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The Economist on the Uptick in Public Offerings: Telling its Readers What Mine Have Known for Years

From The Economist:

FOR years, discussions of America’s public markets have usually featured a lament for their dwindling appeal. According to Jay Ritter of the University of Florida, the number of publicly listed companies peaked in 1997 at 8,491 (see chart). By 2017 it had slumped to 4,496. True, many of the companies that went public in the internet’s early days should never have done so. But the decline worries anyone who sees public markets as the best way for ordinary investors to benefit from the successes of corporate America.

The mood right now is more buoyant. ... “There are plenty of signs that IPO activity is about to surge,” says Kathleen Smith of Renaissance Capital, a research firm.

The question is whether one quarter a revival makes. ...  

Underlying these concerns is an older one—that the vast and varied costs of first bringing shares to market, and then remaining public, are just too high. These costs include bankers’ and lawyers’ fees, the risk of class-action litigation, the need to reveal commercially sensitive information that could benefit rivals, and the prospect of fights with corporate raiders who want juicier returns for shareholders and social activists who want executives to pay heed to their values. Added to all these are public reporting and tax requirements that private companies can often avoid.

Mr Ritter attributes much of the decline in the number of companies that are listed to the difficulty of being a small public company.

Hello? Haven't I been saying that for years? See, e.g., Corporate Governance and U.S. Capital Market Competitiveness (October 22, 2010). UCLA School of Law, Law-Econ Research Paper No. 10-13. Available at SSRN: https://ssrn.com/abstract=1696303

This essay was prepared for a forthcoming book on the impact of law on the U.S. economy. (The American Illness: Essays on the Rule of Law) It focuses on the impact the corporate governance regulation has had on the global competitive position of U.S. capital markets.

During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.

Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.

This essay argues that litigation and regulatory reform remain essential if U.S. capital markets are to retain their leadership position. Unfortunately, the article concludes that federal corporate governance regulation follows a ratchet effect, in which the regulatory scheme becomes more complex with each financial crisis. If so, significant reform may be difficult to achieve.

The SEC should authorize mandatory arbitration of shareholder class action lawsuits

Bloomberg reports that:

The Securities and Exchange Commission, in its long history, has never allowed companies to sell shares in initial public offerings while also letting them ban investors from seeking big financial damages through class-action lawsuits. That's because the agency has considered the right to sue a crucial shareholder protection against fraud and other securities violations.

But as President Donald Trump's pro-business agenda sweeps through Washington, the SEC is laying the groundwork for a possible policy shift, said three people familiar with the matter. The agency, according to two of the people, has privately signaled that it's open to at least considering whether companies should be able to force investors to settle disputes through arbitration, an often closed-door process that can limit the bad publicity and high legal costs triggered by litigation.

One can already hear the howls from the plaintiff's bar and their allies in certain institutional investor sectors, but this is an idea whose time has come.

The current system of securities class‐action litigation is an inefficient means to redress the harm to investors. Prominent studies have concluded that securities class‐action litigation fails to compensate adequately those harmed by fraud. The median ratio of settlement amount to total alleged investor loss has ranged between two and three percent. Securities classaction lawsuits are essentially wealth transfers among shareholders and often are circular in nature. Existing shareholders bear the burden of compensating aggrieved shareholders, some of whom also may be existing shareholders.

Although individual class members receive relatively little of the ultimate recovery that is spread across a class, the plaintiffs’ attorneys receive customarily twenty to twenty‐five percent of the total recovery. During the past ten years, plaintiffs’ lawyers, along with other middlemen, have obtained nearly $17 billion in fees from securities class actions. The diffused investors in the class lack the ability to bargain over attorney fees and courts rarely reduce the fees proposed by the plaintiffs’ attorneys.

In class‐action litigation, the interests of the plaintiffs’ attorneys and class members may not be aligned in some instances. The plaintiffs’ attorneys bear the full costs of pursuing the litigation but receive only a portion of the ultimate award. Consequently, the decisions of the plaintiffs’ attorneys may be driven by concern over litigation costs and personal gain rather than by an interest in obtaining the best result for class members. Indeed, the recent scandals involving plaintiffs’ attorneys paying large sums to repeat plaintiffs illustrate how class‐action litigation can be abused at the expense of harmed investors.

Companies and their shareholders incur enormous costs to defend against securities class‐action lawsuits. In one recent study, approximately forty‐one percent of the companies listed on the major stock exchanges had been named as defendants in at least one federal securities class action. The total monetary value of securities class‐action settlements in 2008 was $3.09 billion. The average settlement value from 2002 to 2008 was $45.6 million, which represents approximately a 175% increase from the average value of $16.6 million from 1996 to 2001.

Private securities litigation has become a real concern, particularly for new businesses that do not have the resources to handle a large lawsuit. A major lawsuit could sound the death knell for new companies that already bear a disproportionate amount of the total business tort costs in the United States. Although small companies account for nineteen percent of business revenue in the United States, they bear sixty‐nine percent ($98 billion) of the business tort costs. To cope with the cost of securities litigation, companies must raise the prices of their goods and services. Doing so, in turn, logically harms the competitiveness of U.S. businesses in a global marketplace that is dominated by low‐cost goods and services in the nations where providers do not face such threats.

Securities class actions impose a competitive disadvantage on U.S. capital markets relative to markets in other countries. Indeed, foreign companies are reluctant to list in U.S. markets due to concerns with the American litigation system. According to the Committee on Capital Markets Regulation - an independent, bipartisan body composed of twenty‐two corporate and financial leaders from business, finance, law, accounting, and academia - since the late 1990s the percentage of the world’s Initial Public Offerings (IPOs) conducted in the United States has dropped from forty‐eight percent to six percent in 2005. Of the world’s twenty‐five largest IPOs in 2005, only one of them took place in the United States. That trend continued in 2006, when a report dated November 30 observed that, in the year to date, nine of the ten largest IPOs had occurred in markets outside of the United States. Dollar figures are also staggering: Between 2000 and 2005, the percentage of dollars raised in global IPOs in the United States decreased by a factor of ten, dropping from fifty percent to five percent.

Where is the IPO activity going? The Committee report states that over the same time, London’s share of the global IPO market nearly quintupled from five percent to almost twenty‐five percent. United States exchanges attracted only about one‐third of the share of the global IPO volume in 2006 that they had in 2001 and only three of the twenty largest IPOs of 2008 were listed on U.S. stock exchanges. In 2009, the United States regained the global lead in amount of funds raised in IPOs, boasting a robust twenty‐seven percent share of global capital raised. But this number may be of little comfort when one considers that the share is mostly attributed to the $19.6 billion Visa IPO - the largest IPO in U.S. capital market history. Looking beyond this single outlier, it is apparent that capital formation has moved overseas in droves.

An unwieldy class‐action regime impacts not only the market for public offerings, but also the market for private offerings. The success of the venture capital industry relies, in large part, on how readily a start‐up or other privately held company can be taken public. Absent a desire to access the public equity markets in the United States, the amount of private equity activity in the United States also suffers. In contrast to federal litigation, securities arbitration appears to provide a more efficient and cost‐effective mechanism to resolve disputes with integrity while minimizing the burdens on our judicial system. Arbitration ensures that all relevant facts are presented to the panel without the evidentiary hurdles of federal court. In addition, the use of arbitrators knowledgeable about the securities industry may reduce the uncertainty of resolving securities claims in jury trials.

Bondi, Bradley J., Facilitating Economic Recovery and Sustainable Growth through Reform of the Securities Class-Action System: Exploring Arbitration as an Alternative to Litigation (2010). Harvard Journal of Law and Public Policy, Vol. 33, pp. 607-638, 2010. Available at SSRN: https://ssrn.com/abstract=1601305 

House GOP gets money market mutual fund reform hopelessly wrong

I still agree with Jill Fisch that a sponsor guarantee of the buck is the best solution to regulating money market mutual funds. https://t.co/LQMqSFwxkQ

— Professor Bainbridge (@ProfBainbridge) January 29, 2018

Is Dodd-Frank/SOX reform dead?

Despite controlling both houses of Congress and the Presidency, the GOP has accomplished very little other than getting Gorsuch onto the Supreme Court. In particular, they've failed to reform Dodd-Frank and Sarbanes-Oxley. Granted, the House passed a bill, but the Senate killed it.

The prospects for reforming federal corporate governance law have further dimmed with the announcement that House Financial Services chairman Jeb Hensarling will retire at the end of this Congress. Without his leadership, it seems unlikely that the next Congress will have any greater success.

Understanding Dual Class Stock III: The Conflict of Interest Argument

The strongest argument against dual class stock rests on conflict of interest grounds. There is good reason to be suspicious of management's motives and conduct in certain mid-term dual class recapitalizations.[1] Dual class transactions motivated by their anti-takeover effects, like all takeover defenses, pose an obvious potential for conflicts of interest. If a hostile bidder succeeds, it is almost certain to remove many of the target's incumbent directors and officers. On the other hand, if the bidder is defeated by incumbent management, target shareholders are deprived of a substantial premium for their shares. A dual class capital structure, of course, effectively assures the latter outcome.

In addition to this general concern, a distinct source of potential conflict between managers' self-interest and the best interests of the shareholders arises in dual class recapitalizations. An analogy to management-led leveraged buyouts ("MBOs") may be useful. In these transactions, management has a clear-cut conflict of interest. On the one hand, they are fiduciaries of the shareholders charged with getting the best price for the shareholders. On the other, as buyers, they have a strong self-interest in paying the lowest possible price.

In some dual class recapitalizations, management has essentially the same conflict of interest. Although they are fiduciaries charged with protecting the shareholders' interests, the disparate voting rights plan typically will give them voting control. The managers' temptation to act in their own self-interest is obvious. Yet, unlike MBOs, in a dual class recapitalization, management neither pays for voting control nor is its conduct subject to meaningful judicial review. As such, the conflict of interest posed by dual class recapitalizations is even more pronounced than that found in MBOs.

While management's conflict of interest may justify some restrictions on some disparate voting rights plans, it hardly justifies a sweeping prohibition of dual class stock. First, not all such plans involve a conflict of interest. Dual class IPOs are the clearest case. Public investors who don't want lesser voting rights stock simply won't buy it. Those who are willing to purchase it presumably will be compensated by a lower per share price than full voting rights stock would command and/or by a higher dividend rate. In any event, assuming full disclosure, they become shareholders knowing that they will have lower voting rights than the insiders and having accepted as adequate whatever trade-off is offered by the firm in recompense. In effect, management's conflict of interest is thus constrained by a form of market review.

Another good example of a dual class transaction that fails to raise conflict of interest concerns is subsequent issuance of lesser-voting rights shares. Such an issuance does not disenfranchise existing shareholders, as they retain their existing voting rights. Nor are the purchasers of such shares harmed; as in an IPO, they take the shares knowing that the rights will be less than those of the existing shareholders. For the same reason, issuance of lesser-voting rights shares as consideration in a merger or other corporate acquisition should not be objectionable.

Second, even with respect to those disparate voting rights plans that do raise conflict of interest concerns, it must be recognized that there is only a potential conflict of interest. Despite the need for skepticism about management's motives, it is worth remembering that "having a 'conflict of interest' is not something one is 'guilty of'; it is simply a state of affairs."^[2] That the board has a conflict of interest thus does not necessarily mean that their conduct will be inconsistent with the best interests of any or all of the corporation's other constituents. To the contrary, the annals of corporate law are replete with instances in which managers faced with a conflict of interest did the right thing.^[3] The mere fact that a certain transaction poses a conflict of interest for management therefore does not justify a prohibition of that transaction. It simply means that the transaction needs to be policed to ensure that management pursues the shareholders' best interests rather than their own.

Accordingly, efforts to categorically prohibit dual class stock are essentially misguided.

Understanding Dual Class Stock Part I: An Historical Perspective

Dual class stock is back in the news. Institutional investors are seeking ways to delegitimize this governance structure, with some success as reported by the Council of Institutional Investors:

Following the egregious no-vote IPO of Snap Inc. and requests by CII and other concerned investor groups, three major index providers opened public consultations on their treatment of no-vote and multi-class structures. The FTSE Russell consultation resulted in a decision to exclude past and future developed market constituents whose free float constitutes less than 5 percent of total voting power. S&P Dow Jones' consultation resulted in a broader, but only forward-looking exclusion, which bars the addition of multi-class constituents to the S&P Composite 1500 index and its components, covering the S&P 500, MidCap 400 and SmallCap 600 indexes. MSCI's consultation concluded on August 31; a decision remains pending.  

I find this hysteria vastly overblown, as I shall explain in a series of posts. Today, I begin by setting the background through a review of the relevant history. As we shall see, dual class capital structures are not an historical anomaly. Rather, it is prohibitions on them that are the oddities.

Famed oilman and takeover raider T. Boone Pickens once asserted that "equal voting rights and common stock ownership are inextricably linked. Over 200 years of experience have established equal voting rights as a fundamental tenet of American democracy."[1] Pickens' rhetorical powers are considerable, but in this case his grasp of economic history was not. Worse yet, his claim is a common misconception.

In fact, however, one share-one vote is not the historical norm. To the contrary, limitations on shareholder voting rights in fact are as old as the corporate form itself.

Prior to the adoption of general incorporation statutes in the mid-1800s, the best evidence as to corporate voting rights is found in individual corporate charters granted by legislatures. Three distinct systems were used. A few charters adopted a one share-one vote rule.[2] Many charters went to the opposite extreme, providing for one vote per shareholder without regard to the number of shares owned.[3] Most followed a middle path, limiting the voting rights of large shareholders. Some charters in the latter category simply imposed a maximum number of votes to which any individual shareholder was entitled. Others specified a complicated formula decreasing per share voting rights as the size of the investor's holdings increased. These charters also often imposed a cap on the number of votes any one shareholder could cast.[4]

Gradually, however, a trend towards a one share-one vote standard emerged.[5] Maryland's experience was typical of the pattern followed in most states, although the precise dates varied widely.[6] Virtually all charters granted by the Maryland legislature between 1784 and 1818 used a weighted voting system. After 1819, however, most charters provided for one vote per share, although approximately 40 percent of the charters granted between 1819 and 1852 retained a maximum number of votes per shareholder. Finally, in 1852, Maryland's first general incorporation statute adopted the modern one vote per share standard.

Legislative suspicion of the corporate form and fear of the concentrated economic power it represented probably motivated the early efforts to limit shareholder voting rights.[7] A variety of factors, however, combined to drive the legal system towards the one share-one vote standard. Because reform efforts were almost invariably led by corporations, apparently under pressure from large shareholders,[8] it may be assumed that one factor was a desire to encourage large scale capital investment. The ease with which restrictive voting rules could be evaded also undermined the more restrictive rules. Large shareholders simply transferred shares to strawmen, for example, who thereupon voted the shares as the true owner directed.[9] Finally, while other factors also contributed, the most important factor probably was the fading of public prejudice towards corporations.[10]

By 1900, a majority of U.S. corporations had moved to one vote per share.[11] Indeed, contrary to present practice, most preferred shares had voting rights equal to those of the common shares.[12] State corporation statutes of the period, however, merely established the one share-one vote principle as a default rule.[13] Corporations were free to deviate from the statutory standard,[14] and the trend towards one vote per share reversed in the first two decades of the 20^th Century as a growing number of issuers adopted dual class governance structures.

Two distinct deviations from the one share-one vote standard emerged in the years prior to the Great Crash. One involved elimination or substantial limitation of the voting rights of preferred stock. In particular, it became increasingly common to give preferred shares voting rights only in the event of certain contingencies (such as non-payment of dividends). While controversial at the time,[15] this practice is the modern norm.[16]

The more important development for present purposes was the emergence of nonvoting common stock. One of the earliest examples was the International Silver Company, whose common stock (issued in 1898) had no voting rights until 1902 and then only received one vote for every two shares.[17] After 1918, a growing number of corporations issued two classes of common stock: one having full voting rights on a one vote per share basis, the other having no voting rights (but sometimes having greater dividend rights).[18] By issuing the former to insiders and the latter to the public, promoters could raise considerable sums without losing control of the enterprise.[19]

While disparate voting rights plans were gaining popularity with corporate managers in the 1920s, and investors showed a surprising willingness to purchase large amounts of nonvoting common stock, an increasingly vocal opposition also began emerging. William Z. Ripley, a Harvard professor of political economy, was the most prominent (or at least the most outspoken) proponent of equal voting rights. In a series of speeches and articles, eventually collected in a justly famous book, he argued that nonvoting stock was the "crowning infamy" in a series of developments designed to disenfranchise public investors.[20] In essence, this was an early version of the conflict of interest argument made below: promoters were using nonvoting common stock as a way of maintaining voting control for themselves.

The opposition to nonvoting common stock came to a head with the NYSE's 1925 decision to list Dodge Brothers, Inc. for trading. Dodge sold a total of $130 million worth of bonds, preferred stock and nonvoting common shares to the public. Dodge was controlled, however, by an investment banking firm, which had paid only $2.25 million for its voting common stock.[21] In January 1926, the NYSE responded to the resulting public outcry by announcing a new position:

Without at this time attempting to formulate a definite policy, attention should be drawn to the fact that in the future the [listing] committee, in considering applications for the listing of securities, will give careful thought to the matter of voting control.[22]

This policy gradually hardened, until the NYSE in 1940 formally announced a flat rule against listing nonvoting common stock.[23] Although there were occasional exceptions, the most prominent being the 1956 listing of Ford Motor Company despite its dual class capital structure, the basic policy remained in effect until the mid-1980s.[24]

Long before 1940, Ripley had proclaimed the demise of nonvoting common stock.[25] He was somewhat premature: in the years between 1927 and 1932, at least 288 corporations issued nonvoting or limited voting rights shares (almost half the total number of such issuances between 1919 and 1932).[26] But the Great Depression, with an assist from the opposition led by Ripley and the NYSE's growing resistance, killed off many disparate voting rights plans.[27]

Even so, however, dual class governance structures did not disappear. Far from it. Famous firms such as Ford and Hershey retained (as they still do) dual class capital structures. In the period 1988-2007, moreover, dual class firms held more or less steady at approximately seven percent of the total number of public corporations.

In sum, while their popularity has waxed and waned many times, neither dual class stock nor complaints about it are new. Granted, the one share-one vote rule fairly early became the default rule. But it remained only a default rule and departures from it remained common into the 1930s. Today's dual class capital structures thus were almost more of a revival of the historical norm than a departure from it.

If we must replace LIBOR, what should the replacement look like?

Bloomberg reports that:

A Federal Reserve-sponsored group that has been working on an alternative is slated Aug. 1 to discuss the timing of the release of the measure. The new rate, which the New York Fed plans to begin publishing daily sometime in the first half of 2018 in cooperation with the Treasury Department's Office of Financial Research, eventually could be the benchmark for pricing some $350 trillion of U.S. derivatives, student loans, home mortgages and many other types of credit.

The meeting of the Alternative Reference Rates Committee follows comments recently by the U.K. Financial Conduct Authority that it intends to stop compelling banks to submit London interbank offered rates by the end of 2021, igniting concerns global regulators may have to speed up their implementation timelines for new alternative benchmarks. According to an interim report, ARRC said it considered and rejected plans that call for a “quicker and more disruptive transition” and recognized that its proposed recommendations “could take several years to accomplish.”

I discussed ideal characteristics of a benchmark in my article Reforming LIBOR: Wheatley versus the Alternatives (January 31, 2013), NYU Journal of Law & Business, Vol. 9, No. 2, 2013, available at SSRN: https://ssrn.com/abstract=2209970.

Some key points:

• It is speculated that, “in globally integrated capital markets,” it does not make “sense to have different benchmark borrowing rates for domestic U.S. and international dollar loans.”
• In an increasingly globalized market, control over such a systemically important benchmark by any single government likely would be a source of on-going tension and perhaps would trigger an arms race of sorts in which all of the major financial center nations seek to privilege their domestic benchmark.
• The US working group therefore should be coordinating with counterparts in other countries to develop a global benchmark.
• If a single global rate is desired, even though LIBOR is a U.S. dollar rate, it makes more sense to have the alternative continue to be produced by a London-based government agency or central bank. This is so because it is widely recognized that one of LIBOR’s major advantages was that the London time zone allowed it to straddle the Asian and U.S. markets.
• The benchmark should look to private sector lending, not government rates. The difference between interbank offering rates like LIBOR and potential government substitutes becomes particularly pronounced during periods of economic uncertainty or crisis. In such periods, there is a flight to quality by investors that drives down the rates on presumptively risk free investments like Treasury bills.Conversely, as was the case in the post-Lehman Brothers crisis, banks become less creditworthy and liquidity in the interbank lending market dries up. In such periods, accordingly, benchmarks based on government or central bank funding costs would be especially inappropriate alternatives to one based on interbank offering rates.
• The benchmark should be administered by a private sector body. The Wheatley Review, for example, expressed concern that “public ownership” would reduce the ability of LIBOR to adapt to changing needs of users.The profit motive gives a private actor an incentive to respond to changing conditions in the markets for its product. In contrast, government agencies and state-owned enterprises lack that incentive.

Can the SEC unilaterally ignore Dodd-Frank rule making requirements?

When Dodd-Frank was passed, the Democrats had control of Congress, the White House, and the SEC. Despite that preponderance, Leviathan moved ever so slowly. As a result, seven years after Dodd-Frank became law there are a slew of rule making requirements imposed by the statute that remain unfulfilled.

Now, of course, the GOP controls the White House, Congress, and the SEC. The new Wall Street cops clearly have a deregulatory focus. But can they just ignore the Dodd-Frank requirements?

Bloomberg reports that the GOP is ignoring a number of Dodd-Frank regulatory mandates. Assuming Congress doesn't try twisting the SEC's arm, could a private party sue to compel the SEC to initiate the required rule making proceedings?

As I understand that law, the general rule is that "private parties have “no right to compel the agency to hold rulemaking proceedings."  Prof'l Drivers Council v. Bureau of Motor Carrier Safety, 706 F.2d 1216, 1223 (D.C.Cir.1983). See also WWHT, Inc. v. FCC, 656 F.2d 807, 818 (D.C.Cir.1981) (“It is only in the rarest and most compelling of circumstances that this court has acted to overturn an agency judgment not to institute rulemaking.”). 

On the other hand, at least one court has seen fit to grant an order compelling the SEC to initiate a rule making under Dodd-Frank:

Section 1504 of Dodd-Frank amends the Securities Exchange Act of 1934 to require “publicly traded oil, gas, and mining companies,” or “resource extraction issuers,” to disclose payments made to foreign governments or the federal government for the commercial development of oil, natural gas or minerals. D. 18 at 4. Under Dodd-Frank, these disclosures must be made in annual reports to the SEC. Id. Section 1504 requires the SEC to issue a rule implementing the new disclosure requirements. Id. Specifically, Section 1504 provides that:

Not later than 270 days after the date of enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Commission shall issue final rules that require each resource extraction issuer to include in an annual report of the resource extraction issuer information relating to any payment made by the resource extraction issuer, a subsidiary of the resource extraction issuer, or an entity under the control of the resource extraction issuer to a foreign government or the Federal Government for the purpose of the commercial development of oil, natural gas, or minerals ....

*171 Id. (quoting 15 U.S.C. § 78m(q)(2)(A)) (emphasis omitted). As such, the SEC's statutory deadline for promulgating a final disclosure rule was April 17, 2011. Id. at 5.

Oxfam Am., Inc. v. United States Sec. & Exch. Comm'n, 126 F. Supp. 3d 168, 170–71 (D. Mass. 2015).

By the time the case got before the First Circuit, the SEC was in default by over a year even though it had gotten two 270 day periods to complete the rule.

The court held that because Congress had set a date-certain deadline for the issuance of the final regulation, the court had no discretion to delay the mandatory duty imposed. Accordingly, it issued an order compelling the SEC to act. See South Carolina v. United States, No. 1:16-CV-00391-JMC, 2017 WL 1053844, at *9 (D.S.C. Mar. 20, 2017) (holding that "a few courts have agreed with Forest Guardians' conclusion that when an agency action is “unlawfully withheld” under § 706(1), a reviewing court has no equitable discretion to deny an order compelling the action").

The key factor may be whether the statute in question contains both a rule making mandate AND a date-certain deadline by which the rule must be adopted. See  Cobell v. Norton, 240 F.3d 1081, 1096 (D.C. Cir. 2001) ("The D.C. Circuit, confronting a case in which an agency had unreasonably delayed an action under a statute that provided no deadline (rather than and [sic] agency that unlawfully withheld an action under a statute that imposed a deadline), explained that 'a finding that delay is unreasonable does not, alone, justify judicial intervention’”).

Keith Paul Bishop questions whether The Financial Choice Act will repeal the pay ratio rule

Here

Put this is in the BFD File: House Passes Dodd-Frank Reform Bill

I thought about doing a big thought piece on the House passage of the Dodd-Frank reform bill. But what's the point? It'll never get past the inevitable Democratic filibuster in the Senate. For that matter, the Republican moderates in the Senate might suffice to keep it from getting 50 votes, let alone 60.

PCAOB Announces New Auditing Standard Governing Unqualified Auditor Opinions

Audited financial statements long have been accompanied by a report from the independent auditor attesting that, in its opinion, the financial statements are presented fairly in all material respects.[1] On June 1, 2017, the PCAOB adopted Auditing Standard 3101, governing the information an independent auditor must include in its report:

The final standard retains the pass/fail opinion of the existing auditor's report but makes significant changes to the existing auditor's report, including the following:

• Critical audit matters … requires the auditor to communicate in the auditor's report any critical audit matters arising from the current period's audit of the financial statements or state that the auditor determined that there are no critical audit matters:
  • A critical audit matter is defined as a matter that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment.
  • In determining whether a matter involved especially challenging, subjective, or complex auditor judgment, the auditor takes into account, alone or in combination, certain factors, including, but not limited to:
    • The auditor's assessment of the risks of material misstatement, including significant risks;
    • The degree of auditor judgment related to areas in the financial statements that involved the application of significant judgment or estimation by management, including estimates with significant measurement uncertainty;
    • The nature and timing of significant unusual transactions and the extent of audit effort and judgment related to these transactions;
    • The degree of auditor subjectivity in applying audit procedures to address the matter or in evaluating the results of those procedures;
    • The nature and extent of audit effort required to address the matter, including the extent of specialized skill or knowledge needed or the nature of consultations outside the engagement team regarding the matter; and
    • The nature of audit evidence obtained regarding the matter.
  • The communication of each critical audit matter includes:
    • Identifying the critical audit matter;
    • Describing the principal considerations that led the auditor to determine that the matter is a critical audit matter;
    • Describing how the critical audit matter was addressed in the audit; and
    • Referring to the relevant financial statement accounts or disclosures.
  • The documentation of critical audit matters requires that for each matter arising from the audit of the financial statements that (a) was communicated or required to be communicated to the audit committee, and (b) relates to accounts or disclosures that are material to the financial statements, the auditor documents whether or not the matter was determined to be a critical audit matter (i.e., involved especially challenging, subjective, or complex auditor judgment) and the basis for such determination.
• Additional Improvements to the Auditor's Report—the final standard also includes a number of other improvements to the auditor's report that are primarily intended to clarify the auditor's role and responsibilities related to the audit of the financial statements, provide additional information about the auditor, and make the auditor's report easier to read:
  • Auditor tenure—a statement disclosing the year in which the auditor began serving consecutively as the company's auditor;
  • unqualifIndependence—a statement that the auditor is required to be independent;
  • Addressee—the auditor's report will be addressed to the company's shareholders and board of directors or equivalents (additional addressees are also permitted);
  • Enhancements to basic elements—certain standardized language in the auditor's report has been changed, including adding the phrase whether due to error or fraud, when describing the auditor's responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements; and
  • Standardized form of the auditor's report—the opinion will appear in the first section of the auditor's report and section titles have been added to guide the reader.[2]

 

[1] Where the auditor determines that the issuer’s financial statements are not fairly presented in accordance with GAAP, the auditor may issue a qualified opinion, an adverse opinion, or a disclaimer of opinion. Under PCAOB Auditing Standard 3105, a “qualified opinion states that, except for the effects of the matter(s) to which the qualification relates, the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the entity in conformity with generally accepted accounting principles. … An adverse opinion states that the financial statements do not present fairly the financial position, results of operations, or cash flows of the entity in conformity with generally accepted accounting principles. … A disclaimer of opinion states that the auditor does not express an opinion on the financial statements.”

[2] PCAOB Release No. 2017-001 (June 1, 2017).

Why hasn't the SEC issued final rules on Dodd-Frank 954 for clawbacks of erroneously paid compensation?

Anybody know? If so, kindly drop me a line.

My friends at the Washington Legal Foundation take on the CFPB

(Gordon v. Consumer Financial Protection Bureau)
U.S. Supreme Court

Media Contact: Glenn Lammi
glammi@wlf.org | 202-588-0302

“Whether the Supreme Court opts to review Gordon v. CFPB will have major ramifications for all federal agencies, those whom they regulate, and the survival of the Constitution’s constraints on the President’s appointment power.”
—Mark Chenoweth, WLF General Counsel

WASHINGTON, DC—Washington Legal Foundation today filed a reply brief on behalf of its client, Chance Gordon, in the U.S. Supreme Court. WLF’s brief in Gordon v. Consumer Financial Protection Bureau refutes the Consumer Financial Protection Bureau’s (CFPB) much-delayed brief in opposition filed on April 24. It invites the Court to review and reverse a Ninth Circuit decision that condones a federal agency’s ratification of an unauthorized enforcement action. The Justices will now receive all of the briefs and consider the petition later this month.

This case arises from the recess appointment of Richard Cordray as Director of CFPB in January 2012. CFPB concedes that Cordray’s appointment was invalid, which means that he lacked authority to act on behalf of the federal government for 18 months until renominated in 2013 and confirmed by the Senate that July. During that time CFPB (at Cordray’s direction) brought a civil enforcement action against a California attorney, Chance Gordon, for alleged violations of consumer protection laws. The Bureau insists that Cordray can retroactively ratify that lawsuit.

As WLF’s reply brief points out, CFPB’s position would upend the separation of powers. Under Article II of the Constitution, only Officers of the United States may bring litigation on behalf of the Executive Branch. Since Cordray’s appointment was defective, the new Bureau had no such officers and thus never received the executive authority it needed to bring this lawsuit. Moreover, the Consumer Financial Protection Act contained an express statutory prohibition against filing enforcement actions of this sort until the Senate confirmed CFPB’s Director. As the brief puts it:

CFPB is not simply attempting to ratify an exercise of power by an official whose appointment … was invalid. It is also attempting to ratify an executive action that Congress expressly provided could not be done when undertaken.

WLF’s brief also debunks the agency’s argument for Article III standing. It points out that CFPB’s reply does not challenge the Supreme Court’s recognition that a federal court does not have jurisdiction in cases where the government lacks an authorized representative. Without a valid Officer of the United States in place at CFPB at the time the suit was filed, WLF argues that CFPB had no standing to bring a civil enforcement action in federal court.

House Financial Choice Bill will change the shareholder proposal rule for the better

The House Financial Services Committee has just passed the Financial Choice Act, which reworks major parts of Dodd-Frank and other recent financial services bills and rules. One noteworthy corporate governance provision will work significant changes in the shareholder proposal rule. Specifically, Section 844 provides that:

(a) RESUBMISSION THRESHOLDS.—The Securities and Exchange Commission shall revise section 240.14a– 8(i)(12) of title 17, Code of Federal Regulations to—

(1) in paragraph (i), adjust the 3 percent threshold to 6 percent;

(2) in paragraph (ii), adjust the 6 percent threshold to 15 percent; and

(3) in paragraph (iii), adjust the 10 percent threshold to 30 percent.

Rule 14a-8 allows a shareholder proponent to resubmit a defeated proposal year after year provided it garners a rather de minimis level of support. This allows weak proposals to resurface time after time. The bill would significantly raise the vote required in order for a proposal to be resubmitted, which will weed out the weakest proposals.

(b) HOLDING REQUIREMENT.—The Securities and Exchange Commission shall revise the holding require- ment for a shareholder to be eligible to submit a share- holder proposal to an issuer in section 240.14a–8(b)(1) of title 17, Code of Federal Regulations, to—

(1) eliminate the option to satisfy the holding requirement by holding a certain dollar amount;

(2) require the shareholder to hold 1 percent of the issuer’s securities entitled to be voted on the proposal, or such greater percentage as determined by the Commission; and

(3) adjust the 1 year holding period to 3 years.

Currently investors who own just $2,000 worth of a company's stock can submit proposals, even if that represents an infinitesimally small percentage of the issuer's total market capitalization. As of today, for example, Apple has a total market capitalization of $776.6 billion. So a shareholder who owns 0.00000026% of Apple's stock can make a proposal. And the investor only needs to have held the stock for a year. The bill eliminates the $2,000 dollar threshold, so that investors will have to own at least 1% of the issuer's market capitalization in order to use the proposal, and lengthens the minimum holding period. This change will eliminate a lot of the gadflies and limit the use of proposals to investors with serious long-term skin in the game.

(c) SHAREHOLDER PROPOSALS ISSUED BY PROXIES.—Section 14 of the Securities Exchange Act of 1934 (15 U.S.C. 78n) is amended by adding at the end the following:
‘‘(j) SHAREHOLDER PROPOSALS BY PROXIES NOT PERMITTED.—An issuer may not include in its proxy materials a shareholder proposal submitted by a person in such person’s capacity as a proxy, representative, agent, or person otherwise acting on behalf of a shareholder.’’.

This provision basically eliminates the ability of busybodies like the former Harvard Shareholder Rights Project from acting as the "representative" of some shareholder, whereas in fact the Project was the real party in interest and was just piggybacking on the shareholders investment because it didn't own stock in the company.

The bill's comprehensive summary explains the need for these commonsense reforms:

Section 14 and Rule 14a-8 under the Securities Exchange Act of 1934 govern the submission of shareholder proposals. The Rule allows any shareholder who holds $2,000 or 1 percent worth of a company’s stock – for a period of one year – to submit a non-binding shareholder proposal on any subject matter that they please. ...

 

Due in part to the extremely low bar for qualification to submit a proposal, as well as the SEC’s increasing tendency to err on the side of proponents in allowing these proposals access to the corporate proxy, the shareholder proposal process has become one of the favorite vehicles for special interest activists to advance their social, environmental, or political agendas. Proponents largely include activist public pension funds, social, or environmentally-focused funds, as well as so-called “gadfly” investors who own miniscule amounts of a company’s stock, often times just so they are able to submit proposals year after year. ...

To put the gadfly comment into perspective, consider this excerpt from Proxy Monitor's 2014 report on "frequent filers" of shareholder proposals:

Since 2006 (the first year in the ProxyMonitor.org database), the three most frequent sponsors of shareholder proposals at Fortune 250 companies have been corporate gadflies: John Chevedden (including, in earlier years, his family trust and now-deceased father, Ray); William Steiner (and son, Kenneth); and Evelyn Davis. Over the last nine years, Chevedden has sponsored 232 proposals, Steiner 215, and Davis 153 (Figure 1). Other frequent filers over the time span include Emil Rossi (and family), James McRitchie (and wife, Myra K. Young), John Harrington, and Gerald Armstrong. These seven people (and their family members) are the only individual investors to file more than ten shareholder proposals during the 2006–14 period.

These folks need to get a life. Find a hobby. Something besides wasting people's time with proposals that almost never come close to passing.

Back to the bill's summary:

Despite the increasing number of proposals at public companies, shareholder support for environmental, social, or political issues remains stubbornly low. According to Proxy Monitor, in the decade they have been tracking proposals at Fortune 250 companies, not a single environmental-related shareholder proposal has received the majority support of shareholders over board opposition. Proposals related to political spending disclosure have not fared much better - only one proposal in that timeframe has received majority support, and in 2016 such proposals averaged only 23% support from shareholders.

As explained by former Commissioner Gallagher:

the SEC’s shareholder proposal rule, Rule 14a-8, is being abused by special interest groups to advance idiosyncratic goals that may directly conflict with the interests of most shareholders. A proponent, often with little to no skin in the game, can force a company to include in its proxy a proposal, which can touch on any of a wide range of issues, including immaterial social and political matters. Or, the company can expend substantial corporate resources seeking exclusion of the proposal.456

In addition to low thresholds for the initial submission of a proposal, shareholders are allowed to resubmit their proposal in subsequent years, even if they receive extremely low levels of support. Current regulations allow a company to exclude a resubmitted proposal from its proxy only if it failed to receive the support of 3% of shareholders the last time it was voted on; 6% if it has been voted on twice in the last five years; and 10% if it was voted on three or more times in the last five years. Thus, in many cases shareholder proposals that have been opposed by over 90% of shareholders on multiple occasions are allowed to be resubmitted, forcing companies to spend time and money in deciding how to deal with them.

The increasing use of the shareholder proposal system to embarrass companies or to advance idiosyncratic agendas – while the vast majority of shareholders vote in opposition to them – shows that this system is broken and in need of reform. The resounding message from a majority of shareholders is that they care about the companies they invest in generating a decent return, and have no interest in becoming involved in the pet issues of others. Despite the fact that the majority of shareholders oppose the activist shareholder proposals, because of the current regulatory regime, public companies must dedicate time, and money to defend against them. We want our companies to better use their resources to grow, and create more jobs – not fight politically motivated activist shareholders.

As I have repeatedly explained over the years, for example, shareholder proposals to require corporations to disclose political contributions are not about improving corporate governance but are aimed exclusively at defunding conservatives for the benefit of the Democrats.

Let's hope this provision passes. But we need not depend just on the Congress doing the right thing (I remain doubtful that this bill will survive a Democratic filibuster in the Senate). In my view, having adopted Rule 14a-8 and often amended it over the years, as well as frequently changing its interpretations of the rule, the SEC has all the authority it needs to do this by amending the rule.

House Dodd-Frank "Repeal" Bill Leaves Several Key Corporate Governance Provisions Intact

The Dodd-Frank Act had six major provisions that affected Main Street corporate governance, all of which I have derided as "quack" corporate governance:

1. Section 951’s so-called “say on pay” mandate, requiring periodic shareholder advisory votes on executive compensation.
2. Section 952’s mandate that the compensation committees of reporting companies must be fully independent and that those committees be given certain specified oversight responsibilities.
3. Section 953’s direction that the SEC require companies to provide additional disclosures with respect to executive compensation.
4. Section 954’s expansion of SOX’s rules regarding clawbacks of executive compensation
5. Section 971’s affirmation that the SEC has authority to promulgate a so-called “shareholder access” rule pursuant to which shareholders would be allowed to use the company’s proxy statement to nominate candidates to the board of directors.
6. Section 972’s requirement that companies disclose whether the same person holds both the CEO and Chairman of the Board positions and why they either do or do not do so.

The House Financial Services Committee has just passed the Financial Choice Act. It's not as big a statute as Dodd-Frank (few are), but it's still pretty huge. I've read the summaries and done searches in the text, however, and have determined that while the bill repeals several of of Dodd-Frank's corporate governance provisions outright, it also leaves several intact and makes just tweaks of varying degrees to others:

1. I can't find any reference to section 951's say on pay provision. My colleague Steve Bank points out that section 843 of the Act eliminates shareholder voting on golden parachutes and changes the frequency of shareholder votes "by striking ‘'Not less frequently than once every 3 years’ and inserting ‘Each year in which there has been a material change to the compensation of executives of an issuer from the previous year.'"
2. Ditto section 952's compensation committee rules.
3. Section 953 had two key provisions:
   1. Subsection (a) requiring improved disclosures of pay versus performance. This subsection appears to have survived intact.
   2. Subsection (b) required disclosure of the ratio of the CEO's pay to that of the median paid employee. This provision is repealed. See Financial Choice Act section 857(a)(24) at p. 474, line 19 of the Act.
4. Section 954's clawback provisions left intact were limited to executives "had control or authority over the financial reporting that resulted in the accounting restatement. See  Financial Choice Act section 849 at p. 468, lines 1-7 of the Act. (Thanks again to my friend Steve Bank) for spotting that error)
5. Section 971 is repealed. See Financial Choice Act section 857(a)(30) at p. 474, line 25 of the Act.
6. Section 972 is repealed. See Financial Choice Act section 857(a)(31) at p. 475, line 1 of the Act.