IN-DEPTH: Proxy advisors, stewardship teams face new legal challenges
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Since 2016, proxy advisory firms have come under sustained pressure from regulators, corporate lobby groups, and politicians, writes Josh Black.
Their recommendations on environmental, social, and governance (ESG) matters have invited scrutiny, with their influence on proxy voting outcomes seen as a soft target for policy groups leading the anti-ESG backlash.
Though some federal initiatives to regulate proxy advice have faltered, with this month’s Supreme Court decision that vacated a 2020 rule by the Securities and Exchange Commission (SEC) that proxy advisors’ recommendations were solicitations and therefore subject to higher scrutiny, a new front has opened at the state level.
On June 20, Governor Greg Abbott signed SB 2337 into law, making Texas the first state to regulate proxy advisors. Starting September 1, firms like Institutional Shareholder Services (ISS) and Glass Lewis must accompany any recommendation against company management with a detailed financial analysis and a disclaimer disclosing the potential influence of nonfinancial factors. These materials must be shared not only with investor clients, but also with the relevant issuer and the Texas attorney general.
What SB 2337 seeks to achieve – and what it may disrupt
The new law’s proponents say it enhances transparency and protects shareholders. But practitioners see more fundamental consequences.
“It seemed to me they were trying to level the playing field for Texas investors that may have been disadvantaged by proxy advisory firms’ policies toward companies in the state,” Steve Cross, managing director and head of the Houston office of compensation consultant FW Cook told Diligent Market Intelligence (DMI) in an interview. “It could have a range of outcomes, and it could be meaningful. It could mean proxy advisors excerpting out proposals that would require additional analysis, it may result in additional analysis that attempts to quantify the financial impact of the proposal, and it could also range all the way to the proxy advisory firms hosting on their websites the disclosure that, for example, their analysis is not based primarily on the financial interest of the shareholder.”
The bill is sometimes sparse on details and certainly open to interpretation. Litigation seems inevitable. But when it goes into effect it will force proxy advisors to make a wide swathe of disclosures.
“I don’t think people are fully appreciating that proxy advisors will have to accompany any recommendation opposing management with financial analysis to support that recommendation – regardless of the ESG aspect,” Ferrell Keel, a Dallas-based partner at law firm Jones Day, said in an interview with DMI.
Cross wonders whether it will affect not just reports and recommendations, but ratings and scores created by the proxy advisors too.
“It’s going to really disrupt the corporate governance landscape in Texas and potentially have further-reaching effects,” said Keel. “It's going to be an interesting proxy season because it’s not just proxy advisors who need to navigate compliance – there will be ancillary impacts on institutional investors and companies too.”
Impact on investors
According to Cross, the wide scope of the bill – affecting some 300 to 500 companies including a significant number of the S&P 500 – means it’s not something proxy advisors can sidestep. “When we're talking about the number of companies involved here and the high level of some of those companies, I think the proxy advisors are going to want to find a way to stay engaged.”
Institutional investors have developed a range of options to offset their use of proxy advisors in recent years, including scaling up their in-house data and analysis capabilities, direct engagement with issuers, and pass-through voting, which allows beneficial owners to make voting decisions.
One provision of the bill – requiring disclosures when proxy advisors give different advice or recommendations to different clients that haven’t been expressly requested – should make investors more prescriptive about their voting approach. “I don't think that this bill is meant to inhibit specialist custom policies – if anything, it may promote the use of them because those wouldn't be captured under this bill if the client ‘expressly requested services for a nonfinancial purpose’,” Keel said. “But requesting advice for nonfinancial reasons may present inherent challenges to institutional investors.”
Indirect consequences: redomiciling and investor behavior
Beyond the direct compliance costs for proxy advisors and investors, SB 2337 could influence decisions about where companies choose to incorporate or maintain their headquarters. While Delaware remains the traditional domicile of choice for many public companies, Texas is among the states positioning itself as an alternative – particularly for issuers aligned with the state’s approach to ESG and fiduciary oversight.
Some observers believe the law might also prompt changes in investor behavior. The higher documentation requirements could deter proxy advisors from making negative recommendations, especially when financial metrics are ambiguous. Over time, this could dampen voting participation – especially on ESG issues, where the connection to financial performance is often contested and may need to be reestablished every proxy season. “There are a lot of ways this could go, but it might result in a universe where institutional investors redefine their fiduciary duty to vote – particularly on social and political issues,” Keel told DMI. “And we may inch towards a world where fewer investors are voting, particularly passives, on certain matters.”
Looking ahead: regulatory and market dynamics in flux
Even if parts of the law are blocked or revised, the precedent it sets could encourage similar action in other conservative-led states, especially those seeking to compete with Delaware for corporate charters. One quirk of the Texas bill is that it applies to companies considering a move to Texas – so that proxy advisors would have to provide a financial analysis to justify any recommendation against such a proposal, potentially making it harder to demur.
At the federal level, the SEC under the fresh leadership of Chair Paul Atkins will be closely watched for its agenda.
Yet even as regulatory risks mount, market developments suggest resilience in the proxy advisory sector. “My thinking is that the proxy advisory firms will adapt because I do think they serve a pretty central role in helping large investors sort through a very complicated environment,” said Cross.
Deutsche Boerse’s recent steps toward an IPO of ISS Stoxx may reflect a stronger foundation or an effort to exit before conditions worsen.
For now, the corporate governance ecosystem is bracing for a period of adaptation. Proxy advisors, institutional investors, and issuers are already adjusting to changes in the first six months of 2025 – including shareholder proposal rules, 13D guidance, and now proxy advisor rules. Depending on the focus for the rest of this presidential term, Texas may only be the beginning.
