Proxy advisors, which provide advice on corporate voting matters for institutional investor clients, are an increasingly important fixture in modern corporate governance. 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 (SEC). 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 this Report, the Final Rule represents the culmination of a decade-long review and analysis of the role and regulation of proxy advisory businesses. This Report examines the SEC’s rulemaking process that led to the Final Rule and how the SEC responded to concerns aired during the public comment period to narrow the scope of the Proposed Rule and shift the regulatory approach to a more flexible, principles-based framework. In Part I, we briefly describe the history of the proxy advisory industry in the United States, as well as the criticisms that have accompanied its rise in significance. In Part II, we turn to the SEC’s efforts to address these criticisms through the Proposed Rule noticed in November 2019. Part III discusses the intense response to this rulemaking from both supporters and critics of the proxy advisory industry. Part IV outlines the various modifications the SEC made in the Final Rule, adopted after careful review of the many comments on the Proposed Rule.
Finally, Part V surveys the potential legal challenges to the Final Rule. We conclude that it is unlikely that a federal court would invalidate the Final Rule under the Administrative Procedure Act and related administrative law doctrines. The SEC convincingly demonstrates the need for regulation given the potential for conflicts of interest and poor-quality governance advice in the proxy advisory industry. Furthermore, the likelihood of a successful legal challenge decreased substantially when the SEC thoughtfully made significant changes to its regulatory approach from the Proposed Rule to the Final Rule. In the Final Rule, the SEC embraced a middle-ground approach to regulating proxy advisors—one that responds to the major concerns raised by proxy advisory businesses and their supporters during the notice-and-comment rulemaking process.
Likewise, a legal challenge to the SEC’s interpretation of “solicitation” in Section 14(a) of the Exchange Act to apply to proxy guidance is unlikely to prevail. Congress did not define the term in the statute but, instead, charged the SEC with promulgating rules and regulations “as necessary or appropriate in the public interest or for the protection of investors.” Accordingly, under the seminal Chevron deference doctrine, the reviewing court will defer to the SEC’s interpretation of the ambiguous statutory provision so long as the agency’s interpretation is reasonable. Especially in light of the decades of agency and judicial precedent interpreting “solicitation” and the policy purposes that motivate Section 14(a), challengers will be hard pressed to argue that the SEC’s approach to solicitation in the Final Rule is unreasonable.
In sum, the SEC’s Final Rule is a step in the right direction to address deficiencies in the proxy advisory system. Due to the SEC’s decision to embrace a middle-ground regulatory approach, the strong proponents and strong opponents to the Proposed Rule are likely both dissatisfied with the Final Rule as a matter of policy. As a matter of law, however, it is difficult to argue that the SEC failed to engage in reasoned decisionmaking or otherwise acted outside its statutory mandate in promulgating the Final Rule.