FROM ISSUE NUMBER 30 ~ WINTER 2017 GO TO TABLE OF CONTENTS
Saving Securities Regulation
Over the eight years of the Obama administration, the Securities and Exchange Commission has lost its way in a fog of partisan initiatives. Nowhere has this been more apparent than in the realm of securities disclosure. From Congo conflict minerals to income inequality, from global warming to campaign finance, the venerable agency has seen its energies and resources dissipated in pursuit of a hodgepodge of political pet projects utterly irrelevant to its three-fold mandate to "protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation." This mission creep — which former SEC Commissioner Daniel Gallagher once described as the "engraft[ing]" of "social or foreign policy provisions...onto the securities laws" — has uniformly been in derogation of the SEC's core responsibilities.
Fault for the SEC's politicization can sometimes be laid at the feet of Congress, and sometimes the wounds have been self-inflicted. For an agency that ought to focus on chasing future Madoffs rather than Mobutus, the advent of a new presidential administration means that the time is ripe for a reassessment of the SEC's priorities, starting with its regulation and enforcement of the corporate disclosure system and the concept of "materiality."
LIVING IN A "MATERIAL" WORLD
The SEC's origins lie in the Great Depression, when Congress established the independent agency through passage of the Securities Exchange Act of 1934. Together with its sister statute, the Securities Act of 1933, the law was intended to restore public faith in capital markets following the stock-market crash of 1929.
The SEC was created to enforce new transparency and anti-fraud laws, to encourage market stability, and, most important, to protect investors. Then as now, the Great Crash was widely ascribed to a lack of corporate transparency, with corporate disclosure being the generally accepted prescription. As Justice Louis Brandeis famously said, "Sunlight is said to be the best of disinfectants; electric light the most efficient policeman." In the capital markets, corporate disclosure serves as that policeman. Indeed, it would not be an overstatement to say that regulating and enforcing our corporate-disclosure regime is the raison d'être of the SEC. By any reasonable standard, the SEC has been wildly successful — U.S. capital markets are the broadest, deepest, and most liquid the world has ever seen.
The Securities Act introduced requirements pertaining to disclosures at the time of the first offering and sale of securities, including, for example, disclosures made in connection with a company's initial public offering of stock. By contrast, the Exchange Act broadly required public companies issuing securities in U.S. capital markets to publish periodic disclosure reports.
Today, thousands of U.S. and foreign private issuers (known in SEC parlance as "reporting companies") are subject to, among other things, the Exchange Act's requirements to issue quarterly, annual, and extraordinary reports. These reports contain a vast array of quantitative and qualitative data relating to a reporting company's business, operations, executive-compensation practices, corporate governance, and financial statements. They are produced by the reporting companies at no small expense, typically under the meticulous scrutiny of outside legal counsel and the auditors of a company's financial statements. The SEC serves as primary lawgiver and enforcer of this statutory system, which has been elaborated over the ensuing decades by countless regulations, agency guidance documents, generally accepted accounting principles, and court cases, as well as by the practical lore of the securities bar and accounting profession.
If there is a defining principle of our system of securities regulation, it is this: Robust disclosure means informed investors, and informed investors are protected investors. Modern corporations are operated by management but owned by widely dispersed shareholders — a feature that corporate-governance scholars call the "separation of ownership and control." If they are to make reasoned investment decisions, shareholders (and other holders of corporate securities, like bonds) must have timely and accurate information regarding the goings-on at corporate headquarters, including the latest financial figures and management's analysis thereof. Keeping individual and institutional investors apprised of material risks and developments affecting a reporting company's business, financial condition, and results of operations is the surest basis for vibrant, liquid, and fair capital markets.
The key term of art in the foregoing paragraph is "material." In a formulation as well known to securities lawyers as "you have the right to remain silent" is to criminal-defense attorneys, under the SEC's securities anti-fraud rule, it is unlawful for securities issuers "to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading" (emphasis added). Merely misstating or omitting irrelevant minutiae is insufficient to trigger liability — rather, a fact must be material to an investor's decision to buy, sell, or hold a security or vote his rights thereunder. While neither Congress nor the SEC has ever issued a bright-line definition, one SEC rule broadly defines "material" facts as those "to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security registered." Leading Supreme Court opinions in TSC Industries v. Northway, Inc. and Basic v. Levinson have further refined the contours of the standard. In general, material facts are those that a "reasonable" investor would view "as having significantly altered the 'total mix' of information made available."
There is arguably an advantage to preserving a degree of constructive ambiguity for securities regulators in this context, as engineering a precise numerical standard of materiality presents difficulties. Setting too low of a standard risks "bury[ing] the [investor] in an avalanche of trivial information — a result that is hardly conducive to informed decisionmaking," as Justice Thurgood Marshall wrote for the Supreme Court in TSC Industries. Learning that the CEO had ham and eggs for breakfast yesterday morning rather than the granola claimed in the company's quarterly report is unlikely to bear significantly on the company's share price. Setting too high of a threshold means that information with the potential to move markets could be misstated or omitted with impunity. Allowing a company to misstate its quarterly earnings by 20% would plainly harm the economic interests of investors once the misstatement is discovered and the share price tumbles. Implicit in this analysis is that the reasonable investor cares about the probability that a given misstatement or omission, once divulged, will adversely affect the price of his security and the magnitude of this effect.
From here, we begin to tread on disputed territory. As former SEC Commissioner and Brooklyn Law School Professor Roberta Karmel observed recently in The Business Lawyer, "historically, the SEC generally has interpreted materiality to mean economic materiality." That is, a traditional reading of materiality asks what a hypothetical reasonable investor cares about qua investor in corporate securities — not in his role as a concerned global citizen, trade unionist, or Sierra Club member, whatever importance he or society at large may attach to such roles. With few exceptions, the touchstone of the materiality inquiry has heretofore been what a reasonable investor would find relevant to his investment decision, namely, information with the propensity to affect his investment returns.
In recent years, however, this traditional definition of economic materiality has increasingly been supplanted by a new interpretation more concerned with social-justice considerations than financial ones.
DODD-FRANK AND THE HEART OF DARKNESS
In the wake of the latest financial crisis and under pressure to respond forcefully to perceived financial shenanigans on Wall Street, Congress rushed to pass the massive Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The 800-page behemoth introduced a variety of financial regulatory measures, ranging from the establishment of the Financial Stability Oversight Council and Consumer Financial Protection Bureau, to regulation of the swaps and derivatives markets, to the infamous Volcker Rule. Tucked away in Section 1502 of Dodd-Frank's penultimate title (the aptly named "Miscellaneous Provisions"), one stumbles upon a curious statement:
It is the sense of Congress that the exploitation and trade of conflict minerals originating in the Democratic Republic of the Congo is helping to finance conflict characterized by extreme levels of violence in the eastern Democratic Republic of the Congo, particularly sexual- and gender-based violence, and contributing to an emergency humanitarian situation therein, warranting the provisions of [a new § 13(p)] of the Securities Exchange Act of 1934.... [emphasis added]
Undeniably, the Congo region remains a horror lifted straight from the pages of Joseph Conrad. The role of so-called "conflict" minerals (columbite-tantalite or "coltan," cassiterite, gold, wolframite, and others) in catalyzing the ongoing violence is similarly indisputable. That it should be a high priority of U.S. foreign policy to foster peace and stability in the Congo is unexceptionable. That the foregoing "warrants" an amendment to the Exchange Act is, perhaps, less than self-evident.
Dodd-Frank's Section 1502 amended the Exchange Act to mandate annual disclosure of whether any conflict minerals "necessary to the functionality or production" of a reporting company's manufactured products originated in the Democratic Republic of the Congo or adjoining countries. If so, the company must submit a report to the SEC detailing the due-diligence measures taken with respect to the company's supply chain. Such measures must include a certified third-party audit. Furthermore, the company must include descriptions of the following: any products that are not "DRC conflict free"; any facilities used in processing conflict minerals; the country of origin of the conflict minerals; and the company's efforts to ascertain the originating mine. This information must be published to the reporting company's website, as the statute relies upon the so-called "name and shame" strategy favored by many Obama-administration policies.
Of course, Congress did not simply "mandate" the above disclosures. In keeping with contemporary legislative practice, Congress delegated the details to an administrative agency — in this case, the SEC. In 2012, the commission adopted final regulations implementing Section 1502's due diligence, supply-chain management, and reporting regime and instituting a new Form SD to be filed annually with the agency. (In securities-law argot, a "filed" document subjects the filer to greater potential liability for material misstatements or omissions than does "furnished" information.)
One might expect that "the burden of diplomatic and humanitarian aid should come from agencies and groups that can better shoulder the formidable responsibility of peacemaking in the [Congo]," as Karen Woody put it in her legislative history of the Congo conflict-minerals provision. It seems that at least some SEC staffers may agree. In reading the SEC's final rule release — 92 pages of minuscule, tri-columned Federal Register text — one detects a hint of bewildered exasperation on the part of the SEC staff that they, of all people, have been saddled with this task. Indeed, the rule's preamble emphasizes twice over the course of two paragraphs that "Congress chose to use the securities laws['] disclosure requirements to accomplish its goals," as if to remind the private securities bar that Congress is to blame for this bizarre excursion into sub-Saharan Realpolitik.
The SEC's two Republican minority commissioners were not reticent in registering their dissent from the rule's adoption. After justly praising the professionalism of the SEC staff charged with drafting the rule and decrying the "shameful" and "murderous, rapacious conduct" of the Congo's warlords, former commissioners Gallagher and Troy Paredes allowed cool heads to prevail over warm hearts. Their separate critiques each centered on the SEC's (unsurprising) lack of relevant experience in resolving international humanitarian crises. This inexperience is excusable for an agency staffed primarily by lawyers, accountants, and economists hailing from the country's top law firms, accountancies, and universities. Since 2010, the SEC staff has gamely assumed the monumental burden of promulgating the thousands of pages of new securities and derivatives regulations mandated by Dodd-Frank. SEC staffers are generally well respected by their private-sector counterparts. Their competency, however, has its limits. As Commissioner Paredes put it in his dissent: "[T]he Commission has no expertise when it comes to the humanitarian goal of ending the atrocities that besiege the [Congo]. The agency is not even expert when it comes to supply chain management."
Sounding a depressingly regular theme, Commissioners Gallagher and Paredes also faulted the rulemaking for its lack of sound analysis of the costs and benefits of the new disclosure regime. The compliance costs of reporting companies subject to the rule have proven severe, and the rules provide for no de minimis exception for issuers using only tiny amounts of conflict minerals. A large technological company — e.g., Intel, Hitachi, or Samsung — may have hundreds of component suppliers, each of which is subject to a thorough due-diligence process under the rule. Many such suppliers are not reporting companies themselves and thus technically fall outside the SEC's jurisdiction, yet they nevertheless must incur substantial compliance costs to satisfy their customers' regulatory obligations or risk losing business. The Congo region remains war-torn and lacking in infrastructure, compounding the difficulty of ascertaining which of the Congo's innumerable small smelting operations and mines are truly "conflict-free."
The SEC's rule release estimated the collective initial costs of establishing compliance systems to be between $3 and $4 billion, with ongoing annual costs of $207 to $609 million. One industry group predicted total outlays of $8 to $16 billion. In practice, the costs appear to exceed even the high end of the SEC's range. According to a study prepared by Chris Bayer of Tulane University and Assent Compliance, for the reporting year that ended June 2, 2014, filers of conflict-minerals reports "worked a combined total of 6 million hours on their conflict mineral program and reporting," incurring "a total expenditure of $790.7 million, or an average of half a million dollars per filer." As Bayer noted to the Wall Street Journal, the task imposed by Section 1502 is akin to "apply[ing] modern supply-chain logistics to the equivalent of the 1849 California gold rush."
By contrast, the benefits of the rule are anybody's guess. To be sure, the SEC has regularly been criticized for shoddy cost-benefit analysis and has sometimes seen its rules invalidated by courts — in particular, by the U.S. Court of Appeals for the District of Columbia Circuit. One sympathizes, however, with the SEC staffers who wrote in the final rule release that Section 1502 "aims to achieve compelling social benefits, which we are unable to readily quantify with any precision, both because we do not have the data to quantify the benefits and because we are not able to assess how effective Section 1502 will be in achieving those benefits." Weighing hundreds of millions of dollars of compliance costs against the likelihood that a single Congolese life (or a hundred? a thousand?) will be spared by Section 1502 is a job for Immanuel Kant or Jeremy Bentham, not the SEC's economic-analysis division.
As was feared by some commenters at the time of the rule's adoption, some have suggested that by creating incentives for a de facto embargo on Congolese minerals, the SEC may have actually contributed to a worsening of the violence, as warlords who formerly embezzled from mining concerns have redirected their rapaciousness toward the populace at large. I will refrain from discussing this evidence — as a financial-regulatory lawyer, my own assessment lacks the specialist knowledge required to make a reasoned judgment on such matters. For the same reason, the task of addressing the Congo's strife is best left to those who occupy offices in the West Wing, the State Department, or the Department of Defense — not the SEC.
RULES FOR REGULATORY RADICALS
The senators who first introduced the amendments that would eventually become Section 1502 — including Senators Sam Brownback, Richard Durbin, and Russ Feingold — cannot be faulted for their motives. Their bipartisan effort to aid the beleaguered people of the Congo followed several investigative trips to the region and benefitted from close coordination with humanitarian organizations. If the issue were simply a lack of regulatory and enforcement resources, the usual budgetary channels might suffice to reinforce an agency already stretched by Dodd-Frank's overwhelming rule mandates. The problem is that Congress (and sometimes the SEC itself) has fundamentally misunderstood the role and purpose of corporate disclosure in our capital markets and, specifically, has ignored the critical concept of materiality.
While SEC rules intentionally leave the precise definition of "materiality" ambiguous, as noted above, it is obvious that the Congo conflict-minerals rule deviates sharply from any traditional interpretation of economic materiality. Arguments that conflict-minerals disclosures are intended to "protect" investors by informing them of "material" economic facts are facetious. Even the final rule release conceded that the conflict-minerals provision's "nature and purpose" are "qualitatively different from the nature and purpose of the disclosure of information that has been required under the periodic reporting provisions of the Exchange Act." The same goes for Sections 1503 and 1504 of the Dodd-Frank Act (more "Miscellaneous Provisions"), in which Congress respectively required disclosure of certain violations of mine health and safety standards and payments to the U.S. or foreign governments by resource extraction companies for the purpose of "the commercial development of oil, natural gas, or minerals." No plausible case for an investor-protection motivation can be asserted regarding these two requirements.
Alas, the conflict-minerals rule and its sibling provisions are not sui generis but are rather just a few examples from a lengthening list of SEC rules or guidance documents mandating immaterial disclosures, including with respect to such disparate matters as income inequality and global warming.
Unable to resist the temptation to (mis)direct the disclosure system toward nakedly partisan ends, Congress also passed into law Section 953(b) of the Dodd-Frank Act, which ordered the SEC to issue rules requiring disclosure of the ratio of the total compensation of a reporting company's CEO to the compensation of the firm's median employee. The apparent simplicity of this requirement is deceptive, as determining the "median" employee in a multi-national firm with diverse compensation systems presents significant compliance challenges. The SEC's final rule release, issued in August 2015, made certain concessions to practicality by clearly defining "total compensation," allowing the median-employee calculation to be updated only once every three years, and according companies a degree of flexibility in their selection of a methodology for identifying the median employee, including the use of statistical sampling methods. Notably, the rule applies to all of a firm's employees, including non-U.S. employees, although the latter may be excluded from the calculation where foreign data-privacy laws prohibit compliance or where a de minimis headcount exception applies.
As the SEC staff stated in the final rule release, "neither [Dodd-Frank] nor the related legislative history directly states the objectives or intended benefits of the provision or of a specific market failure, if any, that is intended to be remedied." Nevertheless, as Commissioner Michael Piwowar observed in a pair of scathing dissents, the concerns animating the pay-ratio requirement are clear. Proponents of the rule — prominently including organized labor and some institutional investors, like public pension funds — argue that investors are entitled to a "say on pay" and that pay-ratio data are necessary to rein in the perceived overpayment of chief executives. Here, too, Congress has essentially mandated a "name-and-shame" mechanism designed to embarrass corporations into changing their compensation practices.
Arguing that the rule "has nothing to do with protecting investors, ensuring fair, orderly, and efficient markets, or facilitating capital formation" — the SEC's statutory mission — Commissioner Piwowar explicitly attributed the pay ratio's successful passage to "the use of Saul Alinskyan tactics by Big Labor and their political allies." Commissioner Gallagher heartily agreed, quoting no lesser authority on such bare-knuckled tactics than the AFL-CIO: "Disclosing this ratio will shame companies into lowering CEO pay." Brandon Rees of the AFL-CIO put it even more succinctly: "They will be embarrassed, and that's the whole point."
It is hard to escape the conclusion that the pay-ratio rule has more to do with a fixation on income inequality than with any investor-protection concerns. SEC filings have long required detailed disclosures on executive compensation and related corporate-governance issues. Unlike material disclosures relating to executive compensation, the pay ratio is virtually useless as a basis for making meaningful comparisons across companies or industries. Let's suppose that the median employee of a fast-food chain (e.g., McDonald's) earns "McWages" for flipping hamburgers, whereas the median Ivy League graduate on the trading floor of Morgan Stanley earns a six-figure salary for flipping derivatives. Assuming that the two companies' CEOs have identical compensation packages, what are we to make of data that show McDonald's to have a pay ratio many multiples of Morgan Stanley's ratio? That Morgan Stanley is somehow a more just and equitable workplace than McDonald's and therefore more deserving of investment?
Or consider two manufacturing firms, one with factories in the relatively high-cost United States and the other basing its plants in low-cost foreign jurisdictions. Holding CEO pay constant, what is a reasonable investor to make of the pay-ratio disparity between, say, Ohio and Cambodia? The rule explicitly excludes workers who are "not employed by the [reporting company] or its subsidiaries"; thus, a company that outsources low-wage work to independent contractors will, all else being equal, appear to have a "better" (meaning "fairer," one presumes) pay ratio than a firm that pays its own employees the same wages. It is not even clear what benefit such apples-to-oranges data provide to progressive activists — let alone the reasonable investor — aside from a vacuous talking point.
Misguided disclosure initiatives have not been limited to congressional statutes. In January 2010, the commissioners voted along party lines to issue interpretive guidance detailing the agency's views on climate-change disclosure. The guidance is framed as a "reminder" to reporting companies "to consider climate change and its consequences as they prepare disclosure documents." The agency highlighted the obligation to disclose material risks arising from domestic climate legislation and regulation; international accords; "indirect consequences" of legal, technological, political, and scientific developments; and the physical effects of climate change (weather patterns, sea levels, and the like). The release specifically notes the potential for "reputational risk" where public opinion turns against a company on the grounds, for example, that its greenhouse-gas emissions are too high.
Interpretive guidance releases are not uncommon. For example, in 1998, the SEC provided guidance on disclosure of reporting companies' preparations for addressing the Y2K problem. While guidance releases do not have the force of law — unlike statutes or agency regulations promulgated through notice and comment rulemaking — they are generally helpful in that they promote consistency, signal the agency's enforcement objectives, and assist practitioners in crafting compliant disclosure. What is unusual is for a guidance document to provoke such fierce dissent. Former commissioner Kathleen Casey described the climate-change release as "unnecessary," and, like the other dissents discussed above, she faulted the release for "address[ing] concerns unrelated to investor protection." She also highlighted the gross misallocation of staff resources to climate change at a time in early 2010 when, suffice it to say, the agency might be thought to have had other, more pressing — and more germane — matters on its mind.
In one sense, the climate-change guidance is unremarkable. As discussed above, reporting companies have long been under a general obligation to disclose material risks, including the potential effects of adverse legislation. Specially situated companies — for example, a Japanese issuer whose major operations are located near a geological fault line — might even include in their disclosure a specific risk factor detailing the likelihood that a natural disaster or act of God would affect their businesses. Moreover, disclosure requirements relating to environmental matters have existed since the early 1970s. In the guidance release, the SEC offered no indication that reporting companies systematically fail to disclose risks pertaining to environmental laws and regulations as compared to, say, tax or product-safety laws. As Commissioner Casey noted, "legal requirements and reputational pressures relating to climate change issues are, fundamentally, no different [from] those that arise in other regulatory contexts." Why, then, in the midst of the greatest financial crisis since the Great Depression, did the SEC decide to adopt guidance that, at best, recapitulates prior agency rules and guidance and, at worst, mires the SEC in the ongoing debate over the effects of climate change?
Per Commissioner Casey's dissent, the main distinction is, of course, that "climate change is currently a 'hotter' and more controversial political topic than most other regulatory issues." While the guidance release affected a pose of agnosticism as to the science of climate change, it plainly operates on the presumption that reporting companies will have something material to disclose on this subject. To question the need for the climate-change guidance does not necessarily imply that one must "deny" the reality of climate change or its anthropogenic sources. Even the most frenzied climate Cassandra will readily concede that the physical effects of climate change will manifest themselves gradually and over the long term, certainly not on the quarter-to-quarter comparison basis relevant to corporate disclosures. Indeed, there are indications that the SEC has recognized the oddity of the climate-change guidance. In 2010 and 2011, the agency sent numerous letters to reporting companies commenting on various climate-change disclosure inadequacies. Since then, the agency has substantially decreased its enforcement activity in this area, despite insistent calls from environmental activists and state attorneys general that the SEC more stringently police environmental disclosures.
Other than their myriad unintended consequences, what binds these disparate disclosure regimes together — conflict minerals, mine safety, resource-extraction payments, pay ratio, and climate change — is that they each depart significantly from the SEC's statutory mission. To wit, the disclosure requirements surveyed here fail to accomplish any of the stated purposes of the SEC. They fail to protect investors, by bloating already lengthy periodic reports with immaterial data that distract from the clear and concise presentation of decision-useful information. They fail to maintain fair, orderly, and efficient markets, by distracting the SEC staff from more critical enforcement priorities. They fail to facilitate capital formation, by imposing enormous compliance costs on U.S. issuers, while giving foreign private issuers another reason to avoid securities issuances in the U.S. capital markets altogether, thus harming our competitiveness. In a word, they fail.
PROSPECTS FOR DISCLOSURE REFORM
A child soldier brandishes an AK-47, looming over the slave laborers in a Congolese tantalum mine. A mailroom worker in a Wall Street investment bank struggles to keep body and soul together, while the CEO jets to Davos in a private Gulfstream. A Vanuatan hotelier warily eyes the inexorable rise of the sea. In a world filled with anguish and despair, our nation turns its lonely eyes to...the SEC?
As the incoming Trump administration prepares its agenda, it is worth pausing to assess the effectiveness of the SEC's disclosure policies over the past eight years in preparation for the next.
The story has not been entirely bleak. Under the leadership of former chairman Mary Jo White, appointed by President Obama in 2013, the SEC's Division of Corporation Finance has engaged in a multi-year "disclosure effectiveness" initiative, in compliance with a Jumpstart Our Business Startups ("JOBS") Act mandate to streamline periodic disclosure requirements. Even aside from politically motivated disclosure requirements, there has long been a trend toward inclusion of generic boilerplate disclosures in corporate filings, for which excessively risk-averse corporate counsel are the primary culprits. Ideally, disclosures should be tailored to the reporting company in hopes of providing as accurate a picture of the company's financial condition as possible, preferably in "plain English" rather than rebarbative legalese. As Commissioner Gallagher has said, "excessive illumination by too much disclosure can have the same effect as inundation and obfuscation — it becomes difficult or impossible to discern what really matters." In July 2016, the commissioners voted unanimously to propose amendments to "eliminate [certain] redundant, overlapping, outdated, or superseded provisions." While the proposals are "modest," in former chairman White's view, and mainly limited to technical matters, they are to be applauded.
The courts, too, will have their say. Legal challenges to various SEC disclosure regimes have been brought with varying degrees of success. Plaintiffs challenging the agency have often taken their cues from the dissenting commissioners' critiques of faulty cost-benefit analysis, but other grounds have been asserted, too, such as irregularities in administrative procedure or even the First Amendment's (disputed) protection of corporate free speech. The shifting composition of the federal courts — and, most especially, the D.C. Circuit and Supreme Court — will without doubt have great influence over the outcome of these suits.
Most important, the election of Donald Trump may yield some real changes on this front. Early indications as to President Trump's financial regulatory appointments bode favorably for a return to a more sensible disclosure policy. Consider, for example, recent calls from activists for disclosure of corporate "political activities." In 2011, a committee of prominent professors, led by Professor Lucian Bebchuk of Harvard Law School, petitioned the SEC to "develop rules to require public companies to disclose to shareholders the use of corporate resources for political activities," particularly donations to "super PACs" but potentially also other issue-advocacy organizations or trade groups. The professors were in part motivated by their concerns over the Supreme Court's controversial 2010 decision in Citizens United v. FEC. Much, although not all, of the professors' desired information is already disclosed by a variety of state and federal regulators, including the Federal Election Commission, surely a more appropriate arbiter of such matters than the SEC. A provision inserted by congressional Republicans into the 2015 budget omnibus bill prohibited the SEC from applying its 2016 budget toward "finaliz[ing], issu[ing], or implement[ing] any rule, regulation, or order regarding the disclosure of political contributions, contributions to tax exempt organizations, or dues paid to trade associations."
The provision expired in September 2016, and a bevy of prominent Democrats — including Senators Robert Menendez, Elizabeth Warren, Jeff Merkley, and Charles Schumer, among others — have informed the SEC of their view that "the SEC retains the authority to take important steps to prepare for a rulemaking on this issue," specifically "discussing, planning, investigating, or developing plans or possible proposals." Former SEC Commissioner Paul Atkins has described the initiative as "yet another questionable regulation from Washington designed to serve the narrow political objectives of a few at the expense of general shareholder interests." With a resurgent Republican Party taking control of all three branches of government, the proposed corporate contributions rule is as good as dead, at least for the present. It is likely to be joined in its grave by the pay-ratio rule and possibly other regulations, depending on the fate of the Dodd-Frank Act and other legislative initiatives in the incoming Congress.
The SEC has not always been a political cockpit, and it need not remain so. Congress, especially, should reacquaint itself with the basic premises of our system of securities regulation. Unlike some other nations, the United States has shied away from a so-called "merit-based" system, in which paternalistic securities regulators pass on the "appropriateness" or "fairness" of an issuance and have the authority to deny registration to a securities offering before it ever reaches the public. Rather, the U.S. system simply requires the sunlight of disclosure and allows investors to apply their own best judgment. Abusive issuers — those who violate disclosure or anti-fraud rules — swiftly find themselves on the wrong end of a securities-enforcement action by the SEC or a private lawsuit. The mere threat of such actions reduces the incidence of securities fraud ex ante. As securities markets mature around the world, our competitor nations have come to see the wisdom in our American way of doing business, particularly in Asia, where regulators in Hong Kong, Japan, Malaysia, and Singapore have to varying degrees taken steps toward adopting a disclosure-based model.
Just as the old Bureau of Standards oversaw uniformity in the weights and measures that allowed a commercial economy to flourish, so, too, do the SEC and its designated standard-setters, like the Financial Accounting Standards Board, provide a solid foundation for our financial markets. This system comports well with Americans' rugged individualism and native antipathy toward bureaucracy and red tape, but we must remain vigilant.
What is problematic about the SEC's recent disclosure initiatives is not so much that they have been motivated by progressive causes célèbres, although that is certainly the case. A conservative push to force corporate disclosure of religious liberty issues would be no more justifiable. Rather, politically motivated disclosure derogates from a system that has, since the 1930s, succeeded in making U.S. capital markets the envy of the world. In searching for material contributors to the continued prosperity of the United States, one could do worse than protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation.
C. Wallace DeWitt is a lawyer in Washington, D.C.