Last week, at a meeting of the SEC’s Investor Advisory Committee, SEC Chair Jay Clayton delivered an opening statement, part of which addressed two governance topics of recent debate. One of the topics—dual-class share structures—was on the Committee’s agenda, while the other—mandatory shareholder arbitration provisions—was not. In both cases, Clayton’s mission was to explain “why they are not on my list of near-term priorities.”
In Clayton’s view, the SEC has limited rulemaking capacity and resources, which should be reserved for matters that are more pressing for investors and markets, more central to the SEC’s core “mission” and are ripe for consideration and addressable with a reasonable time commitment. To Clayton—and, in his view, Main Street investors and others who take a broad view of the markets and economy—these matters
“currently include, among others, (1) standards of conduct for investment professionals, (2) an examination of equity and fixed income market structure, (3) the regulation of investment products, including ETFs, (4) the impact of distributed ledger technology (including cryptocurrencies and ICOs), (5) FinTech developments, (6) the elimination of burdensome regulations that do not enhance investor protection or market integrity with an eye toward facilitating capital formation, and, of course, (7) Congressionally-mandated rulemaking, as well as inevitable issues that we have not yet identified but will emerge as pressing.”
Rulemakings that fit within these categories were included in the SEC’s Regulatory Flexibility Act agenda. (See this PubCo post.) Notably absent from this list of priorities are both of these topics du jour.
With regard to mandatory shareholder arbitration provisions, as Clayton has previously testified (see this PubCo post), he is “not anxious for this issue to come before the agency. This is a complex issue that invokes divergent and deeply held perspectives and could inevitably exhaust a disproportionate share of the Commission’s resources.…This does not mean that the topic is not worthwhile to discuss, and I encourage those with strong views to support their position with robust analysis.” Moreover, Clayton pointed out that investors continue to invest overseas, where their protection through private rights of action is often weaker: “In this regard, I offer one data point that is worthy of illumination for various investor protection reasons—U.S. investors have, directly or indirectly, invested roughly $6.4 trillion in equity securities in jurisdictions that have substantially different, and in most cases less demonstrably significant private rights of action for shareholders. I expect this trend—a greater proportion of U.S. investment being made outside the SEC registration system—to continue.” Nevertheless, Clayton clarified that he had “not formed a definitive view on whether or not mandatory arbitration for shareholder disputes is appropriate in any particular circumstance. I believe any decision would be facts and circumstances dependent.”
In a recent speech to an investor forum, new SEC Commissioner Robert Jackson expressed his concerns about “rumors that the securities industry is eager to slip mandatory arbitration of shareholder disputes into an upcoming IPO.” In his remarks, he argued that regulators cannot do the job of investor protection alone: “We need multiple layers of protection. That’s especially true in the financial sector, where investors are often the last line of defense keeping insiders from committing fraud. Insiders who would cheat investors know that, if they’re caught, shareholders can sue—and they’ll have their day in court….That’s why the Supreme Court has said for years that policing corporate wrongdoing is a team effort—the government and investors working together to make sure insiders who betray investors are held to account.” Moreover, he contended, holding proceedings in public is a key part of the process; while arbitrations are held behind closed doors, “the resolution of private disputes in public courts creates positive externalities. In other words, the public also benefits when private litigants use courts because a public hearing gives judges a chance to tell corporate insiders what the law expects of them. Holding wrongdoers to account tells the public that we take corporate fraud seriously—and sends a signal to insiders, the bar, and investors, that being unfaithful to investors doesn’t pay.” In any case, he advocated, any action on this subject should be implemented through a considered rulemaking process, not “through a clandestine effort by corporate lobbyists.”
Clayton then addressed a topic that was on the committee’s agenda for that day: “With respect to dual class structures, I commend the Committee for examining this issue and look forward to your recommendations. I understand that those recommendations focus on potential disclosure deficiencies and investor confusion. Of course, we should be striving to address any material gaps in governance disclosure and address investor confusion. Disclosure regarding the operation of dual class voting structures is a question that should be discussed.” However, he added, the issue should be addressed in a broader context: he “would like to see more analysis of this topic that considers other related issues of significance, including concerns about short-termism and concerns about the attractiveness of U.S. public capital markets compared to foreign public markets and global private markets.“ But, as noted above, this topic was not on his priority list.
In its meeting last week, the SEC’s Investor Advisory Committee voted to adopt recommendations to Corp Fin related to disclosures regarding dual-class and other “entrenching governance structures.” In particular, the Committee recommended that Corp Fin:
- Require disclosure of the “wedge” data between ownership and voting control, e.g., the numerical relationship between the amount of common equity or its equivalent economic beneficial ownership interest held by any 5% holder and the amount of voting rights held or controlled by those controlling holders.
- Require disclosure of the risk that these superior voting rights could be used to approve governance changes that would further increase the disparity between ownership and voting rights.
- Require disclosure of the minimum ownership level that would still allow the holder to retain control over a majority of voting rights, without the need for approval by other shareholders.
- Require disclosure of the risk of exclusion from major indices and the potential effects of exclusion on stock liquidity and value.
- Require disclosure of the risk of delisting if the controlling holders exercised their voting rights to increase their relative voting power or to decrease the relative voting power of other shareholders.
- Monitor shareholder disputes arising out of dual-class structures to identify trends, common issues and resulting conflicts of interest, with a view to disclosure improvements.
- Define “common stock” for securities law disclosure purposes to distinguish between stock with voting rights under the one-share, one vote system from stock with fewer rights, including possibly restricting the prominent use of the term “common stock” in offering documents to one-share, one-vote single-class common stock. (The committee viewed this position as an enhancement of Corp Fin’s practice of requiring companies to prominently include phrases such as “non-voting” on the first page of the prospectus, even when “non-voting” is not formally in the title of the securities.)
- Consider adding disclosure requirements to Form 10-K that would provide information equivalent to that ordinarily included in a Schedule 14A (e.g., the beneficial ownership table).
As reported in Law360, the Committee also decided to address at a later time a recommendation by Commissioner Jackson that the exchanges require companies to include sunset provisions in dual-class structures. In a speech in Berkeley, Jackson addressed the question of “whether dual-class structures, once adopted, should last forever.” While, Jackson acknowledged that, “at least for a defined period of time early in a company’s life, dual-class can be beneficial,” that may not be the case for the long term, he believed; his studies showed preliminarily that, “at some point that structure is no longer beneficial.” However, Jackson took issue with the approach of simply excluding companies with dual-class structures from major indices as too “blunt” a tool. That is because Main Street investors often invest through index funds and should not be forced to “lose out on the chance to be a part of the growth of our most innovative companies.” Instead, he advocated that the exchanges amend their listing requirements to impose sunset provisions on dual-class shares as the price of admission to the exchange.