When Gary Gensler was rumored to be the nominee for SEC Chair, Reuters reported that, in light of his “reputation as a hard-nosed operator willing to stand up to powerful Wall Street interests”—notwithstanding his former life as an investment banker—the appointment was “likely to prompt concern” among some that he would promote “tougher regulation.” (See this PubCo post.) This week, Gensler faced his interrogators on the Senate Committee on Banking, Housing and Urban Affairs, but the questioning didn’t really generate much heat—unless you count Senator Pat Toomey’s observation that Gensler had a “history of pushing legal bounds.” There was, however, a mild skirmish over—of all things—the meaning of “materiality,” essentially a surrogate for the fundamental divide on the Committee about whether the securities laws should be used to elicit disclosure regarding social and environmental issues.
Toomey set the stage in his opening statement:
“The SEC has historically administered the federal securities laws on a bipartisan basis. There are some, however, who want the SEC to stray from its tradition of bipartisanship by using its regulatory powers to advance a liberal social agenda on issues such as climate change and racial inequality.
Based on Mr. Gensler’s record, I’m concerned he may be inclined to use the SEC in this inappropriate manner. The securities laws are not the appropriate vehicle to regulate climate change nor to correct racial injustice or intimidate companies regarding political spending. That is why we have environmental, civil rights, and political spending laws.”
Gensler’s history at the CFTC “of pushing the legal bounds of the agency’s authority,” raised the question for Toomey of “whether he will also push the legal bounds of the SEC’s authority in particular to advance a liberal social agenda.”
[Below based on my notes, so standard caveats apply.]
In his questioning, Toomey introduced the topic of the meaning of “materiality” by reminding Gensler that in their prior conversation, Gensler had committed to basing SEC disclosure requirements on the concept of materiality. But how would Gensler apply that concept in practice? For example, if a big public company spent an insignificant amount on, say, electricity, is it material whether that electricity came from renewable sources? Gensler replied that, according to SCOTUS, the test is whether it’s material to a reasonable investor in the context of the total mix of information. So, in the hypothetical, the information about renewable sources may or may not be material, depending on the total mix of information. Often a financially insignificant amount may be immaterial, but it must be viewed in the broader context of the mix of information. Toomey responded that, if the amount was financially insignificant, he did not see how it could be material.
Similarly, Toomey asked, if a large public company reported revenues of hundreds of billions of dollars, and it spent a million dollars on political issue ads, should disclosure be required? Gensler responded that the question is what information reasonable investors are seeking to make voting or investment decisions, and last year, based on their proxy votes on shareholder proposals, about 40% of shareholders said that political spending information would be material. So, even though the amount of spending is completely insignificant, Toomey asked, did he think it could be appropriate to mandate that disclosure? Gensler replied that he would be grounded in economic analysis and the courts’ views of materiality as the information reasonable investors want to see as part of the total mix of information. Why not leave it up to the companies to decide, Toomey asked? Gensler repeated that it’s a really a question of investors making the choice about the information they want.
Picking up on Toomey’s line of questioning, Senator Richard Shelby asked Gensler to discuss the difference between “economic materiality” and what he called “political materiality.” Gensler said that, although he was aware of the political ebb and flow, he would be grounded in the economic side together with the courts’ definition of materiality as based on the type of information reasonable investors want among the total mix to make voting and investment decisions. Gensler also confirmed to Shelby that he viewed the cost/benefit analysis as important to good decisions about regulation. Senator Bill Hagerty also urged Gensler not to allow regulations to be used to backdoor social policy, and advocated a cost/benefit approach.
Looking at the issue of materiality from a different perspective, Senator Chris Van Hollen noted that the determination of materiality changes over time. For example, 20 years ago, investors may not have seen climate change risks as essential to the success of a particular company, but they do now. Gensler confirmed that it was important for the SEC to keep an eye open to changing investor demands for information; as the courts have defined it, Gensler reiterated, reasonable investors are the ones who decide what is important, not the government. Gensler said that he would be guided by that. In 2021, Gensler agreed that investors with tens of trillions of invested assets are seeking information about climate risk, and the SEC has a role to play to bring comparability and consistency. Van Hollen also raised the issue of whether reasonable investors might not view political spending disclosure as material in light of the possibility of corporate reputational risk that could arise out of political spending. Gensler agreed that that could factor into a reasonable investor’s voting and investment decisions. The SEC could work to provide guidance to issuers about how to provide that information.
Toomey also asked whether Gensler had any plans to revisit the SEC’s new rulemakings about proxy advisory firms and shareholder proposals? (See this PubCo post and this PubCo post.) Gensler said he would work with the staff to understand the rules and see if they achieved the purposes of the SEC at the least cost, such as the issue of conflict of interest in the proxy advisor rules. Senator Steve Danes also questioned whether Gensler was concerned about the domination of the market by the two main proxy advisory firms and resulting lack of competition, as well as the potential for conflicts of interest to affect the advice they provide. Gensler recognized that competition was important for efficiency, but also stressed that the two firms performed an important function in providing services and efficiency for pension funds and investors through proxy season. He would work with the staff to see if there were unaddressed issues following the adoption of the new rules last year.
Toomey also used the opportunity to refer to the letter that he and other Republican Committee members sent to the SEC objecting to the Nasdaq comply-or-explain diversity proposal (see this PubCo post), questioning the propriety of Nasdaq’s acting “as an arbitrator of social policy or forc[ing] a prescriptive one-size-fits-all solution upon markets and investors.” (See this PubCo post.) He asked whether Gensler considered it a good idea to pressure boards to comply with a diversity quota? Gensler replied that he considered diversity on boards to benefit decision-making, and reiterated his previous statement to Committee Chair Sherrod Brown that he would look to make diverse hires at the SEC. On that topic, Senator Tim Scott indicated that he opposed a diversity mandate, but did not oppose disclosure as long as it was not in pursuit of a specific outcome based on implicit bias.
Senator Robert Menendez dug further into the question of political spending disclosure. He said that over 1.2 million individuals had previously pressed the SEC to adopt a political spending disclosure mandate. Now, in the absence of disclosure standards, executives can spend corporate funds to serve their own political interests without any transparency. In addition, in light of the events of January 6, many companies had recently reevaluated their prior decisions on political donations, in part out of concern for the potential impact of donations on their corporate reputations. He said he was reintroducing his legislation to mandate disclosure and shareholder approval. How did Gensler view political spending disclosure? Gensler agreed that, without addressing the particular issue, that disclosure was important, that he would be guided by the materiality standards he had previously described. He added that he considered the 80 shareholder proposals submitted last year on the topic and the 40% vote in favor as a strong indicator. In light of that level of investor interest, political spending disclosure was something he thought the SEC should consider.
Menendez also raised the issue of diversity disclosure, observing that corporate America still lacks diversity and that, based on his surveys, women and racial/ethnic minorities have made only marginal gains over the past 10 years. The SEC’s 2009 diversity disclosure rule, in his view, failed to even define diversity. He also cited McKinsey studies showing that greater diversity benefited performance. (See, e.g., this PubCo post.) Gensler agreed that diversity enhances decision-making and that information about human capital was important to investors. The SEC previously adopted amendments for human capital disclosure, but, he noted, that information that investors want to see in human capital is evolving.
In addition to Van Hollen, a number of other senators urged Gensler to adopt mandatory climate disclosure regulations. Chair Brown observed that the Acting Chair Lee had recently issued a directive to review the 2010 guidance on climate and asked whether Gensler planned to do more than that. Senator Elizabeth Warren and Senator Tina Smith had also weighed in to the same effect. Gensler responded that investors, with tens of trillions in assets behind them, increasingly want to see climate risk disclosure. He also noted that issuers could benefit from standardization and the clarity of guidance. Gensler said that, based on good economic analysis and public feedback, he would work with the staff on a rulemaking on climate. In response to a concern raised by Lummis about a potentially adverse impact of climate disclosure regulation in her state of Wyoming, Gensler replied that disclosure regimes can actually be pro-issuer and pro-investor by helping to provide standardization and consistency about disclosure of material risks.
The Senators also raised issues regarding digital currency, a particular interest of Gensler’s, given that he has taught courses about digital assets at M.I.T. in the last few years. In the digital asset space, Gensler said he would be “technology neutral,” but recognized the challenge of ensuring investor protection in that context. Senator Cynthia Lummis characterized the SEC as a “black hole for digital innovators,” and asked whether the SEC would be providing more guidance. Gensler said that he thought more guidance would be helpful to provide clarity to market participants, even if sometimes it’s a “thumbs down.” In addition, he advocated investor protection surrounding the issues of custody, and, more importantly, fraud and manipulation. Everyone wanted to appropriate Senator Bill Hagerty’s line that, with regard to new regulation, in light of the pace of innovation in the digital currency market, “you don’t want to be shooting where the rabbit was.”
The hearing also offered plenty of discussion about current topics such as market structure, conflicts of interest and payment for order flow (to which Gensler indicated that his interest was in promoting efficient, fair and orderly markets). Shelby also posed the question he asks perennially: who owns the corporation—shareholders or management? Doesn’t that mean that management is required to work for the shareholders first? Gensler agreed that that was his view and that he thought it was the law in all 50 states (with not so much as a nod to notions of stakeholder capitalism). Danes raised the issue of enforcement, particularly his concern that the SEC has taken action based on previous actions and guidance, as opposed to violations of rules. Gensler said that enforcement actions should follow the facts and the law, using limited resources to address the greatest problems in the market. Senators also raised issues regarding NRSROs, compulsory arbitration clauses, private equity, transaction taxes and “housekeeping” issues such as 10b5-1 plan (see this PubCo post and this PubCo post) and the 8-K trading gap (see this PubCo post). On the latter two topics, Van Hollen asked Gensler for technical help from the staff on legislation he is preparing to address the gaming that he perceives is allowed under the current rules.
