Jarkesy and climate disclosure: how far will the courts go in constraining the administrative state?
On Wednesday, in an Expert Forum sponsored by Cornerstone Research, Stanford professor and former SEC Commissioner Joe Grundfest and Vice Chair and Chief Legal Officer of Millennium Management and former SEC General Counsel Simon Lorne discussed “The Evolving SEC Landscape: Jarkesy v. SEC and the Proposed Climate Rules.” The two seemingly disparate topics were united by a common thread—the intense skepticism exhibited by some courts (including a likely majority of SCOTUS) of the vast power of the administrative state and their undisguised enthusiasm to constrain it. As Grundfest put it, in a slightly different context, the words are different but the melody is the same. What will be the impact?
Yesterday, the SEC announced that it is reopening the comment period for its 2015 proposal for listing standards for recovery of erroneously awarded compensation. Wait—didn’t they just do that? Yes, in October 2021. (See this PubCo post.) But no, that’s not Sonny and Cher on the radio. The SEC has decided to reopen the comment period AGAIN to allow further public comment in light of a new, just released DERA staff memorandum containing “additional analysis and data on compensation recovery policies and accounting restatements.” The new comment period will be open until 30 days after publication of the reopening notice in the Federal Register.
Are corporate boards awash in faux gatekeepers? This article, Board Gatekeepers, from a law professor at the University of Wisconsin, begins with a catalogue of infamous board failures to act as effective monitors of company conduct—including, in one case, a nascent scandal that continued for 11 years and another the subject of a successful Caremark claim. As framed by the author, the board plays a critical role, serving on behalf of the shareholders—and now perhaps also other stakeholders—to “ensure that the executive team is acting in the company’s best long-term interests,” in particular, “to ‘set up guardrails for the CEO’—that is, protect shareholders (and stakeholders) from corporate malfeasance.” Given the “structural power” that CEOs typically hold in the boardroom—such as through control over information and renominations—courts, regulators and investors often look to independent directors to act as a check on that power. Investors and regulators have also sought to address this power imbalance within the boardroom by introducing two key independent leadership roles—an independent board chair and a lead independent director. One or both of these “board gatekeepers” are now regular fixtures on boards, intended to add a “second layer of protection to the independence of the board” and signal and ensure “the existence of proper monitoring of management by the board.” The proliferation of these board gatekeepers, the author contends, “should have cemented board independence in what one can term its functional form: the ability to serve the crucial gatekeeping role that has been demanded of it.” But the inventory of recent scandals calls that conclusion into question. Are board gatekeepers really just window dressing?
On Friday, the SEC announced that it had adopted amendments to require electronic submission of several forms that currently may be submitted on paper and to require structured data reporting (i.e., XBRL) for Form 11-K. Most notably, the amendments require electronic submission of Forms 144 and, in PDF format, of “glossy” annual reports. According to SEC Chair Gary Gensler, in “fiscal year 2021, more than half of all filed Form 144 forms—30,000 in total—were filed on paper. In a digital age, it’s important for investors to have easy, online access to material information, rather than needing to visit SEC facilities to access that information. This is particularly important during Covid-19, which has made in-person visits to access these filings even more challenging. Even when access to physical copies isn’t restricted, there are other costs associated with paper filings. It costs investors money and time to travel to the SEC’s reading room. It costs the SEC money and time to process paper filings. These amendments will reduce costs and drive more efficiencies for investors, filers, and the SEC.”
In a recent report, Board Composition: Diversity, Experience, and Effectiveness, The Conference Board explores the implications for board composition of current trends toward ESG expertise and board diversity, together with the continuing emphasis on ensuring the right mix of skills and experience. This expanding list of priorities has led to increased diversity disclosure as well as greater functional expertise, larger boards and enhanced needs for board education. But while there has been a significant increase in disclosure regarding board diversity, that increase “has not been matched by increases in racial/ethnic diversity.” One cautionary note from the report: as boards seek to recruit more directors with functional expertise, such as cybersecurity or climate, the proportion of board members with business strategy experience has declined. For example, among companies in the Russell 3000, the percentage of directors with experience in business strategy decreased by five percentage points in the last three years. According to the Executive Director of the ESG Center at The Conference Board, the “recent decline in board members with business strategy experience is worrisome. Directors without broad strategic experience risk hindering effective board discussions and will likely be less useful partners for management….Although boards may want to add functional experience…, directors can bring meaningful value only if they can make the connection between these functional areas and business strategy.”
In December 2020, the Holding Foreign Companies Accountable Act, co-sponsored by Senators John Kennedy, a Republican from Louisiana, and Chris Van Hollen, a Democrat from Maryland, was signed into law. The HFCAA amended SOX to prohibit trading on U.S. exchanges of public reporting companies audited by audit firms located in foreign jurisdictions that the PCAOB has been unable to inspect for three sequential years. (See this PubCo post.) The U.S.-China Economic and Security Review Commission reports that, as of March 31, 2022, Chinese companies listed on the three largest U.S. exchanges had a total market capitalization of $1.4 trillion. As a result, the trading prohibitions of the HFCAA, which could kick in in just a couple of years—or perhaps even sooner, if Congress speeds up the timeline—could have a substantial impact. According to SEC Chair Gary Gensler, “[w]e have a basic bargain in our securities regime, which came out of Congress on a bipartisan basis under the Sarbanes-Oxley Act of 2002. If you want to issue public securities in the U.S., the firms that audit your books have to be subject to inspection by the [PCAOB]….The Commission and the PCAOB will continue to work together to ensure that the auditors of foreign companies accessing U.S. capital markets play by our rules. We hope foreign governments will, working with the PCAOB, take action to make that possible.” But China and Hong Kong have not permitted PCAOB inspections, largely because of purported security concerns. Last week, in remarks to International Council of Securities Associations, YJ Fischer, Director of the SEC’s Office of International Affairs, addressed “recent regulatory developments related to the lack of US inspections of audits and investigations in China and Hong Kong, and the implications for continued trading of China-based issuers on US exchanges.” The main message: although there has been progress, “significant issues remain,” and reaching an agreement would be only “a first step.” In other words, there is still “a long way to go.”
Audit Analytics has just posted its 2021 annual review of financial restatements, which this year covered a 21-year period. The review showed a 289% increase in the number of restatements to 1470, the highest level of restatements since 2006. You may have guessed that the increase was attributable to restatements by SPACs. Excluding SPACs, the numbers actually reflected a 10% decrease in the number of restatements year over year. SPACs also account—largely but not entirely—for a large increase in the proportion of reissuance (“Big R”) restatements. Audit Analytics found that 62% of restatements were reissuance restatements, the biggest proportion since 2005. But even excluding SPAC restatements, 24% of 2021 restatements were reissuances, an increase from 2020 of three percentage points.
The California Secretary of State has announced that she has directed counsel to file an appeal of the May 13 verdict of the Los Angeles Superior Court in Crest v. Padilla, which ruled unconstitutional SB 826, California’s board gender diversity statute. Crest v. Padilla was filed in 2019 by three California taxpayers seeking to prevent implementation and enforcement of the law. Framed as a “taxpayer suit,” the litigation sought a judgment declaring the expenditure of taxpayer funds to enforce or implement SB 826 to be illegal and an injunction preventing the California Secretary of State from expending taxpayer funds for those purposes, alleging that the law’s mandate was an unconstitutional gender-based quota and violated the Equal Protection Provisions of the California Constitution. After a bench trial, the Court agreed with the plaintiffs and enjoined implementation and enforcement of the statute. (See this PubCo post.) This verdict follows summary judgment in favor of the same plaintiffs in their case against AB 979, California’s board diversity statute regarding “underrepresented communities,” which was patterned after the board gender diversity statute. (See this PubCo post.)
In testimony this week before the Subcommittee on Financial Services and General Government of the House Appropriations Committee, SEC Chair Gary Gensler talked about the budget request for SEC operations for next year. He emphasized that, over the last five years, while the capital markets have grown to $100 trillion, the SEC has “shrunk.” And for Corp Fin, the “shrinkage” has been quite significant.