A drastic new change to long-established rulemaking practices may signal that our increasingly partisan political process is now exerting a powerful influence on proposed rules relating to the financial markets. The consequences of this shift may affect investors and the broader markets for years to come.
Historically, rulemaking by the Securities and Exchange Commission and other independent regulators rarely attracted much interest outside policy circles. This was attributable in part to the fact that the legislative process was seen as the arena for playing out the political concerns that drive the substance of new statutes. Congress would hash out differences of opinion across the aisle, and then regulators would simply propound rules implementing legislative intent pursuant to a procedure clearly defined by statutes.
Financial regulation was no exception. The framework for the SEC's oversight of the securities markets is largely set out in the federal securities laws, including the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, and the Sarbanes-Oxley Act. Congress drafted these statutes broadly, establishing their basic principles, objectives, and parameters, but leaving many details to regulators to resolve in the implementation process. In turn, the Commission's charge has been to ensure, through rulemaking, that the intent of Congress is carried out in the application of these statutes when issues would arise as the securities markets evolved technologically, expanded in size, and offered new products and services.
The judiciary has traditionally been deferential to the Commission's rulemaking. Pursuant to §706 of the Administrative Procedure Act (5 U.S.C. §706) (APA), the Commission's conclusions of law with respect to the statutes it administers are meant to be "binding in the courts unless procedurally defective, arbitrary or capricious in substance, or manifestly contrary to the statute." United States v. Mead, 533 U.S. 218, 227 (2001) (citing Chevron, U.S.A. v. Natural Res. Def. Council, 467 U.S. 837, 843-44 (1984)). Similarly, the Commission's findings of fact are meant to be conclusive so long as they are supported by substantial evidence. See, e.g., Graham v. SEC, 222 F.3d 994, 999-1000 (D.C. Cir. 2000) (applying substantial evidence standard to SEC's findings of facts); see also Time Warner Entm't v. FCC, 240 F.3d 1126, 1133 (D.C. Cir. 2001) ("Substantial evidence does not require a complete factual recordwe must give appropriate deference to predictive judgments that necessarily involve the expertise and experience of the agency").
This historical deference was shaken soon after Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, a statute intended to address the structural causes of the financial crisis of 2007 and 2008. While Dodd-Frank's reforms were warmly welcomed by the investor community, they provoked strong opposition in the financial services sector.
There can be no doubt that the statute was wide-ranging in scope. Dodd-Frank contains approximately 400 specific mandates, to be implemented by agency rulemaking, with the intent to "promote the financial stability of the United States by improving accountability and transparency in the financial system." Dodd-Frank Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010). Of these mandates, the SEC was made responsible for approximately 100.
In the view of many in the financial services industry, these hundreds of mandates represented untold hours of internal corporate compliance procedures and paperwork, restructuring and expanding corporate governance departments, and additional potentially costly reporting expenses. Having lost the argument over these burdens in the legislature, the financial industry's response was to target the Commission's rulemaking process with repeated lawsuits. The most successful of these challenges has centered on the adequacy of the SEC's "cost/benefit analysis" in its rulemaking.
In general terms, cost/benefit analysis is a methodology that involves the estimation, in monetary terms, of the net economic value of a given policy, and then the weighing of these benefits against the economic costs. No statute requires the Commission to conduct a formal cost/benefit analysis as part of its rulemaking activities. In fact, the Government Accountability Office (GAO) has explicitly stated to the contrary:
As part of the rulemaking process, federal financial regulatory agencies are required to conduct a variety of regulatory analyses, but benefit-cost analysis is not among the requirements.
GAO-12-151 at 9 (2011).
However, since the early 1980s, the Commission has been considering potential costs and benefits as a matter of good regulatory practice whenever it adopts rules, and it has been telling Congress as much. This may be what has given the cost/benefit analysis challenge its traction.
Rule 14a-11. The landmark lawsuit attempting to make such analyses mandatory and much more detailed, at least for certain regulations issued pursuant to the Dodd-Frank Act, was brought by the Business Roundtable and Chamber of Commerce. The suit challenged the SEC's Dodd-Frank-authorized Rule 14a-11, the "proxy access" rule, intended to facilitate the effective exercise of shareholders' state-law rights to nominate and elect directors to company boards of directors. Specifically, Rule 14a-11 required a company, under certain circumstances, to include in its proxy materials information about and the ability to vote for shareholders' nominees for director.
Commission Analysis. The Commission determined that, by enabling nominating shareholders to include their director nominees in a company's proxy materials instead of engaging in a traditional proxy contest, Rule 14a-11 would provide shareholders direct cost savings in the form of reduced expenditures for advertising and promoting their director nominees as well as reduced printing and postage costs. In addition, the Commission determined that nominating shareholders would result in certain intangible benefits.