Gary Gensler has been leading the Securities and Exchange Commission on an ambitious rulemaking agenda since he assumed the chairman’s role in April. In June, the SEC released its list of short- and long-term regulatory actions covering 49 areas, including 36 at the proposed rule stage. That compares to 16 proposed rules on the Fall 2020 agenda (32 overall) and 19 proposed rules (43 overall) on the Spring 2020 agenda. The agenda includes numerous hot-button topics such as ESG and diversity, corporate insider trading plans, gamification (i.e., the GameStop phenomenon), SPACs, and enhancing shareholder democracy. It also includes a revisiting of amendments to the agency’s shareholder proposal rule in 2020—changes adopted under former SEC Chairman Jay Clayton’s Commission that remain highly contentious among commissioners.
Looking forward to 2022, several of the proposed rulemakings merit special attention.
Under the umbrella term ESG (environmental, social & governance), the SEC is very intently looking to increase and improve the disclosures that public companies make to investors concerning climate change, human capital, and diversity in both the workplace and on corporate boards. This is a priority item for the Commission’s majority, and some may have expected proposed rules to have been issued already. Whenever the SEC does propose these new rules, they are virtually certain to draw incredible interest from a wide audience and be hard-fought in the public comments, the behind-the-scenes lobbying, and in the courts. New rules will inevitably find their way into contract terms, including M&A agreements.
ESG rulemaking under Gensler is likely to be initially designed to lay a foundation for ESG disclosures while defending against charges of overreach. One should expect additional rounds of ESG rulemaking by the current Commission, with later initiatives amending earlier rulemaking to build out an evolving ESG regulatory regime. The agency will probably follow the approach that it approved for Nasdaq in August. Nasdaq’s new rule on corporate board diversity, listing rule 5605(f), requires most Nasdaq-listed companies to either include at least two “diverse directors” on the company’s board or publicly explain the reasons for noncompliance. Diversity under Rule 5605(f) means at least one self-identifying female director and one self-identifying underrepresented minority or LBGTQ+ director. By structuring its new rule as “comply or explain”, rather than prescribing a certain board composition, it can be argued that Nasdaq-listed corporate boards are not actually required to diversify their boards.
The SEC’s ESG rulemaking may be expected to follow this structure, not simply to minimize opposition, but to limit the potential for embarrassing setbacks in the courts. In the past decade or so, the agency has suffered high-profile reversals of its rulemakings by the D.C. Circuit Court of Appeals due to a court-perceived lack of rigorous, data-intensive analysis on the SEC’s part.
When the SEC ultimately dips its toes into ESG regulatory waters, it will do so with a strong focus on collecting data and assessing the regulatory burden on those charged with reporting. It will likely ask for companies to either make more ESG-related disclosures or explain why they have not. New rules may also attempt to reel in greenwashing by investment advisers and funds, as some have sought to portray their investments as more ESG-friendly than the reality supports.
Special Purpose Acquisition Companies
SPACs were one of the financial darlings of the pandemic—until the SEC began to noisily take greater interest. The SPAC boom moved these financial vehicles into the mainstream, attracting Main Street investors who often didn’t fully understand how SPACs work and may have been enticed to buy shares because of SPACs’ celebrity promoters. Everyone seemed to be getting in on this game, but not everyone had an equal chance to walk away with a profit.
The SEC took steps to cool SPAC IPOs by giving strong signals that its eyes were now fixed on the sector. The SEC issued a warning to retail investors on Mar. 10 about the risks of investing in celebrity-backed SPACs. In April, the agency jolted the market by cracking down on the widespread practice of SPACs not accounting for the warrants they issue as balance sheet liabilities, declaring that no SPAC IPO would be cleared to trade unless their warrant accounting was in order.
These were only the first actions taken to begin to rein in the frothy SPAC market, but their impact was quick and strong. SPAK ETF, an exchange-traded fund investing in U.S. listed-SPACs and companies derived from SPACs, fell from delivering a +26.1% return on Feb. 16 to a -19.2% return on May 13. The SEC continues to look for ways to address the perceived issues SPACs generate.
The most significant issues with SPACs, however, have not been occurring at the IPO stage. The SPAC activities the SEC is most concerned about take place during the de-SPACing stage, when the SPAC negotiates with and agrees to merge with a target corporation. SPACs have taken full advantage of the more liberal M&A rules to promote these business combinations. Securities regulations prohibit deal promotion, or the release of many types of new information, at the IPO stage during what is called the “quiet period.” The rules for mergers and acquisitions allow both stock promotion and public projections, a considerable advantage when trying to pump up interest.
The SEC has been subtly laying the groundwork for restricting promotion and projections by SPACs. In April, the agency began shifting the narrative away from viewing de-SPACing as a merger event and toward regulating the de-SPAC stage as it would when a real IPO takes place. Gensler took this approach further in May when he told Congress that retail investors need “appropriate and accurate information” about SPACs—not only at their blank-check IPO stage, but also at their second “target IPO” stage. That Gensler chose not to refer to the second stage as the “reverse merger” stage is telling. When proposed new rules governing SPACs are eventually released, it is reasonable to expect that the SEC will seek to restrict de-SPACing activities to bring them more in line with traditional IPO restrictions and to ensure similarly robust disclosures (and probably similar SEC staff review).
The cost structure of the SPAC is likely to be a particular focus of enhanced disclosures at both stages. These vehicles are less expensive at the initial IPO stage, but over the course of a SPAC’s lifecycle, the expenses typically significantly exceed traditional IPOs. The high cost of SPACs—starting with the “promote,” or founders shares that give SPAC sponsors 20% in stock—dilutes the value of the investment for investors. The Chairman has promised that the SEC will conduct an economic analysis of how SPAC transactions advantage and disadvantage investors. Expect new SPAC rulemaking to address the disadvantages identified.
Revisiting 2020 Amendments
The Commission under prior chairman Clayton adopted amendments to Rule 14a-8, the shareholder proposal rule, and to the rules that regulate proxy voting advice.
These measures run against the usual less-is-more deregulation philosophy of Clayton-era rulemaking, and have made it much more difficult for small investors to include their initiatives in company proxy materials. The amendments also restricted the activities of proxy advisory firms, adding significant burdens to their participation in proxy actions. One of the major changes significantly increased resubmission thresholds. To resubmit a failed proposal, much greater prior support by shareholders is now needed. This change particularly impacts ESG matters, a subject supported by the Commission’s current majority.
Expect Gensler to call a vote to roll back at least some of these 2020 amendments that will split the commissioners along party lines.
Access additional analyses from our Bloomberg Law 2022 series here, including pieces covering trends in Litigation, Regulatory & Compliance, Transactions & Contracts, and the Future of the Legal Industry.
Bloomberg Law subscribers can find related content on our In Focus: ESG, In Focus: Special Purpose Acquisition Companies (SPACs), In Focus: Proxy Regulation, and on our Securities Practice Center resource.
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