David Lynn points out that the Commission's loss could have been a lot worse given its recent track record before the DC Circuit:
... On the benefit side of the equation, the Court stated "we find it difficult to see what the Commission could have done better," noting that the SEC determined that Congress intended the rule to achieve "compelling social benefits" which the agency was "unable to readily quantify" due to a lack of data about the rule's effects. The Court noted that the SEC had to promulgate the rule based on the statute, and thus necessarily relied on Congress's determination that the costs were necessary for achieving the goals.
With this outcome, the rule writers at the SEC are no doubt breathing a sigh of relief, as they still have a relatively full plate of Dodd-Frank Act and JOBS Act mandated rulemakings that continue to percolate. After a string of high profile losses in this Court and the U.S. District Court for the District of Columbia, this outcome is probably the best that the SEC and the Staff could have hoped for and may serve to pave the way for moving forward with the rest of the rulemaking agenda.
He's got a point.
A coalition of business groups--including the U.S. Chamber of Commerce, National Association of Corporate Directors, National Black Chamber of Commerce, American Petroleum Institute, American Insurance Association, The Latino Coalition, Financial Services Roundtable, Center on Executive Compensation, and Financial Services Forum--have filed a rulemaking petition with the SEC asking that the Commission amend Rule 14a-8 "to increase significantly the percentage of favorable votes required before the company is obligated to include in its proxy materials the substance of proposals shareholders previously rejected."
They make a good case for it, but tis proposal is small beans compared to the much more sweeping changes the rule requires (about which I blogged recently).
Just as I have reservations about empirical scholarship in the law, I have different but equal reservations about economic modeling in the law. But, setting those aside, An Evaluation of Shareholder Activism is a very interesting paper:
We develop a method to evaluate shareholder activism when an activist targets firms whose shareholders are diversified portfolio holders of possibly correlated firms. Our method of evaluation takes the portfolios of all of the shareholders, including the activist, as its basis of analysis. We model the activist from the time of the acquisition of a foothold in the target firm through the moment when the activist divests the newly acquired shares. We assume that during this period, all exchanges of securities, and their corresponding prices, are achieved in Walrasian markets in which all participants, including the activist, are risk-averse price-takers. Using the derived series of price changes of all the firms in the market, as well as the derived series of changes in all the portfolio holdings over this period, we evaluate the impact of activism on the activist, on the group of other shareholders, and on the combined group. We show that when activism is beneficial to the activist, the group of other investors may not benefit; furthermore, even when the activist benefits from activism, the value of the market may decrease. When the activist benefits from activism, an increase in the value of the market is a necessary but not sufficient condition for the group of other investors to benefit also from activism. In addition, we show that the combined group, the activist plus the group of other investors, benefits if and only if the value of the market increases and, under this condition, either the activist or the group of other investors, but not necessarily both, benefits.
In his recent speech, SEC Commissioner Daniel Gallagher also commented on the state of SEC Rule 14a-8--the so-called shareholder proposal rule.
First, he identified the problem:
The Commission’s rules have for decades permitted qualifying shareholders to require the company to publish certain proposals in the company’s proxy statement, which are then voted upon at the annual meeting.
Unfortunately, the Commission has never adequately assessed the costs and benefits of this process. Currently, a proponent can bring a shareholder proposal if he or she has owned $2,000 or 1% of the company’s stock for one year, so long as the proposal complies with a handful of substantive—but in some cases discretionary—requirements. Activist investors and corporate gadflies have used these loose rules to hijack the shareholder proposal system.
The data and statistics are striking. In 2013, the number of shareholder proposals rose ... [but] only 7% of shareholder proposals received majority support in 2013.
These proposals are not coming from ordinary shareholders concerned with promoting shareholder value for all investors. Rather, they are predominantly from organized labor, including union pension funds, which brought approximately 34% of last year’s shareholder proposals, as well as social or policy investors and religious institutions, which accounted for about 25% of 2013’s proposals. Approximately 40% were brought by an array of corporate gadflies, with a staggering 24% of those proposals brought by just two individuals.
He then turned to possible solutions:
First, the holding requirement to submit proxies should be updated. $2,000 is absurdly low, and was not subject to meaningful economic analysis when adopted. The threshold should be substantially more, by orders of magnitude: perhaps $200,000 or even better, $2 million. But I don’t believe that this is actually the right fix: a flat number is inherently over- or under-inclusive, depending on the company’s size. A percentage threshold by contrast is scalable, varies less over time, better aligns with the way that many companies manage their shareholder relations, and is more consistent with the Commission’s existing requirements. Therefore, I believe the flat dollar test should be dropped, leaving only a percentage test. ...
I also think we need to take another look at the length of the holding requirement. A one-year holding period is hardly a serious impediment to some activists, who can easily buy into a company solely for the purpose of bringing a proposal. All that’s needed is a bit of patience, and perhaps a hedge. A longer investment period could help curtail some of this gamesmanship. ...
He also recommends giving companies greater power to exclude shareholder proposals affecting ordinary business matters and capping the number of times a proposal can be repeated.
Much of the Commissioner's analysis is consistent with arguments I made recently in Preserving Director Primacy by Managing Shareholder Interventions. As the abstract explains:
Even though the primacy of the board of director primacy is deeply embedded in state corporate law, shareholder activism nevertheless has become an increasingly important feature of corporate governance in the United States. The financial crisis of 2008 and the ascendancy of the Democratic Party in Washington created an environment in which activists were able to considerably advance their agenda via the political process. At the same time, changes in managerial compensation, shareholder concentration, and board composition, outlook, and ideology, have also empowered activist shareholders.
There are strong normative arguments for disempowering shareholders and, accordingly, for rolling back the gains shareholder activists have made. Whether that will prove possible in the long run or not, however, in the near term attention must be paid to the problem of managing shareholder interventions.
This problem arises because not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors.
This [essay] proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable.
In particular, I argued that:
An appropriate starting point would be the shareholder proposal rule, which figures in about a third of shareholder interventions. Under current law, companies may not opt out of Rule 14a-8. If the law were changed to permit companies to adopt provisions in their articles of incorporation–either in the initial pre-IPO articles or by charter amendment thereafter–that would provide both a check on shareholder interventions and, if widely adopted, it would also provide evidence that investors prefer such provisions.
A less sweeping opt out provision would allow corporations to opt out of the current exemption in Rule 14a-8(i)(1) for proposals that are not proper as a matter of state corporate law. Under present law, a corporation must include in its proxy statement a shareholder proposal that is not a proper subject of a shareholder action under the law of the state of incorporation provided that the proposal is framed as a recommendation. Allowing companies to exclude such proposals even if phrased in precatory terms would provide a rough first cut at effecting the proposed substance/procedure distinction.
In order to effect that distinction, the exemption under Rule 14a-8(i)(7) for proposals relating to ordinary business expenses needs to expanded and revitalized. Under current law, the ordinary business exclusion is essentially toothless. The SEC requires companies to include proposals relating to stock option repricing, sale of genetically modified foods and tobacco products by their manufacturers, disclosure of political activities and support to political entities and candidates, executive compensation, and environmental issues. Obviously, however, these sort of ordinary business decisions are core board prerogatives. Because deference to board authority remains the default presumption, this exemption therefore needs to be expanded and revitalized.
Activist shareholders who make use of Rule 14a-8 should be required to provide greater disclosures with respect to their motivations, goals, economic interests, and holdings of the issuer’s securities (including derivative positions), so that their fellow shareholders can assess whether the activist’s goals are consistent with the interests of all shareholders. Towards the same end, the eligibility threshold for using Rule 14a-8 should be increased to require that the proponent have held a net long position of 1 percent of the issuer’s voting stock for at least two years. In addition to decreasing the risk that the activist would be pursuing private rent seeking, by discouraging proposals from activists using an empty voting strategy, such a change will ensure that activists are long-term investors rather than short-term speculators.
The proxy rules also should be amended to prevent hedge funds from compensating those members of an issuer’s board of directors that were nominated by the fund. The recent trend toward such payments raises serious conflicts of interest, as the hedge fund’s nominees likely will be loyal to the fund rather than the issuer. In particular, such directors have financial incentives to acquiesce in—or even assist—private rent seeking by their fund sponsor.
In an important recent speech, SEC Commissioner Daniel Gallagher touched on a number of key issues, all of which will be blog fodder. First, he discussed what I have called "The Creeping Federalization of Corporate Law":
Unfortunately, the trend towards increased federalization of corporate governance law seems well-entrenched. ...
Some of [SOX and Dodd-Frank's] requirements unashamedly interfere in corporate governance matters traditionally and appropriately left to the states. Others masquerade as disclosure, but are in reality attempts to affect substantive behavior through disclosure regulation. This mandated intrusion into corporate governance will impose substantial compliance costs on companies, along with a one-size-fits-all approach that will likely result in a one-size-fits-none model instead. This stands in stark contrast with the flexibility traditionally achieved through private ordering under more open-ended state legal regimes.
I couldn't agree more. Indeed, back in 2003 I wrote that:
The basic case for federalizing corporate law rests on the so-called “race to the bottom” hypothesis. States compete in granting corporate charters. After all, the more charters the state grants, the more franchise and other taxes it collects. According to the race to the bottom theory, because it is corporate managers who decide on the state of incorporation, states compete by adopting statutes allowing corporate managers to exploit shareholders. As the clear winner in this state competition, Delaware is usually the poster-child for bad corporate governance. Interestingly, the two main poster-children for reform, Enron and WorldCom, were not Delaware corporations. (They were incorporated in Oregon and Georgia, respectively.)
Basic economic common sense tells us that investors will not purchase, or at least not pay as much for, securities of firms incorporated in states that cater too excessively to management. Lenders will not lend to such firms without compensation for the risks posed by management’s lack of accountability. As a result, those firms’ cost of capital will rise, while their earnings will fall. Among other things, such firms thereby become more vulnerable to a hostile takeover and subsequent management purges. Corporate managers therefore have strong incentives to incorporate the business in a state offering rules preferred by investors. Competition for corporate charters thus should deter states from adopting excessively pro management statutes. The empirical research bears out this view of state competition, suggesting that efficient solutions to corporate law problems win out over time.
Roberta Romano’s event study of corporations changing their domicile by reincorporating in Delaware, for example, found that such firms experienced statistically significant positive cumulative abnormal returns. In other words, reincorporating in Delaware increased shareholder wealth. This finding strongly supports the race to the top hypothesis. If shareholders thought that Delaware was winning a race to the bottom, shareholders should dump the stock of firms that reincorporate in Delaware, driving down the stock price of such firms. As Romano found, and all of the other major event studies confirm, there is a positive stock price effect upon reincorporation in Delaware.
The event study findings are buttressed by a well-known study by Robert Daines in which he compared the Tobin’s Q of Delaware and non-Delaware corporations. (Tobin’s Q is the ratio of a firm’s market value to its book value and is a widely accepted measure of firm value.) Daines found that Delaware corporations in the period 1981-1996 had a higher Tobin’s Q than those of non-Delaware corporations, suggesting that Delaware law increases shareholder wealth. Although subsequent research suggests that this effect may not hold for all periods, Daines’ study remains an important confirmation of the event study data.
Additional support for the event study findings is provided by takeover regulation. Compared to most states, which have adopted multiple anti-takeover statutes of ever-increasing ferocity, Delaware’s single takeover statute is relatively friendly to hostile bidders. An empirical study of state corporation codes by John Coates confirms that the Delaware statute is the least restrictive and imposes the least delay on a hostile bidder. Given the clear evidence that hostile takeovers increase shareholder wealth, this finding is especially striking. The supposed poster child of bad corporate governance, Delaware, turns out to be quite takeover-friendly and, by implication, equally shareholder-friendly.
The takeover regulation evidence is especially important, because state anti-takeover laws are the principal arrow in the quiver of modern race to the bottom theorists. In a series of articles, Lucian Bebchuk and his co-authors point out that state takeover regulation demonstrably reduces shareholder wealth but that most states have nevertheless adopted anti-takeover statutes. Even many advocates of the race to the top hypothesis concede that state regulation of corporate takeovers appears to be an exception to the rule that efficient solutions tend to win out. But so what? Nobody claims that state competition is perfect. The question is only whether some competition is better than none. Delaware’s relatively hospitable environment for takeovers suggests an affirmative answer to that question.
Bebchuk et al.’s arguments in favor of federal preemption, moreover, betray a complete lack of sympathy for—and perhaps even awareness of—the vital relationship between federalism and liberty. In other words, even if Bebchuk could prove that state competition is a race to the bottom, basic federalism principles would still counsel against federal preemption of corporate law. The corporation is a creature of the state, “whose very existence and attributes are a product of state law.” States have an interest in overseeing the firms they create. States also have an interest in protecting the shareholders of their corporations. Finally, a state has a legitimate “interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.” In other words, state regulation not only protects shareholders, but also protects investor and entrepreneurial confidence in the fairness and effectiveness of the state corporation law.
According to the Supreme Court’s CTS decision, the country as a whole benefits from state regulation in this area, as well. As Justice Powell explained in that case, the markets that facilitate national and international participation in ownership of corporations are essential for providing capital not only for new enterprises but also for established companies that need to expand their businesses. This beneficial free market system depends at its core upon the fact that corporations generally are organized under, and governed by, the law of the state of their incorporation. This is so in large part because ousting the states from their traditional role as the primary regulators of corporate governance would eliminate a valuable opportunity for experimentation with alternative solutions to the many difficult regulatory problems that arise in corporate law. As Justice Brandeis pointed out many years ago, “It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of country.” So long as state legislation is limited to regulation of firms incorporated within the state, as it generally is, there is no risk of conflicting rules applying to the same corporation. Experimentation thus does not result in confusion, but instead may lead to more efficient corporate law rules.
In contrast, the uniformity imposed by Sarbanes-Oxley will preclude experimentation with differing modes of regulation. As such, there will be no opportunity for new and better regulatory ideas to be developed—no “laboratory” of federalism. Instead, we will be stuck with rules that may well be wrong from the outset and, in any case, may quickly become obsolete.
The point is not merely to restate the race to the top argument. Competitive federalism promotes liberty as well as shareholder wealth. When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. if one regulator overreaches, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, such that exit by the regulated is no longer an option, an essential check on excessive regulation is lost.
In other words, by promoting the economic freedom to pursue wealth, competitive federalism does more than just expand the economic pie. A legal system that pursues wealth maximization necessarily must allow individuals freedom to pursue the accumulation of wealth. Economic liberty, in turn, is a necessary concomitant of personal liberty—the two have almost always marched hand in hand. The pursuit of wealth has been a major factor in destroying arbitrary class distinctions, moreover, by enhancing personal and social mobility. At the same time, the manifest failure of socialist systems to deliver reasonable standards of living has undermined their viability as an alternative to democratic capitalist societies in which wealth maximization is a paramount societal goal. Accordingly, it seems fair to argue that the economic liberty to pursue wealth is an effective means for achieving a variety of moral ends.
In turn, the modern public corporation has turned out to be a powerful engine for focusing the efforts of individuals to maintain the requisite sphere of economic liberty. Those whose livelihood depends on corporate enterprise cannot be neutral about political systems. Only democratic capitalist societies permit voluntary formation of private corporations and allot them a sphere of economic liberty within which to function, which gives those who value such enterprises a powerful incentive to resist both statism and socialism. As Michael Novak observes, private property and freedom of contract were “indispensable if private business corporations were to come into existence.” In turn, the corporation gives “liberty economic substance over and against the state.”
Jonathan Adler weighs in:
In an opinion by Judge Raymond Randolph (joined by Judge David Sentelle), the court concluded that compelled disclosures of commercial information are subject to the same level of First Amendment scrutiny as are other regulations of commercial speech (under the Central Hudson test), unless the disclosures are limited to “purely factual and uncontroversial information” and the mandatory disclosure is “reasonably related to the State’s interest in preventing deception of consumers.”
Because, as the SEC conceded, the conflict mineral disclosure requirements have nothing to do with preventing consumer deception, the court concluded the rules should be evaluated under Central Hudson. Under this test, the requirements must serve a substantial government interest, directly advance that interest, and be narrowly tailored. Whether or not the SEC could demonstrate that its conflict mineral disclosure rule satisfies a substantial government interest, the court found the SEC offered no evidence that its rule was narrowly tailored. On this basis the court struck down the requirement that companies declare that products “have not been found to be ‘DRC conflict free.’” Insofar as Dodd-Frank requires other disclosures, including reports to the SEC, such requirements were upheld.
Go read the whole thing.
The DC Circuit's decision in NAM v. SEC, which partially struck down the SEC's conflict mineral disclosure rule is doubtless an important decision. But let's not get carried away. If anyone thinks that the conflict minerals case presages constitutional invalidation of the mandatory disclosure, they would be reading way too much into the opinion.
First, it seems clear that the court is not foreclosing all conflict mineral disclosure rules, just this one. See footnote 14 of the majority opinion:
The requirement that an issuer use the particular descriptor “not been found to be ‘DRC conflict free’” may arise as a result of the Commission’s discretionary choices, and not as a result of the statute itself. We only hold that the statute violates the First Amendment to the extent that it imposes that description requirement. If the description is purely a result of the Commission’s rule, then our First Amendment holding leaves the statute itself unaffected.
Second, note the majority's discussion of SEC v. Wall Street Publishing Institute at page 20-21 of the opinion. It rather clearly suggests that SEC securities regulation that plausibly can be linked to preventing consumer deception will be reviewed under the commercial speech standards.
Third, note the concurrence/dissent's discussion of the pending American Meat Institute v. United States Department of Agriculture case. As Judge Srinivasan notes, the en banc panel in that case "will receive supplemental briefing on the question whether review of 'mandatory disclosure' obligations can 'properly proceed under Zaudere' even if they serve interests 'other than preventing deception.'" The panel decision here assumes that the answer to that question is no. But what if it is yes?
Finally, beyond the scope of the present decision, there are lots of precedents suggesting that the constitutonality of the basic mandatory disclosure regime is beyond peradventure. See, e.g., Ohralik v. Ohio State Bar Ass'n 436 U.S. 447, 456 (1978) (stating in dicta that: Numerous examples could be cited of communications that are regulated without offending the First Amendment, such as the exchange of information about securities . . . .”); Paris Adult Theatre I v. Slaton, 413 U.S. 49, 61-62 (1973) (noting that “both Congress and state legislatures have ... strictly regulated public expression by issuers of and dealers in securities ... commanding what they must and must not publish and announce”); Full Value Advisors, LLC v. SEC, 633 F.3d 1101 (D.C. Cir. 2011) (“Securities regulation involves a different balance of concerns and calls for different applications of First Amendment principles.” ); United States v. Bell, 414 F.3d 474, 484-85 (3d Cir. 2005) (holding that the government may regulate speech so as to prevent consumer deception and, accordingly, that “mandatory disclosure of factual, commercial information does not offend the First Amendment”); Blount v. SEC, 61 F.3d 938, 944-47 (D.C. Cir. 1995) (holding that the SEC's anti-pay to play Rule G-37 survived strict First Amendment scrutiny); SEC v. Wall St. Publ'g Inst., Inc., 851 F.2d 365, 374-76 (D.C. Cir. 1988), cert. denied, 489 U.S. 1066 (1989) (holding that an investment newsletter could be required to disclose whether it was being paid to run an article touting a stock article).
In sum, don't bet the house on a constitutional challenge to mandatory disclosure.
As my Competitive Enterprise Institute colleague Hans Bader and I have written in blog posts, articles, and regulatory comments, the conflict disclosure mandate creates a compliance nightmare, hurts American miners and manufacturers, and does the greatest harm to those it was intended to help — the struggling worker in and nearby the Democratic Republic of Congo. ...
Fighting violence in the Congo is a laudable goal, but it defies common sense and basic civics to pursue foreign-policy objectives through a banking and investment bill. The government entity charged with enforcing this provision is neither the State Department nor the Defense Department, but rather the Securities and Exchange Commission — which no one would call an agency well-schooled in the nuances of foreign policy.
The Court looked at this leap of logic and decided that the provision could not survive the First Amendment’s prohibition against “compelled speech,” even under the lesser standard for “commercial speech.” As Judge A. Raymond Randolph wrote in the majority opinion, this compelled speech is not even “reasonably related” to the SEC’s mission of “preventing consumer deception.” The opinion concludes, “By compelling an issuer [publicly-traded company] to confess blood on its hands, the statute interferes with that exercise of the freedom of speech under the First Amendment.”
I agree with much of what Berlau says, although I would caution that I read the majority opinion as making a rather narrow ruling:
This brings us to the Association’s First Amendment claim. The Association challenges only the requirement that an issuer describe its products as not “DRC conflict free” in the report it files with the Commission and must post on its website. ... That requirement, according to the Association, unconstitutionally compels speech. ...
Specifically, the Commission argues that issuers can explain the meaning of “conflict free” in their own terms. But the right to explain compelled speech is present in almost every such case and is inadequate to cure a First Amendment violation. See Nat’l Ass’n of Mfrs., 717 F.3d at 958. Even if the option to explain minimizes the First Amendment harm, it does not eliminate it completely. Without any evidence that alternatives would be less effective, we still cannot say that the restriction here is narrowly tailored.
We therefore hold that 15 U.S.C. § 78m(p)(1)(A)(ii) & (E), and the Commission’s final rule, 56 Fed. Reg. at 56,362-65, violate the First Amendment to the extent the statute and rule require regulated entities to report to the Commission and to state on their website that any of their products have “not been found to be ‘DRC conflict free.’”14
14 The requirement that an issuer use the particular descriptor “not been found to be ‘DRC conflict free’” may arise as a result of the Commission’s discretionary choices, and not as a result of the statute itself. We only hold that the statute violates the First Amendment to the extent that it imposes that description requirement. If the description is purely a result of the Commission’s rule, then our First Amendment holding leaves the statute itself unaffected.
It seems to me that that court left the SEC (and Congress) a lot of room to go back and adopt new conflict mineral disclosure rules. Such rules would be a bad idea, but they could doubtless be crafted to pass constitutional muster. After all, the whole SEC disclosure apparatus regulates speech and nobody with any sense thinks federal courts are ever going to strike down that apparatus as a violation of the First Amendment.
The WSJ reports that:
A federal appeals court, citing free-speech concerns, partly overturned a controversial rule requiring publicly traded U.S. companies to disclose whether their goods contain certain minerals whose sales result in profits that fund violent armed groups in Central Africa.
The U.S. Court of Appeals for the District of Columbia Circuit said the Securities and Exchange Commission's rule violates the First Amendment by "compelling" companies to disclose whether their products are "ethically tainted, even if they only indirectly finance armed groups."
I've been a critic of the rule on grounds that it was over burdensome, but did not see a successful First Amendment claim coming. It is almost unheard of for the SEC to have a rule struck down on free speech grounds. Indeed, I often tell my students that there is a little-known codicil to the first amendment that allows the SEC to regulate speech however it wants.
Back in January, by way of contrast, Frank Murray of Foley & Lardner predicted this might happen:
While much of the focus within the business community has been on the administrative burdens of tracing the origin of conflict minerals (tin, tantalum, tungsten and gold) used in a company’s products, the most spirited questioning from the bench during the recent oral argument related to whether the rule infringes companies’ freedom of speech. The business groups challenging the SEC’s rule have alleged that the conflict minerals disclosure regime represents government-compelled speech in contravention of the First Amendment. They have contended that the conflict minerals regime unconstitutionally compels companies to make an ideologically-driven, rather than fact-based, statement about their own products – namely, that the products “have not been found to be conflict-free.” This type of speech, they contend, forces companies to stigmatize themselves and denounce their own products based on information that is speculative, rather than fact-based. The business groups also object to the requirement that companies post conflict minerals reports and information on their corporate websites, contending during oral argument that those websites “are our space.”
Apparently, the appeals court ended up agreeing at least in part (I haven't seen the opinion yet).
Going even further back Thomas Armstrong and Beth J. Kushner argued in a WLF Legal Backgrounder that the rule was constitutionally suspect:
Because Section 1502 forces publicly-traded corporations to speak publicly on matters having nothing to do with the safety of their products or the economics of investing in their stock but, rather, compels those companies to speak to the general public on matters of public interest, the authors submit that Section 1502 likely violates the First Amendment. This is particularly so with respect to Section 1502’s requirement that publicly-traded corporations disclose information to consumers on company websites, in addition to providing conflict minerals reports to the SEC. ...
Because the purpose of Section 1502 has nothing to do with preventing consumer deception, the required information proposes no commercial transaction with the public, the compelled disclosure does not relate solely to the interests of the speaker, and the disclosure on company websites is unrelated to stock ownership in the company or to marketing the company’s securities, it would seem apparent that the compelled disclosures are not commercial speech. Rather, as evidenced by the declared purpose of Section 1502 – i.e., to reduce or eliminate the humanitarian crisis in the DRC by depriving armed groups of the economic benefits of commercial activity involving conflict minerals – the information relates to matters of significant public concern. Speech concerning such a matter of public importance, or the right not to speak on this subject, likely enjoys full First Amendment protection. ...
Go read the whole thing. It's succinct and helpful.
Update: Copy of the opinion available here.
In a criminal trial, the federal government has long been obliged to promptly turn over to the defense any evidence that could show that the accused did not commit the offense of which he is accused. The Brady rule (announced in the 1963 Supreme Court case, Brady v. Maryland), prevents one-sided prosecutions in which the defendant is kept in the dark about information that might show that he is innocent.
The government's job as criminal prosecutor is not to obtain convictions, but "to do justice," according to the traditional legal maxim. It should be required to follow the Brady rule in civil trials as well. But the SEC does not, even when it accuses a citizen of fraud. Had the agency complied with this simple rule in its recent insider-trading case against one of us, Mark Cuban, it is unlikely that a lawsuit would even have been filed, let alone go to trial. ...
An agency that has the ability to bring the full force of the federal government against a citizen in a fraud case should play by the same fair rules that have governed federal prosecutors for decades. It should be required to turn over, without awaiting a request, any evidence that could exculpate the defendant. It should announce now that it will follow the mandates of the Brady rule in all pending and future cases.
It is curious that the SEC has not done so. The agency's internal rules effectively compel it to disclose exculpatory evidence to defendants in administrative proceedings where it has a huge "home court" advantage. But no such rule applies to its litigation, and the SEC for years has fought imposition of a Brady obligation.
The Brady rule would not simply mean that civil trials instituted by the federal government would be conducted on the basis of the whole truth. The best result would be that weak cases would not be brought in the first place. Not even the most stubborn or ambitious SEC lawyer would pursue a case when he knew, in advance, that evidence disproving his case must be turned over to the other side.
The agency should embrace the concept that "justice be done" in all of its cases, not just some of them, and hold itself to the same principle of "accountability" that is at the core of the agency's promise to investors.
There was a very good student note in the Minnesota Law Review back in 2011 that argued in much greater detail that the SEC and other administrative agencies should adopt the Brady rule:
Abstract: Due process protections for defendants vary greatly between the numerous federal agencies vested with civil enforcement powers. Many of these agencies fail to provide defendants with basic safeguards, including the protections available in the Federal Rules of Criminal Procedure. As federal administrative agencies continue to increase both the scope of their enforcement authority and the penalties they assess, such due process deficiencies become even more apparent. This state of affairs is surprising considering the U.S. Supreme Court’s ruling in Brady v. Maryland, in which it held that the Fifth Amendment binds government prosecutors with a duty to disclose material, exculpatory evidence to a defendant. This duty derives from the Court’s axiom that a government prosecutor must seek justice, not victory, in the courtroom—an axiom that logically extends to civil enforcement actions.
To rectify this due process deficiency, the Note argues that the Brady precedent should apply to all federal administrative agencies’ formal adjudications. The few federal agencies that have adopted the Brady rule for this purpose have employed it successfully and can serve as a model for other federal agencies. Additionally, defendants facing these agencies receive due process protections that are more comparable with Article III civil and criminal defendants than those defendants before agencies that reject Brady.
In preparing to teach shareholder voting in today's Business Associations class, I came across this very helpful video walking novices through a sample proxy statement from Apple. Recommended viewing for my students (and readers):
Theo Francis, freelance journalist and researcher for Disclosure Matters LLC, offers a walk-through of Apple's proxy, providing tips for analyzing many company filings accessed through SEC.gov.
The Wall Street Journal this week documented several, though not all, of the types of market abuse and manipulation that the current outmoded reporting rules permit and facilitate. The existing rules give activists an over-long 10-day period before they are required to report crossing the 5% ownership threshold in publicly traded companies. According to The Wall Street Journal, during the 10-day reporting window, activist hedge funds are “tipping” each other regarding their plans as they coordinate wolf-pack attacks, while ordinary investors and the targeted companies are left in the dark. When finally made, the 13(d) reports are often market-moving. This delivers outsized returns to the activist and those they tip, while injuring investors who are deprived of the same knowledge.
In an era of high frequency trading, the 10-day reporting window adopted by the Williams Act in 1968 simply makes no sense. It is time for the SEC to act on our petition to shorten the reporting window to one day, to adopt a “cooling-off period” of two business days following the public filing of an initial Schedule 13D, during which acquirers would be prohibited from acquiring additional beneficial ownership, and to modernize the definition of “beneficial ownership” under the Section 13 reporting rules to prevent activists from acquiring significant influence and control using a variety of stealth techniques and derivative instruments to evade Section 13D reporting requirements.
The ten day window maybe made sense back in the old days when one filed everything on paper. But in these days of electronic filing, when the SEC has accelerated filing of a host of disclosures, it makes no sense to let 5% holders have 10 days of secrecy. (Assuming you buy the case for any disclosure by 5% holders, of course.)
Interesting speech by SEC Division of Corporate Finance Director Keith Higgins highlighting the flux in the regulatory landscape for angel investors.
The SEC requires all settling parties to agree that they will neither directly nor indirectly make any public statement that calls into question the accuracy of any allegation made in the SEC’s complaint. Thus, a settling party who had meritorious defenses, but could not afford to litigate, may not say so publicly. Moreover, the policy, intended to put teeth into the SEC’s enforcement message, can have the unintended consequence of allowing government lawyers to operate “in the shadows” by preventing those with the greatest knowledge of the stated accusations or the process used to develop those accusations from criticizing either.
He goes on to make a very impressive case.