By Bill Flook
Institutional Shareholder Services (ISS) on September 18, 2020, asked a U.S. District Court to invalidate the SEC’s rules and guidance that impose new restrictions on the proxy advice industry.
In a motion for summary judgment and amended complaint, ISS argued the SEC regulations run counter to the text of the Securities Exchange Act of 1934 and violate First Amendment protections “because they impose content-based and viewpoint-based restrictions on protected speech,” among other points.
The lawsuit represents an effort by ISS – one of the two dominant proxy advisory firms along with Glass Lewis & Co. – to counter an industry-supported push by the SEC to place proxy firms under a new, harsher regulatory regime.
Proxy firms provide recommendations to asset managers on how to vote on a range of topics, including director elections, executive compensation, and environmental, social, and governance (ESG) issues such as climate risk disclosure.
Critics, who include Republican lawmakers and industry groups that support corporate management, such as the U.S. Chamber of Commerce, have long pushed the SEC to crack down on the firms, who they say operate with little oversight and transparency, and hold an outsized sway over shareholder votes. They argue ISS’s lawsuit is without merit.
Institutional investors who rely on ISS and Glass Lewis recommendations say the firms provide critical insight in helping navigate thousands of votes that would be impossible to research individually.
The SEC, in a move that largely aligned with industry wishes, issued guidance in August 2019 in Release No. 34-86721, Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice, which deals with the exemption the firms rely on when providing voting recommendations under Rule 14a-2(b) of the Exchange Act. In the guidance, SEC staff concluded that advice provided by a proxy firm “generally” constitutes a solicitation under federal proxy rules under the Exchange Act, which “authorizes the Commission to establish rules and regulations governing such solicitations as necessary or appropriate in the public interest or for the protection of investors.”
ISS sued in October 2019, arguing that it was already properly regulated under the Investment Advisers Act of 1940, and that the commission’s guidance was a substantive enough change to require a formal notice-and-comment period for a rulemaking, among other arguments. ISS challenged the core notion in the SEC guidance that it should be regulated under a separate regulatory regime covering proxy solicitation.
Several months after ISS filed its suit, the SEC issued a proposal in Release No. 34-87457, Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice, which proposed a more comprehensive set of new requirements on proxy firms. Both sides agreed to stay the case until the SEC issued its final rules, which it did in July in Release No. 34-89372, Exemptions from the Proxy Rules for Proxy Voting Advice, following a 3-1 vote.
In its amended complaint filed on September 18, the firm added the SEC rules to its lawsuit, and made a separate filing seeking summary judgment.
In that motion, ISS argued that the SEC’s “attempt to regulate independent proxy advice through a statute that applies only to proxy solicitation is foreclosed by the unambiguous statutory text, and the legislative history and statutory purpose confirm that Section 14(a) was never intended to apply in this context.”
The rules and guidance are arbitrary and capricious, the proxy firm argued, “because the Commission failed to adequately explain why these rules were needed at all; failed to consider why the preexisting regulatory framework for proxy voting advice under the Investment Advisers Act was insufficient to achieve the Commission’s stated objectives; and failed to acknowledge that it was discarding decades of settled precedent and upending the industry’s legitimate reliance interests.”
Finally, the firm argued, the final rules violate constitutional free speech protections.
“The Final Rules co-opt and commandeer proxy advisers’ speech by forcing them to share their advice and recommendations with issuers and then provide a ‘mechanism’ for the issuer to respond,” ISS wrote in the motion for summary judgment. “The Supreme Court has repeatedly invalidated laws that seek to commandeer one person’s speech to facilitate someone else’s.”
This article originally appeared in the September 21, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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