As Wall Street Fights Regulation, It Has Backup on the Bench

Deep in enemy territory, Wall Street has found a powerful ally.

An appeals court in Washington has become ground zero for legal challenges to financial reform. Over the years, judges have rejected several major rules, saving financial firms millions of dollars in compliance costs and exposing government regulators to further litigation.

As regulators once again take aim at Wall Street with the Dodd-Frank regulatory overhaul, the financial industry is racing to fill the docket of its favorite court.

The latest legal attacks are largely aimed at the Securities and Exchange Commission. The United States Court of Appeals for the District of Columbia last year struck down the agency's so-called proxy access rule, a Dodd-Frank plan that would have empowered shareholders to oust company directors. The court is also expected to hear lawsuits over the S.E.C.'s new corporate whistle-blower program and the so-called Volcker Rule.

The flurry of litigation will play out on friendly political turf for Wall Street. Noted for its conservative credentials and harmonious culture, the appeals court is stacked with judges who enjoy rock-star status in Republican circles.

But Wall Street's winning streak reflects more than partisan ideology, lawyers say. The rulings, which often hinge on whether a regulator fully studied the costs of a rule, are also rooted in the court's philosophy to keep government watchdogs on a short leash.

“I think it's a court that sees one of its responsibilities as regulating how agencies discharge their duties,” said Eugene Scalia, a prominent corporate lawyer who has defeated the S.E.C. four times before the Washington court.

Dodd-Frank is under attack from multiple directions. Congressional Republicans and banking lobbyists are picking apart the overhaul with some success, but the lawsuits present a greater threat.

Lobbyists can create the occasional loophole, but courts can halt ne w regulations and reshape the financial industry with one swing of the gavel.

Bracing for the worst, the S.E.C. and other regulators are scrambling to safeguard their rules. The cautious approach, which has delayed new regulation, raises questions about the government's ability to rein in banks four years after the financial crisis.

“The court has given tremendous power to business groups, causing the agencies to operate out of fear,” said Harvey Goldschmid, a law professor at Columbia and a former S.E.C. commissioner. By virtue of its perch in Washington, the circuit court is seen as the second most important court in the country. It is akin to a farm system for the Supreme Court, producing four current justices, including the chief, John Roberts.

Though corporate groups routinely file lawsuits in the Washington circuit, this court was not always so business friendly. Under a landmark Supreme Court ruling, judges must defer to a government agency when its authority is ambiguous - so long as its approach is reasonable. But the Washington circuit court in recent years reversed nearly 23 percent of the rules it reviewed, up from 14 percent in the early 1980s. This year, the court overturned an air pollution rule and a crackdown on cigarette advertising.

The lawsuits against Wall Street regulation enjoy special advantages. For one, financial regulators are often facing off against Mr. Scalia, a seasoned litigator at Gibson Dunn and the son of Justice Antonin Scalia.

Gibson Dunn often represents the United States Chamber of Commerce, which defeated the S.E.C.'s proxy access plan and twice persuaded the court to knock down a mutual fund rule.

The rulings also coincided with a conservative makeover of the court. Of the court's 13 members, nine are Republican presidential appointees. George W. Bush selected four judges, including Brett Kavanaugh, who advised Mr. Bush on the 2000 election recount in Florida. The court has three vacancies, but none of President Obama's picks have received Congressional approval.

“There's very little true resistance to the conservative power of the court,” said Thomas C. Goldstein, a partner at Goldstein & Russell and the founder of Scotusblog, a Web site dedicated to the Supreme Court.

But the court's decisions, Mr. Goldstein said, stem only in part from partisan ideology. The circuit has overturned the S.E.C. six times in seven years, including in the proxy access case. In all but one instance, the court was tossing aside a Bush administration rule. The cases were unanimous decisions, with the court's liberal bloc siding with conservatives each time.

The decisions reflect the collegial dynamic among the judges. The court became deeply polarized in the 1980s, but under Harry T. Edwards, a Democratic appointee who became chief judge in 1994, peace became a priority.

It began with Judge Edwards sending handmade birthday card s to fellow jurists. The good will then spilled into their work. The court rarely reconsiders cases en banc anymore, a somewhat contentious procedure in which the entire court will gather to second-guess a ruling of a three-judge panel.

“I felt we were becoming a broken court, and I wanted to bring us together on a professional and personal level,” Judge Edwards, who now sits as a senior judge, said in an interview. “It became a matter of great pride.”

The court also regards itself as an expert check on regulatory power. While Washington circuit receives a smaller number of cases than most appeals courts, its complex workload requires judges to review the minutiae of administrative rules.

“You don't want to deny the agency the right to be wrong on occasion,” Judge Edwards said. “But when it goes too far, we're supposed to tell them to do it right.”

Dodd-Frank is particularly vulnerable. After the success of the proxy case, Wall Street groups twice sued the Commodity Futures Trading Commission in cases likely destined for the appellate court's docket. The industry is now weighing another potential lawsuit against the Volcker Rule, a still-uncompleted plan to stop banks from trading with their own money.

“It's common-sense litigation 101,” said Paul Clement, the former solicitor general under President Bush who is now a partner at Bancroft P.L.L.C. “If you keep winning, you keep going back.”

Rather than attack a rule on the merits or constitutionality, Wall Street is building lawsuits around the costs a rule will impose on the economy.

The challenges are largely rooted in a 1996 law that requires the S.E.C. to examine the effect of a new rule upon “efficiency, competition and capital formation.” The S.E.C. is merely required to “consider” the costs, not write a formal study.

The strategy has worked. In the proxy case, the court ruled that the S.E.C.'s policy “failed adequately to consider” its economic effects, even though the agency drafted a roughly 60-page cost-benefit analysis.

Proponents of regulation fear that the court created an impossible standard. In a 2012 report, the advocacy group Better Markets noted that the S.E.C.'s “pre-eminent duty” is to “protect investors.” The group also argued that the S.E.C.'s cost-benefit analyses should account for the cost of government bailouts that might result from lax regulation.

For its part, the S.E.C. has hired additional economists to scrutinize rules and published guidelines for evaluating regulations. “The S.E.C. is finally starting to figure it out,” said Michael Livermore, executive director of the Institute for Policy Integrity at New York University Law School. “The new approach just might save Dodd-Frank.”