More Legal Challenges to Dodd-Frank Could Be in the Works

Emboldened by its legal victory over the Security and Exchange Commission's shareholder proxy access rule, the U.S. Chamber of Commerce is gearing up to contest other upcoming Dodd-Frank Act rules.

The business lobbying group will launch legal challenges of other Dodd-Frank provisions if the SEC continues to produce insufficient economic analyses of these rules, says Tom Quaadman, vice president at the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce. “We will focus specifically on rules and provisions that impact the ability of companies to raise capital and remain competitive globally,” he says.

In July, the Chamber, along with the Business Roundtable, an association of large-company CEOs, succeeded in overturning the SEC's proxy access rule when a three-judge appellate court in Washington, D.C. held that the SEC failed to do an adequate study of the costs that its proxy access rule would impose on businesses before the agency adopted the rule earlier this year.

The proxy access ruling “sets a precedent that may improve the other 400 plus mandatory and discretionary rulemakings arising from the legislation,” says Quaadman. The Chamber doesn't necessarily oppose the Dodd-Frank Act, but Quaadman says the SEC needs to carefully weigh the costs of rules against the benefits and make sure the rules don't interfere with market efficiency and capital formation.

Quaadman says the Chamber is concentrating its efforts to focus on major areas of the Act, including the development of rules by the Consumer Financial Protection Bureau, and issues on systemic risk, corporate governance, and the Volcker rule, which prohibits banks from engaging in some proprietary trading.

One example of a rule that the Chamber is considering challenging, according to Quaadman, is the SEC's proposed rule on conflict minerals. He says that while the Chamber agrees that the rule targets a human rights tragedy that must be resolved, the disclosure regime could impose a tremendous cost burden on companies without resolving the issue at hand. Once finalized, the rule will require all companies to verify the origin of certain materials—mostly originating in The Republic of the Congo or neighboring countries—used in their businesses.

“Such verification is difficult if not impossible in some cases,” Quaadman says. The Chamber estimates that the rule could cost billions of dollars and says it would affect tens of thousands of companies. On the contrary, the SEC estimates that the rule will affect between 1,000 and 5,000 companies at a cost of $71 million.

“If we believe that an agency has gotten the rule wrong, then we will exercise our constitutional rights to seek redress in courts to prevent a wrong from being committed,” says Quaadman. For rules that raised serious concerns, he says, the Chamber will review the final rule and records to determine if there are sufficient grounds to warrant legal challenges to be made in court.

Seven rules related to corporate governance and disclosure are scheduled for proposal and then adoption by the end of this year. Two additional rules are slated for the first half of 2012. Rules that the Chamber could potentially challenge include compensation clawbacks, pay ratio disclosure, and conflict minerals disclosure, say legal experts.

The pay ratios disclosure rule, which will require companies to compute the CEO's compensation as a ratio to the average pay of all other employees, is a particularly attractive target for the Chamber says David Scileppi, a partner at law firm Gunster, Yoakley & Stewart. “The Chamber will most likely look at rules closely related to their members, such as rulemaking that falls into the executive compensation provision,” he says.

“If we believe that an agency has gotten the rule wrong, then we will exercise our constitutional rights to seek redress in courts to prevent a wrong from being committed.”

—Tom Quaadman,

VP, Center for Capital Markets Competitiveness,

U.S. Chamber of Commerce

The cost-benefits analysis, which the SEC is required to conduct on all Dodd-Frank rules before they are finalized, is a good weapon for the U.S. Chamber to use when contesting rules that they find impose unreasonable costs to their members, he says. However, he warns companies not to count on the Chamber winning such cases all the time. Just because the SEC's economic analysis differs from theirs is not sufficient grounds to bring a legal challenge against a rule, says Scileppi. At some point, the D.C. circuit court will have to look at the figures and decide which numbers make sense.

No Sure Things

Claudia Allen, a partner at law firm Neal, Gerber & Eisenberg, agrees that the proxy access case doesn't necessarily set an ironclad precedent that will dictate how future cases turn out. Although the D.C. Circuit set a high bar in its last judgment and will follow the principle it has applied to previous cases, companies should not assume that future cases will produce the same outcome, he says.

“It is hard to say in the abstract what should be done regarding compliance because some rules are self-operative under Dodd-Frank,” says Stanley Keller, a partner at law firm Edwards Angell Palmer & Dodge. The issue will be to what extent the SEC has authority to rationalize what Congress mandated and if it chooses whether to exercise the authority or not.

The ability to challenge SEC Dodd-Frank rules may depend somewhat on how much the SEC deviates from what is mandated by the specific language of the legislation. The proxy access rule was a special case, since the SEC had the discretion to fill out the specific standards of the rule. That differs from many other Dodd-Frank rules that Congress has specifically ordered the SEC to adopt and that are fairly straight forward—and litigation over those rules might produce a different outcome. Depending on how the SEC will interpret the mandate given to them by Congress in finalizing the rules, Allen says the only argument trade groups can potentially have is on the regulator's interpretation in drawing up the rules.  

SO FAR, SO GOOD?

Below is a list of the SEC's latest accomplishments in implementing Dodd-Frank:

Adopted rules to remove credit ratings as eligibility criteria for companies seeking to use "short form" registration when registering securities for public sale. (July 26, 2011) [§939A]

Reported to Congress jointly with the CFTC and the Federal Reserve Board, on improving the common framework for designated clearing entity risk management (July 21, 2011) [§813]

Reported to Congress a review of existing references to credit ratings in statutes and regulations (July 21, 2011) [§939A]

Requested public comment jointly with the CFTC for a study on swap regulation and clearinghouse regulation in the United States, Asia, and Europe (July 20, 2011) [§719]

Proposed rules establishing external business conduct standards for security-based swap dealers and major security-based swap participants (June 29, 2011) [§764]

Adopted rules implementing the exemption from registration for advisers to venture capital firms and to certain advisers to private funds (June 22, 2011) [§§407 and 408]

Adopted rules defining “family office” (June 22, 2011) [§409]

Adopted rules and form changes to implement the transition of mid-sized investment advisers (between $25 and $100 million in assets under management) from SEC to State regulation, as provided in the Act (June 22, 2011) [§410]

Source: Securities and Exchange Commission.

“The strategy now is for companies and trade groups to submit more comments and lay down the groundwork for future challenges,” she says. She adds that the SEC will have to respond to major comments somehow and take their opinions into account in most of the rulemaking processes.

Of course a legal victory in challenging aspects of a Dodd-Frank rule is not the last word on keeping it off the books. In the case of proxy access, for example, the SEC has several options in proceeding with the rule, including appealing the court decision and simply addressing the court's concerns and re-filing the rule. "The regulator can always ask for a new hearing,” says Allen. Given all the uncertainties, companies should still prepare to comply with SEC Dodd-Frank rules, even if they are successfully challenged in court.

Keller says some rules, like clawbacks, raise concerns because of the potential for retroactive application. “Companies are best off proceeding on the basis that the rules required by Congress will be implemented in some way, absent corrective legislation,” he says.

At the very least, Scileppi recommends companies put in place some of the procedures that companies will use to implement upcoming rules. “Certainly you cannot rely on the U.S. Chamber to keep on winning,” he says.