The SEC gets slapped again on independent directors

A long time ago, the forgettable SEC Chairman Bill Donaldson launched a rule requiring mutual funds to have independent directors. Thanks to the US Chamber of Commerce's suit, the SEC has twice had to defend its procedures in adopting the rule in the DC Circuit. Yesterday the court struck down the rule for the second time and again sent the Commission back for justification.  The whole thing is a fitting tribute to the Donaldson era.

But first some history.

Around when the independent director rule was first proposed, about two years ago, I wrote: "these proposals [to reform mutual funds] are likely to have costs exceeding their benefits. "

Sure enough, in its first opinion, the DC Circuit said:

the Commission violated its obligation under 15 U.S.C. § 80a-2(c), and therefore the APA, in failing adequately to consider the costs imposed upon funds by the two challenged conditions. * * *

I commented on that opinion and Donaldson's response here and here.

Donaldson, facing the end of his tenure at the SEC, swiftly reaffirmed the rule without additional public comment or opportunity to gather evidence. I noted:

This is essentially a flouting of a decision by Chief Judge Ginsburg of the DC Circuit . . .insisting on an analysis not only of the costs of the rule but of lower-cost alternatives. Donaldson's hurry-up review in the face of a substantial and well-reasoned judicial knuckle-rap is the bureaucratic equivalent of telling one of the major courts in the country to go stuff it. Needless to say, the court will have the last word, at more taxpayer expense.

I added that reaffirmance is "a low point even for the Donaldson era of mediocrity." Commissioner Cynthia Glassman highlighted the Commission's atrocious procedure in a stinging dissent.

Yesterday the DC Circuit, as might have been expected, sent the matter back to the SEC. The court vacated the rule, but delayed its mandate 90 days to give the SEC one more chance to come up with some support for the rule, following proper procedures.

The court criticized the Commission for "relying on materials not in the rulemaking record without affording an opportunity for public comment." The court noted that

the Commission’s recourse to extra-record materials indicates that even for the more refined task of estimating direct costs . . . the Commission continued to view the rulemaking record as lacking reliable cost information.

Also,

the bulletins [the SEC relied on] themselves acknowledge 'wide divergence' among the funds represented in the summarized extra-record survey 'in the methodologies used to calculate director compensation.' . . . .this caveat suggests that other, possibly more reliable estimates may exist that could have influenced the Commission’s assumptions about director compensation, which supports the Chamber’s claim of prejudice.

Was the Commission justified in its hurry-up reconsideration in response to the court's first ruling?  Nope:

* * * The Commission’s preference to proceed with the same five Commission Members who were familiar with the rulemaking in considering the cost estimates described in Chamber I. . . is not the type of exigent circumstance that comes within the narrow “good cause” exception of section 553(b)(B).

So the SEC gets one more chance under a new chairman.  Meanwhile, it's too bad there's nothing in the APA requiring Donaldson to stand in the corner wearing a dunce's cap.