Examining the SEC’s Proxy Advisor Rule

Paul Rose is the Robert J. Watkins/Procter & Gamble Professor of Law, and Christopher J. Walker is the John W. Bricker Professor of Law at The Ohio State University Moritz College of Law. This post is based on their recent report, prepared for the U.S. Chamber Center for Capital Markets Competitiveness.

As proxy advisors have taken on greater visibility and importance in markets in the United States and around the world, scrutiny of the power and influence of proxy advisors has increased commensurately. Over the last decade, Congress has repeatedly considered the role and regulation of proxy advisors. The same is true at the Securities and Exchange Commission. Beginning with a 2010 Concept Release and through a series of informal interpretations, notice-and-comment rulemaking, and engagements with proxy advisors, investors, company officials, academics, and others, the SEC has considered questions of proxy advisor conflicts of interest and advice quality. Following this extensive study and analysis, the SEC promulgated a new rule in July 2020 that is designed to increase the transparency, accuracy, and completeness of the information proxy advisors provide to investors making proxy voting decisions (Final Rule).

As described in our report, prepared for the U.S. Chamber Center for Capital Markets Competitiveness, the Final Rule represents the culmination of a decade-long review and analysis of the role and regulation of proxy advisory businesses. After a review of the history of proxy advisor regulation, the report provides a detailed analysis of the SEC’s Proposed Rule in November 2019, the extensive comments on the Proposed Rule, and the impact of those comments on the Final Rule promulgated in July 2020. Reviewing potential legal challenges to the Final Rule, we conclude that it is unlikely that a federal court would invalidate the Final Rule.

The Administrative Procedure Act (APA) establishes the default standards for judicial review of rulemaking and other agency action. The APA judicial review standards apply when Congress has made a particular agency action “reviewable by statute” and the action is “final agency action for which there is no other adequate remedy in a court.” The SEC’s Final Rule here, if challenged in court, will be subject to the judicial review provisions of the APA and related administrative law doctrines.

The report reviews three sets of potential challenges to the Final Rule: (A) the traditional arbitrary-and-capricious challenge under the APA; (B) a challenge under the logical outgrowth doctrine for the substantive differences between the Proposed Rule and the Final Rule; and (C) a challenge to the SEC’s statutory interpretation of “solicitation” to encompass proxy advice services.

APA Arbitrary-and-Capricious Challenges

Under the APA, the reviewing court must set aside an agency action that is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” This requirement has been interpreted as a reasoned decisionmaking requirement. The relevant inquiry is whether the agency addressed and considered the factors set forth by Congress in the agency’s organic statute; whether the agency considered all important aspects of the problem it was seeking to address through regulatory action; whether its proposed action is consistent with the evidence gathered; and whether the action otherwise demonstrates reasoned decisionmaking as evidenced by the quality and coherence of the agency’s reasoning. Under the APA, the Supreme Court in Perez v. Mortgage Bankers Ass’n (2015) has emphasized that “[a]n agency must consider and respond to significant comments received during the period for public comment.” That is because this APA-guaranteed “opportunity to comment is meaningless unless the agency responds to significant points raised by the public” (Home Box Office, Inc. v. FCC, D.C. Cir. 1977).

In a trilogy of cases concerning cost-benefit analysis in financial regulation at the SEC, the D.C. Circuit has articulated a number of principles it perceives as required by APA arbitrary-and-capricious review and the SEC’s organic statute (Bus. Roundtable & U.S. Chamber of Commerce v. SEC (2011); Am. Equity Inv. Life Ins. Co. v. SEC, (2010); Chamber of Commerce v. SEC, (2005)). As others have documented, the SEC seems to have substantially improved the economic analysis in its rulemaking since the D.C. Circuit’s trilogy of cases. The Final Rule here appears to be yet another example of improved economic analysis and reasoned decisionmaking more generally. As detailed in the report, the SEC engaged in a deliberative process to ensure it considered a variety of regulatory alternatives against a well-defined baseline, as well as considered the various intended and unintended costs, benefits, and other effects. The SEC expressly considered reliance interests implicated, was careful to note when and why it could not quantify certain benefits or costs, and exhaustively analyzed how the Final Rule would promote the values outlined in the SEC’s governing statute of efficiency, competition, and capital formation.

The SEC also carefully addressed the various comments and criticisms raised during the comment period. Indeed, the SEC ultimately adopted “a less prescriptive, more principles-based manner” for regulating proxy advice than initially suggested in the Proposed Rule. The SEC stated in the Final Rule that it did so “in response to comments received to provide appropriate flexibility to proxy voting advice businesses to meet the principles that underlie the objectives of the rule, and to avoid unnecessary potential disruptions to their ability to provide their clients with timely voting advice.” These changes were also made, the SEC explained, to “address[] the concerns raised by commenters regarding the potential unintended consequences of requiring a proxy voting advice business to engage with a registrant in connection with its proxy voting advice, including those related to timing and the risk of affecting the independence of the advice or diminishing competition in the proxy voting advice business industry.”

Especially in light of the SEC’s decision to narrow the regulatory reach on proxy advisors in the Final Rule, it is difficult to see how proxy advisors (or proponents of the Proposed Rule, for that matter) could mount a successful legal challenge to the Final Rule under the APA’s arbitrary-and-capricious standard. Here, the SEC seems to have effectively and deliberately engaged in such reasoned decisionmaking as required by the Supreme Court and the D.C. Circuit under the APA’s arbitrary-and-capricious standard of review.

Logical Outgrowth Doctrine Challenge

When an agency engages in notice-and-comment rulemaking, the APA requires the agency to publish a “[g]eneral notice” that includes “terms or substance of the proposed rule or a description of the subjects and issues involved.” Just as courts have required agencies to respond to significant comments, they have required that agencies provide adequate notice of the anticipated regulatory action in the proposed rule and that the final rule be a “logical outgrowth” of the proposed rule. In other words, as the D.C. Circuit has framed the doctrine, “Where the change between proposed and final rule is important, the question for the court is whether the final rule is a ‘logical outgrowth’ of the rulemaking proceeding” (AFL-CIO-CLC v. Marshall, D.C. Cir. 1980). And “the logical outgrowth test normally is applied to consider whether a new round of notice and comment would provide the first opportunity for interested parties to offer comments that could persuade the agency to modify its rule” (Nat’l Exch. Carrier Ass’n, Inc. v. FCC, D.C. Cir. 2001).

The Supreme Court has explained that, under the logical outgrowth doctrine, “[t]he object, in short, is one of fair notice” (Long Island Care at Home, Ltd. v. Coke, 2007). Here, the SEC made some relatively major changes from the Proposed Rule to the Final Rule. The Final Rule embraced a more “principles-based” rule than the Proposed Rule that provides greater flexibility for proxy advisors compliance and removing the provisions in the Proposed Rule that would have given companies the opportunity to review and comment on proxy advice before it was sent to investor clients. All of the significant changes from the Proposed Rule to the Final Rule were made in response to concerns raised by proxy advisors and their supporters—to lessen the regulatory burden and address the costs and unintended consequences raised during the public comment period.

Accordingly, arguments that the Final Rule flunks the logical outgrowth test are unavailing. The public had fair notice that the agency may not adopt all of the regulatory actions set forth in the Proposed Rule. Another round of notice-and-comment rulemaking would not be the first opportunity for proxy advisors to raise arguments against the SEC’s approach on the Final Rule. Indeed, it would be curious for the proxy advisors to argue against the changes in the Final Rule when the changes occurred to accommodate their concerns.

Challenge to the SEC’s Statutory Definition of “Solicitation”

When reviewing an agency’s statutory interpretation that is promulgated through notice-and-comment rulemaking, federal courts apply the familiar Chevron two-step deference doctrine. At step one, the reviewing court must assess whether the statutory provision at issue is ambiguous. If so, the court proceeds to step two to determine whether the agency’s position is a reasonable interpretation of the statute.

Section 14(a) of the Exchange Act makes it “unlawful for any person . . . in contravention of such rules and regulations as the Commission may prescribe . . . to solicit or to permit the use of his name to solicit any proxy or consent or authorization in respect of any security . . . .” There is no dispute that Congress has charged the SEC to promulgate regulations “as necessary or appropriate in the public interest or for the protection of investors” to implement Section 14(a). The Supreme Court has held that Section 14(a) has “broad remedial purposes,” including “to prevent management or others from obtaining authorization for corporate action by means of deceptive or inadequate disclosure in proxy solicitation” (J. I. Case Co. v. Borak, 1964). Accordingly, the SEC had authority to engage in this rulemaking, and thus a reviewing court will review the SEC’s statutory interpretation under the Chevron deference framework.

Turning to Chevron’s first step, Congress did not define the term “solicit” in the Exchange Act. In light of this congressional silence, many courts would thus proceed to Chevron’s second step to determine whether the agency’s interpretation is reasonable—a step at which one study has found that agencies win nearly 95% of the time in the federal courts of appeals. If the reviewing court reaches step two here, it is difficult to see how challengers could prevail in convincing the court that the SEC’s definition of solicitation is unreasonable.

As detailed in the Final Rule, the SEC defined solicitation in 1935 and over the years has amended that definition “as needed to respond to new and changing market practices that have raised the concerns underlying Section 14(a).” In 1956, the SEC updated the definition to encompass more than proxy requests but also any “communication to security holders under circumstances reasonably calculated to result in the procurement, execution, or revocation of a proxy.” In its 2019 interpretive release and then in the Final Rule, the SEC explained that, under the 1956 definition, “proxy voting advice businesses generally engage in solicitations when they provide proxy voting advice to their clients.” Based on a number of factors, the SEC concluded that proxy voting advice is “a communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” This seems like a reasonable interpretation, especially in light of the broad remedial purposes of Section 14(a) and the decades of agency and judicial precedent that similarly interpret this term.

Because Congress did not define “solicit” in Section 14(a) of the Exchange Act but instead charged the SEC with promulgating rules and regulations to develop a definition “as necessary or appropriate in the public interest or for the protection of investors,” it is difficult argue that the agency should lose at Chevron’s first step. In light of the decades of agency and judicial precedent interpreting and implementing Section 14(a) and the policy purposes behind Section 14(a), it is even more difficult to argue that the SEC’s approach to solicitation in the Final Rule is unreasonable.


The SEC’s Final Rule to regulate the proxy advisor industry is unlikely to be the final word on the subject. After all, the Proposed Rule had sought to impose even more regulatory oversight on the industry, in response to extensive criticisms about accuracy, transparency, and fairness. Yet, in the Final Rule, the SEC listened to concerns raised by the proxy advisors and their supporters and adopted a more flexible, principles-based framework that results in less regulatory oversight. As a policy matter, we believe the SEC made an important step in the right direction to address issues in the proxy advisor industry. But strong critics of the proxy advisor industry will no doubt press for further regulatory oversight.

From a litigation perspective, moreover, the SEC’s decision to retreat from the Proposed Rule and embrace a more flexible regulatory approach makes it much harder for the proxy advisory industry to challenge the Final Rule under the Administrative Procedure Act and related administrative law doctrines. The SEC here appears to have engaged in a very deliberative, reasoned-decisionmaking process. And arguments that the SEC exceeded its statutory authority seem unavailing and contrary to decades of judicial and agency precedent.

The full report may be downloaded here.

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