Democrats and Republicans are busy “lobbying” the SEC these days. Republicans want the SEC to nix Nasdaq’s proposal for new listing rules regarding board diversity and disclosure. Democrats want the SEC to beef up its insider trading rules in connection with Rule 10b5-1 plans. Will either find a receptive audience?
Letter from Republican Senators. In a letter to Acting SEC Chair Allison Lee, Senator Pat Toomey and the other Republican members of the Senate Committee on Banking, Housing, and Urban Affairs asked the SEC to reject the Nasdaq board diversity proposal. You might recall that, at the end of 2020, Nasdaq filed with the SEC a proposal for new listing rules regarding board diversity and disclosure. The new listing rules would adopt a “comply or explain” mandate for board diversity for most listed companies and require companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards. Under the proposal, new Rule 5605(f), Diverse Board Representation, would require Nasdaq-listed companies, subject to certain exceptions, to have at least one director who self-identifies as a female, and to have at least one director who self-identifies as an Underrepresented Minority or LGBTQ+. The term “Underrepresented Minority” reflects the EEOC’s categories and would include Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, and two or more races or ethnicities. If a company did not satisfy the new diversity “expectations,” it would be required to explain, in its annual proxy statement or on its website, why it “does not have at least two directors on its board who self-identify in the categories listed above.” In addition, under new Rule 5606, Board Diversity Disclosure, Nasdaq-listed companies, subject to certain exceptions, would be required to provide annually, in a proposed Board Diversity Matrix format, statistical information regarding the company’s board of directors related to a director’s self-identified gender, race and self-identification as LGBTQ+. The disclosure would be required in either the company’s proxy statement for its annual meeting or on the company’s website. (See this PubCo post.)
While the Senators applauded board diversity as a concept, they believed that Nasdaq was, among other things, acting outside its proper scope as an SRO:
“it is not the role of NASDAQ, as a self-regulatory organization, to act as an arbitrator of social policy or force a prescriptive one-size-fits-all solution upon markets and investors. NASDAQ’s narrow concept of mandated diversity, one that prioritizes race, gender, and sexual orientation, and pressured board diversity, misses the mark. It interferes with a board’s duty to follow its legal obligations to govern in the best interest of the corporation and its shareholders. It violates central principles of materiality that govern securities disclosures, and finally, it harms economic growth by imposing costs on public corporations and discouraging private corporations from going public.”
The Senators argued that the Nasdaq proposal would interfere with a board’s fiduciary responsibility to govern in the best interests of shareholders because it “ignores the dictum, most famously articulated by Warren Buffett, that board members should be chosen on merit and ability to improve corporate performance. NASDAQ’s proposal compels the prioritization of a narrowly defined concept of diversity in board membership over merit.” They also viewed the voluminous research provided by Nasdaq in support of its proposal to be inadequate because it didn’t show that diversity caused improved corporate performance or address sufficiently research that is contrary to Nasdaq’s that showed little correlation with performance. In addition, they viewed the proposal as unnecessary because corporations are already seeking to diversify, and “the imposition of a mandate with strict deadlines may undermine the ability of corporations to find the best suited candidates for them.” Further, Nasdaq’s definition of diversity was, in their view, too narrow; it focused on gender and race to the exclusion of religion, age, political affiliation, geography, education, veteran’s status and physical disability. Interestingly, the Senators also raised the issue of whether Nasdaq’s board recruiting solution, albeit complimentary for the first year, might create potential conflicts of interest after that.
They also questioned whether Nasdaq’s proposed disclosure requirement would elicit information that is truly material because, in their view, the required disclosures would not help a reasonable investor evaluate a company’s performance. The materiality concept, they said, “preserves social policymaking for democratically elected representatives, not regulators, such as the SEC, or quasi-regulatory entities, such as NASDAQ” and “prevents the development of an unstable, politicized securities regime that would be ripe for abuse of power.” Here, they contended, Nasdaq “appears to be motivated by an inappropriate desire to influence social policy.”
Finally, they contended that Nasdaq’s proposal “would harm economic growth by introducing unnecessary regulatory costs, decreasing the attractiveness of U.S. capital markets, and presenting an additional concern for corporations deciding to go and stay public.” In addition, they maintained that the risks of the proposal “could cause some private corporations to avoid going public at all.”
Letter from Democratic Senators. On the other side of the aisle, three Democratic Senators, Elizabeth Warren, Sherrod Brown and Chris Van Hollen, all members of the same committee, the Senate Committee on Banking, Housing, and Urban Affairs, submitted a letter to Lee appealing for SEC action on an entirely different matter—Rule 10b5-1 plans. They contended that new evidence showed that executives were “abusing these plans to obtain huge windfalls at the expense of ordinary investors. These abuses, and the plans’ lack of transparency, damage investors and risk undermining public confidence. We urge you to improve disclosure and enforcement of 10b5-1 plans and to consider further reforms that would prevent abusive practices.”
In support of their request, these Senators cited research suggesting that initial trades set up by 10b5-1 plans often appear to be based on MNPI and that executives modify or cancel their plans “in response to inside information in order to increase their own profits.” One recent study they cited “found that ‘public companies disproportionately disclose positive news on days when corporate executives sell shares under predetermined 10b5-1 plans,’ distorting stock prices for other investors.” The Senators also observed that, while plans were intended to set the time for trades months in advance, “it is not unusual for the plans to be modified days or hours before a major public announcement.” Another study “found that ‘executives at over 100 companies used plans that executed a trade the same day the plan was adopted.’ These short-term trades undermine the purpose of the 10b5-1 provision by eliminating the distance between the executive’s access to inside information and their transactions. Concerns about this use of 10b5-1 plans led the SEC Chair to call for a ‘cooling-off period’ of four to six months between the adoption of a 10b5-1 plan and the execution of its first trade. But the SEC has yet to take action on such a cooling-off period, which would mark a significant change, affecting 70% of plans adopted from 2016 to 2019.”
The Senators also contended that 10b5-1 plan problems disadvantage other investors. According to experts, they said, many 10b5-1 plans operate by setting a trigger price that prompts a sale of shares when the price is met (apparently “one of the primary mechanisms leading to large stock sales on the days of ‘good news’ announcements”). While it may be not necessarily be an abuse of MNPI, the Senators argued that the lack of transparency adversely affected investors: large sell orders from the company’s executives drag down the market price, but buyers are “unaware of this dynamic until, at the earliest, executives’ trades are disclosed two days after the fact—if at all.” Many are disclosed late, they observed.
Recommendations identified in the letter that were offered by experts included requiring cooling-off periods, public disclosure of 10b5-1 plans and trades, better enforcement of filing deadlines and enforcement of penalties “when executives benefit from short-term windfalls that do not translate into long-term gains….The SEC could consider working with Congress to modify [Section 16] to cover profits obtained through 10b5-1 sales that follow disclosure of material information that cause share prices to fall in the period immediately following the disclosure.”
The Senators also asked for responses to the following questions:
“1. What actions does the SEC currently take to ensure that 10b5-1 plans are compliant with the Commission’s current rules and requirements?
2. How many enforcement actions has the agency taken with regard to 10b5-1 plans in the past five years? Please provide a list and summary of all such actions.
3. Has the SEC taken action to require a ‘cooling off period’ between the adoption or amendment of any 10b5-1 plan and any stock sales under that plan?
4. Does the agency intend to require that 10b5-1 plans are disclosed publicly and posted online in advance of any trades made under that plan?
5. Has the SEC considered or evaluated modifications of regulations to ensure that 10b5-1 adequately covers ‘short-swing’ purchases?
6. What other actions has the SEC taken or are under consideration to prevent the abuse of 10b5-1 plans?”