Should the SEC protect investors or facilitate capital formation — when promotion of one of those goals necessarily harms the other? Competing visions of the Securities and Exchange Commission’s mission have driven a pronounced split between Democratic and Republican members of the five-member Commission that governs the agency.
At times, both goals have been simultaneously advanced by Commission rulemaking. On other occasions in recent years, however, rulemaking by the Commission’s majority has prioritized capital formation over investor protection.
A new presidential administration — and with it, a rebalancing of power on the Commission in favor of Democrats — is likely to refocus future rulemaking to emphasize investor protection.
The Mission of the Commission
The SEC is charged by the U.S. Congress with a three-part mission. It must protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.
A review by Bloomberg Law of the Commission’s rulemaking under Chairman Jay Clayton finds that the Commission’s three Republican commissioners have taken the agency in a direction that emphasizes its objective to facilitate capital formation, often presenting fundamental changes as updates that “modernize” and “simplify” rules. This rulemaking de-emphasizes — in effect, if not by intention — the SEC’s mandate to protect investors, particularly retail investors.
This policy direction has engendered frequent dissents from the minority commissioners with regard to the majority’s rulemaking and to its underlying policy agenda, as they see the new and updated rules as eroding important investor protections.
‘Modernizing’ the Rules to Facilitate Capital Formation
Since the adoption of Regulation Best Interest on June 5, 2019, the goals of the Commission’s majority’s rulemaking efforts may broadly be summarized as:
1. Promoting capital formation in the private markets, although arguably without improving the SEC’s ability to observe the operation of those opaque markets. An example is increasing the offering limits applicable to exempt private offerings.
2. Reducing disclosures and/or registration requirements or declining to impose new disclosures sought by investors (e.g., environmental, social, and governance or “ESG” disclosures). This may reduce the cost and complexity of compliance by issuers.
3. Broadening exemptions to include substantially more individuals or entities (e.g., accredited investors; finders; Form 13F filers) or expediting review of requests for exemptions (under the Investment Company Act). These efforts benefit the private markets, at least partially at the expense of the more regulated public markets because it increases the private market’s relative attractiveness.
4. Easing restrictions on the raising of public capital via direct listings without mitigating the impact on investors’ longstanding remedies for material misstatements or omissions, which require the ability to trace their purchased shares back to the registration statement.
5. Imposing significant oversight and disclosure requirements on proxy advisory firms. Proxy firms are typically hired by institutional investors to provide independent advice regarding how to vote on important matters that the companies in which they have invested have put to shareholder vote. The Commission has required that those firms provide to the company itself the same advice they give to clients, either before the advice is provided to the firm’s clients or contemporaneously, and also to pass along the company’s views on that advice to the firm’s clients. This additional regulatory burden appears to be motivated by a desire to reduce shareholder interference in how executives run their corporations, with less involvement by proxy advisory firms providing their clients with independent advice that may run contrary to the corporation’s wishes.
Taken together, these rulemakings appear designed to give corporations and their executives a freer hand in how they conduct business.
Impacts on Investor Protections
The Commission’s relaxation of securities rules to facilitate capital formation, both in the private and public markets, has sometimes come with a notable tradeoff: the weakening of investor protections. What follows is a summary of some of the more significant examples of how Commission rulemaking, in the past year and a half, has diminished safeguards for investors — particularly non-accredited, retail investors.
What to Expect in 2021
Commissioner Allison Herren Lee, now the senior Democrat on the Commission, has argued forcefully for the Commission to focus on what she views as its core mission of protecting, serving, and empowering investors.
The coming year will see the inauguration of a new president, a new appointment to replace Jay Clayton as Commission chairman, and the appointment of an additional SEC commissioner affiliated with the Democratic Party, giving them a majority. Those changes represent a rebalancing of the parties’ relative power on the Commission and portend a likely reordering of the hierarchy of the SEC’s tripartite mission, as viewed by the Commission’s new majority.
The priority for the new Commission will likely be to reverse or temper the past several years of rulemakings in areas where the previous Commission’s majority is perceived to have underregulated (e.g., Regulation Best Interest), overregulated (e.g., proxy advisory firms), or purposefully ignored (e.g., ESG disclosure). These areas, along with inspections and enforcement, appear most likely to attract close scrutiny from a newly constituted Commission as they include rulemakings that were especially controversial for many Democrats.
Access additional analyses from our Bloomberg 2021 series here, including pieces covering trends in Litigation, Transactions & Markets, the Future of the Legal Industry, and ESG.
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