Thoughts on SEC Rulemaking Push

Compliance officers, we need to talk about the Securities and Exchange Commission. Something’s happening there. 

The latest sign of this came earlier this week, when Democratic commissioner Robert Jackson said that he now plans to stay in his job at least through the fall, and possibly longer. Earlier this year Jackson had signaled that he would leave the Commission by Labor Day to return to his teaching job at New York University. Now he’s not.

Jackson

This gives Democrats more time to suggest Jackson’s successor, have the Trump Administration nominate that person, and get him or her through Senate confirmation. Jackson’s formal term as SEC commissioner expired in July, but under federal law he can remain in office another 18 months. So, really, Jackson could stay at the SEC until the end of President Trump’s first term. 

I don’t believe Jackson will stay that long; I believe Senate Democrats will get their act together and find his replacement sometime this fall. Whatever. The real question here is why Democrats want to keep a warm behind on that seat now. 

After all, that hasn’t always been the case. For the first half of this year the SEC hobbled along with only four commissioners, where Jackson was the lone Democratic representative. Allison Lee finally joined him as a fellow Democratic commissioner in July. So what’s happening at the SEC where keeping those two Democratic seats on the commission occupied is so important? 

Well, I believe it’s because we’re about to enter a busy period of SEC rulemaking — one that will be partisan and pointed, with accusations that SEC leadership isn’t doing its homework about whether proposed policy changes are really necessary. 

Which brings us to the other sign that something is happening at the SEC: its vote last week to curb the power of proxy advisory firms. 

SEC Tempting Fate

Proxy advisory firms work with institutional investors — who might routinely own shares in thousands of firms — to help the institutionals decide how to vote on shareholder questions such as executive pay plans, nominations for the board of directors, and so forth. Advisory firms wield a lot of power. As such, they are a frequent target for conservatives in Washington and CEOs everywhere. Those folks view proxy advisory firms as self-appointed kingpins of corporate governance with scant oversight. 

Most ethics and compliance officers won’t deal with proxy advisory firms directly. But look at how the SEC handled its vote to curb the power of proxy advisory firms — because, I suspect, it’s suggestive of how the SEC will deal with other policy reforms later this fall, and those issues will be more relevant to compliance professionals. 

Specifically, the SEC framed its proxy advisory firm proposals as updates to existing staff guidance, rather than adoption of a new SEC rule. That allows the agency to avoid numerous requirements under the Administrative Procedures Act, such as putting proposed rules out for public comment or conducting a detailed cost-benefit analysis. 

None of those things happened with the proxy advisory firm proposals. Instead, SEC staff drafted the updates, and at a meeting last week SEC commissioners voted 3-2 along party lines to adopt them. At one point SEC chairman Jay Clayton even asked the agency’s general counsel, Michael Conley, to confirm that the updates could avoid the APA’s rule-making requirements. 

The two Democratic commissioners minced no words in their displeasure. Consider this statement from Lee:

Significantly, we are creating these risks without notice and comment, without justifying the choices made to affected parties and the public, and without weighing the costs and benefits of the chosen course.

I understand there is a view that today’s actions do not go beyond the staff guidance issued in 2014. But I do not agree. Staff views like those expressed in Staff Legal Bulletin 20 are non-binding and cannot create legal rights or obligations. Commission action, on the other hand, is different and commands attention and compliance.   

That sounds like an unhappy commissioner telegraphing to outside parties, “Somebody else unhappy with this action, please sue us in federal court.”

Critics of the SEC’s vote last week are thinking along similar lines. Here’s a statement from Better Markets, a Washington think tank that often sides with Democratic views on financial regulation:

The SEC’s actions today are unlawful. The votes re-write long-established rules and de facto impose new ones.  Such actions violate the Administrative Procedures Act because they were undertaken without notice or the opportunity for public comment.  

Yikes. Better Markets hasn’t said that it will file a lawsuit over the SEC’s new rules updated staff guidance, but it might; or other  groups could. The U.S. Chamber of Commerce filed lawsuits against the SEC all the time during the Obama Administration — and now, perhaps, we may see more of that from the opposite side of the political spectrum during the Trump Administration. 

Relevance for Compliance Issues

This is where we get back to Jackson sticking around and SEC policy proposals more relevant to compliance officers. There are several, such as reforming the SEC whistleblower awards program, exempting more firms from audits of internal control over financial reporting, and scaling back disclosures to investors as required under Regulation S-K.

Those are much bigger deals than proxy advisory firm reforms, and the SEC has put them all out for public comment. And as proposed new rules, these ideas will also require a cost-benefit analysis. 

Well, Jackson excels at doing his own research, and asking pointed questions about the assumptions behind the SEC staff’s cost-benefit research. One of my favorite examples of this happened in May, when Jackson released a statement about the idea of exempting more firms from internal control audits as required under Section 404(b) of Sarbanes-Oxley.

Not only did Jackson present a cogent argument for why relaxing 404(b) audits is a bad idea. He picked apart the SEC staff’s own analysis. He challenged the fundamental assumption that relaxing audits will lead to more IPOs. He questioned why the SEC proposal didn’t assess the benefits of 404(b) audits to others, instead of focusing only on the costs to public filers. His statement included charts and graphs, for Pete’s sake. 

Jackson doesn’t speak often, but when he does, this is how he does it. He demolishes Republican talking points with actual data, in statements that feel like a roadmap somebody might use in federal litigation to argue that Clayton’s agenda is based on weak analysis and tired GOP talking points. 

So let’s put all this together. Clayton hasn’t been able to advance much of Republicans’ dream agenda yet, because he’s been distracted by one crisis after another: the rise of cryptocurrency and the need to put a regulatory framework around it; the scandal of senior PCAOB officers swapping inspection secrets in exchange for lucrative jobs at KPMG; the SEC’s own data breach announced in 2017; the government shutdown at the beginning of this year. 

Now Clayton seems like he needs a hurry-up offense to push through these plans. The last year of President Trump’s first term is looming, and it’s very possible there will be no second. So Clayton needs to use every administrative trick he can to advance his agenda. 

Fair enough. But if Democrats and Clayton critics were ever going to stall that agenda, this is how they’d do it: by making sharp statements at SEC meetings against new proposals, that read like open invitations for outside groups to tie up the SEC in court at least until 2021, when a new Democratic administration would kill all the Clayton-era efforts anyway. 

So far Jackson has skillfully played that game, so why not have him stick around until a successor is in place and Lee gets up to speed? Democrats can taste blood in the water now. It should make for an interesting 18 months.

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