United States: SEC's Investor Advocate Bemoans 2020 Rulemaking Agenda And Has Some Ideas For 2021

Let's just say that the SEC's Investor Advocate, Rick Fleming, was none too pleased with the work of the SEC this year.  Although, in his  Annual Report on Activities, he complimented the SEC for its prompt and flexible response to COVID-19, that's about where the accolades stopped.  For the most part, Fleming found the SEC's rulemaking agenda “disappointing.”  While cloaked in language about modernization and streamlining, he lamented, the rulemakings that were adopted were too deregulatory in nature, with the effect of diminishing investor protections. But issues that definitely called for modernization—such as the antiquated proxy plumbing system—despite all good intentions, were not addressed, nor did the SEC establish a “coherent framework” for ESG disclosure. And the SEC “also selectively abandoned its deregulatory posture by erecting higher barriers for shareholders' exercise of independent oversight over the management of public companies” through the use of shareholder proposals and by imposing regulation on proxy advisory firms. That regulation could allow management to interfere in the advice investors pay to receive from proxy advisory firms and was widely opposed by investors.  What's your bet that he'll be a lot happier next year?

The report makes a number of recommendations, including the following:

• Reversal of the shareholder proposal rule. Among other things, the new rules modified the eligibility criteria for submission of proposals and raised the resubmission thresholds; provide that a person may submit only one proposal per meeting, whether as a shareholder or acting as a representative; and prohibit aggregation of holdings for purposes of satisfying the ownership thresholds. (See  2020/10/02/amendments-to-shareholder-proposal-rules-updated/">this PubCo post.) Fleming opposed the rulemaking because the “new ownership thresholds significantly diminish the ability of shareholders with smaller investments to submit proposals,” and many of these holders have played an important role in the process. In addition, he believed the economic analysis was fundamentally flawed, particularly failure to take into account “the most important and obvious question in the economic analysis of a rulemaking that changed eligibility thresholds: specifically, how many shareholders that were eligible under the prior rules would become ineligible under the amended rules.” Staff analysis estimated that number to be between one-half and three-quarters of the retail investor accounts; however, he indicated, that analysis was withheld from public view and from the Advocate's office until 40 days prior to the SEC vote and months after the public comment period had formally closed.
• Reversal of the proxy advisory firm rules.   These rules made proxy voting advice subject to the proxy solicitation rules and conditioned exemptions from those rules for proxy advisory firms, such as ISS and Glass Lewis, on disclosure of conflicts of interest and adoption of principles-based policies to make proxy voting advice available to the subject companies and to notify clients of company responses. In addition, the changes modified Rule 14a-9 to include examples of when material omissions in proxy voting advice could be considered misleading within the meaning of the rule. (See  2020/07/24/sec-amendments-proxy-advisors-updated/">this PubCo post.)  Fleming characterized the changes as requiring proxy advisory firms, which are engaged by institutional investors to provide advice, “to act as conduit[s] for company management to rebut the advice given.”  Fleming was troubled by the absence of empirical evidence supporting claims of select market participants that “proxy voting advice historically had not been transparent, accurate, and complete.”  In addition, Fleming believed that investors should be able to seek this advice without have to “pay for feedback mechanisms that subject them to further lobbying by corporate management….We worry that the newly mandated feedback mechanism enables undue interference in the voting process and will likely result in the suppression of dissenting views.”  He also contended that the economic analysis for this rulemaking was inadequate.
•  Reversal of the rulemaking to “harmonize” various Securities Act exemptions. As summarized in the report, the amendments address “in one broadly applicable new rule, the ability of issuers to move from one exemption to another, as well as to a registered offering; [raise] offering limits for Regulation A, Regulation Crowdfunding, and Regulation D Rule 504 offerings, and rais[e] individual investment limits; [relax] restrictions on general solicitation; and [adjust] certain disclosure and eligibility requirements and bad actor disqualification provisions in order to reduce differences between exemptions.” (See  2020/11/03/final-amendments-private-offering-exemptions/">this PubCo post.) Fleming expressed concern about the continued shift of capital-raising from public markets—and the protections to the public that it provides—to private markets, facilitated by the “ever-expanding exemptions that allow companies to raise increasing amounts of capital with less and less public disclosure. As a practical matter, a company can now raise as much money as it wants from as many people as it wants for as long as it wants, without ever having to go through the registration process. We view the ‘harmonization' rulemaking…as a further step toward making registration entirely voluntary.” In particular, the report contends that the integration doctrine was “nearly eviscerate[d]” and points to the failure of the SEC “to provide a balanced analysis of the potential ramifications for investors who are being given greater access to private offerings,” such as information limitations and illiquidity of shares.
• Adoption of a framework for ESG disclosure. The report notes that numerous investors have long been calling for the adoption of ESG disclosure requirements, pointing to a 2018 rulemaking petition (see  2018/10/04/climate-change-disclosure-petition/">this PubCo post) and recommendations from the SEC Investor Advocacy Committee (see  2020/05/27/investor-advisory-committee-disclosure-recommendations/">this PubCo post). Recognizing that some favor the SEC's principles-based approach to ESG disclosure, Fleming nevertheless agrees “with the many investors who assert that the principles-based disclosure requirements have failed to deliver important, decision-useful information. The information provided by companies tends to vary in quality, and it is not presented in a standard format that enables comparisons between companies.”  He also expressed concern that the lack of substantive ESG disclosure standards contributed to the proliferation of greenwashing. He viewed as “sensible” the recommendation of Commissioners Allison Lee and Caroline Crenshaw  to create a special ESG advisory committee to make recommendations to the SEC, as well as an internal SEC task force to consider and implement policies for ESG disclosure requirements. (See  2020/11/20/sec-amends-mda-requirements/">this PubCo post.)

• Adoption of minimum listing standards for exchange.   Although, the report indicates, the SEC has oversight responsibility over exchanges' proposed amendments to their listing standards to ensure consistency with the Exchange Act, corporate governance remains largely the province of state law. Beyond “the proxy voting process, only the exchanges themselves have broader authority to regulate other substantive aspects of corporate governance for their listed issuers.” Fleming advocates that this allocation of responsibility be revisited. Why? Because the “primary listing exchanges are now for-profit entities that, unlike their prior mutual ownership structure, have an inherent conflict of interest between protecting investors and generating business revenue from listed issuer fees,” creating a potential race to the bottom when it comes to qualitative corporate governance standards. Fleming advocates that Congress set, by statute—or give the SEC statutory authority to set—minimum listing standards to guarantee investor protections. Fleming views the Holding Foreign Companies Accountable Act as one example of Congressional action in this area.  (See  2020/12/22/consolidate-rulemaking-holding-foreign-companies-accountable-act/">this PubCo post.)  The report suggests that minimum standards should include a sunset provision for dual-class share structures and more complete board and management diversity disclosure.
• Adoption of rules to make disclosures machine-readable.  Investors are increasingly using technological tools to analyze data and would benefit from improvements such as the use of legal entity identifiers and other uniform data standards.  Fleming supports adoption of  the Financial Transparency Act and implementation of the directives of the Open, Public, Electronic and Necessary Government Data Act, which “provides a sweeping, government-wide mandate for all federal agencies to publish government information in a machine-readable language by default.”

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