As you’ve probably heard, the DC Circuit struck down the SEC’s proxy access rule last month, in Business Roundtable and Chamber of Commerce v. SEC. The three-judge panel held that the SEC’s proxy access rule was “arbitrary and capricious” because the SEC failed “adequately to assess the economic effects of a new rule.” Unlike most securities lawyers, to whom proxy access is a huge deal, I personally don’t find proxy access terribly interesting. But the Business Roundtable decision will affect many future SEC rules required under Dodd-Frank, so it’s important to consider the decision, and how the SEC should proceed in light of the decision.

For a variety of reasons, I think the DC Circuit’s decision was terrible — hilariously biased, and generally not worth the paper it was written on. (Not surprisingly, the opinion was written by failed Reagan Supreme Court nominee Douglas Ginsburg, who also wrote the 2005 opinion striking down another SEC rule.)

In the court’s words:

[T]he Commission has a unique obligation to consider the effect of a new rule upon “efficiency, competition, and capital formation,” 15 U.S.C. §§ 78c(f), 78w(a)(2), 80a-2(c), and its failure to “apprise itself — and hence the public and the Congress — of the economic consequences of a proposed regulation” makes promulgation of the rule arbitrary and capricious and not in accordance with law.
The SEC did, in fact, engage in an unusually lengthy cost-benefit analysis in its proposed rule and its final rule. But the court, clearly determined to find some reason to strike down the proxy access rule, found a few arguments raised by commenters that the SEC didn’t completely and definitively rebut, and used that to conclude that the SEC had failed to adequately consider the effect of the new rule on “efficiency, competition, and capital formation.”

As a preliminary matter, I think the court’s reasoning was comically weak. On one issue, the court conceded that the empirical evidence was “mixed,” but then bizarrely refused to allow the SEC any deference whatsoever in arbitrating between competing empirical studies. In other words, the SEC chose to believe the empirical studies that went against the court’s policy preferences. Awesome. On another issue, the court faulted the SEC for not irrationally assuming that “union and government pension funds” would use the proxy access rule to harm “shareholder value.” (Remember when conservatives used to argue that employee ownership schemes would promote glorious efficiency by aligning the interests of labor and management? I miss those days.)

So what should the SEC — which has to write a slew of regulations implementing Dodd-Frank in the next few years — do in light of the Business Roundtable decision? First, where it’s able to, the SEC should certainly humor the DC Circuit and engage in a (very) detailed cost-benefit analysis.

Second, and more importantly, the SEC shouldn’t be afraid to admit that a proposed rule won’t necessarily maximize “efficiency, competition, and capital formation.” The DC Circuit can’t strike down an SEC rule on the grounds that it doesn’t promote “efficiency, competition, and capital formation.” Let’s look at the statute, 15 U.S.C. § 78c(f):
Whenever pursuant to this chapter the Commission is engaged in rulemaking, or in the review of a rule of a self-regulatory organization, and is required to consider or determine whether an action is necessary or appropriate in the public interest, the Commission shall also consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. (emphasis mine)
The SEC isn’t required to only promulgate rules that will promote efficiency, competition, and capital formation — it’s only required to consider those factors. And that’s in addition to another, separate, factor — the protection of investors. So if the SEC can’t prove that one of its proposed rules will promote efficiency, competition, and capital formation, the agency can still issue the rule on the grounds that it protects investors. The other relevant statute, 15 U.S.C. § 78w(a)(2), simply requires the SEC to determine that any harm to competition caused by a proposed rule is “appropriate in furtherance of the purposes of” the ’34 Act — which includes investor protection. The Business Roundtable decision just means that the SEC has to lay out its efficiency analysis in detail, even if the conclusion is that the rule won’t promote efficiency.

Essentially, the SEC shouldn’t be afraid to tell the DC Circuit to take its “efficiency, competition, and capital formation” analysis and shove it, and that investor protection is still paramount, thank you very much. Not in those words, of course. But you get the idea.

Monday, August 8, 2011

On S&P, Downgrades, and Idiots

This is not going to be one of those posts that laments S&P’s decision to downgrade the US, but then says that S&P was probably right about our oh-so-dysfunctional political system.

No, S&P was flat-out wrong — no caveats. They are, to put it very bluntly, idiots, and they deserve every bit of opprobrium coming their way. They were embarrassingly wrong on the basic budget numbers, as everyone knows now, so they were forced to remove that section from their report, and change their rationale for the downgrade. (Always a sign that you’re dealing with hacks.)

S&P’s rationale for the downgrade now is based entirely on their subjective political judgement — and their political judgement is wrong. The brilliant political minds over at S&P said that “the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges.”

That sounds like a Very Serious and Sober assessment, but it’s really not. It’s true that the debt limit debate was ridiculous, and that a large contingent of Tea Party freshmen in the House were threatening to not raise the debt ceiling. But here’s the thing: we still raised the debt ceiling, and in such a way that this Congress won’t have the opportunity to use the debt ceiling as a political bargaining chip again.

S&P’s assessment is only remotely serious if you assume that this particular Congress, with its huge contingent of crazy Tea Partiers, is going to serve in perpetuity. But this Congress isn’t going to serve in perpetuity — there are elections next year, and many of the Tea Party freshmen are likely to lose. They won in 2010 because it was a “wave election” in the middle of a very severe economic slump. But 2012 is a presidential election cycle with an incumbent Democratic president. A lot of these Tea Partiers who won in traditionally Democratic districts (and swing districts) are going to lose. In fact, it’s probably even odds that the Dems take back the House.

The simple fact is that the Tea Partiers are almost certainly at the height of their power in this Congress. And no, the debt ceiling debate doesn’t reflect some sort of secular change in US policymaking — the next time there’s a Republican president, House Republicans will be all about raising the debt ceiling, and Democrats won’t engage in the same kind of political brinksmanship. You’d have to be stunningly naïve not to believe this.

There have also been plenty of political de-escalations over the years — Republicans didn’t shut down the government every year after 1995, for instance. After Tom DeLay won the Medicare Part D vote by holding the vote open for 3 hours, everyone claimed that this would be the new normal on all controversial votes. Didn’t happen. There are plenty of one-off political confrontations. Simply assuming that every political confrontation represents a secular change in US politics and policymaking is ridiculous.

(S&P tries to side-step this obvious weakness in their so-called “argument” by claiming that by the time the 2012 elections roll around, it will be too late. Please. The idea that we have to act in the next 18 months in order to meaningfully affect our long-term solvency is patently absurd.)

Look, I know these S&P guys. Not these particular guys — I don’t know John Chambers or David Beers personally. But I know the rating agencies intimately. Back when I was an in-house lawyer for an investment bank, I had extensive interactions with all three rating agencies. We needed to get a lot of deals rated, and I was almost always involved in that process in the deals I worked on. To say that S&P analysts aren’t the sharpest tools in the drawer is a massive understatement.

Naturally, before meeting with a rating agency, we would plan out our arguments — you want to make sure you’re making your strongest arguments, that everyone is on the same page about the deal’s positive attributes, etc. With S&P, it got to the point where we were constantly saying, “that’s a good point, but is S&P smart enough to understand that argument?” I kid you not, that was a hard-constraint in our game-plan. With Moody’s and Fitch, we at least were able to assume that the analysts on our deals would have a minimum level of financial competence.

I’ve seen S&P make far more basic mistakes than the one they made in miscalculating the US’s debt-to-GDP ratio. I’ve seen an S&P managing director who didn’t know the order of operations, and when we pointed it out to him, stopped taking our calls. Despite impressive-sounding titles, these guys personify “amateur hour.” (And my opinion of S&P isn’t just based on a few deals; it’s based on countless deals, meetings, and phone calls over 20 years. It’s also the opinion of practically everyone else who deals with the rating agencies on a semi-regular basis.)

Treasury has every right to be outraged. S&P mangled the economic argument so badly that they had to abandon it entirely, and then fell back on a political argument which they are in no position to make, and which isn’t even correct.

So to S&P, I say: you should be ashamed of yourselves, and I truly hope this is your downfall.