In late July, the Court of Appeals for the District of Columbia (D.C. Circuit) handed the Securities and Exchange Commission (SEC) a scathing rebuke, after reviewing the agency’s first Dodd-Frank Act (DFA) regulation, a rule that would have required publicly traded companies to include in proxy materials potentially voluminous information on director candidates nominated by shareholders rather than by the board of directors. The opinion in Business Roundtable v. SEC1 sent a strong message that the agency’s proposed "proxy access" rule must meet much higher standards than the SEC had expected with respect to cost-benefit analysis and justification.2 Saying the SEC had "acted arbitrarily and capriciously," and therefore impermissibly under the Administrative Procedure Act (APA), by "inconsistently and opportunistically fram[ing] the costs and benefits of the rule; fail[ing] adequately to quantify the certain costs or to explain why those costs could not be quantified; neglect[ing] to support its predictive judgments; contradict[ing] itself; and fail[ing] to respond to substantial problems raised by commenters," the court vacated the final rule.
Observers have been quick to identify other forthcoming rules that the SEC – and the Commodity Futures Trading Commission (CFTC) – will have to scramble to justify, by developing far more serious economic analyses than regulators put forward to support the proxy access rule. These include the costly conflict minerals rule,3 two swap rules, and the incentive-based compensation rule.4 These proposed rules have generated considerable controversy and are particularly vulnerable because of specific statutory language that appears in the Exchange Act and the Investment Company Act of 1940, requiring regulatory authorities to consider the rule’s effect on efficiency, competition, and capital formation when determining whether an action is necessary or appropriate in the public interest.5
The D.C. Circuit’s emphasis on the "unique obligation" of the SEC and CFTC to conduct a thorough economic analysis, due to the presence of specific language in their organic statutes, raises an interesting question as to how much less rigor the courts will accept in reviewing cost-benefit justifications presented by other agencies administering DFA obligations under different laws. Probably it is not safe to relax too much. Regulated entities seem to have developed an appetite for putting costly DFA rules to the test, and the D.C. Circuit in Business Roundtable reaffirmed that, even apart from the special SEC and CFTC statutory requirements, the court "must reassure [itself] the agency has ‘examine[d] the relevant data and articulate[d] a satisfactory explanation for its action including a rational connection between the facts found and the choices made.’"6
But going beyond this general APA-based standard, other factors will be in play in new rules promulgated by the Consumer Financial Protection Bureau (CFPB), which as of July 21, 2011, took over responsibility for 18 Enumerated Consumer Financial Laws under the DFA’s financial institution reorganization provisions. In creating the CFPB, Congress specified that in its rulemaking, the CFPB "shall consider … the potential benefits and costs" of its rules to consumers and regulated entities, including the potential reduction in access by consumers to financial products, and also the impact of its rules on depository institutions and credit unions with total assets of less than $10 billion, as well as effects on consumers in rural areas.7 Further, in Section 1100G, Congress made the CFPB one of three agencies subject to enhanced requirements designed to protect small business,8 another example of statutory language creating a special obligation to conduct a heightened economic analysis. This provision was added as a last-minute amendment, and requires the CFPB, like the Environmental Protection Agency and the Occupational Safety and Health Administration to follow special procedures to evaluate and reduce unnecessary burden on small entities.9 Not stopping there, Congress directed the CFPB to consider the impact of "any projected increase in the cost of credit for small entities" likely to result from its rules. There seems little question that these DFA directives will force the CFPB to undertake a serious inquiry into the economic effects of its rules and also that they provide a ready basis for strict scrutiny by the courts.
The SEC, CFTC, and financial institution regulators do not have a tradition of sophisticated cost-benefit analyses in their rulemaking, but the courts are signaling increased interest, particularly where statutory language indicates an emphasis on economic justification. The new DFA mandates impose numerous broad, costly obligations, and are ripe for challenge if regulators give short shrift to the economic analyses underpinning regulatory requirements. Regulated entities should be alert to opportunities presented by Business Roundtable and related judicial precedent to insist that forthcoming DFA regulations fulfill the standard of a proper assessment of projected economic impacts.