July 22, 2011
Business Roundtable v. SEC
Posted by Gordon Smith

In May 2009, the SEC proposed proxy access rules, which would give shareholders the right in specified circumstances to nominate directors on the company's ballot. One of the early challenges to the proposed rules rested on the uncertainly regarding the SEC's authority to require proxy access. In response to this uncertainty, Dodd-Frank (Section 971) amended Section 14(a) of the Securities Exchange of 1934 to authorize the SEC to adopt proxy access rules and to set the terms and conditions of shareholder access. In August 2010, the SEC promulgated the final proxy access regulation, which was quickly challenged in court by the Business Roundtable and the U.S. Chamber of Commerce. Today, the DC Circuit vacated Rule 14a-11.

The opinion is short, and it's an easy read. The Court reviewed the SEC's rulemaking process under the Administrative Procedure Act, and found the process wanting. According to Judge Ginsberg's opinion, "the Commission acted arbitrarily and capriciously for having failed once again — as it did most recently in American Equity Investment Life Insurance Company v. SEC, 613 F.3d 166, 167–68 (D.C. Cir. 2010), and before that in Chamber of Commerce, 412 F.3d at 136 — adequately to assess the economic effects of a new rule."

The Court was concerned that the SEC did not adequately account for the direct costs of the new rule, including the potentially high expenditures that companies would incur in opposing shareholder nominees. The SEC failed to even attempt to quantify these costs, even though historical data on the costs of proxy contests is available. Importantly, the costs of opposing shareholder nominees might not be discretionary or self-serving, as the incumbent directors would feel obliged by their fiduciary duty to oppose unqualified nominees.

The SEC also failed to quantify the benefits of the rule, which include improved corporate performance from the election of dissident directors. The Court concluded that the SEC did not adequately evaluate the empirical evidence on this issue. In the face of "mixed" empirical evidence, the SEC was not entitled to claim benefits from the rule. 

The most interesting part of the opinion is where the Court considered the possibility that union and state pension funds might use Rule 14a-11 for personal gain. The Court: "By ducking serious evaluation of the costs that could be imposed upon companies from use of the rule by shareholders representing special interests, particularly union and government pension funds, we think the Commission acted arbitrarily."

Finally,* the Court challenged the SEC's conclusions about the frequency of shareholder nominations: "the Adopting Release does not address whether and to what extent Rule 14a-11 will take the place of traditional proxy contests."

The Court vacated the rule, and the U.S. Chamber of Commerce is pleased: "We applaud the court’s decision to prevent special interest politics from being injected into the boardroom." Well, at least for now. The opinion is a rather limited indictment of the proxy access proposal, relying on the lack of sufficient justification. The SEC is considering its options. While it might challenge the ruling, I suspect that the agency is more likely to produce a newly justified rule in the near future.     


*The Court also has a section dealing with the application of the rule of investment companies, but I won't summarize that here. 

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