The U.S.
Court of
Appeals
for the
District
of
Columbia
vacated
the
SEC’s
proxy
access
rule,
Exchange
Act Rule
14a-11,
holding
that the
SEC was
arbitrary
and
capricious
in
promulgating
the
rule.
The
court
said the
SEC
failed
once
again to
adequately
assess
the
economic
effects
of a new
rule.
Rule
14a-11
would
permit a
shareholder
or group
of
shareholders
to
submit a
nomination
to the
board of
directors
if they
have
continuously
held at
least
three
percent
of the
voting
power of
a
company’s
securities
for at
least
three
years.
The
company
would
have to
include
the
nominee
in its
proxy
statement
and on
the
proxy
voting
card.
The SEC
adopted
Rule
14a-11
in a
three to
two
vote.
The
majority
believed
the rule
would
lead to
improved
performance
by
boards,
which
would
justify
its
costs.
The
commissioners
who
voted
against
the rule
argued
that the
SEC had
failed
to act
on the
basis of
empirical
data and
sound
analysis.
The
court
said the
SEC has
a unique
obligation
to
consider
the
effect
of a new
rule
upon
efficiency,
competition
and
capital
formation.
The
failure
to do so
makes
the
promulgation
of the
rule
arbitrary
and
capricious,
and not
in
accordance
with the
law,
according
to the
court.
The
petitioners
argued
that the
SEC had
neglected
its
statutory
responsibility
to
determine
the
likely
economic
consequences
of Rule
14a-11
and to
connect
those
consequences
to
efficiency,
competition
and
capital
formation.
Petitioners
also
challenged
the
SEC’s
decision
to apply
the rule
to
investment
companies
The
court
said the
SEC
inconsistently
and
opportunistically
framed
the
costs
and
benefits
of the
rule. It
failed
to
adequately
quantify
the
costs or
to
explain
why the
costs
could
not be
quantified.
The SEC
also
failed
to
support
its
predictive
judgments
and
contradicted
itself,
according
to the
court.
The SEC
predicted
that
companies
may
include
shareholders’
director
nominees
rather
than use
corporate
funds to
resist
them
without
a good
faith
corporate
purpose,
and that
the
ownership
threshold
and
ownership
period
would
limit
the
number
of
nominations
that a
board
would
receive.
The
court
agreed
with
petitioners
that the
SEC’s
prediction
had no
basis
beyond
mere
speculation.
The SEC
did
nothing
to
estimate
and
quantify
the
costs
that
companies
might
incur to
oppose a
nomination,
the
court
said,
even
though
empirical
evidence
from
traditional
proxy
contests
was
readily
available.
The
court
said the
SEC also
relied
upon
insufficient
empirical
data
when it
concluded
that
Rule
14a-11
would
improve
board
performance
and
increase
shareholder
value by
facilitating
the
election
of
dissident
shareholder
nominees.
Numerous
studies
were
submitted
by
commenters
that
reached
the
opposite
result,
but he
SEC
relied
on two
studies
which
the
court
found to
be
unpersuasive.
The
court
said the
SEC
discounted
the
costs,
but not
the
benefits
of the
rule.
The SEC
also
failed
to
seriously
evaluate
the
costs
that
could be
imposed
by
special
interest
groups’
use of
the
rule,
such as
unions
and
government
pension
funds.
The
court
noted
that the
SEC
revised
its cost
estimate
in the
adopting
release
from
that
used in
the
proposing
release.
The
adopting
release
did not
address
whether
and to
what
extent
Rule
14a-11
would
take the
place of
traditional
proxy
contests.
The
SEC’s
discussion
of the
estimated
frequency
of
nominations
under
Rule
14a-11
was
internally
inconsistent,
in the
court’s
view.
The
court
said the
SEC
anticipated
the
frequent
use of
the rule
when
estimating
benefits,
but
assumed
an
infrequent
use when
estimating
costs.
The
court
concluded
that,
because
the rule
is
arbitrary
and
capricious
on its
face, it
is also
invalid
as
applied
to
investment
companies.
The
court
outlined
its
concerns
about
the
application
of the
rule to
investment
companies,
which it
said had
not been
addressed
by the
SEC.
The
court
said the
SEC
failed
to
adequately
address
whether
the
regulatory
requirements
of the
Investment
Company
Act
reduce
the need
for, and
the
benefit
to be
derived
from
proxy
access,
and
whether
the rule
would
impose
greater
costs
upon
investment
companies
by
disrupting
the
structure
of their
governance.
The SEC
did not
adequately
address
the
probability
that the
rule
would be
of no
net
benefit
as
applied
to
investment
companies,
according
to the
court.
In
holding
that the
SEC was
arbitrary
and
capricious
in
promulgating
Rule
14a-11,
the
court
found no
need to
address
the
petitioners’
First
Amendment
challenge
to the
rule.
Meredith
Cross,
the
director
of the
Division
of
Corporation
Finance,
said the
SEC was
disappointed
by the
court’s
decision
to
strike
down a
rule
that
would
make it
easier
for
shareholders
to
nominate
a
candidate
to a
company’s
board of
directors.
She
added
that a
rule to
allow
shareholders
to
submit
proposals
for
proxy
access,
which
was
adopted
at the
same
time, is
unaffected
by the
ruling.
The SEC
is
considering
its
options
in light
of the
court’s
decision,
according
to Ms.
Cross.
□
Business
Roundtable
v. SEC
(DC Cir)
is
reported
at
¶96,358.