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August 04, 2011

More On The DC Circuit's Proxy Access Decision

Posted by David Zaring

The D.C. Circuit's proxy access decision keeps getting attention, see here for a roundup, and here, from Elliott Spitzer. Seems like an opportune time to add some belated thoughts about the opinion. It’s worth noting that when the D.C. Circuit rejects big SEC rules, which it does with some frequency these days, it is applying principles of administrative law. Steve Davidoff has already provided a nice analysis of the case here. But here’s a smidgen more realpolitik for you:

It was smart for the blue chip plaintiffs (the Chamber of Commerce and the Business Roundtable) to get Delaware and the ICI (if they did - the ICI has some interests orthagonal to the chamber, to be sure) - blue chip amici – on board. This sort of amicus gathering is quite the appellate litigation parlor sport these days, and it usually seems like a lot of work for a limited benefit, but if you must do it, serious players in corporate governance are nice to have on your side.
There is no question that the SEC has the statutory authority to promulgate a rule like this one. The court only ruled that the agency had acted arbitrarily and capriciously in doing so. It’s not easy to win cases against agencies on these grounds, but one way to do so is to argue that the agency failed to consider a relevant fact. Here the court thought that the agency had failed to consider the economic impact of the rule, and seeks in the opinion to essentially require the agency to do a cost-benefit analysis before acting, because of unique language in the SEC’s governing statute requiring the agency to consider the effect of its actions on “efficiency, competition, and capital formation.” It is worth noting that there is no explicit requirement that a cost-benefit analysis be done in the statute.
- The Court’s analysis of the SEC’s failure to consider the economic consequences of its actions is probably best characterized as fly-specking, and the kind of searching inquiry no agency could survive – it’s “why did you reject this one study over here?” stuff, and probably best characterized either as political decisionmaking by three Republican judges, or the discomfort that complicated rules often cause judges (why the 3% ownership stake, and why the inability to use the rule if you’re trying to take over the company? for example).
- That latter discomfort came through in particular in the extension of the rule to mutual funds, which I must say, I don’t really understand myself. Why do they need proxy contests? The DC Circuit didn’t appear to understand it either, and wrote separately to make clear its mystification in “we don’t see how you could possibly justify this” terms.

Reversal on arbitrary and capricious grounds in theory isn’t difficult to overcome. The agency can issue the same rule with a better explanation, hitting the court’s points one by one, and hope for a more sympathetic review next time. But that’s why “why did you reject this one study over here?” reversals are scary, because they suggest that the court may unpredictably reverse again by settling on another obscure study, or failure to say something, or whatever. In that sense, the fact that the opinion isn’t very good (though it’s admirably concise), is a good thing for the Business Roundtable. There isn’t a very clear path for affirmance for the agency, nor is there a “no way, no how” moment that would make clear that it needs to go to Congress.
When the SEC does pass a big new rule, one way to signal to the DC Circuit that it should be reversed is clearly to split 3-2 on adoption.
And when the SEC loses these cases, it isn’t without weapons. It’s an enforcement agency, and I’ve heard it observed that it sure is interesting that after its hedge fund rule got reversed, which happened when the hedge fund industry sued en masse, the SEC launched a massive insider trading investigation against said industry. With wiretaps. One wonders if the mutual fund industry, to say nothing of the Business Roundtable, considered whether it was involved in litigation, or a larger negotiated process of compliance.

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It was smart for the blue chip plaintiffs (the Chamber of Commerce and the Business Roundtable) to get Delaware and the ICI (if they did - the ICI has some interests orthagonal to the chamber, to be sure) - blue chip amici – on board. This sort of amicus gathering is quite the appellate litigation parlor sport these days, and it usually seems like a lot of work for a limited benefit, but if you must do it, serious players in corporate governance are nice to have on your side.
There is no question that the SEC has the statutory authority to promulgate a rule like this one. The court only ruled that the agency had acted arbitrarily and capriciously in doing so. It’s not easy to win cases against agencies on these grounds, but one way to do so is to argue that the agency failed to consider a relevant fact. Here the court thought that the agency had failed to consider the economic impact of the rule, and seeks in the opinion to essentially require the agency to do a cost-benefit analysis before acting, because of unique language in the SEC’s governing statute requiring the agency to consider the effect of its actions on “efficiency, competition, and capital formation.” It is worth noting that there is no explicit requirement that a cost-benefit analysis be done in the statute.
- The Court’s analysis of the SEC’s failure to consider the economic consequences of its actions is probably best characterized as fly-specking, and the kind of searching inquiry no agency could survive – it’s “why did you reject this one study over here?” stuff, and probably best characterized either as political decisionmaking by three Republican judges, or the discomfort that complicated rules often cause judges (why the 3% ownership stake, and why the inability to use the rule if you’re trying to take over the company? for example).
- That latter discomfort came through in particular in the extension of the rule to mutual funds, which I must say, I don’t really understand myself. Why do they need proxy contests? The DC Circuit didn’t appear to understand it either, and wrote separately to make clear its mystification in “we don’t see how you could possibly justify this” terms.

Reversal on arbitrary and capricious grounds in theory isn’t difficult to overcome. The agency can issue the same rule with a better explanation, hitting the court’s points one by one, and hope for a more sympathetic review next time. But that’s why “why did you reject this one study over here?” reversals are scary, because they suggest that the court may unpredictably reverse again by settling on another obscure study, or failure to say something, or whatever. In that sense, the fact that the opinion isn’t very good (though it’s admirably concise), is a good thing for the Business Roundtable. There isn’t a very clear path for affirmance for the agency, nor is there a “no way, no how” moment that would make clear that it needs to go to Congress.
When the SEC does pass a big new rule, one way to signal to the DC Circuit that it should be reversed is clearly to split 3-2 on adoption.
And when the SEC loses these cases, it isn’t without weapons. It’s an enforcement agency, and I’ve heard it observed that it sure is interesting that after its hedge fund rule got reversed, which happened when the hedge fund industry sued en masse, the SEC launched a massive insider trading investigation against said industry. With wiretaps. One wonders if the mutual fund industry, to say nothing of the Business Roundtable, considered whether it was involved in litigation, or a larger negotiated process of compliance.

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