The Long Road Back: Business Roundtable and the Future of Sec Rulemaking

• Publication year: 2012

Washington Law ReviewVolume 36, No. 2, WINTER 2013

The Long Road Back: Business Roundtable and the Future of SEC Rulemaking

Jill E. Fisch(fn*)

I. INTRODUCTION

The Securities and Exchange Commission (SEC or Commission) has faced a number of challenges in the last few years. Judge Rakoff s decision in Citigroup,(fn1) the Madoff scandal,(fn2) and the Business Roundtable decision(fn3) are just a few of the developments that have dealt lasting damage to the SEC's reputation.(fn4) Critics have scrutinized the agency's decisionmaking on multiple fronts-from its enforcement policy to the quality of its rulemaking-and the SEC has largely come up short in the analysis.(fn5) The once-revered top cop(fn6) of the securities markets has taken a hit, and it is unclear whether it can recover.

The Business Roundtable decision is of particular importance. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank)(fn7) tasked the SEC with an unprecedented number of required rulemakings.(fn8) Although the SEC has failed to complete many of these within the statutorily mandated time frames,(fn9) the Jumpstart Our Business Startups Act (JOBS Act),(fn10) signed by President Obama on April 5, 2012, requires additional SEC rulemaking in connection with its im-plementation.(fn11) Commentators have observed that these rulemakings must withstand the rigorous scrutiny to which the D.C. Circuit subjected the SEC's proxy access rule.(fn12) Indeed, the media reports that regulators are "paralyzed" by the threat of litigation.(fn13) The SEC has also announced a number of changes to its rulemaking practices in response to the Business Roundtable decision.(fn14)

Rule 14a-11, the SEC's proxy access rule, was clearly flawed, a point I detail extensively in other work.(fn15) It is unlikely, however, that these flaws resulted from the SEC's failure to conduct an adequate cost-benefit analysis, the basis on which the D.C. Circuit invalidated the rule. Similarly, it is unlikely that the SEC's changes to its rulemaking procedures, which focus largely on the role of economic analysis, address the true weaknesses in those procedures. Instead, this Article argues that the SEC's decisionmaking process is artificially constrained by structural requirements that limit the agency's effectiveness in formulating policy and reaching consensus. As a result, the rationales for its rules are inadequately articulated, and the rules are poorly designed.

As a first step, it is necessary to evaluate the Business Roundtable decision more carefully. This Article examines the decision and the context in which it was decided in Part II. In Part III, this Article discusses the statutory obligations imposed on SEC rulemaking that the court applied in the Business Roundtable case-the Administrative Procedure Act (APA)(fn16) and section 2(b) of the Securities Act of 1933.(fn17) Part IV explores two critical structural constraints on SEC rulemaking-the notice-and-comment procedure imposed by the APA, as well as the Government in the Sunshine Act (the Sunshine Act)(fn18)-and describes the practical effect that these constraints have on the rulemaking process in general and on Rule 14a-11 in particular. In Part V, this Article considers the effect of Dodd-Frank's legislative policy choices on judicial oversight of agency rulemaking.

Bad rules make bad law, and Rule 14a-11 was arguably a bad rule.(fn19) But the flaws in SEC rulemaking are quite different from those identified by the D.C. Circuit. At the same time, the Business Roundtable decision was itself flawed. In evaluating the SEC's decision to adopt a proxy access rule, the D.C. Circuit completely disregarded the congressional policy judgments reflected in Dodd-Frank. Congress played a critical role by explicitly authorizing the SEC to adopt a proxy access rule. By substituting its own policy judgment for that of Congress, the D.C. Circuit threatens not just the ability of administrative agencies to formulate regulatory policy, but also the ability of Congress to direct agency policymaking. Explicit congressional determinations regarding regulatory policy warrant greater judicial deference than the courts have given to them. At the same time, Congress may implicitly subject the agency's implementation of that policy to greater scrutiny as to whether the agency has been faithful to its legislative directive.

II. The Business Roundtable Decision

A. Background to the Decision: The Proxy Access Rule

The starting point of this Article is the D.C. Circuit's decision in Business Roundtable.(fn20) This case presented a challenge to the legitimacy of Rule 14a-11, the proxy access rule that the SEC adopted in 2010.(fn21) Notably, Congress explicitly authorized the SEC to adopt a proxy access rule in section 971 of Dodd-Frank.(fn22) Although the SEC had been considering some form of proxy access for seventy years(fn23) and had issued a notice of proposed rulemaking prior to the enactment of Dodd-Frank,(fn24) it did not act until after Congress formally authorized a proxy access rule.(fn25)

I have described the provisions of Rule 14a-11 in detail else-where.(fn26) To summarize, the rule would have required public companies to include a limited number of director candidates nominated by large shareholders on the issuer's proxy statement. To qualify to nominate director candidates, a shareholder was required to have held at least three percent of the company's stock for three years or more.(fn27) Shareholders were not permitted to use Rule 14a-11 to seek control of an issuer.(fn28) Neither issuers nor states were permitted to create a mechanism by which an individual company could opt out of the required proxy access proce-dure.(fn29)

The Business Roundtable and the U.S. Chamber of Commerce, which had previously threatened to challenge an SEC rule mandating proxy access(fn30) and had successfully challenged other SEC rulemaking efforts,(fn31) filed their complaint just a month after the rule was adopted.(fn32) The petitioners argued, among other claims, that the SEC's adoption of Rule 14a-11 was arbitrary and capricious in violation of the APA and that the SEC failed to adequately assess the rule's effect on efficiency, competition, and capital formation.(fn33)

B. The Circuit Court Decision

The D.C. Circuit vacated Rule 14a-11, agreeing with the petitioners that the SEC had acted arbitrarily and capriciously.(fn34) In particular, the court observed that the SEC has "a unique obligation to consider the effect of a new rule upon 'efficiency, competition, and capital formation.'"(fn35) In concluding that the SEC had failed to meet this obligation, the court largely faulted the quality of the SEC's economic analysis.(fn36) The court identified several ways in which the SEC had, in the court's opinion, failed to estimate or quantify the potential costs of proxy access properly or failed to obtain sufficient empirical data to support its con-clusions.(fn37) On issues for which commentators had presented the SEC with competing economic analysis, the court criticized the agency's failure to "make tough choices about which of the competing estimates is most plausible."(fn38)

The Business Roundtable decision was noteworthy for several reasons. First and foremost was the level of vitriol in the opinion. The court did not simply fault the SEC's rulemaking procedures; it characterized the SEC as acting "inconsistently and opportunistically"(fn39) and its reasons for acting as "unutterably mindless."(fn40) The court stated that the SEC's rejection of the petitioners' prediction of the potential costs of issuer opposition to shareholder nominees "had no basis beyond mere specula-tion."(fn41) The court described the SEC as "ducking serious evaluation of the costs that could be imposed [by special interests]."(fn42) Notwithstanding the fact that SEC rulemakings are conducted by scores of staff members and ultimately adopted by a commission whose composition changes over time, the opinion seemed to attribute a stable (and deficient) institutional character to both the SEC and its rulemakings, describing the agency as having "failed once again" to conduct an adequate cost-benefit analysis.(fn43)

These statements suggest that the court was not merely challenging the SEC's rulemaking process, but was questioning its good faith in analyzing the desirability of the rule. Although the court did not identify a basis for this concern, its language seemed to highlight the particular vulnerability of the agency's reputation and institutional competence.

The court did not defer to the SEC's rationale for its rulemaking, its evaluation of the quality of alternatives and data presented by industry participants, or its assessment of the methodology of studies included in the public-comment file.(fn44) At the same time that the court criticized the SEC for inappropriately discounting commentators' predictions about the costs of the rule, the court branded the agency as inconsistent for increasing the qualification requirements to use Rule 14a-11 from its original rule proposal-a change that would lower costs by reducing the number of shareholder nominations.(fn45) In short, the court's statements were less about the SEC's failure to assess costs and benefits than the SEC's erroneous assessment.

Ultimately, the court appeared to make an independent policy judgment that, notwithstanding the SEC's...