An appeals court has rejected a new Securities and Exchange Commission rule intended to make it easier for shareholders to nominate directors to corporate boards.

In a major blow to the SEC, the Court of Appeals for the District of Columbia Circuit said the SEC's rule was arbitrary and capricious and that the agency had failed to properly weigh the economic consequences.

Friday's ruling marks the first successful legal challenge to a provision in last year's Dodd-Frank financial overhaul law that was intended to curb the type of Wall Street excesses that led to the global financial crisis.

The SEC rule, which had been put on hold pending the outcome of this case, would have required companies to include a shareholder candidate on corporate ballots known as proxies -- provided that the nominating shareholders held at least 3 percent of the voting power in the corporate stock for three years.

SEC Chairman Mary Schapiro had pushed for a rule on proxy access, saying the rule would give long-term shareholders greater voice by making it easier for them to nominate directors to the boards of the companies they own.

The U.S. Chamber of Commerce and the Business Roundtable, which filed the lawsuit challenging the rule, feared it would give minority shareholders too much power and could have cost companies millions of dollars in contested board elections.

To fight the rule, they hired Eugene Scalia, a partner at Gibson Dunn & Crutcher and the son of U.S. Supreme Court Justice Antonin Scalia.


Judge Douglas Ginsburg, who wrote the opinion for the court, said the SEC 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, and contradicted itself, among other things.

Although the court threw out the rule, the SEC could try to revive it. To do so, the agency would have to start the rule-writing process from scratch or appeal the decision. It could ask for a re-hearing from the three-judge panel or the entire D.C. Circuit, or appeal directly to the U.S. Supreme Court.

Scalia said on Friday the court's ruling was likely to give the SEC serious pause before revisiting proxy access.

Meredith Cross, the SEC's director of Corporation Finance, issued a statement saying the SEC is disappointed by the ruling and considering our options going forward.

David Hirschmann, the president and CEO of the chamber's Center for Capital Markets Competitiveness, said the court's decision should serve as a reminder to all federal financial regulators as they work to implement hundreds of new rules required by Dodd-Frank.

They have an obligation to do a cost-benefit (analysis) and they have an obligation to look at alternatives, he told Reuters in an interview.


This is not the first time the SEC has lost a court challenge to its rule-making procedures in the D.C. circuit.

The SEC previously lost to the chamber on a case challenging a rule on mutual fund director independence. It also lost in 2009 on a rule that would have regulated indexed annuities as securities. All of those challenges were successfully argued by Scalia.

The SEC had anticipated business groups would sue over proxy access after the groups expressed fears it would give activist shareholders undue influence over corporate boards and would trample state laws on corporate governance.

To protect the SEC, Congress granted the agency authority to write proxy access rules in Dodd-Frank. That provision, however, does not protect the SEC from challenges to its rule-making process.

Lately, some Republican lawmakers have raised concerns more broadly about a lack of adequate cost-benefit analysis on many Dodd-Frank rulemakings. On Friday, some of them pointed to the court ruling as evidence of carelessness.

This decision is an unequivocal validation of the concerns that Republicans have raised repeatedly, Senate Banking Ranking Republican Richard Shelby said, calling the regulators' approach to rulemaking cavalier.

Most experts felt the SEC faltered in its defense of the rule at an April hearing, with the judges appearing skeptical about the agency's estimates for how many contested board elections would result.

Nevertheless, supporters of the rule had still hoped it would prevail.

We will continue to advocate for proxy access and will encourage the SEC to promptly address the court's concerns, said Ann Yerger, the executive director for the Council of Institutional Investors.

Elisse Walter, an SEC commissioner and strong supporter of the rule, expressed her personal frustration by the setback.

We have been waging a fight for a stronger shareholder voice to hold boards accountable, she said. Unfortunately shareholders lost this round.

(Reporting by Sarah N. Lynch, editing by Matthew Lewis and Carol Bishopric)