In December last year, the Federal District Court for the Western District of Texas issued an Order granting summary judgment to the SEC and Chair Gary Gensler and denying summary judgment to the National Association of Manufacturers and the Natural Gas Services Group in the litigation surrounding the SEC’s adoption in 2022 of amendments to the rules regarding proxy advisory firms, such as ISS and Glass Lewis.  Those 2022 rules reversed some of the key controversial provisions governing proxy voting advice that were adopted by the SEC in July 2020 and favored by NAM.  NAM’s complaint, filed in July last year, had asked that the 2022 rules be set aside under the Administrative Procedure Act and declared unlawful and void, and, in September, NAM filed its motion for summary judgment, characterizing the case as “a study in capricious agency action.” The District Court begged to differ, and NAM appealed. This week, a three-judge panel of the Fifth Circuit heard oral argument on NAM’s appeal. Let’s just say that the Court didn’t appear to be particularly 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.”


For years, many companies and business lobbies, such as NAM, 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 postthis 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. In September 2019, the SEC 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 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 advisors and “solicitations.”  In addition, the SEC adopted two new conditions to the exemptions from those rules for proxy advisors, which required disclosure of conflicts of interest and adoption of principles-based policies designed to facilitate effective engagement between proxy advisors and the companies that are the subjects of their advice proxy voting advice by making the advice available to the subject companies when sent to clients and providing a mechanism for clients to become aware of company responses. Compliance with the new conditions was not required prior to December 1, 2021. (See this PubCo post). 

In June, soon after assuming his position as SEC Chair, 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. Then, following a notice-and-comment process, the SEC adopted new amendments to the proxy advisor rules reversing some of those key provisions governing proxy voting advice that were adopted in July 2020.

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 a 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.  As summarized in the order by the District Court, 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.)

NAM then filed the complaint at issue here, contending that the 2022 rules were “both procedurally defective and arbitrary and capricious, and therefore must be set aside under the Administrative Procedure Act (APA). “The agency,” 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.” NAM’s motion for summary judgment was then filed in September and the SEC’s cross-motion in October. In its motion, 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.” What’s more, when it issued the new proposal in November, NAM highlighted, the SEC provided only a 31-day public comment period, which took place over the holidays. NAM contended that the 2022 rules should be set aside under the APA because the SEC “erred in several independent respects: In abruptly reversing course, the SEC improperly disregarded its earlier factual findings that contradict its new action; the SEC’s reasoning is demonstrably irrational; the SEC failed to address significant criticisms leveled by commenters and dissenting Commissioners; and the SEC denied the public a meaningful opportunity to comment.”

The District Court granted the SEC’s motion for summary judgment and denied NAM’s motion. NAM had contended that, under the “arbitrary and capricious” standard, the SEC must provide a “‘more detailed justification’ than normal because the 2022 Rescission reversed a prior policy decision.” As explained by the District Court, the standard for “arbitrary and capricious” enunciated by SCOTUS is whether the “agency examined ‘the relevant data’ and articulated a ‘satisfactory explanation.’ A ‘satisfactory explanation’ includes a ‘rational connection between the facts found and the choice made.’” Normally, that standard would apply unless the change in policy rested on new factual findings.  But the SEC contended that it “merely weighed the same risks that the 2020 Rule did but reached a different conclusion”; in 2020, it had concluded that the rules posed little risk to the timeliness and independence of proxy advisors, but in 2022, it concluded that there were potential adverse effects sufficient to tank those aspects of the 2020 rule.  The District Court concluded that the SEC “did not contradict prior factual findings and was not required to provide a more detailed justification.”

The Court also concluded that the stated justifications were rational. As described by the District Court, the SEC gave two reasons for its policy change: first, to alleviate the costs to proxy advisors and companies of the 2020 rules and, second, to address the concerns of clients and investors about proxy advisors’ timeliness and independence. In light of public comments indicating that the company engagement provisions increased costs “without corresponding investor protection benefits,” the District Court found that the SEC’s “reasoning rationally connected the facts (the increased compliance costs) to its conclusion (rescinding the 2020 rule would alleviate those costs).” In addition, the Court concluded, in light of the “continued, strong opposition” in the public comments, rescinding those provisions of the 2020 Rules “was ‘rationally connected’ to the public commentators’—and the Commission’s—concerns that such conditions posed a risk to the timeliness and independence of [proxy advisors].”

The District Court also made short shrift of NAM’s argument that the SEC’s 30-day comment period was too short and did not provide a “meaningful opportunity for comment.”  The District Court observed that the APA does not specify a time period, but notes that SCOTUS has consider the comment period under the APA to be a minimum of 30 days, a standard that has also been followed in the Fifth Circuit. The District Court stated that it would not introduce its own policy preferences about what is a ‘meaningful opportunity,’” and found that the 2022 rules were not procedurally deficient.

“Like it or not,” the District Court concluded, “changing political winds may factor into an agency’s policy preference. But ‘a court may not set aside an agency’s policymaking decision solely because it might have  been  influenced  by  political  considerations  or  prompted  by  an  Administration’s priorities.’ The Commission’s 2022 Rescission need only to have been within ‘the bounds of  reasoned  decision  making.’ As  explained  above,  it  was.” Accordingly, the District Court  granted the SEC’s motion for summary judgment. (See this PubCo post.)

Oral argument before the Fifth Circuit

[Based on my notes, so standard caveats apply.]

NAM opened by reminding the Court that proxy firms wield considerable influence and have been described as “force multipliers” on ESG issues.  NAM contended that the SEC’s rescission of the 2020 rules was unlawful for three reasons: it was based on a direct contradiction of prior findings without doing what is necessary for an agency to change its position; the justifications given were arbitrary and capricious on their face; and it was procedurally unlawful.

In NAM’s view, to reverse the rule based on a change of prior factual findings requires a much more detailed justification than the SEC provided of why the prior view was mistaken.  The SEC’s 2019 proposal was roundly criticized for risking timeliness and independence, but in response to the those comments, the SEC had modified the final rule so that those risks were no longer issues in the final 2020 rule.  NAM pointed to numerous statements that the timeliness and independence risks, including issuer engagement, were not material risks under the 2020 final rules.  Agreeing with NAM, Jones questioned how there could be a timeliness  concern—didn’t the rule just require a proxy advisor to push a button to “hit send” to provide the required notice to issuers at or before sending its advice to clients? How does that make timeliness an issue?

The District Court had concluded that because the SEC had not contradicted prior factual findings, it was not required to provide a more detailed justification. On appeal, NAM contended, notwithstanding the SEC’s contention that the reversal was not based on changes in the fact-findings, that the determination of whether the rule created a risk to timeliness or independence is a factual determination—a predictive factual judgment—not just a policy decision, in line with earlier caselaw.  If that’s the case, the SEC should have provided substantive reasons for the change. Instead, NAM contended, the SEC was just recycling arguments from the 2019 proposal, which predated the 2020 changes, and didn’t provide much in the way of quantitative detail about the “aggregate burden” and its potential effect.   The 2020 rule went into great detail explaining the burden; the 2022 rule didn’t really provide much in the way of quantification, NAM maintained.

NAM also questioned whether the modified rule adopted in 2020 really did still create independence concerns. In Jones’ (somewhat cynical?) rendition of the SEC’s argument, the possible need to respond to issuer arguments and criticism could “stultify decision-making” in advance, and thus impair independence. NAM maintained that the proxy firms are criticized regardless of the rule. And there were problems with conflicts of interest and the quality of advice—that’s why the SEC adopted the reforms in 2020. And isn’t criticism the whole point of the rule, Jones asked, to provoke dialogue?  

Finally, NAM argued that the 30-day comment period was inadequate, and that, if the Court affirmed the use of 30 days in this case—with the comment period stretching over the holidays—it would effectively create a safe harbor under the APA that 30 days is a “meaningful opportunity.”  Here, there was inadequate time for commenters to provide supportive quantitative data, and a requested extension of time was denied. At this point, Jones asked whether the litigation about the SEC’s non-enforcement decision (see the SideBar above) had yet commenced; if so, she suggested, that might well be a reason for the brevity of the comment period—to quickly adopt new rules and undermine the case before the district court.

In its presentation, the SEC observed that reasonable people can and do disagree about the notice and awareness provisions in the 2020 rule, stemming from different reasonable judgments about how to weigh the conditions’ uncertain and unquantifiable benefits and risks. In 2022, the SEC provided good reasons for weighing the interests differently than the SEC had done in 2020, particularly in light of the strong objections from the vast majority of clients of proxy advisors about the burdens on timeliness and independence.

How could they know, Jones asked, since the rule never went into effect? All the proxy advisor needs to do is press that send button. How is that a burden, she asked? But that’s just the notice condition, the SEC responded, not the awareness condition, which would require a monitoring process for thousands of recommendations. But again, Jones asked, if the issuer files a response, doesn’t the proxy advisor just need to press a button to alert its clients to the SEC filing?

The SEC responded that, even in 2020, the SEC acknowledged that the timeliness risk still existed, even if mitigated. Jones was implicitly critical of the absence of detailed explanation by the SEC in the 2022 rule—only 20 pages compared to the 80 pages in 2020. And, in her view, the 2022 rule just parroted the earlier contentions about timeliness and independence. But in 2020, she said, the SEC believed that it had addressed those issues by requiring that the notice to issuers be delivered only “at or before” the advice is sent to clients, instead of the original requirement to allow issuers an advance preview.  It didn’t make sense to her to undo the whole process developed in the 2020 rule because of this one thread that the SEC pulled. In addition, the SEC had acknowledged that there weren’t a lot of proxy advisor errors anyway. So just what is the problem with timeliness, she asked? It seemed irrational to her. Judge James Ho likened the process to lawyers now being required to send emails to the courts. 

The 2020 release, the SEC argued, concluded only that the changes would result in fewer disruptions, not that they were eliminated.  The SEC did not make any finding about the magnitude of the disruption risk because it was uncertain. In 2022, the SEC was simply weighing those unquantifiable risks and benefits differently to make a different policy call.  The 2022 economic analysis explained the economic effects of the rule and the anticipated risks to timeliness and independence that had been mitigated but not eliminated. Those were the risks the SEC was addressing. With regard to the burden of notice and awareness, the SEC differentiated the proxy advisor rule by noting that the proxy advisors were required to implement systems for monitoring issuer responses.   With regard to independence, the analysis explained that the burdens imposed may cause proxy advisers to err on the side of caution in contentious matters, potentially eroding the integrity of the advice and causing its clients to lose confidence.

Jones observed that this process of trying to put more democracy and transparency into the process had been going on for ten years. That was ten years of discussion and debate but not consensus, the SEC responded.  The point, she contended, was to level the playing field between proxy advice, which may be in favor of goals and purposes that were “inimical to shareholder value maximization,” and the issuers’ ability to be informed of that advice and to counter it. “But you’re saying,” she added mockingly, “Oh my, I clutch my pearls! They may have to spend a little more time monitoring responses to their proxy advice, so the whole idea of notice to inspire rational debate falls by the wayside.”

The SEC said that it was simply listening to the same voices that caused the 2020 changes to the 2019 proposal, but then expressed concern that the 2020 rule did not go far enough. The SEC looked at the same benefits and risks and just came out with a different policy conclusion.  He noted that proxy advisors were still subject to significant regulation, such as liability for material omissions—the rescission here just related to one particular regulatory intervention.

Jones then turned to the 30-day comment period, asking how many rules the SEC had proposed with a 30-day comment period over the holiday season? The SEC responded that there were certainly other targeted rules modifying prior policies with the same comment period; the SEC chose that period because of the targeted nature of the rule and because there was no need for an entirely new record.   Jones pointed out that none of the identified rules were from the SEC and that the rule received only 10% of the number of comments received on the earlier version.

Jones then asked the SEC about the status of the non-enforcement litigation, which was underway at the time of the 2022 rulemaking, implicitly suggesting that the SEC was rushing this rule change to undermine that litigation. The SEC responded that NAM did not raise that issue. (Note, however, that later in the hearing, NAM noted that the 2022 release did include a footnote suggesting that the rule change would render the litigation moot, so, he suggested, there probably was some relationship.)  Jones had this response: Well, I understand that, but “we’re in a markedly unusual time in the administrative state where various administrations seem to have a policy of pulling in new rulemakings every time they get challenged in court, and this is not something that courts have had to deal with.”

The SEC responded that rule changes following a change in administration are common and happened in the last administration too; the courts have said that agencies may make those types of changes as long as they go through notice and comment and provide a reasoned explanation. The SEC did that here. In addition, NAM had not shown that it was harmed by the 30-day period. But they asked for more time to provide data but were refused, Jones observed.  No party has come forward with any quantitative evidence, the SEC responded; there was no data provided in 2020 either. Ho asked why give only 30 days for the rescission but 60 for the original rule?  The SEC responded that these issues were ventilated in the prior broader rulemaking and this was a narrower rulemaking.  The SEC was just revisiting the balance of interests and did not need to develop an entire new factual record.  The SEC considers comments submitted following the end of the comment period, and there were only a trickle of comments at the end, suggesting there was not a huge pent-up demand.

Jones then made an interesting big-picture observation: “The whole point of administrative agencies,”  she said, “is that they are supposed to be disinterested and experts, but the trend in today’s administrative world—and we’ve now had three administrations affected by this trend—is that there is one change in the balance on the commission, and suddenly the experts have a different view and the former disinterested advice is not today’s disinterested advice.  So we’re now in a Kafkaesque world. It undercuts the whole idea of the administrative state.”   The SEC countered that this has happened for many years. As the cases have shown, agencies can change their minds on difficult or controversial issues—there’s nothing nefarious or surprising about it.

Then, of course, ESG made an appearance, as Jones suddenly shifted to a new issue: whether any comments on the 2022 rule discussed the importance of proxy advisors providing advice on ESG issues? She was just wondering what the legal basis was for incorporating any ESG concerns into SEC regulations?  But the SEC responded that ESG was not an issue raised in this case and offered no opinion. 

The SEC concluded that, while NAM argued that the SEC made a definitive finding in 2020 that the rule did not raise any risks at all, in fact, those risks were only mitigated;  distinct risks remained that were cited in 2022.  The SEC just made a policy change based on a different balancing of those uncertain risks and benefits and gave reasons why it came out differently.

NAM concluded that the APA was designed to have a stabilizing effect on agencies.  To make  a change requires a reasonable explanation of why prior factual determinations were mistaken, which the SEC did not provide. Contrary to the SEC’s contention, any risk that remained after 2020 was not significant.  In addition, NAM did not see the risk to timeliness and independence remaining—the SEC provided no rational articulation of how those risks were posed. Accordingly, in the absence of any substantive rationale for the change, the rulemaking was arbitrary and capricious.

Posted by Cydney Posner