Chamber of Commerce v. Sec. and Exchange Com'n

• Citation: 412 F.3d 133
• Decision Date: 21 June 2005
• Docket Number: No. 04-1300.,04-1300.
• Parties: CHAMBER OF COMMERCE OF THE UNITED STATES OF AMERICA, Petitioner v. SECURITIES AND EXCHANGE COMMISSION, Respondent
• Court: United States Courts of Appeals. United States Court of Appeals (District of Columbia)

412 F.3d 133

CHAMBER OF COMMERCE OF THE UNITED STATES OF AMERICA, Petitioner v. SECURITIES AND EXCHANGE COMMISSION, Respondent

No. 04-1300.

United States Court of Appeals, District of Columbia Circuit.

Argued April 15, 2005.

Decided June 21, 2005.

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On Petition for Review of an Order of the Securities and Exchange Commission.

Eugene Scalia argued the cause for petitioner. With him on the briefs were John F. Olson, Douglas R. Cox, Cory J. Skolnick, Stephen A. Bokat, and Robin S. Conrad.

Giovanni P. Prezioso, General Counsel, Securities & Exchange Commission, argued the cause for respondent. With him on the brief were Meyer Eisenberg, Deputy General Counsel, Jacob H. Stillman, Solicitor, and John W. Avery, Special Counsel.

Before: GINSBURG, Chief Judge, and ROGERS and TATEL, Circuit Judges.

GINSBURG, Chief Judge.

The Chamber of Commerce of the United States petitions for review of a rule promulgated by the Securities and Exchange Commission under the Investment Company Act of 1940(ICA), 15 U.S.C. § 80a-1 et seq. The challenged provisions of the rule require that, in order to engage in certain transactions otherwise prohibited by the ICA, an investment company— commonly referred to as a mutual fund— must have a board (1) with no less than 75% independent directors and (2) an independent chairman. The Chamber argues the ICA does not give the Commission authority to regulate "corporate governance" and, in any event, the Commission promulgated the rule without adhering to the requirements of the Administrative Procedure Act, 5 U.S.C. § 551 et seq.

We hold the Commission did not exceed its statutory authority in adopting the two conditions, and the Commission's rationales for the two conditions satisfy the APA. We agree with the Chamber, however, that the Commission did violate the APA by failing adequately to consider the costs mutual funds would incur in order to comply with the conditions and by failing adequately to consider a proposed alternative to the independent chairman condition. We therefore grant in part the Chamber's petition for review.

I. Background

A mutual fund, which is "a pool of assets... belonging to the individual investors holding shares in the fund," Burks v. Lasker, 441 U.S. 471, 480, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979), is operated by an "investment company" the board of directors of which is elected by the shareholders. Although the board is authorized to operate the fund, it typically delegates that management role to an "adviser," which is a separate company that may have interests other than maximizing the returns to shareholders in the fund. In enacting the ICA, the Congress sought to control "the potential for abuse inherent in the structure of [funds]" arising from the conflict of interests between advisers and shareholders, id.; to that end, the ICA prohibits a fund from engaging in certain transactions by which the adviser might gain at the expense of the shareholders. See generally 15 U.S.C. § 80a-12(a)-(g). Pursuant to the Commission's long-standing Exemptive Rules, however, a fund that satisfies certain conditions may engage in an otherwise prohibited transaction. See, e.g., Rule 10f-3, 17 C.F.R. § 270.10f-3 (2004) (when conditions are satisfied, fund may purchase securities in primary offering although adviser-affiliated broker-dealer is member of underwriting syndicate).

Early in 2004 the Commission proposed to amend ten Exemptive Rules by imposing five new or amended conditions upon any fund wishing to engage in an otherwise prohibited transaction. See Investment Company Governance, Proposed Rule, 69 Fed.Reg. 3472 (Jan. 23, 2004). Although the Commission had amended the same ten rules in 2001 to condition exemption upon the fund having a board with a majority of independent directors (that is, directors who are not "interested persons" as defined in § 2(a)(19) of the ICA), see Role of Independent Directors of Investment Companies, Final Rule, 66 Fed.Reg. 3734 (Jan. 16, 2001), by 2004 the Commission had come to believe that more was required. "[E]nforcement actions involving late trading, inappropriate market timing activities and misuse of nonpublic information about fund portfolios" had brought to light, in the Commission's view, "a serious breakdown in management controls," signaling the need to "revisit the governance of funds." 69 Fed.Reg. at 3472. Accordingly, the Commission proposed to condition the ten exemptions upon, among other things, the fund having a board of directors (1) with at least 75% independent directors and (2) an independent chairman. Id. at 3474.

After a period for comment and a public meeting, the Commission unanimously adopted three of the proposed new conditions and, by a vote of three to two, adopted the two corporate governance conditions challenged here. See Investment Company Governance, Final Rule, 69 Fed. Reg. 46,378 (Aug. 2, 2004). The Commission majority adopted those two conditions in light of recently revealed abuses in the mutual fund industry, reasoning that the Exemptive Rules

rely on the independent judgment and scrutiny of directors, including independent directors, in overseeing activities that are beneficial to funds and fund shareholders but that involve inherent conflicts of interest between the funds and their managers.... These further amendments provide for greater fund board independence and are designed to enhance the ability of fund boards to perform their important responsibilities under each of the rules.

Id. at 46,379. Raising the percentage of independent directors from 50% to 75%, the Commission anticipated, would "strengthen the independent directors' control of the fund board and its agenda," id. at 46,381, and "help ensure that independent directors carry out their fiduciary responsibilities," id. at 46,382. The Commission justified the independent chairman condition on the ground that "a fund board is in a better position to protect the interests of the fund, and to fulfill the board's obligations under the Act and the Exemptive Rules, when its chairman does not have the conflicts of interest inherent in the role of an executive of the fund adviser." Id.

The dissenting Commissioners were concerned the two disputed conditions would come at "a substantial cost to fund shareholders," and they believed the existing statutory and regulatory controls ensured adequate oversight by independent directors. 69 Fed.Reg. at 46,390. Specifically, they faulted the Commission for not giving "any real consideration to the costs" of the 75% condition, id. at 46,390-46,391; for failing adequately to justify the independent chairman condition, id. at 46,391-46,392; and for not considering alternatives to that condition, id. at 46,392-46,393. The Chamber timely petitioned for review asserting an interest in the new conditions both as an investor and as an association with mutual fund advisers among its members.

II. Analysis

The Chamber makes two arguments on the merits: The Commission had no authority under the ICA to adopt the two conditions; and the Commission violated the APA in the rulemaking by which it promulgated the conditions. Before addressing those arguments, we must assure ourselves of the Chamber's standing, and thus of our jurisdiction.

A. Jurisdiction of the Court

Under Article III of the Constitution the "judicial Power of the United States" is limited to the resolution of "Cases" or "Controversies," a corollary of which is that a party invoking our jurisdiction "must show that the conduct of which he complains has caused him to suffer an `injury in fact' that a favorable judgment will redress." Elk Grove Unified School Dist. v. Newdow, 542 U.S. 1, 124 S.Ct. 2301, 2308, 159 L.Ed.2d 98 (2004). In this case the Chamber claims it is injured by the two challenged conditions because it would like to invest in shares of funds that may engage in transactions regulated by the Exemptive Rules but do not meet those conditions. See Dec'l of Stan M. Harrell ¶ 2 (Chamber currently invests in funds, intends to continue doing so, and would like to invest in funds unconstrained by the conditions).

The Chamber cites two cases for the proposition that loss of the opportunity to purchase a desired product is a legally cognizable injury. Consumer Fed'n of Am. v. FCC, 348 F.3d 1009, 1011-12 (D.C.Cir.2003) (injury-in-fact where merger would deprive plaintiff of opportunity to purchase desired service); Competitive Enter. Inst. v. Nat'l Highway Traffic Safety Admin., 901 F.2d 107, 112-13 (D.C.Cir. 1990) (injury-in-fact where fuel economy regulations foreclosed "opportunity to buy larger passenger vehicles"). The Commission argues in response that there is no evidence a fund of the type in which the Chamber wants to invest would perform better than a fund that conforms to the two corporate governance conditions. In Consumer Federation, however, we held "the inability of consumers to buy a desired product ... constitute[d] injury-in-fact even if they could ameliorate the injury by purchasing some alternative product." 348 F.3d at 1012. Under our precedent, therefore, the Chamber has suffered an injury-in-fact and, because a favorable ruling would redress that injury, it has standing to sue the Commission. And so to the merits.

B. The Commission's Authority under the ICA

The Chamber maintains the Commission did not have authority under the ICA to condition the exemptive transactions as it did. First the Chamber observes rather generally that "matters of corporate governance are traditionally relegated to state law"; and second, it maintains these particular conditions are inconsistent with the statutory requirement that 40% of the directors on the board of an investment company be independent, see 15 U.S.C. § 80a-10(a). The Commission points to § 6(c) of the ICA, 15 U.S.C. § 80a-6(c), as the source of its authority.^* That provision conspicuously confers upon the...