On July 22, 2011, the federal court of appeals in Washington, D.C., invalidated the "proxy access" rules adopted by the SEC, which would have required public companies and mutual funds to include in their proxy materials director candidates nominated by 3% (or larger) shareholders meeting certain holding period requirements. The Court's written opinion in Business Roundtable v. SEC is available here.

The Court, in a strongly worded decision, held that the SEC's assessment of the costs and benefits of the proxy access regime was "arbitrary and capricious" in violation of the Administrative Procedures Act. Writing for the Court, Judge Ginsburg pointed to the areas where, in his view, the SEC had underestimated the costs of implementing proxy access and found that "the [SEC] acted arbitrarily and capriciously for having failed once again to adequately assess the economic effects of a new rule." Of particular note was the Court's observation that the SEC's analysis of the costs and benefits of the rule was internally inconsistent in that the SEC anticipated frequent use of Rule 14a-11 when anticipating benefits, but assumed less frequent use of the rule when anticipating costs. Moreover, the Court cited the SEC's failure to address the possibility that the rule would be used by unions and pension funds to benefit their constituencies rather than to improve corporate governance. Finally, while noting that these overall defects in the rule render it invalid with respect to all types of issuers, the opinion is particularly critical of the decision to subject investment companies to the proxy access rules, due, in part, to the enhanced regulation imposed by the Investment Company Act of 1940.

In vacating the rule on these grounds, the Court concluded that it did not need to address other arguments the petitioners had raised, including that the SEC improperly rejected reasonable alternatives to a proxy access rule, and that the rule violated the First Amendment. As a result of the Court's decision, the proxy access rule will not go into effect. Should the SEC choose to re-propose a rule mandating shareholder access to company proxy materials for director elections, it will need to overcome the numerous deficiencies identified by the Court.

The Director of the SEC's Division of Corporation Finance issued a statement that pointedly noted that the Business Roundtable decision did not invalidate the separate rulemaking allowing shareholders to submit proposals for proxy access, which was adopted in conjunction with the proxy access rule. The amendments narrow the so-called "election exclusion" under Rule 14a-8(i)(8) in order to permit shareholders to propose additional proxy access at their companies. However, the SEC's October 2010 stay of the proxy access rule also included the Rule 14a-8 amendments because they were "designed to complement" the proxy access rule, and the SEC viewed the two as "intertwined."

The SEC now has the option of refining its economic analysis and re-proposing the proxy access rule. It also must determine whether the Rule 14a-8 amendments are separable from the larger "proxy access" reforms. Conceivably, the SEC also could appeal the DC Circuit's decision to the U.S. Supreme Court, but this seems unlikely in light of the strong business opposition and the fact that these rules are already the result of a very long and arduous rulemaking process. As was noted by the Court, this is the third time in recent years that the D.C. Circuit has vacated an SEC rulemaking.