The D.C. Circuit Court’s recent decision to vacate SEC Rule 14a-11, designed to facilitate director nominations known colloquially as proxy access, is a significant defeat for the SEC.
The Commission’s efforts to adopt a proxy access rule date back to the early 2000s. In addition, the loss is made more confounding by the fact that the SEC, and supporters of a federal rule on proxy access, were able to have included in the Dodd-Frank legislation explicit and express authorization for the SEC to adopt a proxy access rule. Dodd-Frank thus eliminated any legal uncertainties surrounding the SEC’s authority to adopt Rule 14a-11. That meant the SEC only had to satisfy the requirements of the Administrative Procedures Act (APA) in order for the rule to pass muster. The APA requires only that an independent agency not act in a way that is “arbitrary, capricious, an abuse of discretion or otherwise not in accordance with law” in its rule making; a low standard designed to afford independent agencies such as the SEC broad discretion, and to minimize judicial second-guessing. Despite this, the SEC was not able to get over this low hurdle. What should the SEC do now?
In addition to pursuing the suggestions of the court in it’s ruling, the SEC must now appeal the decision of the D.C. Circuit Court. The SEC must do this to preserve the ability of all independent agencies to adopt rules without undue judicial interference—just the thing the APA was adopted and designed to prevent. The D.C. Circuit Court largely, and inappropriately, substituted its own judgment for that of the SEC when it ruled that the agency did not properly evaluate the potential costs and benefits of Rule 14a-11. The Court second guessed the SEC in the area of the cost/benefit analysis requirement, and in doing so, elevated that analysis to a level of substantive importance equivalent to the rule itself. This approach is an end run around the APA, and opens all agency rulemaking to the risk that a court will replace its judgment for that of the agency on the costs and/or benefits of a new rule.
But is a court able to make that judgment at all? How would a court, for example, be expert enough in the details of the securities markets, banking, healthcare or any of the myriad industries subject to agency rule making in order to assess in a judicial context costs and benefits? The answer is no court can or should be tasked with this duty. The court’s duty should extend, and stop, at an inquiry into whether an analysis was made at all, and in good faith, by the agency. If these two concerns are met, the court should defer to the agency.
In the case of the SEC and Rule 14a-11, there is no question the SEC undertook significant work in the cost/benefit analysis—after all, the agency was not only anticipating a legal challenge on just these grounds, but also had other rules vacated by the same court on similar grounds. Indeed, reading the SEC’s release adopting Rule 14a-11 is an exercise in caution, as if the SEC’s office of the general counsel poured over every word and phrase, girding the language and its action against the legal challenge it knew was coming.
That an agency staffed with as many talented lawyers as the SEC cannot pass a rule that has been under consideration for nearly a decade, and with express Congressional authorization to do so, is a sad commentary on the state of agency rulemaking.
In fact, it requires a rethinking of the APA and its intersection with the requirements of the law adopted by Congress in 1995 requiring enhanced cost/benefit analyses. A better approach, and one the SEC should argue on appeal, is for courts to adopt a standard of review similar to that undertaken in business cases, when the actions of a board of directors has been challenged. In such circumstances, many courts determine whether there was a process in place for decision-making, and whether such process was followed in good faith, without conflict of interest and in accordance with law. If met, the court defers to the actions of the board, careful not to disturb the business judgment of American corporations. Under the business judgment rule, courts will not second-guess corporate decisions, awards of compensation, or other actions taken in lawful due course and corporate purpose.
Independent agencies should be afforded a similar level of “agency judgment” protection. If, for the purposes of an APA review, an agency can demonstrate a process whereby costs and benefits are considered, and a good faith adherence to that process is free of conflicts or illegalities, the court should defer to the expertise of the agency. This is a preferred approach whether one believes the SEC should adopt a uniform rule on proxy access or not. The stakes are bigger than the right of large shareholders to access the corporate proxy. They implicate the ability of agencies to do what they have been tasked to do, within the parameters of their jurisdiction and expertise. If we are going to have bodies like the SEC, they should be allowed to function as intended. That the SEC was not given appropriate deference in the proxy access case is bad news for them, and for all agencies.
Roger Coffin is associate director of the Weinberg Center for Corporate Governance at the University of Delaware.