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A Critical Summary of Project 2025's Blueprint for Trump's SEC and CFTC with Suggestions

John Jenkins reports that:

With the election in the rear-view mirror, many people are speculating about the potential implications of Trump 2.0 for the SEC and securities regulation in general.  Some of these are pretty obvious – Donald Trump promised that Gary Gensler would be a goner “on day one,” and he seems likely to depart even before Trump takes office. The SEC’s climate disclosure rules also are almost certainly on the chopping block, and its long-delayed proposals on human capital management and corporate board diversity disclosures will probably never see the light of day.

Those political footballs may garner most of the headlines during the next few months, but what about the Trump Administration’s approach to more “meat & potatoes” securities law issues?  Even though Donald Trump claims to know nothing about Project 2025, plenty of others in his orbit do, and it seems likely that many of the policy objectives laid out in that document will be on the agenda when it comes to securities regulation. 

Herewith a critical summary of the Project's proposals, focusing on those in my wheelhouse:

One central focus is reform of the Securities and Exchange Commission (SEC) and related bodies, which the Project's authors argue have evolved into overly complex, costly structures that inhibit economic growth. (There's certainly some truth to that.) It argues that the SEC’s regulatory mandates, developed over decades, have become a burden for companies, with recent rules such as the climate change disclosure mandate purportedly adding prohibitive costs to being a public company. To rectify this, the authors propose reorienting the SEC’s mission to reduce barriers to capital formation, favor transparency, and prioritize traditional financial metrics over politically driven criteria like environmental, social, and governance (ESG) standards.

The blueprint advocates for a simplified securities disclosure system that organizes firms into private, intermediate, and public categories, each with scaled reporting requirements. It's not entirely clear what the authors have in mind here. But two possibilities come to mind. First, by referencing an intermediate category, they may have in mind additional regulatory relief for smaller public issuers. If so, a number of ideas spring to mind:

• Quarterly Reporting Adjustments: Allow small public companies the option to provide biannual or simplified quarterly reports, which reduces reporting frequency and helps alleviate compliance costs without compromising transparency for investors.
• Shortened MD&A Requirements: Limit the Management’s Discussion and Analysis (MD&A) requirements for small companies to emphasize only significant developments and omit extensive discussions of historical financial results and off-balance-sheet arrangements that may be less relevant.
• Broaden Regulation A+ Eligibility: Permit smaller, seasoned public companies to conduct public offerings under Regulation A+, which would allow them to raise capital with less regulatory burden compared to traditional public offerings.
• Increased Offering Caps: Raise the maximum offering limit for Regulation A+ from $75 million to a higher threshold for small public companies, facilitating larger capital raises under more simplified procedures.
• Streamlined Proxy Requirements: Implement reduced requirements for proxy statement disclosures, allowing small public companies to focus on material issues and minimize lengthy governance disclosures.
• Exemptions from Say-on-Pay Rules: Exempt small public companies from say-on-pay and related executive compensation voting requirements, alleviating the burden of preparing detailed compensation reports and disclosures. On say-on-pay, see my article Remarks on Say on Pay: An Unjustified Incursion on Director Authority: https://ssrn.com/abstract=1101688 
• Exempt Small Public Companies from ESG Reporting Mandates: As ESG disclosure requirements continue to evolve, exempt small public companies from detailed ESG and climate-related disclosures, reducing complexity and compliance costs for companies with limited resources to manage these disclosures. For a critique of ESG in general, see my book The Profit Motive.

Second, the authors may be referring current SEC Chairman Gary Gensler's  proposals for expanding the SEC's oversight of private companies. If so, I urge that the line between which companies are subject to the SEC's regulatory jurisdiction and which are not remain as clear as possible. Requiring disclosures from non-reporting (private) corporations because it could impose excessive compliance costs on businesses that are not publicly traded, potentially stifling innovation, growth, and flexibility that these firms rely on. Public disclosure rules are designed to protect public shareholders; however, private companies raise capital primarily from sophisticated investors who typically require and negotiate access to necessary information independently. Imposing public-company-style disclosures on private firms may not provide meaningful investor protection benefits while undermining their ability to operate efficiently and meet capital needs effectively within the private market’s distinct regulatory environment.

Project 2025 argues for the elimination of the Public Company Accounting Oversight Board (PCAOB) and Financial Industry Regulatory Authority (FINRA), recommending instead that their functions be integrated into the SEC to reduce bureaucracy and enhance effectiveness. As for the PCAOB, I agree. The PCAOB adds excessive costs to public companies through its audit standards and inspections, which disproportionately impact smaller firms. In addition, much of what the PCAOB does duplicates existing SEC oversight functions, creating redundancy without clear benefits in fraud prevention or investor protection.

As for FINRA, however, I disagree. FINRA provides valuable industry-specific insights, quicker responses to industry issues, and a structure that allows for the adaptation of regulatory practices. Its ability to oversee a vast network of broker-dealers through industry-led governance can enhance market expertise that may be diluted if its functions were moved entirely under the SEC.

Entrepreneurial growth is another critical area of Project 2025's focus, with proposals to ease the regulations surrounding entrepreneurial capital formation. Suggested reforms include streamlining exemptions for small offerings and crowdfunding under Regulation A and Regulation CF, removing the accredited investor restriction, and allowing more flexible access to private capital markets. These adjustments are intended to foster broader market participation and empower smaller entrepreneurs to compete in capital markets, enhancing economic dynamism. As discussed above, I favor these proposals. I elaborated on the importance of capital market competitiveness and capital formation in my book chapter Corporate Governance and U.S. Capital Market Competitiveness: https://ssrn.com/abstract=1696303

The blueprint envisions significant changes to the oversight of securities markets to strengthen their functionality and accessibility. It proposes preempting state-level securities registration requirements for securities traded on national exchanges and dismantling regulatory barriers that limit market liquidity. Congress should repeal disclosure requirements viewed as tangential to financial returns, such as those in the Dodd-Frank Act related to CEO pay ratios and mine safety. Additionally, the authors argue for terminating programs like the Consolidated Audit Trail (CAT), which they suggest have become financially burdensome without adding equivalent value. I would gladly see most of the corporate governance provisions of Dodd-Frank and Sarbanes-Oxley repealed. See my book Corporate Governance After the Financial Crisis.

Digital asset regulation is an area of particular interest, with a call for coordinated oversight between the SEC and the Commodity Futures Trading Commission (CFTC). Instead of relying on enforcement actions that have sown confusion and hindered innovation, both agencies should establish clear, unified rules to define the regulatory status of digital assets. The proposed framework differentiates securities from commodities, recommending that only digital assets offering revenue shares or liquidation rights be considered securities. In the absence of regulatory coordination, the authors recommend that Congress enact legislation to clarify digital asset classifications, empowering the CFTC to regulate digital assets not meeting the criteria of investment contracts, which sounds reasonable. 

Finally, the blueprint emphasizes a restrained approach to federal influence over business operations, particularly opposing mandates that require businesses to engage in socially-driven disclosures. It criticizes federal initiatives aimed at redefining the purpose of businesses to address societal goals and argues for returning to a model where corporations focus on shareholder value rather than broader social or political objectives. This is accompanied by calls for the elimination of disclosures deemed extraneous to financial performance. All of which is consistent with the arguments made in my book The Profit Motive.

In sum, while I recognize that much of Project 2025 is highly controversial, many of the proposals for SEC reform are good ideas that I and other conservative/libertarian corporate law commentators have long supported.

The SEC Proposes Trashing the Stock Market Part 1A: The WSJ on Best Order Execution

The Securities and Exchange Commission proposes 1,656 pages of regulation that would re-engineer the equities market in the name of fixing a nonexistent problem. https://t.co/GXKBfB5yl3 via @WSJ

— Steve Bainbridge (@PrawfBainbridge) December 16, 2022

"An SEC Inspector General report recently warned that @GaryGensler's move-fast-and-break-things agenda is overwhelming staff and diverting resources from investor protection." https://t.co/5Rj3R3n0Uv via @WSJ

— Steve Bainbridge (@PrawfBainbridge) December 16, 2022

@GaryGensler's "stock-trading overhaul isn’t intended to improve competition or protect retail investors. The beneficiaries are Nasdaq, Calpers and brokers that can support zero-commission trading with other revenue." https://t.co/woaitSGFMR via @WSJ

— Steve Bainbridge (@PrawfBainbridge) December 16, 2022

The SEC Proposes Trashing the Stock Market Part 1: Best Order Execution

The SEC has proposed new Regulation Best Execution:

Proposed Regulation Best Execution would require broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to comply with the proposed best execution standard. Further, the proposal would require these policies and procedures to address how broker-dealers will comply with the best execution standard and how they will determine the best market and make routing or execution decisions for customer orders.

The policies and procedures would also be required to address additional factors for conflicted transactions with retail customers. With respect to such transactions, the proposal would require broker-dealers to document their compliance with the best execution standard, including all efforts to enforce their best execution policies and procedures for conflicted transactions and the basis and information relied on for their determinations that such conflicted transactions would comply with the best execution standard. Broker-dealers would also be required to document any arrangement concerning payment for order flow.

For starters, if this goes through, retail investors can kiss zero commission brokerage accounts goodbye. SEC Commissioner Hester Peirce opines that:

I cannot support this proposal, which is unduly prescriptive and seems less concerned about whether customers actually get best execution than if brokers implement a checklist that the Commission itself is not confident will help brokers achieve even better—much less best—execution. 

...

The proposed rule provides a handy checklist for SEC examiners and enforcement attorneys, but it does not foster brokers’ exercise of judgment to achieve what is best for customers.  Best execution cannot be reduced to a checklist.  Indeed, a checklist mandated by the Commission invites a culture of check-the-box compliance that does little to improve execution quality.  Instead, it may promote broker and regulatory complacency about working creatively to get the best execution possible for customers. 

Peirce further explains that institutional investors will also suffer:

Institutional customers arguably do not need the protection of a best-execution rule, particularly one as prescriptive as this proposal.  The proposed rule makes price the primary objective of the broker.  Institutional investors may have other important objectives, such as speed and minimizing the effect on price. The rule makes it hard for institutional brokers to tailor best execution to a customer’s objectives.

Finally, Peirce sends potential challengers a none too subtle hint about how to challenge the rule:

The release does not take serious account of the potential for increased commissions when it assesses likely changes in execution quality, even though it seems that any estimate of execution quality, particularly in a rulemaking like this, should take the per-share cost of commissions into account.  At some points in the release, the discussion hints that a broker-dealer, to meet its requirements under the rule, should convert PFOF into price improvement.  Why is withholding price improvement from the customer worse than charging the customer a (likely higher) commission?

As we know, the SEC has lost a number of cases in recent years for doing an inadequate cost-benefit analysis, which seems to be what Peirce is teeing up.

Commissioner Uyeda is also not a fan of the Commission's cost-benefit analysis:

This particular proposal uses the phrase “the Commission believes” 77 times.  What does that phrase mean?  If the phrase is employed as a reasoned conclusion of the Commission after a discussion of supportive evidence and relevant analysis, then I suppose that is fine.  However, when the expression—“the Commission believes”—is employed as a substitute for evidence, like spackling used to fill a hole, then that is a problem.  Indeed, “the Commission believes” seems to be used as another regulatory shortcut for situations when the Commission has no hard evidence or data, but nonetheless has a theoretical concern.

 

SOX Section 404 at Twenty

Mildly revised version of my article "Sarbaes-Oxley Section 404 at Twenty" has been posted: https://t.co/u1Ni6DtRgd pic.twitter.com/InuwllSmYj

— Steve Bainbridge (@PrawfBainbridge) October 18, 2022

Yours truly cited by SEC Commissioner Hester Peirce

The paper Commissioner @HesterPeirce cited was Sarbanes-Oxley § 404 at Twenty (August 26, 2022). UCLA School of Law, Law-Econ Research Paper No. 08, 2022, Available at SSRN: https://t.co/042KbCQSbF

— Steve Bainbridge (@PrawfBainbridge) October 14, 2022

SOX 404 at 20

I wrote this. https://t.co/JLyJZLzgNw

— Steve Bainbridge (@PrawfBainbridge) September 23, 2022

My new paper: Sarbanes-Oxley § 404 at Twenty

Bainbridge, Stephen Mark, Sarbanes-Oxley § 404 at Twenty (August 26, 2022). UCLA School of Law, Law-Econ Research Paper No. 08, 2022, Available at SSRN: https://ssrn.com/abstract=4201778

Section 404 of the Sarbanes-Oxley Act of 2002 (SOX) was intended to improve public company internal controls over financial reporting (ICFR). Faulty internal controls were believed to have contributed to many corporate scandals during the dot-com era. Empirical research of the pre-SOX era suggested that reporting companies with poor internal controls tended to have more frequent earnings restatements, more SEC enforcement proceedings, and poorer performance than comparable firms with strong internal controls. When SOX was adopted § 404 was not among the most controversial provisions. Instead, it was the attorney conduct rules, CEO and CFO certification requirements, and the ban on loans to officers and directors—plus the larger question of federalizing corporate governance—that generated most of the early criticism aimed at the statute. Once companies began implementing § 404’s mandate for assessments of their internal controls over financial reporting, however, it became apparent that compliance costs were considerably greater than anticipated. In short order, § 404 became—and remains—SOX’s most controversial provision. SOX’s twentieth anniversary seems an opportune time to reassess the controversy over § 404. There is a considerable body of empirical evidence on the costs and benefits of § 404, which this article reviews. As it turns out, however, there are so many potential confounding factors that all of the evidence must be viewed with a degree of skepticism. Nonetheless, a few conclusions can be drawn. With the benefit of hindsight, it seems clear that Congress in 2002 had no idea what it would cost companies to comply § 404. The SEC had an estimate of what § 404(a) compliance would cost but had no idea what § 404(b) compliance would cost. Sticker shock seems the right description of the reaction once those costs became clear. Section 404 compliance costs were substantial from the outset. Those costs were disproportionately borne by smaller firms from the outset. Section 404 compliance costs remain high and show no signs of dropping over time. It remains the case that those costs are disproportionately borne by smaller firms. As far as achieving its main goal of reducing material weaknesses in ICFR, § 404 cannot be deemed a success. Both adverse managerial reports and auditor attestations actually rose prior to 2014 and have dropped only slightly in the subsequent period. Problems with firms failing to remediate persistent material weaknesses remain a source of concern.

Recommended reading: Fisch's "GameStop and the Reemergence of the Retail Investor"

Fisch, Jill E., GameStop and the Reemergence of the Retail Investor (February 8, 2022). U of Penn, Inst for Law & Econ Research Paper No. 22-16, Boston University Law Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=4049896

The GameStop trading frenzy in January 2021 was perhaps the highest profile example of the reemergence of capital market participation by retail investors, a marked shift from the growing domination of those markets by large institutional investors. Some commentators have greeted retail investing, which has been fueled by app-based brokerage accounts and social media, with alarm and called for regulatory reform. The goals of such reforms are twofold. First, critics argue that retail investors need greater protection from the risks of investing in the stock market. Second, they argue that the stock market, in term, needs protection from retail investors.

This Article challenges calls for broad-based regulatory reform. It argues that, although retail investing is likely to impact the capital markets, claims about the harms from increased retail investing are overstated. More importantly, the debate overlooks potential benefits from retail investing both to investors themselves and the capital markets. Regulators should not be clamping down on the conditions such as commission-free trading, gamified trading platforms, and the expanded use of social media, that have enabled a generation of new investors to participate in the capital markets. These innovations, through their ability to facilitate direct market participation by retail investors have the potential to democratize the capital markets and increase the connections between ordinary citizens and U.S. businesses. Regulators should instead be focusing on how to facilitate the effectiveness of that process.

The Article defends the reemergence of the retail investor and its potential promise in enabling citizen capitalism – providing ordinary citizens with a stake in the nation’s productivity while, at the same time, increasing the accountability of those businesses to societal interests. It explains that retail investment can reduce the increasing problematic power of institutional intermediaries. It also holds the possibility of increasing corporate consideration of stakeholder interests without the need for formal structural changes or heavy-handed regulation.

Critically, however, effective citizen capitalism requires retail shareholders to participate in the capital markets on an informed basis. Although the extent to which the GameStop frenzy reflected rational investing behavior is questionable, its effect has been to draw retail investors to the market, and there is evidence that retail investment and engagement will both continue and evolve. The Article identifies opportunities to improve the retail investing experience, including greater oversight of sources of investment information, limiting the manipulative use by brokers of customer information, and the extension of fintech innovation to mechanisms for improving financial literacy. Attention to these concerns, rather than heavy-handed efforts to discourage retail investing, will increase the effectiveness of the retail investor.

I'd rather have the Wall Street Journal's readers running the SEC than the current majority

The WSJ reports:

The Securities and Exchange Commission voted 3-1 to issue a proposal that would increase the amount and timeliness of confidential information that private-equity and hedge funds report to the agency on a document known as Form PF.

The main goal, Chairman Gary Gensler said, is to allow regulators to better spot risks building up in private markets, stepping up an effort that began after the 2008 financial crisis.

Meanwhile, over on the editorial page, two of the Journal's readers proved they ought to be running the Commission:

While it is premature to judge the merits or validity of the proposal outlined in “SEC Eyes Stronger Oversight of Private Firms” (Page One, Jan. 11), some of the apparent motives are troubling. The Securities and Exchange Commission was established to administer securities laws for investor protection, orderly markets and capital access. Labor and environmental issues are important, and may be legitimate for regulation, but not by the SEC.

Using the SEC as a universal regulator draws resources away from the critical functions and core areas of responsibility entrusted to it by Congress. It also invites abuse if constituencies across the political spectrum come to see securities law as a legitimate tool for achieving their desired ends. Such an outcome would politicize securities law to the detriment of investors, the SEC and the country.

Brian Knight

 

There is no statutory authority for the SEC to provide such “oversight” to nonfinancial private firms. This unjustified power grab must be resisted.

As the head of a private firm that has underwritten IPOs since the late 1960s, I believe the more pertinent question is this: Why are so few firms availing themselves of the public markets when they need capital? The answer is obvious. Increased reporting requirements and costs discourage them, despite the better valuation metrics and liquidity in public markets versus private markets.

For Walmart’s 1970 IPO, the entire S-1 registration statement (the most detailed filing required by the SEC) was 26 pages. Everything one might need to assess this company was in the prospectus. The total offering raised less than $5 million.

This would be impossible today. The grinding increase in disclosure and costs over the decades and administrations of both parties is to blame. For example, the January 2022 IPO of TPG Inc. raised $1 billion, an impressive valuation. But the prospectus was 424 pages. No one has time to read that.

The SEC doesn’t need to expand its power. As Rep. Patrick McHenry of North Carolina says ..., the regulator would serve public markets better by revisiting its current, highly burdensome disclosure rules.

Warren A. Stephens

I couldn't have said it better myself.

Do You Remember Sherron Watkins? Or Just The Myth?

Corporate Counsel reports:

While Frances Haugen and Tyler Shultz/Erika Cheung are currently top of mind, there was a time – 20 years ago! – when the world was abuzz about Sherron Watkins, who raised concerns internally at Enron and later testified before Congress about those warnings.

A recent Bloomberg article checks in on where the major Enron players are today, and reports that Watkins now teaches business ethics. Here’s a Houston news outlet with a couple of short video interviews in which Sherron shares what the company’s collapse looked like from the inside – and how it still feels like yesterday to her.

Personally, I think Watkins gets way too much credit:

Part of the Enron mythology is that former Enron VP Sherron Watkins blew the whistle on Ken Lay, Jeff Skilling, and their fellow miscreants. In fact, however, so-called “Enron whistle-blower” Sherron Watkins never really blew a whistle. A real whistle-blower would have reported the misconduct to the SEC or the cops. Watkins simply reported it to Ken Lay, and even warned him that potential real whistle-blowers were lurking among within the company.

Indeed, there is a school of thought that Watkins got away with insider trading:

Watkins’ testimony was downright bizarre regarding her $47,000 in insider trades of Enron stock that she made after delivering her memo to Lay and prior to the company’s announcement of the charge to earnings. Despite having certified in a 2002 Enron employment agreement and sworn in Congressional testimony that she had not engaged in any illegal insider trading while at Enron, Watkins yesterday conceded on direct examination that the trades were not “proper” because “I had more information than the marketplace did.”

Senator Marco Rubio's "Mind Your Own Business Act" would make bad law and is premised on dumb policy grounds

On Thursday, Marco Rubio announced that he had "introduced the Mind Your Own Business Act, which would enable shareholders to hold woke corporations accountable." (HT: Stefan Padfield)

Specifically, the legislation would require corporate directors to prove their “woke” corporate actions were in their shareholders’ best interest in order to avoid liability for breach of fiduciary duty in shareholder litigation over corporate actions relating to certain social policies. It would also incentivize corporate management to stop abusing their positions to advance left-wing social policies by increasing their personal liability to shareholders for breaches of fiduciary duty resulting from those policies.

“Patriotic Americans who love their country and the opportunity it provides should be able to fight back against the growing tyranny of the woke elites running corporate America,” Rubio said.

...

“No more legal tricks that shield these corporate executives from accountability,”Rubio continued. “If they really believe that being woke is good for business, they should have to say so—and prove it—under oath in court.”

[Insert world weary sigh and eyeball here.]

As regular readers know, I am not a fan of woke capitalism--particularly when committed by social justice warrior CEOs. But the Rubio proposal is a lousy response to woke capitalism.

First, it would represent a further step towards the federalization of corporate law. I address the arguments against expanding the federal role in corporate governance in my book, Corporate Governance After the Financial Crisis at 261-70. The supremacy of federal law and the uniform opposition of Congress and the SEC to private ordering eliminates opportunities 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.” New State Ice Co. v. Liebmann, 285 U.S. 262, 311 (1932) (Brandeis, J., dissenting). 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 federal law precludes 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. Likewise, the persistent refusal to accommodate private ordering eliminates solutions from emerging from competition in the market. Instead, the federalization of corporate governance has resulted in rules that were wrong from the outset or may quickly become obsolete, but are effectively carved into stone with little prospect for change.

I would also draw the reader's attention to an older article, The Creeping Federalization of Corporate Law, Regulation, Spring 2003, at 26. In it, I explain that:

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, as the Court noted in CTS v. Dynamics, 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 Justice Powell explained, 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. . . .

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, exit is no longer an option and an essential check on excessive regulation is lost.

Second, we know that much derivative litigation is meritless. Unless the legislation is extremely narrowly focused, changes intended to “increase stockholder plaintiff’s chances of making it pass the pleading stage” will simply increase the settlement value of such suits. Suppose, for example, in the wake of a tragic mass shooting Walmart decides to stop selling firearms. Do we really want some plaintiff lawyer filing suit against Walmart in that instance? Especially since trial lawyer political contributions primarily go to Democrats?

Third, unless the legislation is extremely narrowly drafted, it will likely involve delegating substantial discretion to a Democrat-dominated SEC.

Fourth, it takes a procedural approach to a substantive problem. A derivative suit is a procedural device mainly used to allow shareholders to bring suit against the firm’s directors and officers for breaching a fiduciary duty owed to the corporation. At present, the sort of woke decisions to which I object almost certainly would be insulated from judicial review by the business judgment rule. See my post Can Tim Cook Ignore ROI When Deciding How to Design an iPhone? So the law would have to create an underlying cause of action.  Which would make the intrusion on state corporate law even greater.

Finally, such proposals are just slapping a Band-Aid on a deep systemic problem. I address the underlying problem in my article Corporate Purpose in a Populist Era at pages 568-577. In short,  I think the rise of CEO social justice warriors resulted from a combination of virtue signaling, the business world equivalent of the Linda Greenhouse effect, and the Ivy League/Upper East Side bubble most of them live in. Most large corporation CEOs these days live in families and social circles where social conservatism is regarded as moronic, retrograde, trailer trash, flyover country nonsense. Acting out as SJWs keeps their spouses and kids off their backs, ensures that the NY Times will say nice things about them, gets their pictures on the society pages, and gets them invited to all the best parties. It lets them hobnob with Hollywood elites and hang out with at Clinton Foundation functions. And it differentiates them from the proles in the GOP base. Tinkering with corporate law at the margins is unlikely to do much until the dynamics of the underlying social phenomena change.

At somewhat greater length, I suggest that what we’re seeing is the culmination of what Christopher Lasch called The Revolt of the Elites. In his 1995 classic, Lasch identified an emergent split between what he called the New Elites and the rest of society. The changes Lasch spotted became trends that accelerated in subsequent years. In particular, Lasch explained that “the new elites . . . regard the masses with mingled scorn and apprehension.”  They dismissed the masses’ values as “mindless patriotism, religious fundamentalism, racism, homophobia, and retrograde views of women.”  This tension was perhaps nowhere more pronounced than with respect to religion. When Lasch wrote over two decades ago, he opined that “[a] skeptical, iconoclastic state of mind is one of the distinguishing characteristics of the knowledge classes. . . .  The elites’ attitude to religion ranges from indifference to active hostility.”

If anything, today’s elites have become even more hostile to religious values. As Samuel Gregg observes, the Davos Man’s moral creed is “a mélange of social liberalism, environmentalism, and a new order of a borderless world. . . . [R]eligion is considered the refuge of fanatics and anyone stupid enough to be skeptical of gender ideology and techno-utopianism.”

A quarter-century later, Lasch’s new elites have risen to the top of corporate hierarchies. They brought their values into the C-suite. CEOs increasingly reflect the values of the Blue state coastal bubbles in which they are embedded, especially on environmental and social issues. No Fortune 100 CEOs contributed to Donald Trump’s 2016 presidential campaign, for example, but eleven gave to Hillary Clinton. More generally, “liberal groups accounted for eight of the top ten ideological causes of the ultra-rich, and seven of the ten congressional candidates most dependent on money from such people were Democrats.” Even one of the progressive movement’s favorite whipping boys—David Koch—publicly self-identifies as “a social liberal.”

As a result, as a Slate essay observed, “Fortune 500 companies today are socially liberal, especially on areas surrounding diversity, gay rights, and immigration; they are unabashedly in favor of free trade and globalization, express concern about climate change, and embrace renewable energy.” In doing so, they are simply reflecting the changing values of their CEOs.

Tinkering with corporate law at the margins is unlikely to do much until the dynamics of the underlying social phenomena change.

An abridged case against making it easier for shareholders to sue woke CEOs

As regular readers know, I am not a fan of woke capitalism--particularly when committed by social justice warrior CEOs. But what should we do about it, if anything?

I've heard some folks suggest a federal law making it easier for shareholders to bring derivative suits against directors or officers who inject their corporation into woke politics. I'm sympathetic to the goal, but skeptical of the means.

First, it would represent a further step towards the federalization of corporate law. I address the arguments against expanding the federal role in corporate governance in my book, Corporate Governance After the Financial Crisis at 261-70. The supremacy of federal law and the uniform opposition of Congress and the SEC to private ordering eliminates opportunities 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.” New State Ice Co. v. Liebmann, 285 U.S. 262, 311 (1932) (Brandeis, J., dissenting). 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 federal law precludes 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. Likewise, the persistent refusal to accommodate private ordering eliminates solutions from emerging from competition in the market. Instead, the federalization of corporate governance has resulted in rules that were wrong from the outset or may quickly become obsolete, but are effectively carved into stone with little prospect for change.

I would also draw the reader's attention to an older article, The Creeping Federalization of Corporate Law, Regulation, Spring 2033, at 26. In it, I explain that:

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, as the Court noted in CTS v. Dynamics, 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 Justice Powell explained, 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. . . .

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, exit is no longer an option and an essential check on excessive regulation is lost.

Second, we know that much derivative litigation is meritless. Unless the legislation is extremely narrowly focused, changes intended to “increase stockholder plaintiff’s chances of making it pass the pleading stage” will simply increase the settlement value of such suits. Suppose, for example, in the wake of a tragic mass shooting Walmart decides to stop selling firearms. Do we really want some plaintiff lawyer filing suit against Walmart in that instance? Especially since trial lawyer political contributions primarily go to Democrats?

Third, unless the legislation is extremely narrowly drafted, it will likely involve delegating substantial discretion to a Democrat-dominated SEC.

Fourth, it takes a procedural approach to a substantive problem. A derivative suit is a procedural device mainly used to allow shareholders to bring suit against the firm’s directors and officers for breaching a fiduciary duty owed to the corporation. At present, the sort of woke decisions to which I object almost certainly would be insulated from judicial review by the business judgment rule. See my post Can Tim Cook Ignore ROI When Deciding How to Design an iPhone? So the law would have to create an underlying cause of action.  Which would make the intrusion on state corporate law even greater.

Finally, such proposals are just slapping a Band-Aid on a deep systemic problem. I address the underlying problem in my article Corporate Purpose in a Populist Era at pages 568-577. In short,  I think the rise of CEO social justice warriors resulted from a combination of virtue signaling, the business world equivalent of the Linda Greenhouse effect, and the Ivy League/Upper East Side bubble most of them live in. Most large corporation CEOs these days live in families and social circles where social conservatism is regarded as moronic, retrograde, trailer trash, flyover country nonsense. Acting out as SJWs keeps their spouses and kids off their backs, ensures that the NY Times will say nice things about them, gets their pictures on the society pages, and gets them invited to all the best parties. It lets them hobnob with Hollywood elites and hang out with at Clinton Foundation functions. And it differentiates them from the proles in the GOP base. Tinkering with corporate law at the margins is unlikely to do much until the dynamics of the underlying social phenomena change.

At somewhat greater length, I suggest that what we’re seeing is the culmination of what Christopher Lasch called The Revolt of the Elites. In his 1995 classic, Lasch identified an emergent split between what he called the New Elites and the rest of society. The changes Lasch spotted became trends that accelerated in subsequent years. In particular, Lasch explained that “the new elites . . . regard the masses with mingled scorn and apprehension.”  They dismissed the masses’ values as “mindless patriotism, religious fundamentalism, racism, homophobia, and retrograde views of women.”  This tension was perhaps nowhere more pronounced than with respect to religion. When Lasch wrote over two decades ago, he opined that “[a] skeptical, iconoclastic state of mind is one of the distinguishing characteristics of the knowledge classes. . . .  The elites’ attitude to religion ranges from indifference to active hostility.”

If anything, today’s elites have become even more hostile to religious values. As Samuel Gregg observes, the Davos Man’s moral creed is “a mélange of social liberalism, environmentalism, and a new order of a borderless world. . . . [R]eligion is considered the refuge of fanatics and anyone stupid enough to be skeptical of gender ideology and techno-utopianism.”

A quarter-century later, Lasch’s new elites have risen to the top of corporate hierarchies. They brought their values into the C-suite. CEOs increasingly reflect the values of the Blue state coastal bubbles in which they are embedded, especially on environmental and social issues. No Fortune 100 CEOs contributed to Donald Trump’s 2016 presidential campaign, for example, but eleven gave to Hillary Clinton. More generally, “liberal groups accounted for eight of the top ten ideological causes of the ultra-rich, and seven of the ten congressional candidates most dependent on money from such people were Democrats.” Even one of the progressive movement’s favorite whipping boys—David Koch—publicly self-identifies as “a social liberal.”

As a result, as a Slate essay observed, “Fortune 500 companies today are socially liberal, especially on areas surrounding diversity, gay rights, and immigration; they are unabashedly in favor of free trade and globalization, express concern about climate change, and embrace renewable energy.” In doing so, they are simply reflecting the changing values of their CEOs.

Tinkering with corporate law at the margins is unlikely to do much until the dynamics of the underlying social phenomena change.

Recommended Reading: Roe and Shapira's "The Power of the Narrative in Corporate Lawmaking"

A new paper by Mark Roe and Roy Shapira makes some very valuable contributions to the debate over short-termism and, more important, to the way we understand corporate and securities law debates:

This Article explores the role of narrative power. Some ideas are better at being popular than others. The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: (1) connotation — the words themselves tell us what is good (reliable long-term commitment) and what is not (unreliable short-termism); (2) category confusion — disparate types of corporate misbehavior, such as environmental degradation and employee mistreatment, are mislabeled as being truly and primarily short-termism phenomena emanating from truncated corporate time horizons (when they in fact emanate from other misalignments), thereby making us view short-termism as even more rampant and pernicious than it is; and (3) confirmation — the idea is regularly repeated, because it is easy to communicate, and often boosted by powerful agenda-setters who benefit from its repetition.

The Article then highlights the real-world implications of narrative power — powerful narratives can be more certain than the underlying evidence, thereby leading policymakers astray.

Roe, Mark J. and Shapira, Roy, The Power of the Narrative in Corporate Lawmaking (August 24, 2020). Available at SSRN: https://ssrn.com/abstract=3703882 or http://dx.doi.org/10.2139/ssrn.3703882

The Department of Labor’s Proposed Rulemaking on Financial Factors in Selecting Plan Investments

I don't spend a lot of time thinking about ERISA and investment company issues, but I recognize their importance as a body of law closely adjacent to the areas in which I am interested. So I have been sort of following the DOL's proposals to regulate plan fiduciary investments using ESG metrics.

Max Schanzenbach and Robert Sitkoff are two names I trust very much in this area, so I read with interest their comment letter on the DOL's plan, which has been posted to SSRN. 

Abstract: In June of 2020, the Department of Labor proposed a rule-making on financial factors in selecting ERISA plan investments (“Proposal”), in particular environmental, social, and governance factors (“ESG”). In general, we are supportive of the Proposal’s central purpose of subjecting ESG investing to the same fiduciary principles of loyalty and prudence that are applicable to any type or kind of investment.

We do, however, have some criticisms. Our basic point is that the law neither favors nor disfavors ESG investing. Any investment decision by an ERISA trustee or other fiduciary — whether in the context of a direct investment, shareholder engagement (including proxy voting), or menu construction, and whether reliant on ESG factors or otherwise — is subject to the same fiduciary principles embodied in the duties of loyalty and prudence. Our chief criticisms, therefore, reflect instances in which the Proposal differentiates or could be construed as differentiating ESG investing from other types or kinds of investment strategies.

First, the Proposal and accompanying commentary could be read to suggest that all manner of ESG investing is inherently suspect, presumably on fiduciary loyalty grounds, and therefore that ESG investing by an ERISA trustee or other fiduciary is always subject to enhanced scrutiny that requires extra process relative to other types of kinds of investment strategies. Such a position is inconsistent with law and sound policy. To be sure, an ERISA trustee or other fiduciary violates the duty of loyalty if she uses ESG factors to provide benefits for third parties (what we call “collateral benefits ESG”). However, use of ESG factors in pursuit of enhanced risk-adjusted returns (what we call “risk-return ESG”) is not suspect under the duty of loyalty. Instead, risk-return ESG is analyzed under the duty of prudence, which applies in the same manner to risk-return ESG as to any other type or kind of investment strategy. Departure from neutral application of fiduciary principles also requires drawing distinctions between ESG investing and other investing, a definitional morass that would create uncertainty and invite litigation.

Second, portions of the commentary are unclear or phrased in a manner that could be construed as taking positions, such as with respect to active versus passive investing, that are not consistent with neutral application of the principles of fiduciary investment law. The commentary is also notable for not addressing certain other relevant matters, such as the use of ESG factors in shareholder engagement (sometimes called “stewardship” or “active shareholding”). We identify material instances of such language or omissions and urge appropriate clarification, particularly regarding the “tiebreaker” rule for purportedly economically equivalent investments.

Their analysis strikes me as eminently sensible.

Verstein on "Improving Corporate Governance with D&O Insurer Rotations"

My friend and UCLA colleague Andrew Verstein has had a busy summer. Over at CLS, he has posted a summary of his new article “Changing Guards: Improving Corporate Governance with D&O Insurer Rotations,” available here.

I explain that a pernicious mixture of agency costs and relational contracting is largely responsible. When corporations buy D&O insurance, it is the directors and officers who decide what to buy. These managers prefer policies without extensive loss-mitigating interventions that would constrain their freedom and expose them to criticism. Insurers would hesitate to offer such risky policies, but managers implicitly promise to cover any extra losses with lucrative future business. Renewal rates approach 100 percent.[2] These renewals occur despite increasing premiums. Global D&O premiums may be around $15 billion,[3] with U.S. premiums expected to perhaps double in the upcoming year.[4]Dependable renewals at higher rates allow insurers to recoup any losses and thus make them comfortable tolerating, rather than preventing, losses today; shareholders and society bear the cost of ever rising governance risk.

A solution is implicit in the diagnosis: Force corporations to rotate D&O insurers every few years.  Mandatory rotation would impose a final round on an otherwise indefinite insurance relationship. Theory predicts that it would stir both participants to action. If insurers know that they are going to lose a client soon, they will realize that there is no chance to recoup losses in the future and will seek to control their risks now. If executives know that insurers are going to demand and enforce risk-mitigation, they will know there is no benefit to paying extra for insurance from passive insurers and will seek to control their costs now. Both sides will seek benefits over a shorter period. That will help control governance risks that could harm shareholders and other stakeholders.

Do read the whole thing.