Bloomberg reports that staff from the Department of Government Efficiency is currently at the SEC, according to communications to SEC staff, who were “instructed to treat them as internal employees.” Bloomberg also reports that the “SEC has designated an internal team to work with DOGE,” including “the offices of the chief operating officer, the general counsel, human resources and enforcement.” According to the article, about 10% of the SEC’s workforce (arounds 500 staff members) have already ”accepted the government-wide buyout and deferred-resignation offers. The agency also intends to eliminate the leases for its offices in Los Angeles and Philadelphia, and the General Services Administration has also explored ending the Chicago office’s lease. The most-senior positions at regional offices have also been cut, though the individuals in those roles aren’t being forced out.” The Shadow SEC fear that they are “watching the SEC face a death by 1,000 cuts.”
What is the Shadow SEC? At the end of last year, in this post on the CLS Blue Sky Blog, two leading authorities on securities law, Professors John C. Coffee, Jr. and Joel Seligman, made some predictions about SEC regulation under the new Administration. (See this PubCo post.) In light of their concerns about the potential changes to the SEC under the new Administration, they announced their intent to form a “Shadow SEC,” composed of acknowledged experts in securities regulation, intended to encourage debate through the presentation of “cogent and factual arguments”: “Such a shadow body—more scholarly than political—might frame issues in fuller detail and offer less drastic alternatives.” Although “[c]larity and objectivity will not always win,” they suggested, “sometimes they might. That is enough to justify the effort.” As the Shadow SEC (composed of Coffee, Seligman, John Coates, James D. Cox, Jill E. Fisch and Merritt B. Fox) explain in this Statement No. 2, The Crisis Deepens as SEC Staff and Budget Cuts are Directed, what they mean is not that the SEC will vanish, but rather that the SEC might end up a “shell of its former self,” that it is “on the verge of being shrunk by both budget cuts and mandated staff reductions, while it is losing its traditional independence.” (The loss of independence was discussed in the Shadow SEC’s Statement No 1. See this PubCo post.) While “some with a strong ‘anti-regulatory’ point of view may welcome the SEC being decimated, the majority of experienced practitioners on both sides of the political aisle understand that the SEC adds value to our capital market system and that its staff does significantly improve the quality of disclosure.”
Here are some of the Shadow SEC’s arguments against shrinking the SEC:
History. Although they recognize that factors other than SEC underfunding also played a large role, the Shadow SEC contend that “inadequate funding of the SEC program to regulate our largest investment-bank holding companies contributed to the 2007-2009 economic collapse…and subsequent declines of 54-56 percent in stock indices between selected dates in October 2007 and March 2009.” There were also major job losses, along with declines in household income and an explosion of the federal deficit.
Delay, Loss of Talent and the Impact on Capital Formation. Staff review of registration statements is “statutorily required,” and the “SEC received over 2,200 registration statements for review in 2023 (totaling over $1 trillion in the amount offered for sale).” As a result, “the prospect of chaos in our financial markets seems significant if the staff’s numbers were greatly reduced.” The Shadow SEC suggest that a loss of many experienced and able reviewers on staff could substantially extend the process, with the result that public companies “will be less able to rely on the registration process and may turn to other sources of capital, including bank debt.” Similarly, depletion of the staff (especially experienced staff) may impede timely responses to no-action requests. If the staff is substantially reduced in size, it may not have “the same level of expertise….Indeed, the sad truth is that ability and mobility go together, and those most likely to leave will be those whom private firms most want to attract.”
False economy. Applying a common metric for staff reductions, the Shadow SEC contend, “ignores one extraordinary fact about the SEC: It consistently has generated more in fees than in operating expenses. In effect, the SEC pays for itself and costs taxpayers nothing. Cutting its staff and budget is thus counterproductive and inflationary.” [Emphasis added.] In addition, they identify a growing disparity between “the SEC’s size and the growing markets it is expected to monitor. Among financial regulators, the SEC is relatively small. But the fields it is expected to watch over can grow by leaps and bounds, as new markets and new types of securities suddenly appear.” Consider, for example, the growth of crypto, they suggest. “Reducing the size and independence of the SEC,” they maintain, “may well have a hidden cost: a higher cost of capital for U.S. issuers. Of course, this will have an adverse impact on the ability of U.S. issuers (which today have a uniquely low cost of equity capital) to compete with foreign rivals.”
Costs of Failure. On top of the costs described above, the Shadow SEC contend, other latent costs may ultimately be much greater: “When securities enforcement is constrained, the impact may not be discovered until much later,” citing as examples the problems with Madoff and Enron that “were not detected for years, deepening the eventual losses.” That risk may be compounded in the event that deregulation increases, when individuals and companies may be “willing to gamble that violations will not be detected by undermanned regulators or that technical rules will not be enforced closely. For example, a company intent on launching takeovers may believe that it can ignore the requirement to immediately disclose its securities holdings once its ownership in a company crosses the Williams Act’s 5% threshold. The result likely would be an increasing number of undisclosed blocks as to which the target company could not identify the true owner. Such practices could erode the tradition of law compliance that has characterized most U.S. public companies.” Moreover, they suggest, “if the SEC is perceived as weak or so overloaded that it cannot take on more enforcement actions,” less scrupulous actors may enter “gray areas in the belief that the SEC lacks the manpower to respond. Eventually, those with high standards may feel compelled to follow them,” potentially leading to a “race to the bottom.”
Finally, they emphasize that, if the SEC’s staff is greatly reduced, then “large numbers of private actors—attorneys, investment bankers, accountants, and entrepreneurs—can expect their ability to pursue transactions, implement business plans, offer new products, or respond to new developments will be impeded,” as they “face both delay and uncertainty” in the absence of timely responses and review by SEC staff. Delay may even “result in issuers and others facing greater risk and liability at a later point when litigation may be brought by either the SEC or private plaintiffs.”
All of the above leads the Shadow SEC to conclude that diminishing the size and independence of the SEC may actually increase the cost of capital and produce “no real savings because the SEC actually makes a profit. Thus, the upside of the proposed cuts is negligible and the downside is catastrophic. To our minds, no rational decisionmaker would accept such a gamble where it can win little and lose much.”
