Securities Law and Practice Need Reorienting Around Materiality

With Republicans taking control of Congress and a new leader to chair the Securities and Exchange Commission, the incoming administration has an opportunity to modernize the securities law framework.

Record stock prices belie the troubling fact that our public markets are suffering substantial secular decline. The number of public companies has shrunk dramatically in recent decades, while the SEC has layered increasing obligations on issuers and market participants. It’s time for a reboot.

Public status provides a sense of permanency, equity to compensate employees and fund acquisitions, and a commitment to quality and compliance that investors appreciate. The US public market also provides deep liquidity to retail and institutional investors and unparalleled price discovery. Yet, these benefits increasingly are outweighed by regulatory burdens, some of which focus on social issues that are ill-suited to securities regulatory oversight.

So, what can be done?

We should reorient legislation and regulation around the historical touchstone of materiality for information—a substantial likelihood that a reasonable person would consider it important from a financial point of view. Disclosure requirements that fail to meet this mark should be abandoned.

This guiding principle should be paired with an emphasis on simplification. The regulatory framework has become unnecessarily complex, heightening the cost of going and being public, and constraining economic growth and job expansion.

Significant steps could be taken. A few illustrative ones follow.

Since 1933, federal law has mandated that public offers and sales of securities be registered with the SEC. As a result, possible SEC review of each offering is a hurdle to accessing the market, except only for the largest companies, which benefit from an exception.

The SEC should rehabilitate the idea of company registration. Under this approach, only the company would register with the SEC, and offerings would be de-regulated. A public offering could be done as and when desired, without the speed bump of SEC approval. The SEC could concentrate on reviewing periodic filings, and companies, underwriters, auditors, and other gatekeepers would remain liable for any fraud committed when offering and selling securities.

Private placements, used by entrepreneurs and small businesses to raise capital, also should be made simpler. In particular, state securities, or “blue sky” laws, can be expensive and time-consuming to comply with, while providing little investor protection. Exclusive regulation of securities offerings should sit with the SEC.

Allowing investors who pass a financial knowledge exam to invest in private placements would further democratize private market access, so it’s not merely the province of the wealthy.

Direct listings should be de-regulated to allow greater continuity between private markets and public markets. This would spur more private market trading and promote tighter spreads, while providing issuers with an alternative to M&A or a traditional IPO.

Disclosure for directors, officers, and large equity holders should be rationalized to eliminate overlapping rules. Although clear, simple disclosure is sensible, insiders should be freed from short-swing trading. This framework allows a specialized plaintiffs’ bar to trap unwary insiders with draconian disgorgement rules for deemed insider trades that don’t involve any wrongdoing, information advantage or profit.

The antiquated publicity rules for both public and private offerings likewise should be abandoned. They are unsuited to the information age and unduly restrict speech relating to offerings. Investors can be directed to defined offering materials such as the prospectus, so that investors know exactly which documents they should rely on. Fraud laws still would apply to misleading statements, regardless of where made.

The liability management rules governing issuer self-tenders and exchange offers should be rethought. Current law mandates up to 20 business days for a holder to consider whether to sell or exchange a security. The same holder, however, may well have decided to purchase that security in mere minutes. The law also currently is subject to a long history of complex regulatory exceptions, making it difficult to follow and inconsistent across deal types. Modernization again is warranted.

The Investment Company Act was adopted in 1940 to prevent rampant abuses involving pooled investment products. The act broadly defines “investment company,” resulting in operating companies sometimes being treated like mutual funds, limiting their ability to go public or requiring drastic steps to retool their balance sheets.

The rules have been moderated in some instances, such as with the business development company structure. However, more could be done to properly limit its scope and further liberalize it—for example, by creating a framework for permanent capital vehicles, such as those holding limited partner stakes in private equity and hedge funds, to be publicly offered and listed, as is the case in Europe.

These ideas are only indicative of much more that could be done with the right political backing and a genuine desire to improve the health of our markets for companies and investors alike.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Adam Fleisher is partner at Cleary Gottlieb Steen & Hamilton. The views expressed in this editorial are his own and do not reflect the views of the firms.

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