Inside the SEC's Rule-Making Apparatus

This past summer, the Securities and Exchange Commission proposed two rules on shareholder proxy access with opposing aims: One provides for greater access to ballots, while the other upholds the status quo of restricting access. Together, the initiatives received more than 34,000 comment letters. In an effort to remain politically neutral on the issue, SEC Chairman Christopher Cox voted to push through both proposals. Since then, Commissioner Roel Campos, a Democrat, has resigned, and a public dispute has ensued over whether a vote should go forward with a lopsided commission.

This rocky path is fairly typical of the SEC’s rule-making apparatus. Even simple, widely supported proposals are often put through a back-and-forth cycle, which can take months, or even years, before becoming regulation. After a rule is passed, numerous levels of guidance are further factored into the process. Similarly, once an adopted rule has been broken, a robust debate over the correct course of action for investigations and issuance of penalties follows.

Politics also play a major role, as the issue of proxy access has demonstrated. As a rule, no more than three commissioners on the five-person panel can be of the same party, and the dominant party traditionally reflects that of the President. Congressional members are also eager to express their views on what rules should be passed and, more often, which ones should not.

"It can often be convoluted and protracted, but the process usually ends up serving the purpose of making the final rules better and fairer." --Russel G. Ryan, King & Spalding 

The pace of SEC rule making is rarely described as fast or efficient. It took the SEC five years, countless panels, and six deferments to come to an agreement on whether or not smaller companies needed to conduct a review of internal controls, as large companies do under Section 404 of the Sarbanes-Oxley Act (SOX). Now that it has been decided they do, as a provision of Audit Standard 5 (AS5) issued by the Public Company Accounting Oversight Board, a discussion period is open until December 17, and so the final guidance has yet to be issued. (The PCAOB, which issues rules for auditors, was created by SOX as a non-government, corporate agency that falls under the SEC’s purview, and all of its rules need the commission’s approval.)

But while the rule-making process can be complex, many say that it is transparent—sometimes to a fault—and usually fair. “It can often be convoluted and protracted, but the process usually ends up serving the purpose of making the final rules better and fairer than they otherwise would be,” says Russell G. Ryan, a former assistant director of enforcement at the SEC and now a partner at law firm King & Spalding.

From a Concept to a Rule

The SEC’s rule-making process generally involves four steps: a concept release, a proposed rule, a final rule, and then issued guidance on the final rule. Before a rule can be adopted, it is first formulated into a draft proposal, known as a concept release, which describes the idea to amend or implement a rule. A comment period is then opened to collect opinions on what the SEC is considering.

“We’re interested in as broad an input from the public as possible,” says SEC Spokesman John Heine. “The invitation is wide open. We take comments from anybody. It’s not limited to U.S. citizens or people with law degrees, or anything like that.”

The release is issued with a list of questions asking the public its views on the issue, and the feedback is then taken into consideration while the SEC chooses which approach, if any, is appropriate. On occasion, Heine says, a concept release has gone back to the drawing board, but it is rare that one would be summarily withdrawn.

Once the Commission has digested enough feedback from a concept release, it publishes a detailed, formal rule proposal in the Federal Register for further public comment. The SEC determines the length of the comment period and gives instructions on how comments should be submitted. Normally, the SEC gives anywhere from 30 to 60 days for review and comment from the public on a rule proposal.

“If [the SEC] wants to change something in the proposed rule based upon something they learn, they have to start over and propose a new rule,” says Thomas J. Lehner, director of public policy at Business Roundtable, whose work on corporate governance issues puts him into regular contact with the SEC.