As has been widely reported, there are currently two nominees to fill the two empty slots at the SEC—from the Democratic side, Robert Jackson, a professor at Columbia Law School, and from the Republican side, Hester Peirce, a fellow at George Mason University. However, Senator Tammy Baldwin had put a “hold” on the nominees back in November, as reported in the WSJ, until they provided “their views on whether regulators should rein in activist investors, stock buybacks and executive pay.” Now that they have both responded to her questions, Baldwin has lifted her hold on the nominees, according to Law360, “clearing a hurdle for confirmation.” Their responses, although not exactly surprising, provide some insight into their views on these key issues.
Senator Baldwin has previously expressed concern regarding the impact of hedge-fund activism on long-term value creation. To address this issue, in 2016, she and Senator Jeff Merkley introduced the “Brokaw Act,” which was designed to enhance transparency, protect companies from “wolf packs” (by shortening the 13D filing period and expanding the definitions of “beneficial ownership” and “person”), end secret net short positions (by requiring more disclosure of derivatives), and address the larger problem of short-termism. The bill was named after the town of Brokaw, Wisconsin, where, after the Wausau Paper Company was targeted by a hedge-fund activist in 2011, the company shuttered its paper mill, devastating the residents of Brokaw as well as the village itself, which is apparently still in the process of dissolution.
Currently, when a holder acquires beneficial ownership of 5% or more of a registered class of equity, the holder must file a Schedule 13D within 10 days. In addition, under Rule 13d-5, when two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities, all of those persons together form a “group” and are deemed to beneficially own all of securities owned by persons in the group. If the group together owns 5% or more of a company’s shares, all of the persons in the group may be required to make filings with the SEC. As a result, Schedule 13D has become the object of media and regulatory scrutiny; indeed, some commentators view its long filing window as something of a loophole. In 2015, for example, the WSJ reported that the SEC was investigating whether some hedge-fund activists formed 13D “groups” but failed to make appropriate disclosure of their alliances.
Had it been enacted into law, the Brokaw Act would have required the SEC to amend Rule 13d-1 to shorten the time to file a Schedule 13D from 10 days to two business days and to expand the definition of beneficial ownership in Rule 13d-3 to include, in addition to voting or investment power, a direct or indirect pecuniary interest in the security. One problem the failed bill was designed to address was the conduct of “wolf packs,” which, some argue, rely on the tactic of “conscious parallelism” and use the 10-day window prior to disclosure to tip their plans, profiting from the use of material nonpublic information. (See this PubCo post and this PubCo post.)
In his response, Jackson indicated that he shared Baldwin’s “concern about the effects hedge funds can have on American companies, workers, and families, and if confirmed I will be a strong advocate for those communities’ voices at the SEC….That’s not to say, of course, that blockholders cannot play an important role in holding corporate managers’ feet to the fire. Capturing the benefits of blockholders, while also protecting American families, communities, and investors, is the task that now faces the SEC.” With respect to his previous work, which had concluded that outside blockholders improved corporate governance and benefited public investors, he seemed to have come around closer to Baldwin’s view, observing that the evidence of the effect of hedge funds had grown considerably since that time, and “the empirical evidence makes clear that, among other strategies, certain activist hedge funds often encourage public companies to engage in stock buybacks” to the detriment of investments in R&D. He also shared Baldwin’s concern that some investors were coordinating their activities while avoiding disclosure and thought that the applicable rules should be modernized, including the disclosure threshold, the 10-day window and the use of derivatives.
In her letters, Baldwin had inquired about the nominees’ levels of concern with the prevalence of stock buybacks, pointing out that over “the last decade, net equity issuances (stock issuances minus buybacks) averaged negative $412 billion per year (money flowing out of companies to shareholders).” Jackson concurred that the volume of buybacks was a concern and advocated updating the buyback rules, including Rule 10b-18, and making the rationale for the buyback more transparent.
In addition, he expressed his deep concern that “corporate executives are too focused on short-term share prices instead of sustainable value creation.” In that regard, he contended, “the structure of much stock-based compensation—especially top executives’ freedom to unload shares in the short term—has led corporate managers to pursue short-term profits rather than long-term value creation.” He suggested that developing new rules that would encourage corporate executives to commit to hold their shares for the longer term might be a tool that could be used to address the problem of short-termism and could discourage the use of tactics, including buybacks, often employed to spike short-term stock prices. In addition to looking at executive pay structures, Jackson suggested that the SEC should consider “whether and how to enable public companies to choose” some version of tenure voting (see this PubCo post) and revisit the stock buyback rules to address the issue of short-termism.
Jackson also committed to supporting the finalization of a number of mandatory Dodd-Frank rules: the “fact that these proposals have not yet been acted upon reflects a troubling failure to follow the law at the Commission.” He also indicated his support for pay-ratio disclosure, which might spur companies to examine “the growing pay divide,” and suggested that he was open to considering pay measures other than “estimated fair value.”
Note that the SEC has back-burnered those Dodd-Frank rulemakings, as indicated in the SEC’s new Regulatory Flexibility Agenda. See this PubCo post.
In her response, Peirce had a somewhat different slant on things—let’s say, on some issues, her assessment diverged from that of Jackson, while on other issues, she expressed a more noncommittal view in response to the questions of the Democratic Senator. Peirce’s view of hedge-fund activists was relatively neutral. In her view, large blockholders, such as hedge-fund activists, can have a positive or negative influence—“encouraging companies to take steps that will increase their long-term value,” or “inducing companies to focus on objectives that further the Blockholder’s interests, but undermine the company’s value.” If confirmed, she looked forward “to working to ensure that investors have the information they need to understand and assess companies’ and shareholders’ actions and the implications of those actions for companies’ long-term value.” In addition, with regard to potential changes to Schedule 13D, she hoped to work with everyone “to understand, in light of relevant evidence, whether and, if so how, the scope, timing, and applicability of Section 13(d) disclosure requirements should be changed or clarified.” For 13D disclosure, she considered an “evidence-based reassessment” to be “valuable because it could take into account the years of experience with the disclosure rules to date and the many changes that have occurred in our markets in the years since these rules were put in place.” If confirmed, she looked forward to working with everyone “to assess whether, in light of the substantial changes in the nature of markets, shareholders, and the state corporate governance framework since these rules were adopted, the rules are achieving their objectives or whether any changes are necessary.” She also recognized that, as “part of any reconsideration of the Section 13(d) framework,… it would be important to look at whether purchasers are avoiding the application of existing requirements in a manner that runs counter to the objectives of Section 13(d).”
With respect to stock buybacks, if they are conducted properly and used legally, she believes that they “can contribute to economic growth,” by allowing shareholders who received money from companies without productive uses for it to invest that money in other companies that did have productive uses for it. “Whether a particular buyback benefits the economy is a fact-specific question,” she maintained, “but it is useful to monitor trends about how and why buybacks are occurring.” Although she had “not seen empirical studies that explore whether there is a causal link between buybacks and economy- or industry-wide changes in wages and jobs,” she acknowledged “that some companies have engaged in buyouts around the same time they have announced job cuts.” The answer, she believed, was “to ensure that companies of all sizes can raise money in our capital markets, which they then can use to hire workers, expand production, and invest in research and development. In a healthy, growing economy, share buybacks may occur less frequently, and when they do, any associated layoffs will take less of a human toll….” In her view, the “SEC should work to ensure that the regulatory framework facilitates the flow of capital to its highest and best use,” but she planned to work toward understanding “why buyouts are occurring, how they are affecting the economy, and what the SEC can do to better facilitate capital formation,” including what changes to the regulatory framework—such as retrospective review of Rule 10b-18—may be needed. Similarly, with regard to disclosure about buybacks, she was open to assessing whether the current disclosure requirements were adequate.
Peirce did indicate support for completion of rulemakings required by Congress, such as Dodd-Frank. She viewed executive pay as one factor that can affect corporate priorities, but had not “seen studies that explore empirically whether there is a causal link between stock-based pay and buy-back decisions.” She also indicated support for “SEC efforts to implement and enforce statutory mandates, including the pay ratio disclosure mandate,” but suggested that the SEC “may need to make adjustments to the rule or provide additional guidance.” Asked whether reducing the pay ratio was a worthy goal, her response was that companies “should pay people for the contributions they make to the corporation.” The SEC’s role was to ensure that investors have “properly calibrated” material information about a company’s pay decisions and to facilitate capital formation to foster competition for talented workers.
According to Law360, in removing her hold, Baldwin indicated that both nominees “share her view that the SEC must pay attention to Wall Street’s practice of seeking short-term financial success to the detriment of long-term growth.” In addition, “Baldwin noted that Jackson understands how activist funds, stock buybacks and executive compensation arrangements can influence corporate decisions and impact communities and workers, while acknowledging that Pierce expressed ‘an openness to reviewing rules’ in regard to these matters.” The WSJ observed that Peirce’s responses “don’t repeat her often-stated criticisms of regulators and laws that try to curb financial risk-taking.” She “has criticized many Dodd-Frank provisions, saying the law hasn’t made the financial system safer. ‘Congress didn’t really take the time to figure out what had gone wrong before Congress started to design the law,’ she said in a video interview….”