Chamber of Commerce of the United States of America v.Securities and Exchange Commission

Brief Fact Summary.

It was argued by the Chamber of Commerce of the United States (Chamber) (Plaintiff) that the SEC (Defendant) was lacking authority as per the ICA to publish a rule regulating the corporate governance of mutual funds and that the rule was enacted by the SEC while failing to conform to the conditions of the Administrative Procedure Act (APA).

Synopsis of Rule of Law.

(1) In a rule issued by a federal agency that affect its capacity to invest in mutual funds unrestrained by the conditions, a mutual fund investor has standing to petition for review of conditions.
(2) Under the ICA, the SEC has authority to publish a rule regulating the corporate governance of mutual funds.
(3)The APA is violated by the SEC when it fails to sufficiently consider the detriments of conditions it enforces and the alternatives thereto.

Facts.

A rule was enacted under the ICA by the SEC that, in order to participate in sales that are banned by the ICA, required an investment company (mutual fund) to have a board with at least 75% independent directors and an independent chairman. A review of the rule was petitioned by the Chamber of Commerce of the United States (Chamber) contending that authority was never given to the SEC by the ICA to regulate “corporate governance†and regardless, the rule was promulgated by the SEC without conforming to the conditions of the APA. The Chamber insisted it had standing for two reasons; it was an investor and some of its members would be affected by the rule because they were mutual fund advisers. The rule was implemented by the SEC in hopes of shrinking conflicts of interest between mutual fund shareholders and advisers. A mutual fund is defined as a pool of assets that belong to individual investors holding shares in the fund, is run by an “investment company†and the board of directors is elected by shareholders. The management role in charge of the fund is usually delegated to an “adviserâ€, which is a company not affiliated with the fund that may have conflicting interests than those of the shareholders, even though the board is authorized to operate the fund. Even though funds that participate in specific transactions where the adviser could gain at the shareholders expense are banned by the ICA, pursuant to the SEC’s long-standing Exemptive Rules a fund that satiates specific requirements is permitted to participate in transactions that are otherwise banned. Adopting the corporate governance requirements that it promulgated would aide in the reduction of abuses, the SEC determined, seeing as requirements would grow the independent judgment and analysis of directors by increasing the percentage of independent directors. The SEC found the independent directors vital to keeping the natural conflicts betwixt the mutual fund shareholders and advisers in check and justified the independent chairman requirement on the ground that a “a fund board is in a better position to protect the interests of the fund, and to fulfill the board’s obligations under the Act and the Exemptive Rules, when its chairman does not have the conflicts of interest inherent in the role of an executive of the fund adviser.” The dissenters alleged that current statutory and regulatory controls were sufficient and that these new requirements would up the costs for shareholders. The court of appeals granted review.

Issue.

(1) In a rule issued by a federal agency that affects its capacity to invest in mutual funds unrestrained by the conditions, does a mutual fund investor has standing to petition for review of conditions?
 (2) Under the ICA, does the SEC have authority to publish a rule regulating the corporate governance of mutual funds?
 (3) Is the APA violated by the SEC when it fails to sufficiently consider the detriments of conditions it enforces and the alternatives thereto?

Held.

(Ginsburg, J.) (1) Yes. In a rule issued by a federal agency that affect its capacity to invest in mutual funds unrestrained by the conditions, a mutual fund investor has standing to petition for review of conditions. A party must demonstrate that is has been injured-in-fact to have standing and a judgment will compensate the injury. In this case, the Chamber purports to have been injured by the two contested requirements due to it wanting to invest in shares of funds that have the possibility of participating in transactions regulated by the Exemptive Rules but the funds in question fail to meet the requirements. Currently investing in funds, with no plans of ceasing, the Chamber would like to invest in funds unrestricted by conditions with the SEC’s retort being that there is no proof that the sort of fund the Chamber wishes to invest in would achieve more than a conforming to the two corporate governance conditions fund would. Regardless, the consumers incapacity to purchase a desired product has been held to establish injury-in-fact, even if through buying an alternative product the injury could be rectified. So, as per this precedent, an injury-in-fact has been suffered by the Chamber and as a result of a favorable ruling being able to redress that injury, the Chamber has standing to sue the SEC.
 (2) Yes. Under the ICA, the SEC has authority to publish a rule regulating the corporate governance of mutual funds. Corporate governance is regulated by state law and the requirements of concern are not consistent with ICA § 10(a)’s condition that 40% of the board of directors of an investment company be independent, the Chamber argues. The SEC is bestowed, by § 6(c) of the ICA, with the authority to exempt transactions from rules enacted under the ICA only subject to the purposes of the ICA and public interest. § 6(c) cannot be read to bestow authority to the SEC that is relegated to the states, the Chamber counters. The cases the Chamber relied upon, ruling on the SEC’s power under the Securities and Exchange Act of 1934, are unsuitable. A main function of the ICA is to temper the conflicts of interests natural to the structure of investment companies and regulation of governance structure of those companies is how Congress attempts to effect that function. In accordance with the function and structure of the ICA and Congress’ intent was the SEC’s effort to expand the role of independent directors on the boards of investment companies. Contradicting the Chamber’s stance, § 10(a) only informs that a fund is not to have more than 60% inside directors, meaning that at least 40% must be independent and implies that a larger amount may be. For the aforementioned reasons, by enacting the conditions, the SEC did not overstep its authority.
 (3) Yes. The APA is violated by the SEC when it fails to sufficiently consider the detriments of conditions it enforces and the alternatives thereto. The court must be certain the SEC has “examined the relevant data and articulated a satisfactory explanation for its action including a rational connection between the facts found and the choice made†under the APA. The first argument presented by the Chamber is that the SEC violated the APA because it was lacking evidence of a connection between the abuses that incited the rulemaking and the recently added requirements in the Exemptive Rules.  The conditions were imposed as a response to abuses that had recently been discovered within the mutual fund industry, the SEC indicated and with blatant disregard of the fact that zero of the documented abuses included a transaction covered by the Exemptive Rules, the SEC felt it practical to amend those rules because the abuses revealed a broader issue with conflicts of interest than thought prior and felt if that issue was not addressed that there would be additional abuses. Just because the transactions in question were currently regulated does not mean that more regulation as a preventative measure would not be appropriate. Seeing as all the abuses the SEC mentioned were traceable to the failure of investment company boards to protect against adviser conflicts of interest, it was reasonable for the SEC to determine that inflating the minimum amount of independent directors to 75% would “strengthen the hand of the independent directors when dealing with fund management, and may assure that independent directors maintain control of the board and its agenda.”In summation, the effort by the SEC to stop abuses of exemptive transactions from occurring in the future was not arbitrary, impulsive or an abuse of its discretion, in violation of the APA. Another of the Chamber’s allegations was that the SEC lacked to sufficiently give thought to if the conditions would “promote efficiency, competition, and capital formationâ€, as needed per the APA.  It is contended by the Chamber that the SEC violated this directive by not cultivating new (or taking into account existing) empirical data comparing the performance of funds led by independent, inside chairmen and by failing to give thought to the costs of the requirements it was enforcing, with costs hindering efficiency, capital creation and competition. In this case, the SEC’s lack of development of empirical data was not an abuse (an agency cannot base all of its actions on empirical data because depending on the issue, an agency may be potentially “entitled to conduct . . . a general analysis based on informed conjecture.”The conditions were generated by the SEC on the foundation of its own experience and the experience of its staff along with a myriad of received comments and based on this, its judgment cannot be questioned. The rejection of empirical data by the SEC with regard to articulation of the data’s restrictions and explanations of why it was unconvincing is also not an abuse; however, the failure of the SEC to sufficiently consider the cost of the conditions was an abuse. The SEC stated that it did not have a dependable foundation for figuring out the costs connected with the election of independent directors. It may signal that only the scope within which a fund’s compliance cost will land (depending on the manner in which it responds to the requirement) can be determined by the SEC but fails to excuse it from its statutory duty to do the best it can to decide the economic repercussions of the rule it is proposing. With regards to the costs of the independent chairman condition, the SEC simply stated that it had no foundation for deciding the cost of extra staff hired by an independent chairperson.  While the SEC may not have been capable of estimating the collective cost to the mutual fund of the extra staff hired by the independent chairman, it could have easily estimated the cost to an individual fund and an estimate such as that would be relevant to its assessment of the condition’s effect upon competition and efficiency, if not upon the formation of capital. So, even though doubt may restrict the SEC’s capability to determine cost, it fails to excuse it from its statutory duty to do all it can to acquaint itself with the economic repercussions of a proposed regulation prior to choosing to implement it. In this regard, the SEC is in violation of the APA. Lastly, it was argued by the Chamber that the SEC violated the APA by insufficiently deliberated recommended alternatives to the independent chairman condition. One of the primary recommended alternatives was that individual funds be required to blatantly disclose if it has an independent or inside chairman, thus permitting investors to make an informed decision. The reasoning behind this as stated by the SEC, was due to Congress denying a completely disclosure-based approach to regulating conflicts of interest as per the ICA and also because an agency has nothing requiring it to deliberate every alternative and the main alternatives has been considered. The justification by the SEC for failing to deliberate this alternative is unconvincing because the alternative was worth consideration, regardless of the fact that Congress has requested more than disclosure involving some issues overseen by the ICA, it fails to mean that it finds disclosure is inadequate with regard to all issues. In actuality, a requirement of funds under the ICA is to make extensive disclosures, so even as it was deliberating the independent chairman condition, the SEC augmented the disclosure requirements of the ICA. As a result of the disclosure alternative not overstepping its bounds or being inconsequential, the SEC had a responsibility to consider it and while it may have still rejected it, it had an obligation to sufficiently consider it by bearing its expertise upon it. Consequently, the APA was violated by the SEC by not considering this alternative. Petition granted in part.  Matter remanded to the SEC to focus on the deficits regarding the 75% independent director condition and the independent chairman condition identified here.

Discussion.

The APA has four simple purposes: (1) to necessitate agencies to make certain the public is privy to their organization, rules and procedures; (2) to offer for public involvement in the rulemaking process; (3) to createuniform standards for the action of formal rulemaking and adjudication; and (4) to clarify the scope of judicial review.Applicable to both federal executive departments and independent agencies, the APA has been referred to as “a bill of rights for the hundreds of thousands of Americans whose affairs are controlled or regulated” by federal government agencies. The APA can considerably affect the rule-making procedure of the SEC and can be invoked by associations, individuals and other entities, as witnessed in this case.