SEC Reacts to Potential Litigation Against Other Rulemaking Initiatives

By Cydney Posner

As a follow-up to my article from 7/29/11, here is a link to a Reuters article contending that, in light of the recent circuit court decision that tossed out proxy access because of a flawed economic analysis, U.S. regulators are "scrambling to bulletproof dozens of financial reforms." According to the article, the "ruling sent shivers down the spines of the SEC and Commodity Futures Trading Commission, and has them bracing for more court challenges as they strain to complete well over 100 rules called for in Dodd-Frank that was enacted last year.

" ‘I was afraid of this all along,' said Jill Sommers, a Republican commissioner at the CFTC….Scott O'Malia, the other Republican CFTC commissioner, says he is going to call for a briefing with agency staff to review the ruling and assess the agency's vulnerabilities. ‘I just don't want to make any mistakes that set us back,' O'Malia said. ‘It's a very serious concern.' "

According to the article, the "court ruling on proxy access has jolted the SEC into going back and reviewing all of its pending rules for any legal weaknesses, according to people familiar with the matter.

"Prior to its July 26 open meeting, which came just days after the ruling, the SEC went back and made substantial last-minute changes to the cost-benefit analysis portions of several final and proposed rules, one of those people said."

The most likely legal challenges that would relate to a failure to follow federal rule-making procedures, such as a failure to properly consider all of the public comments or to perform a poor cost-benefit analysis. In addition to proxy access, flawed economic analysis was also the basis for prior litigation losses by the SEC involving rules for mutual fund director independence and regulating indexed annuities as securities instead of insurance. An economist at NERA suggests that the language in many Dodd-Frank comment letters from industry groups and companies "appears to lay the groundwork for future challenges" by establishing a record for the judge who may hear the challenge. For example, in the comment process for proxy access, the Business Roundtable had commissioned and submitted with its comments a study on the subject by individuals at NERA and Yale University. The study was used by the court to criticize the SEC for failing to adequately take that study's findings into account and instead relying on other studies to supports its rulemaking.

The proxy access case may provide a good template for future litigation. A professor at the University of Houston cited in the article suggested that "[a] lot of market participants are going to think this is extremely expensive for me, might as well give it a legal shot and see if that works." The article reports that the U.S. Chamber of Commerce, which challenged the proxy access rule with the Business Roundtable, has already said it may challenge the conflict minerals rule.

According to the article, Republicans in Congress have also begun to question the quality of the economics, especially with regard to derivatives rules issued by the CFTC. Apparently, while SEC has an obligation to look at a rule's effect on capital formation, competition and efficiency, the requirements applicable to the CFTC are even tougher. The CFTC has started to include an economist on each of its rulemaking teams and giving their opinions greater weight.