Feb. 26, 2024, 12:15 PM EST; Updated: Feb. 26, 2024, 2:36 PM EST

Martina Barash Reporter

Andrew Ramonas Senior Reporter

• Interpretation made voting advisors subject to proxy rules

• SEC exceeded its statutory authority, federal court rules

A 2020 SEC rule subjecting firms that offer proxy voting advice to the regulator’s authority is invalid, a federal court ruled.

The Securities and Exchange Commission “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,” Judge Amit P. Mehta said Feb. 23 for the US District Court for the District of Columbia. A 2022 SEC repeal of some proxy firm requirements under the rule was insufficient, he said.

Large institutional investors rely on Institutional Shareholder Services Inc., Glass, Lewis & Co. and other firms for advice when considering votes—typically by proxy, rather than in person—on major company issues. “Reliance on proxy advisory firms, and their impact on vote outcomes, has steadily grown over the past 25 years,” Mehta said.

The decision is a setback for business groups that are pursuing separate cases to void the SEC’s 2022 rollback and maintain its 2020 regulations. Companies long have claimed proxy firms improperly influence the results of votes on board directors and environmental, social and governance-related proposals at companies’ annual meetings. ISS and Glass Lewis, the two largest proxy firms, have disputed the allegations.

Linda Kelly, chief legal officer of the National Association of Manufacturers, which intervened in the case and is fighting to save the 2020 rule in a different legal challenge, said 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,” Kelly said in a statement.

An ISS spokesman said in a statement that the firm was “pleased” with the ruling. An SEC representative didn’t immediately respond to a request for comment.

Restrictions Loosened

The SEC issued its final rule in September 2020 interpreting the term “soliciting” proxies under the Securities Exchange Act and its implementing regulations to include providing proxy-voting advice. The change meant that public filing requirements, other documents, and anti-fraud provisions would apply to advisory firms, according to the court.

The commission loosened the restrictions in July 2022, with SEC Chair Gary Gensler saying then, “It is critical that investors who are the clients of these proxy advisory firms are able to receive independent and timely advice.” The changes removed a 2020 requirement for proxy firms to give their voting advice to their clients and companies at the same time. They also eliminated an obligation for proxy firms to make what companies said about their recommendations available to investors.

By then, ISS, one of the largest proxy advisory firms, had already sued the agency, asserting that its business doesn’t involve seeking proxy authority or asking shareholders to vote a certain way.

At the time of the 2022 SEC vote, the firm said the initial rulemaking should have been “rescinded in its entirety.” The agency’s action “misses the mark by failing to address the most critical defect; namely, the reclassification of proxy advice provided in a fiduciary capacity as proxy solicitation,” ISS said in a statement at the time.

Other Cases

The ruling comes as cases from the National Association of Manufacturers and US Chamber of Commerce are pending in federal appeals courts. The SEC is facing claims in those cases that it exceeded its authority in 2022 by reversing 2020 regulations.

The US Court of Appeals for the Fifth Circuit raised questions about the need for the 2022 changes during oral arguments in the manufacturers’ case in August 2023. The updated rules then got a mixed reception at the US Court of Appeals for the Sixth Circuit in the Chamber’s case in October 2023.

The appeals courts took up the cases after lower courts upheld 2022 alterations.

In the ISS case, the commission overstepped when it interpreted “solicit” and “solicitation” to include what the proxy firms do, Mehta said. “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.”

Phrases with the meaning of urging, moving to action, or inciting “were no longer ordinary meanings of ‘solicit’” in 1934, the judge said.

Consovoy McCarthy PLLC and Pickard Djinis & Pisarri LLP represented ISS. The SEC represented itself. Gibson, Dunn & Crutcher LLP represented the National Association of Manufacturers, which intervened as a defendant.

The case is Institutional S’holder Servs. Inc. v. SEC, 2024 BL 59512, D.D.C., No. 19-cv-3275, 2/23/24.

(Updates with additional background throughout)

To contact the reporters on this story: Martina Barash in Washington at mbarash@bloomberglaw.com; Andrew Ramonas in Washington at aramonas@bloomberglaw.com

To contact the editor responsible for this story: Andrew Harris at aharris@bloomberglaw.com

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