The Securities and Exchange Commission’s loss on its stock buyback rule is a warning for the agency to do its homework on cost estimates, as the regulator looks to wrap up other contested regulations.
The rule requiring more information on companies’ stock repurchases was thrown out after the US Court of Appeals for the Fifth Circuit found the SEC didn’t properly weigh the costs and benefits. The agency’s adoption of the rule, which was meant to shine a light on opportunistic buybacks, was arbitrary and capricious, the appeals court said.
The SEC under Chair Gary Gensler has been dealt a string of defeats in court, and the Fifth Circuit’s decision on the buyback rule was a particularly significant setback. It could signal trouble for other rulemaking efforts, including the much-anticipated climate rules, as business trade groups and other challengers zero in on the agency’s cost-benefit calculations.
Such scrutiny of the calculations “will be a theme going into 2024,” said Baker Botts LLP partner Carina L. Antweil, who works with SEC-regulated companies.
Court Stumbles
The SEC has lost several challenges to its actions under the Administrative Procedure Act since Gensler took over in April 2021.
Appeals courts have overturned the agency’s rejection of Grayscale Investments LLC’s proposal to create an exchange-traded fund based on Bitcoin, and vacated a rule curbing the powers of the New York Stock Exchange and
“Again and again, federal courts of appeal hold that the SEC acted arbitrarily and capriciously in violation of the Administrative Procedure Act,”
The Fifth Circuit’s decision on the stock buyback rule could have particular significance.
That rule would have required companies to provide more data and rationale behind decisions to repurchase their own shares. But the SEC never determined whether the rule’s benefits were real, according to the US Chamber of Commerce and other groups challenging the rule.
The Fifth Circuit in an October ruling agreed the primary benefit offered by the SEC—addressing concerns about opportunistic or improperly motivated buybacks—wasn’t adequately substantiated. The agency needed to show those kinds of buybacks were a genuine problem, the court said.
“It really does force the SEC to consider, are we regulating just for the sake of regulating, or indeed is this necessary for the protection of investors?” said Alston & Bird LLP partner David A. Brown, who advises companies on SEC regulations.
‘Half-Baked’ Analysis
Other recent lawsuits have highlighted perceived holes in the SEC’s economic analysis.
The American Investment Council, Managed Funds Association, and other groups brought a lawsuit in September challenging a rule that will require hedge funds and private equity firms to disclose more about their fees and expenses. The SEC didn’t properly weigh the costs and benefits, the groups said in a November filing accusing the regulator of a “vast power grab.”
“The Rule’s half-baked economic analysis falls short of the Commission’s statutory responsibilities,” the groups said.
MFA is part of a separate legal challenge to another SEC rule that would force investors to reveal more about short selling and related stock lending. Those provisions “impose substantial costs that outweigh their purported benefits,” the lawsuit argues.
Both cases were filed in the Fifth Circuit, which many observers consider to be the most conservative and business-friendly appeals court. Economic analysis “will play a pretty strong role” in that circuit, said Troutman Pepper Hamilton Sanders LLP partner David I. Meyers, who advises public companies on securities rules.
“As you see the courts becoming more conservative and more pushback against administrative rules, you’re seeing more emphasis on that aspect of the Administrative Procedure Act,” Meyers said.
The SEC under Gensler has also left itself vulnerable to challenges by taking an aggressive tack in its rulemaking, some attorneys said.
“The more burdensome the requirement, the more it should be justified,” Alston & Bird’s Brown said.
Even some within the agency have fretted that the SEC’s approach, “particularly as it relates to high-profile rules that significantly impact external stakeholders,” could limit the time available for staff research and analysis, the agency’s inspector general said in a report last year.
‘Better Justification’
Numerous other high-profile rules are on the horizon at the SEC, teeing up more opportunities for potential challenges.
Proposals intended to address the definition of “dealer” and to address conflicts in brokers and money managers’ use of predictive analytics and artificial intelligence are among several the SEC is aiming to finalize by April, according to the agency’s latest regulatory agenda.
The Managed Funds Association in comments to the SEC this month cautioned the agency against violating the Administrative Procedure Act in the dealer rule.
The SEC is also expected to finalize rules requiring public companies to report on their greenhouse gas emissions and other climate matters. The proposed climate rules, seen as Gensler’s marquee policy, have received significant pushback since they were introduced last year.
See also: SEC Weighs Weakening Climate Disclosure Rule Opposed by Industry
Business groups and Republican state attorneys general, including West Virginia Attorney General Patrick Morrisey, have already threatened lawsuits if the SEC moves ahead. The SEC’s cost-benefit analysis could be a centerpiece for any such challenges, building off the Fifth Circuit’s precedent.
“This may force the SEC to rethink some of their cost analysis in the climate proposal and otherwise so that they have a better justification for the cost that they’re putting on companies for each of these,” Brown said.
To contact the reporter on this story:
To contact the editor responsible for this story:
Learn more about Bloomberg Law or Log In to keep reading:
See Breaking News in Context
Bloomberg Law provides trusted coverage of current events enhanced with legal analysis.
Already a subscriber?
Log in to keep reading or access research tools and resources.