In a speech given yesterday at Columbia University, SEC Chair Jay Clayton reviewed the SEC’s regulatory achievements over the past year, metaphorically slapping the SEC and the staff on the back for a job well done in accomplishing 88% of the items identified on the SEC’s near-term agenda for fiscal 2018. Of particular interest, however, was his discussion of the some of the priority items on the 2019 agenda. In closing, Clayton hammered again at three risk areas that the SEC is currently monitoring—yes, those three. Clearly, the signal is that companies should consider these risks.
Having just heard substantial input from the recent proxy roundtable (see this PubCo post), Clayton advised that he has asked the staff to formulate recommendations regarding the issues discussed. Given that “these issues will not improve on their own with time,” he indicated that he intended “to move forward with the staff recommendations, prioritizing those initiatives that are most likely to improve our markets for our long-term Main Street investors.” Here are some of his takeaways from the roundtable:
One of the key initiatives for 2019 identified Clayton was improving the proxy process. With regard to “proxy plumbing,” Clayton observed that it was clear that a “major overhaul” was overdue. Conceding that a major overhaul “could take time,” he suggested that, in the interim, the SEC go for the low-hanging fruit to improve the current system. He encouraged more thinking about ways to improve the “plumbing,” whether through technology or otherwise, and further comments “regarding actionable, interim improvements.”
Clayton also expressed his view that it was “clear” that the SEC should consider reviewing the ownership and resubmission thresholds for shareholder proposals, particularly given that the “current $2,000 ownership threshold was adopted 20 years ago, and the resubmission thresholds have been in place since 1954. A lot has changed since then.” The approach taken, he advised, should reflect “the realities of today’s markets and today’s investors,” particularly the “interests of the long-term retail investors who invest directly in public companies and indirectly through mutual funds, ETFs and other products. With these long-term, retail investors in mind, we also should consider whether there are factors, in addition to the amount invested and the length of time shares are held, that reasonably demonstrate that the proposing shareholder’s interests are aligned with those of a company’s long-term investors.”
Proxy Advisory Firms
With regard to proxy advisory firms, Clayton identified several needed changes about which he believed there was growing agreement. These included “greater clarity regarding the division of labor, responsibility and authority between proxy advisors and the investment advisers they serve” (presumably a reference to concerns about “robo-voting” by investment advisers), and “clarity regarding the analytical and decision-making processes advisers employ, including the extent to which those analytics are company- or industry-specific. On this last point, it is clear to me that some matters put to a shareholder vote can only be analyzed effectively on a company-specific basis, as opposed to applying a more general market or industry-wide policy.” Finally, he indicated that the SEC should also consider a framework for addressing conflicts of interest at proxy advisory firms and a process for “ensuring that investors have effective access to issuer responses to information in certain reports from proxy advisory firms.”
Capital Formation and Access to Investment Opportunities
Parallel to the JOBS Act 3.0 (see this PubCo post), which seems to be languishing somewhere in Congress, 2019 agenda items include expansion of “testing-the-waters,” expansion of Reg A for public reporting companies and a study of the quarterly reporting regime. Corp Fin is also looking at harmonizing and streamlining the “patchwork” private offering system. Watch for a new concept release on this topic, including whether the accredited investor definition is still appropriate.
Encouraging Long-Term Investment
Here, Clayton recognized the ongoing debate regarding “mandated quarterly reporting and the prevalence of optional quarterly guidance, and whether our reporting system more generally drives an overly short-term focus. I encourage all market participants to share their views to let us know if there are other aspects of our regulations that drive short-termism.” (See this PubCo post and this PubCo post.)
Finally, Clayton addressed three risks that the SEC is currently monitoring: (1) the impact of Brexit; (2) the transition away from LIBOR as a reference rate for financial contracts; and (3) cybersecurity. These are topics that SEC representatives have emphasized at recent events, clearly suggesting that companies need to think hard about the potential impact of these risks in their upcoming reports. (See this PubCo post and this PubCo post.)
The SEC is obviously concerned that companies are not adequately considering and disclosing the potential impact of Brexit. Clayton has “directed the staff to focus on the disclosures companies make about Brexit and the functioning of our market utilities and other infrastructure.” (Emphasis added.) To that end, Clayton enumerates specifically his key concerns, which although admittedly personal, are also “reflective of the SEC’s approach to Brexit”:
- “The potential adverse effects of Brexit are not well understood and, in the areas where they are understood, are underestimated.
- The actual effects of Brexit will depend on many factors, some of which may prove to be beyond the control of the U.K. and E.U. authorities.
- Our markets, at many levels—from multinational companies, to market infrastructure, to investment products and services—are international, and the effects of Brexit will be international, including on U.S. markets and our Main Street investors.
- The actual effects of Brexit are likely to manifest themselves in advance of implementation dates and, based on corporate disclosures, some of those effects are upon us.
- The actual effects of Brexit will depend in large part on the ability of U.K., E.U. and E.U. member state officials to provide a path forward that allows for adjustment without undue uncertainty, disruption or cost. That is a tall order that I believe requires: (a) a broad understanding of market interdependencies—knowledge that goes well beyond the labor and financial markets; (b) foresight—people and firms will act in their own interests and the interests of their shareholders; and (c) flexibility—miscalculations are inevitable and will need to be addressed promptly. More generally, limiting the adverse effects of Brexit requires a willingness of governmental authorities to look beyond potential immediate, local economic and other opportunities provided by a blunt transition and pursue a course that focuses on broad, long-term economic performance and stability. While many involved in the Brexit process agree with this perspective, and some important steps have been taken, I do not yet see wide acceptance of this principle.”
While there has been a range in the level of detail and analysis provided by disclosures, even within the same industry, Clayton advises that he “would like to see companies providing more robust disclosure about how management is considering Brexit and the impact it may have on the company and its operations.” Clayton also indicated that the staff has been in continuing planning discussions with U.K. and E.U. counterparts and market participants regarding the potential impact of Brexit on U.S. investors and markets.
Transition Away from LIBOR
LIBOR is used extensively as a benchmark reference for short-term interest rates for various commercial and financial contracts—including interest rate swaps and other derivatives, as well as floating rate mortgages and corporate debt— but it is expected that its use as a reference rate will end after 2021. As cited by Clayton, according to the Fed, “in the cash and derivatives markets, there are approximately $200 trillion in notional transactions referencing U.S Dollar LIBOR and that more than $35 trillion will not mature by the end of 2021.” An alternative reference rate, the Secured Overnight Financing Rate, or “SOFR,” has been proposed by—what else? — the Alternative Reference Rate Committee. For public companies that have floating rate obligations tied to LIBOR, Clayton warns, a significant risk is
“how to manage the transition from LIBOR to a new rate such as SOFR, particularly with respect to those existing contracts that will still be outstanding at the end of 2021. Accordingly, although this is a risk that we are monitoring with our colleagues at the Federal Reserve, Treasury Department and other financial regulators, it is important that market participants plan and act appropriately. For example, if a market participant manages a portfolio of floating rate notes based on LIBOR, what happens to the interest rates of these instruments if LIBOR stops being published? What does the documentation provide; does fallback language exist and, if it exists, does it work correctly in such a situation? If not, will consents be needed to amend the documentation? Consents can be difficult and costly to obtain, with cost and difficulty generally correlated with uncertainty. In the area of uncertainties, we continue to monitor risks related to the differences in the structure of SOFR and LIBOR. SOFR is an overnight rate, and more work needs to be done to develop a SOFR term structure that will facilitate the transition from term-based LIBOR rates.”
With regard to cybersecurity, the SEC is concerned with a number of aspects, including the risk for market participants, investors and companies, as well as for the SEC itself. For public companies, Clayton stressed the importance of adequately informing investors of material cybersecurity risks and incidents, noting in particular the SEC’s recent guidance. In addition to disclosure, the guidance also emphasized the importance of reviewing disclosure controls and procedures and insider trading policies to ensure that they adequately address cybersecurity. (See this Cooley Alert regarding the SEC guidance and this PubCo post regarding a recent SEC investigative report that advises public companies of the need to consider cyber threats when implementing internal accounting controls.)