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Letter To SEC on Corporate Transparency and Accountability and the Coronavirus Pandemic

The following letter was submitted by the authors on May 26, 2020, to the Securities and Exchange Commission (SEC) Chairman Jay Clayton and filed in response to selected rulemakings (listed in the appendix below). SEC proposed rules and public comments are available here.

Dear Chairman Clayton,

America is in crisis. The raging coronavirus pandemic has infected more than 1.6 million Americans and killed nearly 100,000 to date.[1] The health crisis has also caused a unprecedented economic shutdown that threw more than 20 million Americans out of work in April alone.[2] Unemployment is predicted to remain above 10 percent through the end of 2021, long after social distancing measures have ended.[3] Making this crisis worse are the decades of economic and financial regulatory policies that have stripped workers and investors of information and rights, while allowing anti-competitive and abusive corporate practices to flourish.

The Securities and Exchange Commission (SEC or Commission) is operating in a profoundly different world than that which existed just a few months ago. However, rather than taking stock of how the world and capital markets have fundamentally changed since February, the Commission seems to be acting as if little has happened. This is a mistake.

If anything, the extraordinary shocks and interventions arising from the coronavirus crisis have demonstrated that U.S. capital markets need more, not less market transparency and accountability. Investors and the public are demanding the ability to scrutinize corporations and their management, as they and other stakeholders rightly need to know which firms are receiving trillions of dollars of Federal support, how they are spending it, whether workers are getting the monies intended for the survival of their households, and whether companies remain susceptible to future waves of the pandemic, future lockdowns, and other economic shocks.[4]

Moreover, the pandemic makes it more difficult for the agency to solicit, and for interested parties to provide, input. This on its own justifies slowing down and freezing many rulemakings.[5] More importantly, the new circumstances that are still developing must be taken into account as the Commission and staff develop reforms. The epidemic is shaking every part of the capital markets to their core—many capital markets have frozen or required emergency government loans or liquidity, established businesses have sought emergency funding, and businesses from start-ups to public companies have shed businesses and terminated thousands of employees. Far more needs to be done to understand which capital markets are functioning, which are fundamentally unstable, and what regulatory remedies are required. The data simply does not support sweeping deregulation under these circumstances.

We urge the SEC to reverse course. Instead of undermining the working families and retirees whose investment nest egg has only shrunk further in recent weeks, the SEC should be taking regulatory actions to protect those workers and investors, promote sustainable corporate practices, and promote competition. This would include immediately taking action to promote corporate transparency, enhance investor rights, enforce the rule of law, and promote competition.

To achieve these objectives, the Commission should:

  • Reduce—not expand—exemptions to public offering rules to ensure capital is allocated in brightly lit U.S. public markets;

  • expand—not undermine—disclosures that protect investors, workers, taxpayers, and other corporate stakeholders; and

  • lower—not raise—barriers to the exercise of corporate suffrage.

Background and the Importance of Disclosure and Accountability in the Public Markets

For decades, the federal securities laws ensured that investors had essential information about the companies in which they might invest, as well as the power to take actions based on what they learned. The justification was simple: as the Commission explains on its website:

Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions.

The result of this information flow is a far more active, efficient, and transparent capital market that facilitates the capital formation so important to our nation’s economy.[6]

We agree.[7] Congress came to the same conclusion nearly 90 years ago, when it adopted the federal securities laws.

Whatever may be the full catalogue of the forces that brought to pass the present depression, not least among these has been this wanton misdirection of the capital resources of the Nation … The bill closes the channels of such commerce to security issuers unless and until a full disclosure of the character of such securities has been made.[8]

Unfortunately, this bedrock principle underpinning the securities laws and the Commission’s own existence is under attack. Sweeping deregulation has resulted in companies no longer needing to tell the public basic information about themselves in order to raise billions of dollars. From the 1930s through the 1970s, strict Commission rules required nearly all offerings of securities to be registered. Beginning in the early 1980s, however, holes began to be poked in this regime. Those holes—the exemptions and exceptions—have now overwhelmed the general rule. In fact, by 2019, nearly 70 percent of capital was raised outside of the SEC’s public registration and disclosure regime.[9] To put it mildly, the “channels of commerce” are clearly not “closed” to companies selling securities without “full disclosure.”

To the contrary, along with unprecedented volumes of exempt offerings, we’ve seen a slew of “private” trading venues emerge,[10] some of which extract enormous costs from investors[11] and provide exceedingly little information to them. “Private” securities offerings and any subsequent trading in these increasingly large and numerous companies lack much of the essential information and many of the investor protections that have been hallmarks of U.S. capital markets since the 1930s.[12] Without robust information and accountability, companies have engaged in a myriad of troubling practices, ranging from taking dubious financial risks, to inappropriately compensating senior executives, to putting workers at risk.[13] Just about every aspect of the market is less efficient too, featuring exacerbated agency costs, elevated risks (including trading costs, valuation risks, and market risks),[14] and more fertile ground for fraud and manipulation.[15] These unavoidable realities negatively impact far more than just investors, but also business partners, competitors, workers, and more.[16]

Indeed, the recent crisis has starkly illustrated the profound risks to workers, companies, and the economy from the rapid expansion of private markets. As a recent statement recognizes, investors, taxpayers, and other stakeholders in America’s companies need to know how companies are navigating the crises, including their use of various governmental assistance programs.[17] These disclosures are essential to effective oversight—in corporate governance matters, in labor-management relations, and in broader public policy areas. And we have already seen disclosure work as intended. Once some public companies began disclosing their receipt of federal assistance, for example, there was an immediate public outcry, the terms of the programs were revised, and companies were advised to give funds back to the government.

Yet with far too many large companies no longer in the public markets, this critical oversight protection is lost. Investors in private companies, their workers, their business partners, and even their government may lack this essential information.

For example, without company-mandated disclosures, the public may never know the true scope of the Federal Reserve System’s bailout of oil and gas companies, and if aide has wrongfully flowed to undeserving hands.[18] The negative impacts extend not only to the carbon-related financial stability risk that the Federal Reserve itself is now financing—one which needs full transparency across the Fed’s portfolio—but also the efficient allocation of capital.[19] The Fed is using its resources to support the finances of some companies, and not others, with implications on those companies’ investors, employees, business partners and more. Are these choices being made wisely? Without transparency and accountability, the public’s trust in business and government is undermined.

Concerns for investors and the public that are multiplying in this crisis are not confined to COVID-19. Twice over the past dozen years, corporate America has demanded and received trillion-dollar taxpayer-backed bailouts. With climate change a systemic risk to the financial system, it is essential to that ensure investors and the public are better prepared to address economic shocks.[20] The SEC must do things differently.

The Commission needs to restore public capital markets to help address these challenges.

The SEC Is Moving In the Wrong Direction

The Commission’s numerous recent deregulatory actions have and will (1) reduce the requirements for companies to make disclosures, and (2) reduce the ability of investors to act based on that information. These actions do not protect investors, maintain fair, orderly, and efficient markets, facilitate capital formation, or serve the broader public interest. Instead, they will do the opposite.

We wish to highlight several examples in which the Commission should change direction.

Eroding the Public Company Regulatory Framework

The SEC and Congress, in various measures since the 1980s, have engaged in successive rounds of deregulation attacking the public company regulatory framework.[21] As noted above, the impact of these changes has been enormous, dramatically undermining the scope of the public markets and replacing them with “private” securities markets.

Against this already troubling backdrop, the agency has proposed its most sweeping reforms to its public company regulatory framework in decades. The Commission’s June 2019 Concept Release,[22] as well as subsequent rulemaking proposals in December 2019[23] and March[24] of this year are breathtaking both in scope and impact. By expanding the scope of persons outside the protections of the public company regulatory framework and further loosening important limitations on offerings outside of that framework, these “private markets” proposals together represent aggressive deregulation of the capital markets.

Together, these proposals aggravate an initial public offering (IPO) off-ramp that enables large companies to avoid disclosure requirements and effective corporate governance features. Moreover, these proposals drain liquidity from the public markets—liquidity that protects investors and also drives economic growth. Although ostensibly about adding investment choice, these policies actually reduce information and choice by encouraging current public companies to go dark and other companies to not pursue the IPO route. What is perhaps most disappointing, the Commission has been repeatedly marketing these proposals in the name of investors, yet, as shown in letter[25] after letter, real investors and their advocates—unlike the troubling astroturfing campaign orchestrated to fool the Commission[26]—overwhelmingly oppose them.

Put simply, at the very moment that investors and the public are demanding more information about companies, the Commission is proposing to dramatically expand the scope of securities offerings and trading transactions for which the public disclosure regime and other investor protections will generally not apply.

Corporations and executives also work better when they know they will be held accountable for their actions. That can only happen when investors, corporate stakeholders like workers, and the public have meaningful information and corporate governance rights. In particular, the rapid expansion of environmental, social and governance (ESG) investing and accountability are almost entirely dependent on the public company regulatory regime. Any attack on public markets is an attack on that vision of corporate long-termism and shared prosperity.[31]

The current pandemic crisis has further underscored the significant risk of certain types of securities, such as collateralized loan obligations, being issued into and traded on private markets, where there are weak disclosure regimes and anemic price discovery.[32] Indeed, financial crises fester in darkened capital markets. Markets with high incidences of risk, fraud, and manipulation also are unlikely to inhibit strong and stable valuations, which are essential to enabling investor confidence and a speedy recovery.[33]

Ultimately, the Commission’s efforts to turbocharge the growth of private markets comes at the expense of the public markets[34] that are vital to recapitalizing American businesses and making our economy more resilient to upcoming threats, such as climate change.[35] Indeed, public companies appear, initially, to be faring somewhat better than private companies during the pandemic, with even some of the more troubled larger companies able to raise money in the public markets while a number of prominent private companies have entered bankruptcy.[36] Even before the pandemic, private equity (one corner of the private markets) was no longer yielding significantly better financial returns than public markets.[37] Yet even core users of private markets themselves, such as venture capital funds and private family businesses, are harmed by the decline of robust public markets, as exit options, valuations, and investor confidence all deteriorate.[38]

The Healthy Markets Association,[39] the Council of Institutional Investors,[40] the Consumer Federation of America,[41] Americans for Financial Reform Education Fund,[42] Better Markets,[43] more than a dozen of the leading securities law academics,[44] and many others all indicated that the health of the U.S. capital markets depends on robust and transparent public markets, which are being directly undermined by the Commission’s recent regulatory actions and would be decimated by the adoption of its numerous proposals. The Commission should be supporting a more robust IPO on-ramp by limiting, not dramatically expanding, private markets.

Lastly, we are deeply troubled by the SEC’s decision to loosen, without any public input or justification, the requirements for its Regulation Crowdfunding rules.[45] While we are sympathetic to the needs of small businesses for financial assistance in these extraordinary times, [46] we see no evidence that exposing investors to greater risks and less information—while in the midst of an economic crisis—will spur sound investments and economic growth. Even more troublingly, we fear that the Commission is failing to fulfill its most basic procedural obligations. Simply ignoring the law and deregulating based upon ideological dispositions and anecdote, without public input, is not a sustainable model. This practice also raises serious concerns under the Administrative Procedure Act.

Eroding the Value of Existing Public Company Disclosures

The Commission has proposed stripping existing disclosures for public companies. Investors and the public are increasingly seeking more comparable information from companies regarding a broader scope of issues than ever before. For example, in response to the COVID-19 crisis, investors are seeking more information on companies’ supply chain risks and worker health and wellbeing. Investor concerns may range from tax policies to political spending to any number of other ESG issues.[47] At the same time, modern technologies permit issuers to more easily aggregate and disclose, and stakeholders to assimilate, analyze, and use that information more effectively than ever before.

Nevertheless, the SEC is proposing to eliminate, reduce, and otherwise undermine the utility of disclosures by public companies. Recently, for example, the agency proposed “modernizing” Regulation S-K, ostensibly to reflect the fact that capital markets and the economy have both changed in the more than 30 years since adoption.[48] However, the focus of the proposal is to move disclosure away from detailed, objective, and comparable standards to ambiguous, amorphous, less comparable “principles.”

As various experts,[49] including Commissioners Robert Jackson and Allison Lee[50] have noted, a more principles-based approach to disclosures gives companies more discretion over what kind of information they share with investors. This would reduce the quality and comparability of information disclosed. Moreover, we note that a lack of specific disclosure requirements will mean that industry practices may diverge over time. This would leave the Commission in a position of either not enforcing intended disclosure requirements or being subject to accusations that it is pursuing regulation by enforcement.[51] Just as significantly, private investors that have been the victim of fraud will be in a far weakened position in protecting their own property rights.[52] Capital markets and broader economic efficiency will be negatively impacted by the inability of market participants to effectively distinguish between quality corporate leadership and poor management strategies.[53]

The materiality standard is too often misunderstood and misapplied. Too many securities professionals forget that the legal lodestone is whether information is material to investors, and not how executives of the company might perceive it impacts the company’s finances.[54] Although the addition of “human capital” as one of the topics to be disclosed is one of the few bright spots in the SEC’s recent agenda,[55] the proposed rule[56] fails to include information around climate change as a required topic for disclosure. This failure is glaring given how many investors now view climate change as a critically important factor in making decisions—a point made by thousands of comments to the Commission over the years, and with distinct clarity by Commissioner Lee in recent months.[57]

The Commission’s proposed changes to the management discussion and analysis section of corporate disclosure exhibit a similar thrust towards reducing disclosure content, comparability, and utility.[58] As the CFA Institute and Council of Institutional Investors point out, these proposals shift the burden from companies to investors in terms of collecting and providing useful information.[59]

The Commission’s recent reduction in disclosure on mergers and acquisitions (M&A) transactions exhibit the same flaws.[60] In the face of high levels of M&A activity in the markets in recent years, [61] this misguided final rule reduces transparency, including by lowering the necessary financial statements from three years to two. The current economic crisis is likely to lead to more M&A activity, including in high risk situations of rising insolvencies and in the context of extraordinary Federal support for targets and acquirers.[62] In the face of a declining number of public companies,[63] the SEC should be expanding the ability for investors, other stakeholders, and the public to carefully scrutinize the wisdom of mergers and reject those that will harm investors, raise consumer prices, and undermine robust competition.

The Commission’s proposal to weaken transparency around extractive industries practices is another example of its deregulatory agenda facilitating concentration and abuse by decreasing transparency.[64] It is also out of step with international disclosure standards and the needs of investors and stakeholders for robust anti-corruption protections.[65]