The plaintiffs in the San Antonio lawsuit, the National Association of Manufacturers and Natural Gas Services Group Inc., allege that the SEC exceeded its authority when, on July 13, it approved a final rule rescinding two amendments adopted in 2020. The rescissions are seen as concessions to Institutional Shareholder Services (ISS) and other proxy advisory firms.

Two proxy advisory firms, ISS and Glass Lewis, comprise a duopoly in the United States that effectively control up to 38 percent of shareholder votes for U.S. public companies through their proxy advice, according to the U.S. Chamber of Commerce.

"Today, these entities … wield outsized influence on proxy voting," the San Antonio complaint asserts. "Indeed, institutional investors controlling over $5 trillion in assets under management 'voted in lockstep alignment with either ISS or Glass Lewis in 2020,' with the result that these proxy firms' recommendations directed those institutions' votes on over 100,000 individual corporate resolutions that year."

This has long been a concern because these firms routinely provide investors with false and misleading information, thus creating an unacceptable potential for critical corporate decisions based on inaccurate or incomplete facts, the complaint states.

Midland-based Natural Gas Services (NGS) alleges that it has repeatedly been the victim of materially misleading or factually incorrect statements from proxy advisory firms.

"NGS has been forced to file supplemental proxy statements in response to this misleading proxy advice in seven of the past nine annual proxy seasons, often on unreasonably short time frames," the co-plaintiff asserted.

"This process has required NGS's employees, primarily senior executives, to divert significant time and effort away from running the business in order to correct proxy firms' misleading or incorrect statements. It has also required NGS to make hard expenditures, including payments to outside consultants. The 2020 rule would have significantly mitigated the costs imposed on NGS by the pre-rule status quo to which the 2022 rescission has now returned," Natural Gas Services said.

2020 SEC Rule

Over a period of a decade, the SEC extensively investigated whether it should implement basic safeguards with respect to proxy voting advice. This culminated in the 2020 rule, which clarified that proxy voting advice generally constitutes a solicitation under federal rules.

Usually, entities soliciting a proxy are subject to various information and filing requirements. The rule exempts proxy firms from these requirements, provided they disclose potential conflicts of interest to their clients, supply companies subject to their analyses with information about their final voting recommendations, and notify their clients prior to the vote if the subject companies respond to their recommendations.

It also subjects proxy firms to the federal proxy rules' anti-fraud provisions.

Before the SEC even issued its final 2020 rule, ISS filed suit in 2019 against the SEC. The U.S. Chamber of Commerce filed an amicus curiae in the District of Columbia case in defense of the 2020 rule.

"It is difficult to overstate the influence that proxy advisory firms have on shareholder voting," the organization said. "For years, amici, their members, and others (including the SEC) have raised concerns about well-documented problems with proxy advisory firms, including sharp conflicts of interest and a lack of transparency and accuracy in proxy recommendations. These concerns are far from theoretical; they are grounded in real-world experience."

Despite the evidence, industry support, and SEC's prior stance, the commission kept the 2020 rule active for only seven months.

The plaintiffs observe that in April 2021, after the confirmation of Democrat Gary Gensler as the new chair, the SEC "abruptly changed course," by first suspending the 2020 rule and then rescinding two critical pieces—one regarding timely notice of analysis to subject companies, with a requirement the subject companies' response be given to proxy advisory firm clients; and the other a notice that, depending on the facts, proxy advisory firms may be liable for misrepresentations.

The plaintiffs assert the rescission is procedurally defective, arbitrary, and capricious and must be set aside under the Administrative Procedure Act. They allege the commission came to a complete opposite outcome based on the exact same factual record that established the 2020 rule.

"The SEC notes that some market participants have raised concerns that the 2020 rule could endanger the 'timeliness' and 'independence' of proxy voting advice, but the agency does not even attempt to describe why that would be the case—that is, the actual mechanisms by which that harm is supposed to occur—or what has changed in the two years since the agency firmly concluded that the 2020 rule 'does not create the risk that proxy voting advice would be delayed or that the independence thereof would be tainted,'" the complaint said.

The manufacturers' association and Natural Gas Services are represented by Debbie E. Green in Dallas and Paul W. Hughes in Washington, D.C., of McDermott Will & Emery; and Erica T. Klenicki of NAM Legal Center.

Daniel Matro of the SEC Office of General Counsel in Washington, D.C., has been representing the agency in the D.C. court, but has not responded yet to the Texas lawsuit.

From: Texas Lawyer