A group of business trade associations that include the Business Roundtable, the US Chamber of Commerce & the Investment Company Institute recently published a report titled “Investors and the Markets First: Reforms to Restore Confidence in the SEC,” which offers a series of proposed reforms to the SEC’s rulemaking process. The report contends that, over the past three years, the SEC has “undertaken an unprecedented and often unlawful rulemaking agenda that, without sound justification, will radically redesign the foundation of our capital markets. The majority of the proposed changes are non-investment–, non-investor–, and non-market–oriented changes that limit choice and flexibility.”
The report then identifies six specific sins that it claims that the SEC has committed when it comes to rulemaking, including ignoring its obligations under the Administrative Procedure Act, adopting final rules that differ drastically from proposals, and exceeding its statutory authority. The report recommends a variety of reforms to the rulemaking process, which are summarized in this excerpt from a Mayer Brown blog:
– Require the SEC to affirmatively conduct an analysis of all interrelated and interconnected rules for each proposed rule and then amend or repeal rules as necessary to account for such interconnectedness;
– Require the SEC to provide comment periods for proposals with a minimum of 60 days, calculated from the Federal Register publication date, unless there is an emergency;
– Require a third party to perform and publish for public comment no later than 90 days from the date of enactment a post-adoption cost impact assessment for each major rule the SEC has adopted in the past three years;
– Integrate and expand on the mission of several offices of the SEC, including, for example, the Office of the Advocate for Small Business Capital Formation; and
– Require the SEC to publish an annual report on the number of exemptions granted or exemptive rules adopted to promote capital formation and innovation and the actions the SEC has taken to promote financial security and review and adjudicate exemptive applications under the Investment Company Act of 1940 for relief in no more than 180 days.
Several of these reform proposals sound like they’re the equivalent of the “Paperwork Production Act of 2024,” and appear designed to simply throw sand in the gears of the rulemaking process. For their proponents, that may be more of a feature than a bug, but the proposals also ignore the problem of legislative gridlock, which I think is the real issue.
The simple truth is that Congress can’t get its act together to pass legislation, so whatever party controls the White House is going to use federal agency rulemaking to accomplish its legislative objectives. Until that’s addressed, rulemaking is going to be a highly partisan and sometimes ugly process, no matter what “reforms” are on the table.
Over on the “Delaware Corporate & Commercial Litigation Blog”, Francis Pileggi recently flagged a concurring opinion by federal appellate judge Kevin Newsom in Snell v. United Specialty Ins. Co., (11th Cir.; 5/24). In that opinion, Judge Newsom explains how he used generative AI tools to help determine the “ordinary meaning” of terms at issue in a piece of litigation. In this particular case, the issue he sought to resolve was whether the installation of a trampoline involved “landscaping” within the meaning of a liability insurance policy.
After unsuccessfully trying to resolve this question by turning to the dictionary and photographs of the (very cool – see the pic on p. 7 of the opinion) in-ground trampoline itself, he decided to take a flyer on Chat GPT. After being intrigued by Chat GPT’s response to the general question “What is the ordinary meaning of ‘landscaping’?” the judge got more specific:
Suffice it to say, my interest was piqued. But I definitely didn’t want to fall into the trap of embracing ChatGPT’s definition just because it aligned with my priors. (Bad.) So, in what might have been a mistake—more on that later—we went ahead and asked it the ultimate question: “Is installing an in-ground trampoline ‘landscaping’”? ChatGPT responded as follows:
Yes, installing an in-ground trampoline can be considered a part of landscaping. Landscaping involves altering the visible features of an outdoor area for aesthetic or practical purposes, and adding an in-ground trampoline would modify the appearance and function of the space. It’s a deliberate change to the outdoor environment, often aimed at enhancing the overall landscape and usability of the area.
For good measure, I posed the same questions to Google’s Bard (since replaced by Gemini). The precise details aren’t particularly important, but the upshot is that both models’ answers indicated that the trampoline-related work Snell had performed—the excavation of the pit, the construction of the retaining wall, the installation of the mat, and the addition of the decorative wooden cap—just might be landscaping.
Judge Newsom then provides a thoughtful appraisal of some of the pros and cons of using AI large language models as a tool for resolving interpretive issues like this, and suggests that they may have a constructive role to play in judicial efforts to determine “the common, everyday meaning of the words and phrases used in legal texts.”
Francis wraps up his blog by summarizing the key takeaway from Judge Newsom’s opinion: “AI in the law is now mainstream when an appellate court includes references to how it was used as part of an analysis in connection with a published opinion.” Stay tuned.
The SEC’s Spring 2024 Reg Flex Agenda was released yesterday, and it looks like most of its rulemaking activity has been pushed out to after the election. Here’s where things stand on some of the potential SEC rules that we’ve been following:
As a reminder, these dates signify general timeframes. New final or proposed rules could come before or after the dates suggested in the agenda. The Reg Flex Agenda only gives insight into the priorities of the Chair as of the date it was submitted — it’s not a definitive guide for anyone trying to predict SEC rulemaking for purposes of specific board agendas, budgets and workflows.
In a recent issue of her “Deep Quarry” newsletter, Olga Usyvatsky noted that although comments on Schedule 13D and 13G filings have been relatively uncommon in the past, the Staff did recently issue a comment letter to Kimmeridge Energy Management LLC questioning the timing of a Schedule 13D filing. Kimmeridge responded to the comment and the Staff apparently didn’t have further comments on the issue, but Olga suggests that this may represent the start of a trend:
While SEC’s comments to Kimmeridge may look like a one-off, Corp Fin’s Director Erick Gerding highlighted compliance with the beneficial ownership rules as one of the priorities for the 2024 disclosure review program:
“Beneficial Ownership Reporting
On October 10, 2023, the Commission adopted amendments to modernize the rules governing beneficial ownership reporting.The Division staff is closely monitoring the implementation of these new rules. The Division staff will review selected beneficial ownership reports to assess compliance with the new, shortened filing deadlines and issue comments as necessary to improve required disclosures.”
Say it differently – we will likely see more SEC comments on 13D and 13G filings.
Jim McRitchie recently blogged about “Campaign GM” – a 1970 Ralph Nader-led shareholder proposal initiative and one of the earliest examples of shareholder ESG activism targeting a major corporation. The blog provides an overview of the campaign and discusses its long-term effects on governance at General Motors and its impact on the broader debate over corporate governance-related issues. It’s a really interesting introduction to a piece of corporate history that I knew very little about. Check it out if you get a chance.
Meredith blogged last week about the demise of the Chevron doctrine and some of its potential implications for the SEC. The conventional wisdom seems to be that the SCOTUS’s Loper decision is a “gut punch” to federal regulatory authority, and the decision has prompted wailing & gnashing of teeth on the Left and jubilation on the Right. However, a recent Law360 article by Dan Berkovitz says that the SCOTUS’s decision isn’t likely to have much of a practical impact on the SEC. Here’s the intro:
The demise of Chevron deference in Loper Bright Enterprises v. Raimondo will not make much of a difference for either the US Securities and Exchange Commission or the Commodity and Futures Trading Commission. The federal courts have a long history, both pre- and post- Chevron, of interpreting the federal securities and commodities laws without deference to the views of the SEC or the CFTC. These interpretations have ebbed and flowed between restrictive and expansive, depending on the philosophical composition of the courts.
In almost all major cases over at least the past two decades, especially in reviews of agency rulemaking, the courts have not granted Chevron deference to these agencies. Rather than charting a new approach, the court’s opinion in Loper reflects the current reality of judicial review for these agencies.
Dan Berkovitz isn’t alone in his assessment. This excerpt from a blog on the decision from the conservative think tank R Street Institute says that there was always less to Chevron deference than meets the eye:
There is also what you might call the dirty secret of judicial deference. Under Chevron, if a judge didn’t like an agency rule, they could usually just say that the rule was unreasonable (or that the statute wasn’t ambiguous) and achieve the same result as if there had been no deference. By contrast, even with the formal Chevron doctrine gone, it’s likely that judges will tend to implicitly defer to an agency’s interpretation more than they would if they had to come up with an interpretation of the rule from scratch.
The SEC’s recent enforcement action against RR Donnelley & Sons is the latest in a series of proceedings in which the agency has broadly interpreted the scope of the Exchange Act’s internal controls provisions. That approach has been sharply criticized by dissenting commissioners and by outside commenters, but in a recent “Radical Compliance” blog, Matt Kelly entertains the possibility that the SEC’s view of the world may be right.
Matt points out that Section 13(b)(2)(B) of the Exchange Act requires companies to maintain internal accounting controls “sufficient to provide reasonable assurances” that, among other things, access to assets is permitted only according to management authorization. He notes that in this enforcement proceeding, the SEC is taking a provision intended to apply to accounting fraud and applying it to cybersecurity – but as he explains in this excerpt, this isn’t necessarily an unreasonable position:
Is it really proper for the SEC to use its books-and-records provision in that manner? Honestly, I dunno. On one hand, we should remember that no actual fraud happened at Donnelley. No transactions were improperly recorded. The company didn’t even suffer a loss of data, since the data was only copied.
On the other hand, Donnelley was locked out of important IT systems. For example, some customers couldn’t receive documentation vital to vendor payments and disbursement checks. If this cyber attack happened in the real world, it would be akin to hooligans strolling into your building, changing the locks to the accounting department, and demanding millions if you want to get the set of new keys. A company that let something like that happen would certainly seem inept to most reasonable investors.
Critics of the SEC (and lord knows there are plenty around) would say the Donnelley case is a novel interpretation of anti-fraud rules, with the SEC basically nosing its way into cybersecurity regulation. That seems outside the SEC’s swim lane.
Then again, suppose those hackers had exploited sloppy cybersecurity controls to steal money from Donnelley rather than copying data, and then covered their tracks by altering the finance department’s banking records. (A frighteningly easy thing to do, by the way.) Few people would fault the SEC for raking Donnelley over the coals then. So why does this case feel a bit weird now, when money wasn’t stolen?
Matt suggests that we step back and look at the big picture – as technology has advanced, the controls required for strong financial reporting and those required for strong cybersecurity are converging into a single system focusing on access control. In this new reality, it’s essential to have strong controls to prevent unauthorized access to IT systems, rather than the historical norm of controls governing access to the accounting department and its physical books and records.
You might think that with all the negative attention from regulators about audit quality issues over the past few years, shareholders might be a little more hesitant to vote in favor of proposals to ratify auditors. However, according to a recent Ideagen/Audit Analytics report, if you thought that, you’d be wrong:
Throughout the last six years, our analysis on shareholder votes reveals that, on average, nearly 98% of total votes are cast in favor of auditor ratification. Shareholder votes filed between January 1, 2021 and December 31, 2023, continued that trend for a sixth consecutive year. Votes against auditor ratification comprised 1.7% of the total votes; abstained votes account for the remaining 0.4% of total shareholder votes cast.
In fairness, the percentage of proposals in which more than 5% of the outstanding shares voted against ratification of the auditors ticked up last year from 7% to 8%, but that still leaves 92% of proposals in which fewer than 5% of the outstanding shares were voted against ratification. Maybe shareholders ought to be a little more reluctant to toe the party line here, because a 2023 study found that higher than expected shareholder dissatisfaction with external auditors is associated with improved audit quality.
A Texas federal judge on Wednesday granted a tax services firm’s motion for a preliminary injunction of the Federal Trade Commission’s nationwide ban on noncompete agreements in employment contracts and has stayed its effective date for the plaintiffs.
As noted, this injunction is limited to plaintiffs and plaintiff-intervenors, but the Court intends to issue a ruling on the merits by August 30, 2024 (before the September 4 effective date). The judge said there’s a “substantial likelihood” that the rule will be found arbitrary and capricious.
On Wednesday, the SEC posted this notice and request for comment for a proposed Nasdaq rule change that would amend Listing Rule 5810(c)(3)(A) to address the situation where a company effectuates a reverse stock split to regain a $1 bid price but, in doing so, trips up another continued listing requirement. This situation is sometimes avoidable; it can be tricky, but companies and their advisors have to take into account all the other minimum requirements when setting a split ratio.
When companies do find themselves in this situation, a new deficiency process is triggered under the existing rules. As amended, a company in this situation will no longer receive additional time to cure non-compliance with the newly violated standard. Here’s an example from the proposal:
Consider a company listed on the Nasdaq Capital Market (“Company A”) that has 1,600,000 Publicly Held Shares. In order to regain compliance with the Bid Price Requirement under Rule 5550(a)(2), Company A effects a reverse stock split at a ratio of 1-for-4. This reverse stock split initially increases Company A’s stock price above $1.00. Assuming Company A thereafter maintains a closing bid price above $1.00 for ten (10) consecutive business days, under current Rule 5810(c)(3)(A), Company A will achieve compliance with the Bid Price Requirement at the conclusion of the tenth (10th) consecutive business day.
However, in this example, at the same time that the reverse stock split increased Company A’s stock price, the 1-for-4 reverse stock split also reduced the number of Publicly Held Shares from 1,600,000 to 400,000, causing Company A to no longer satisfy the minimum number of Publicly Held Shares required to remain listed on the Nasdaq Capital Market. As a result, under these circumstances, the reverse stock split would allow Company A to regain compliance with the Bid Price Requirement of Rule 5550(a)(2) while at the same time causing non-compliance with the minimum Publicly Held Shares requirement of Rule 5550(a)(4).
Under Nasdaq’s current rules, Nasdaq would notify the company about this new deficiency and the company would be afforded 45 calendar days to submit a plan to regain compliance and could be afforded up to 180 calendar days to regain compliance.
Under the proposed amendment, Company A in the example above would continue to be considered non-compliant with the Bid Price Requirement until both the new Publicly Held Shares deficiency is cured and thereafter the company maintains a $1.00 bid price for a minimum of ten (10) consecutive business days. All of this must be accomplished during the compliance period applicable to the initial Bid Price Requirement deficiency.
It’s worth observing here that Nasdaq notes that it is “considering other changes to the delisting process applicable to companies that are noncompliant with the Bid Price Requirement. Any such changes will be subject to a separate rule filing.”
