Securities Regulation Daily CII backs Institutional Shareholder Services suit to vacate SEC regulations and guidance on proxy advisers
Wednesday, October 14, 2020

CII backs Institutional Shareholder Services suit to vacate SEC regulations and guidance on proxy advisers

By Mark S. Nelson, J.D.

The CII reiterated its prior claim that the SEC lacked evidence that the proxy advisory process had produced a significant number of errors that would justify additional regulations.

The Council of Institutional Investors has filed an amicus brief in a case in which Institutional Shareholder Services Inc has challenged the validity of the Commission’s final proxy advisory regulations and related guidance. The CII focused on the lack of sufficient evidence to justify the new regulations and guidance. The SEC is due to respond to the amended ISS complaint by the end of October (Institutional Shareholder Services Inc. v. SEC, September 18, 2020).

SEC proxy guidance and final rules. In September 2019, the Commission issued an interpretive release expressing its views on when a proxy advisory communication may be a solicitation under Exchange Act Rule 14(a). The interpretive release stated that the answer to this question depends on the facts and circumstances, especially the "specific nature, content, and timing" of the communication. The Commission also cited multiple examples of when such communications (or a subset of communications) might be solicitations. The Commission further observed that Exchange Act Rule 14a-9’s prohibition on materially false or misleading statements could apply to these communications.

Nearly a year later, the Commission adopted a comprehensive regulation for proxy voting advisers. That release also clarifies when proxy voting advice is a solicitation and makes Rule 14a-9 applicable to proxy voting advice to the extent that a proxy adviser fails to disclose material information regarding proxy voting advice, such as information about methodology, sources of information or conflicts of interest.

ISS complaint. ISS filed a complaint in the U.S. District Court for the District of Columbia in October 2019 in which it alleged that the Commission’s interpretive release went too far and violated the Administrative Procedure Act. Specifically, ISS argued that: (1) the interpretive release exceeded the Commission’s authority and was contrary to the plain text of the applicable statute; (2) the interpretive release amounted to a substantive rule but the Commission failed to promulgate it via the APA’s notice and comment rulemaking provisions; and (3) the interpretive release is arbitrary and capricious because it signified a major change in Commission policy but the Commission denies it even changed its policy. With respect to the last item, ISS specifically questioned the Commission’s conclusion that the Investment Advisers Act is insufficient to regulate proxy advice businesses.

ISS has since amended the complaint to add numerous counts addressing the Commission’s final proxy adviser rules that were adopted in July 2020. According to ISS, both the final rules and the guidance are contrary to law and they are arbitrary and capricious. The complaint also asserts that the final rules violate the First Amendment. The amended complaint seeks to vacate and set aside the final rules and the proxy guidance.

CII amicus brief. The CII issued a press release after the Commission adopted the final proxy adviser rules, expressing relief that, in its view, the Commission dropped the most concerning aspects of the proposal but still retained provisions that could result in delays and increased costs and threaten the independence of proxy advice. Specifically, the apparent need for investor clients to review issuer responses to proxy advice before voting would be problematic, the CII said.

The CII’s amicus brief summarized its argument thus: "The amendments treat proxy advisors as if they were engaged in proxy solicitation when they are not and then, because they are not, afford advisors an exemption—but only if they satisfy conditions that will impair their independence and harm investors. In the view of amici, there is no legal or economic basis for that approach."

The CII’s brief also picked up one of the themes from its press release issued after the Commission adopted the final rules in that the CII asserts the Commission lacked any evidence that actual errors had occurred in the proxy advisory process that would justify the imposition of new regulations on proxy advisory firms. The CII said issuers and their advocates were behind the false claim that there was a high rate of such errors.

With respect to the lack of evidence, the CII brief also noted SEC Commissioner Allison Herren Lee’s dissent from the final proxy adviser regulations. Said Lee: "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."

The CII’s brief disclosed in a footnote that ISS is a non-voting associate member of the CII and that the CII and some of the other amici are ISS clients. The CII further stated that the views expressed in the amicus brief were solely those of the CII and that the brief was funded solely by CII and other amici.

The case is No. 19-cv-03275.

Attorneys: Jeffrey M. Harris (Consovoy McCarthy PLLC) for Institutional Shareholder Services Inc. Daniel Matro for the SEC. Ryan P. Bates (Bates PLLC) for amici curiae Council of Institutional Investors and others.

Companies: Institutional Shareholder Services Inc; Council of Institutional Investors

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