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News April 10, 2006 Issue

Court Sides With U.S. Chamber of Commerce, Says SEC Violated APA

The U.S. Court of Appeals for the D.C. Circuit has ruled in the U.S. Chamber of Commerce v. SEC case.

The Chamber has won ó for now. In an April 7 opinion, the court said that the SECís fund governance rulemaking violated the notice and comment provisions of the Administrative Procedures Act. The court vacated the independent chair and 75 percent independent requirements of the fund governance rule.

However, in recognition that much of the fund industry already is in compliance with those requirements, the court postponed its "vacation" order for ninety days, to give the SEC time to conduct a notice and comment rulemaking and, presumably, to file a motion asking the court not to vacate the two requirements.

If, of course, the SEC wants to.

In a statement, Gibson Dunn partner Eugene Scalia suggested that the SEC give it a rest, already. "Twice," he said, "the Commission has failed to justify these provisions through the rulemaking process. That is because the provisions are bad policy, they are costly, and they harm competition and efficiency. One hopes that rather than continue to be embroiled in this controversial rulemaking, the Commission will accept the Courtís judgment and move on to other important items on its agenda."

However, added Scalia, if the Commission decides to forge ahead and finalize the provisions, the courtís decision "makes clear that it must listen to the public, gather all relevant data, and fully come to grips with the provisionsí costs, their effects on the industry and investor choice, and the alternatives that could be adopted instead."

And keep this in mind: Even if the SEC goes about collecting cost data from the public and issuing a revised cost-benefit analysis, the rule is not a done deal. It still could face additional judicial review and legal challenges by the Chamber.

What will the SEC do?

Chairman Christopher Cox promised that the Commission would comply "in every respect" with the courtís decision. "We take seriously our responsibility to subject all of the Commissionís proposed rules to public notice and comment, and to apprise ourselves, the public, and the Congress of the economic consequences of proposals before we decide whether to adopt them," he said in a statement. "I am confident that the result of the process that the court has prescribed will be final mutual fund governance rules that protect the interests of the funds and the fund shareholders they serve."

That last part, of course, is a nice way of saying something without really saying something.

In holding that the SEC violated the APA, the court focused on the SECís heavy reliance on C. Meyrick Payneís Management Practice Bulletins and the fact that the industry was not properly informed of that reliance during the rulemaking process. Those bulletins, said the court, were SEC rulemakersí "only source of information" on the number of directors serving on the boards of most mutual funds, the median annual salaries for directors, and the relative number of boards that oversee a large number of funds. The Commissionís request for information on costs "did not place interested parties on notice that, in the absence of receiving reliable cost data during the comment period, the Commission would base its cost estimates on an extra-record summary of extra-record survey data that, although characterized as Ďa widely used survey,í was not the sort, apparently, relied upon by the Commission during the normal course of its official business."

Because the industry was not told how heavily the SEC would rely on the Payne bulletins, the SEC violated the notice and comment provisions of the APA, said the court. It vacated the independent chair and 75 percent independent conditions of the fund governance rule, but said it would withhold the issuance of its mandate for ninety days. That, it explained, would give the SEC the opportunity to seek public comment on the costs of implementing the independent chair and 75 percent independent requirements.

If the court didnít like the way the SEC went about its rulemaking, why didnít the court simply toss the two requirements and make the SEC start from scratch?

"[A] significant portion of the mutual fund industry appears to have come into substantial compliance with the Rule," explained the court. "This compliance tends to suggest that immediate vacation of the two conditions risks substantial disruption to the mutual fund industry because of the resultant inconsistent governance practices that would arise within the industry, which also might sow confusion in the investing public." The court also noted that the SECís decision not to reopen the rulemaking record for comment did not necessarily indicate that the agencyís cost-benefit analysis was incorrect.