ISS, Glass Lewis Curbs Sought by Companies Pressing SEC in Court

The SEC will face tough questions about its rollback of Trump-era shareholder voting adviser restrictions when a conservative court considers a corporate effort to block the move next week.

Trump appointee James Ho and two other Republican-appointed judges will hear oral arguments Monday in the US Court of Appeals for the Fifth Circuit in a case over the Securities and Exchange Commission’s 2022 proxy advisory firm regulations. The National Association of Manufacturers appealed a lower court decision upholding the new rules in December.

The hearing will be the biggest judicial test yet of SEC authority in removing 2020 curbs on Institutional Shareholder Services Inc., Glass, Lewis & Co., and other firms that advise large funds voting on ESG proposals and other matters at annual shareholder meetings. The proceedings will follow in the wake of 2022 Fifth Circuit decisions limiting the power of SEC administrative judges and finding the Consumer Financial Protection Bureau’s funding unconstitutional.

“It’s going to be a challenge” for the SEC, said Jill Fisch, a University of Pennsylvania Carey Law School professor, who studies corporate governance and securities regulation. “There’s a lot of skepticism at the circuit court level of the SEC and administrative agencies generally.”

An SEC spokesperson declined to comment.

ESG Impact?

The National Association of Manufacturers and equipment maker Natural Gas Services Group Inc. sued the SEC in a Texas federal court to void the agency’s new rules in July 2022, only days after the commission adopted them.

The updated regulations dropped 2020 requirements for proxy firms to give their voting advice to companies and their customers simultaneously and make what companies said about the recommendations available to their clients. Companies have said they’ve been unable to ensure investors get accurate voting information if they find errors with the recommendations proxy firms give to shareholders.

The 2020 rules under then-SEC Chairman Jay Clayton came amid a years-long battle between the business community and ISS and Glass Lewis, the two biggest proxy firms.

Some companies argue that the advisory firms’ dominance allows them to improperly shape the results of votes on board directors and proposals related to climate change and other environmental, social and governance issues—claims ISS and Glass Lewis deny. The firms give customized advice to meet their individual clients’ needs, as well as issue general voting guidelines for interested customers.

SEC Chair Gary Gensler, a Democrat, pushed through the 2022 rollback, saying the action was necessary for investors seeking timely and independent advice. Business groups bristled at the move.

“Proxy firms, despite their influence, have largely escaped” oversight, Charles Crain, the National Association of Manufacturers’ senior director for corporate finance and technology policy, told Bloomberg Law. “The 2020 rule was an effort to counter that lack of oversight.”

Early SEC Wins

The National Association of Manufacturers said in its case that the SEC overstepped its powers by engaging in “arbitrary and capricious” rulemaking, which the agency has disputed. Judge David Counts of the US District Court for the Western District of Texas, a Trump appointee, ultimately sided with the SEC in December, saying the agency employed “reasoned decision making.”

Judge Aleta Trauger of the US District Court Middle District of Tennessee, a Clinton appointee, also upheld the SEC’s revised rules in a separate corporate challenge in April. The US Chamber of Commerce and other business groups appealed that decision to the US Court of Appeals for the Sixth Circuit.

The Fifth Circuit, where a majority of judges were appointed by Republican presidents, will be the first appeals court to hear oral arguments in a case over the 2022 rules. Chief Judge Priscilla Richman and Judge Edith Jones will join Ho on the bench. Ho has been outspoken on many issues, suggesting his fellow judges are applying a “woke Constitution” and saying he wouldn’t hire any clerks from Yale Law School due to its support for “cancel culture.”

Paul Hughes, co-head of McDermott Will & Emery’s practices focusing on Supreme Court and appellate litigation as well as government and regulatory litigation, will represent the National Association of Manufacturers during the oral arguments. Daniel Matro, a senior appellate counsel at the SEC, will argue for the agency.

“Obviously, the SEC has had some success at the district court level,” Crain said. “But we think we have really strong arguments about the unlawful nature of their process here with respect to the proxy firm rule.”

Tough Scrutiny

Ho and Jones were among the majority of Fifth Circuit judges who declined to review the court’s 2022 ruling that undercut the SEC’s ability to bring cases in its in-house court, while Richman was in the minority that supported a rehearing. The Supreme Court now will review the decision in SEC v. Jarkesy during its 2023-24 term.

The high court also will take up the Fifth Circuit decision against the CFPB’s funding in its upcoming term. Ho, Jones and Richman weren’t on the panel of three Trump-appointed judges that heard CFPB v. Community Financial Services Association of America and didn’t have to consider a review of the case by the full Fifth Circuit, with the agency opting not to ask the conservative court for another look.

Jonathan Berry, Boyden Gray PLLC’s managing partner, said he anticipates a lot engagement from the judges, whom he said will be informed and prepared. Berry has cases pending before the Fifth Circuit, including Alliance for Fair Board Recruitment v. SEC, a challenge to the the agency’s approval of Nasdaq Inc.‘s board diversity requirements for companies listed on its US exchange.

It’s not certain that the National Association of Manufacturers will win over the judges, Berry said. Courts always give some slack to agencies, he noted.

But the Fifth Circuit is unlikely to fully affirm the SEC’s direction under Gensler as the manufacturers’ challenge, the board diversity case and other agency matters face the court’s scrutiny, Berry said.

“I would be very surprised if his ESG agenda escapes unscathed under review by the Fifth Circuit,” he said.

The case is N.A. of Mfrs. v. SEC, 5th Cir., No. 22-51069, oral arguments scheduled 8/7/23.