By Rodney F. Tonkovic, J.D.
The Court of Appeals for the D.C. Circuit has found that the SEC's approval of a FINRA proposal was arbitrary and capricious. In late 2019, the SEC approved a FINRA proposal regarding a subscription-based service for access to "core" reference data for new issues of corporate bonds. During the rulemaking process, plaintiff Bloomberg L.P. and other commenters raised concerns about the data service, specifically about the costs to implement the program and the fees to maintain it. The court found that the approval of the proposal was not the product of reasoned decisionmaking and was therefore arbitrary and capricious because the SEC failed to give a reasoned explanation in response to Bloomberg's concerns. The court remanded the Commission's order without vacating it (Bloomberg L.P. v. SEC, August 16, 2022, Wilkins, R.).
FINRA's proposal. In 2017, the SEC's Fixed Income Market Structure Advisory Committee determined that there were gaps in the corporate bond reference data market. FIMSAC attributed disparities in the availability and accuracy of the data to the fact that private vendors—like Bloomberg—are not obligated to provide impartial access to new issue reference data and vendors lacking equal access to information from underwriters. To remedy this, FIMSAC recommended that FINRA establish a data service to make core reference data available to all subscribers in a timely manner.
FINRA eventually developed a proposal establishing a centralized new issue reference data service for corporate bonds. The proposal would require underwriters to report data to FINRA before trading on a new issue would begin; this "core" data comprised 32 data elements integral to the valuation, trade, and settlement of corporate bonds. A database would consolidate the data and provide market-wide access via subscription, and a separate filing would be submitted to establish fees for the service. FINRA filed the proposal with the SEC in March 2019, and notice was published in the Federal Register that April.
The SEC received 30 comments in response, including 5 from Bloomberg. As relevant here, Bloomberg commented that FINRA failed to justify the direct and indirect costs of the proposed service. In short, Bloomberg, and other commenters, suggested that the SEC could not properly assess the economic effects of the proposal without knowing the costs FINRA would incur in connection with establishing the service and the fees that would be charged to maintain it.
The SEC approved the proposal in December 2019 and Bloomberg petitioned for review. After a de novo review, the Commission upheld the approval order. Regarding the fees, the Commission said that FINRA could not charge fees for the service without SEC authorization and a showing that the proposal complies with the Exchange Act and the SEC's rules on fee changes. The Commission also disagreed that it could not properly assess the proposal's economic effects without knowing the fees: once the system is built, the costs will be known and they can then be used to assess whether the fees are consistent with the Exchange Act, the Commission said. Bloomberg then filed a petition with the appellate court.
Arbitrary and capricious. The D.C. Circuit concluded that the SEC's approval of the FINRA proposal was arbitrary and capricious under section 706(2)(A) of the Administrative Procedure Act. Bloomberg argued that the approval was arbitrary and capricious because the SEC failed to consider the cost FINRA would incur in building the system and the extent to which those costs would be passed on to users. "Bloomberg raised relevant concerns about the direct and indirect costs of FINRA’s proposal, but the Commission brushed them aside," the court said. "As such, the Commission's decision was not the product of reasoned decisionmaking."
Under the APA, the court explained, agencies must engage in notice-and-comment rulemaking. Under D.C. Circuit precedent, agencies must respond to comments raising significant concerns and must adequately explain its result in a way that would allow courts to evaluate why the agency reacted the way it did. According to the court, the Commission's analysis overlooked a key issue: if the service is unreasonably expensive to implement, market participants would foot the bill (which could amount to millions, or tens of millions, of dollars, the court remarked) at the fees stage. While the Commission could suspend the proposal at the fees stage, FINRA will have incurred the financial burden of building the service and someone would have to pay for it. It was not reasoned decisionmaking for the Commission to approve the proposal without responding to comments that urged it to assess not only the financial impact of the service on FINRA, but also the entities that fund FINRA.
Remand. The appropriate remedy, the court went on to say, was to remand the Commission's order approving the proposal without vacating the order. On remand, the Commission can properly analyze the costs FINRA would incur in building and maintaining the data service. Vacating the order, the court said, would "needlessly disrupt" the Commission and FINRA's efforts to resolve the issue underlying the order.
The case is No. 21-1088.