(Article from Registered Funds Regulatory Update, October 2024)
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The U.S. Court of Appeals for the Fifth Circuit vacated and remanded portions of the proxy voting advice rule that were rescinded by the SEC in 2022 after being adopted by the SEC in 2020. The Fifth Circuit held that the SEC’s rulemaking process to rescind these provisions, known as the “notice-and-awareness” conditions, was arbitrary and capricious thereby violating the Administrative Procedure Act.
In 2020, the SEC adopted a new rule requiring proxy advisory firms to (i) share their advice with registrants “at or prior to” sharing it with clients, and (ii) allow clients to review any written responses from registrants before shareholder meetings (the “2020 Rule”). However, following a change in administration, the SEC in 2022 adopted amendments rescinding these notice-and-awareness conditions (the “2022 Amendments”). Notably, the SEC cited the same “timeliness” and “independence” concerns that it previously concluded the 2020 Rule was designed to remedy—without explaining the reversal in its position.
Plaintiffs challenged the SEC’s amendments under the APA, claiming the amendments were arbitrary and capricious because the SEC failed to justify (i) contradicting its previous factual findings supporting the 2020 Rule, and (ii) the 2022 Amendments on their own merits. Initially, the U.S. District Court for the Western District of Texas granted summary judgment in favor of the SEC stating that the SEC “did not contradict prior factual findings and was not required to provide a more detailed justification.” It also found that the SEC’s justifications were rational and its 30-day comment period was consistent with the comment period standard under the APA.
The Fifth Circuit, however, reversed the decision, finding the SEC’s rescission of the notice-and-awareness conditions arbitrary and capricious and vacated the 2022 Amendments. The Fifth Circuit criticized the SEC for not sufficiently explaining why it disregarded previous findings that these provisions posed minimal risk to the timeliness and independence of proxy voting advice. Additionally, it faulted the SEC for failing to provide a reasonable explanation for why the perceived risks under the 2020 Rule justified their removal. The Fifth Circuit noted that the 2020 Rule had followed extensive study and collaboration over nearly a decade, spanning two presidential administrations, with a 60-day comment period. In contrast, the 2022 Amendments were made after just two years, with a 31-day comment period during the holiday season and minimal feedback received.
While acknowledging the SEC’s authority to change policies under new administrations, the Fifth Circuit stressed the need for a detailed explanation when reversing prior policies based on conflicting factual findings. The ruling is expected to influence future agency rulemaking processes, underscoring the requirement for thorough justification when departing from established regulatory frameworks.
Nat’l Assoc. of Manufacturers v. SEC, No. 22-51069 (5th Cir. June 26, 2024).