Yesterday, in Alliance for Fair Board Recruitment v. SEC, (5th Cir.; 12/24), the 5th Circuit held that the SEC exceeded its authority when it approved Nasdaq’s board diversity rule. The case was decided by a 9-8 vote, and the Court’s action overrules a 5th Circuit panel’s prior decision upholding the rule.
In reaching this decision, the 5th Circuit concluded that the SEC’s actions implicated the “major questions” doctrine and that absent a clear Congressional directive, the agency lacked the statutory authority to authorize Nasdaq’s rule. The SEC and Nasdaq argued, among other things, that because “full disclosure” was central to the Exchange Act, the SEC had broad authority to adopt a board diversity disclosure requirement. The Court disagreed, and this excerpt from the majority’s opinion indicates that it viewed the scope of the authority granted by the Exchange Act more narrowly:
SEC and Nasdaq contend that Supreme Court precedent establishes that full disclosure is the “core” purpose of the Exchange Act. . . But that is not true. What the Court has actually said is that the Act “embrace[s] a fundamental purpose . . . to substitute a philosophy of full disclosure for the philosophy of caveat emptor. and thus to achieve a high standard of business ethics in the securities industry.” Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 151 (1972) (emphasis added) (quotation omitted); compare post, at 45 (Higginson, J., dissenting).
In other words, the Court has acknowledged that disclosure is not an end in itself but rather serves other purposes, such as the purpose of promoting ethical behavior or “the purpose of avoiding frauds.” Ibid. Thus, nothing in the Court’s precedents undermines our conclusion that a disclosure rule is related to the purposes of the Act only if it is related to the elimination of fraud, speculation, or some other Exchange Act–related harm.
The Court ultimately concluded that the board diversity rule was “far removed” from the purposes of the Act. According to a Bloomberg Law article on the decision, Nasdaq doesn’t plan to appeal the ruling, while the SEC is “reviewing the decision and will determine next steps as appropriate.”
Wilson Sonsini recently issued the 2024 edition of its SV 150 Governance Report, which surveys governance practices among Silicon Valley’s largest companies. The report is full of information on topics such as board composition, demographics and governance practices, proxy statement disclosure practices, executive compensation, shareholder proposals and activist activities. Here’s what the report has to say about the prevalence of various defensive measures:
– 54% of companies had staggered boards and charter provisions requiring a supermajority vote to remove a director.
– 55% of companies had plurality voting standards for director elections
– 100% of companies allowed the board to change the number of directors
– 92% of companies permitted the board to fill vacancies
– 99% of companies had an advance notice bylaw
– 28% of companies had a proxy access bylaw
– 27% of companies permitted stockholders to call a special meeting
– 63% of companies required a supermajority vote to amend charter documents
– 96% of companies authorized a class of blank check preferred
– 82% of companies had an exclusive forum bylaw
– 63% of companies had a federal forum bylaw that applied to 1933 Act claims
Only a single company had a poison pill in place, although the prevalence of blank check preferred means that virtually all of the SV 150 have a pill on the shelf or could implement one at a moment’s notice. Less than 1% of the SV 150 companies had cumulative voting rights.
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In light of the shocking murder of UnitedHealth’s CEO last week and the risk that similar events may occur in the future, many companies are enhancing security arrangements for their executives or establishing those arrangements for the first time. While companies may be inclined to conclude that these security arrangements are a necessary business expense, they need to be aware that the SEC typically views them as “perks” subject to disclosure in proxy materials. This excerpt from Chapter 7 of our Executive Compensation Disclosure Treatise (available on CompensationStandards.com) explains the SEC’s position:
From the company’s perspective, [personal security] expense is integrally and directly related to the performance of its executives’ duties—necessary to ensure their safety, particularly where they frequently travel internationally or their celebrity makes them an inviting target for kidnapping or other personal injury.
Notwithstanding these beliefs, the SEC has expressly stated that it considers expenditures incurred to ensure the personal safety of a named executive officer to be a disclosable perquisite. Specifically, the SEC has held that business purpose or convenience does not affect the treatment of an item as a perquisite where it is not integrally and directly related to the performance by the executive of his or her job.
Accordingly, a company’s decision to provide an item of personal benefit for security purposes does not affect its characterization as a perquisite. For example, a company policy that for security purposes an executive (or an executive and his or her family) must use company aircraft or other company means of travel for personal travel, or must use company or company-provided property for vacations, does not affect the conclusion that the item provided is a perquisite or personal benefit.
Companies should also note that as part of its qualitative evaluation of executive comp programs, ISS has sometimes been critical of the amounts expended for executives’ personal security arrangements. Whether recent events will prompt the SEC to take a more nuanced position or ISS to reconsider what security expenditures should be regarded as “excessive” remains to be seen.
We cover compensation-related issues on CompensationStandards.com and this is a topic we’ve blogged about there in the past, but since executive security arrangements are top of mind for so many companies right now, we thought it was appropriate to flag the potential disclosure requirements here as well.
The Financial Timesrecently reported that the SEC is likely to see an exodus of experienced lawyers over the next few months in anticipation of the Trump administration’s expected budget & headcount cuts across a range of federal agencies. According to a recent LegalDive.com article, some of the leading players in the crypto industry want to make sure their law firms know that they’ll pay a price if they hire any of the SEC lawyers involved in enforcement actions targeting crypto companies:
Crypto companies are threatening to wage a war of retribution against law firms if they hire lawyers from the outgoing Biden administration who played a role in trying to rein in their industry through enforcement actions.
The CEO of Coinbase and CLO of Ripple have used social media posts to take a critical look at lawyers leaving the Securities and Exchange Commission and other federal agencies that worked on lawsuits against their industry.
“We’ve let all the law firms we work with know, that if they hire anyone who committed these bad deeds in the (soon to be) prior administration, we will no longer be a client of theirs,” Brian Armstrong, CEO of Coinbase, the largest crypto exchange in the United States, said in a December 1 X post.
What a great idea! Yes, an industry-wide vendetta against former regulators is definitely the best way to ensure the kind of good working relationship with current regulators that crypto leaders will need to achieve a comprehensive system of rules that the industry can live with. As undeniably brilliant as this cutting off your nose to spite your face strategy is, however, it looks like the crypto folks might be better served in the short term to worry about the SEC lawyers who are staying behind, instead of the ones who are leaving.
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Over the weekend, former Chief of the SEC’s Office of Internet Enforcement John Reed Stark posted an in-depth article on X in which he discussed some reforms he expects to see the SEC initiate in the early days of Paul Atkins’ leadership. Stark worked the SEC during Atkins’ last tour of duty and believes he’s an excellent choice to serve as SEC Chair. Based on his experience with Atkins and knowledge of his views, Stark said that he expects to see an “extraordinary, monumental, and urgently required transformation within the SEC, especially within the SEC Division of Enforcement.” Here are some of the specifics:
– “Open Jacket” Disclosure Policy in Enforcement Actions. Unlike federal prosecutors, the SEC doesn’t have a policy requiring it to lay its evidentiary cards on the table before instituting enforcement proceedings. During his time as a commissioner, Stark says that Atkins believed that “failing to share critical incriminating — and most importantly, exculpatory — evidence, violated the rights of U.S. citizens and also inhibited the ability of enforcement staff members to candidly explain an investigation to the SEC Commissioners.” He said he expects Atkins to order Enforcement to fully inform potential defendants about the allegations and the SEC’s evidence before entering into settlement discussions.
– Backing off Cyber Enforcement & Repealing the Cyber Disclosure Rule. Stark expects that Chair Atkins will put the brakes on the SEC’s cyber disclosure enforcement actions targeting companies that have experienced “good faith mishaps that had no real-world consequences” and to instead focus on cyber-related disclosure fraud. He also expects that Atkins will either ask his fellow commissioners to repeal the cyber disclosure rule or freeze its implementation pending further study.
– Deemphasizing Corporate Penalties & Emphasizing Individual Accountability. Stark believes that Chair Atkins is particularly concerned that the corporate managers might agree to a large corporate penalty in order to avoid or reduce sanctions against individual wrongdoers. Stark contends that Atkins thinks this creates a perverse incentive that results in shareholders footing the bill for individual misconduct. He also says that Atkins is concerned that the potential for significant corporate penalties may result in a misallocation of resources by incentivizing the Enforcement Division to chase potential headline grabbing corporate penalties.
The article addresses a number of other potential reforms, including cracking down on what Atkins considers to be the “tyranny of the minority” inherent in the shareholder proposal system, eliminating crypto enforcement, and reducing even further the SEC’s efforts to target ESG-related disclosure shortcomings.
Oh yeah, and one more thing – although Stark didn’t mention this one directly, other media reports continue to indicate that the climate disclosure rule is likely an “ex-parrot.”
In a recent blog, Gunster’s Bob Lamm argues that whatever concerns some of us may have about Donald Trump’s return to the White House, the changes at the SEC will likely make the agency easier to work with for public companies and their legal counsel:
Let’s face it – the SEC under Chair Gary Gensler has been difficult. I will try to take the high road by simply saying that under his leadership the SEC has been dismissive if not downright scornful of the issuer community when it comes to both rulemaking and enforcement.
There are many examples on the rulemaking side, but my favorite (so to speak) was the decision to require quarterly disclosure of corporate stock buybacks on each day during the preceding quarter. Perhaps we were supposed to be grateful that the original proposal – to file reports of each day’s buyback activity – was dropped in favor of the quarterly disclosure requirement. However, from my perspective there was no rational purpose to that disclosure, with the possible exception of giving academics the ability to conjure up correlations between buyback activity and other “nefarious” activities by corporations and their executives and directors. Fortunately, the final rules were thrown out by the federal courts.
Bob’s aside about academics being the only beneficiaries of the SEC’s buyback rules struck a chord with me. It seems to me that SEC rulemaking over the past several years has been unduly deferential to input from academics. To me, the best example of this is the Rule 10b5-1 amendments, which I’ve previously argued mostly represent a solution in search of a problem.
In contrast to the SEC’s deference to academics, Bob says that the agency has given public companies the cold shoulder. For example, he notes the SEC’s refusal to consider an “Issuer Advisory Committee” akin to its Investor Advisory Committee), as well as its reversal of the proxy adviser regulations adopted during the first Trump administration. He also points to the agency’s ham-fisted approach to the adoption of the climate disclosure rule, and its endless pursuit of disclosure controls & procedures enforcement cases against public companies.
Bob’s hope that Trump 2.0 will lead to better relations between public companies and their principal regulator is premised on his view that things weren’t so bad for public companies at the SEC the last time around. That’s probably true, but he acknowledges that the bottom line is that there are no guarantees, and like everything else about Trump 2.0, we’ll just have to wait and see what the next few years bring.
During his first tour of duty as an SEC commissioner, Paul Atkins was not known for his warm and fuzzy feelings toward the PCOAB. Now, as he prepares to assume the position of SEC Chair, it looks like critics of the agency are likely to have his ear, and the implications for the PCAOB could be significant. Here’s an excerpt from a recent Wall Street Journal article:
New leadership likely would scale back the PCAOB’s reach, leading to fewer penalties, slower rule making and a smaller budget, PCAOB observers say. A long-gestating debate over whether the SEC should absorb the PCAOB is poised to resurface, they say.
Atkins, while an SEC commissioner, criticized the PCAOB’s budget, saying salaries paid to board members were disproportionately high. In speeches, he spoke out against rules that limited audit firms’ ability to make professional judgments. “Overly prescriptive standards can rob you of the ability to apply your professional judgment,” Atkins said in 2005.
The board members’ annual salaries have been flat since 2009, with the chair receiving nearly $673,000 and the other members receiving almost $547,000.
Atkins as commissioner showed disdain for the PCAOB when meeting with officials from the audit regulator, said Martin Baumann, an adjunct accounting professor at Southern New Hampshire University and former PCAOB chief auditor. “I don’t expect this to be good for the PCAOB,” he said, referring to Trump’s Atkins pick.
The possibility that the PCAOB may ultimately be on the chopping block shouldn’t come as a surprise. Eliminating the PCAOB was one of the securities regulation reforms specifically called out in the Project 2025 document I blogged about last month. However, that kind of a move would require Congress to act, since the PCAOB was created by Sarbanes-Oxley.
On the other hand, despite her recent appointment to a second term, PCAOB Chair Erica Williams might want to dust off her resume. The WSJ article suggests that she may be replaced, and it wouldn’t be the first time that the SEC has cleaned house at the PCAOB after a change in administrations. Also, I’m guessing that it’s not a good sign that Google is already identifying her as the “former chairperson” of the PCAOB.
The CAQ and Ideagen Audit Analytics recently issued the 2024 edition of their “Audit Committee Transparency Barometer,” which assesses audit committee trends and disclosure practices. The report says that cybersecurity oversight will be a high priority issue for audit committees during the upcoming year, and that disclosures about cyber oversight are expected to become more robust. Here’s an excerpt:
The cybersecurity landscape has changed dramatically in recent years. Cybersecurity incidents are on the rise and the costs associated with a cybersecurity incident are also increasing. In the CAQ and Deloitte joint Audit Committee Practices Report, 69% of audit committee respondents indicated that cybersecurity will be in the top three priority areas for the audit committee in the next 12 months, and 30% ranked cybersecurity as the number one priority for the audit committee in that period.
Additionally, with the SEC Cybersecurity Disclosure Rule in full effect, certain cybersecurity information is required to be included in SEC filings. Further, per the CAQ 2024 Audit Partner Pulse Survey, 47% of audit partners expect to see companies in their primary industry sector voluntarily increasing or enhancing cybersecurity disclosures over the next 12 months.
The report says that consistent with this expectation, more boards are disclosing that they have a cybersecurity expert (60% of the S&P 500 in 2024, compared to 51% in 2023). It also says that in today’s complex & evolving threat environment, boards and audit committees need to stay current through education and training in order to effectively oversee corporate cyber risk management efforts.
The report also addresses disclosure practices with respect to director skills, auditor oversight and tenure, the relationship between audit fees and audit quality, and board oversight of ESG issues.