Cooley Discusses Ruling Against SEC on Non-Enforcement of Proxy Adviser Rules

On September 28, in an action by the National Association of Manufacturers against the SEC and Chair Gary Gensler, the U.S. District Court for the Western District of Texas held that the SEC violated the Administrative Procedure Act when, in June 2021, Corp Fin stated that it would not recommend enforcement of the 2020 proxy advisory firm rules while those rules were under reconsideration. In 2022, however, the SEC formally adopted new amendments to the 2020 rules reversing some of the key provisions and, at the same time, rescinding Corp Fin’s non-enforcement statement. You might think that the adoption of the new 2022 rules and rescission of the non-enforcement statement would make NAM’s suit moot?  At least, that’s what the SEC seemed to think when it moved to dismiss NAM’s complaint in August 2022, contending that the relief NAM sought would now be “meaningless.” But, in mid-September, the Court denied the SEC’s motion—citing West Virginia v. EPA—and late last week, the same Court granted NAM’s summary judgment motion for declaratory and injunctive relief: the SEC’s “suspension” of the rules was vacated because it violated the APA, and the SEC was enjoined from refusing to acknowledge or recognize the 2020 rule’s compliance date.  NAM declared victory.  But was it a hollow victory? Not according to NAM.

2020 proxy advisory firm rules. You might recall that, in September 2019, the SEC published a new  interpretation and guidance directed at proxy advisory firms, such as ISS and Glass Lewis, 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.)  In July 2020, the SEC adopted new amendments to the proxy rules regarding proxy advisory firms, codifying the SEC’s interpretation that made proxy voting advice subject to the proxy solicitation rules.  In addition, the SEC adopted two new conditions to the exemptions from those rules for proxy advisory firms—one requiring disclosure of conflicts of interest and the second designed to facilitate effective engagement between proxy advisory firms and the companies that are the subjects of their advice by requiring proxy advisory firms to adopt principles-based policies to make proxy voting advice available to the subject companies and to notify clients of company responses. Compliance with the new conditions was required by December 1, 2021. (See this PubCo post.)  However, soon after SEC Chair Gary Gensler was confirmed, in June 2021, he asked the SEC staff to take another look at the 2020 rule amendments, and, at the same time, Corp Fin issued a statement that, during the reconsideration period, it would not recommend enforcement action. (See this PubCo post.) At the same time, litigation brought by ISS against the SEC regarding the SEC’s 2019 interpretation and 2020 rules was, in light of these new developments, held in abeyance.

NAM Complaint. In October 2021,  NAM announced that it had filed suit in federal court against the SEC for failure to enforce the 2020 rules. The complaint filed by NAM (and another plaintiff, Natural Gas Services Group, Inc.) in October 2021 regarding the SEC’s decision not to enforce the 2020 rules contended that proxy advisory firms—and specifically ISS and Glass Lewis—“wield outsized influence on proxy voting.” Moreover, the complaint claimed, there have been “grave concerns” about whether they “harbor significant conflicts of interest,” lack transparency regarding the development of their corporate governance standards and routinely provide “investors and other proxy voters with false and misleading information. This creates an unacceptable potential for critical corporate decisions to be made on the basis of inaccurate or incomplete facts. And proxy advisory firms have frequently been unwilling to issue corrections even when they are notified of errors in their reporting.” The compliance date set by the SEC would have required proxy advisory firms to comply with the new rules for the Spring 2022 proxy season. But, the complaint contended, after the new SEC Chair was confirmed, the complaint charged, the SEC “abruptly changed course” and “suspended” compliance. NAM charged that the suspension “immediately harms publicly traded companies and their shareholders, precluding them from receiving the disclosures that the SEC earlier determined were essential to protect the public markets.” Moreover, NAM claimed, the suspension was “flatly unlawful. The SEC may not decide that it no longer stands by a regulation it earlier lawfully promulgated, and—absent any rulemaking process—simply suspend its application. To the contrary, the procedural provisions of the Administrative Procedure Act (APA) exist precisely to bring regularity to agency action.”  To revise or suspend a regulation, NAM asserted, the APA required the SEC to engage in the notice-and-comment process.   But the SEC did not follow that process and, as a result, “its attempt to unilaterally suspend the Proxy Advice Rule is unlawful. The Court should therefore set aside the SEC’s illegal action.” (See this PubCo post.)

2022 proxy advisory firm rules. In 2022, however, in accordance with the APA notice-and-comment process (although the SEC has come under fire for the brevity of some of its comment periods—see this PubCo post), the SEC adopted new amendments to the proxy advisory firm rules reversing some of the 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. Perhaps most important for purposes of this litigation, at the same time, in Note 18 of the 2022 adopting release, the SEC noted that the staff statement did not alter proxy advisory firms’ obligation to comply with the conditions by December 1, 2021, and indicated that, in light of SEC’s adoption of the new rules, it rescinded the staff’s statement. (See this PubCo post.)

SEC motion to dismiss. Once the SEC had rescinded Corp Fin’s non-enforcement statement underlying NAM’s complaint, which NAM had alleged unlawfully suspended the compliance deadline, the SEC and Gensler moved to dismiss the case as moot because it no longer presented a live case or controversy—the non-enforcement statement was no longer operative. The voluntary cessation exception to mootness was inapplicable, they argued: the Corp Fin statement “was rescinded in accordance with its terms, not in response to this litigation.” Nor was there a “reasonable expectation that the [same] plaintiffs will be subject to the same action again.”

In denying the motion to dismiss, the Court found that the voluntary cessation exception to the mootness doctrine did apply, citing SCOTUS’s recent decision in West Virginia v. EPA (see this PubCo post), which held that a “challenge to the EPA’s Clean Power Plan regulations remained live even though the agency was in the process of repealing and replacing them.” As the NYT phrased it, West Virginia was “a case about a regulation that doesn’t exist.” The Court said that, in West Virginia, SCOTUS pointed out that “the Government nowhere suggests that if this litigation is resolved in its favor it will not reimpose emissions limits predicated on generation shifting . . . . [I]ndeed, it vigorously defends the legality of such an approach.”  In addition, the Court highlighted, SCOTUS said that it was the EPA’s burden to “establish that a once-live case has become moot”; that was a “heavy” burden “where, as [in the NAM case], ‘the only conceivable basis for a finding of mootness in the case is the [defendant’s] voluntary conduct.’” Accordingly, SCOTUS held that “‘voluntary cessation [of the challenged conduct] does not moot a case’ unless it is ‘absolutely clear that the allegedly wrongful behavior could not reasonably be expected to recur.’” The Court noted NAM’s contention that the staff statement at issue “contemplated the suspension of enforcement lasting beyond any final decision to retain any part of the Proxy Advice Rule to provide [ISS] time to pursue litigation that remains pending challenging the 2020 amendments.” (Note that, according to the SEC, after the SEC disclosed that the conflicts-of-interest condition would be left in place but prior to adoption of the 2022 rules, the ISS litigation resumed.)  In addition, the Court found that the Corp Fin statement “did not expire by its own terms; instead, the SEC rescinded it. In doing so, the SEC referenced this litigation.”  As a result, the Court held, the “Plaintiffs’ claims are not moot. The voluntary cessation exception applies. Finally, the SEC has failed to carry its heavy burden of disproving any reasonable possibility of recurrence in order to establish that a once-live case has become moot.”



It’s worth noting that the non-enforcement position taken by Corp Fin and Gensler echoed an earlier action by the SEC in 2020 under then-Chair Jay Clayton. In October 2019, ISS filed suit against the SEC and Clayton in connection with the SEC’s 2019 interpretation and guidance regarding proxy advisory firms. (See this PubCo post.) Then, in November 2019, 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 Intelligize, in January 2020, the SEC filed an Unopposed Motion to Hold Case in Abeyance to stay the litigation until the earlier of January 1, 2021 or the promulgation of final rules in the SEC’s proxy advisory firm 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 granted that motion. (See this PubCo post.)


Summary judgment. Both sides then filed for summary judgment. In the Memorandum Opinion, the Court explained that, under the APA, “final agency decisions on the agency’s own regulations, whether it be to promulgate or repeal an existing rule, must undergo a notice-and-comment procedure before any change is made.” The requirement for notice and comment applies to “all forms of ‘rulemaking,’ which implicates the ‘agency process for formulating, amending, or repealing a rule.’”

The Court first examined whether the agency action was reviewable under the APA, which would require that the action be “final.”  The Court determined that the compliance date “consummated the SEC’s decision-making process” and “also determined rights, produced obligations, or caused legal consequences. When the SEC suspended the Proxy Advice Rule’s compliance deadline, it altered the legal regime, was binding, and thus qualifies as textbook final agency action.”

Next, the Court consider whether the SEC’s action was really a “suspension” of the rules. If the compliance date was “suspended,” that would constitute a final agency action, the Court said; the APA “‘does not permit the agency to suspend without notice and comment a promulgated rule,’ including its post-effective compliance date.” In the Court’s view, “[r]efusing to enforce the compliance date for a duly promulgated rule is a functional suspension of said rule.” Under the  APA, agencies can “postpone the ‘effective date’ of an action only if ‘pending judicial review.’” The SEC contended—looking separately at Gensler’s statement, the Corp Fin statement and SEC action to  hold the ISS litigation in abeyance—that the action “was not a suspension because none of the acts in isolation constituted rulemaking under the APA.”  But, the Court said, those actions are not viewed in isolation, but rather, in totality.  And “in totality, Defendants’ June 1 conduct accomplished precisely what they wanted—to provide [proxy advisory firms] with breathing room for complying with the Proxy Advice Rule by suspending the duly promulgated timeline. Indeed, deliberate non-enforcement of a compliance date for an indefinite period is functionally indistinguishable from suspending a compliance date, which has been found to be rulemaking under the APA.”  In effect, the Court said, “Defendants promulgated a ‘binding norm’ of ambiguously postponing the Proxy Advice Rule’s compliance deadline. That’s not to say Defendants cannot internally reconsider an SEC rule. They can. But internal consideration does not grant the ability ‘to indefinitely delay the existing rule pending that reconsideration.’ So while Defendants can claim they have not suspended the compliance date, their actions—showing zero effort to enforce that date—say otherwise.”

The Court concluded that  an “agency cannot effectively repeal a final rule by indefinitely postponing its operative date. So although they might wish it so, Defendants do not have the inherent power to stay or delay a final rule absent notice-and-comment rulemaking. And without that discretion granted by law, Defendants’ actions are not exempted from the notice-and-comment process. Thus, Defendants violated the APA by suspending the Proxy Advice Rule’s compliance date without the required notice-and-comment rulemaking.” Accordingly, the Court vacated “Defendants’ suspension of the Proxy Advice Rule’s compliance date and [enjoined] Defendants from refusing to acknowledge or recognize the Proxy Advice Rule’s compliance date.”

NAM said that it had “notched a significant legal victory yesterday when a federal judge vacated the Securities and Exchange Commission’s suspension of a 2020 rule regulating ‘proxy advisory firms.’” But was it a hollow victory?  After all, the SEC’s “suspension” was rescinded and the SEC’s new 2022 amendments to the proxy advisory firm rules—which were subject to notice and comment—became effective on September 19.  NAM has filed suit against those rules as well, particularly, “the SEC’s 2022 rescission of critical components of the 2020 rule,” claiming that the 2022 rules “epitomize[] ‘arbitrary and capricious’ rulemaking.” (A summary judgment hearing in that case is scheduled for December 9, 2022.)  However, according to NAM, this District Court decision will ensure “that the SEC will not be able to re-suspend the 2020 rule if the NAM is successful in its challenge to the [2022 rules].” According to NAM’s Chief Legal Officer,  the “decision is a victory for the rule of law, and the NAM Legal Center was proud to lead this effort for the industry….Federal agencies are bound by the Administrative Procedure Act—standards the SEC failed to meet by indefinitely delaying the compliance date for the 2020 proxy firm rule without notice-and-comment rulemaking. Manufacturers depend on regulators to promulgate and enforce reliable rules of the road, and the NAM looks forward to similarly holding the SEC to account in our ongoing case against the agency’s unlawful rescission of the 2020 rule.”

This post comes to us from Cooley LLP. It is based on the firm’s blog post, “NAM celebrates victory over SEC on non-enforcement of proxy advisory firm rules—what did it really win?” dated October 3, 2022, and available here.