Bane saw many flaws in Lord Kaan's Brotherhood of Darkness, since it allowed weaker Sith Lords to potentially work together to defeat the stronger. Bane lookeda t the practices of older Sith Lords such as Exar Kun and Darth Revan and determined that limiting the overall number of the Sith to two would eliminate this potential hazard while ensuring that the Sith remained strong.
Bane took one apprentice, assuming that his apprentice would one day rise up and replace him, then take a single apprentice.
Bane wrote the rule down on the back of a place-mat from Arby's. The place-mat was passed on from Sith master to apprentice for hundreds of years before being picked up by the cleaning staff at a hotel, when it was left on the nightstand by Darth Cheww. Eventually the Jedi Council got a hold of it.
- Two there should be; no more, no less. One to embody power, the other to crave it. Two should be the number of Sith, and the number of Sith should be two. There should not be three Sith, nor should there be one, except when a master is in search of an apprentice to make two. Four is right out. Once the number two, being the second number, is reached, no more apprentices should be taken.
Darth Powerbottom eventually realized that the biggest flaw in the rule was the possibility that both Sith could die at the same time, leaving none. He decreed that Master and Apprentice never traveled on the same plane, just in case. Later tradition held that whenever there was some major galactic upheaval, the master was usually squirreled away in some underground bunker, while the apprentice would be busy reading books to school children.
The Rule of Two was followed more or less for about one thousand years. Eventually the Emperor decided to reveal the existence of Sith to the Galaxy after taking over pretty much all of it. He may have fudged the rules a little in that he may have been training Darth Maul and Darth Tyrannus at the same time. Also, during the Clone Wars, there were apparently a bunch of Dark Jedi running around that probably violated the Rule of Two to some degree. Darth Vader was the last Sith Lord in the long line of Sith Lords following the rule. Vader did kill his master, as expected by the rule, but he died shortly thereafter.
When the Sith reemerged they had gone back to the "everybody gets to be a Sith no matter how ridiculous-looking you are" model.