ICI/IDC File Amici Brief with DC Court of Appeals on Application of Proxy Access Rules to Investment Companies
[24777]
December 9, 2010
TO: BOARD OF GOVERNORS No. 12-10CLOSED-END INVESTMENT COMPANY MEMBERS No. 69-10
ETF ADVISORY COMMITTEE No. 54-10
INVESTMENT COMPANY DIRECTORS No. 30-10
SEC RULES MEMBERS No. 134-10
SMALL FUNDS MEMBERS No. 81-10 RE: ICI/IDC FILE AMICI BRIEF WITH DC COURT OF APPEALS ON APPLICATION OF PROXY ACCESS RULES TO INVESTMENT COMPANIES
Today, ICI and IDC, as amici curiae (“friends of the court”), filed a joint brief [1] in support of the Business Roundtable’s and U.S Chamber of Commerce’s petition to the U.S. Court of Appeals for the District of Columbia Circuit, which seeks to vacate Rule 14a-11 and associated amendments to related rules, (hereinafter, “proxy access rules”). [2] The ICI and IDC brief urges the Court to vacate the proxy access rules solely as applied to investment companies.
As we previously informed you, in August 2010, the Securities and Exchange Commission adopted changes to the federal proxy rules to facilitate shareholders’ ability to nominate directors of companies, including funds. [3] In particular, new Rule 14a-11 under the Securities Exchange Act of 1934 requires companies, in certain circumstances, to include shareholder nominees for director in their proxy materials. [4] The Business Roundtable and U.S. Chamber of Commerce filed a petition challenging the validity of the rules with respect to both operating companies and investment companies. The SEC subsequently stayed the effectiveness of the rules pending resolution of the case. [5]
The ICI and IDC brief explains why the SEC’s decision to sweep funds within the ambit of the rule, as though they were materially identical to operating companies, was arbitrary, capricious, and therefore in violation of the Administrative Procedure Act (“APA”). The brief’s arguments are summarized below.
In adopting Rule 14a-11, the SEC adopted a “one-size-fits-all” approach that does not fit the unique structure of fund governance and rests upon reasoning that is arbitrary and capricious. The SEC’s principal mistake, repeated throughout its analysis, was its reliance on the often-stated syllogism that Rule 14a-11 serves to “facilitate the exercise of shareholders’ traditional State law rights to nominate and elect directors,” that such “State law rights apply to the shareholders of investment companies,” and that any other differences between investment companies and operating companies should not “decrease the importance of the rights that are granted to shareholders under State law.” The SEC’s explanation, however, failed to account adequately for the material differences between operating companies and funds in this context.
First, the SEC could not properly rely upon the “importance” of state law rights without addressing whether existing federal law protections for fund shareholders reduce the need for Rule 14a-11. The Investment Company Act of 1940 (“ICA”) supplies fund shareholders with protections far beyond, and different in kind, than anything provided under traditional state law rights. The SEC offered no answer to the question of whether the ICA’s robust federal protections reduce the need for the new federal right embodied in Rule 14a-11, or, at a minimum, call for special tailoring.
Second, the SEC failed to address the distinct burdens that Rule 14a-11 would impose on funds. Fund complexes have adopted unitary or cluster board structures, which are designed to efficiently oversee multiple funds. The SEC admitted that “the election of a shareholder director nominee may, in some circumstances, increase costs and potentially decrease the efficiency of the boards.” Rather than considering whether such costs were justified, the SEC simply concluded that “these costs are associated with the State law right to nominate and elect directors,” and not Rule 14a-11. Yet state law has not changed. Because the rule itself creates the problem, the SEC must explain why such costs would be justified.
Third, the SEC’s state law rationale cannot be squared with the position that the SEC adopted as recently as July 2009, in approving an exemption for funds from a New York Stock Exchange rule concerning director elections. In that instance, the SEC concluded that such protections were less necessary because, among other reasons, the ICA requires a fund to “obtain the approval of a majority of its voting securities” before taking key actions and this “different regulatory regime” thus “supports the exemption.” In adopting Rule 14a-11, the SEC neither addressed its reasoning in the prior decision nor sought to reconcile it.
Fourth, the SEC violated the APA by applying Rule 14a-11 to funds based on empirical studies concerning operating companies. While the SEC need not rely upon empirical studies, it cannot rationally rely on those studies to propose a solution for funds without considering whether there are meaningful differences that would require a different analysis.
Finally, the SEC failed adequately to consider Rule 14a-11’s effect on efficiency, competition, and capital formation. The SEC failed to consider whether sufficient protections for shareholders already existed under the existing regime, so as to outweigh the obvious efficiency costs of Rule 14a-11. The SEC then compounded this error by failing to consider the extent of the existing competition in its analysis. Had the SEC conducted any such analysis, it would have been obliged to recognize that funds exist in a highly competitive market.
A three-judge panel of the Court is slated to hear oral arguments in the case on a date to be determined by the Court. We will keep you apprised of developments in this matter.
Paul Schott Stevens
President and Chief Executive Officer
Investment Company Institute Amy Lancellotta
Managing Director
Independent Directors Council
endnotes
[1] See Brief of Amici Curiae Investment Company Institute and Independent Directors Council In Support of Petitioners and Vacatur as Applied to Registered Investment Companies (December 9, 2010).
[2] See Business Roundtable, et al. v. SEC, No. 10-1305 (D.C. Cir. Filed Sept. 29, 2010). See also Opening Brief of Petitioners Business Roundtable and Chamber of Commerce of the United States of America (D.C. Cir. Filed Nov. 30, 2010).
[3] See Memorandum No. 24533 (Sept. 9, 2010).
[4] Both ICI and IDC participated in the comment process and objected to the application of Rule 14a-11 to funds. See Memorandum No. 23725 (Aug. 18, 2009); Memorandum No. 24083 (Jan. 14, 2010); and Memorandum No. 24235 (April 15, 2010).
[5] See Memorandum No. 24581 (Oct. 6, 2010).