In a ruling that has captured the attention of Washington lobbyists and policy wonks, a three-judge panel said the SEC did not adequately analyze the economic consequences of a rule that would make it easier for shareholders to oust members of corporate boards. The court declared that the SEC had acted “arbitrarily and capriciously.”
In declaring the SEC’s cost-benefit analysis inadequate, the judges set what might be an impossibly high standard, some observers say.
“What the court is doing is second-guessing economic analysis that can always be second-guessed,” said J. Robert Brown Jr., a professor at the University of Denver’s Sturm College of Law.
In justifying the rule, the SEC had said that it would improve the way corporations are run. “But how do you prove that empirically?” asked Harvey J. Goldschmid, a professor at Columbia Law School and a former Democratic SEC commissioner.
“If the court’s unrealistic requirements were applied across the board, the regulatory process would grind to a halt,” he said.
The case pitted two of the capital’s most influential business groups against the government’s primary Wall Street watchdog. It’s called B
usiness Roundtable and Chamber of Commerce of the United States of America v. Securities and Exchange Commission.
In a July decision, a three-judge panel of the U.S. Court of Appeals in Washington struck down a new SEC rule that would have allowed major shareholders to place board candidates on a company ballot.
Boards are generally self-perpetuating; the incumbent directors decide whose names appear on the ballots mailed at company expense. If outsiders want to challenge the official slate, they must mount a “proxy contest,” which can be as much of an uphill battle as a political write-in campaign if not more so because it involves sending voting materials to shareholders at the challengers’ expense.
The SEC said the new rule could make board members more responsive to shareholders and more independent from management, and less complacent. By improving the way companies are run, the rule could increase shareholder value and restore investor confidence, the SEC said.
In adopting the rule, the agency was using authority granted by Congress last year to extend proxy access to shareholders.
Advocates of the new SEC rule, including labor unions and pension funds, argue that letting major shareholders have access to the corporate ballot would bring greater democracy and accountability to the boardroom. Some proponents have criticized boards as bastions of cronyism where directors all too willingly award executives excessive compensation.
On the other side, the Business Roundtable, which represents chief executives, and the Chamber of Commerce said labor unions could abuse ballot or “proxy” access by advancing agendas at odds with the interests of other shareholders.
The business representatives also argued that the SEC failed to account for expenses companies would incur campaigning against outside nominees for board seats.
In the so-called proxy access rule, the SEC devoted nearly 80 pages to a cost-benefit analysis, trying to quantify with precision some costs that are inherently unpredictable even as the agency justified the rule based on intangible value judgments.
In the document issued last August laying out the rule, the SEC acknowledged that companies might spend money campaigning against outside board candidates and listed a range of estimated costs companies have incurred in past proxy contests. But the agency said campaign spending was not required by the rule.
The opinion issued by the three judges, all appointed by Republican presidents, accused the SEC of failing to address concerns raised by industry in formal comments submitted as part of the rule-making process.
“The SEC needs to more seriously address the concerns raised by commenters in the rule-making process,” Business Roundtable Executive Director Larry Burton said in a written response to questions.
The decision also could force the SEC to focus more on economic analysis. Paul S. Atkins, a former Republican SEC commissioner, said that, instead of letting economic analysis guide policy, the SEC has long used it to rationalize policy that the agency has already charted.
Eugene Scalia, a lawyer who argued the case for the business groups, said court rulings make it clear that the SEC can act in the absence of complete or perfect data, as long as it does its best.
But he added, “If it just doesn’t know that what it’s doing is positive, it shouldn’t do it.”
An SEC spokesman declined to discuss the court ruling in any depth. The agency is still assessing its options, which include abandoning the undertaking, appealing the decision or rewriting the rule.
The decision comes as regulators are already behind schedule writing rules to implement the sweeping Dodd-Frank Wall Street Reform and Consumer Protection Act enacted last year in response to the financial meltdown of 2008.
Rules still on the drawing board include a new regulatory regime for trading in derivatives, which have been both a cash cow and a source of risk for Wall Street, and additional disclosure requirements for executive pay. One measure would force companies to publish the ratio of the chief executive’s pay to that of the typical employee. Businesses have argued that this proposal would be costly and impractical to implement.