Rational Boundaries for Cost-Benefit Analysis in SEC Rulemaking

In a recent paper co-authored with Connor Raso, I argued that D.C. Circuit’s Business Roundtable decision has set a very high bar for cost-benefit analysis in rulemaking by financial regulators like the SEC. In 2011, the court struck down the agency’s long-pondered proxy access rule—a rule expressly authorized by Dodd-Frank—and did so in a way that calls into question the practical ability of the SEC and other financial regulatory agencies with similar mandates to adopt future rules that will withstand timely challenge.

Our paper, Rational Boundaries for Cost-Benefit Analysis in SEC Rulemaking (forthcoming, Yale Journal on Regulation), analyzes the interplay of legislative, executive, agency and judicial actions over the last thirty years that led to this situation. We point out the contradiction between the Commission’s structure (bipartisan by statute and often requiring logrolling compromises to reach a result) and the assumption of global rationality that underlies cost-benefit analysis.

The SEC declined to interpret its cost-benefit mandates from their 1996 enactment until issuance of guidance in March of 2012, leaving the task to interested, often hostile, commentators on a rule-by-rule basis. But of course administrative agencies are due no deference for determinations they fail to make, and this omission left the courts free rein to develop an ad hoc, open-ended jurisprudence that has proven increasingly unworkable in practice. Of the three rules challenged since 2005 under these mandates, all were remanded and the SEC has re-proposed none.

Bills pending in Congress promise to codify these cases and introduce additional antiregulatory innovations. For example, the Business Roundtable court replaced the “extreme degree of deference” due an agency “when it is evaluating scientific data within its technical expertise” with a burden of providing “sufficient support” for its judgment call when the economic evidence is mixed. And one pending bill would effectively replace the judicial deference traditionally shown to agency determinations with an agency burden to demonstrate to a court the need for action by clear and convincing evidence. Another bill, which has bipartisan sponsorship, would authorize the President to extend OMB rulemaking review to independent agencies such as the SEC, but, in stark contrast to the way the CBA executive orders work, would make all of the agencies determinations, analyses, explanations and assessments subject to judicial review as well.

The paper then analyzes how the SEC responds. It commends the SEC’s March 2012 guidance as an important first step toward reclaiming the initiative. Refined to set rational boundaries around what should and should not be asked of its expert economists, future iterations of the guidance may pave the way for future economic analyses that are both meaningful and feasible. We conclude that this effort, at both the staff and Commission levels, should help reclaim the judicial deference that the Commission’s decisions are due.

The paper has attracted media attention, including a favorable notice by Floyd Norris in his column in the New York Times, and sharp disagreement in The Wall Street Journal from petitioners’ counsel, Eugene Scalia. Tellingly, though, Mr. Scalia’s op-ed offered no riposte to the key criticisms stressed in Floyd Norris’s column: the Court’s uncritical acceptance of the expert report that Mr. Scalia attached to his brief, a report that took a statistic from an independent study out of context, and used it to support an interpretation–that proxy fights reduce shareholder value by up to 40%–which the study’s own authors had rejected.

Mr. Scalia won another case last week, this one against the CFTC’s position limits rule, but, his op-ed piece to the contrary, the court in that case did reach his critique of the agency’s cost-benefit analysis, since it remanded the rule on purely statutory grounds under Chevron. It seems likely that this case will join the ranks of rules remanded and never re-proposed, and will further encourage regulated entities to mount challenges to newly-proposed rules.

The full paper is available for download here.