ISS vs. SEC – Rumble in the proxy advisor jungle11.07.19
Seemingly in response to the rising influence of proxy advisors on stockholder voting procedures, the Securities and Exchange Commission (SEC) issued guidance late this summer purporting to assist investment advisers in fulfilling their proxy voting responsibilities.
In a standalone guidance release (SEC Release No. 34-86721), the SEC expanded the applicability of certain proxy rules to the advice given by proxy advisor firms, such as Institutional Shareholder Services Inc. (ISS), in three areas:
- The definition of the term “solicitation” under Rule 14a-1(l) under the Securities Exchange Act of 1934, as amended (Exchange Act) includes a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” The Guidance states that the definition of “solicitation” found in Rule 14a-1(l) encompasses proxy voting advice. The Guidance also makes clear the SEC’s view that a solicitation may even be made in cases where the proxy advisor is indifferent to the outcome of the solicitation, or in instances where the proxy advice is tailored to a particular recipient or investor.
- The SEC’s staff is recommending that the SEC provide further rule amendments to address proxy advisory forms’ reliance on the proxy solicitation exemptions set forth under Rule 14a-2(b) of the Exchange Act.
- The August Guidance also indicates that solicitations (including those made by proxy advisor pursuant to the August Guidance) are subject to Rule 14a-9 of the Exchange Act’s prohibitions on false or misleading statements and/or omissions, including those solicitations that are otherwise exempt from Exchange Act filings under Rule 14a-2(b).
It’s important to note that the SEC views guidance such as the August Guidance to be nonbinding and not enforceable by the SEC or others. Even though the August Guidance has been adopted by the SEC, it is still considered by the SEC to be merely interpretive and therefore not subject to the notice-and-comment requirements of the Administrative Procedure Act (APA), which would accompany a rule or regulation being adopted by the SEC.
Regardless, on October 31, ISS filed suit against the SEC and Chairman Walter Joseph “Jay” Clayton III in his official capacity, alleging that the August Guidance was substantively tantamount to the adoption of a rule (and should have followed the corresponding notice-and-comment procedures required for rule adoptions). ISS’ complaint further alleges:
- The August Guidance exceeds the SEC’s statutory authority under the Exchange Act.
- The provision of proxy advice is not a proxy solicitation and cannot be regulated as such.
- The August Guidance is arbitrary and capricious because, even though it marks a significant change in the regulatory regime applicable to proxy advice, the SEC has denied that it is changing its position at all. The agency has thus flouted the basic requirement of reasoned decision-making by not disclosing awareness that it is changing its position.
ISS’s case is before Judge Amit P. Mehta in the U.S. District Court for the District of Columbia, Civil Docket Number 1:19-cv-03275-APM.
The SEC has not yet filed a response. However, the SEC may take the position that the complaint fails to state a claim upon which relief may be granted because the August Guidance is nonbinding and therefore not subject to the APA’s requirements. All three counts in the complaint – that the August Guidance is contrary to the law, that it fails to follow notice and comment procedures, and that it is arbitrary and capricious – are tied to the APA, 5 U.S.C. § 706.
A motion to dismiss on the grounds that the APA is inapplicable would necessarily raise important questions of administrative law: can the District Court for the District of Columbia override the SEC’s view? Who is better positioned to interpret the SEC’s own guidance than the SEC? How should the District Court interpret precedent from the D.C. Circuit that “an agency may not escape the notice and comment requirements . . . by labeling a major substantive legal addition to a rule a mere interpretation”? See Appalachian Power Co. v. E.P.A., 208 F.3d 1015, 1024 (D.C. Cir. 2000).
If the District Court agrees with the SEC that the guidance is nonbinding and not enforceable, ISS cannot obtain injunctive relief: there would be no direct and concrete harm to ISS for which relief may be granted. If the District Court agrees with ISS, on the other hand, that the APA applies, it could significantly limit the scope of the SEC’s power to issue regulatory guidance to proxy advisory firms.
The SEC upped the ante on this issue on November 5, 2019, issuing Release No. 34-87457, which among other proposed rule changes, would modify:
- Rule 14a-1(l)’s aforementioned definition of the terms “solicit” and “solicitation,” to specify the circumstances when a person who furnishes proxy voting advice will be deemed to be engaged in a solicitation subject to the proxy rules.
- The exemptions relied upon by proxy advisors under Rule 14a-2(b), three new requirements: to disclose material conflicts of interest in their proxy voting advice, provide the company about which the advisor is providing advice with an opportunity to review and comment on their advice before it is issued, and, if requested by the company, include in their voting advice a hyperlink leading to a written statement that sets forth the company’s position on the advice.
- Rule 14a-9 to include examples of when failing to disclose certain information in the proxy voting advice would be considered misleading.
It remains to be seen whether the ISS will update its lawsuit to include mention of these proposed rules. ISS’s case is also noteworthy in that it is at least the second time this year that a private company has sued the SEC in an attempt to stop an SEC regulatory action.
In February of this year, the three largest U.S. stock exchanges sued the SEC in an effort to stymie the SEC’s attempts to limit the fees that exchanges can charge for trading on such exchanges. It’s possible that these lawsuits have been encouraged by the Loan Syndication and Trading Association’s successful lawsuit against the SEC and the Federal Reserve relating to the retraction of risk limitations on collateralized loan obligation managers. It will be interesting to see if ISS (and/or the largest stock exchanges) are successful in their historic lawsuits against their own federal regulator.