Writing Sample by Anthony Maddaluno

A Short Analysis on the Enforceability of 17 C.F.R. §240.15a-6By

Anthony Maddaluno

TABLE OF CONTENTS

INTRODUCTION.………………………………………………………………………..3

ANALYSIS OF THE ENFORCEABILITY OF RULE 15a-6……………………………4

A. The SEC used quantified estimates to support its conclusions about the costs that chaperoning broker-dealers would incur complying with Rule 15a-6………………….....4

B. The SEC used quantified estimates about the aggregate costs of compliance with Rule 15a-6 to support its conclusions about Rule 15a-6’s effect on the market in terms promoting efficiency, competition and capital formation ……………………………….11

C. The SEC failed to produce quantified estimates to support its conclusions that chaperoning broker-dealers would receive several benefits under Rule 15a-6……….....14

D. The SEC drew internally inconsistent conclusions about the costs and benefits that Rule 15a-6 imposes on chaperoning broker-dealers……………………………………..17

E. The SEC acted arbitrarily and capriciously because it failed to adequately address the problems raised in comments that could impose additional costs on chaperoning broker-dealers …………………………….…………………………………………..................21

CONCLUSION…………………………………………………………………………..25

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INTRODUCTION

In 1989, the Securities Exchange Commission (“Commission” or the “SEC”)

found that U.S. investors, including large institutional investors, were increasingly

trading foreign securities on foreign securities markets through U.S. registered broker-

dealer intermediaries (“chaperoning broker-dealers” or “registered broker-dealers”).1

In response to these trends, the SEC enacted Rule 15a-6 which requires chaperoning

broker-dealers to provide U.S. investors trading in foreign securities the same protections

that U.S. investors have when trading in domestic securities.2 This paper advances the

position that Rule 15a-6 is unenforceable because the SEC failed to fulfill its statutory

obligation under 15 USC, §78c(f), 78(w)(a) and 80a-2(c).

Under 15 USC, §78c(f), 78(w)(a) and 80a-2(c), the SEC is required to consider

how the costs and benefits (“economic consequences”) effectuated by Rule 15a-6 relates

to promoting efficiency, competition and capital formation in the market.3 The analysis

section of this paper will demonstrate that the SEC failed to satisfy this statutory

obligation for the following reasons. First, the SEC’s conclusions about the benefits that

chaperoning broker-dealers would receive under the amended Rule 15a-6, were not based

on quantified estimates. Second, the SEC’s conclusions are internally inconsistent. Third,

the SEC’s conclusions are inconsistent with the conclusions of members of the industry

that were submitted in comments to the SEC.

1 Registration Requirements for Foreign Broker-Dealers, 54 Fed. Reg. 30013, 30014 (July 18, 1989) (to be codified at 17 C.F.R. pt. 240).2 Registration Requirements for Foreign Broker-Dealers, 54 Fed. Reg. at 30014.3 15 USC,” §78c(f), 78(w)(a), 80a-2(c).

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ANALYSIS OF THE ENFORCEABILITY OF RULE 15a-6

A. The SEC used quantified estimates to support its conclusions about the costs that chaperoning broker-dealers would incur complying with Rule 15a-6

One reason why the court in Business Roundtable found that the proposed rule

was unenforceable, was that the court found that the SEC had failed to conduct a serious

evaluation of the costs that companies could incur under the rule. 4 Specifically, the court

held that the SEC acted arbitrarily and capriciously by not conducting a serious

evaluation of costs that could be imposed upon companies from use of the rule by

shareholders representing special interests, particularly union and government pension

funds.5

Here, the SEC used quantified estimates of the costs of compliance with the

specific requirements of Rule 15a-6 in a release in 2008 that amended the rule. For

example, the SEC used quantified estimates of the costs incurred by chaperoning broker-

dealers under Rule 15a-6’s collection of information requirements.6 Specifically, the SEC

calculated that each chaperoning broker-dealer who intermediates transactions between

foreign-broker dealers under exemption (A)(1) under the rule would incur a total cost of

$10,800 per year in order to remain in full compliance with the rule’s collection of

information provisions. 7 For chaperoning broker-dealers who intermediate transactions

for foreign broker-dealers who rely on exemption (A)(2) of the rule, the SEC has

estimated that the total cost incurred by each chaperoning broker-dealer would be

4 Business Roundtable. at 1144.5 Business Roundtable. at 1144.6 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr at 39208.7 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr at 39208.

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$13,527 per year.8

The SEC made these cost determinations by multiplying the estimated hourly

salary for a compliance attorney by the estimated number of hours per year that a

compliance attorney would have to work to ensure that the chaperoning broker-dealer is

in full compliance.9 The SEC used the same formula to estimate the costs incurred by

foreign-broker dealers under the rule’s collection of information requirements.10

A second example of the SEC’s use of quantified estimates of the costs that

chaperoning broker-dealers would incur under Rule 15a-6, is the SEC’s implementation

of the provisions of Rule 15c3-1 to determine the specific costs that chaperoning broker-

dealers would incur in order to maintain the required minimum amount of net capital.

Rule 15a-6 requires that chaperoning broker-dealers must maintain sufficient net capital

in accordance with Rule 15c3-1.11 Specifically, Rule 15c3-1 provides the following

mathematical formulas that can be used to quantify the cost that each chaperoning

broker-dealer under Rule 15a-6 would incur in order to maintain the required minimum

of net capital.

Under Rule 15c3-1, a chaperoning broker-dealer can elect to have its minimum

net capital requirement measured by its aggregate indebtedness to all other persons.

Under this aggregate indebtedness standard, the chaperoning broker-dealer must set aside

enough liquid assets as net capital so as to prevent its aggregate indebtedness to all of its

8 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr at 39208.9 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr at pp. 39208.10 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39208.11 Exemption of Certain Foreign Brokers or Dealers. 73 Fed. Reg 34-58047 at pp. 11-12.

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clients i.e. U.S. Investors and Foreign Broker-dealers does not exceed 1500% of that net

capital amount.12 The chaperoning broker-dealer can also opt for an alternative

computation under Rule 15c3-1(a)(2). Under this alternative standard, a chaperoning

broker-dealer cannot allow its net capital to be less than $250,000 or 2% of aggregate

debit items whichever figure is greater.13

Rule 15c3-1 also mandates quantified adjustments to the minimum net capital

requirement based on the specific services that the broker-dealer provides. The

implementation of these quantified adjustments in the context of Rule 15a-6’s net capital

requirements illustrates the SEC’s use of quantified cost estimates when considering the

impact of Rule 15a-6’s net capital requirement in terms of promoting efficiency,

competition and capital formation in the market.

Specifically, a chaperoning broker-dealer only needs to maintain a minimum net

capital of no less than $250,000 if it carries customer or broker-dealer accounts and

receives funds or holds funds for those persons.14 A broker-dealer receives funds under

this provision if it receives checks, drafts, or other evidences of indebtedness made

payable to itself or persons other than the requisite registered broker-dealer carrying the

account of a customer, escrow agent, issuer, underwriter, sponsor, or other distributor of

securities.15

A broker-dealer is deemed to hold securities if it carries securities or funds in

either a customer or broker-dealer dealer account and it does not promptly forward or

deliver all of the securities or funds owed to its clients.16 Moreover, a chaperoning

12 17 C.F.R. § 240.15c3-1(a)(1)(i).13 17 C.F.R. § 240.15c3-1(a)(1)(ii).14 17 C.F.R. § 240.15c3-1(a)(2)(i).15 17 C.F.R. § 240.15c3-1(a)(2)(iv).16 17 C.F.R. § 240.15c3-1(a)(2)(iv).

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broker-dealer is required to maintain a minimum of $50,000 in net capital if it introduces

transactions and accounts of customers or other brokers or dealers to another registered

broker-dealer, it carries such accounts on a fully disclosed basis, and it only receives but

does not hold securities or funds on behalf of its customers or other broker-dealers.17

Conversely, a chaperoning broker-dealer would only be required to maintain no

less than $5,000 in net capital if it does not: receive funds directly or indirectly, holds

funds or securities, owe funds or securities to customers and does not carry accounts of or

for customers.18 In addition, the SEC has clarified that chaperoning broker-dealers can

become eligible for the $5,000 minimum net capital requirement if they enter into a fully

disclosed carrying agreement with another registered broker-dealer who has agreed to

comply with the SEC’s rules and has accepted responsibility for receiving and holding

the securities during the course of these transactions.19

A third example of the SEC using quantified estimates of the costs of compliance

for chaperoning broker-dealers with Rule 15a-6 is the implementation of provisions

under Rule 15c3-3. Rule 15c3-3 quantifies the specific costs that Rule 15a-6 imposes on

chaperoning broker-dealers who receive, deliver and safeguard funds and/or securities on

behalf of the foreign broker-dealer and/or U.S. investor. 20 Specifically, Rule 15c3-3

requires chaperoning broker-dealers to determine from their own books or records the

quantity of fully paid securities and excess margin securities that are within their

possession or control. 21 Rule 15c3-3 also requires chaperoning broker-dealers to

17 17 C.F.R. § 240.15c3-1(a)(2)(iv).18 17 C.F.R. § 240.15c3-1(a)(2)(vi).19 Frequently Asked Questions Regarding Rule 15a-6 and Foreign Broker-Dealers, www.sec.gov/divisions/marketreg/faq-15a-6-foreign-bd.htm. 20 Exemption of Certain Foreign Brokers or Dealers. 73 Fed. Reg 34-58047 at 11-12. 21 17 C.F.R. § 240.15c3-3(c)(7).

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http://www.sec.gov/divisions/marketreg/faq-15a-6-foreign-bd.htm

determine the quantity of fully paid securities and excess margin securities that are not

within the their possession or control.22

A fourth example of the SEC using quantified estimates to determine the costs

that chaperoning broker-dealers will incur complying with Rule 15a-6 are the quantified

estimates that the SEC used concerning the costs of compliance with Rule 15a-6(a)(3)(iii)

(B) and (D). These provisions require chaperoning broker-dealers to obtain and record

consents to service of process from foreign broker-dealers, foreign associated persons and

qualified persons.23

Specifically, the SEC estimated that each chaperoning broker-dealer acting under

Exemption (A)(1) of Rule 15a-6 would be required to obtain and record a total of fifty

consents to service of process from foreign associated persons as well as ten consents to

service of process from foreign broker-dealers.24 The SEC also estimated that

chaperoning broker-dealers acting under Exemption (A)(2) would be required obtain a

total of eighty three consents to service of process from foreign associated persons and

sixteen consents from foreign broker-dealers.25

Next, the SEC estimated the amount that the compliance attorney for each

chaperoning broker-dealer would spend 30 minutes obtaining and recording per

consent.26 The SEC then multiplied this estimated time a compliance attorney would

spend obtaining and recording each consent, by the estimated number of consents that

22 17 C.F.R. § 240.15c3-3(c)(7).23 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39204.24 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39204.25 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39204.26 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39204.

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each chaperoning-broker dealer would be required to obtain. The product of this order is

the estimated cost that chaperoning broker-dealers would incur under these provisions.

The SEC also used this formula to determine the cost that each chaperoning broker-dealer

acting under Exemption (A)(2) would incur.27

A fifth example of the SEC’s use of quantified estimates in considering the costs

that chaperoning broker-dealers incur under Rule 15a-6 are the quantified estimates of the

costs relating to compliance with Rule 15a-6(a)(3)(iii)(C).28 Rule 15a-5(a)(3)(iii)(C)

obligates each registered broker-dealer that assumes the role of a chaperoning broker-

dealer under either Exemption (A)(1) or Exemption (A)(2) to obtain representations from

the foreign broker-dealer concerning the types of information that is required by Rule

17a-3(a)(12).29 Specifically, the SEC estimated that each chaperoning broker-dealer who

intermediates transactions under Exemption (A)(1) of the rule would have to pay its

compliance attorney for 5 hours of work per year to prepare and the required

representations from the foreign broker-dealers.30 The SEC also estimated that each

chaperoning broker-dealer that is intermediating transactions under Exemption (A)(2)

would be required to spend approximately eight hours per year obtaining and recording

this information.31

All these examples demonstrate that the SEC used quantified estimates of costs

and mathematical formulas rather than mere conjecture to determine the costs incurred by

27 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39204.28 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39203.29 17 C.F.R. §240.15a-6(a)(3)(iii)(C).30 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39203.31 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39203.

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each chaperoning broker-dealer under Rule 15a-6. Therefore, Rule 15a-6 is not

unenforceable on the ground that the SEC failed to make a serious evaluation as to the

costs that would be effectuated under the rule.

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B. The SEC used quantified estimates about the aggregate cost of compliance with Rule 15a-6 to support its conclusions about Rule 15a-6’s effect on the market in terms promoting efficiency, competition and capital formation

The SEC also used quantitative estimates to support its conclusions about the

aggregate cost that the Rule 15a-6 would impose on the industry as a whole. For

example, the SEC used quantified estimates of the annual cost that chaperoning broker-

dealers incur under the reporting and recordkeeping requirements of Rule 15a-6(a)(3)(iii)

(B) and (D).32

The SEC also estimated that approximately forty U.S. registered broker-dealers

would act as chaperoning broker-dealers under Exemption (A)(1) of the rule and fifty-

eight U.S. registered broker-dealers would act as chaperoning broker-dealers under

Exemption (A)(2).33 The SEC then multiplied the estimated number of chaperoning

broker-dealers by the estimated number of hours that each chaperoning broker-dealer was

required to pay its compliance attorney per year.34 Using this data the SEC determined

that the industry would collectively incur the costs of paying for 2,300.18 hours of work

and 1,400 hours of work for chaperoning broker-dealers acting under Exemption (A)(1)

and Exemption (A)(2) respectively. Thus, ensuring universal compliance with Rule 15a-

6(a)(3)(iii)(B) and (D).35

Another example of the SEC using quantified estimates of the aggregate burden

32 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39204.33 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39204.34 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39204.35 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39204.

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that the industry incurs under Rule 15a-6(a)(3)(iii)(C).36 Specifically, the SEC multiplied

the estimated number of chaperoning broker-dealers acting under Exemption (A)(1) by

the estimated number of hours that a compliance attorney would have to work to ensure

compliance. The SEC used the subsequent results to determine the number of hours that

each chaperoning broker-dealer acting under Exemption (A)(1) in order to remain in

compliance. 37

Next, the SEC employed that same formula to determine the number of hours that

each chaperoning broker-dealer acting under Exemption (A)(2) would have to pay its

compliance attorney in order to comply with Rule 15a-6(a)(3)(iii)(C). 38 Finally the SEC

added the products from both of those equations to conclude that the aggregate burden on

all chaperoning broker-dealers in the industry would be the amount that all of the

chaperoning broker-dealers in the industry would have to pay their compliance attorneys

to perform 344 hours of work per year.39

After estimating these aggregate costs, the SEC considered the effect of Rule 15a-

6 on the market in terms of promoting efficiency, competition and capital formation.

Specifically, the SEC concluded that the proposed amendments that it is implementing

will promote efficiency by reducing the costs of compliance for both registered broker-

dealers and foreign broker-dealers who conduct transactions pursuant to paragraph (a)


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(3).40 In addition, the SEC concluded that the proposed amendments would not impose

any burden on competition not necessary or appropriate in furtherance of the Exchange

Act.41 Finally, the SEC concluded that the currently amended form of Rule 15a-6 will not

have any significant effect on capital formation.42

Since the SEC produced quantified estimates of individual costs to each

chaperoning broker-dealer and to the industry in the aggregate, the enforceability of Rule

15a-6 cannot be successfully challenged on these two grounds.

40 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39209.41 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39208.42 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39209.

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C. The SEC failed to produce quantified estimates to support its conclusions that chaperoning broker-dealers would receive several benefits under Rule 15a-6

Another reason the court in Business Roundtable held that Rule 14a-11 was

unenforceable was because the SEC only identified “intangible” or “less readily

quantifiable,” benefits. 43 Specifically, the court found that the SEC concluded that Rule

14a-11 would result in mitigated collective action and free-rider concerns as well as the

potentiality of improved board performance and enhanced shareholder value.44 However,

the court found that the SEC did not base these conclusions on any quantified estimates.45

In addition, the court found that by ignoring “this crucial datum” the SEC “has no way of

knowing whether the rule…will be of net benefit.”46

Comparatively, the SEC’s conclusions about the benefits that would result from

the amended Rule 15a-6’s implementation are also unsupported by any quantified

estimates.47 For example, the SEC concluded that the amended rule would allow a

broader category of U.S. investors greater access to foreign broker-dealers and foreign

markets by expanding and streamlining the conditions under which a foreign broker-

dealer could operate without triggering the registration requirements of §15(a)(1) or

§15B(a)(1) of the Exchange Act.48 However, the SEC did not estimate the amount of

43 Business Roundtable. at 1149.44 Business Roundtable. at 1149.45 Business Roundtable. at 1149.46 Business Roundtable. at 1153.47 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39206.48 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39206.

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costs that a chaperoning broker-dealer acting under Exemption (A)(1) or Exemption (A)

(2) could be expected to save under the amended rule.49

Another benefit that the SEC identified was the elimination of the need for

chaperoning broker-dealers to “double-book” transactions under Rule 15a-6(a)(3).

Specifically, the SEC failed to provide any estimates of the difference between the cost of

“double booking” under the old version of Rule 15a-6 and the currently amended

version.50

The SEC also concluded that because chaperoning broker-dealers acting under

Exemption (A)(1) of the amended Rule 15a-6 were not required to “effect” transactions,

these chaperoning broker-dealers would no longer be required to perform all the

functions associated with effecting transactions.51 Such functions included: complying

with recording and recordkeeping rules, issuing confirmations, and maintaining custody

of customer funds and securities.52 However, the SEC also did not base this conclusion on

any estimates of the amount of cost reductions that could be expected.

Since the SEC did not quantify the extent that any of these benefits would offset

the costs of compliance under the amended rule, the SEC did not know and therefore

could not consider whether or not the supposed benefits of the amended rule would

outweigh the anticipated increases in costs that the rule imposes. In other words, the SEC

failed to determine the individual benefits that chaperoning broker-dealers would receive


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under the specific provisions of the amended rule and the net benefit effectuated by the

amended rule as a whole because it did not use any quantified estimates. Therefore, the

SEC has failed to satisfy their statutory obligation under 5 U.S.C.A. § 78c-f,§ 78(w)

(f)§80a-2. More poignantly, by failing to quantify these benefits, the SEC has also

disregarded its stated mission to protect investors, maintain fair, orderly and efficient

markets and facilitate capital formation.53

53 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. at 39183.

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D. The SEC drew internally inconsistent conclusions about the costs and benefits that Rule 15a-6 imposes on chaperoning broker-dealers

Another reason why the court in Business Roundtable held that Rule 14a-11 was

un-enforceable, was that the SEC had drawn internally inconsistent conclusions about the

anticipated benefits that would be effectuated by the rule. Specifically, the court found

that the SEC predicted that one benefit of the rule would be “direct printing and mailing

cost savings” in regards to proxy materials.54 The court then found that the SEC predicted

that the number of election contests under Rule 14a-11 “would be quite high.” For this

reason, the court concluded that the SEC’s conclusion about the anticipated benefits was

inconsistent because the increase in the frequency of election contests would result higher

printing and mailing costs in the aggregate, which would undermine any realized cost

reductions.55

Thus, the court found drew some internally inconsistent conclusions in its 2008

release about the costs and benefits that the newly amended Rule 15a-6 would impose on

chaperoning broker-dealers. These internally inconsistent conclusions further undermined

the SEC’s considerations about the amended rule’s effect on the market in terms of

promoting efficiency, competition and capital formation.

Comparatively, the SEC drew an inconsistent conclusion about the effect of

amended Rule 15a-6 that undermined its conclusion that chaperoning broker-dealers

acting under Exemption (A)(1) would benefit from cost reductions under paragraph (a)

(3). Specifically, the SEC initially reasoned that chaperoning broker-dealers acting will

experience cost reductions when complying with the requirements Rule 15a-6(a)(3)

54 Business Roundtable. at 1153.55 Business Roundtable. at 1153.

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because they will no longer be required to perform all of the functions associated with

effecting transactions.56 Such functions include recording and recordkeeping, issuing

confirmations and holding securities and funds on behalf of U.S. investors.57

However, the SEC also found that under the amended rule, chaperoning broker-

dealers acting under Exemption (A)(1) would be required to maintain certain books and

records including confirmation statements, albeit in the form and manner mandated by

the foreign securities authority.58 It stands to reason that these additional requirements

would result in incurred costs to chaperoning broker-dealers that would offset the benefits

that they would receive under paragraph (a)(3).

In addition, the SEC also concluded that the these unspecified, un-quantified cost

reductions that chaperoning broker-dealers who act under Exemption (A)(1) will

supposedly benefit from, may further be undermined by the increase in the aggregate

costs that will be incurred in order to accommodate increasing trading activity under the

rule.59

For these reasons, the SEC’s conclusion about chaperoning broker-dealers

benefiting from cost reductions for reporting and bookkeeping is inconsistent and

misleading. Furthermore, the SEC’s conclusion that the costs incurred as a result of the

increased trading activity will be “incremental” and “insignificant does not rectify the

inconsistency because the SEC did not provide any quantified estimates to justify this


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conclusion.60 Thus, the SEC’s internally inconsistent conclusions closely parallel the

SEC’s inconsistent conclusions about the “direct printing and mailing cost savings” and

predicted increase in elections in Business Roundtable.

Another example is the SEC’s inconsistent conclusions about the affect of

amended Rule 15a-6 on competition in the industry. Specifically, the SEC proposed an

85% threshold for determining whether a foreign broker-dealer conducts a predominantly

foreign business (“foreign business test”) because a lower threshold may allow a foreign

broker dealer to conduct significant business in U.S. securities without being regulated.61

This 85% threshold implies that a foreign broker-dealer may be allowed to

conduct some business activities in U.S. securities albeit not rising to the level of

“significant business.” The SEC also noted that allowing a foreign broker-dealer to

conduct any business in U.S. securities could affect the competitive positions of U.S.

registered broker-dealers and foreign broker-dealers.62 Therefore, since foreign broker-

dealers may be engaged in at least some business activity involving U.S. securities, it is

possible that the amended rule may have some effect on competition. Therefore, the

SEC’s conclusion that the amended Rule 15a-6 would not impose any burden on

competition not necessary or appropriate in furtherance of the Exchange Act is

inconsistent. 63 In addition, the SEC’s request for comments on whether the proposed


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amendments would impose a burden on competition suggests that its conclusion was also

based on incomplete information.64

64 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39209.

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E. The SEC acted arbitrarily and capriciously because it failed to adequately address the problems raised in comments that could impose additional costs on chaperoning broker-dealers

Another reason why the court in Business Roundtable held that Rule 14a-11 was

unenforceable was that the SEC acted arbitrarily and capriciously by entirely failing to

consider an important aspect of the problem raised in a comment.65 Specifically,

commenters to Rule 14a-11 had expressed concern that these employee benefit funds

would impose costs upon companies by using Rule 14a-11 as leverage to gain

concessions, such as additional benefits for unionized employees, unrelated to

shareholder value.66 The court found that while the SEC did not completely ignore the

potential costs that these commenters raised, its failure to respond to these comments

amounted to arbitrary conduct.67

Comparatively, the SEC acted arbitrarily and capriciously because it failed to

adequately respond to comments that raised potential costs that chaperoning broker-

dealers and other small entities could incur under amended Rule 15a-6. For example, one

comment, submitted by the State Street Corporation, urged the SEC to reconsider the

SEC’s decision to use the foreign business test in amended Rule 15a-6. 68 Specifically,

this commenter argued that the foreign business test would be: unnecessarily complex

and burdensome, raise numerous questions about how to value a wide range of securities

such as non-equities and require a significant undertaking to establish systems of

65 Business Roundtable. at 1151.66 Business Roundtable. at 1151.67 Business Roundtable. at 1152.68 SEC Comment, File No. S71608-25. (September 8, 2008)

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compliance.69 In addition, this commenter also asserted that the application of U.S.

research rules, particularly Regulation AC, to research reports made by foreign broker-

dealers would unnecessarily hinder the free flow of information that the SEC is seeking

to encourage with no concomitant increase in investor protection.70

Given the nature of the problems that were raised in this comment, it can be

reasonably inferred that chaperoning broker-dealers would incur significant costs under

this rule. In addition, it can be inferred that these costs would be disproportionately borne

by smaller chaperoning broker-dealers who will receive less benefits as a result of less

trading, yet still have to incur the same amount of costs in establishing the required

compliance systems. For these reasons, the SEC’s failure to adequately address these

problems and the potential costs that they raise is analogous to the SEC’s failure to

address the concerns raised by the Chamber of Commerce in Business Roundtable. 71 The

implications this comment also casts doubt on the validity of the SEC’s conclusion that

Rule 15a-6 would not have a significant economic impact on a substantial number of

small entities.72

The SEC also failed to adequately address the economic impact of a problem that

was raised in a comment by Dorsey and Whitney LLP. 73 Specifically, this comment

raised the issue that proposed NASD Rules 2711(h) and 472(k) would frustrate one of the

primary objectives of Rule 15a-6 i.e. to facilitate access to foreign markets through

foreign broker-dealers and the research that they provide.74 The concern, raised in this

69 SEC Comment, File No. S71608-25. (September 8, 2008)70 SEC Comment, File No. S71608-25. 71 Business Roundtable. at 1151.72 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39209.73 SEC Comment, File No. SR-NASD-2002-21 and SR-NYSE-2002-09. (April 18, 2002)74 SEC Comment, File No. SR-NASD-2002-21 and SR-NYSE-2002-09. (April 18, 2002)

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comment is still valid today because proposed NASD rules can be adopted as FINRA

proposed rules.

It can be logically inferred that the frustration of the ability of U.S. investors to

access foreign markets and the research provided by foreign broker-dealers would impose

additional costs on chaperoning broker-dealers when it comes to soliciting U.S. investors

to trade in these foreign markets with these foreign broker-dealers. Such costs that these

two proposed rules can impose on chaperoning broker-dealers could include reduced

benefits in the form of less trading and additional costs in preparing trading data on the

foreign securities. Therefore, the SEC’s failure to address the concern raised by Dorsey

and Whitney LLP would significantly undermine the SEC’s conclusion that Rule 15a-6

would not have any impact on small entities.75

In addition, the SEC’s failure to address the potential costs raised by Dorsey and

Whitney LLP undermines the SEC’s conclusions about the anticipated benefits that

chaperoning broker-dealers could receive under amended Rule 15a-6. Specifically, the

SEC’s conclusion that amended Rule 15a-6 would benefit chaperoning broker-dealers by

allowing broader category of investors to gain greater access to foreign broker-dealers

and foreign markets would be undermined.76 The SEC’s conclusion that amended Rule

15a-6 would result in cost reductions for chaperoning broker-dealers who intermediating

transactions between U.S. investors and foreign broker-dealers would also undermined if

if chaperoning broker-dealers by the costs that could be incurred if FINRA adopts those

75 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39209.76 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39206.

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two proposed rules.77

Comparatively, the court in Business Roundtable found that the SEC

acknowledged but did not adequately address numerous studies by commenters that

reached the opposite result regarding the anticipated benefits of Rule 14a-11.78 Therefore,

the SEC’s failure to address the enactment of these two proposed rules by FINRA is

analogous to the SEC’s failure to address the challenge to its quantified estimates raised

by the Chamber of Commerce in Business Roundtable.

77 Exemption of Certain Foreign Brokers or Dealers, 73 Fed. Reg. 34-58047fr, at pp. 39206.78 Business Roundtable. at 1150-1151. (See also Elaine Buckberg, NERA Econ. Consulting & Jonathan Macey, Yale Law School, Report on Effects of Proposed SEC Rule 14a-11 on Efficiency, Competitiveness and Capital Formation 9 (2009), available at www.nera.com/upload/Buckberg_Macey_Report_Final.pdf. )

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http://www.nera.com/upload/Buckberg_Macey_Report_Final.pdf

4. CONCLUSION

For these reasons, the enforceability of amended Rule 15a-6 could be successfully

challenged on the grounds that the SEC failed to fulfill its statutory obligation under 15

USC, §78c(f), 78(w)(a) and 80a-2(c) as interpreted by the D.C. Court of Appeals for the

District of Columbia in Business Roundtable.

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