Thursday, March 07, 2019

Peirce warns of unintended consequences to new disclosure types

By Rodney F. Tonkovic, J.D.

SEC Commissioner Hester M. Peirce's remarks before the Council of Institutional Investors included both praise for the role institutional investors play in the market and criticism of some of CII's positions. While she supported the perspective of institutional investors and their participation market reforms, she warned that some reforms could go too far and cause a loss of focus on how effectively companies put their money to work.

Praise for CII. Peirce began her remarks at CII's 2019 Spring Conference in Washington, D.C. by noting CII represents an important group of sophisticated, long-term, and bulk players in the market. Therefore, the group's views on how to improve the functioning and structure of the capital markets are of real interest, Peirce said. She also praised CII's advocacy for systemic change in the proxy system, such as its support for universal proxy cards and suggestions on tracking proxy voting using blockchain technology.

Peirce also expressed her appreciation of CII's active participation in the Commission's disclosure reform efforts. Here, she noted that CII had provided helpful feedback in a comment letter on the value of modernizing EDGAR and improving data tagging. The Commissioner observed that she has concerns about the costs and drawbacks of embedding specific technology in rules, so CII's views on the matter were especially valuable. Peirce also pointed to CII's participation in other areas of debate, such as its objection to the use of dual-class shares and its views on stock buybacks.

Airing of grievances. Shifting tone slightly, Pierce quoted from the Seinfeld "Festivus" episode: "I got a lot of problems with you people, and now you're gonna hear about it." She emphasized, of course, that she was grateful for CII's views on financial regulation and corporate governance and affirmed that she would continue to look to CII for advice.

Peirce's chief criticism concerns the focus of many investors "on non-investment matters at the expense of concentration on a sound allocation of resources to their highest and best use." She is concerned with a broad trend of securities disclosures focusing more on "an amorphous and shifting set of virtue markers," or "matters that do not go to an assessment of how effectively companies are putting investor money to work."

Mandatory arbitration. To this point, she specifically referenced CII’s position with respect to a recent Johnson & Johnson shareholder proposal concerning mandatory arbitration. The Division of Corporation Finance, relying heavily on an opinion by the New Jersey attorney general, said that the proposal could be excluded under Exchange Act Rule 14a-8(i)(2). While this decision concerned the interpretation of state law, Peirce noted, that it was not much help in confronting how such a bylaw provision would interact with federal law, and that would be a matter for the courts. However judges may decide the issue, CII's stance is that such clauses threaten the principles of sound corporate governance due to, among other concerns, the non-public nature of arbitration. Peirce countered that, while she would not insist on mandatory arbitration for all companies, the alternative of class action litigation and its accompanying costs can be harmful to shareholders.

14a-8 reform. Turing to shareholder proposals more broadly, Peirce sees a clear need for fundamental reform of the shareholder proposal process, where CII does not. The current thresholds encourage small handfuls of shareholders, Peirce argued, to repeatedly put forward losing proposals reflecting "idiosyncratic preferences" that incur costs that are borne by all of the shareholders. And, when companies such as Johnson and Johnson come to the SEC, the 14a-8 process foists staff into what Peirce sees as an inappropriate policymaking role.

Disclosure. Another area in which Peirce and CII do not see eye to eye is the push for new types of disclosure. Peirce favors the current disclosure-based regime for capital markets regulation over other potential models, while CII has, for example, supported efforts to require companies to disclose information about board members’ personal characteristics. While new Compliance and Disclosure Interpretations have also emphasized such self-identification, Peirce is wary that board members will see pressure to divulge personal details that they would rather keep private, among other unintended consequences.

In conclusion, Peirce cautioned that asking the SEC to concentrate on issues other than protecting investors, facilitating capital formation, and fostering fair, orderly, and efficient markets, shifts its focus away from its primary mission. She noted that the Commission is engaged in rulemaking that requires considerable effort, such as proxy reform, Dodd-Frank rulemaking, and market structure reforms. "I do not believe that investors are best-served when our staff is distracted by matters unrelated to our core mission," she said.