Analysis: Bruised regulators brace for Dodd-Frank court fights

Editor’s Note:  The following article discusses the DC Circuit Court of Appeal’s decision to vacate an SEC rule because the agency failed to appropriately analyze the costs and benefits of their regulation.  In the attached Opinion, the court held that “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. . . and before that in Chamber of Commerce, 412 F.3d at 136 — adequately to assess the economic effects of a new rule. Here the Commission inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.”  The court decision further emphasizes the imperative that agencies adhere to the good government laws that regulate the regulators.

(Reuters) – U.S. regulators are scrambling to bulletproof dozens of financial reforms after a court last month tossed out an important part of the Dodd-Frank financial oversight law.

The federal appeals court ruling faulted the Securities and Exchange Commission for conducting a flawed economic analysis to support a rule to make it easier for shareholders to nominate directors to corporate boards, a process called “proxy access.

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. “The SEC had a rule that was challenged on grounds that I think there are concerns in our rules about, and I feel like we could equally have the same kind of challenges.”

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.”

Among rules considered targets of litigation are the SEC’s conflict minerals proposal, requiring company disclosure of the sources of certain ores and metals, and the CFTC’s speculative trading curbs.

Some legal experts say the cost-benefit requirements applying to CFTC rules are stricter than at the SEC.

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 regulators face on Dodd-Frank rulemakings would rest on a failure to follow federal rule-making procedures.

These could include allegations that regulators did not properly consider all of the public comments on a rule, or that they failed to evaluate a rule’s economic impact.

Flawed economic analysis has gotten the SEC into trouble even before the proxy access rulemaking attempt, with SEC losing cases involving rules for mutual fund director independence and regulating indexed annuities as securities instead of insurance.

The language in many Dodd-Frank comment letters from industry groups and companies appears to lay the groundwork for future challenges, said Jim Overdahl, a vice president at National Economic Research Associates Inc, or NERA. He is a former chief economist at both the SEC and CFTC.

“Yes, they are interested in providing information for regulators so they can make well-informed decisions, but they also want this well-established record… and they are treating this much more like a legal proceeding,” Overdahl said.

The U.S. Chamber of Commerce, which challenged the proxy access rule with the Business Roundtable, has already said it may challenge the SEC’s conflict minerals rule. And the CFTC’s curbs on speculative trading have been widely criticized for having no economic basis.

Overdahl said many of the comment letters are actually targeting two audiences: the regulators themselves and judges who might hear challenges.

In the proxy access example, the Business Roundtable had commissioned a study on the subject by NERA’s Elaine Buckberg and Yale University’s Jonathan Macey. This study was placed into the public record during the comment process.

In the U.S. Court of Appeals for the District of Columbia’s ruling, the judges criticized the SEC for failing to adequately take that study’s findings into account, and instead relying on other “unpersuasive studies” to bolster its rule.

“The court used this example to imply the SEC may have cherry picked the results that were on the record,” Overdahl said.

Experts say the recent ruling on proxy access is likely to help pave the way for future challenges, and the various failings of the SEC that were cited by the court help provide a good template for how to win.

“These rules are likely to be so far-reaching and so expensive that I think legal challenges are almost inevitable,” said Craig Pirrong, a professor and a director for the Global Energy Management Institute at the University of Houston.

“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,” he said.


Industry players have not been the only ones to raise cost-benefit concerns about rule proposals. Republicans in Congress have begun to question the quality of the economics.

Earlier this year, the CFTC’s inspector general issued a study at the request of House Agriculture Chairman Frank Lucas which found some serious flaws, including a lack of available data on industry compliance costs and a one-size-fits-all approach.

In response to the criticism, the CFTC issued an internal memo in May that laid out new guidelines to help bolster its cost-benefit analysis as it gears up to finalize new Dodd-Frank rules on derivatives.

The memo, which was viewed by Reuters, was issued jointly by the CFTC’s General Counsel Dan Berkovitz and Chief Economist Andrei Kirilenko. It cites past cases the SEC has lost, in a move that suggests it is trying to learn from the SEC’s mistakes.

Jeff Harris, finance professor at Syracuse University and a former chief economist at the CFTC, said the agency responded to the report by putting an economist on each of its rulemaking teams, and gave their opinions greater weight.

Eugene Scalia, a partner at Gibson, Dunn & Crutcher who won the proxy access case for the Chamber of Commerce and Business Roundtable, said the court’s decision sends a “strong message” about reading the public’s comments and being “attentive to the costs.”

He said that while the SEC has an obligation to look at a rule’s effect on capital formation, competition and efficiency, the laws governing how the CFTC are even stiffer.

The CFTC is required to look at costs and benefits in light of five broad areas that include competition and efficiency, but also cover risk management and price discovery.

“The CFTC, like the SEC, is governed by a statute that imposes specific obligations to consider economic effects,” Scalia said. “Indeed, the CFTC quite arguably is subject to a more demanding standard than the SEC.”


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