Some of the U.S. Securities and Exchange Commission's Dodd-Frankrules may face legal challenges after a federal appeals courtruling rejected an agency regulation on shareholder rights,analysts said.

The SEC rule written last year was meant to open company boardsto candidates pushed by major shareholders. The U.S. Court ofAppeals in Washington yesterday agreed with business groups thatthe rule shouldn't be implemented because the regulator didn'tproperly explore the costs of the change.

The requirement that the SEC do a full cost-benefit analysis onits rulemaking has been a trouble spot for the agency, which haslost several similar cases in the same court. Today's defeat comesas the SEC works on more than 100 rules it was assigned by theDodd-Frank overhaul enacted a year ago.

“The whole implementation of Dodd-Frank is at risk,” said HalScott, director of the Committee on Capital Markets Regulation, aresearch group that has been critical of the regulatory overhaul.“This is a problem that we should have been aware of from thebeginning. That's why this rush to rulemaking was flawed.”

Among federal regulators, the SEC faces the largest share ofDodd-Frank rule-writing. About 70 of the rules have been proposedso far, SEC Chairman Mary Schapiro told lawmakers at a hearing July21. The law requires the agency to study each rule's effect on“efficiency, competition and capital formation.”

Three-Judge Panel
The SEC declined tocomment on whether Dodd-Frank rules are legally vulnerable. Onyesterday's ruling, Kevin Callahan, an SEC spokesman, said thecommission is “reviewing the decision and considering ouroptions.”

In the so-called proxy access rule struck down by the courtyesterday, the three-judge panel sided with the U.S. Chamber ofCommerce and the Business Roundtable, finding that the agencyfailed to study how much the rule would cost companies to fightinvestors' bids to oust board members.

“The commission inconsistently and opportunistically framed thecosts and benefits of the rule; failed adequately to quantify thecertain costs or to explain why those costs could not bequantified; neglected to support its predictive judgments;contradicted itself; and failed to respond to substantial problemsraised by commenters,” U.S. Circuit Judge Douglas Ginsburgwrote.

“The court has sent a clear signal that the agency must continueto improve its efforts in that area,” said Eugene Scalia, a lawyerat Gibson, Dunn & Crutcher LLP in Washington who representedthe business groups. “The decision is notable for the number ofdifferent errors it finds in the commission's analysis and thedegree for which those errors go to the very core of thecommission's argument.”

Fourth Victory
Yesterday's finding wasScalia's fourth victory since 2005 challenging the cost-benefitreviews of SEC rules. The Court of Appeals in Washington rejectedother SEC rules that defined indexed annuities as securities andthat required 75 percent of a mutual fund's directors to beindependent. Scalia said the latest finding gives guidance to theSEC to consider “the rationales for its other rulemakings,including those under Dodd-Frank.”

“This is sort of a wake-up call for Dodd-Frank,” said JeffMorgan, president and chief executive officer of the NationalInvestor Relations Institute in Vienna, Virginia. “It puts a lighton the SEC and their process for how they make decisions.”

Morgan, whose group represents investor-relations officials at3,500 public companies, offered advice to the SEC: “You really needto make sure you spend the time.”

'Agency of Lawyers'
Scott, the director ofthe capital markets group who is also a professor at Harvard LawSchool, said that the SEC is “an agency of lawyers” whereeconomists struggle for recognition. Its failure to review the fulleconomic weight of its rules “is largely, in my mind, a culturalproblem in the agency.”

President Barack Obama this month issued an executive order forindependent agencies to look at the costs of new and existing rulesto avoid regulations that are “excessively burdensome.”

In a June report examining whether the SEC had properlyestimated the costs and benefits of new rules, Inspector General H.David Kotz said the agency had set up teams of officials with“sufficient expertise to conduct a comprehensive and thoughtfulreview.” Kotz said two rules had “potential deficiencies” and thatthere was a lack of quantitative analysis in a rule that wouldestablish municipal advisers' registration with the commission.

“This is a very difficult time for the commission,” said JeffreyW. Rubin, chairman of the American Bar Association's committee onfederal regulation of securities. “Maybe it'll add some degree ofcaution in its rulemaking.”

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