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Case number 16-1061, Susquehanna International Group, LLC, at L Petitioners versus Securities and Exchange Commission.

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Mr. Thompson for Petitioners, Ms.

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Harden for the Respondent, and Ms.

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Nissen, Mr. Nissen for the Intervener.

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Good morning, Your Honors, and may it please the Court, David Thompson for the Petitioners.

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At issue in this case is whether the SEC is anything more than a rubber stamp for the SROs at issue.

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The Options Clearing Corporation for decades operated as a public utility, and in 2015 they proposed a rule which would convert themselves into a for-profit monopoly under the APA.

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If the SEC approved that plan, but under the APA, if it is arbitrary and capricious, or if it is contrary to law, it must be stricken.

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And it is both.

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It is contrary to law for a number of reasons.

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Number one, the SEC is under an obligation to ensure that investors are protected.

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And here, the SEC did nothing to assess

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the rate of return.

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They blindly defer to the rate of return.

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In fact, we don't even know what the OCC thought the rate of return would be.

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It is not in the record.

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Number one.

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Number two, if we look for the, we are told there was a need for immediate capital.

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But again, there's no analysis of why did they need the capital immediately, particularly when they were designated a so-called systemically important financial market utility in 2012 and for 18 months did precisely nothing.

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and then took nine months to study it.

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So two and a half years they took to study this question.

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And then they say, well, we need to do this immediately.

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And at the same point, they had hundreds of millions of dollars of excess fees that they had retained and which were immediately available.

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There is zero analysis of why that alternative would not be sufficient.

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In addition,

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The SEC was under an obligation to determine whether the plan was, quote, consistent with promoting competition.

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And they admit that they did not consider that.

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They said, well, we considered the separate question of whether there was an undue burden on competition.

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That is clearly a distinct inquiry.

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You could have a cartel where the members are cheating on each other and their quotas and it's totally ineffectual, it doesn't have a big burden on competition, and yet it has no pro-competitive attributes whatsoever.

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So these are distinct questions, and they looked at the one, but they did not look at the pro-competition.

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And, you know, critically,

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So that's why it's contrary to law.

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But if we switch to whether it was arbitrary and capricious, did they look at, quote, the relevant data?

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Did they provide a cogent explanation for the decisions they made?

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There are a number of critical issues where they did not.

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Rate of return, no cogent explanation, no relevant data.

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The notion that there was a need for immediate capital, I addressed that.

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$130 million capital buffer.

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So they have the six months, that's $117 million of capital.

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There is no explanation in this joint appendix, in this record, as to where the $130 million of extra capital that was allegedly needed, how that was determined.

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We are told that they did not expect the fees to increase.

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They looked at the wrong, first of all, there's no empirical data in this record on that question, but second of all, they seem to have looked at gross fees rather than net fees.

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Gross fees, that's not the relevant metric.

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If somebody is paying taxes and having $10,000 withheld and gets a $10,000 refund in one world, and then in the next world,

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they pay $5,000 or withheld and they get no refund, they don't think they've got a tax cut.

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They're looking at the net number.

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The SEC looked at the gross number.

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If they had looked at the net number, they would have seen it necessarily follows that the net fees were going to increase under this.

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And they had no indication of that in the commission?

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There is no discussion, Your Honor, and at the risk of doing a little bit of math without a whiteboard behind me, let me just say that, just let me walk through why it is true that it necessarily means that the net fees will go up.

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Under the prior regime, they say there was a 31 percent capital buffer.

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which they grossed up.

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So let's say there was $100 of expense.

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They said we would charge $144.

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That's 31% grossed up.

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$144.

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And then they would refund all of the excess, the $44.

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And so the net charge to the customers would be $100.

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Under the new regime, they say, well, the capital buffer is lower.

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It's $25.

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So they gross it up to $133.

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That's the amount of fees that will be charged.

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They say, oh, that's less.

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But there's only $16.50 of refunds because the other $16.50 goes for dividends.

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So it is a mathematical fact that is incontrovertible that if the fees, that the net fees will go up.

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There was no discussion at all of the differential treatment of the $72 million of retained capital.

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So this fee, this plan is,

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$150 million of capital from the incumbent, Oligopolous, and then $72 million coming in, no return provided whatsoever on that $72 million of capital infusion, which came from the clearing members.

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They failed to address key alternatives.

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One of them was

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Well, maybe the non-shareholder exchanges would put it in capital.

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And this is really critical.

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I would urge the court to look at Joint Appendix, page 85, footnote 10, where the OCC says, you know, that we only looked at alternatives that would benefit the incumbents because we don't think they would agree to any changes that won't benefit them.

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a decision they made, but it is not rational for the SEC.

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Can you give that page again?

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Sure.

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It's Joint Appendix 85, footnote 10.

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And what it speaks to is essentially the veto power that these five members of the board.

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One of the things they've said is, well, we're only five members of an 18-person board.

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But it's like dealing with the permanent members of the UN Security Council.

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They may only be five votes on that council, but every one of them has a veto.

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And so these five were deemed to be the OCC said, we're not going to propose anything that might not be in their interest, because that would run counter

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to their veto authority.

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They also didn't look at the ability to do a sunset provision.

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Even if there was an immediate need, even if the massive retained earnings couldn't meet the need or the non-shareholder exchanges, you could have put in the capital and then paid it back.

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You know, that's what people do when they get expensive capital.

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I'm sorry to back you up, but what was the J.A.

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paying?

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Oh, it's 85, Your Honor.

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85?

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Yes, J.A.

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85.

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So, you know, people in the real world, if they have to take immediate capital on, and it's expensive capital, they refinance.

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They don't lock themselves in perpetuity to a plan.

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If there's an opportunity to get lower cost of capital, they do that.

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And then one thing which they admit

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they made a mistake on in the order is this idea of replenishment capital.

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And in the order, they misdescribe it.

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And then they say, well, we understood it at other times and places.

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Even if that is true, there is zero analysis as to what is the right rate of return for that.

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That is a separate

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It is a separate financial instrument, just like a home mortgage equity line is different from the underlying mortgage.

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This was essentially a line of commitment, a line of credit, no analysis as to the market data.

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So really, for all these reasons where we have no explanations, no relevant data, no articulation of the alternatives, for these reasons, Your Honor, we would submit it should be struck down the plan.

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and remanded.

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Let's start with the ending, struck down and remanded.

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You asked for vacatur.

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Vacatur, I apologize.

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I'm sorry.

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Don't you agree that if we were to do that, it would be a logistical nightmare?

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I don't, Your Honor, because we could do the sunsetting the piecemeal, so the temporary.

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So for example, if they've got the $247 million of capital now, they could simply keep that in place, but pay it down as excess fees are generated.

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And don't you think that

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It would be implausible that the highly financially sophisticated exchanges and members would be able to address all this bookkeeping, tax related issues involving unwinding.

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No, I think they could have figured that out, Your Honor.

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Didn't you take the opposite position in your motion for a stay?

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I'm quoting from your motion for a stay.

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I'm going to have the same trick for the other side.

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OK.

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Your Honor, I will confess.

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I know it's not your firm, but you took the position there.

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You had to have a stay, because it would be a logistical nightmare to try to unwind it afterwards.

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And it would be implausible.

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It'll be possible to address these problems and that the others are going to be outside of our jurisdiction, all those things.

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I'm asking whether this is, you know, our court has some analysis as to whether vacatur and remand is appropriate in circumstances or whether remand alone would be appropriate.

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This, of course, assumes you win for the moment, but we're at the end of your argument, so I thought I'd ask you that.

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isn't remand a more appropriate issue here for the SEC both to reconsider in light of the errors in its judgment that it made, most of which, as I understand them, are errors of not actually looking at the data rather than reaching a wrong conclusion.

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And then after they look at the data, maybe come up with some modification or something.

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Well, certainly we'd rather have a remand than an affirmance, Your Honor.

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But in terms of, let me just speak to that logistical question.

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It would be difficult to go back to time zero and unscramble whatever dividends they've received.

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And I don't think that would be necessary, I think, to simply say, let's go on a separate path where we pay down this very expensive capital by retaining earnings and fees and reducing it.

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But that would be an easy way to remedy the problem that we're seeing.

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We'll hear from SEC.

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I know you don't want to start with what happens if you lose, but let's start with that since we were just on the same thing.

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Now, in your opposition, you say,

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It's implausible that the highly financially sophisticated exchanges during the distributions would be made, would be unable to address any unnecessary bookkeeping and any unwinding.

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It might be complicated, but not impossible.

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Do you think that the appropriate result, if you lost, is vacating or merely remanding, and why?

[00:12:27] Speaker 08:
I think it depends a bit, Your Honor, on what the basis of the court's finding is.

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If the court's finding is that the commission's analysis under the APA fails to satisfy recent decision-making, then that is something that may be able to be addressed on remand.

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The court's finding that substantively the plan itself is contrary to law,

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given the statutory scheme or working under year the commission doesn't have discretion altered plan that's something that would have to go back to see and so in that case

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there's very little that could happen on a read and other than just going back to C. C. And in that instance.

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As we said in our state papers, we do think it could be worked out as as you allude to it.

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It may be complicated and it may require me at all.

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And we have to remedy by vacant.

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No, Your Honor, we just remain.

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Nothing's gonna happen.

[00:13:25] Speaker 08:
No, I'm saying it depends on the basis of the court's decision.

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If the court is

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is finds ultimately that the commission's analysis was insufficient.

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Certainly the commission can remedy that on remand.

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We of course submit that the commission's analysis was submitted sufficient, particularly given the context we're working in here.

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uh... the congress has set up a scheme where s r o's do have discretion to conduct their business so long as their decisions meet the baseline requirements and what the commission looked at in this order was that key question does this meet the baseline requirements of the act and the commission independently analyzed this question this is the problem i'm having about the independent analysis so this could be long but i think this is the best way to do this could you pick up the order itself

[00:14:17] Speaker 07:
And I'm just going to go page by page.

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And really, the bottom line question of every question is, was there an independent analysis, or did they just accept what OCC said to them?

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So the first question, and not all the questions are those, but I just found it easiest to organize myself around the order.

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If you look at JA-689 in that,

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complete paragraph at the top of the sentences.

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However, OCC will not resume paying dividends and will recalculate how dividends are made from within 24 months replenishment.

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Now that's an incorrect statement, correct?

[00:15:01] Speaker 08:
That's correct, Your Honor.

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That is mistaken.

[00:15:03] Speaker 07:
So how do we know that the SEC was working off the correct analysis on what seems like a pretty important point?

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Well, I want to take that last statement first, Governor, is that we should put this particular aspect of the plan in context, which is that it only comes into play in what everybody agrees are highly unusual circumstances.

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And so unusual, in fact, that the petitioners didn't even raise this feature of the plan in their petitions for review to the commission.

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But to take your first question, how do we know that the commission understood this aspect?

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I think there's a couple of other places in the record we can look for that.

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Of course, later in the order, when the commission's talking about the dividend policy, there's a footnote that indicates the commission is aware that dividends can be calculated when the refund policy has been eliminated and therefore set to zero.

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Which one is that?

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Sorry, Your Honor.

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It is note 48.

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on J 688 suggests that prior page.

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For that's that's the refunds right?

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Yeah, right.

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But that but that's the point.

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The commission is talking about how you calculate dividends when refunds have been eliminated.

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So it indicates that the commission is aware that that indicated independent analysis.

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Not not of that particular

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Point, your honor.

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Just to finish up with Judge Garland's question, this is also appropriately and correctly described in the commission's notice at the beginning of this process.

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Yeah, so that's the notice at J-10, is that right?

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And the particular place is at the very end.

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You mentioned only... Yeah, so it would be at 24 and 25.

[00:16:56] Speaker 07:
Yeah, I don't see anything on 24.

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I see the very last sentence of the part on 25.

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Is that what you're talking about?

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If replenishment capital has been contributed and remains outstanding, OCC would not pay dividends until such time as the target capital requirement is restored.

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Is that the sentence?

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Yes.

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So it's only that very last clause, until such time, which suggests that there will be a time.

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But this is all in a section of this notice, which is described at JA 10 as coming from OCC

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they prepared that section, right?

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That's what it says, which has been prepared by OCC.

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That's correct, Your Honor.

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I do want to point out on JA 24, it describes that refunds will be eliminated.

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Yes.

[00:17:49] Speaker 07:
And that's also correctly described in your... There don't seem to be any dispute that... I mean, their argument is that refunds are eliminated, but not dividends.

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That's their complaint, right?

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That's correct.

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And the notice, this description and summary of the plan is prepared by OCC, but this is a commission document.

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The submission comes in and it's published two weeks later.

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This is a commission prepared document.

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And to get to Judge Santel's point about the analysis of this issue, I think what the record shows is that the commission was aware of this feature.

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It nonetheless found both the dividend and the refund policies to be reasonable and consistent with the Act.

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Whether or not an analysis was required under the APA of this specific feature goes to the significance, again, of this feature under the plan, which comes up

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again only in highly unusual circumstances, and indeed there's evidence in the record that explains why this feature exists in those unusual circumstances.

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We're talking about a situation where the initial capital

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contributions have been depleted.

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There's been replenishment capital called, and OCC has insufficiently recovered over a period of two years to repay that replenishment capital.

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And it's not unreasonable to alter the compensation for these capital contributions in those circumstances where the risks to the contributions have proved to be much greater.

[00:19:24] Speaker 07:
All right.

[00:19:24] Speaker 07:
Can we look at J697?

[00:19:27] Speaker 07:
Put note 84, it says OCC engage an outside consulting firm to develop capital needs and targets and a financial advisor to provide analysis on dividend returns.

[00:19:37] Speaker 07:
Does the SEC know who the consultant is?

[00:19:42] Speaker 08:
That's not in the record before the court, and it's not relied on in the commission's order.

[00:19:48] Speaker 07:
And has the SEC seen the analysis?

[00:19:52] Speaker 08:
Again, the commission didn't rely on that analysis in its order until it's not in the record before the court.

[00:20:00] Speaker 08:
I do want to note, however, that what we're talking about here is the dividend rate, and this goes to, of course, one of the arguments that petitioners raised, that the commission had to put a precise number.

[00:20:10] Speaker 07:
Well, it's not clear it had to put a precise number.

[00:20:13] Speaker 07:
It at least has to make a reasonable, determine whether it's reasonable.

[00:20:18] Speaker 07:
And the question is, did it do, if it doesn't even know what the analysis that was used to formulate it was, and it doesn't even know what the number is, how can it say it's reasonable?

[00:20:31] Speaker 08:
couple of things your honor first of all the Commission did note the estimates in the record but you're right it didn't rely on what the precise range is and that's because it rationally relied on two other factors right the first is that the dividend rate was negotiated between essentially adverse parties here right it's negotiated between the shareholder exchanges and members of the board who represent clearing members and that is the stakeholder group most directly affected

[00:20:56] Speaker 07:
Do the five members who are shareholders, are they recused from the decision?

[00:21:02] Speaker 08:
No, Your Honor.

[00:21:03] Speaker 08:
That's a separate question that hasn't been raised on appeal.

[00:21:06] Speaker 07:
Well, it's raised on appeal in the sense of whether you make an argument that this is an arm's length agreement.

[00:21:12] Speaker 07:
That is not mentioned, by the way, in the order.

[00:21:15] Speaker 07:
That's what you say in the brief, that it was reached at arm's length.

[00:21:19] Speaker 07:
I'm having a little difficulty seeing how it's arm's length if five

[00:21:25] Speaker 07:
members are on both sides of the arms.

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And also, they appear to have a veto power.

[00:21:33] Speaker 08:
A couple of things, Your Honor.

[00:21:34] Speaker 08:
First, there are financial interests on both sides of this question on the board.

[00:21:38] Speaker 08:
Certainly the directors representing clearing members have an interest as well, particularly when the board voted on this.

[00:21:45] Speaker 08:
It was considering the plan alongside an option of retaining

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Earnings which would probably entail an increase in fees and certainly a decrease in revenues So there were financial interests on both sides of the board when this was considered well that suggests.

[00:22:00] Speaker 07:
It's not arms length at all Everybody's on both sides.

[00:22:04] Speaker 08:
Well.

[00:22:04] Speaker 07:
No, this is not what we normally consider arms.

[00:22:06] Speaker 08:
Well the negotiations are Between parties with divergent interests right the clearing members have an interest in

[00:22:15] Speaker 08:
in maintaining fees and refunds at a level that they would prefer.

[00:22:20] Speaker 08:
The stockholder exchanges have an interest in the dividends.

[00:22:24] Speaker 08:
And so you have essentially an adversarial process there.

[00:22:27] Speaker 08:
And then you have a two-thirds majority of the board

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including four clearing member directors and two public directors who voted in favor of the plan in contrast to the retained earnings point.

[00:22:40] Speaker 08:
So what the commission is essentially relying on here is that the process is likely to yield a reasonable result.

[00:22:47] Speaker 07:
So whatever OCC comes up with is reasonable.

[00:22:50] Speaker 07:
Is that the answer?

[00:22:51] Speaker 08:
no that's not the answer because the other thing the commission relied upon here is the is the structure of the dividend policy and the fee policy and how the components of the plan work together to constrain dividends going forward so if you don't have both then you might have a different decision by the commission but it's rationally relying on both and i want to get to the where is the best discussion of the fee question you're telling us they relied on that

[00:23:18] Speaker 08:
analysis where did they analyze well the discussion of relying on the components components of the plan would be at 705 and 706 of the joint appendix

[00:23:30] Speaker 08:
And what we're talking about here is that the plan establishes this 25% business risk buffer and sets fees at expenses plus the 25% buffer and reassesses fees quarterly to ensure that you're not going above that buffer.

[00:23:49] Speaker 08:
And that acts to constrain the possibility of excessive dividends under the policy.

[00:23:57] Speaker 08:
And ultimately, it's important to remember here that the question before the commission was, is the plan as presented an inappropriate or unnecessary burden on competition in light of both the alternatives available and the significant interest under the Act?

[00:24:16] Speaker 08:
and having a well-capitalized OCC.

[00:24:19] Speaker 08:
So this is a balancing determination by the Commission, as this Court expressed in Bradford.

[00:24:26] Speaker 08:
And putting a precise number on the dividend rate in this context, in this case, wouldn't have materially changed the decision before the Commission.

[00:24:36] Speaker 08:
because you have a situation where the court, the commission looked at the alternatives available, there were reasons for not pursuing those alternatives.

[00:24:46] Speaker 07:
What if the dividend rate were just so obviously so high that no human being could consider it reasonable?

[00:24:53] Speaker 07:
Isn't it necessary for them to the SEC to at least look at them to find out what it is?

[00:25:00] Speaker 08:
Well, but the Commission did look at it at the level you're talking about, Your Honor, right?

[00:25:05] Speaker 08:
The Commission noted the estimates and the record.

[00:25:08] Speaker 07:
Estimates made by the OCC, right?

[00:25:11] Speaker 08:
Estimates made by the commenters, both the commenters and the OCC.

[00:25:16] Speaker 07:
But the commenters didn't have any information about the actual underlying analysis by the financial consultant or anybody else?

[00:25:23] Speaker 08:
Again, I want to push back on that because what everybody had available to them the Commission and the commenters is the the structure and Formula that's going to be used in setting dividends going forward and that's well set out in the notice and additionally in all the comments and

[00:25:43] Speaker 08:
And that is, in fact, what the Commission is approving here, right?

[00:25:47] Speaker 08:
Dividends are not guaranteed every year.

[00:25:48] Speaker 08:
Dividends will vary every year, depending upon, as the Commission noted, a number of circumstances.

[00:25:55] Speaker 08:
And so the Commission's looking to the structure for setting that dividend rate.

[00:25:59] Speaker 07:
See, again, the structure.

[00:26:00] Speaker 07:
The structure's all based on the 25% buffer.

[00:26:02] Speaker 07:
That's what you mean by structure.

[00:26:04] Speaker 08:
I mean, the structure of the entirety of the plan, Your Honor.

[00:26:08] Speaker 08:
And so the structure of the dividend, yes, is set sort of in conjunction with the fee and refund policies, right?

[00:26:15] Speaker 08:
We have the 25% buffer that caps whatever excess revenues could be.

[00:26:21] Speaker 08:
We have the refund policy, which pre-tax gives half of those revenues back to clearing members.

[00:26:28] Speaker 08:
then taxes paid, and then you have the dividend paid.

[00:26:31] Speaker 08:
And so everybody knows precisely how this dividend's going to be calculated every year.

[00:26:36] Speaker 08:
The only thing not in the record are OCC's internal deliberations to put a number on each of those in the first instance.

[00:26:44] Speaker 08:
And again, in the SRO structure, where the SROs do have flexibility and discretion to conduct their business, it's not inappropriate.

[00:26:55] Speaker 04:
I think maybe what underlies the problem here is to what degree can the SEC simply accept

[00:27:00] Speaker 04:
What an SRO has done, and to what degree do they have to analyze it themselves to find out if it's determined if it's reasonable.

[00:27:09] Speaker 04:
Aren't they obligated to make an independent review?

[00:27:12] Speaker 08:
of course your honor, and we submit that the commission did exactly that here.

[00:27:16] Speaker 08:
There's only a few things in the record that the petitioners point to saying the commission should have looked behind, but again, we're talking about the precise numbers of the target capital rate, the structure and formula for developing it were well laid out in the notice, and in fact is consistent with rules the commission has since adopted.

[00:27:37] Speaker 08:
We're talking about

[00:27:39] Speaker 08:
evaluation of alternatives, which again, the commission does not have discretion in the context of approving an SRR rule to choose between alternatives or to even alter the plan presented so long as it meets the baseline requirements of the Act.

[00:27:53] Speaker 08:
In that circumstance, where the commission is just looking to see whether the presence of alternatives renders the proposal inconsistent with the Act, it's not unreasonable not to go down the road of

[00:28:05] Speaker 08:
quantifying incremental differences in benefits and burdens between all the alternatives.

[00:28:12] Speaker 07:
I have the general point.

[00:28:13] Speaker 07:
Can we continue going through the order for a second?

[00:28:17] Speaker 07:
Absolutely.

[00:28:18] Speaker 07:
On page 707, J701, I'm sorry, it says the board determined that the historical practice of solely using fees with annual refunds to cover operating expenses and managing risks did not allow OCC to reach adequate capitalization.

[00:28:33] Speaker 07:
Is the SEC's determination based solely on the board's determination?

[00:28:38] Speaker 08:
No, Your Honor.

[00:28:39] Speaker 08:
The Commission separately looked at the proposed alternative of retaining earnings, and it found that there were good reasons for not pursuing that at the time the board made this decision.

[00:28:50] Speaker 08:
The Commission looked at the fact that that accumulation of capital would not be as expedient, and the fact that it doesn't include a refund, or I'm sorry, a replenishment capital commission.

[00:29:02] Speaker 08:
commitment.

[00:29:03] Speaker 08:
And both of those are reasons that render OCC's determination to pursue this plan as opposed to retain earnings, a reasonable one and not inappropriate or unnecessary.

[00:29:17] Speaker 07:
This sentence is just about that this did not allow OCC to reach adequate capitalization, not whether there was a better plan or not.

[00:29:27] Speaker 07:
Did the SEC actually determine on its own or even by reviewing the analysis of the OCC that the historical practice would not allow the OCC to reach adequate capitalization?

[00:29:41] Speaker 08:
What the Commission noted and looked at was the fact that the Board determined it would take

[00:29:50] Speaker 08:
either an increase in fees of up to 162% or until mid 2017.

[00:29:54] Speaker 07:
That's what the OCC determined.

[00:29:57] Speaker 08:
And the Commission reviewed that analysis and found that it was reasonable not to pursue that path given the problems with it.

[00:30:06] Speaker 07:
When you say they reviewed the analysis, you mean they looked at what the OCC said or they did something else?

[00:30:12] Speaker 08:
The Commission did not recalculate those numbers.

[00:30:15] Speaker 07:
And they didn't even look at what those numbers were.

[00:30:18] Speaker 07:
How those numbers were calculated.

[00:30:21] Speaker 08:
Well, what the commission had before it was the discussion in the comments of what those numbers were.

[00:30:27] Speaker 08:
OCC represents in the comment that it has $150 million in capital as of August 2015.

[00:30:34] Speaker 08:
And the commission noted that analysis and noted that the petitioner's contentions with respect to whether retained earnings

[00:30:43] Speaker 08:
would accumulate sufficient capital in an expedient fashion, A, don't get you to the full capital commitment, and appear to incorporate things that OCC disagrees with.

[00:31:01] Speaker 08:
As laid out in the comments, they don't even take into account taxes.

[00:31:06] Speaker 08:
So the commission looked at the evidence before it in the comments and from OCC and reasonably determined that at the time the board made the decision, it had a good reason not to pursue retained earnings.

[00:31:20] Speaker 08:
And indeed, it's laid out in the comments that that's not

[00:31:23] Speaker 08:
That option is not without its own complications.

[00:31:27] Speaker 08:
I mean, when OCC originally determined to retain earnings here to raise capital, market makers objected and said, no, no, no, you have shareholders.

[00:31:36] Speaker 08:
They should bear part of the cost.

[00:31:38] Speaker 08:
Ultimately, what we're talking about are trade-offs made by OCC and determining to pursue a particular path.

[00:31:45] Speaker 08:
And the commission's role under the SRO process is just to determine whether the path chosen was consistent.

[00:31:53] Speaker 07:
Why was it 50% of the excess fees going to the shareholders?

[00:31:58] Speaker 07:
Why was that reasonable?

[00:32:01] Speaker 08:
Your Honor, I think it's important to look at what the petitioners are arguing, that this somehow renders OCC a profit-taking monopoly.

[00:32:09] Speaker 07:
No, that's not what I'm asking.

[00:32:10] Speaker 07:
I'm asking why this makes this a reasonable return on their investment.

[00:32:14] Speaker 07:
That's what I'm asking.

[00:32:16] Speaker 07:
On what way does the SEC determine?

[00:32:20] Speaker 07:
For many points here, the SEC says,

[00:32:24] Speaker 07:
The components of the capital plan are designed to set the dividends to be paid at a level that the board, with the assistance of independent outside financial experts, has determined to be reasonable for the costs and risks associated with their contributions.

[00:32:38] Speaker 07:
I understand that the OCC believes that, and their independent

[00:32:43] Speaker 07:
Financial experts determine that it's reasonable.

[00:32:46] Speaker 07:
But if the SEC doesn't look at the reasoning, doesn't look at the analysis by the independent or by the outside financial experts, whether they're independent or not, we don't know, how can it make that determination?

[00:33:01] Speaker 07:
The order is just replete with this.

[00:33:06] Speaker 07:
The next page says, the commission believes that the various components operate to set reasonable dividends.

[00:33:13] Speaker 07:
but again i don't know how you can do you know what a reasonable dividend is unless you look at at least the financial analysis used to determine the cost of capital and the risks a couple of things again at the commission is relying on the process of the the board went through to

[00:33:32] Speaker 08:
to come up with what is a reasonable rate.

[00:33:35] Speaker 08:
And there's a reason for that, not just because.

[00:33:39] Speaker 07:
What was the process that the board came up with to use a reasonable rate other than hiring a financial consultant who looked at it?

[00:33:46] Speaker 08:
Again, negotiating between the clearing member directors and the shareholder directors who have adverse interests here and

[00:33:53] Speaker 07:
the approval of the two-thirds majority of the board, including clearing member directors and public directors, but at the other... But that does suggest that the SEC is saying, look, we think the OCC is set up in a fair way and whatever results they come up with are going to be fair.

[00:34:09] Speaker 07:
Is that right?

[00:34:09] Speaker 08:
No, Your Honor, because the Commission's looking at that the board process saying that that is a process set up to essentially come to a

[00:34:21] Speaker 08:
an adversarial determined compromise rate and the structure of the plan, which is what it's approving here, right?

[00:34:28] Speaker 08:
What the commission said is that the process set up came to what the two-thirds majority of the board considered to be the best transaction possible under these circumstances, trust those adversarial negotiations,

[00:34:43] Speaker 08:
in the context where there's no good analogy here for what a rate of return would be on a capital contribution to OCC?

[00:34:51] Speaker 07:
Well, the SEC doesn't say that.

[00:34:53] Speaker 07:
I could almost get it if they say this is just too hard, although we have another case in which we say the SEC saying this is too hard is not good enough.

[00:35:02] Speaker 07:
The SEC still has to do its own analysis.

[00:35:05] Speaker 07:
But that's not what they said.

[00:35:06] Speaker 07:
They didn't say, that's the reason we're doing this.

[00:35:10] Speaker 07:
This is too hard for us.

[00:35:11] Speaker 07:
They just didn't do it.

[00:35:13] Speaker 08:
No, but the commission noted the unusual circumstances, right, and the unusual nature of this capital contribution.

[00:35:23] Speaker 08:
And given those unusual circumstances and the fact that the board set up a process that is likely to lead to a reasonable rate, it's rational in this

[00:35:34] Speaker 08:
context, in the context of the review of an SRO rule.

[00:35:38] Speaker 08:
Your Honor notes cases in which the court has said, well, the SEC has to do the best it can.

[00:35:44] Speaker 08:
But those cases all talk about what the determination the commission is making there.

[00:35:51] Speaker 08:
Certainly, when the commission is choosing among options, you might expect a greater degree of analysis of the precise incremental benefits of burdens between those options.

[00:36:00] Speaker 08:
But that's not what the commission's doing here.

[00:36:03] Speaker 08:
Ultimately, this comes down to an argument about the Commission's finding that this is consistent with a portion of 17-Café, that an SOR rule not impose a burden on competition that's not necessarily appropriate in furtherance of the Act.

[00:36:19] Speaker 07:
How do you distinguish the MET coalition case?

[00:36:23] Speaker 08:
In the net coalition case, what the court found the commission should have looked at was evidence to substantiate assumptions it was making about the current competitive nature of the marketplace.

[00:36:36] Speaker 08:
And those were things that were not self-evident and, in fact, appeared to be contradicted by other parts of the commission's analysis.

[00:36:43] Speaker 08:
Here, the reasons for rejecting alternatives are not pursuing alternatives.

[00:36:49] Speaker 07:
Here's the language.

[00:36:52] Speaker 07:
The self-serving views of the regulated entities provide little support to establish that significant competitive forces affect their pricing decisions.

[00:37:02] Speaker 08:
That's right, Your Honor.

[00:37:03] Speaker 08:
The key part of that sentence is provide little to support the competitive nature of that particular marketplace.

[00:37:13] Speaker 08:
And that is something where you would expect to see quantification here.

[00:37:17] Speaker 08:
The reasons for not pursuing these alternatives

[00:37:21] Speaker 08:
did not require precise quantification.

[00:37:24] Speaker 08:
And the commission's qualitative discussion of those reasons was sufficient.

[00:37:30] Speaker 08:
And this court has made clear in a number of cases that quantification is not always required.

[00:37:36] Speaker 08:
And qualitative discussion can be sufficient depending upon the nature of the decision being made here.

[00:37:42] Speaker 08:
And the decision being made here did not require that degree of precise quantification.

[00:37:49] Speaker 01:
Any questions?

[00:37:50] Speaker 01:
Thank you.

[00:37:56] Speaker 07:
The OCC is up.

[00:38:12] Speaker 05:
May it please the court.

[00:38:12] Speaker 05:
My name is William Nissen on behalf of the Options Clearing Corporation.

[00:38:17] Speaker 05:
Your honors, one thing that's kind of been lost here today, I think, is the importance of a well-capitalized OCC.

[00:38:25] Speaker 05:
OCC has been determined to be a systemically important financial market utility.

[00:38:31] Speaker 02:
We haven't heard anything about that today, which means... Maybe the reason we haven't heard anything, but it's not material with the issues before.

[00:38:39] Speaker 05:
Well, I think it is, Your Honor, because I will assume it's very important.

[00:38:42] Speaker 05:
Yeah.

[00:38:43] Speaker 05:
How does that change our analysis?

[00:38:46] Speaker 05:
And I think that you can't take forever to put in force a rule that will well capitalize the OCC.

[00:38:55] Speaker 05:
I think that's the relevance to it, that as it was, it took over a year

[00:39:00] Speaker 05:
to get the final approval of this plan through the SEC with the administrative proceedings and so forth.

[00:39:08] Speaker 05:
We were able to put the plan in effect in September 2015 because the SEC had vacated the automatic stay.

[00:39:19] Speaker 05:
And just, you know, just in terms of the question the court asked the SEC at the outset about, if you lose, what should we do?

[00:39:28] Speaker 05:
I would like to address that.

[00:39:30] Speaker 05:
By saying please, I don't mean a suggestion.

[00:39:33] Speaker 05:
No, I understand.

[00:39:34] Speaker 05:
I understand.

[00:39:35] Speaker 05:
But I do want to say it.

[00:39:37] Speaker 05:
I mean, could it be done?

[00:39:38] Speaker 05:
Unscramble the eggs?

[00:39:40] Speaker 05:
I suppose so, but it would be extremely disruptive.

[00:39:44] Speaker 05:
And I think that's relevant also to OCC's extremely important role in our financial system.

[00:39:54] Speaker 05:
And in addition, the arguments that the petitioners have made are arguments that could be cured.

[00:40:01] Speaker 05:
What their main argument is, is there's not enough support for this.

[00:40:06] Speaker 05:
uh... and and i think that i think their fundamental argument may be that commission did not explain its reasoning did not provide an independent review more bluntly put that they think they're rubber-stamped with what they put forth yeah i understand that that that is their argument your honor and i think based on that argument i think that giving the sec another chance would be far preferable and much more

[00:40:34] Speaker 05:
responsible for our financial system.

[00:40:38] Speaker 01:
There's another argument behind that, isn't there?

[00:40:40] Speaker 01:
And that's the suggestion that something nefarious is taking place here, right?

[00:40:45] Speaker 01:
That we've gone from a public utility to a for-profit entity and that it's the shareholders in OCC who have done this.

[00:40:54] Speaker 01:
Were you here to address that?

[00:40:56] Speaker 05:
I would, Your Honor.

[00:40:56] Speaker 05:
Yeah, there's nothing nefarious.

[00:40:59] Speaker 05:
The veto power that was talked about, I mean, that was put into OCC's bylaws with an SEC approval many years ago.

[00:41:09] Speaker 05:
So that's what OCC had to work with in terms of coming up with this plan.

[00:41:14] Speaker 05:
And as counsel for the SEC said, there was a negotiation between the clearing member representatives on the board and

[00:41:24] Speaker 05:
the exchange representatives on the board, each of which has opposing interests.

[00:41:29] Speaker 05:
That's why, I mean, OCC is unique and I think it has a unique structure and I think that's very important here as to how they came up with it.

[00:41:38] Speaker 05:
So there's nothing nefarious.

[00:41:39] Speaker 05:
There are competing interests within OCC in order to achieve the public interest because

[00:41:46] Speaker 05:
They are a regulated entity, and they are important to the financial system.

[00:41:49] Speaker 05:
So there's nothing nefarious.

[00:41:51] Speaker 05:
There is a group of clearing members that has an interest in maximizing refunds.

[00:41:57] Speaker 05:
There's a group of exchanges that have an interest in what they believe is fair compensation for the investment they're making.

[00:42:06] Speaker 05:
And those two worked this out, and then it was developed by

[00:42:13] Speaker 05:
sorry, approved by two-thirds of the board, 12 out of 18, including public members of the board, who have no affiliation with anybody in the industry.

[00:42:21] Speaker 05:
So, and all of these directors have a fiduciary duty to OCC, even though they represent certain interests.

[00:42:27] Speaker 05:
So, there's nothing nefarious going on.

[00:42:29] Speaker 05:
This came about through a give and take of a structure that was set up to represent the industry, so that I think

[00:42:39] Speaker 05:
In terms of the SEC review, there's less need for an independent SEC review in this particular situation than there might otherwise be where you would have.

[00:42:49] Speaker 05:
For example, if the five shareholder exchanges like a traditional corporation control entirely that corporation, that's not the case here.

[00:42:58] Speaker 05:
They're only five out of 20.

[00:43:01] Speaker 05:
Certain areas, they do have so-called veto where they have to all agree upon it.

[00:43:07] Speaker 05:
But otherwise, it's the give and take of all these different interests.

[00:43:11] Speaker 05:
And so there's nothing nefarious going on here.

[00:43:14] Speaker 05:
I see the time is up.

[00:43:18] Speaker 05:
Unless the court has any other questions, we would request that the court affirm the SEC's order and alternatively, if the court didn't, that you remand rather than vacate.

[00:43:30] Speaker 05:
Thank you.

[00:43:31] Speaker ?:
Thank you.

[00:43:32] Speaker 07:
Is there any timeline?

[00:43:39] Speaker 06:
Just very quickly, Your Honor.

[00:43:41] Speaker 07:
It would be most helpful if you obviously responded to the SEC's argument, one, that the refund feature isn't significant, and therefore doesn't make it arbitrary and capricious.

[00:43:52] Speaker 06:
Could you say that again, sir?

[00:43:53] Speaker 06:
I apologize.

[00:43:54] Speaker 07:
I'm sorry.

[00:43:55] Speaker 07:
She argued that because the end to refunds provision only occurs under extraordinarily unusual circumstances, it's not significant enough to make the plan arbitrary and capricious.

[00:44:09] Speaker 07:
That's just sort of one very narrow thing.

[00:44:11] Speaker 07:
And then more specifically on the idea that the structure and the formula for determining the dividend rate is sufficient to make the plan, or at least that part of the plan, reasonable.

[00:44:24] Speaker 06:
Happy to do so your honor on the first point they do say that the replenishment capital to provision they say is quote highly unusual but if we look at page 705 of the Joint Appendix they they point to the committed capital as one of the bases for why the return is reasonable they can't have it both ways your honor they can't both in the one sentence where they purport to just

[00:44:48] Speaker 06:
this, invoke it, and then on the other hand say it's extremely unusual and this product, your honor, is really like an insurance policy and so if it is extremely unusual that it will ever be called upon, then the rate of return for it should be very, very small.

[00:45:05] Speaker 06:
your honor, so it actually really works against them that it's an extremely remote circumstance in which the companies will ever be called to put this money in would be one response, your honor.

[00:45:19] Speaker 06:
In addition, they do suggest, well, you know the formula, so you know what the rate of return will be.

[00:45:24] Speaker 06:
The formula is very pernicious, your honor, because what it says is the more they increase their expenses,

[00:45:32] Speaker 06:
the more profits they make.

[00:45:34] Speaker 06:
If they double their expenses from 100 million to 200 million, they will double the rate of dividends that they've received from 16.5 to 33 million.

[00:45:46] Speaker 06:
And so we don't know anything about what they project in the way of increased expenses.

[00:45:52] Speaker 06:
We do have some historical data on that, where we can see on JA58 that the expenses have exploded.

[00:46:01] Speaker 06:
from 165 million in 2013 to 234 million in 2015.

[00:46:10] Speaker 06:
Precisely what you would expect if monopolists were increasing expenses to increase their profits.

[00:46:18] Speaker 06:
And in terms of nefariousness, the other thing we haven't touched upon is the failure to provide notice.

[00:46:24] Speaker 06:
to the non-shareholder exchanges.

[00:46:26] Speaker 06:
There is not a single non-shareholder exchange on the board.

[00:46:31] Speaker 06:
And the bylaws say that if something is of competitive significance in the view of the executive chairman, he is to give notice.

[00:46:38] Speaker 06:
He did not do this to the other members of the industry.

[00:46:43] Speaker 06:
So we don't know enough to calculate the rate of return because we don't know the expenses.

[00:46:48] Speaker 07:
So when she says that the industry is represented on the board,

[00:46:52] Speaker 07:
You're saying that none of the non-shareholder exchanges have any vote on the board at all.

[00:46:57] Speaker 06:
Right.

[00:46:57] Speaker 06:
And they're supposed to be given notice if something impacts them.

[00:47:00] Speaker 06:
That's because they're not on the board.

[00:47:02] Speaker 06:
That's why you would have that provision in the bylaw saying, we understand we do need to get notice.

[00:47:07] Speaker 06:
And that was circumvented.

[00:47:09] Speaker 06:
And the notion that this would not have competitive significance, if anything would have competitive significance, this sort of plan would, Your Honor.

[00:47:18] Speaker 06:
We would respectfully suggest.

[00:47:20] Speaker 06:
Questions?

[00:47:21] Speaker 07:
All right.

[00:47:22] Speaker 06:
Thank you.

[00:47:22] Speaker 07:
Very good arguments again on both sides.

[00:47:23] Speaker 07:
We'll take them out on your submission.