Even before the Dodd-Frank Act (“Dodd-Frank” or “Act”), rules promulgated by the Securities and Exchange Commission (“SEC”) occasionally struggled to cross the threshold of the D.C. Circuit’s arbitrary and capricious review standard. This standard is bolstered by the requirement found in various acts of Congress that, before the appropriate agency promulgates a rule, it must consider whether the rule promotes efficiency, competition, and capital formation. Striking examples of rulemaking failures include the fixed-indexed annuity rule, the independent director rules, and most recently, the proxy access rule. While Dodd-Frank did not create the difficulties inherent in defining and exceeding the standard, it did exacerbate the problem. The Act mandated the promulgation of more than 100 new rules, contained a slew of non-mandatory rulemaking provisions, and imposed other new responsibilities. The SEC has proceeded with implementation of “the broadest financial reforms since the 1930s” “almost entirely with existing staff,” much of whose time has been taken away from “other critical responsibilities.” Consequently, an understanding of the standard of judicial review should become increasingly important as these new rules come out.
This article will examine parallels between the standard applied by the D.C. Circuit and well-established law and economics principles. Because of the impact of the Law and Economics movement on the legal profession, most judges should be familiar with the basic precepts.7 Consequently, before promulgating a rule, agencies that are required to analyze the rule’s effect on systemic efficiency and competition should perform their analysis in accordance with what are now well-established insights from the Law and Economics movement.8 Doing so should ensure that the rule survives judicial scrutiny by satisfying the requirement found in many authority-granting statutes that the agency must consider the rule’s effect on efficiency, competition, and capital formation. This article will use Dodd-Frank’s incentive-based compensation rules and clawback provisions as illustrations. Ultimately, this article will lay out guidelines that, if followed, should increase the likelihood that a rule passes judicial review.