The Emperor Has No Clothes: Confronting the DC Circuit’s Usurpation of SEC Rulemaking Authority

Abstract

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 introduced the most sweeping reforms of financial markets since the Great Depression. Nestled among its numerous provisions was the amendment to section 14(a) of the Securities Exchange Act expressly authorizing the Securities and Exchange Commission (SEC) to adopt rules for shareholders to nominate directors to the boards of reporting companies. Earlier, financial institutions had long lobbied the SEC for a rule providing shareholders access to the nominating process of publicly held corporations. Their cause gained momentum with a 2003 SEC staff report recommending that large, long-term holders, under very limited circumstances, should have the right to nominate a minority of the directors to be elected. After that report, a battle royal ensued, a pro-access chairman was terminated, and under the new SEC chairman the SEC side-tracked shareholder access and even curbed the institutions’ access to the proxy machinery as a means to authorize shareholder nominations to the board. Then, with the imprimatur of Dodd-Frank, the SEC acted, albeit timidly, to provide, in Rule 14a-11, a process for limited shareholder board nominations. In broad overview, Rule 14a-11 permitted a shareholder or group of shareholders that has held at least three percent of the voting power for over three years to nominate a maximum of 25 percent of the board. Institutions rejoiced, but only briefly. Rule 14a-11 never became operative. The rule was immediately challenged so that the SEC suspended its effect until the legal challenge to the rule was resolved. Ultimately the D.C. Circuit held that Rule 14a-11 was invalid due to the SEC’s failure to “consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation” when adopting rules approved.