The Republican-controlled Securities and Exchange Commission may be running out of time to push President Donald Trump’s deregulatory agenda over the finish line, and that has spurred a flurry of activity. In the past several months, the agency has issued a raft of new and proposed rules that may be good for some businesses, but not so good for investors.
The changes include proposals to streamline mutual fund and exchange-traded fund disclosures; new rules on corporate disclosures and regulating proxy advisors; and an expanded definition of “accredited,” investors who are allowed to own nonpublicly traded companies or securities. The SEC is scheduled to vote soon on a controversial measure to raise the threshold for shareholder resolutions, and it may be close to expanding exemptions for companies to sell shares outside of public-offering rules. A vote on new whistleblower rules was just canceled, though the proposed changes would be significant.
The SEC has also sweetened rules for the brokerage and fund industries, including a new “best interest” rule that covers investment advice by brokers, and streamlined rules for launching ETFs, closed-end funds, and business-development corporations—all big wins for Wall Street and brokerage firms.
Proponents of the changes, including SEC Chairman Jay Clayton, have long argued that regulations are often so burdensome that they put a chill on “capital formation” and impose steep, unnecessary compliance costs on companies and investment firms. Much of the new framework is designed to be “principles-based,” allowing for more discretion in what needs to be disclosed. And many of the rules have been designed to help foster the private markets—for example, allowing Silicon Valley’s “unicorns,” valued at over $1 billion each, to remain privately held for longer and broadening the eligible investor base.
But gains for the business community may be losses for investors. Indeed, investor advocates say the SEC is making it easier for companies to curtail disclosures, which reduces transparency in public markets. And they argue that the regulatory rollback will make it tougher to push through shareholder-friendly resolutions in areas like executive pay and disclosures of environmental, social, and corporate governance, or ESG, factors.
“From an investor’s perspective, the changes are terrible to varying degrees,” says Tyler Gellasch, executive director of Healthy Markets, an investor advocacy organization. “The rules limit shareholder rights and information in the public markets in the name of capital formation.” Amy Borrus, executive director of the Council of Institutional Investors, says new rules on proxy voting could “tilt recommendations in favor of management to avoid the threat of legal action. There’s a risk that companies threaten to sue when they don’t like the proxy advisor’s recommendation. It’s indirect pressure.”
Fewer Risk Disclosures
One of the more sweeping sets of changes, in an area known as Regulation S-K, covers disclosures for public companies. New guidelines give companies more flexibility to summarize and disclose risks to their business and reduce line-item disclosures, and give corporate executives more discretion over what to reveal.
Several changes appear purposefully vague. New guidance on “human capital” requires companies to describe their workforce with measures they deem relevant, but stops short of requiring details in areas like diversity or compensation practices. The principles-based approach should lead to “more meaningful” disclosures, the SEC said. But the rule is so watered-down that it prompted a rebuke from Democratic Commissioner Allison Herren Lee, who wrote that she would have supported it “if it had included even…simple, commonly kept metrics such as part-time versus full-time workers, workforce expenses, turnover, and diversity. But we have declined to take even these modest steps.”
Indeed, just as significant as what’s in the rules is what regulators aren’t requiring. Principles-based rule-making is less prescriptive than bright-line regulations, creating more ambiguity and giving companies wider discretion over what they choose to share. Notably, the new Regulation S-K rules don’t include much additional ESG-related disclosure requirements and raise the bar for mandated reporting in some areas. Companies, for instance, won’t have to report a proceeding unless it resulted in a government settlement or judgment of $300,000 (up from $100,000), and firms can now select their own reporting thresholds for amounts less than $1 million or 1% of their assets, whichever is less.
Less Information for Investors
More broadly, the SEC appears to be punting on a framework for ESG reporting—despite widespread demand in the investment community. Large institutional investors are clamoring for such guidelines, arguing that companies disclose data selectively and without uniformity within industries. Disclosures tend to be fragmented in voluntary sustainability reports, annual filings, and proxy statements for shareholder meetings. And large companies are often inundated with ESG reporting requests, posing challenges over what to report—and often resulting in boilerplate language without context or quantitative metrics.
Adding to the confusion: Scoring metrics are highly subjective, making it tough for pension funds and other large investment pools—which control trillions of dollars—to assess ESG initiatives and rank their progress. According to the Aggregate Confusion project at Massachusetts Institute of Technology, it’s highly likely that a firm scoring in the top 5% for one ESG ratings agency is in the bottom 20% of another. “This extraordinary discrepancy is making the evaluation of social and environmental impact impossible,” the project leaders say.
The SEC has signaled concerns about ESG ratings in the fund industry—which Clayton has called “significantly over-inclusive and imprecise”—and an investor advisory committee to the SEC recently recommended developing an ESG regulatory framework. But Republicans remain opposed. Commissioner Elad Roisman said in a recent speech that he had “serious reservations about imposing prescriptive requirements in this area,” echoing skepticism from other Republican leaders, including Clayton.
A Boon for Private Companies
Gellasch is particularly concerned about the growing list of exceptions for large companies to stay in private hands and raise funds from a wider pool of accredited investors (along with looser rules for small-company “crowdfunding”). Many large companies are now essentially forced into the public markets for regulatory reasons:
(ticker: FB), for instance, had to issue shares to the public after its investor base crossed a regulatory threshold of 500 shareholders of record.
But regulators appear eager to facilitate private markets. The SEC proposed expanding exemptions in March that would allow companies to raise significant sums of capital in private offerings without having to make disclosures that would be required in a public offering. Partly, that reflects the fact that private capital markets are growing much faster than public equity markets. Last year, a record 70% of the nearly $4 trillion in financing went to private companies, up from a small fraction decades ago.
The new rules benefit private-equity and venture-capital firms, along with other large investors and executives at companies that issue private securities. But they would weaken a bedrock protection for the general public—the principle that everyone is entitled to the same information related to a security. Moreover, looser rules on solicitation increase the chances that nonaccredited investors will wind up buying private securities. The changes, Lee wrote in a letter, “chip away at the differences” between public and private markets, dismantling longstanding legal and policy barriers. If the SEC’s latest proposals are finalized, Gellasch says, “it’s extremely unlikely that any company would be compelled to go public.”
That may sound alarmist, and rule changes are moving targets. Congress may modify or rescind them, a new administration can rewrite the previous guidelines, and legal challenges abound. Congress also has “look back”powers for agency rules, and can scrap what it doesn’t like through the Congressional Review Act. The only certainty: Whenever the SEC changes the rules, it keeps the lawyers busy. B
Write to Daren Fonda at [email protected]