Fifth Circuit Vacates SEC’s Rescission of Notice-and-Awareness Requirements for Proxy Advisors

Finds SEC Acted Arbitrarily and Capriciously in Reversing Requirements for Proxy Advisory Firms to Notify Companies of Proxy Voting Advice and Make Investors Aware of Companies’ Responses

In 2020, the SEC required proxy advisory firms to (1) make proxy voting advice about a company available to the company in advance of or concurrently with disseminating it to their clients and (2) have a mechanism for making clients aware of the company’s response statement before they vote. In 2022, the SEC adopted amendments to remove these notice-and-awareness requirements.[1] On June 26, 2024, a three-judge panel of the U.S. Court of Appeals for the Fifth Circuit ruled in National Association of Manufacturers et al. v. U.S. Securities and Exchange Commission that the SEC acted arbitrarily and capriciously in removing these requirements, and therefore violated the Administrative Procedure Act (“APA”).

Shortly after the SEC adopted the 2022 amendments, two groups—National Association of Manufacturers and Natural Gas Services Group, Inc.—challenged the amendments under the APA. These groups argued that the amendments were arbitrary and capricious because the SEC failed both to (1) provide an adequate justification for contradicting its prior factual finding that underlay the 2020 rule and (2) justify the 2022 amendments on their own terms. A district court rejected these arguments and granted summary judgment in favor of the SEC.

In reversing the district court’s decision, the Fifth Circuit panel noted that the 2020 rule was the result of 10 years’ consideration by the SEC, but the 2022 amendments came just two years later and made a different factual finding that “contradicted the factual finding that underlies the 2020 rule”. The panel found that the SEC failed to adequately explain its decision to disregard the prior factual finding that the notice-and-awareness requirements posed little or no risk to the timeliness and independence of proxy voting advice. The panel also found that the SEC failed to justify the 2022 amendments on their own terms because the SEC did not provide a reasonable explanation as to why the risks of the notice-and-awareness requirements were so significant as to justify rescission.[2]

The U.S. Chamber of Commerce, the Business Roundtable and the Tennessee Chamber of Commerce & Industry also challenged the 2022 amendments in a case pending before the U.S. Court of Appeals for the Sixth Circuit. The Sixth Circuit heard oral arguments last fall, but has not yet issued its ruling as of the date of this publication. Unless the Sixth Circuit reaches a different conclusion, companies and investors should expect the notice-and-awareness requirements under the 2020 rules to be reinstated, which we expect will impact proxy advisory firm practices and proxy season engagement in the future. The Fifth Circuit’s reasoning could also have implications for future agency rulemakings. In particular, the panel emphasized that, when an agency reverses a prior policy based on factual findings that contradict those underlying its prior policy, the agency must provide a more detailed explanation.