SEC Runs Roughshod Over Administrative Procedure Act

S ecurities and Exchange Commission chairman Gary Gensler often talks about how there’s a basic bargain that led to the creation of the SEC. Those wanting to run a public company must agree to certain rules of the road that require disclosure to investors.

There’s also a basic bargain in government service. Those wanting to run a government agency must have their actions be accountable to the public, which includes complying with the Administrative Procedure Act (APA) and basic principles of open and accountable government, such as regulatory consistency and compliance with precedent.

The APA, signed into law in 1946, was drafted by Democratic senator Pat McCarran, who called it “a bill of rights for the hundreds of thousands of Americans whose affairs are controlled or regulated” by the government.

Under Gensler there have been persistent allegations that the SEC has regularly violated that principle of government service. Earlier this year, Senator Pat Toomey (R., Pa.) and Representative Patrick McHenry (R., N.C.) complained that the commission has proposed rules with “unreasonably short comment periods,” noting that an overwhelming majority of proposals for new SEC rules provided only 30 days for public input.

The SEC’s latest iterations of the proxy-adviser rule (which replaces the prior rule implemented during the Trump administration but that hasn’t gone into effect yet) was one example — the 30-day comment period closed a full 48 hours after Christmas Day. But it appears that the commission is guilty of a further breach of administrative procedure with its implementation of the new rule.

The recent drama and interest-group politics surrounding the way the SEC regulates proxy advisers violates the basic bargain of government service: accountability and transparency.

The cast of players includes union pension funds that own shares in publicly traded companies. They will often vote those shares in support of shareholder proposals involving climate, social, and political issues.

There are also two large proxy-advisory firms, which advise mutual funds on how to vote their shares on matters such as shareholder proposals. Mutual funds have tended to take a more neutral stance on shareholder proposals, but the proxy-adviser recommendations tend to align with the more left-leaning union and state pension funds.

During the last administration, a rule was put in place to govern proxy advisers, requiring in part that they “show their work” in how they arrived at recommendations for social and political proposals. That rule complied with the APA, went through public notice and comment, and absorbed criticisms of an initial draft to iron out a compromise in the final rule.

Since then, a new SEC chairman, Gensler, has taken office, supported by some of the more progressive members of the Senate. He did something rarely seen in our modern administrative state: Before the Trump-era rule on proxy advisers went into effect, Gensler announced that it would not be enforced. Gensler further cited no changes in the underlying market to support that about-face, not that that should have made a difference. Blanket refusal to enforce an adopted rule (the rule had been adopted some months before and was due to come into effect) is strongly disfavored by the current Supreme Court.

Back up a second and note that ISS, one of the two prominent proxy advisers, started litigation against the SEC designed to stop enforcement of the rule. That case is ongoing. Meanwhile, the National Association of Manufacturers (NAM) has also sued the SEC, arguing that the SEC’s decision to suspend enforcement of the proxy-adviser rules is a violation of the APA.

The SEC has now tied itself up in knots by taking mutually opposed positions in these two cases. In the ISS case, the SEC claims that the case can be stayed thanks to its announcement that it will no longer enforce the rule. Then the SEC did an about-face in the NAM litigation, maintaining that it did not actually stay the proxy-adviser rule, and therefore NAM’s litigation should be stopped.

Did the SEC suspend the rule? It depends on which SEC you are talking to. As if what is likely a violation of the APA and choosing not to enforce a validly adopted rule were not enough, the SEC is also playing games with the federal courts by taking contradictory positions in these two cases.

This is precisely the type of behavior that the APA was designed to stop. It violates the basic bargain underlying the operation of government agencies. If the SEC’s leadership cannot be trusted to maintain adherence to basic principles of administrative law, how can the public trust it to enforce the federal securities laws?