In a strongly worded opinion, a three-judge panel of the D.C. Circuit has unanimously voided the SEC’s Proxy Access Rule, which would have permitted shareholders who owned in the aggregate 3% of the voting power of a U.S. public company (including investment companies) for at least three years to include a limited number of alternate director nominees in the company’s proxy materials.1 We noted this challenge in our update of October 5, 2010, to our alert of September 16, 2010, discussing the Rule.2
The Court agreed with plaintiffs — the Business Roundtable and the U.S. Chamber of Commerce — that the SEC acted arbitrarily and capriciously, by failing adequately to assess the economic effects of the Rule, thus violating the Administrative Procedures Act and the requirement to consider the rule’s effect upon efficiency, competition and capital formation, contained in both the Securities Exchange Act and the Investment Company Act. In particular, it faulted the SEC for:
- underestimating the likely costs to issuers of contested elections under the Rule, while overestimating its benefits on the basis mainly of two “relatively unpersuasive” studies‚
- failing seriously to evaluate the potential costs from use of the Rule by special interests, particularly union and government pension funds‚ and
- inconsistently assuming frequent use of the Rule in estimating benefits, but infrequent use when estimating costs.
The Court directed particular criticism at the SEC’s application of the Rule to investment companies, faulting the SEC for failure adequately to address:
- whether the requirements of the Investment Company Act reduce the need for, and potential benefits from, the Rule, and
- the potential for greater costs by disrupting the unitary and cluster board structures of families of funds.
The Court characterized part of the SEC’s rationale for applying the Rule to investment companies as “utterly mindless” and warned the SEC not to reapply to them a newly justified version of the Rule, without adequate consideration of these specific issues. Given the Court’s reference to “the probability the rule will be of no net benefit as applied to investment companies,” it seems unlikely in the investment company context that the SEC could pass the test of net economic benefit in the D.C. Circuit, at least with this panel.
The ball is now in the court of the SEC. It could appeal this decision to the full D.C. Circuit, but the unanimity of the decision may make that unlikely. It could in the alternative appeal to the Supreme Court, but only with the approval of the U.S. Solicitor General. The SEC may instead decide to go back to the drawing board, considering the same or a similar Rule, based on a different and presumably stronger factual record. Whatever course the SEC takes on this, it seems unlikely that Proxy Access will be with us in the 2012 proxy season. It also seems highly likely that the Commission will, in one way or another, undertake to complete a rulemaking on this subject, given that Congress, in Section 971 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, expressly authorized the SEC to require the inclusion of shareholder nominees in an issuer’s proxy materials.
The opinion takes pointed note of two similar decisions by the same Court invalidating two other SEC rules for failure by the SEC adequately to assess their economic effects.3 This bodes well for similar challenges to controversial SEC rules, particularly those adopted by a 3-2 vote with strong dissents, as here. It should also prod the SEC to devote more effort, to the extent its budgetary constraints allow, to the economic analysis required for new rules under the Administrative Procedures Act, the Exchange Act, and the Investment Company Act.
For additional information concerning this alert, please contact your regular Bingham corporate contact or the following lawyers:
Michael P. O’Brien
Laurie A. Cerveny
David K. Robbins
Barry N. Hurwitz
Charles A. Sweet