At the beginning of June, the U.S. Securities and Exchange Commission (“SEC”) Division of Corporate Finance, at the direction of SEC Chair Gary Gensler, announced that it is re-examining Trump-era proxy adviser interpretation and rules that it had issued over the past two years. The SEC also stated that it will not be recommending enforcement actions against proxy advisers arising out of those rules during the period in which the SEC is considering further regulatory action in this area.
In 2019, the SEC issued interpretation and guidance stating that voting advice provided by proxy firms should be considered a “solicitation” under federal proxy rules (making proxy firms potentially liable for materially misleading or false statements) and anti-fraud rules and regulations should apply to that advice. (For additional background and information, see our 2019 article on this subject.) This interpretation and guidance sparked a partisan debate among the Commissioners. Republican Commissioners supported the interpretation, as they were concerned that proxy firms had become too influential in shaping corporate governance without sufficient regulation. Democrats were opposed because they feared the rules were seeking a solution to a problem that did not exist, would suppress the free and full exercise of shareholder voting rights, and would harm investors’ ability to obtain unbiased advice and hold corporate executives accountable.
In 2020, the Commissioners passed the SEC’s 2019 interpretation in a 3-1 vote, with lone Democrat Commissioner Allison Herren Lee casting her vote in opposition. In a public statement of dissent, Commissioner Lee highlighted that there was no evidence that there was a problem with proxy advisory firms’ voting recommendations and therefore the rules added unnecessary complexity and cost into a system that was working. She also underscored that there was almost universal opposition from investors, the supposed beneficiaries of the rules. Nonetheless, in the waning months of the Trump administration, the rules were enacted and codified in a package that also required proxy advisers to provide more robust disclosures on potential conflicts of interest and permitted companies additional leeway to review and respond to proxy firms’ recommendations prior to shareholders voting. (For additional information on those recent rules, see our 2020 article on the subject.) The SEC’s rules became effective on November 2, 2020, but they did not require proxy firms to be compliant with them until December 1, 2021.
There was concern that these rule changes would have introduced delay and uncertainty into the proxy advisory process, where firms would have been required to provide clients with notice of multiple events, including conveying management’s views on proxy recommendations to clients, effectively requiring consideration of those corporate rebuttals prior to voting. This would have made it harder and more costly for shareholders to cast their votes, especially in reliance on independent and unbiased advice, which in turn would have made it more difficult for investors to hold management accountable.
As a result of these new rules, proxy firms—including the two largest, Institutional Shareholder Services Inc. (“ISS”) and Glass, Lewis, & Co. (“Glass Lewis”)—were facing the possibility of being hampered in their efforts to effectively advise institutional investors on how to vote on everything from merger proposals to CEO pay to climate and diversity policies for companies in which their clients were invested. Therefore, in response to the proposed rule changes, ISS sued the SEC in 2019 alleging that the new guidance and rules could increase compliance costs and make ISS vulnerable to litigation by regulators and public companies. Following the SEC’s recent announcement that it would not be bringing enforcement actions on the rules and was considering further regulatory action, the lawsuit has been held in abeyance until either the SEC revisits the rules or December 31, 2021, whichever comes first. In seeking to suspend the matter, the SEC stated that further regulatory action could “substantially narrow or eliminate” the issues in dispute.
ISS and Glass Lewis were not the only entities that welcomed the SEC Division of Corporate Finance’s recent announcement. Groups representing institutional investors lauded the SEC for signaling a change of course on the new proxy adviser rules. Council of Institutional Investors Executive Director Amy Borrus cheered, “[I]t’s Christmas in June for investors,” explaining that “institutional investors, who are the paying clients of proxy advisory firms, did not seek [the rule change], nor did they support it.” Dennis Kelleher, president of the advocacy group Better Markets, said, “The actions by Trump’s SEC were wrong and likely illegal. Given that the SEC exists to protect investors, not incumbent management, today’s actions properly begin the process to restore investors’ rights and re-empower investors.”
Some business groups, including the U.S. Chamber of Commerce’s Center for Capital Market Competitiveness and the National Association of Manufacturers (“NAM”), were less enthusiastic. “This rule was developed after years of debate and multiple rounds of public comment, and there is no justification for repealing it less than a year after finalization without any chance for its vital investor protections to take effect and be fairly evaluated,” said Aric Newhouse, NAM’s senior vice president of policy and government relations.
While the proxy adviser rules remain in flux, a fresh look provides another opportunity to weigh the fairness of the rules and strive to strike the right balance where investors are better advised and protected.