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US Securities and Exchange Commission

SEC Asks Court to Toss Out Institutional Shareholder Services Lawsuit

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

By Bill Flook

The SEC on October 30, 2020, asked a U.S. District Court judge to toss out a lawsuit by Institutional Shareholder Services (ISS) over the SEC’s July proxy advice rules. The agency, in the filing, argued that ISS had provided “no supportable legal basis” for a court to vacate the rules.

The SEC, following a 3-1 vote, finalized a broad set of new requirements for proxy firms in Release No. 34-89372Exemptions from the Proxy Rules for Proxy Voting Advice, a move cheered by industry groups who have long called for a regulatory crackdown on firms such as ISS and Glass Lewis & Co.

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 clamp down on the firms, who they say operate with little oversight and transparency, and hold an outsized sway over shareholder votes. Institutional investors, however, rely on proxy firm recommendations, and say the firms provide critical insight in helping navigate thousands of votes that would be impossible to research individually.

ISS is challenging both the SEC’s rules and its earlier guidance in Release No. 34-86721Commission 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 Securities Exchange Act of 1934

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.”

Release No. 34-86721 allow proxy firms to remain exempt from the information and filing requirements of the proxy solicitation rules. But for a proxy firm to rely on the exemption, the rule not only allows companies to review the proxy advice, but proxy advisory firms must also provide a way for clients to access any response that the company provides to the voting advice in a timely manner before the vote. Proxy advisory firms must also disclose material conflicts of interest in their proxy advice or in an electronic medium used to deliver the proxy voting advice.

(See SEC Issues Rule Increasing Regulation of Proxy Advisers in the July 23, 2020, edition of Accounting & Compliance Alert.)

ISS, in its suit, argues that it is already adequately covered by the Investment Advisers Act of 1940, and that subjecting it to a separate regulatory framework covering proxy solicitation is inappropriate and unnecessary.

The SEC, in its October 30 filing in U.S. District Court for the District of Columbia, argued that “it has long been clear that advice provided by proxy voting advice businesses falls within the Commission’s 1956 definition of solicitation.”

“And the new exemption conditions give proxy voting advice businesses flexibility to comply by building upon practices they already have in place,” the SEC wrote. “Moreover, the Commission’s interpretation of solicitation comports with the Exchange Act and furthers its purpose of ensuring that shareholders are properly informed about proxy voting.”

The agency contented that it “rationally determined that it was appropriate to tailor proxy voting advice businesses’ exemptions to the important role they have come to play in facilitating their clients’ participation in the proxy process.”

The SEC, in the lawsuit, is supported by the National Association of Manufacturers (NAM), the largest manufacturing association in the U.S. that earlier in October sought to intervene in the case.

ISS is backed up by the Council of Institutional Investors (CII), a group representing some $4 trillion in funds, which filed an amicus brief warning the rules put at risk the “continued availability of timely, high-quality, and independent advice and analysis of issues subject to shareholder vote.”

 

This article originally appeared in the November 2, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.

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