CHAMBER OF COMMERCE OF THE UNITED STATES OF AMERICA, PETITIONER v. SECURITIES AND EXCHANGE COMMISSION, RESPONDENT
No. 04-1300
United States Court of Appeals FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued April 15, 2005 Decided June 21, 2005
On Petition for Review of an Order of the Securities and Exchange Commission
Giovanni P. Prezioso, General Counsel, Securities & Exchange Commission, argued the cause for respondent. With him on the brief were Meyer Eisenberg, Deputy General Counsel, Jacob H. Stillman, Solicitor, and John W. Avery, Special Counsel.
Before: GINSBURG, Chief Judge, and ROGERS and TATEL, Circuit Judges.
GINSBURG, Chief Judge: The Chamber of Commerce of the United States petitions for review of a rule promulgated by the Securities and Exchange Commission under the Investment Company Act of 1940 (ICA),
We hold the Commission did not exceed its statutory authority in adopting the two conditions, and the Commission‘s rationales for the two conditions satisfy the APA. We agree with the Chamber, however, that the Commission did violate the APA by failing adequately to consider the costs mutual funds would incur in order to comply with the conditions and by failing adequately to consider a proposed alternative to the independent chairman condition. We therefore grant in part the Chamber‘s petition for review.
I. Background
A mutual fund, which is “a pool of assets ... belonging to the individual investors holding shares in the fund,” Burks v. Lasker, 441 U.S. 471, 480 (1979), is operated by an “investment company” the board of directors of which is elected by the shareholders. Although the board is authorized to operate the fund, it typically delegates that management role to an “adviser,” which is a separate company that may have interests
Early in 2004 the Commission proposed to amend ten Exemptive Rules by imposing five new or amended conditions upon any fund wishing to engage in an otherwise prohibited transaction. See Investment Company Governance, Proposed Rule, 69 Fed. Reg. 3472 (Jan. 23, 2004). Although the Commission had amended the same ten rules in 2001 to condition exemption upon the fund having a board with a majority of independent directors (that is, directors who are not “interested persons” as defined in
After a period for comment and a public meeting, the Commission unanimously adopted three of the proposed new conditions and, by a vote of three to two, adopted the two corporate governance conditions challenged here. See Investment Company Governance, Final Rule, 69 Fed. Reg. 46,378 (Aug. 2, 2004). The Commission majority adopted those two conditions in light of recently revealed abuses in the mutual fund industry, reasoning that the Exemptive Rules
rely on the independent judgment and scrutiny of directors, including independent directors, in overseeing activities that are beneficial to funds and fund shareholders but that involve inherent conflicts of interest between the funds and their managers. ... These further amendments provide for greater fund board independence and are designed to enhance the ability of fund boards to perform their important responsibilities under each of the rules.
Id. at 46,379. Raising the percentage of independent directors from 50% to 75%, the Commission anticipated, would “strengthen the independent directors’ control of the fund board and its agenda,” id. at 46,381, and “help ensure that independent directors carry out their fiduciary responsibilities,” id. at 46,382. The Commission justified the independent chairman condition on the ground that “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.” Id.
The dissenting Commissioners were concerned the two disputed conditions would come at “a substantial cost to fund shareholders,” and they believed the existing statutory and
II. Analysis
The Chamber makes two arguments on the merits: The Commission had no authority under the ICA to adopt the two conditions; and the Commission violated the APA in the rulemaking by which it promulgated the conditions. Before addressing those arguments, we must assure ourselves of the Chamber‘s standing, and thus of our jurisdiction.
A. Jurisdiction of the Court
Under Article III of the Constitution the “judicial Power of the United States” is limited to the resolution of “Cases” or “Controversies,” a corollary of which is that a party invoking our jurisdiction “must show that the conduct of which he complains has caused him to suffer an ‘injury in fact’ that a favorable judgment will redress.” Elk Grove Unified School Dist. v. Newdow, 124 S.Ct. 2301, 2308 (2004). In this case the Chamber claims it is injured by the two challenged conditions because it would like to invest in shares of funds that may engage in transactions regulated by the Exemptive Rules but do not meet those conditions. See Dec‘l of Stan M. Harrell ¶ 2 (Chamber currently invests in funds, intends to continue doing so, and would like to invest in funds unconstrained by the
The Chamber cites two cases for the proposition that loss of the opportunity to purchase a desired product is a legally cognizable injury. Consumer Fed‘n of Am. v. FCC, 348 F.3d 1009, 1011-12 (D.C. Cir. 2003) (injury-in-fact where merger would deprive plaintiff of opportunity to purchase desired service); Competitive Enter. Inst. v. Nat‘l Highway Traffic Safety Admin., 901 F.2d 107, 112-13 (D.C. Cir. 1990) (injury-in-fact where fuel economy regulations foreclosed “opportunity to buy larger passenger vehicles“). The Commission argues in response that there is no evidence a fund of the type in which the Chamber wants to invest would perform better than a fund that conforms to the two corporate governance conditions. In Consumer Federation, however, we held “the inability of consumers to buy a desired product ... constitute[d] injury-in-fact even if they could ameliorate the injury by purchasing some alternative product.” 348 F.3d at 1012. Under our precedent, therefore, the Chamber has suffered an injury-in-fact and, because a favorable ruling would redress that injury, it has standing to sue the Commission. And so to the merits.
B. The Commission‘s Authority under the ICA
The Chamber maintains the Commission did not have authority under the ICA to condition the exemptive transactions as it did. First the Chamber observes rather generally that “matters of corporate governance are traditionally relegated to state law“; and second, it maintains these particular conditions are inconsistent with the statutory requirement that 40% of the directors on the board of an investment company be independent, see
The thrust of the Chamber‘s first contention is that
In Business Roundtable v. SEC, 905 F.2d 406, 416-17 (1990), we held the Commission did not have authority under the 1934 Act to bar a stock exchange from listing common stock with restricted voting rights. The Commission had invoked the provision of that Act authorizing it to make rules “otherwise in furtherance of the purposes” of the Act. Id. at 410. Reasoning that “unless the legislative purpose is defined by reference to the
Business Roundtable is of little help to the Chamber because, as the Commission documents, the purposes of the ICA include tempering the conflicts of interest “inherent in the structure of investment companies,” Burks, 441 U.S. at 480; see also
In Teicher v. SEC, 177 F.3d 1016, 1019-20 (1999), we held a provision of the 1934 Act authorizing the Commission to “place limitations on the activities or functions” of a person convicted of securities fraud in the broker-dealer industry did not authorize it to place limitations upon the activities or functions of that person in an industry regulated under a different “occupational licensing regime” administered by the Commission. The Commission‘s authority, we reasoned, must
The Chamber‘s second contention is that the conditions conflict with the intent of the Congress, expressed in
C. The Requirements of the APA
The condemnation of the APA extends to any rule that is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.”
The Chamber argues the Commission violated the APA because it (1) failed to show the connection between the abuses that prompted the rulemaking and the conditions newly included in the Exemptive Rules; (2) did not comply with its obligation under the ICA to consider whether those conditions “will promote efficiency, competition, and capital formation,”
1. Justification for the Rulemaking
The Chamber maintains the “rulemaking is flawed for the elementary reason that the Commission amended ten separate and distinct pre-existing rules [by imposing the two challenged conditions] without any meaningful consideration of them.” Similarly, the Chamber argues the Commission did not adequately explain why the conditions it added were necessary in light of the conditions previously contained in the Exemptive Rules. The Commission answers that its stated justification for amending the Exemptive Rules satisfies the standards of the APA. We agree.
In the wake of recent revelations of certain abuses in the mutual fund industry, the Commission was concerned about what it diagnosed as “a serious breakdown in management controls.” See 69 Fed. Reg. at 46,378-46,379; 69 Fed. Reg. at
The Chamber claims the Commission‘s decision was unreasonable because the conditions for engaging in exemptive transactions had already been tightened in 2001. But that begs the question whether the conditions of 2001 were adequate in view of the new evidence that some boards were failing to prevent egregious conflicts of interest involving late trading and market timing. Might not they also fail to police sufficiently the conflicts of interest inherent in the exemptive transactions? That those transactions were already subject to some regulation does not render unreasonable the Commission‘s judgment that additional regulation was called for as a prophylactic.
Finally, the Chamber argues the “actual terms” of the conditions were not reasonable in light of “the problems [the Commission] claimed justified the rulemaking.” Those problems all trace to the failure of investment company boards, for whatever reason, to guard against advisers’ conflicts of interest. See 69 Fed. Reg. at 3473 (“boards may have simply abdicated their responsibilities, or failed to ask the tough questions of advisers; in other cases, boards may have lacked the information or organizational structure necessary to play their proper role“). So that boards are apprised of the activities of
To that end, the Commission reasonably concluded that raising the minimum percentage of independent directors from 50% 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.” 69 Fed. Reg. at 46,382. Similarly, the Commission concluded that having an independent chairman would be beneficial because the chairman plays “an important role in setting the agenda of the board[,] ... in providing a check on the adviser, in negotiating the best deal for shareholders when considering the advisory contract, and in providing leadership to the board that focuses on the long-term interests of investors.” 69 Fed. Reg. at 46,383. We have no basis upon which to second-guess that judgment.
In sum, the Chamber points to nothing in the ICA to suggest the Congress restricted the authority of the Commission to make “precautionary or prophylactic responses to perceived risks,” Certified Color Mfrs. Ass‘n v. Mathews, 543 F.2d 284, 296 (D.C. Cir. 1976); and the Commission‘s effort to prevent future abuses of exemptive transactions was not arbitrary, capricious, or in any way an abuse of its discretion, in violation of the APA.
2. Consideration of Costs
The ICA mandates that when the Commission “engage[s]
The particulars of the Chamber‘s first contention are that the Commission should have directed its staff to do a study of the effect of an independent chairman upon fund performance and that when such a study, commissioned by Fidelity Investments, was presented during the comment period, the Commission gave it short shrift. 69 Fed. Reg. at 46,383 n.52; see Geoffrey H. Bobroff and Thomas H. Mack, Assessing the Significance of Mutual Fund Board Independent Chairs (Mar. 10, 2004). As to the former point, although we recognize that an agency acting upon the basis of empirical data may more readily be able to show it has satisfied its obligations under the APA, see Nat‘l Ass‘n of Regulatory Util. Comm‘rs v. FCC, 737 F.2d 1096, 1124 (D.C. Cir. 1984) (in informal rulemaking it is “desirable” that agency independently amass [and] verify the accuracy of data), we are acutely aware that an agency need not – indeed cannot – base its every action upon empirical data; depending upon the nature of the problem, an agency may be “entitled to conduct a general analysis based on informed conjecture.” Melcher v. FCC, 134 F.3d 1143, 1158 (D.C. Cir. 1998); Nat‘l Ass‘n of Regulatory Util. Comm‘rs, 737 F.2d at 1124 (failure to conduct independent study not violative of APA because notice and comment procedures “permit parties to bring relevant information quickly to the agency‘s attention“); see also
Here the Commission, based upon “its own and its staff‘s experience, the many comments received, and other evidence, in addition to the limited and conflicting empirical evidence,” concluded an independent chairman “can provide benefits and serve other purposes apart from achieving high performance of the fund.” 69 Fed. Reg. at 46,383-46,384. The Commission‘s decision not to do an empirical study does not make that an unreasoned decision. See BellSouth Corp. v. FCC, 162 F.3d 1215, 1221 (D.C. Cir. 1999) (“When ... an agency is obliged to make policy judgments where no factual certainties exist or where facts alone do not provide the answer, our role is more limited; we require only that the agency so state and go on to identify the considerations it found persuasive“).
Nor did the Commission violate the APA in its consideration of the Fidelity study. Although Chairman Donaldson did, as the Chamber points out, betray a dismissive attitude toward the value of empirical data, SEC Open Meeting, 57-58 (June 23, 2004) (“there are no empirical studies that are worth much. You can do anything you want with numbers and we‘ve seen evidence of that in a number of our submissions“), the Commission did not reject the Fidelity study or decline to do its own study upon that basis. Rather, the Commission concluded the Fidelity study was “unpersuasive” because, as the authors acknowledged, it did not rule out “other important differences [than independence of the chairman] that may have impacted performance results,” 69 Fed. Reg. at 46,383 n.52 (quoting study), and because it did not use a reliable method of calculating fund expenses, id. The Commission also noted that
We reach a different conclusion with regard to the Commission‘s consideration of the costs of the conditions. With respect to the 75% independent director condition, the Commission, although describing three methods by which a fund might comply with the condition, claimed it was without a “reliable basis for determining how funds would choose to satisfy the [condition] and therefore it [was] difficult to determine the costs associated with electing independent directors.” 69 Fed. Reg. at 46,387. That particular difficulty may mean the Commission can determine only the range within which a fund‘s cost of compliance will fall, depending upon how it responds to the condition but, as the Chamber contends, it does not excuse the Commission from its statutory obligation to determine as best it can the economic implications of the rule
With respect to the costs of the independent chairman condition, counsel maintains the Commission “was not aware of any costs associated with the hiring of staff because boards typically have this authority under state law, and the rule would not require them to hire employees.” The Commission made that observation, however, in regard not to the independent chairman condition but to a condition not challenged here, and we cannot therefore consider counsel‘s rationalization for the regulation under review. See Motor Vehicle Mfrs. Ass‘n, 463 U.S. at 50 (“courts may not accept appellate counsel‘s post hoc rationalizations for agency action“). In any event, the argument is a non sequitur; whether a board is authorized by law to hire additional staff in no way bears upon the contention that, because of his comparative lack of knowledge about the fund, an independent chairman would in fact cause the fund to incur additional staffing costs.
What the Commission itself did was acknowledge in a footnote that an independent chairman “may choose to hire [more] staff” but it stopped there because, it said, it had no “reliable basis for estimating those costs.” 69 Fed. Reg. at 46,387 n.81. Although the Commission may not have been able to estimate the aggregate cost to the mutual fund industry of additional staff because it did not know what percentage of funds with independent chairman would incur that cost, it readily could have estimated the cost to an individual fund, which estimate would be pertinent to its assessment of the effect the condition would have upon efficiency and competition, if not upon capital formation. And, as we have just seen, uncertainty may limit what the Commission can do, but it does not excuse
In sum, the Commission violated its obligation under
3. Consideration of Alternatives
Finally, the Chamber argues the Commission gave “inadequate consideration” to suggested alternatives to the independent chairman condition, citing as an example – the only significant one, it seems to us – the proposal, endorsed by the two dissenting Commissioners, that each fund be required prominently to disclose whether it has an inside or an independent chairman and thereby allow investors to make an informed choice. Commission counsel responds by noting generally that the agency is “not required to discuss every alternative raised” and that it did consider the “major alternatives” proposed by commenters, adding more specifically that it had no obligation to consider the dissenters’ disclosure alternative because the “Congress rejected a purely disclosure-based approach to regulating conflicts of interest under the [ICA].”
We conclude the Commission‘s failure to consider the disclosure alternative violated the APA. To be sure, the Commission is not required to consider “every alternative conceivable by the mind of man ... regardless of how uncommon or unknown that alternative” may be. Motor Vehicle Mfrs. Ass‘n, 463 U.S. at 51. Here, however, two dissenting Commissioners raised, as an alternative to prescription, reliance upon disclosure, see 69 Fed. Reg. at 46,393 – a familiar tool in
The Commission would nevertheless be excused for failing to consider this alternative if it were, for whatever reason, unworthy of consideration. Commission counsel accordingly suggests one such reason, namely, that in the ICA the Congress rejected a “purely disclosure-based approach.” See also SEC v. Variable Annuity Life Ins. Co., 359 U.S. 65, 78 (1959) (ICA “passes beyond a simple ‘disclosure’ philosophy“). Counsel‘s statement is true but irrelevant; that the Congress required more than disclosure with respect to some matters governed by the ICA does not mean it deemed disclosure insufficient with respect to all such matters. On the contrary, the ICA requires funds to make extensive disclosures. See, e.g.,
In sum, the disclosure alternative was neither frivolous nor out of bounds and the Commission therefore had an obligation to consider it. Cf. Laclede Gas Co. v. FERC, 873 F.2d 1494, 1498 (D.C. Cir. 1989) (“where a party raises facially reasonable alternatives ... the agency must either consider those alternatives
III. Conclusion
For the foregoing reasons, we grant in part the Chamber‘s petition for review. This matter is remanded to the Commission to address the deficiencies with the 75% independent director condition and the independent chairman condition identified herein. See Fox Television Stations, Inc. v. FCC, 280 F.3d 1027, 1048-49 (D.C. Cir. 2002); Allied Signal, Inc. v. U.S. Nuclear Regulatory Comm‘n, 988 F.2d 146, 150-51 (D.C. Cir. 1993).
So ordered.
Notes
The Commission, by rules and regulations upon its own motion, or by order upon application, may conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of this [Act] or of any rule or regulation thereunder, if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of this [Act].
The Chamber also argues the Congress‘s subsequent direction to the Commission to “provide[] a justification” for the independent chairman condition, see Consolidated Appropriations Act, 2005, Pub. L. No. 108-447, 118 Stat. 2809 (2004), establishes that the Commission failed to provide an adequate justification in the rulemaking proceeding. That does not follow, however; the Congress may require a more detailed explanation for a rule than is required by the APA. See Motor Vehicle Mfrs. Ass‘n, 463 U.S. at 44-45 (rejecting view “congressional reaction” to rule necessitated stricter judicial review).