On Tuesday, September 24, 2019, SEC Chairman Jay Clayton, along with Commissioners Jackson, Lee, Peirce and Roisman, testified before the House Financial Services Committee (Committee) in a hearing titled “Oversight of the Securities and Exchange Commission, Wall Street’s Cop on the Block.” Chairwoman Maxine Waters observed that the last time all the SEC Commissioners had been before the Committee was over a decade ago, in 2007.
The SEC submitted written remarks that begin with the agency’s “tripartite mission—to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation . . . .” The remarks describe the agency’s strategic plan and highlight the 2019 initiatives in the following areas: (1) enforcement and compliance; (2) market developments and risks; (3) regulatory and policy agenda; and (4) investor education.
While the hearing covered a very broad range of topics, including the SEC’s oversight of self-regulatory organizations, this summary primarily covers topics related to corporate governance.
I. Key Takeaways
The hearing provided a forum for the Commissioners to state or restate their current opinions on ESG disclosure. Commissioner Peirce reiterated her opposition to additional ESG disclosure requirements; in contrast, Commissioners Jackson and Lee continue to believe that investors want this additional disclosure, with Commissioner Jackson stating the need for more quantitative disclosure requirements as well as for more political contributions disclosure in particular. Chairman Clayton’s statements indicate a continued belief that any additional disclosure requirements should be grounded in materiality and that a principles-based approach would be more flexible to account for investor views that change over time.
In addition, with regard to shareholder proposals, Chairman Clayton reminded us that the SEC continues to consider increasing resubmission thresholds, but gave no indication of what they may be.
II. Opening Remarks in the Order Presented
Chairwoman Maxine Waters: Chairwoman Waters stressed the importance of the hearing and expressed concern regarding the SEC satisfying its mission to, as she put it, act as “Wall Street’s Cop”. She listed concerns regarding certain regulations and market practices such as the recently adopted Regulation Best Interest and the 8-K trading gap (when insiders trade securities during the four-day period between the date the Form 8-K is filed to report a development and the date the development occurred). Chairwoman Waters complained about companies spending money to buy back their own shares rather than investing in their respective companies or offering employees pay raises. Moreover, she noted that executives personally benefited from selling their shares to their respective companies during a buyback.
Ranking Member Patrick McHenry: McHenry’s opening remarks centered on the need for policies that make American public markets stronger and more competitive. He complimented the SEC on its work relating to capital formation, particularly those items that benefit Main Street investors. He stated that policies that encourage companies to go public and preserve their options to raise capital will increase competitiveness.
Representative Carolyn Maloney, Chair of the Subcommittee on Investor Protection, Entrepreneurship and Capital Markets: Representative Maloney’s brief remarks noted that the most important recent SEC action related to Regulation Best Interest. She felt however that it failed to sufficiently raise the standard for broker-dealers.
Commissioner Robert J. Jackson, Jr.: Commissioner Jackson’s opening remarks described three main concerns: (1) the 8-K trading gap; (2) the increase in stock buybacks; and (3) the need for required disclosure by public companies regarding their political contributions.
Commissioner Hester M. Peirce: Commissioner Peirce framed her remarks around three principles that she keeps in mind while performing her Commissioner duties: (1) investor protection extends to protecting investor opportunities; (2) regulation is the SEC’s primary charge (the SEC is a regulatory agency and not an enforcement agency); and (3) “regulatory humility”—regulators cannot and do not know everything (regulators rely on the expertise of SEC staff and regulators from other agencies as well as communication with market participants).
She also explained that the role of the SEC is not to make investment decisions for investors, but rather to provide a regulatory framework under which clear and accurate information is made available. This perspective on the SEC’s role informs her views on digital assets and the need for clear regulation. As part of its regulatory function, she added that the Commission is continuously looking at rules to see whether changes are needed, including codifying a long-standing no-action position.
Commissioner Elad L. Roisman: Commissioner Roisman’s opening statement reaffirmed the importance of all three parts of the SEC’s mission and recognized contributions by various SEC divisions and offices. He also expressed appreciation regarding the Commission’s focus on the proxy process (Roisman has been leading the SEC’s proxy advisory reform initiative).
Commissioner Allison Herren Lee: Commissioner Lee expressed that critical issues had been identified for the hearing discussion, including: (1) capital raised in private versus public markets; (2) public companies’ making disclosures in an effective manner that investors need to inform their decisions; (3) the SEC’s enforcement program; (4) digital assets; and (5) the role of financial intermediaries. She noted the importance of keeping the SEC accountable and that the SEC’s rulemaking must be fair and transparent.
Chairman Jay Clayton: Chairman Clayton opened by verbalizing three key points: (1) the funding that the SEC received for fiscal year 2019 helped lift the hiring freeze, though more work needs to be done in the cybersecurity department; (2) the SEC’s focus on the interests of Main Street investors; and (3) the increase in the attractiveness of public markets.
III. Key Topics Raised
1. ESG-Related Topics
Representative Gregory Barr observed that the Business Roundtable recently published a statement on the purpose of a corporation (the statement was issued on August 19, 2019, and was signed by 181 CEOs who have committed to lead their companies for the benefit of all stakeholders, not solely shareholders). Representative Barr asked Commissioner Peirce whether companies can effectively serve the interest of multiple stakeholders without focusing on maximizing shareholder value.
Commissioner Peirce responded that the singular focus on shareholder value is necessary and important. As companies focus on maximizing shareholder value, they will also be considering other stakeholders. Serving customers well furthers companies’ ability to serve shareholders.
Representative Barr shared that Chairman Clayton has stated that lumping environment, social and governance (ESG) topics together is difficult because they are very different. He also noted that Commissioner Peirce has analogized ESG metrics to a scarlet letter. He then asked Chairman Clayton whether he believes that this type of disclosure should be required only when it is material. Chairman Clayton responded that materiality should be the touchstone for the U.S. markets. Moreover, a principle-based approach provides the flexibility needed as materiality changes with the markets.
Representative Katie Porter recounted that Chair Clayton had highlighted the importance of disclosure in the context of ESG during an Investor Advisory Committee meeting. Representative Porter then asked Chairman Clayton whether he generally believed ESG disclosure to be a useful investor tool, and Chairman Clayton responded that, in his opinion, there are disclosures in each of the E, S and G categories that are material and important.
2. Climate Risk
Representative Sean Casten expressed a concern regarding the ability to properly evaluate a company’s climate change risk. Representative Casten questioned Commissioner Jackson on the necessity of quantitative disclosure. Commissioner Jackson answered affirmatively, reasoning that quantitative disclosure is the best method to assess risk and keep companies accountable.
In January 2018, the SEC introduced its Diversity Assessment Report, which is designed to help regulated entities conduct voluntary self-assessments of their diversity policies and practices. Companies have the option to submit the assessment information to the SEC. Representative Gregory Meeks observed that most public companies have declined to participate. Chairman Clayton responded that he has been working with the director of the SEC’s Office of Minority and Women Inclusion to try to facilitate and improve participation.
4. Human Capital Management
Representative Juan Vargas noted that Commissioners Jackson and Lee released a joint statement in response to the recently proposed FAST Act Modernization and Simplification of Regulation S-K. The statement applauded the proposal for including human capital as a disclosure topic, but expressed concern that climate risk was omitted. He then asked the two Commissioners to discuss their positions.
Commissioner Lee responded first, stating that there were a lot of good points made in the proposal, and she appreciated the inclusion of human capital; however, comparability needed more consideration given its extreme importance to investors. Solely having principle-based rules will make comparing information across companies difficult for investors. Commissioner Jackson added that he and Commissioner Lee wondered why the proposal did not go further given strong investor interest.
The use of buybacks rose significantly after the enactment of the Tax Cuts and Jobs Act (TCJA) in December 2017 which, among other things, reduced the corporate tax rate. Concerns were expressed during the hearing about corporations using the tax savings to repurchase their own shares rather than invest in their respective companies or workforce. Representative William Lacy Clay explained that according to one study, there was a 64 percent increase in stock repurchases while wages remained flat. He added that analysts estimate that, in 2018, companies used nearly 60 percent of their corporate tax cuts to repurchase stock and collectively paid $1 trillion to executive directors and large shareholders.
Representative Clay asked Commissioner Jackson how he viewed buybacks. Commissioner Jackson replied that he released research earlier this spring and last year that shows that current SEC rules allow executives to personally benefit from the buyback process and that it was time to revisit the buyback rules given that the SEC has not conducted a review of these rules in over a decade.
Representative Bryan Steil wondered whether the discussion surrounding buybacks was really a question concerning asset allocation by private management. He asked Chairman Clayton how the SEC would approach the analysis, and Chairman Clayton responded that how a company chooses to allocate its capital, such as to buy another company or pay a dividend, is not within the SEC’s purview. Rather, once the company decides to conduct a buyback, the SEC’s role is to ensure that the company’s execution of the buyback does not impermissibly affect the market.
6. Political Spending Disclosure
An issue raised at the hearing concerned whether companies should be required to provide more disclosure on their political activities and contributions. Commissioner Jackson stated in his opening remarks that, in 2013, he published a study showing that $1.5 billion in corporate funds had been donated to intermediaries with nonpublic donor lists. He explained that shareholders should know where the corporate money is going because it may be supporting policies or ideas that shareholders disagree with.
Representative Juan Vargas asked Chairman Clayton about political spending disclosures and Chairman Clayton responded that the current rules require disclosure when the spending is material.
Representative Katie Porter questioned Commissioner Peirce about her position on political spending disclosure in light of the fact that it was disclosed during the hearing that the SEC received 1.2 million comments in support of such disclosure. Commissioner Peirce responded that political spending is not on the SEC regulatory agenda and she believed there to be a legislative ban on the SEC considering the topic.
7. Shareholder Proposals and Proxy Advisory Firms
Representative Ted Budd opined that proxy advisory firms have too much power and feared that shareholders and fiduciaries may have an overreliance on recommendations from proxy advisors. Representative Budd asked what the SEC could do (including with Congress’s assistance) to increase the transparency of proxy advisory firms. Chairman Clayton responded broadly by talking about issues surrounding the mechanics of the proxy voting process. Commissioner Roisman agreed with Chairman Clayton’s comments and added that vote integrity is important.
Representative Ayanna Pressley stated that the first shareholder resolution filed concerning a social issue sought to stop a company from doing business in South Africa in 1971. Currently, to submit a shareholder resolution a shareholder must own shares worth at least $2,000 or own at least 1% of the company. Representative Pressley observed that for companies with a large capitalization, applying the 1% threshold would mean the investor would need to own stock valuing in the billions of dollars. She asked whether the SEC Chairman thought it was responsible to require an investor to own over $3 billion in shares to file a resolution.
Chairman Clayton responded in the negative and continued to state that in an ideal world, a threshold allows access to shareholders that have a meaningful and long-term stake in the company. By the same token, he did not like that 25 to 30 percent of proposals originate from the same handful of investors. While he could not speak to how the other Commissioners felt, he stated that he was not looking to restrict investors from making the initial proposal; however, he was reviewing the resubmission thresholds. He noted that the current rule was instated when mail was the main communication avenue. Now investors have faster means of communicating and staying abreast of developments and issues surrounding the companies in which they invest.
When asked to expound, Chairman Clayton stated that engagement should involve a meaningful or “nuanced conversation” with the company and not merely a proposal directing a company to do something. However, sometimes, a proposal does need to go to a vote before the shareholders. The question is how many times and what level of shareholder support must it receive to continue to be resubmitted.