On Tuesday of last week, a House Subcommittee held a hearing titled "The SEC’s Aversion to Cost-Benefit Analysis." The Committee received testimony from the Chairman of the SEC, Mary Schapiro. The other witnesses included the former Inspector General of the SEC, David Kotz, Henry Manne, emeritus dean from George Mason, Jacqueline McCabe from the Committee on Capital Markets, JW Verret from George Mason, and Mercer Bullard from the University of Mississippi Law School.
Much of the testimony was highly critical of the SEC. Often the testimony pointed to the decision of the DC Circuit in Business Roundtable as evidence of how it should be done. For example, one witness described the opinion as "remarkable" and notes that the author "lays out a veritable catalog of components to an acceptable cost-benefit analysis."
The approach suggests that the SEC conducted an extraordinarily weak cost benefit analysis and that the DC Circuit provided a guide post for how to properly conduct the analysis. Both are not a particularly accurate perspective on what actually happened.
First, it often overlooked in the debate that the SEC conducted an extraordinary amount of cost benefit analysis in adopting the shareholder access rule. The adopting release for Rule 14a-11 the cost benefit analysis begins on page 305 and continues more or less until page 383. In other words, there is almost 80 pages of analysis. Of that analysis, 22 pages (beginning on page 343) assessed costs. In those 22 pages, the staff identified a number of costs, including "(1) potential adverse effects on company and board performance; (2) additional complexity in the proxy process; and (3) preparing the required disclosures, printing and mailing, and costs of additional solicitations." In other words, the staff conducted a thorough analysis of costs that were entirley speculative since shareholder access has never existed in any meaningful sense.
Second, whatever one thinks of the DC Circuit's opinion (for a criticism of the decision, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC), the decision does not really criticize the economic analysis used by the Commission. Instead, the court bought off on a mish mash of criticism of the staff's approach, almost none of which would be corrected by a more rigorous cost benefit analysis.
For example, according to the court, the staff did not adequately take into account the "costs" associated with an access challenge. The staff noted that boards "may be motivated" to expend considerable resources to combat an access challenge. The staff also noted, however, that the costs "may be limited . . . to the extent that the directors’ fiduciary duties prevent them from using corporate funds to resist shareholder director nominations for no good-faith corporate purpose." The staff cited three comment letters for the proposition.
In other words, the staff merely noted that the expenditure of considerable resources may not always occur. Given that access has not been implemented, the degree to which management will resist is entirely speculative. To conclude that, depending upon the circumstances, management may not always resist in a significant fashion, seems a reasonable observation. Yet it was this very determination that gave the DC Circuit the basis for finding the SEC's determination arbitrary.
In what was an entirely speculative endeavor, the court found only the conclusion that boards would not always expend significant resources as speculative. The support? A letter from the ABA Committee on Federal Regulation of Securities. According to the letter:
If the [shareholder] nominee is determined [by the board] not to be as appropriate a candidate as those to be nominated by the board's independent nominating committee..., then the board will be compelled by its fiduciary duty to make an appropriate effort to oppose the nominee, as boards now do in traditional proxy contests.
But the letter did not support the court's position. The letter was conditioned upon a finding that the board had determined that shareholder nominees were "not . . . as appropriate" as those nominated by management. In those cases, the board be compelled by its fiduciary duties to "make an appropriate effort" to resist.
First, boards might find that shareholder nominees are as qualified. In those circumstances, there would be no fiduciary obligation to resist. Second, boards might decide that the access candidates had no realistic chance of winning. The "appropriate" response, therefore, could easily be a statement of opposition in the proxy statement and nothing else. In short, the board might not expend "considerable resources" to resist a proxy challenge. In other words, the ABA letter did not disprove the staff's reasonable conclusion that boards might not always expend "considerable resources" to resist.
Indeed, had the Commission concluded the opposite, that boards would always expend considerable resources to resist, the court could easily have faulted the staff for having made that determination. On this issue, the staff could not win.
Most importantly, however, the court's analysis provides no support for a dramatic change in the SEC's approach to cost benefit analysis. Had the SEC turned the matter over to a raft of economists, as some seem to suggest, the problem would have been the same. In computing costs, those economists still must determine what costs are included. Had those economists concluded (reasonably) that management would not always expend "considerable resources" to resist, they presumably would have discounted the total costs associated with tis resistance. Under the DC Circuit's reasoning, this would have resulted in an arbitrary determination.
There is nothing in the analysis of this issue that provides any guidance on how to better conduct a cost benefit analysis in the future.