A Federal District Court has just held invalid the SEC’s rule regarding proxy advisory firms. The case dates back to 2019(!), when ISS sued the SEC and then-SEC Chair Jay Clayton in connection with the SEC’s interpretive guidance that proxy advisory firms’ vote recommendations were, in the view of the SEC, “solicitations” under the proxy rules and subject to the anti-fraud provisions of Rule 14a-9. (See this PubCo post.) Rules confirming that interpretation were adopted in 2020. In its amended complaint, ISS contended that the interpretation in the release and the subsequent rules were 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. Now, after 1576 days, the DC District Court has 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.”
Background
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.) 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 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, viewed favorably by many companies and business organizations—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. The case was then reactivated and both parties filed for summary judgment. (See this PubCo post).
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. 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. (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 have considered a core element of the 2020 amendments.) 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. A decision from the DC District Court has just been rendered.
Opinion
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.” 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.”
In its complaint, ISS argued that, “when Congress enacted Section 14(a) in 1934, the ordinary meaning of ‘solicit’ was to “[i]nvite, make appeals or requests to, importune.” Applying this definition to Section 14(a), ISS asserted that “the words ‘solicit any proxy’ in Section 14(a) ‘plainly refers to actions taken by a person who seeks to achieve a certain outcome in a proxy vote.’” Accordingly, ISS contended, proxy advisory firms don’t “solicit” proxies because they “do not seek to support one side or the other in a contested proxy vote and are indifferent to the ultimate outcome of the vote.” The SEC, on the other hand, asserted that the term “solicit” is “inherently vague” and that it could also have a broader meaning of “to move to action.” The SEC argued that this alternative meaning “captures the act of giving advice to influence a client’s voting decisions in exchange for a fee,” and does not require “an interest in obtaining a particular outcome.” The SEC further argued that recent cases support the proposition that “proxy solicitations” do not necessarily “request or seek to obtain anything.” NAM argued that, given that ISS also casts votes for some shareholders, it is not a “mere neutral advisor but seeks to achieve a certain outcome.”
After a lengthy examination of various historical dictionary and judicial definitions, the Court ultimately disagreed with the SEC’s interpretation, reasoning that, although “‘a definition is broad enough to encompass one sense of a word[, it] does not establish that the word is ordinarily understood in that sense.’” Acknowledging that, in some circumstances, courts have viewed “communications that on their face did not seek to provide, withhold, or revoke a proxy” to nevertheless be “covered ‘solicitations,’” the Court emphasized that “none of these cases involved a communication by a disinterested individual,” and none 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 the ISS’s position “better reflects the purposes and history of Section 14(a).” The focus of Congress in adopting Section 14(a), the Court said, “was to promote transparency and the exchange of complete and truthful information by and among interested parties seeking to obtain proxies in connection with a shareholder vote.” But here, the “regulation of proxy voting advice as ‘solicitation’ would seem to do little to advance these legislative purposes.” Because proxy advisors are hired by a shareholder, “the risk that a proxy advisor’s advice will deceive or mislead an ordinary, non-client shareholder is minimal.” And because “they have no financial or governance interest in the outcome of a vote,” [t]heir advice will be tailored to the client’s interests, not their own. This puts proxy advisors is a very different posture vis à vis the ordinary shareholder compared to, say, management or an activist investor.”
Applying the Chevron test (the ongoing viability of which is currently a big question mark before SCOTUS, see this PubCo post), the Court held,
“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. By defining the terms ‘solicit’ and ‘solicitation’ in the proxy rules to include proxy voting advice for a fee,…the SEC acted contrary to law and in excess of statutory authority…. Accordingly, the court grants summary judgment in favor of Plaintiff as to Counts I and II, denies the SEC’s and NAM’s cross-motions, and vacates the definitional amendment codified at [Rule 14a-1(l)(1)(iii)(A) regarding proxy advice as a solicitation].”
A representative of NAM told Bloomberg that “her group is considering an appeal. ‘The court has sided with conflicted third-parties that exercise outsized influence over manufacturers’ corporate governance decisions—and undermined the SEC’s obligation to protect investors and provide certainty for businesses.’” The SEC told several news outlets that it was “still reviewing the decision.”
It’s worth noting that in footnote 1, the Court graciously apologized “to the parties and counsel for the length of time it has taken to issue this decision.”
