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Chenery Corp. v. SEC

United States Court of Appeals
75 U.S.App.D.C. 374, 128 F.2d 303 (1945)
ELI5:

Rule of Law:

An administrative agency cannot retroactively apply a new standard of conduct to penalize parties for transactions that were otherwise legal, fair, and not in violation of any existing statute, judicial precedent, or previously promulgated agency rule.


Facts:

  • Federal Water Service Corporation ('Federal'), a public utility holding company, filed a voluntary plan of reorganization with the Securities and Exchange Commission (SEC).
  • During the multi-year period while the reorganization plans were pending before the SEC, several officers and directors of Federal, including the Chenery Corporation (petitioners), purchased shares of Federal's preferred stock.
  • These stock purchases were made on the open market at current prices, with full disclosure, and without any evidence of fraud or misuse of inside information.
  • The petitioners' stated purpose for the purchases was to transfer their investment from a class of stock the SEC deemed worthless to one that would have voting rights in the reorganized company.
  • The final reorganization plan submitted to the SEC provided for the petitioners' purchased preferred stock to be converted into common stock on the same terms as all other preferred stockholders.

Procedural Posture:

  • Federal Water Service Corporation submitted a reorganization plan to the Securities and Exchange Commission (SEC).
  • The SEC issued an order approving the plan but required that preferred stock purchased by corporate officers during the reorganization be surrendered at cost plus interest, rather than converted into new common stock.
  • The officers (petitioners) sought review in the U.S. Court of Appeals for the D.C. Circuit, which reversed the SEC's order.
  • The U.S. Supreme Court granted certiorari, and in SEC v. Chenery Corp., 318 U.S. 80 (1943), affirmed that the SEC's reasoning was wrong but remanded the case back to the SEC for further proceedings.
  • On remand, the SEC, without new evidence, reaffirmed its original order using a different rationale.
  • The petitioners again sought review of the SEC's second order in the U.S. Court of Appeals for the D.C. Circuit.

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Issue:

Does the Securities and Exchange Commission have the authority to disapprove a corporate reorganization plan by limiting the participation of stock purchased by corporate fiduciaries during the reorganization process, when those purchases did not violate any existing law or promulgated rule and were found to be honest and fair?


Opinions:

Majority - Groner, C. J.

No. The Securities and Exchange Commission cannot disapprove the plan based on a new standard of conduct applied ad hoc to this specific case. Before transactions that are otherwise legal can be outlawed, they must fall under the ban of some standard of conduct prescribed in advance by an agency of government. On remand from the Supreme Court, the SEC did not produce new evidence or findings of misconduct, but instead re-asserted its disapproval based on its 'special experience' and 'unresolved doubts' about the conflicting interests of the fiduciaries. This is impermissible. The Supreme Court's prior ruling established that neither Congressional statute nor established judicial doctrines condemned these transactions, and the SEC has not since promulgated a general rule to prohibit such conduct. An agency's adjudicatory decision must be based on a reasoned conclusion from evidence in the record, not on an 'unsupported suspicion' or a rule of 'fiat' created and applied retroactively to a single case. To allow the SEC to act on its 'unfettered discretion' would make the statutory requirement for a hearing an empty form and render its decisions free from judicial review.



Analysis:

This decision represents a significant check on the power of administrative agencies to create new legal standards through adjudication. The court champions the principle that regulated parties must have prior notice of the rules governing their conduct, which is best achieved through formal rulemaking. By rejecting the SEC's attempt to formulate policy on a case-by-case basis based on its 'experience,' the court defended a more rigid separation between quasi-legislative (rulemaking) and quasi-judicial (adjudication) functions. This opinion is historically important because it was ultimately reversed by the Supreme Court, which in SEC v. Chenery Corp. (Chenery II), 332 U.S. 194 (1947), established that an agency generally has the discretion to announce new principles of law through either rulemaking or ad hoc adjudication.

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