Biden and the SEC: Some Possible Agendas

This is the gossip season, and almost everyone has heard a rumor about who will be the next chair of the SEC. Although I was interviewed by the Biden transition team (for my views, not as a candidate), my sources are no better than those of others. Nonetheless, they all tell me that the next chair will be Gary Gensler, the former chair of the Commodity Futures Trading Commission and current chair of the Transition Taskforce for Financial Regulation for President-elect Biden. In my view, he is probably the optimal choice — experienced, tough at enforcement, and well versed in the economics of securities markets. The only real question is whether he will hold out to become deputy secretary of the Treasury Department.

To be sure, presidents can go their own way or be compelled to favor others in order to balance the ticket along gender or racial lines. Other potential (and qualified) candidates include Preet Bharara (the former U.S. Attorney in Manhattan), Rob Jackson (a former SEC commissioner) and the senior current Democratic commissioner, Allison Herren Lee (who will probably be the interim chair if Chairman Jay Clayton resigns at the end of December).

More interesting to me is where might a Democratic SEC depart from the agenda pursued by Chairman Clayton. Here, although I recognize that Chairman Jay Clayton stayed within the mainstream — unlike other Trump chairs at other agencies — a host of topics exist on which Democrats will likely want to move in a different direction.

Only 10 such issues can be compressed into a single column (but there are many more):

1. ESG and Shareholder Voting. Under Clayton, the SEC reversed course and began to suggest that fiduciaries (for example, the investment advisers to mutual funds) were not required under all circumstances to vote their fund’s shares (which previously had been seen as a fiduciary duty to which investment advisers were subject). Although the SEC did not go nearly as far as the Department of Labor under Secretary Scalia, which has a proposed rule pending that would bar ERISA fiduciaries from voting the shares held by a pension plan unless the fiduciaries could show a likely financial benefit to the pension plan, both positions go too far and seem intended to curb activism by BlackRock and like-minded investors that favor ESG goals.

On the general topic of ESG, the SEC is 10 years behind Europe, where ESG disclosures are now mandatory. To be sure, ESG rankings and criteria are often unrationalized, contradictory, or inexplicable. But this actually calls for more SEC oversight, not less.

Why do ESG disclosures matter? Cynics may say that, whatever a corporate issuer discloses on ESG issues, the board will stay focused on shareholder wealth maximization and short-term profits. That is, however, too narrow a view. The reality is that “executives manage what they measure.”[1] The more the corporation is required to measure and disclose its impact (say, on climate change), the more it will attempt to improve its impact and rating. Fuller disclosure is a “soft law” lever for encouraging greater regard for these non-economic goals. If the Biden Administration intends to pursue a more activist climate change policy than the Trump Administration did, this is a lever that it needs to use.

Will a Biden Administration insist on mandatory ESG disclosures? Here, it is too early to predict, but that is a possibility. Anyone approaching the nomination hearing for the SEC needs to have thought out his or her position on this issue.

2. Proxy Advisers and Proxy Proposals. Over the dissent of its two Democratic commissioners, the SEC has subjected proxy advisers to burdensome new rules that require them to give advance notice to corporate issuers of the positions they will recommend on shareholder votes and to consider the issuers’ responses. These rules will stretch out the proxy solicitation process and possibly chill advisers’ ability to recommend policies disliked by managements. Still, they do not become fully effective until 2022, which gives a Democratic SEC time to reconsider and revise them.

Also, the Clayton SEC withdrew a critical no-action letter that protected proxy advisers from being deemed to have solicited a proxy by providing advice to their clients with respect to approaching votes. Currently, the SEC and Institutional Shareholder Services (“ISS”) are locked in litigation over this and related issues. Under a Democratic chair, the no-action letter could be reinstated (possibly with some modest changes) and the ISS litigation settled.

Similarly, the Clayton SEC revised Rule 14a-8 dealing with shareholder proxy proposals, in part by significantly increasing the necessary percentages that the vote must receive in order to be resubmitted in later years. This rule also seems ripe for reversal.

3. “Short-Termism. The European Commission has now decided that “short-termism” is a chronic problem that requires a number of important responses, including the revision of directors’ duties. It is unlikely that the U.S. will follow this specific approach, but pressure from hedge fund “wolf packs” is a continuing issue in the United States. For years, law firm Wachtell, Lipton has urged the SEC to address “short-termism” by closing the window under Section 13(d) of the Williams Act, which gives an acquirer or group 10 days to file its Schedule 13D. Chairman Clayton, an experienced M&A lawyer, had no interest in changing the balance of advantage in M&A transactions, but a number of Democratic “progressives” are skeptical of hedge fund activism and believe closing that loophole would be a useful improvement. Similarly, hedge fund “wolf packs” are able to dominate the board by threatening proxy contests because the definition of “group” under the Williams Act is loose and unconfining. It could easily be tightened by rulemaking. This is an area where the business community (which hardly loves hedge fund activists) and Democratic progressives could form an alliance. No prediction is here made that such a reform will occur, but it could be discussed and debated, depending on the chair’s preferences.

4. Regulation Best Interest. This alleged reform was adopted by the SEC last year on a strictly party-line vote. The new rule does not make the broker a fiduciary to its clients, and may even preempt state laws (such as that of California), which does deem a broker to be a fiduciary. A liberal Democratic commission could re-examine this weak reform and insist on revisions that made the broker a fiduciary (or at least spared state laws to such effect from preemption by the new rule). This would provoke a firestorm, and the new chair needs to choose his or her priorities.

5. Public Company Accounting Oversight Board (“PCAOB”). The Trump Administration proposed to shut this agency down by merging it into the SEC (which has been much more passive about auditors who acquiesce in client fraud). That was the PCAOB’s perverse reward for being the one agency in Washington that would not acquiesce in the conduct of wayward accountants. In light of WireCard and other recent auditing scandals, Democrats may want a tougher, more skeptical SEC. If so, they must recognize that the PCAOB is the only agency likely to deal objectively and appropriately with wayward auditors. (The possible reforms here could fill an entire column).

6. Deregulation of Exempt Offerings. In the last year, the SEC has liberalized the definition of “accredited investor” and greatly expanded the scope of the crowdfunding exemption, Rule 701, and Regulation A+. However, the one reform that has not been considered (but that the SEC staff has favored in past years) would be to subject the definition of “accredited investor” to inflation indexing. When Regulation D was adopted in the early 1970s, its $1 million and $250,000 minimum requirements to qualify as an accredited investor amounted to real money. Today, such numbers no longer do (when many young associates can qualify as accredited investors if bonuses are paid by their law firm). Because no disclosure must be provided under Regulation D if the purchasers are all accredited investors, brokers sensibly restrict all private placements to them. The brokerage industry loves this extraordinarily broad exemption, but it is a disgrace, and by itself largely explains why private placements now vastly exceed public offerings in the amounts annually raised.

7. SEC Enforcement. Every few years, the issue is certain to be raised: Why does the SEC persist in “neither admit nor deny” settlements, which allow an issuer to avoid acknowledging any misconduct. In contrast, even deferred prosecution agreements require some admissions by the defendant. When Mary Jo White was confirmed as SEC chair, she promised to reconsider this pattern, but exceptions have been rare. In the interim, the Second Circuit has admonished Judge Rakoff that he has little or no authority to reject a proposed SEC settlement. But even if the SEC has this power, that does not imply that it should invariably use it. Here, a fuller study of the possible options might be the first step towards a stronger enforcement program. Today, under Trump, the SEC seldom sues public companies, but only chases after small-time brokers and other crooks. Democrats do not generally believe that public companies should be immune from SEC discipline and may want the commission to scrutinize Wall Street as well as Main Street.

8. Direct Listings. Direct listings may well be an efficient technique for IPO issuers to consider, but progress toward that end is currently stalled because direct listings effectively deny purchasers the ability to rely on the liability provisions of Section 11 of the Securities Act. This is because the “tracing” requirement of Section 11 cannot be satisfied,[2] unless the SEC takes action to make tracing feasible. It could, and should, but probably won’t.

9. “Principled” Disclosure. Under Chairman Clayton, the SEC has trimmed Regulation S-K by moving from rules to principles. This is not invariably wrong (or right). A careful review should be undertaken as to whether disclosure of material information has now become increasingly optional. Yes, there is a case for “principled” disclosure, but we do not know how it is working. A study of its impact is needed.

10. Budget. The SEC, of course, needs a much, much larger budget, which the Trump Administration regularly pruned.

ENDNOTES

[1] I borrow this phrase from my late colleague, Professor Louis Lowenstein, who used it to describe how disclosure affects managerial behavior. He was right.

[2] In one case, a federal district court has this year determined that the “tracing” of IPO shares is infeasible and therefore has exempted plaintiffs from such a requirement. See Pirani v. Slack Technologies, Inc., 445 F.Supp 3d 367 (N.D. Calif. 2020). However, the court granted an interim appeal, and the likelihood is that this decision will be reversed.

This post comes to us from John C. Coffee, Jr., the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance.

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