WALL STREET FAILED to halt the passage of Dodd-Frank financial reform in Congress last year. But using a loophole in federal law, it's starting to win in the courts. The strategy threatens to undermine the essence of the law to make Wall Street more accountable. Congress needs to cut short this strategy lest the country forget the hard lesson from 2008 that Wall Street's recklessness will be curbed only through aggressive regulation and oversight.
It was inevitable that after the passage of Dodd-Frank business groups would push back against the hundreds of new rules that flow from the law. The U.S. Chamber of Commerce as well as others in the financial sector unleashed an army of lobbyists to neuter the regulations coming out of the Securities and Exchange Commission, the Commodity Futures Trading Commission and other federal agencies.
But for those rules that the lobbyists haven't been able to modify, another potentially more damaging strategy is being pursued through the courts. That includes one pushed by Eugene Scalia, a lawyer and son of U.S. Supreme Court Justice Antonin Scalia.
The legal hook is a provision of federal law passed in 1996 that requires the SEC to promote "efficiency, competition and capital formation." From this, businesses have successfully argued that the agency must assess the economic effects of any new rule, and if this is not done properly the agency's rulemaking will be deemed arbitrary and capricious, and the rule vacated.
In July, the chamber and the Business Roundtable won a case using this approach before the U.S. Circuit Court of Appeals for the District of Columbia. The court tossed out a proxy access rule that promoted shareholder rights. The rule gave large shareholders the ability to list their board nominees on proxy ballots alongside the candidates offered by the corporate management. It would have made corporate boards that gave huge compensation packages to executives more answerable to shareholders by making directors more susceptible to ouster.
Among other defects, the court found that the SEC was arbitrary when it failed to estimate the cost to companies of campaigning to oppose director candidates from shareholders. Those costs could be substantial, the court said. Yet the SEC had done an extensive cost-benefit analysis of the proxy rule — 60 pages' worth — before its adoption.
Striking down a rule after so much groundwork by the agency will invite a tsunami of additional challenges. Already, financial trade groups are contemplating going after the SEC's new corporate whistle-blower office created in the Dodd-Frank law.
While the SEC is responding to the new legal landscape by bringing on a number of economists to do more analysis on each rule, only Congress can fix this. The law needs to be clarified so that regulatory agencies can do their job. Otherwise Wall Street will have gotten what it wanted: a financial reform law that is all paper and no teeth.