United States: Texas Court Jettisons NAM Challenge To SEC's Proxy Advisor Rules

Is it ok for an agency to change its mind? The Federal District Court for the Western District of Texas seems to think so—at least if the agency's decision is "reasonable and reasonably explained." So says this Order granting summary judgment to the SEC and Chair Gary Gensler and denying summary judgment to the National Association of Manufacturers and the Natural Gas Services Group in the litigation surrounding the SEC's adoption in 2022 of amendments to the rules regarding proxy advisory firms, such as ISS and Glass Lewis. Those 2022 rules reversed some of the key controversial provisions governing proxy voting advice that were adopted by the SEC in July 2020 and favored by NAM. In July of this year, NAM filed a complaint asking that the 2022 rules be set aside under the Administrative Procedure Act and declared unlawful and void, and, in September, NAM filed its motion for summary judgment, characterizing the case as "a study in capricious agency action." The Court begged to differ. But, no surprise, we haven't heard the last of this matter—NAM has already filed its notice of appeal.

Background

For years, many companies and business lobbies, such as NAM, repeatedly raised concerns about proxy advisory firms' concentrated power and significant influence over corporate elections and other matters put to shareholder votes, leading to questions about whether these firms should be subject to more regulation and accountability. (See, e.g., this PubCo post, this PubCo post and this PubCo post.) Whether and how to regulate proxy advisory firms has long been a contentious issue, with some arguing that their vote recommendations were plagued by conflicts of interest and often erroneous, while others saw no reason for regulation, given that the clients of these firms were satisfied with their services. In September 2019, the SEC published in the Federal Register a new interpretation and guidance directed at proxy advisory firms confirming that their vote recommendations were considered to be "solicitations" under the proxy rules and subject to the anti-fraud provisions, and providing some "suggestions" about disclosures that would help avoid liability. (See this PubCo post.) The proxy advisory firms were not happy with the new interpretation and guidance, leading one, ISS, to sue the SEC. (See this PubCo post.) Then, in 2020, the SEC adopted amendments to the proxy rules that codified the SEC's interpretation regarding proxy advisory firms and "solicitations." In addition, the SEC adopted two new conditions to the exemptions from those rules for proxy advisory firms, which required disclosure of conflicts of interest and adoption of principles-based policies designed to facilitate effective engagement between proxy advisory firms and the companies that are the subjects of their advice proxy voting advice by making the advice available to the subject companies when sent to clients and providing a mechanism for clients to become aware of company responses. Compliance with the new conditions was not required prior to December 1, 2021. (See this PubCo post).

In June, soon after assuming his position as SEC Chair, Gensler directed the staff to take another look at the 2020 Rules, and the staff announced that it would decline to recommend enforcement in the interim. Then, following a notice-and-comment process, the SEC adopted new amendments to the proxy advisory firm rules reversing some of those key provisions governing proxy voting advice that were adopted in July 2020. Under the 2022 amendments, proxy voting advice would still be considered a "solicitation" under the proxy rules and proxy advisory firms would still be subject to the requirement to disclose conflicts of interest; however, the new amendments rescinded the second central condition that was designed to facilitate engagement between proxy advisory firms and the subject companies—which some might characterize as a core element of the 2020 amendments. The amendments also rescinded a note to Rule 14a-9, also adopted as part of the 2020 rules, which provided examples of situations in which the failure to disclose certain information in proxy voting advice may be considered misleading. As summarized in the order by the Court, the SEC explained that the rescinded conditions designed to facilitate engagement "did not 'sufficiently justify the risks they pose[d]to the cost, timeliness, and independence of proxy voting advice on which many investors rely.' And when rescinding Note (e), the SEC highlighted that Note (e) presented a 'risk of confusion regarding the application of Rule 14a-9 to proxy voting advice.'" (See this PubCo post.)

NAM then filed its complaint, contending that the 2022 rules were "both procedurally defective and arbitrary and capricious, and therefore must be set aside under the Administrative Procedure Act (APA). "The agency," NAM argued, "has come to a completely opposite outcome to that reached only two years ago, and it has done so on the basis of the exact same factual record that drove the SEC to adopt the 2020 Rule in the first place. The SEC does not—no doubt because it cannot—offer any compelling justification for why the exact same factual record requires a different result this time around." NAM's motion for summary judgment was then filed in September and the SEC's cross-motion in October. In its motion, NAM contended that the 2020 rules represented a rulemaking compromise that was the result of a "decade of bipartisan policymaking"; new Chair Gensler, NAM argued, made "an abrupt about-face." What's more, when it issued the new proposal in November, NAM highlighted, the SEC provided only a 31-day public comment period, which took place over the holidays. NAM contended that the 2022 rules should be set aside under the APA because the SEC "erred in several independent respects: In abruptly reversing course, the SEC improperly disregarded its earlier factual findings that contradict its new action; the SEC's reasoning is demonstrably irrational; the SEC failed to address significant criticisms leveled by commenters and dissenting Commissioners; and the SEC denied the public a meaningful opportunity to comment."

Court Order

The Court's Order was issued last week. According to the Court, NAM's case involved three issues:

Detailed justification? NAM contended that, under the "arbitrary and capricious" standard, the SEC must provide a "'more detailed justification' than normal because the 2022 Rescission reversed a prior policy decision." As explained by the Court, the standard for "arbitrary and capricious" enunciated by SCOTUS is whether the "agency examined 'the relevant data' and articulated a 'satisfactory explanation.' A 'satisfactory explanation' includes a 'rational connection between the facts found and the choice made.'" Normally, that same standard would apply to "both initial agency action and subsequent agency action undoing or revising that action," unless the "agency's 'new policy rests upon factual findings that contradict those which underlay its prior policy.' In that case, the agency must give a 'more detailed justification.'"

Here the SEC contends that it "merely weighed the same risks that the 2020 Rule did but reached a different conclusion"; in 2020, it had concluded that the rules posed no risk to the timeliness and independence of proxy advisors, but in 2022, it concluded that there were potential adverse effects sufficient to tank those aspects of the 2020 rule. NAM contended that the "existence or non-existence of a particular risk is a factual finding," which should have led the SEC to provide a more detailed justification. Examining some of the plaintiffs' own language—e.g., the reference to the "exact same factual record"—the Court concluded that the risk did exist in 2020 and that the reason for the 2022 reversal "was not a 'factual finding' but a policy decision that weighed the same factual record differently." Accordingly, the SEC "did not contradict prior factual findings and was not required to provide a more detailed justification."

Stated justifications rational? Under the applicable standard, the SEC "must have (1) examined 'the relevant data' and (2) articulated a 'satisfactory explanation' possessing a 'rational connection between the facts found and the choice made.'" According to the Court, there was no issue regarding the relevant data; rather, the question was whether the SEC articulated a "satisfactory explanation" that rationally connected the facts to the conclusion. The Court explained that the agency does not need to show that its reasons for the change in policy are better than the prior reasons, just that it has good reasons. As described by the Court, the SEC gave two reasons for its policy change: first, to alleviate the costs to proxy advisors and companies of the 2020 rules and, second, to address the concerns of clients and investors about proxy advisors' timeliness and independence. Are those reasons rationally connected to the change in the 2022 rules? Public comments indicated that the company engagement provisions increased costs "without corresponding investor protection benefits," and, the Court concluded, the SEC's decision to remove those increased compliance costs was well within the "zone of reasonableness." Accordingly, the Court found that the SEC's "reasoning rationally connected the facts (the increased compliance costs) to its conclusion (rescinding the 2020 rule would alleviate those costs)."

The SEC cited several public comments to support its conclusion that the 2020 rules could jeopardize proxy advisors' timeliness and independence. The plaintiffs argued that the SEC must provide its own reasons. But the Court disagreed: there was no reason not to look to the public record—indeed, agencies should be encouraged to do so. If an agency were barred from incorporating public comments into the final rule, the Court reasoned, "what's the point of public comment?"

Therefore, the Court concluded, in light of the "continued, strong opposition" in the public comments, rescinding those provisions of the 2020 Rules "was 'rationally connected' to the public commentators'—and the Commission's—concerns that such conditions posed a risk to the timeliness and independence of PVABs."

Procedurally valid? The Court also made short shrift of NAM's argument that the SEC's comment period was too short and did not provide a "meaningful opportunity for comment." (Brevity of comment periods is a frequent subject of attack these days, both from Republican SEC commissioners and from Congress. See, e.g., this PubCo post.) The Court observed that the APA does not specify a time period, but notes that SCOTUS has consider the comment period under the APA to be a minimum of 30 days, a standard that has also been followed in the 5^th Circuit. The Court was also not persuaded that the inclusion of the major December holidays effectively shortened the comment period, especially given the dearth of judicial authority for that position and the support in the FRCP for counting holidays, unless otherwise specified. Quoting SCOTUS, the Court concluded that "the lower courts should not 'impose upon an agency its own notion of which procedures are best.' Thus, the Court will not introduce its own policy preferences about what is a 'meaningful opportunity.'" NAM also contended that the comment period should be 60 days, but again, in the Court's view, lacked authority for that position. Accordingly, the Court found that the 2022 rules were not procedurally deficient.

Jurisdiction to review removal of Note (e). NAM finally argued that the SEC's justification for removing Note (e)—eliminating confusion created by the Note–did not make sense because the SEC repeated the substance of the Note in the release. However, the Court agreed with the SEC's contention that the Court did not have jurisdiction to review that change because Note (e) was just an explanatory note, and would not fall under the APA's five categories of "agency action."

Conclusion. The Court granted the SEC's motion for summary judgment. "Like it or not," the Court observed, "changing political winds may factor into an agency's policy preference. But 'a court may not set aside an agency's policymaking decision solely because it might have been influenced by political considerations or prompted by an Administration's priorities.'" The SEC's 2022 rules "need only to have been within 'the bounds of reasoned decision making.' As explained above, it was."

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