ESG
Texas v. SEC
Date: May 10, 2024
Issue: Whether Texas, Louisiana, Utah, and West Virginia possess standing in their lawsuit challenging the Securities and Exchange Commission (SEC)’s “Enhanced Reporting of Proxy Votes by Institutional Investment Managers” final rule (Proxy Rule).
Case Summary: In a 3-0 decision, a Fifth Circuit panel dismissed a petition filed by Texas, Louisiana, Utah and West Virginia seeking to invalidate the SEC’s Proxy Rule.
The Proxy Rule requires fund managers to disclose how they vote on executive pay matters. The SEC enacted the Proxy Rule to clarify how mutual fund and exchange-traded fund managers cast their proxy votes. The rule overhauls the existing N-PX, which the SEC developed to inform investors how fund managers vote shares on their behalf. Fund managers must also categorize their votes, sorting them into fourteen categories, four of which are focused on environmental, social and governance (ESG) issues. The rule will go into effect on July 1, 2024. The states petitioned the Fifth Circuit to review and set aside the Proxy Rule, claiming it “adversely affected” its residents.
The panel concluded the states lacked standing to bring its lawsuit. The states claimed they suffered an injury as investors in funds subject to the Proxy Rule because the funds would pass the costs of the rule on to all investors. In other words, the states theorized funds will incur increased regulatory costs from having to categorize votes and report the categories. Funds would then pass those costs along to individual investors, including the states. But the panel highlighted a difference between theory and practice: regulated parties do not necessarily pass costs on to their consumers. According to the panel, the record speculates that new regulatory burdens on the funds could potentially increase costs for investors. The panel concluded that, without evidence of a cost pass-through, the states had not proven a “substantial risk” of economic injury to investors.
Next, the states tried to establish standing under the parens patriae doctrine. The states argued the term “parens patriae” encompasses two lawsuits—lawsuits allowing a state to litigate on behalf of citizens who cannot represent themselves, and lawsuits allowing a state to assert its quasi-sovereign interest separate from their citizens’ interests. The states tried to assert their quasi-sovereign interest in the general economic well-being of its residents. Still, the court concluded the evidence is insufficient to prove the Proxy Rule infringes this interest.
The states also argued their residents who invest in funds under the categorization requirement will bear the regulatory costs passed on by the funds. But the panel again determined the evidence is insufficient to provide the funds will pass on costs to investors. The panel rejected the States’ argument that requiring funds to disclose ESG votes will damage the oil and gas industries by making it easier for activists to pressure the funds to disinvest from energy producers. The panel concluded this theory relies on a “highly attenuated chain of possibilities” not supported by the record.
In concurrence, Judge James Ho agreed the record lacks sufficient evidence to establish standing, but noted the states may refile if they can assemble stronger evidence of injury than presently available. Judge Ho conceded the states’ theories of injury are interesting and potentially viable, but reiterated the record evidence does not support the claims.
Bottom Line: The states have yet to refile their petition to invalidate the Proxy Rule.
Documents: Opinion
