEC to provide more oversight of proxy advisors as institutional ownership of the public markets had “increased to unprecedented levels and rendered the voting advice sold by proxy voting advice businesses more widely consumed—and influential—than ever before….Advocates for reform have argued that new regulations are needed to address conflicts of interests, factual errors, and methodological biases in these businesses’ proxy voting advice.” Commissioner Hester Peirce approved of the final rules as a “measured” change, which achieved the SEC’s “objective of ensuring that investors and their advisers who rely upon proxy voting advice are provided with more transparent, accurate, and complete information. The rules achieve this goal without imposing unduly burdensome requirements on proxy voting advice businesses given the significant time constraints of the proxy voting process.”

Commissioner Lee contended that the new rules would “increase issuer involvement in what is supposed to be independent advice from proxy advisory firms. The release still wholly fails to explain how amplifying the views of issuers will improve the substance of proxy voting recommendations. The final rules will still add significant complexity and cost into a system that just isn’t broken, as we still have not produced any objective evidence of a problem with proxy advisory firms’ voting recommendations. No lawsuits, no enforcement cases, no exam findings, and no objective evidence of material error—in nature or number. Nothing.” Lee also noted her objection to the codification of “a new interpretation of what it means to solicit a proxy under Exchange Act Section 14(a) that departs from the Commission’s historical interpretation of that term. The interpretation largely ignores the significance the Commission has traditionally given to the distinction between solicited and unsolicited advice.” Although the final release reflected modifications in response to public comment (46 in favor, 159 in opposition), to Lee, all the changes did was make the rules less objectionable, but still didn’t justify it; the final rules may be “less prescriptive in terms of issuer intervention,” but much of that flexibility “is abrogated by the safe harbors which, as is well understood, will become the de facto rules.”

In June, soon after assuming his position, new SEC Chair Gary Gensler directed the staff to consider whether to recommend further regulatory action regarding proxy voting advice. In his statement, Gensler highlighted his direction that the staff consider “whether to recommend that the Commission revisit its 2020 codification of the definition of solicitation as encompassing proxy voting advice, the 2019 Interpretation and Guidance regarding that definition, and the conditions on exemptions from the information and filing requirements in the 2020 Rule Amendments, among other matters.” As a result, Corp Fin issued a Statement indicating that “it will not recommend enforcement action to the Commission based on the 2019 Interpretation and Guidance or the 2020 Rule Amendments during the period in which the Commission is considering further regulatory action in this area.” (See this PubCo post.)

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At the time of the Corp Fin statement, Commissioners Peirce and Roisman issued a separate Statement questioning this action, indicating that, while they were “open to seeing what, if any, changes to our rules the staff recommends and to working with our colleagues to consider such recommendations,” they were perplexed as to “what has changed in the roughly ten months since the Commission last considered this issue that would call into question such recently adopted requirements. Indeed, the compliance date for the exemption conditions is still months away, which makes it challenging, if not impossible, for us to know how these requirements will work in practice. How can we evaluate the appropriateness of further changes without considering such new data or experience? We find it even harder to understand how the Commission would justify a departure from its longstanding legal interpretation about proxy solicitation.”

Acknowledging that some groups were displeased with the rules, they nevertheless believe that the SEC’s rulemaking “was beyond reproach. During the years-long rulemaking process, the Commission considered all policy arguments, including those in opposition to the proposed amendments. The rule’s adopting release discusses the Commission’s analysis of these points in the context of the rule’s entire administrative record. The rule we adopted reflected the broad range of input we received on the proposal.” They hoped that any future SEC action “will not deprive users of proxy voting advice of information they need to properly consider such advice or lead them to make decisions based on misinformation.”

The complaint filed by NAM (and another plaintiff, Natural Gas Services Group, Inc.) contends that proxy advisory firms—and specifically ISS and Glass Lewis—“wield outsized influence on proxy voting.” Moreover, the complaint claims, there have been “grave concerns” about whether they “harbor significant conflicts of interest,” lack transparency regarding the development of their corporate governance standards and routinely provide “investors and other proxy voters with false and misleading information. This creates an unacceptable potential for critical corporate decisions to be made on the basis of inaccurate or incomplete facts. And proxy advisory firms have frequently been unwilling to issue corrections even when they are notified of errors in their reporting.” In support of its contention regarding inaccurate information, the complaint cites, among other things, surveys of CEOs from 2013 and 2018, demonstrating that “nearly all respondents had ‘found one or more factual errors in reports prepared by proxy advisory firms about their companies.’….Moreover, ‘[t]he 2018 survey results further indicate that although 90 percent of companies notify the proxy advisory firms of the errors, only 8 percent of companies find that the errors are consistently corrected.’” NGS is cited in the complaint as having been “the subject of repeated materially misleading or factually incorrect proxy advice from proxy advisory firms. Indeed, NGS has been forced to file supplemental proxy statements in response to this misleading proxy advice in seven of the past eight annual proxy seasons, often on unreasonably short timeframes.” At the same time, the complaint states, NGS has “received repeated solicitations and marketing materials from ISS’s corporate governance consulting arm.” The complaint argues that conflicts could arise regularly when a proxy advisory firm provides voting advice about a company from which it earns fees for consultation work on corporate governance and compensation policies. The plaintiffs cites a 2016 empirical study, which concluded that proxy advisory firm “conflicts regularly occur in practice and have negative real-world consequences for shareholder value.”

The compliance date set by the SEC would have required proxy advisory firms to comply with the new rules for the Spring 2022 proxy season. But after the new SEC Chair was confirmed, the complaint charges, the SEC “abruptly changed course” and “suspended” compliance. NAM charges that the suspension “immediately harms publicly traded companies and their shareholders, precluding them from receiving the disclosures that the SEC earlier determined were essential to protect the public markets.”

Moreover, NAM claims, the suspension “is flatly unlawful. The SEC may not decide that it no longer stands by a regulation it earlier lawfully promulgated, and—absent any rulemaking process—simply suspend its application. To the contrary, the procedural provisions of the Administrative Procedure Act (APA) exist precisely to bring regularity to agency action.” To revise or suspend a regulation, NAM asserts, the APA requires the SEC to engage in the notice-and-comment process. But the SEC did not follow that process and, as a result, “its attempt to unilaterally suspend the Proxy Advice Rule is unlawful. The Court should therefore set aside the SEC’s illegal action.”

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