In remarks this week before PLI’s 55th Annual Institute on Securities Regulation, SEC Commissioner Mark Uyeda shared his views about the disclosure rulemaking process. He observed that, since becoming a commissioner 16 months ago, the SEC has adopted five major disclosure rules—pay versus performance, clawbacks, amendments to rule 10b5-1, share repurchases and cybersecurity—and has identified four more that are in the works. He focused on four key issues: determining purpose, the need for re-proposals, scaling disclosure and considering rulemaking costs and burdens on a cumulative basis. As you might guess, Uyeda had some thoughtful criticisms of the rulemaking process and offered some potential remedies.
Purpose of the rules. Uyeda suggested that the first step in SEC rulemaking should always be determining what problem the SEC is trying to solve. With SOX or Dodd-Frank, Congress directed the SEC to adopt rules on specific topics. Sometimes a market crisis or news event will trigger rulemaking. But recently, Uyeda maintained, the “answer is often that investors desire the additional information”; in that case, Uyeda cautioned, “demands for disclosure should not be taken at face value.”
He recommended that the SEC first undertake two forms of critical analysis. First, the SEC should evaluate both direct and opportunity costs. In his view, the real question was the extent to which investors not only want the information, but are also willing to pay for it. Here, he raised the issue of the “free rider” problem, where only a few investors may want the information, but all investors end up paying for it. That problem, he asserted, is compounded when the goal is “to have consistent and comparable information across all public companies,” even though the information may not be particularly relevant at all companies subject to the rule. Then, while costs are paid by all companies, the benefits of the rule may “accrue only to a select subset,” an important consideration for the SEC, he contended, in satisfying its “statutory obligations to consider costs and any effects on efficiency, competition, and capital formation.”
Second, he recommended, the SEC should analyze why investors want this information. Is it to help value the company’s shares, to sell investment products or services, to use in private negotiations with the company or “as a means to drive social change”? From Uyeda’s perspective, it’s problematic to use the SEC’s disclosure regime to address social issues: the SEC, in contrast to Congress, is an unelected, independent regulatory agency with limited political accountability, and addressing social problems is not within the SEC’s authority. That, in his view, should more appropriately be left to the legislature.
Uyeda suggests that, to help determine the underlying reasons for investor information demands, the SEC should employ analytical tools, “including investor testing as authorized by the Dodd-Frank Act. This analysis, together with consideration of the costs of providing the information, can help the Commission identify the specific problem that it is trying to solve at the outset of a rulemaking.”
Re-proposals. In Uyeda’s view, rules “should not be adopted without informed engagement with stakeholders,” and the notice-and-comment process provides the opportunity for that conversation. Uyeda advocated that the SEC issue re-proposals and revised economic analyses more frequently than it has in recent years—either when the SEC has made significant changes from the proposal or when significant time has elapsed since the original proposal. According to staff practice, that would be more than five years. Failure to adhere to this rulemaking best practice, he suggested, can lead to flawed rules that are costly and ineffective.
To illustrate, Uyeda looked, rather painfully, at the pay-versus-performance rule, a rule that was mandated under Dodd-Frank in 2010, initially proposed in 2015 and then adopted in 2022, two months after he became a commissioner. Although the proposal was over seven years old, the SEC reopened the comment period in January 2022 for only 30 days, and without an updated economic analysis.
Equally troubling, he contended, was the significant change in the final rule of the “calculation of ‘compensation actually paid’ and the treatment of equity awards, without seeking public feedback on this revised methodology.” This failure to engage with the public was reflected in the PVP disclosure during the past proxy season, he said, when, according to staff data, approximately “34% of companies subject to the new rule reported a negative amount for the principal executive officer’s ‘compensation actually paid’ in one of the three years” included in the new PVP table. Is that what Congress expected? The reason for the negative numbers, Uyeda explained, was the change in the method for valuation of equity awards in the final rule: as opposed to using fair value as of the vesting date of any awards that vested during the year, as proposed, instead, the “final rule required companies to use the change in fair value of awards from the beginning of the year though the end of the year or the vest date during the year.” Declines in stock prices over the year led to the presentation of negative CAP. The 2015 proposal had noted this outcome as a possible result from an alternative methodology described in the economic analysis and had received only two comments in favor. The 2022 reopening notice did not even include an updated economic analysis and did not receive much feedback on this alternative. Had the rule been re-proposed with a new economic analysis, Uyeda wondered, might the SEC have received some valuable comments about the usefulness of negative CAP? One publication apparently questioned whether some shareholders might think that the negative CAP meant that the CEO owed money to the company. And, he advised, let’s not forget the significant costs involved in preparing the disclosure, primarily the cost of comp consultants to calculate equity fair value.
According to Uyeda, the PVP rule stands as a “stark reminder not to take procedural shortcuts. This process was far from rulemaking best practices and the consequences are apparent in the results.” He hoped that the SEC would apply the lesson of PVP when it comes to adoption of final climate disclosure rules and, in the event of significant deviation from the proposal, re-propose the rule with revised rule text and an updated economic analysis. In his view, following that practice should lead to a better rule that is not costly and ineffective—and perhaps also not “indicative of a flawed process that raises the question of whether the rule is arbitrary and capricious under the Administrative Procedure Act.”
Scaling. Uyeda believed that “appropriately scaling the rule’s application to companies based on their size and maturity as a public company is as important as not taking procedural shortcuts.” Although the SEC recognized back in 1992 that smaller companies “are disproportionately affected by the complexities in the disclosure requirements,” the SEC “did not provide scaled disclosure relief in its recent rulemakings for cybersecurity, share repurchases, amendments to rule 10b5-1, and clawbacks” for smaller reporting companies or emerging growth companies nor did it provide staggered dates for compliance with the share repurchase or clawback rules.
Uyeda advocated that the SEC consider whether further scaling might be appropriate, such as by applying scaled disclosure using a triangle model, with large accelerated filers at the top providing the most disclosure, and smaller reporting companies and emerging growth companies at the triangle’s base. He believed that this approach would take into account disproportionate costs and resource constraints affecting smaller companies and the need for an “on-ramp” for newly public companies. “Today,” Uyeda observes, “an accelerated filer with a $250 million public float would be subject to the same disclosure requirements as a large accelerated filer with a $250 billion public float. However, the accelerated filer is likely to have much fewer resources to comply with those requirements.”
His triangle approach would create a new “middle class” of public companies. However, given that about “56% of companies are smaller reporting companies or emerging growth companies, 7% are accelerated filers, and 34% are large accelerated filers,” the SEC would first need to actually create a triangle. That could be accomplished, Uyeda suggested, by adjusting the category thresholds so that the number of accelerated filers would be relatively greater than the number of large accelerated filers. Uyeda reminded us that public float threshold for large accelerated filers was established as $700 million in 2005, covering approximately 18% of reporting companies at that time. But now, “the top 18th percentile for reporting companies’ public float is approximately $3.2 billion; if the threshold was adjusted to that amount, over 50% of the current large accelerated filers would no longer be treated as such.”
In addition, Uyeda recommended that the SEC evaluate whether there might be other disclosures that should be required of only large accelerated filers. Currently, he noted, “only one requirement differentiates large accelerated filers—the 60 day deadline for filing Form 10-K.”
Cumulative costs. Finally—and perhaps most importantly—Uyeda advocated that the SEC consider the “importance of assessing the cumulative costs—both human and financial”—of SEC disclosure rules, as opposed to the current practice of assessing each proposal in a vacuum. To illustrate the enormity of the burden that companies will face, Uyeda ran through a timeline of compliance dates for a December 31 year-end company that will need to comply with PVP, clawbacks, amendments to rule 10b5-1, share repurchases and cybersecurity, all of which will go into effect between the 2023 proxy season and the 2025 proxy season. Not to mention the significant increase in shareholder proposals during the 2023 proxy season, which may continue in the upcoming season. (I won’t repeat the timeline here, but it’s worth taking a look at the speech if only to check it out. It’s a bit intimidating.)
What’s more, he argued, the SEC tends to underestimate—to put it mildly—the additional hours and costs that the new requirements will impose. Here’s a good example: the hourly rate the SEC uses in its cost estimates for law firms is $600. (It was increased last year from $400, which was the rate used for the preceding 16 years.) “Aggregating the hours and costs across the five recently adopted rulemakings,” Uyeda advised, the SEC “estimates that the new rules will impose a mere 120 additional internal hours and about $24,000 of outside advisor fees, annually per company. These estimates represent a worst-case scenario where all possible disclosure requirements are triggered, including having a material cybersecurity incident required to be reported on Form 8-K, engaging in share repurchases, adopting or terminating rule 10b5-1 plans, and clawing back compensation.” Presumably, plus PVP. Seem plausible? And, he pointed out, “drafting high-quality disclosure also imposes more time and costs on companies compared to preparing boilerplate disclosure. If the Commission expects to be served non-boilerplate disclosure,…then it should ensure that its disclosure rules’ hours and cost estimates reflect that quality.”
In addition, he pointed out that the SEC “may be overwhelming companies’ ability to produce quality disclosure…by setting compliance dates for multiple new disclosure rules over the same one or two proxy seasons.” Drafting complicated disclosure often requires significant involvement from in-house counsel and other company personnel, who may already be consumed by work related to proxy season and therefore “hamstrung in their ability to craft the new disclosure without boilerplate language. Given the tight deadlines and resource constraints, it would not be surprising if companies rely more on boilerplate disclosure that provides little or no benefit to investors.”
Uyeda concluded by advising that the SEC “might better accomplish its mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation by re-evaluating its approach to rulemaking for public company disclosure,” and applying one or more of his recommendations.