Fifth Circuit Vacates the SEC’s Rescission of its Proxy Advisor Notice-and-Awareness Requirements

On June 26, 2024, the United States Court of Appeals for the Fifth Circuit determined that the Securities and Exchange Commission (SEC) violated the Administrative Procedures Act when it rescinded its notice-and-awareness requirements for proxy advisory firms by failing to provide an adequate explanation of its reason for the change. This represents a defeat of the SEC’s effort to roll back the regulation of proxy advisory firms adopted under former Chairman Clayton’s leadership.

The 2020 Rule

In 2020, the SEC amended its proxy rules to, among other things, impose new requirements on firms that provide proxy voting advice to institutional shareholders of publicly traded corporations, such as Glass Lewis and Institutional Shareholder Services. The amendments (Rule) gave publicly traded companies an opportunity to speak on inaccuracies in the proxy voting recommendations made by these firms.

The Rule required proxy firms to alert public companies of their voting recommendations and to provide them with an opportunity to address inaccuracies in those recommendations before their shareholder meetings. Among other things, the Rule contained two requirements known as “notice-and-awareness” conditions. The notice condition required proxy advisory firms to make their recommendations available to companies at or prior to the time such advice is given to the proxy advisory firms’ clients. The awareness condition required proxy advisory firms to provide their clients with a mechanism by which they can reasonably be expected to become aware of any written statement by companies regarding the voting advice in a timely manner before a meeting.

SEC Rescission of the 2020 Rule

Under new Chairman Gensler’s leadership, the SEC rescinded the Rule one month before it was scheduled to go into effect. This Rule reversal was quickly challenged by the National Association of Manufacturers (NAM), claiming that the agency violated the Administrative Procedures Act by failing to adequately explain the reason for the change. NAM argued that the SEC’s justification for the Rule rollback was based on the exact same factual record that the SEC used to adopt the Rule and was both procedurally defective and arbitrary and capricious. The United States District Court for the Western District of Texas rejected NAM’s argument and upheld the Rule reversal by granting summary judgment to the SEC. NAM appealed the decision, and the Fifth Circuit Court of Appeals reviewed the case.

The Fifth Circuit’s Ruling

On June 26, 2024, after a de novo review of the case, the Fifth Circuit found that the SEC’s explanation for its 2022 rollback of the Rule violated the Administrative Procedure Act.

The Court observed that the SEC failed to explain why it was disregarding the findings that initially supported the Rule. In rescinding the notice and awareness requirements, the SEC determined that they posed dangers to the timeliness of security holder meetings and the independence of the proxy advisory firms. However, in initially adopting the Rule, the SEC concluded that these same risks were substantially addressed if not eliminated altogether. This required a more detailed description of the reason for the SEC’s reversal.

The Fifth Circuit also concluded that the SEC failed to justify the rescission of the Rule on its own terms, having failed to explain why its concerns about timeliness and independence were reasonable.

As a result, the Court vacated the rescission of the Rule’s notice-and-awareness conditions, and remanded the matter back to the SEC. An SEC spokesperson said the SEC is reviewing the decision and determining its next steps.

Impact of the Decision

Since the Fifth Circuit remanded the matter to the SEC, it remains to be seen how the SEC will address it. Another case is actively pending before the United States Court of Appeals for the Sixth Circuit in which the U.S. Chamber of Commerce, the Business Roundtable, and the Tennessee Chamber of Commerce & Industry have also challenged the SEC’s rescission of the Rule. To the extent it has an opportunity to do so, it is likely that the SEC will make another effort to rescind the Rule with a more detailed explanation of its reasons for the rescission.