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UCLAW's James Park's article Karmel’s Dissent: The SEC’s Use and Occasional Misuse of Section 21(A) Reports of Investigation

My friend and UCLA colleague Jim Park has just posted a new article that will be of interest to securities lawyers:

Section 21(a) of the Securities Exchange Act gives the SEC the option of publishing a report of its findings after conducting an investigation. Typically, the SEC issues such reports about once a year to highlight major compliance and enforcement issues. This Article examines the SEC’s use of Section 21(a) investigative reports with special attention to its 1979 report in Spartek, where Commissioner Roberta Karmel filed a famous dissent. In that opinion, she argued that the report effectively sanctioned conduct over which the SEC did not have jurisdiction and that Spartek did not have sufficient notice of its regulatory obligations. While such concerns have not been at issue in most Section 21(a) reports of investigation, they were recently raised by the SEC’s report in DAO, which analyzed whether a digital token was a security under the Howey test. While the SEC’s conclusion was reasonable, it was a close call, and the report did little to clarify the scope of the SEC’s jurisdiction over tokens. The SEC should be cautious in using reports of investigation to define its own jurisdiction and should actively seek adjudication to confirm the scope of its authority.

Karmel’s Dissent: The SEC’s Use and Occasional Misuse of Section 21(A) Reports of Investigation (January 13, 2022). Brooklyn Journal of Corporate, Financial & Commercial Law (forthcoming), UCLA School of Law, Law-Econ Research Paper No. 22-01, Available at SSRN: https://ssrn.com/abstract=4008573

Statement by SEC Commissioners Peirce and Roisman Slamming Chair Gensler’s Regulatory Agenda

Peirce and Roisman slam Gary Gensler's agenda:

While Chair Gary Gensler’s newly released regulatory agenda is ambitious in scope, we are disappointed with its content. It fails to include any items intended to facilitate capital formation and misses opportunities to foster fair, orderly, and efficient markets and further investor protection. Instead the agenda is brimming with plans to redo recently completed rules, add new regulatory obligations, and constrain investor choice. ...

The Agenda makes plenty of room for rulemakings to undo rulemakings that the Commission only recently completed.  These include proposals to further amend our rules on proxy solicitation and shareholder proposals; the Resource Extraction Payments Rule; the rules pertaining to the accredited investor definition and the private offering exemption integration framework; as well as our whistleblower rules. Not only are the Commission’s most recent amendments to each of these rules barely or less than a year old; none have been effective for more than a few months. As we said when we initially raised these concerns, we have not seen any new information that would warrant opening up any of these rules for further changes at this time.  So, why the rush to revisit them?

Why, indeed. The whole thing makes depressing reading.

Keith Bishop asks "Could The SEC Have Made A Weaker Case For Mandating Enhanced Repurchase Disclosures?"

It's a great question:

As I read the SEC's 102-page rule proposal, I was struck by the SEC's repeated use of "could".   According to my count, the word appears 90 times in the proposing release.   

"Could" is the past participle of "can".  When used as a substitute for "can", "could" implies a greater degree of uncertainty.   When we say that something "could happen" we mean that it might or might not happen.   Essentially, it means that something is possible, not that it necessarily will occur.  Thus, the proposing release's constant use of the word conveys a notable incertitude on the part of the SEC. 

I wonder if one could use that as a challenge to the eventual rule. After all, the SEC's seen a lot of high profile rules go down in flames due to lousy cost-benefit analyses.

What I need are some really rich conservatives to finance a Rule 14a-8 shareholder proposal campaign

I have a splendid idea to advance the pro-life cause while calling attention to the SEC's recent liberalization of the shareholder proposal rule. It came up in a Twitter conversation with SEC Commissioner Hester Peirce:

I'm still hoping there's an anchor in common sense--a company's proxy should be about the company. We'll have to evaluate, though, at the end of the proxy season.

— Hester Peirce (@HesterPeirce) November 30, 2021

Plus, imagine the havoc if some concerned law professor could persuade wealthy conservatives to mimic James McRitchie and John Chevedden. If there is no nexus, we could bombard companies with anti-abortion proposals and dare the SEC to say they lack social significance. pic.twitter.com/CwXTpKPMaW

— Steve Bainbridge (@PrawfBainbridge) November 30, 2021

Will the SEC now allow shareholder proposals on abstract political, social, and economic questions?

The SEC's latest guidance on Rule 14a-8 (the shareholder proposal rule) abandoned an important limitation on the scope of permissible shareholder proposals:

Rule 14a-8(i)(7), the ordinary business exception, is one of the substantive bases for exclusion of a shareholder proposal in Rule 14a-8. It permits a company to exclude a proposal that “deals with a matter relating to the company’s ordinary business operations.” ...

... staff will no longer focus on determining the nexus between a policy issue and the company, but will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal. In making this determination, the staff will consider whether the proposal raises issues with a broad societal impact, such that they transcend the ordinary business of the company.

It has been speculated that this announcement "represents a wholesale abandonment of any assessment of relevance of a proposal to a company’s business (as compared to relevance to society at large)." If so, it would represent an abandonment of longstanding rules, including "the “nexus” concept was embedded in the 1998 Release, as stated in Staff Legal Bulletin 14E (Oct. 27, 2009), at footnote 4 (citing the 1998 Release), and reaffirmed in Staff Legal Bulletin 14H (Oct. 22, 2015)."

I am reminded in this regard of a 1945 SEC opinion, which concluded that "the phrase “proper subject for action” to mean proposals which relate directly to the affairs of the particular corporation and concludes that proposals which deal with general political, social or economic matters are not, within the meaning of the rule, 'proper subjects for action by security holders.'" The Sec Today Released an Op. of Baldwin B. Bane, Release No. 735 (S.E.C. Release No. Jan. 3, 1945). Has the SEC now abandoned that position, such that "proposals which deal with general political, social or economic matters" unrelated tp the company's business will now be includable?

This makes no sense. As the 1945 release explained, the purpose of the shareholder proposal rule is "to place stockholders in a position to bring before their fellow stockholders matters of concern to them as stockholders in such corporation ...." The clear implication is that there must be some nexus between the proposal and the company's bison's activities:

... in 1945 the Commission issued a release containing an opinion of the Director of the Division of Corporation Finance that was rendered in response to a management request to omit shareholder resolutions which bore little or no relationship to the company's affairs; for example, these shareholder resolutions included proposals "that the anti-trust laws and the enforcement thereof be revised," and "that all Federal legislation hereafter enacted providing for workers and farmers to be represented should be made to apply equally to investors." The Commission's release endorsed the Director's conclusion that "proposals which deal with general political, social or economic matters are not, within the meaning of the rule, ‘proper subjects for action by security holders.'"

Med. Comm. for Human Rights v. Securities and Exch. Commn., 432 F.2d 659, 677 (D.C. Cir. 1970), vacated, 404 U.S. 403 (1972). Are shareholder proposals "that the anti-trust laws and the enforcement thereof be revised" now admissible? It seems possible:

“By repealing longstanding guidance about treatment of shareholders proposals, the SEC has stated its preference to turn board rooms and shareholder meetings into political debate societies on issues the SEC admits have no nexus to the actual business of the company,” Tom Quaadman, an executive vice president with the Chamber, said in a statement. “This will all come at the expense of companies' ability to focus on long-term performance, including the welfare of their employees, customers, and shareholders.”

Commissioners Criticize New SEC Staff Interpretation on Rules Governing Shareholder Proposals, WGL-ACCTALERT VOL 15 NO 213.

All of which strikes me as problematic. After all, shareholders have a “First Amendment interest in not being forced to be associated with political speech that they do not support." Lucian A. Bebchuk & Robert J. Jackson, Jr., Corporate Political Speech: Who Decides?, 124 Harv. L. Rev. 83, 113 (2010). If that's true about political speech by the corporate, as Bebchuk and Jackson claim, should it not be even more true with respect to political speech foisted upon the corporation by government fiat regardless of whether the speech has any meaningful relationship to the company's business?

Milbank ducks the hard question: Why does the SEC get to decide what issues have social significance?

In an otherwise very useful post on the new SEC shareholder proposal rule guidance, Milbank ducks the really hard question:

As a result of the SEC’s most recent Staff Legal Bulletin[1] (“SLB”), shareholder proposals that focus on a “significant social policy” will not be excludable simply because the policy issue is not, in fact, “significant” to the company receiving the proposal. The SEC has decided it will no longer “focus on the nexus between a policy issue and the company.”  Previously, shareholder proposals that did not raise a “policy issue of significance for the company” were excludable under the “ordinary course of business” exception to Rule 14a-8.[2] The new Staff Legal Bulletin is a departure from past SEC practice, and led the SEC to simultaneously rescind three previous Staff Legal Bulletins on the same subject.

Leaving aside the issue of why the SEC – which is presumably dedicated to the regulation of securities – should be determining in the abstract which social issue are “significant,” it is clear from the new bulletin that climate change and human capital management are issues that will be considered “significant.” Beyond that specific guidance, the SEC promises only that “in making this determination [regarding significance], the staff will consider whether the proposal raises issues with a broad societal impact.” This is a standard that doesn’t exactly hem in the SEC or limit the imagination of activists and gadflies.

Given the new woke majority at the SEC led by wide awake Gary Gensler, we can expect firms to be forced into including all sorts of progressive proposals having no meaningful nexus to their business. In a world in which the First and Seventh Amendments had teeth, this would be a regulatory taking by compelled speech.

Dear Securities and Exchange Commission: I Do Not Want to Know How my Funds Vote

From Davis Polk:

On September 29, 2021, the Securities and Exchange Commission (SEC) proposed amendments to Form N-PX to enhance the information mutual funds, exchange-traded funds (ETFs), and other registered management investment companies (collectively, funds) currently report annually about their proxy votes. The SEC also proposed new Rule 14Ad-1 under the Securities Exchange Act of 1934, as amended (Exchange Act) and amendments to Form N-PX to require institutional investment managers subject to Section 13(f) of the Exchange Act (managers) to report annually on Form N-PX how they voted proxies on executive compensation, or so-called “say-on-pay” matters.

...

The SEC is also proposing to require funds and managers to categorize each proxy voting matter reported on Form N-PX so that investors can focus on the topics they find important.

I am going to try to explain this in words simple enough even for an SEC bureaucrat to understand: Because I am an intelligent investor, I invest in passively managed index funds. The only thing I need or want to know about my funds is whether they are matching the index they claim to track. In the case of my S&P 500 fund, for example, all I want to know is how the S&P 500 index did in the relevant period and how the fund did. 

I do not want my funds spending my money on administrative nonsense like detailed proxy voting disclosures. All that does is raise my costs and reduce my returns.

How hard is that for you people to understand?

SEC Commissioner Hester Peirce was the sole commissioner to vote against this moronic proposal. She explained that:

Although a fund’s voting strategy can be an important part of the overall fund management strategy, how or why a fund votes, or even whether a fund votes on a particular issue at a particular portfolio company is unlikely materially to influence an investor’s choice to invest in a particular fund. 

Exactly right.

So what's going on here? Is the SEC just stupid? Or is this part of Chairman Gary gensler's woke capitalism agenda? Back to Commissioner Peirce:

The real interest in this kind of detailed voting information seems to come from activists and the ever-expanding population of “stakeholders,” for whom proxy voting seems to be the fund’s highest purpose.  In 2003, when the SEC was considering the original Form N-PX fund voting disclosure mandate, the heads of the two then-largest asset managers jointly penned a remarkably prescient Wall Street Journal opinion piece.  In it, they warned that:

[R]equiring mutual-fund managers to disclose their votes on corporate proxies would politicize proxy voting.  In case after case, it would open mutual-fund voting decisions to thinly veiled intimidation from activist groups whose agendas may have nothing to do with maximizing our clients’ returns.

Expect the SEC to Favor Woke Shareholder Proposals: The SEC's Appalling New 14a-8 Guidance

Wachtell Lipton reports:

The SEC Staff has issued revised guidance rescinding prior Staff Legal Bulletins addressing the exclusion of Rule 14a-8 shareholder proposals based on the social significance to a company, “micromanagement” or  “economic relevance.”  The changes will likely facilitate a larger number of shareholder proposals, including ESG proposals, coming to a shareholder vote. ...

The new guidance revises the SEC’s application of the “ordinary business” exclusion, which considered whether a proposal was of social policy significance or sought to micromanage a company.  While the Staff has previously focused on the significance of a social policy issue to a particular issuer, they will now focus on the proposal’s “broad societal impact.”  

This is appalling. In effect, the SEC is saying that corporate proxy statements can be conscripted by somebody owning a trivial amount of stock to solve "societal problems" that may have virtually no nexus to the company.

In addition, the SEC is encouraging shareholders to micromanage the company when it comes to woke issues:

For example, a proposal requesting a company set greenhouse gas emission targets, but providing the company with discretion on a method for its implementation, will no longer meet the threshold for exclusion based on micromanagement.  

How is deciding corporate environmental policy not micromanagement?

Wachtell concludes:

it is not clear which social issues the Staff will deem broad enough to “transcend the ordinary business,” beyond the Staff’s examples of proposals relating to human capital management with a broad social impact or to greenhouse gas emissions targets without specific methodologies.  

Piffle. It is perfectly obvious that the SEC has become a tool of the Warren/Sanders/AOC wing of the Democratic Party and is now leading the charge towards woke capitalism. I feel confident in predicting that woke shareholder proposals will breeze through the process. In the unlikely event that conservatives emulated progressives and started using the shareholder proposals to effect their policy goals, however, I'd bet the SEC allows their exclusion.

 

Alan Palmiter On Capitalism Healing Itself

Alan Palmiter has a new article out, with a handy summary on The CLS Blue Sky Blog:

A paradigm shift is underway: The corporation – much reviled as a cost-externalizing, short-termist, inward-focused, politically manipulative machine – is undergoing a fundamental change. This is good news. Corporations are beginning to confront the harm they created, allowing capitalism to start healing itself.

Alan argues there are three factors at work:

First, most large investment funds are either incorporating ESG into their investment decisions or tracking stock market indices. ...

The second powerful force at work is ESG.  Over the last several years, it has become clearer that corporations that seek to be aware of their environmental, social, and governance actions (ESG) have perform better financially. ...

The third powerful force at work is the (almost miraculous) communication and information advances of the internet. Investors learn in milliseconds what is happening with companies.

He concludes:

Here’s the takeaway.  Indexing, ESG performance, and the internet seem to have come together in a way that puts capitalism in a position to heal itself.

I'm a bit more skeptical, probably because I'm more cynical and pessimistic about human nature. But I like the project a lot anyway.

 

New SEC Proxy Voting Disclosure Proposal

This tweet kicks off a string of 8 tweets on the new proposal:

1/ The @WSJ reported today that the SEC plans to require asset managers to provide more extensive disclosures about how they vote the shares of portfolio companies. https://t.co/4XIT2JQLAC #lawtwitter This annoys me.

— Steve Bainbridge (@PrawfBainbridge) October 1, 2021

My post on the SEC steeping out of its wheelhouse by investigating Activision's employment practices got noticed

Keith Bishop at @JDSupra also picked up my post on Activision and the SEC's stepping outside its wheelhouse.https://t.co/FNUC3AfrfB

— Steve Bainbridge (@PrawfBainbridge) September 22, 2021

The SEC is not an Employment Civil Rights Agency. So Why is it Acting Like One in re Activision?

From the WSJ:

Federal securities regulators have launched a wide-ranging investigation into Activision Blizzard Inc., ATVI -3.33% including how the videogame-publishing giant handled employees’ allegations of sexual misconduct and workplace discrimination, according to people familiar with the investigation and documents viewed by The Wall Street Journal.

The Securities and Exchange Commission has subpoenaed Activision, known for its Call of Duty, World of Warcraft and Candy Crush franchises, and several of its senior executives, including longtime Chief Executive Bobby Kotick, according to the people and documents.

The agency is asking for documents including minutes from Activision board meetings since 2019, personnel files of six former employees and separation agreements the company has reached this year with staffers, records show. The SEC is asking for Mr. Kotick’s communications with other senior executives regarding complaints of sexual harassment or discrimination by Activision employees or contractors, the documents show.

If there are plausible allegations that senior Activision management engaged in discriminatory practices, a investigation into whether employment civil rights laws were violated is clearly appropriate. But that is not the SEC's job.

As the SEC itself explains:

The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.

To be sure, the SEC (and plaintiff securities lawyers) have sometimes tried to use disclosure claims to regulate substantive behavior. Apparently, that's the wedge the SEC is relying on here to insert itself into Activision's employment practices. But such efforts are contrary to both the letter and the spirit of the securities laws.

As I explained some years ago in my WLF Legal Pulse post, SEC Drifting Further Away From Its Statutory Mission With Latest “Therapeutic Disclosure” Idea, with respect to an SEC proposal to require board diversity disclosure:

This sort of disclosure, as Chairman White remarked when discussing another potential SEC disclosure mandate, is “directed at exerting societal pressure on companies to change behavior, rather than to disclose financial information.” So what she’s proposing now with regards to board diversity is known as therapeutic disclosure.

Therapeutic disclosure requirements undoubtedly affect corporate behavior in a substantive way, as the WSJ opinion piece explains. Therapeutic disclosure, however, is also troubling from a legal perspective on at least two levels.

First, seeking to effect substantive goals through disclosure requirements violates the congressional intent behind the federal securities laws. ...

I go on to explain the relevant historical background, from which I conclude that "the substantive behavior of corporate issuers is not within the SEC’s purview." Hence, the SEC has no business using alleged disclosure concerns about Activision's human resources practices as a pretext for getting Activision to correct alleged unlawful practices.

Second, and even more disturbing, in this case the SEC’s rules overstep the boundaries between the federal and state regulatory spheres. ... [F]ederal securities regulation has two principal goals. First, and foremost, it regulates the disclosures shareholders receive. Second, it regulates the procedures by which events such as tender offers and proxy solicitations are conducted. But the [Securities Exchange] Act’s purposes do not include matters such as regulating the substantive aspects of shareholder voting.

 Regulating the substance of employee relations is even further outside the purview of that statute.

Obviously, the SEC will claim that it is about Activision's allegedly deficient disclosures relating to its Human Resources practices. But even if we accept that risible claim at face value, the SEC is still overstepping its bounds.

It's critical that Activision management has not been convicted of any civil or criminal violations. If they had been, it would be arguable that failing to disclose those convictions would be a material omission (obviously, I realize that one is not convicted of civil violations, but I'm using it as a shorthand). 

Where plaintiff complains of noncriminal conduct allegedly constituting mismanagement, courts have been unwilling to require disclosure. In Amalgamated Clothing and Textile Workers Union, AFL―CIO v. J. P. Stevens & Co., 475 F.Supp. 328 (S.D.N.Y.1979), for example, plaintiffs argued that the board of directors had either knowingly violated the labor laws or, at least, failed to prevent management from doing so. According to plaintiffs, this alleged misconduct had harmed the corporation's reputation and exposed it to liability. The failure to disclose these purported facts in connection with the election of the directors allegedly constituted an omission of material facts. In rejecting plaintiff's argument, the court held that it would be "silly" to "require management to accuse itself of antisocial or illegal policies."

Yet, that is precisely what the SEC investigation of Activision assumes management is required to do.

And that is, as the court opined, just silly.

 

"Does the SEC Have Legal Authority to Adopt Climate-Change Disclosure Rules?"

Andrew Vollmer says no.

When evaluated against the Supreme Court’s normal and straightforward method of determining an agency’s rulemaking power, the two main securities acts limit the SEC’s power to issue disclosure rules to specific types of information, such as the business of the company selling the securities, the management, capital structure, and financial statements. Climate-change disclosure rules would have a different subject matter and a different objective from the kind of disclosure requirements Congress permitted the SEC to write.

The need for the SEC to have explicit statutory power for climate-change disclosure rules is important to the U.S. form of self-government and the accountability of government officials to the voters. The SEC should respect the role of Congress in setting national policy and stay within the bounds of its statutory authority.

Critiquing The WSJ's Reporting on Climate Change Disclosure

There's an article on climate change disclosure in today's WSJ that uncritically accepts two highly contested propositions:

1. Investors want climate change disclosure
2. Climate change disclosure is desirable

I'm not claiming bias. I am claiming shoddy reporting.

As to the question of whether investors want climate disclosure, I have no doubt that some do. But how many? I addressed the related ESG issue of diversity disclosure in my 5/14/201 post SEC Chairman Gary Gensler is not being serious about what investors want:

The best data on what investors really want comes not from surveys (as evidenced by the disastrous performance of the polling industry in recent years, which has cast doubt "on all types of survey research"), but from what people actually do when given the opportunity to vote on shareholder proposals relating to ESG issues. ...

I went back to the Gibson Dunn report I cited in that post. It found that climate change-related shareholder proposals are garnering, on average, about 30% support (p.7). To be sure, Gibson Dunn claims that this shows an increase in investor support but it's still less than 1/3.

On a related topic, see my post Do apolitical investors want corporations to disclose political contributions?, which concludes that some do but most do not.

As for the desirability of climate change disclosure, see my 3/14/21 post Objecting to Climate Change Disclosure: It's Just Progressive Political Theater. In it, I make three points:

1. Even if we assume that climate change disclosure would lead to public corporations reducing their carbon output, it would still be at best a minor change. It doesn't effect output in other countries.
2. Disclosing climate-related risk factors will not bend the curve on climate change.
3. Climate change disclosure is likely to be hugely expensive.

And, finally, I continue to recommend

Mahoney, Paul G. and Mahoney, Julia D., The New Separation of Ownership and Control: Institutional Investors and ESG (March 22, 2021). Columbia Business Law Review, Forthcoming, Virginia Law and Economics Research Paper No. 2021-09, Virginia Public Law and Legal Theory Research Paper No. 2021-18, Available at SSRN: https://ssrn.com/abstract=3809914

Scholars and policy makers have long debated whether corporations should serve social purposes at the expense of shareholder wealth. The SEC has recently been drawn into the debate as it faces calls to mandate environmental, social, and governance (ESG) disclosures. This Article urges the SEC to proceed with caution. The adoption of ESG disclosure mandates in order to serve environmental or social goals is not well-aligned with the SEC’s stated mission of protecting Main Street investors and maintaining fair, orderly, and efficient markets. Accordingly, the SEC should decline to act absent a showing that ESG disclosures will serve the financial interests of the households for whom institutional investors are fiduciaries and whose retirement and other savings they manage.

Does no one at the SEC listen to Commissioner Hester Pierce? The SEC Progressive Pezzonovante's Moronic Ramping up of ESG Enforcement

The SEC is a financial regulation agency that has two purposes: protecting investors and promoting capital formation. Saving the planet is not a task with which it has been assigned or as to which it has any expertise.

THE SEC HAS NO BUSINESS REGULATING ESG ISSUES, INCLUDING DISCLOSURE ASPECTS.

I posted the other day a link to SEC Commissioner Hester Pierce's incisive and decisive demolition of the arguments in favor of SEC regulation of ESG disclosures. But apparently the progressive pezzonovantes running the SEC have their marching orders from Liz Warren and are going to proceed not just with new rules but with enforcement proceedings:

... the SEC has its eye on “systemically large firms” as part of its inspection work related to environmental, social, and governance issues, he said. Kahl is the deputy director of the agency’s Division of Examinations and is set to become the acting director in August.

The agency’s examiners are interested in getting a readout on firms’ thinking about climate risk for a potential risk alert, he said. Risk alerts highlight problems examiners are seeing and can precede enforcement actions.