A recent federal appeals court decision is likely to cause the delay of dozens of pending Dodd-Frank Act regulations.
The U. S. Court of Appeals for D.C. Circuit Court ruled July 22 that the Securities and Exchange Commission (SEC) did not properly conduct a cost-benefit analysis before finalizing a proxy rule required by the regulatory reform law.
The decision serves as a stark warning for all federal regulators tasked with writing the myriad of regulations under Dodd-Frank, and gives the industry and others more leeway to challenge new rules in court. As a result, industry observers said regulators are likely to take more time to ensure they can adequately justify their decisions.
"The entire Dodd-Frank implementation is at heavy risk because if any of these rules are challenged by the courts, they won't survive," said Hal Scott, Nomura professor and director of the program on international financial systems at Harvard Law School.
Rules put out by other federal agencies will be "completely attackable under this decision," Scott said.
Republicans, who opposed Dodd-Frank and have sought to push back many of its regulations, immediately seized on the ruling, arguing it proved their fears that the new rules would be costly and burdensome to banks and the economy at large.
"Our regulatory agencies are not undertaking rigorous and deliberate analysis to understand the economic impacts of their actions," said Sen. Richard Shelby, ranking member of the Senate Banking Committee, following the court's decision. "The decision is an unequivocal validation of the concerns that Republicans have raised repeatedly over the past year."
At issue is a case brought by the U.S. Chamber of Commerce and Business Roundtable, which claimed the SEC didn't take into account the full costs associated with a new proxy rule. In its decision, Justice Douglas Ginsburg agreed with the industry, saying the SEC had acted "arbitrarily and capriciously" in failing to adequately assess the economic effect of the rule.
Ginsburg also said the SEC had "inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters."
This was not the first time the SEC has lost a case on the same grounds. Unlike other agencies, it is required to show a rule's effect on efficiency, competition and capital formation. "It's a black eye not just for Dodd-Frank, but it's a black eye for the SEC," said Cornelius Hurley, director of the center for banking and financial law at Boston University.
But the impact is likely to go well beyond the SEC. Industry representatives said the banking agencies will be more cautious now as they develop proposals.
"The immediate impact is that it puts the Dodd-Frank rulemaking under a sharper microscope," said Tom Quaadman, vice president of the Chamber of Commerce's center for capital markets competitiveness. "There's no question that there's going to be much heightened scrutiny."
Randall Kroszner, a former Federal Reserve Board governor and now professor at the University of Chicago, agreed.
"It is the shot across the bow saying the cost benefit analysis needs to be something done well and should be front and center in assessing the impact of regulations," he said.
It also provides Republicans with more ammunition in their battle against Dodd-Frank, giving them more opportunities to showcase the potential costs of the law.
"This is part of the war of attrition that the Republicans are waging against Dodd-Frank," said Hurley. "Unfortunately, Dodd-Frank is a deeply flawed statute, so they have a lot of opportunities to criticize. The way they are going to kill it is through court challenges and short funding the regulators."
Sen. Mike Crapo, R-Ind., joined Shelby in calling the court decision a critical ruling.
"Regulators charged with implementing the hundreds of Dodd-Frank rules must take this decision as a wakeup call and take the necessary time to get the final rules right by incorporating the meaningful public comments and economic analysis in their proposed rules," Crapo said in a press release.
Similarly, several top members of the House Financial Services Committee, including Rep. Scott Garrett of New Jersey, chairman of the capital markets subcommittee, Rep. Jeb Hensarling of Texas and Rep. Randy Neugebauer of Texas, wrote a letter raising concerns to SEC Chairman Mary Schapiro.
"The court's decision raises fundamental questions about the adequacy of the SEC's rulemaking pursuant to the Dodd-Frank Act and the Commission's exercise of its general rulewriting authority," they wrote in a letter dated July 28.
In response to the decision, the SEC has said it is reviewing the case and considering its options.
While no decision has been made yet, the agency has the ability to seek a panel rehearing or appeal to the Supreme Court. It could even opt to do nothing, or redo the entire rulemaking process from scratch.