The SEC, Social Benefit Rules, and the Inapplicability of Cost-Benefit Analysis: The Legal Challenge to Rule 13q-1 (Part 1)
There was a time when corporate governance was neatly divided between the substance, which was a matter for the states, and disclosure, which was left to the Securities and Exchange Commission. An attempt by the SEC to regulate substance through the vehicle of listing standards was struck down by the DC Circuit in Business Roundtable v. SEC, 905 F.2d 406 (2nd Cir. 1989).
The division of authority was never really that clear. The SEC, for example, had (and still has) a practice of trying to use disclosure to influence substantive behavior. See Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.
More importantly, however, Congress officially obliterated the distinction with the adoption of SOX, and then Dodd-Frank. SOX gave the SEC authority over audit committees of listed companies (see Rule 10A-3) and provided a mechanism for clawing back excessive compensation, among other things. Dodd-Frank went further and gave the Commission authority over compensation committees (see Rule 10c-1), over say-on-pay, and over the factors to be used by the board in determining director independence. All of these inserted the SEC directly into the substance of corporate governance.
So the SEC is no longer limited to disclosure. This is a new task for the Commission but one that is at least something investors and others participating in the market consider important. Dodd-Frank, however, did something even more radical to the traditional authority of the Commission. It fundamentally altered the disclosure role of the Commission.
Dodd-Frank required the SEC to put in place disclosure requirements that were mostly unmoored from market-related disclosure. In other words, the SEC was ordered to adopt disclosure requirements that were foremost designed to benefit interest groups other than those operating in the market. Resource extraction disclosure was one of them. Section 13(q) of the Exchange Act was not primarily intended to make the securities markets more efficient, investors more informed, or shareholders more involved. Instead, the provision, as the adopting release explained, was intended “to increase the accountability of governments to their citizens in resource-rich countries for the wealth generated by those resources.”
To be sure, the SEC has often been subjected to requests to implement disclosure requirements that involve issues important to interest groups not participating in the market. Just glance through the rulemaking petitions filed with the Commission. Climate change and political contributions are issues that transcend the markets. But they also are of interest to investors and shareholders.
With respect to resource extraction disclosure, however, the connection between the disclosure requirement and the market is far more attenuated. Moreover this type of disclosure is not something where the Commission has any significant expertise.
The validity of the rule has been challenged in the DC Circuit. The unusual nature of the disclosure requirement and the attenuated nexus to the markets may well play a role in the outcome of the case. We will discuss these issue in this four part series of posts.
Primary materials on the case including the briefs filed by the Petition and the SEC can be found on the DU Corporate Governance web site.