We’ve been discussing the proxy access case, see here, here, and here, where the DC Circuit overturned an SEC rule for failure to meet its requirement under the National Securities Markets Improvement Act of 1996 to consider the effect of the rule on efficiency, competition, and capital formation in addition to its historical mandate to consider investor protection. As I mentioned in my last post on the topic, I am working on an article this semester to draw the boundaries for what the four principles require in SEC rule-making.
We haven’t had a good blog confrontation in awhile, so I am glad Jay Brown, our rival at Race To The Bottom, has decided to engage with my efforts. Jay takes issue with my recent post:
There are several comments to be made about this approach. First, the post mistakenly assumes that the issue in the case was cost-benefit analysis. In fact, the primary authority used by the court in Business Roundtable was the SEC’s obligation to analyze the effects of a rule on competition, efficiency and capital raising. See Section 3(f), 15 USC 78c(f).
Incorrect. In the view of Congress, cost-benefit analysis is part and parcel of any consideration of efficiency, competition, capital formation, and investor protection for that matter. His review of the legislative history of the NSMIA is incomplete. Congress clearly had cost-benefit analysis in mind as it considered the bill. Consider this statement from Thomas J. Bliley Jr. (R), Chairman of the House Commerce Committee that reported out the bill:
The substitute (the NSMIA) maintains the provision (the efficiency, competition and capital formation language) requiring cost benefit analysis in SEC rulemaking, which we think is very important in light of the enhanced Congressional role mandated for SEC and SRO rules under the Small Business Regulatory Enforcement Act of 1996. (1996 WL 270857 (F.D.C.H.))
On the subject of capital formation: My bill calls for the SEC to consider the promotion of efficiency, competition and capital formation when it makes rules. This is an important provision of the bill becasue it wil introduce an element of explicit cost benefit anaysis into SEC rulemaking. We want to encourage the SEC to take efficiency, competition and capital formation into account in its rulemaking. We view these goals as complimentary to the important goal of investor protection. (1995 WL 706020 (F.D.C.H.))
Second, the comment that cost-benefit analysis “is the only legitimate mode of analysis” reflects JW Verrett’s “policy” perspective but it does not reflect the law. In adopting Section 3(f), Congress had this to say:
- “The new section makes clear that matters relating to efficiency, competition, and capital formation are only part of the public interest determination, which also includes, among other things, consideration of the protection of investors. For 62 years, the foremost mission of the Commission has been investor protection, and this section does not alter the Commission’s mission.”
H. Rep. 104-622, 104th Cong., 2nd Sess., at 39 (June 17, 1996). See also Section 3(f) in 1996, Pub. L. No. 104-290, § 106(a), 110 Stat. 3416, 3424). In other words, the efficiency analysis was only one step required of the Commission. Congress left open the possibility that the goals of investor protection could sometimes override the results of the economic analysis.
He closes by observing that “perhaps JW Verrett could use a course in administrative law.” I admire Jay’s sharp rhetoric, and I certainly opened the door.
That said, he’s completely off-the-mark on his second counter to my post. First, to clarify, what I said was: “The legislative history of the securities laws makes clear that the objective is a purely economic one, to stabilize markets, prevent fraud, and maximize economic growth. The 33? and 34? Acts were a response to the stock market crash of 1929 after all. Cost-benefit analysis is a tough fit in areas where nebulous ideas like justice or equity are at issue (though it is still quite informative) but where as here the underlying objectives are purely economic it is the only legitimate mode of analysis.”
The latter three principles, as we saw above, encompass in large part a wide form of cost-benefit analysis. What about investor protection? First we have to consider what investor protection meant in 1933 and 1934, and then we need to consider how it stands in relation to the recent additions. My review of the legislative history of the 33 and 34 Acts isn’t yet completed because, if you include the Pecora hearings, and I think you should, we’re talking thousands of pages of material. But there is one theme emerging about how Congress understood the phrase “investor protection” and that is a focus on fraud prevention through disclosure about the value of traded assets and through prohibition of manipulative trading schemes.
With respect to the SEC’s mission, we’ve agreed that the promotion of capital formation, competition, and market efficiency must be factors considered whenever the SEC is undertaking a rulemaking based on a public interest determination. This responds to Chairman Levitt’s concern that the original bill might have potentially compromised the SEC’s ability to take actions needed to protect investors. (1996 WL 134449 (F.D.C.H.))
The investor protection rationale would be limited to rules on disclosure about the value of investments or rules aimed at manipulative trading schemes. With this limitation, investor protection actually doesn’t apply in many contexts. In the context of proxy access, that means the SEC could take into account the possibility of fraud in the rule’s requirements on nominee disclosure for example. Minimization of principal-agent costs doesn’t however fit within the investor protection principle taken in light of its historical meaning.
The investor protection principle does not apply to the Commission’s decision to make the proxy access rule mandatory rather than opt-out or opt-in, which was the issue at the heart of the proxy access challenge. (One reader comments that the Dodd-Frank Act proxy access section specifically references investor protection. It does not amend the NSMIA however, so I don’t buy his argument that the DFA language sets the other principles aside or changes the meaning of investor protection from its historical roots).
In contexts where the investor protection rationale does apply, Jay seems to view investor protection as a trump card that could be used to exempt the Commission from the latter three principles. But the legislative history doesn’t indicate the principles are mutually opposed, and economic analysis is certainly relevant when considering the effects of fraud and the market processes that evolve to remedy fraud. The more logical view is to consider including investor protection as a principle gives added weight to the cost of fraud in weighing the costs and benefits of new rules.
This discussion will form a substantial portion of the course I am teaching this semester as a Visiting Assistant Professor of Law at Stanford Law School on The Law and Regulation of Financial Institutions. I will be sure to send Jay links to my course materials.