Wednesday, August 09, 2017

SEC failed to make specific findings in approving OCC capital plan

By Amy Leisinger, J.D.

A D.C. Circuit panel remanded an SEC order approving the Options Clearing Corporation’s proposed rule change to implement a capital plan to help fulfill its role as an FSOC-designated systemically important financial market utility. According to the court, the Commission order was arbitrary and capricious in that the agency did not make specific findings that the plan avoids undue burdens, protects investors and the public, and does not discriminate among interested parties. Instead, the SEC accepted OCC’s findings with minimal evidence of the basis for the company’s own determinations, the court found (Susquehanna International Group, LLP v. SEC, August 8, 2017, Garland, M.).

OCC’s capital plan. OCC, which is owned by five shareholder exchanges, currently is the only clearing agency for standardized U.S. options listed on U.S. exchanges. Trading of listed options can take place on exchanges run by OCC’s shareholder exchanges and on seven other national securities exchanges that are not OCC owners. Changes in market conditions led to a need to boost capital, which OCC planned to do through capital contributions from its shareholder exchange owners, who also could be called upon to make additional replenishment contributions. The shareholder exchanges would be eligible to receive dividends, and the OCC would impose enough fees to meet expenses and provide for a business risk buffer. The dividends were intended to serve as consideration for the exchanges’ capital contributions.

In February 2016, the SEC approved OCC’s proposal, determining that the capital plan and its dividend structure was consistent with the Exchange Act because it would enhance OCC’s capital with relative fairness. Two non-shareholder exchanges, a clearing member, and a market participant sought judicial review, arguing that OCC’s plan failed to satisfy Exchange Act requirements. Specifically, they contended that the dividend rate represented an unnecessary windfall for the shareholder exchanges and that the plan inappropriately burdened competition, harmed investors, and unfairly discriminated against non-shareholders and clearing members. They also moved to stay the SEC’s order, but a D.C. Circuit panel denied the motion.

Remand for further consideration. The Administrative Procedure Act requires a court to hold unlawful any agency action that is arbitrary, capricious, or unsupported by evidence, the panel stated, and, to avoid this, the agency must provide a satisfactory explanation for its action and a “rational connection” between the facts and the final determination. The petitioners argued that the plan burdens completion by overcompensating the shareholder exchanges, harms the public by turning OCC into a “profit-seeking monopoly,” and unfairly discriminates between shareholder exchanges and non-shareholder exchanges by denying non-shareholders the opportunity to contribute capital in exchange for dividends and denying clearing members compensation for capital contributed as fees.

However, it is not necessary to reach a decision on these arguments because the SEC’s approval of the plan “fails in a more basic respect,” the panel found. The Commission did not itself make findings that the plan met Exchange Act requirements, instead relying on OCC’s own determinations. The order states that the SEC made the necessary findings but that is not the same as actually considering the factors, the panel explained. The agency found that the plan met statutory requirements because the dividends represented a reasonable return on the capital contributions and accepted OCC’s claims that the plan would not increase fees, all without justification; “the SEC took OCC’s word for it,” the panel stated.

Finding that the SEC may be able to approve the plan again after a proper analysis and that the Commission and OCC can unwind the plan later as necessary, the panel remanded the matter to the SEC for additional consideration.

The case is No. 16-1061.

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