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The SEC did an interesting thing in the adopting releases for its long-anticipated Schedule 13D & 13G amendments and its overhaul of SPAC regulation. Instead of adopting the most controversial aspects of the rule proposals, the agency opted to issue guidance setting forth its views on the issues they addressed. It seems to me that in an unfriendly judicial environment, a strategy like this for dealing with controversial proposals may offer a lot of advantages for the SEC, at least in the short term.

First of all, SEC guidance statements are non-binding and as this excerpt from a CRS article notes, that makes them a much more flexible tool for the agency than rulemaking:

Guidance is subject to fewer procedural requirements than legislative rules. Legislative rules typically must undergo the informal rulemaking process set forth in the APA, which generally requires that agencies publish a notice of proposed rulemaking in the Federal Register and allow members of the public an opportunity to submit comments on the proposed rule. Final rules generally must be published in the Federal Register at least 30 days before becoming effective, and are then subject to judicial review immediately after taking effect. By contrast, the APA exempts guidance from the notice-and-comment and delayed effective date requirements.

The article also highlights a second advantage that guidance enjoys over rulemaking. The ability to avoid compliance with the APA makes guidance more difficult to challenge in court than new rules are – particularly when that guidance is positioned as “clarifying” existing SEC positions:

In deciding whether guidance is reviewable, courts have considered factors such as the consequences of the guidance, including whether it confers rights or imposes legal obligations beyond those in existing statutes or regulations, and the agency’s characterization and application of the guidance. Courts have also evaluated whether interpretive rules merely interpret or clarify preexisting requirements, or whether they effect a substantive change in existing law or policy.

Guidance may have advantages to the SEC in terms of flexibility and reduced risk of judicial second-guessing, but why come out with an aggressive rule proposal in the first place if guidance is going to be the end result? The market’s reaction to the SEC’s rule proposal on underwriter status in de-SPAC transactions may provide a clue.

If you’ve been following the SPAC saga, you know that as part of the SEC’s initial rulemaking proposal, it offered up a new Rule 140a, which the agency said was intended to “clarify” that an underwriter in a SPAC IPO is also on the hook for subsequent de-SPAC related financings. That prompted a lot of wailing & gnashing of teeth among industry participants about the effect of the proposed rule – but as this Davis Polk memo on the new SPAC rules points out, it also prompted a significant change in market practice:

[W]e think financial institutions participating in de-SPAC transactions are going to continue to take a conservative approach, as they largely have done since the announcement of proposed Rule 140a – treating these transactions more akin to a traditional IPO than a traditional public M&A transaction in terms of potential liability pitfalls.

So, even though the SEC backed away from the proposed rule and substituted guidance, in this case simply offering up the proposed rule was enough to prompt the kind of change in behavior the SEC sought. Since market participants know well that enforcement often follows closely on the heels of guidance, the guidance contained in the adopting release is likely to continue to reinforce this change in behavior.

The issuance of guidance in an adopting release isn’t unprecedented, but its potential benefits to the SEC in the current environment and the agency’s decision to take that approach to the most controversial aspects of two recent high-profile rulemaking initiatives makes me wonder if we may see it more frequently in the future.

– John Jenkins