SEC Calls “Time Out” on Proxy Advisor Guidance and ISS Litigation

Cydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Posner.

You might recall that, at the end of October, proxy advisory firm ISS filed suit against the SEC and its Chair, Jay Clayton (or Walter Clayton III, as he is called in the complaint) in connection with the interpretation and guidance directed at proxy advisory firms issued by the SEC in August. (See this PubCo post.) That interpretation and guidance addressed the application of the proxy rules to proxy advisory firms, confirming that proxy advisory firms’ vote recommendations are, in the view of the SEC, “solicitations” under the proxy rules, subject to the anti-fraud provisions of Rule 14a-9, and providing some suggestions for disclosures that would help avoid liability. (See this PubCo post.) Then, in November, the SEC proposed amendments to the proxy rules to add new disclosure and engagement requirements for proxy advisory firms, codifying and elaborating on some of the earlier interpretation and guidance. (See this PubCo post.) As reported in Bloomberg, the SEC has now filed an Unopposed Motion to Hold Case in Abeyance, which would stay the litigation until the earlier of January 1, 2021 or the promulgation of final rules in the SEC’s proxy advisor rulemaking. In the Motion, the SEC confirmed that, during the stay, it would not enforce the interpretation and guidance. ISS did not oppose the stay, and the Court has granted that motion. As a result, this proxy season, companies should not expect proxy advisory firms to feel compelled to comply with the SEC interpretation and guidance, including advice to proxy advisors to provide certain disclosures to avoid Rule 14a-9 concerns.


Among other things, the guidance provided that, to avoid violations of Rule 14a-9, the proxy advisory firms should consider disclosing:

  • “an explanation of the methodology used to formulate its voting advice on a particular matter (including any material deviations from the provider’s publicly-announced guidelines, policies, or standard methodologies for analyzing such matters) where the omission of such information would render the voting advice materially false or misleading;
  • “to the extent that the proxy voting advice is based on information other than the registrant’s public disclosures, such as third-party information sources, disclosure about these information sources and the extent to which the information from these sources differs from the public disclosures provided by the registrant if such differences are material and the failure to disclose the differences would render the voting advice false or misleading; and
  • “disclosure about material conflicts of interest that arise in connection with providing the proxy voting advice in reasonably sufficient detail so that the client can assess the relevance of those conflicts.”

More specifically, with regard to methodology, the guidance advised that, if the advice is “materially based on a methodology using a group of peer companies selected by the proxy advisory firm, the disclosure may need to include the identities of the peer group members used as part of its recommendation and the reasons for selecting these peer group members as well as, if material, why its peer group members differ from those selected by the registrant. For example, such disclosure may be needed for a voting recommendation on a registrant’s advisory vote on an executive compensation proposal that is based on a comparison of the registrant’s executive compensation policies to those of other companies selected by the proxy advisory firm.”

In the complaint, ISS charged that, by making proxy advisor advice subject to the separate regulatory regime for proxy solicitation under Section 14(a), the guidance was unlawful because it “exceeds the SEC’s statutory authority under Section 14(a) of the Exchange Act and is contrary to the plain language of the statute.” In addition, the complaint charged, the guidance was “procedurally improper because it is a substantive rule that the SEC failed to promulgate pursuant to the notice-and-comment procedures of the Administrative Procedure Act.” ISS also argued that the guidance raises serious First Amendment concerns and was “arbitrary and capricious” because the SEC did not “provide reasoned explanation for its action.”

In its Motion, the SEC observed, in explaining some of the reasons for the Motion, that the new rulemaking may narrow or substantially affect the issues in the case, and the rulemaking process would allow some of ISS’s comments and concerns to be expressed and considered as part of the process. Importantly, the SEC’s Motion states that, although

“the challenged Interpretation and Guidance advised the public of the Commission’s construction of, and potential ways to comply with, certain regulations and statutes, it is our view that the Interpretation and Guidance does not itself create any new or additional obligations and does not have the force and effect of law. Accordingly, the Defendants will not invoke the Interpretation and Guidance as an independent source of binding law in any enforcement or other regulatory action against ISS or any other party while this case is being held in abeyance—though we believe the regulations and statutes that are the subject of the Interpretation and Guidance remain binding law to the extent they are applicable, the Commission may continue to maintain its interpretation of those underlying statutes and regulations, and ISS may continue to challenge those interpretations.” [Emphasis added.]

Bloomberg reported that, according to an ISS spokesperson, ISS has “agreed to a hold ‘in the interests of judicial economy’ and ‘in light of the SEC’s representations that the guidance does not have the force and effect of law.’” Nevertheless, the spokesperson continued, “‘ISS continues to believe that the August guidance is contrary to law, procedurally improper, and arbitrary and capricious.’”


Of course, many have raised concerns about proxy advisory firms’ concentrated power and significant influence over corporate elections and other matters put to shareholder votes, which has led some to question whether they should be subject to more regulation and accountability. Do investment advisers rely excessively on proxy advisory firms for voting recommendations? Are issuers allowed a fair chance to raise concerns about proxy advisory firm recommendations, particularly errors and incomplete or outdated information that forms the basis of a recommendation? Are conflicts of interest sufficiently transparent or addressed? And, as some contend, are proxy advisory firms essentially faux regulators with too much power and little accountability? According to this paper, The Big Thumb on the Scale: An Overview of the Proxy Advisory Industry, from Stanford’s Rock Center for Corporate Governance, while proxy advisory firms influence institutional voting decisions and corporate governance choices to a material extent, it “is not clear that the recommendations of these firms are correct and generally lead to better outcomes for companies and their shareholders.” (See, e.g., this PubCo post, this PubCo post and this PubCo post.)

On the other hand, the SEC’s rulemaking proposal and guidance have both been the subject of a fair amount of pushback, including from the SEC’s own Investor Advisory Committee. That Committee has just voted to submit to the SEC a recommendation that is highly critical of both the guidance and the rulemaking proposal. The recommendation contends that the SEC’s actions are unlikely to reliably achieve the SEC’s own stated goals and advises the SEC to rethink and republish the proposals and reconsider its guidance. The recommendation maintains that the proposals and guidance are almost futile without addressing in advance or in parallel more basic proxy plumbing issues (as the Committee had previously recommended) (see this PubCo post), that none of the SEC’s actions at issue adequately identifies the underlying problems that are intended to be remedied, provides a sufficient cost/benefit analysis or discusses reasonable alternatives that might have been proposed. In addition, the recommendation argues, the rule proposals should provide a more balanced assessment of proxy advisory firms, expressing the concern that the SEC’s actions “may collectively shift the balance in a manner that does not serve investor interests.” With regard to the guidance specifically, the recommendation contends that the guidance did not provide the clarity it purported to provide to market participants, particularly with regard to whether the guidance was an update or involved no material changes. (See this PubCo post.)

In addition, at the time of adoption of the interpretation and guidance, two dissenting Commissioners, Robert Jackson and Allison Lee, objected to the failure by the SEC to study the potential impact of the guidance, which they thought could be significant. Jackson expressed his concern that the guidance “may alter the competitive landscape for the production and use of that advice [from proxy advisory firms]—without addressing whether doing so might make it harder for investors to oversee management.” He explained that the difficulty and cost involved in monitoring public companies leads many institutional investors to rely on proxy advisory firms. Although large institutions can afford to comply with the steps outlined in the guidance, “smaller ones may be less able to bear the costs of doing so. If smaller investors respond to these costs simply by choosing to vote less, the result may be to give more influence to large institutions. We should carefully consider the consequences of that possibility before making policy in this area.” Likewise, he was troubled that the guidance would increase the cost for proxy advisory firms, deterring new entrants and increasing the concentration in an already concentrated industry. He “would have considered the effects of today’s guidance on the competitive landscape more fully before taking these steps.”

Lee contended that the new guidance “introduces increased costs and time pressure into an already byzantine and highly compressed process. Second, it calls for more issuer involvement in the process despite widespread agreement among institutional investors and investment advisers that greater involvement would undermine the reliability and independence of voting recommendations.” She also objected to a process that did not involve compliance with APA procedures, such as notice and comment, or weigh costs and benefits. (See this PubCo post.)

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