LexisNexis Corporate & Securities Law Community 2011 Top 50 Blogs

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The Meaningful Return of Shareholder Access (Part 1)

Directors are not chosen by shareholders.  In the case of most public companies, shareholders can only vote for a single slate of directors in something that resembles an old style Soviet election.  The decision as to who gets to serve on the board, therefore, is made not when shareholders vote but when the slate submitted to shareholders is selected.  The slate is invariably determined by the board, with input (explicit or implicit) from the CEO.  (For a discussion of this influence, see The Demythification of the Board of Directors).  The result is a system whereby directors seeking to remain on the board have greater incentive to side with management than with shareholders. 

Assorted reforms designed to ensure greater board independence and orientation towards shareholders have been tried.  The definition of director independence at the stock exchanges (but not Delaware law) has been tightened.  Listed companies must have a nominating committee that consists only of independent directors.  Nonetheless, these approaches have largely failed.  Id.  The definition of director independence does not ensure independence in fact.  Nominating committees may consist of independent directors but they can still consult with management and accept their nominees.

The one reform that did have the potential to work, however, was shareholder access.  (for a history of the SEC's efforts in this area, see The SEC, Corporate Governance, and Shareholder Access to the Board Room) as a rule by the SEC, shareholder access allowed large shareholders (or groups of shareholders) to submit a minority of directors for inclusion in the company's proxy statement.  Shareholder access made it more cost effective to run nominees not selected by incumbent management.  Access also had the potential to more closely focus directors on the interests of shareholders in order to avoid the submission of competing nominees.

The SEC's shareholder access rule was struck down by the DC Circuit on administrative grounds.  (for a discussion of the case and the weak reasoning, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC).  The opinion was poorly reasoned and had the appearance of a result oriented decision.  Nonetheless, the decision eliminated the SEC's categorical rule on the subject. 

Since then, shareholder access has been a matter of private ordering, with shareholders submitting a modest number of proposals at specific companies calling for access.  A number received majority support.  Nonetheless, its safe to say that for the most part, shareholder access was not at the forefront of investor concerns, probably more a result of exhaustion than disinterest.

As we will discuss in the next post, that is about to change. 


American Meat Institute COOL Rehearing Request Denied

On Oct. 31, the United States Court of Appeals for the District of Columbia Circuit denied a request for a rehearing on a motion for preliminary injunction to block implementation of the United States Department of Agriculture’s May 2013 final rule on country-of-origin (COOL) labeling for red meat. The rehearing request focused on the provisions of the rule prohibiting the commingling of meat, arguing that the requirement exceeded the authority of the Agricultural Marketing Service (AMS). That issue was not addressed by the en banc panel that decided American Meat Institute v. USDA (discussed here).

In a statement, AMI Interim President and CEO James Hodges noted “[t]he ban on commingling, which was the subject of this rehearing request, is a key component that made the 2013 rule even more onerous and burdensome than the previous rule, as was confirmed by the World Trade Organization’s recent report.” He also said, “The court’s refusal to rehear our motion will allow those harms to continue. We will evaluate our options.”

The challenge is all the more interesting because the World Trade Organization ruled last month, for the second time, that the United States has not done enough to fix the COOL law. Specifically, the WTO compliance panel found that the rule was less favorable to meat imports from Canada and Mexico and more favorable to domestically produced meats.

The Obama administration has 60 days to decide whether to appeal the ruling. In the interim, the COOL Reform Coalition, a group of agriculture interests said in a letter to Congress that if Mexico and Canada retaliate it could cost U.S. businesses billions of dollars in lost sales. The COOL Reform Coalition, said tariffs could be slapped on $1.3 billion in Iowa exports, with pork, corn, and soybeans among some products expected to be targeted.

"We request that Congress immediately authorize and direct the secretary of agriculture to rescind elements of COOL that have been determined to be non-compliant with international trade obligations by a final WTO adjudication,” the letter said.

Such action seems unlikely in light of a recent statement from Sen. Chuck Grassley, R-Iowa, and Sen. Tim Johnson, D-S.D. who said Congress should wait to see how the Obama administration responds. Grassley, a member of the Senate Agriculture Committee, said he did not believe Congress would do anything until the Agriculture Department and the United States trade representative decide if they will appeal the decision at the WTO. "We'll have to wait and see if the White House believes there is anything else that can be done administratively to bring COOL into compliance," Grassley said.

Why is this of any interest to corporate lawyers?  Recall that part of the initial challenge to the COOL law was that it improperly compelled corporate speech in violation of the First Amendment. That argument was rejected by the DC Court of Appeals who extended the rationale expressed in Zauderer v. Office of Disciplinary Counsel, to apply rational review to compelled corporate speech aimed at more than preventing consumer deception. The WTO’s objections to the COOL law is that it doesn’t not go far enough—that it does not provide sufficient information to consumers. If the United States does not appeal the WTO ruling, and instead attempts to amend the COOL law to address the WTO concerns by requiring more disclosure, we may see an opportunity to again explore the contours of compelled corporate speech, an issue with ramifications far beyond the meat industry.


Fee Shifting Bylaws and Senator Blumenthal

Senator Blumenthal sent a letter to the Chair of the SEC, Mary Jo White, calling on the SEC to take steps with respect to the implementation of fee-shifting bylaws. The letter described a number of negative ramifications that could arise from the bylaws. 

  • The potential ramifications from this decision are immense. No rational investor, even with significant financial interests at stake and when presented with clear evidence of corporate misconduct, will brave litigation when the corporate defendant can force the investor to face financial ruin unless he substantially wins on every point. While ATP Tour only affects corporations headquartered in Delaware, Delaware is home to many of the country’s largest public companies. Further, the Delaware Supreme Court’s action is already beginning to have a ripple effect in other jurisdictions, leading other state courts to reconsider longstanding doctrine in this area. 

The letter likewise called on the SEC to act.     

  • I call upon the Commission to commence investigation of Alibaba Group Holding, Ltd., one of several companies that have elected to include fee-shifting provisions in their governing documents but failed to disclose it in offering statements. The SEC should label such provisions as major risk factors and require corporations to publicly disclose them before any initial public offering. More broadly, the SEC should clarify that fee-shifting provisions are inconsistent with federal securities law. At a minimum, I urge the SEC to refuse to permit registration statements to move forward for any company that includes these provisions in violation of our federal securities laws.

The letter seeks to pressure the SEC to take steps to minimize the impact of these bylaws. Even if the SEC takes the steps suggested by Senator Blumenthal, the bylaws may still proliferate, albeit in a more limited manner (applicable, for example, only to derivative suits).  

A permanent solution could come from Delaware, with the courts or the legislature rejecting the applicability of the bylaws to for profit companies. To the extent that this does not occur, the issue will likely represent a candidate for federal preemption.    


Omnicare and Oral Argument at the Supreme Court

The Supreme Court heard oral argument on the Omnicare case yesterday.The primary issue was whether an opinion could be false absent allegations of subjective disbelief.  I was counsel of record on a brief on behalf of law and business faculty who argued that the statement at issue was not an opinion. For a copy of the brief, go here.  

One of the statements alleged to be false stated that:  "We believe that our contracts with pharmaceutical manufacturers are legally and economically valid arrangements".  The complaint alleged that the statement was false "when made."  

In part, the case raises the issue of whether a statement in a registration statement prefaced by "we believe" amounts to an opinion.  The issue came up during oral argument came up as evidenced by the following colloquy:   

  • CHIEF JUSTICE ROBERTS:  So if I say or the company says in a prospectus, we believe that we have 3.5 million units of inventory in our secret inventory warehouse, so long as they say we believe, they can't you know, it turns out they have none, that's all right?  They're still protected?
  • MR. SHANMUGAM:  I think that that would probably be a statement of opinion, but it is much closer to the line between statements of opinion and statements of fact.  Let me explain
  • CHIEF JUSTICE ROBERTS:  Really, you think it's an open question if they say it's a very precise number for something that only they know anything about, and it's wildly off, you think they're protected or may be simply by saying "We believe"?
  • MR. SHANMUGAM:  Well, I ­­ I think that ­­the reason why I think it's a close question as to whether or not that would be a statement of opinion is simply because the second restatement's definition of  what constitutes a statement of opinion, which we think is a useful guide, includes not just statements on matters of judgment, like the statements we have at issue here, but also statements that express uncertainty about factual matters.  And I think in your hypothetical, Mr. Chief Justice, you can view that statement as being the equivalent of a factual statement that along the lines of, we have approximately 3 million units or widgets in our inventory, such that if they had nowhere near that, that statement would be an objectively false statement of fact and, therefore, actionable.

The oral argument primarily focused on whether an opinion subjectively believed was required to have a "reasonable basis," something the Government asserted (as did the law faculty brief).  While opinions are difficult to predict, there seems to be a clear majority for the proposition that opinions issued by the company in a Section 11 context must have some support.  

The only question is whether the Court will find that an opinion can be false if subjectively believed but lacking in a reasonable basis or if the lack of a reasonable basis is prima facie evidence that the opinion was not subjectively believed.  The two positions are not equal.  Note the following colloquy between counsel for Petitioner and Justice Alito:   

  • MR. SHANMUGAM:  But, again, our view is that for purposes of pleading a claim, a plaintiff is not restricted to smoking gun evidence that the speaker did not possess the stated belief.  And so, again, if a plaintiff is able to come forward with allegations that cross the pleading threshold of plausibility to suggest that the speaker, in fact, did not hold the stated belief, that will, in fact, be sufficient. 
  • JUSTICE ALITO:  Well, that may be true, but do you deny the fact that there can be situations in which a person makes a ­­ makes a statement of belief and believes that to be true, but lacks a reasonable basis for stating the belief?  There is a difference between those two situations, isn't there?  
  • MR. SHANMUGAM:  I think there is a difference between those two situations, and I think this illustrates an important conceptual distinction.  I think in a case where a speaker has no basis whatsoever for the stated belief, there will be comparatively few cases ­­ and I'm certainly not aware of any case from the reported cases in this area ­­ where the speaker held the stated belief but lacked any basis for it whatsoever.

The other issue was whether the adoption of the reasonable basis standard for opinions subjectively believed required reversal of the 6th Circuit opinion.  While the outcome is difficult to predict, the tenor of the opinion was that the Justices would opt for something like the reasonable basis standard (there was discussion about the precise formulation of the standard) and probably send the case back to the 6th Circuit to apply the standard (and to determine whether it had been sufficiently alleged).  

Our prediction?  A substantive victory for Respondents (opinions can be subjectively believed but still false) but a reversal of the 6th Circuit's decision.   


The SEC and Structured Data (Part 2)

We are discussing the recent speech by Mark Flannery, the new director of DERA.  See The Commission’s Production and Use of Structured Data, Data Transparency Coalition’s Fall Policy Conference, Washington, DC, Sept. 30, 2014 

Of interest was the discussion of "Inline XBRl."  Inline allows for the incorporation of XBRL tags into the HTML formatted document.  As a result, companies do not need to submit an HTML version and a separate file that contains the financial statements using XBRL.  Mark Flannery had this to say about Inline: 

  • DERA staff is working with outside contractors on “Inline-XBRL.” Consistent with its name, this new technology would allow companies to integrate (or embed) the XBRL tagging of the financial statements directly into their standard HTML formatted 10-K and 10Q filings.  This effectively eliminates the need to reconcile separate HTML and XBRL versions of the financial statement content, thus reducing the possibility of rekeying or similar errors.  Work is also proceeding on a prototype viewer that would allow users to display and search the integrated XBRL tagging while viewing the familiar HTML view of the financial statements.  In short, then, SEC staff are committed to improving the availability of financial information through the presentation and analysis of structured data.  

This is another important and serious step forward.  Inline will eliminate some of the data quality issues that have arisen with respect to financial statements submitted in an XBRL format.  In particular, Inline will eliminate the problem of discrepencies between the html and XBRL versions of the finanical statements.  It will not solve the problem of excessive use of custom tags and other issues associated with quality but it represents an important step forward in increasing the usability of tagged data. 


The SEC and Structured Data (Part 1)

The SEC collects massive amounts of data. Much of the data is submitted in html, a format that is difficult to search. Ten years or so ago, the SEC started to require the filing of some information in an interactive format. The format permitted analysis of large amounts of data through the use of "tools" (software).   

The roll out of structured data engendered significant criticism. The requirement that financial statements be submitted in an xbrl format was criticized as the imposition of an expense with little value. Indeed, the House has adopted a bill that would eliminate tagging for emerging growth companies. See HR 5405

Nonetheless, recent developments suggest that the Commission is returning to, and promoting the use of, structured data.  In 2012, the Commission proposed a rule requiring disclosure by resource extraction issuers that had to be filed using XBRL.  See Exchange Act Release No. 67717 (August 22, 2012).  The decision was not a new found interest in data tagging but a result of congressional command.  See Section 1504of Dodd Frank (“The rules issued under subparagraph (A) shall require that the information included in the annual report of a resource extraction issuer be submitted in an interactive data format.”).   Indeed, a contemporaneous rulemaking concerning conflict minerals did not provide that the newly created form would be tagged.     

Nonetheless, by 2013, much stronger evidence of a shift in the Commission’s position began to take shape. First, the agency announced, without notice and comment rulemaking, that Forms 13F would be required to be filed using an online form and filers would be required to “construct their Information Table according to the EDGAR XML Technical Specification.”   

Added impetus was provided by the recommendation of the SEC’s Investor Advisory Committee. In July 2013, the IAC recommended that the Commission adopt a “Culture of Smart Disclosure,” something designed to promote the “collection, standardization, and retrieval of data filed with the SEC using machine-readable data tagging formats.” The rule proposal that year for Regulation A+ and crowdfunding both include forms that would, if adopted, be tagged. Regulation AB likewise required the disclosure of certain information in a machine readable format.

Perhaps the most interesting addition was the speech by Mark Flannery, the recently appointed chief economist and director of DERA. See The Commission’s Production and Use of Structured Data, Data Transparency Coalition’s Fall Policy Conference, Washington, DC, Sept. 30, 2014. The talk emphasized the Commission’s commitment to making data “useable” by the public. See Id.  (“Making useable data available to the public is a key function of many of the Commission’s disclosure rules, and one of the strategies identified in the Commission’s Strategic Plan.”). 

He confirmed that the requirement of machine-readable formats for financial disclosures had become “a routine part of the rulemaking process.” Nothing was automatic. Future endeavors were to consider the appropriateness of tagging (“anticipating what information would be most useful to investors”), the proper format (“Deciding on the right data format involves many considerations, including the complexity of the financial information, need for validation of the reported elements, and the availability of pre-existing industry standards”) and the need to “avoid unnecessary implementation challenges.” 

The speech also discussed a sore spot with respect to structured data, particularly in connection with financial statements: data quality. As the speech pointed out: “Unnecessarily high usage of custom tags by a filer can therefore impair certain financial analyses,” also noting that the “Commission staff is aware" of the issue. Indeed, the speech noted that DERA would continue, “where appropriate,” to “work closely with the Division of Corporation Finance to provide guidance to filers based on these observations.” This looked to be a warning that the DERA/CorpFin partnership could yield additional letters like the CFO Letter concerning XBRL deficiencies, issued in July 2014. 

The speech also set out in specific terms what could be expected from the Agency:   

  • Hence, expect to see more staff observations and updates of filer practices posted on the SEC website.  DERA staff will continue its outreach to corporate filers through seminars, webinars, conferences, and other educational programs. DERA staff are also exploring ways to make aggregated XBRL data available to investors and financial researchers so that they can more easily access and analyze the financial information reported through XBRL submissions. 

The speech, therefore, suggests significant progress toward the goals of increasing the use of structured data and ensuring the quality of the data received by the SEC. The partnership between DERA and CorpFin will provide additional impetus for progress and will reduce the concern that decisions are made in a silo. It is strong movement in the right direction.


SEC v. Cole: Failure to Cooperate with Court Orders

In SEC v. Cole, No. 12-cv-8167 (RJS), 2014 BL 263123 (S.D.N.Y. Sept. 22, 2014), the United States District Court for the Southern District of New York granted the Securities and Exchange Commission’s (“SEC”) motion for relief against Defendants Lee Cole and Linden Boyne (“Defendants”).

The SEC alleged that Defendants, among other things, “lied to the investing public” and “secretly funnel[ed] millions of shares” to certain entities they controlled. Their actions were alleged to have violated several Sections of the Securities Act of 1933 and the Securities Exchange Act of 1934. 

The court entered default judgment against Defendants for failure to comply with five court orders. Notably, Defendants failed to: appear for a deposition, respond to sanctions, or make an appearance during the motion for default judgment. Hence, on November 8, 2013, the court entered default judgment against Defendants.

Unless vacated, a default judgment is deemed “final.” The factual allegations in the complaint are treated as true “except those relating to damages.” Following the determination, the SEC filed a motion seeking (1)  disgorgement, (2) civil penalties, (3) permanent injunctions, (4) a bar from serving as officers or directors of any public company, and (5) a bar from participating in any activities involving the offer of penny stocks.

First, the SEC requested Defendants to disgorge their “ill-gotten gains” and pay prejudgment interest on any monies they had illegally obtained. The court applied a two-part burden-shifting framework to determine the amount of disgorgement. First, the SEC had to show that its calculations were reasonably calculated to the amount of Defendants’ unjust gains. The burden of proof then shifted to the Defendants to show that the SEC’s estimates were “inaccurate, or that some of the gains were not the result of wrongdoing.” Defendants were unable to refute the SEC’s proposed disgorgement figures. Thus, the court found Defendants jointly and severally liable for a total of $14,670,750.99.

Second, the SEC argued that each Defendant should pay civil penalties. Courts may impose civil fines on Defendants for violations of 15 U.S.C. §§ 77t(d)(2) (the Securities Act) and 78u(d)(3)(B) (the Exchange Act). These statutes impose a tiered system of penalties. As the court noted:  “The egregiousness of their conduct and lack of cooperation with the Court warrant a severe third-tier civil penalty.” Thus, the court imposed $7,500,000 in civil penalties for each Defendant.

Third, the SEC sought to permanently enjoin Defendants from (1) violating the securities laws, (2) serving as officers or directors of any public company, and (3) participating in any activities involving the offer of penny stocks.

To enjoin Defendants from violating the securities laws, a court considers whether the defendant has violated the securities laws and there is a “reasonable likelihood that the wrong will be repeated.” Given the lack of care Defendants used, even after the SEC brought its allegations, the court found a permanent injunction was appropriate. 

Fourth, the SEC sought an officer and director bar. To prohibit Defendants from serving as officers or directors of any public company, the court must consider: “(1) the egregiousness of the underlying securities law violation; (2) the defendant’s repeat offender status; (3) the defendant’s role or position when he engaged in the fraud; (4) the defendant’s degree of scienter; (5) the defendant’s economic stake in the violation; and (6) the likelihood that misconduct will recur.” Here, the court determined Defendants' actions required a complete bar.

Fifth, the SEC sought a penny stock bar. The court’s analysis to merit a penny stock bar “essentially mirrors that for imposing an officer-or-director bar.” Therefore, the court also enjoined Defendants from participating in any activities involving penny stocks.

Accordingly, the United States District Court for the Southern District of New York granted the SEC’s motion for penalties and remedies in its entirety.

The primary materials for this case may be found on the DU Corporate Governance website. 


The Shareholder Protection Act of 2013: Another Invisible Initiative

This post is in continuation of a series of posts that address rulemaking and shareholder disclosure after Citizens United.

On April 25, 2013, Congressman Michael E. Capauano re-introduced the Shareholder Protection Act of 2013, H.R. 1734, (“Act”) to the United States House of Representatives, which would amend the Exchange Act to require: (1) a majority vote of shareholder authorization prior to corporate political expenditures; (2) a Board of Directors vote authorizing any expenditure over $50,000; and, (3) a quarterly disclosure of the corporate expenditures to the shareholders, the Securities and Exchange Commission (“SEC”), and the public, with significant expenditures being disclosed on-line within 48 hours.

Congressman Capuano first filed the Act in 2010 in response to the then recent Supreme Court opinion in Citizens United v. Federal Elections Commission, 558 U.S. 310 (2010). The Court noted that “Government may regulate corporate political speech through disclaimer and disclosure requirements” and that today’s advanced technology would allow prompt disclosure to shareholders and the public. Prompt disclosure, in turn, would facilitate the exercise of control over the expenditures by shareholders.

With the advent of the Internet, prompt disclosure of expenditures can provide shareholders and citizens with the information needed to hold corporations and elected officials accountable for their positions. Shareholders can determine whether their corporation’s political speech advances the corporation’s interest in making profits, and citizens can see whether elected officials are “ ‘in the pocket’ of so-called moneyed interests.” Disclosure would, therefore, provide transparency and facilitate accountability to shareholders. 

According to a press release, Congressman Capuano supported the Act because he believed the decision in Citizens United gave corporations an “outsized voice in the political process.” Senator Robert Menendez also supported the Act, stating “[e]nough is enough. Individual citizens should determine the outcome of our elections, not multi-billion-dollar corporate interests, or worse, a foreign government, so it’s time we pass this legislation to give shareholders a voice over how their corporate dollars are spent on elections.” Thirty-six House Representatives, comprised entirely of Democrats, co-sponsored the Act. 

In addition to congressional support, a coalition letter was submitted, expressing concern not only for shareholders and the public, but also for the electoral system. The letter noted that unregulated corporate political spending would foster more negative attack ads, compounding the present public cynicism associated with elections. 

Although the Act was referred to the House Committee on Financial Services (“Committee”) the same day it was introduced, the Committee has not proceeded with the Act. At this juncture, it seems highly unlikely that Congress will enact the Act. In fact, govtrack.us gives it a 0% chance of being enacted. 


Securities and Exchange Commission v. Braverman 

On September 16, 2014, the Securities and Exchange Commission (“SEC”) charged Dmitry Braverman, an employee in an IT department of an international law firm, with insider trading. The SEC alleged that Braverman violated Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5, Section 14(e) of the Exchange Act, and Rule 14e-3 by using nonpublic information to obtain more than $300,000 in unlawful profits.

Braverman’s insider trading allegedly began in 2010 when he used nonpublic information to purchase stock in accounts in his own name. After charges were filed against a lawyer at his same firm for insider trading, Braverman allegedly liquidated the stock purchased on the basis of the inside information. After waiting 18 months, he was alleged to have resumed trading through an account in the name of a Russian relative. The account originally used an email address employed by Braverman on earlier accounts. Braverman, however, changed the address to one that contained the first name of the Russian relative. The relative is named as a relief defendant for purposes of seizing the illegally obtained profits held in the account under his name.

The U.S. Attorney’s Office for the Southern District of New York also brought criminal charges against Braverman related to the matter.  

The primary materials for this case, including the complaint filed by the SEC, may be found on the DU Corporate Governance website.


The Consequences of FEF v. PCAOB

After the adoption of Sarbanes Oxley, which created the PCAOB, a rigorous constitutional challenge to the PCAOB emerged. 

The main line of attack was the novel structure of the governance of the body.  Members to the PCAOB were appointed by the SEC for a term of five years and could only be removed by the SEC for cause.  Because SEC commissioners could also only be removed for cause (a limitation on removal that is not in the statute but is conventional wisdom), the structure provided a significant barrier to influence by the President in the appointment and removal of members of the PCAOB. 

On that basis, the "for cause" restriction on removal was struck down.  PCAOB members became at will appointees who could be removed by the Commission at any time with or without cause.  The Supreme Court decision and assorted filings/briefs can be found at the DU Corporate Governance web site.  As such, the independence of the body was reduced and the control by the Commission (particularly the Office of the Chief Accountant) was significantly enhanced. 

From an administrative perspective, the decision was a poor one.  It restricted an approach to government regulation that sought to increase private sector sensitivities while both avoiding capture by the industry subject to regulation and minimizing the direct role of the bureaucracy.  The PCAOB was structured as a non-profit that was not subject to many of the bureaucratic restrictions on activities (including limits on compensation).  This allowed the body to have a closer connection to the private sector.  At the same time, however, the governance structure was not controlled by industry (minimizing the risk of capture) but by the SEC.  By limiting removal to cause (with cause defined in part as the failure to enforce its own rules), however, the PCAOB also retained independence from the SEC and could therefore avoid some of the problems associated with government bureaucracies. 

The Supreme Court's decision to strike down the limitation on removal of PCAOB members changed all of that.  The efforts by Congress to thread the gap between the Scylla of industry capture and the Charybdis of excessive bureaucratic oversight was disrupted.  While the PCAOB remains in place, Congress is less likely to use this model of governance in other circumstances.  With SEC control enhanced, there is little reason (other than funding) to not simply include this type of oversight directly in the relevant regulatory body, eliminating all pretenses of private sector influence.

All of this brings us to a more recent consequence of the decision.  It turns out that in our federal system of government, there are other instances of the persons subject to a double "for cause" removal limitation.  This is apparently the case with respect to the appointment of administrative law judges.  According to a recent law suit, ALJs at the SEC can only be removed "for cause."  The law suit, therefore, challenges the constitutionality of these decision makers.  For the time being, we offer no views on the case except to say that but for the Supreme Court's decision with respect to the PCAOB, this suit would likely not have been brought.    


The Recommendations of the SEC's Investment Advisory Committee

The SEC's Investor Advisory Committee met in the first half of October and made two recommendations. The link to the IAC's page was on the home page of the SEC's site but has since been removed from that prominent location. But the site can be found here.  

One recommendation concerned the definition of accredited investor. The SEC was instructed in Dodd-Frank to study the definition to determine appropriate reforms. The definition for individuals focuses on income and net worth but contains thresholds that have not changed since 1982. The definition does not screen for actual sophistication (based upon education or experience).

The other recommendation concerned the impartiality of brokers in the proxy process with respect to the disclosure of interim voting data. Brokers are obligated to forward materials to beneficial owners, including voting instructions. Brokers (and their agent, Broadridge) are exempt from the proxy rules for forwarding the materials as long as the task is undertaken in an impartial fashion. The practice has arisen, however, whereby voting data is collected and, on an interim basis, sometimes given to only one side in a contest over a matter submitted to shareholders. The recommendation calls for the application of the concept of impartiality to the disclosure of interim voting information. 


Commercial Banks, the Securities Markets, and the Need for Glass Steagall: The OIG Report on the Supervision of JP Morgan

The OIG at the Fed just issued a report on the Fed's oversight of JP Morgan Chase in connection with the London Whale incident in 2012. A summary of the report is here

The report made findings that the Fed's oversight was inadequate. Interestingly, the report noted that the FRB New York was aware of the risks posed by the trading in London but did not share the concerns with the OCC or conduct its own inspections of the London operations. As the report noted: 

  • We acknowledge that FRB New York's competing supervisory priorities and limited resources contributed to the Reserve Bank not conducting these examinations. We believe that these practical limitations should have increased FRB New York's urgency to initiate conversations with the OCC concerning the purpose and rationale for the planned or recommended examinations related to the CIO. Even if FRB New York had either initiated conversations with the OCC to discuss the planned or recommended examinations in accordance with SR Letter 08-9 or conducted the planned or recommended activities, we cannot predict whether completing any of those examinations would have resulted in an examination team detecting the specific control weaknesses that contributed to the CIO losses.

The report also found that the Fed and OCC staff "lacked a common understanding of the Federal Reserve's approach for examining Edge Act corporations" and that "FRB New York staff were not clear about the expected deliverables resulting from continuous monitoring activities." Finally, the report concluded that "FRB New York's JPMC supervisory teams appeared to exhibit key-person dependencies."   

So what were the recommendations? There were 10. Some of them went to better coordination among banking agencies. Mostly, though, the recommendations focused on improvements in the inspection process. These included: the issuance of "guidance detailing expectations for documenting and approving the deliverables of continuous monitoring activities, tracking identified issues, and performing follow-up activities," the mitigation of "key-person dependency," and the hiring of "additional supervisory personnel with market risk and modeling expertise."   

The Report will likely result in more intense inspections of commercial banks (the section on the response to recommendations indicated little patience by the FRB New York with the recommendations),  particularly with respect to activities in the securities markets. That in turn will likely result in banks becoming more risk averse. Risk aversion is good for commercial banking but bad for the securities markets.

Prior to the repeal of Glass Steagall, increased risk aversion among commercial banks would have had little impact on the securities markets. The securities markets were dominated by a class of investment banks that could not engage in commercial banking (and visa versa) and were therefore outside the scope of oversight of bank regulators. With the repeal of Glass Steagall, though, the commercial banks have ousted the independent investment banks, a dynamic that was eminently predictable. See The "Great Fall": The Consequences of Repealing the Glass-Steagall. With the demise of Lehman, the acquisition of Merrill and Bear Stearns by commercial banks, and the conversion of Morgan Stanley and Goldman, there are no more large investment banks that fall outside the oversight of bank regulators.

The securities markets are about risk taking. Limitations on risk taking in turn hurts the securities markets. Regulatory oversight of commercial banks seeks to reduce risk taking. This has the potential to impose long term harm on United States capital markets.   


Delaware and the Myopic Nature of a "Neutral" Board: In re KKR Financial Holdings

The business judgment rule represents an over-inclusive protection designed to protect risk taking by directors. Boards know that even if they take risks that in hindsight prove to be mistaken and harmful, they will escape liability. The presumption is not, however, designed to protect decisions arguably motivated by a conflict of interest. The judicial erosion of fiduciary duties by the Delaware courts was on display in In re KKR Financial Holdings.   

In that case, KKR formed KKR Financial Corp., a Maryland real estate investment trust. The "primary asset [of KFN] was a portfolio of subordinated notes in collateralized loan transactions that financed the leveraged buyout activities of KKR." The duties of KKR Financial were ultimately assumed by KFN. KFN in turn assigned the day to day management duties to KKR Financial Advisors LLC. KKR, however, owned less than 1% of the shares of KFN. Moreover, the operating agreement for KFN provided that "the business and affairs of [KFN] shall be managed by or under the direction of its Board of Directors." The board of KFN contained 12 directors, two of whom were described as "high-level KKR employees".    

Ultimately, KKR sought to purchase KFN. The board formed a "transaction committee" After back and forth negotiations, the committee recommended approval of the merger. The board met and, with the two "high level KKR employees" excluded, voted to approve the merger.   

Plaintiffs challenged the transaction and argued that KKR "controlled" KFN. As a result, the applicable standard of review should be entire fairness. In rejecting that assertion, the court had this to say:  

  • In my opinion, the allegations of the complaint do not support a reasonable inference that KKR was a controlling stockholder of KFN within the meaning of this Court’s precedents. Although these allegations demonstrate that KKR, through its affiliate, managed the day-to-day operations of KFN, they do not support a reasonable inference that KKR controlled the KFN board—which is the operative question under Delaware law—such that the directors of KFN could not freely exercise their judgment in determining whether or not to approve and recommend to the stockholders a merger with KKR.

The analysis was no surprise. While REITS are typically dependent upon their advisor, KFN carefully preserved the legal authority of the board to oversee the activities of the advisor. Moreover, with less than 1% of the shares, KKR did not have the ability to legally control the board.

What the court ignored, however, was the presence of a potential conflict of interest within the board room.  The board of KFN excluded from approval of the merger the two KKR employees. Nonetheless, the court noted that, based upon plaintiff’s allegations, it was “reasonably conceivable that two other directors . . . would not be found independent of KKR.” One had “longstanding ties to KKR and, among other things, served as a Senior Advisor to KKR and as Chairman of KKR affiliate . . . at the time of the merger.” The other was the dean of a business school “which recently received a $100 million donation from KKR co-founder Kravis, an alumnus.” 

The court went on to determine whether a majority of the board lacked independence and concluded that it did not.  As the court determined:  “I conclude that plaintiffs have failed to allege facts that support a reasonable inference that eight of the twelve KFN directors, constituting eight of the ten who voted on the transaction, were not independent from KKR. Thus, plaintiffs have failed to rebut the presumption that the business judgment rule applies to the KFN board’s decision to approve the merger.”

In other words, as has been discussed before (see Returning Fairness to Executive Compensation) the Delaware courts have created the fiction that boards with a majority of independent directors essentially expunge the taint of any conflict that arises from the presence of directors who are interested or lacking in independence. Having expunged the taint, the applicable standard becomes the all but impenetrable duty of care and the business judgment rule. 

The approach is inconsistent with the theory behind the business judgment rule. As discussed in Returning Fairness:

  • The business judgment rule represents an over-inclusive protection designed to protect risk taking by directors. Boards know that even if they take risks that prove in hindsight to be mistaken and harmful, they will escape liability. The presumption is not, however, designed to protect decisions motivated by a conflict of interest. 

Where potential conflicts of interest exist in the decision making process, which is when there are directors participating in the debate and voting on the final resolution who are arguably interested or not independent, the application of the business judgment rule and a presumption of fairness is inappropriate. In those circumstances, the presumption may be protecting risk taking or it may be protecting a decision influenced or motivated by the interests of the directors allegedly lacking in independence. 

Yet in Delaware that ship has sailed. It is so well established that boards get the presumption of the business judgment rule so long as they have a majority of disinterested and independent directors that the matter was not even discussed in In re KKR


SEC Commissioner Once Again Bemoans Conflict Minerals Disclosure Mandate

From the moment the SEC was charged with drafting disclosure regulations to implement Dodd-Frank Section 1502 (the conflict minerals provision) members of the agency have voiced their unhappiness with being handed the task.  At a recent speech at Fordham University School of Law SEC Commissioner Gallagher once again bemoaned the mandate, along with others.

  • To be blunt, many, if not most, of the 100 mandates imposed upon the Commission by the Dodd-Frank Act do not by any measure represent the best use of the Commission’s time and resources.  Most obviously, whether one views the SEC as a disclosure agency or an enforcement agency, sociopolitical issues such as conflict minerals and extractive resources, while perhaps worthy of attention by the right entities, should not be part of the SEC’s agenda.  Rulemakings for such issues contribute neither to the maintenance of fair, orderly, and efficient markets, nor the facilitation of capital formation, nor investor protection.  They are the creations of special interest groups every bit as strong as K Street lobbyists, and they severely sap the finite bandwidth of the SEC.  As Chair White rightfully noted in this very same venue last year, “[T]he independence of the agency . . . should be respected by those outside, including the industry, other agencies, Congress and the courts.  That independence – and the agency’s unique expertise – should be, for example, respected by those who seek to effectuate social policy or political change through the SEC’s powers of mandatory disclosure.”

Commissioner Gallagher suggests that “[c]ritics of the SEC should focus their attention on whether the SEC is tasked with the right duties.”  But is isn’t criticism of the SEC that leads many, myself included, to argue that conflict minerals disclosure should not be regulated by that agency.  As noted by Commissioner Gallagher “the SEC faces a crushing burden of Congressional mandates that will interfere with our blocking-and-tackling work for years to come if we let them….“Why isn’t there more scrutiny of how we spend our time?”

The real question is one of allocational efficiency and agency competency.  Why do all the vast majority of disclosure regulations seeming automatically get placed on the SEC’s agenda?  It is certainly true that the agency has strong competencies in the disclosure realm—but only when such disclosures pertain to its core mission—that of maintaining free and fair markets.  Social and political issues are not with the purview of the SEC and they are not the best suited to regulate them—despite constant pressure on the agency to do so—pressure that is currently being strongly exerted in the area of corporate political spending. 

Commissioner Gallagher proposes some solutions to the problem of overburdening the SEC.

  • First, we need to affirmatively engage Congress and the Administration and work with them to remove the useless or counterproductive elements of the Dodd-Frank Act.  The emphasis is on affirmatively engaging – we cannot remain passive observers, speaking only when spoken to by policymakers, and expect to succeed in reforming Dodd-Frank.  Second, we need to become a savvier agency – specifically, an agency that serves as an efficient overseer of the capital markets and an aggregator and analyzer of critical market information through the better use of technology.  Finally, we need to affirmatively engage other regulators and relevant policymakers in the critical policy debates of the day – and for that matter, of the past five years.  I have been doing so since the beginning of my term and have found that most stakeholders are receptive to our participation in such debates.  We can learn from their perspective, and they from ours.

These are not radical suggestions—but if the convolute history of the conflict minerals rule is any indication, they are not likely to come to fruition any time soon.


Fee Shifting Bylaws: Strougo v. Hollander (Part 2)

The complaint sets out the text of the bylaw adopted by First Aviation that is being challenged in Strougo v. Hollander. The bylaw provides: 

  • Section VII.8. Expenses for Certain Actions. In the event that (i) any current or prior stockholder or anyone on their behalf (collectively a “Claiming Party”) initiates or asserts and (sic) claim or counterclaim (collectively a “Claim”), or joins, offers substantial assistance to or has a direct financial interest in any Claim against the Corporation or any director, officer, assistant officer or other employee of the Corporation, and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party has a direct financial interest) does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the Corporation and any such director, officer, assistant officer or employee for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) that the parties may incur in connection with such Claim. 

The bylaw is relatively typical. It applies to any current or prior shareholder and anyone acting on their behalf. The bylaw also requires a shifting in any claim or counterclaim and is not limited to derivative actions. Finally, the bylaw provides for a shifting of fees unless the plaintiff obtains a judgment on the merits that "substantially achieves" the full remedy sought (something described by the plaintiffs as an "impossibly high standard of success").    

Primary materials, including the complaint, can be found at the DU Corporate Governance website.


Fee Shifting Bylaws: Strougo v. Hollander (Part 1)

As the Delaware legislature continues to remain inactive with respect to fee shifting bylaws, the next move looks to come from the courts. 

The case where this is currently most likely to occur is Strougo v. Hollander. The complaint in the case alleged a breach of fiduciary duty arising out of a reverse stock split. The transaction was announced on May 16, 2014. According to the complaint, the transaction was consummated on May 30, 2014 and a fee shifting bylaw adopted on June 3, 2014. As the complaint states:

  • Bylaw VII.8 was adopted on June 3, 2014, following the announcement of the Transaction, to deter stockholders such as Plaintiff from pursuing litigation challenging the Transaction. The Bylaw imposes an obligation on Plaintiff to pay “for all fees, costs, and expenses of every kind and description” incurred by defendants if Plaintiff fails to “obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.” First Aviation Bylaws VII.8.  

Because the company is not public (it deregistered as a public company in 2007), there is no obligation to make bylaws or changes in the bylaws public. See Item 5.03 of Form 8-K (requiring amendments to bylaws to be filed within four business days). As a result, shareholders alleged that they were unaware of the bylaw until after a suit challenging the fairness of the stock split was filed.  

Again, according to the complaint:    

  • No public announcement has been made notifying First Aviation stockholders about the existence of a fee-shifting provision, nor has the text of the Bylaw been made publicly available to First Aviation’s stockholders. Plaintiff’s counsel was only allowed access to the text of the Bylaw after Plaintiff caused formal discovery requests to be served on defendants. . . . Plaintiff discovered the existence of the Bylaw shortly after filing this action, when counsel for defendants contacted Plaintiff’s counsel and announced that the Board had adopted a fee-shifting provision.

The complaint also alleges that the bylaw "was adopted to discourage litigation challenging the Transaction." Or as the complaint provides: 

  • It is obvious from the timing of this Bylaw that it was adopted with the goal of stifling litigation arising out of the Transaction. The Bylaw was enacted on June 3, 2014, mere weeks after First Aviation publicly announced the Transaction in a press release on May 16, 2014. Further, it is entirely possible that the Bylaw was adopted after Plaintiff spoke with a member of the Board and expressed his discontent over the Transaction. The Bylaw was not voted upon by First Aviation stockholders. In fact, it was never even publicly announced to First Aviation stockholders. Plaintiff only learned of the Bylaw when defense counsel threatened Plaintiff’s counsel with the Bylaw after Plaintiff filed the instant action. Plaintiff and his counsel were only able to obtain a copy of the Bylaw after serving a formal discovery request on Defendants and their counsel.

The timing of the bylaw may affect the analysis. In Kastis, it was clear that the timing of the bylaw mattered (although the bylaw was adopted after litigation commenced). To the extent that the court does take into account the close proximity of the bylaw to the challenged transaction, the effect will be to encourage even more companies to adopt fee shifting bylaws. They will know that for litigation purposes its better to have them in place as a prophylactic, well before any possible decision or transaction that can be challenged.    

Primary materials, including the complaint, can be found at the DU Corporate Governance website.


Cost of Compliance with SEC Conflict Minerals Rule High—Even If Not As High As Feared

According to a survey recently issued by Tulane University's Payson Center for International Development, issuers spent more than $700 million to comply with Dodd-Frank Section 1502 and the SEC's conflict minerals rule promulgated thereunder. The survey was based on responses from 112 of the 1,300 issuers that filed Form SD (the form on which conflict minerals disclosures must be made). These costs break down as follows: 

Total compliance cost for issuers

•The total aggregated and extrapolated expenses of the 1,300 issuers to comply with Dodd-Frank Section 1502 was $709.7 million by June 2014.

•Thus, on average, an issuer expended $545,962 to comply with the law.

$ value

A. Internal company time


B. Non-IT related external resources


C. IT gap / needs analysis


D. IT project element supporting conflict minerals traceability processes and reporting


E. Independent Private Sector Audit (IPSA)


Total  $709,751,142


These numbers are interesting as it appears that despite the allegation made in the original suit challenge the SEC’s conflict minerals rule that the agency failed to conduct an appropriate cost-benefit analysis, the SEC actually came quite close—far closer than Tulane’s original estimate. At the time of original prognosticating, Tulane assessed the costs of implementation to be approximately $7.93 billion—more than one hundred times greater than the estimate prepared by the SEC of $71.2 million (the lowest estimate was $387 million). Why such a differential in the original cost estimates and the final actual costs? In part, it might be explained by the fact that many issuers simply stated their products were “DRC conflict undeterminable” or it may be that the SEC was just right. Regardless, it cannot be denied that the aggregate cost is large—and of questionable impact.

The survey also asked issuers whether they would like to see any changes made to either Section 1502 or the conflict minerals rule to which 65% said yes, 4% said no and 31% had no comment. Included in the changes issuers would like to see are: 


stipulate a de minimis exemption

clarify rule

focus on importation of 3TG

render disclosure voluntary

offer supply chain degree threshold exemption

extend indeterminable period

provide information on and certify SORs

align with the EU proposed legislation

promote standard process and systems across industry

remove audit requirements

expand scope to include diamonds

remove mandatory disclosure 

Given that the conflict minerals rule is still under challenge it is possible that some of the items on issuers’ wish lists will be met. It is not likely however that most of them will as the only portion of the rule not upheld was the requirement to label products as being “non-conflict free.”


Comment Letters in Favor of the Proposed Rule Mandating Disclosure of Corporate Political Spending

We are discussing possible Rulemaking Regarding Mandated Disclosure of Corporate Political Spending.

In August of 2011 the Committee on Disclosure of Corporate Political Spending (“Committee”) submitted a Petition for Rulemaking (“petition”) to the Securities and Exchange Commission (“SEC”) (the petition is available here). The petition sought rulemaking to require public companies to disclose to shareholders the use of corporate resources for political activities. The Committee’s petition focused on four justifications for the proposed rule: first, in response to changes in investor interests and needs, the SEC’s disclosure rules have evolved over time; second, data shows that public investors have become increasingly interested in receiving information about corporate political spending; third, a large number of public companies have voluntarily adopted policies requiring disclosure of political spending; and fourth, the importance of disclosing political spending for promoting corporate accountability. The petition concluded with preliminary comments about the design of the proposed disclosure rules. 

In response to the Committee’s proposal, the SEC received over one million comment letters, most of which were in favor the proposed rule. One such letter was written on behalf of the American Federation of Labor and Congress of Industrial Organizations (“AFL-CIO”) (the letter is available here). AFL-CIO pointed to the fact that, under the federal Labor-Management Reporting and Disclosure Act, the AFL-CIO, its affiliated unions, and thousands of their state and local affiliates are required to produce itemized reports disclosing political spending on an annual basis. In addition, federal and state lobbying laws require a certain measure of public disclosure regarding corporate and union spending on lobbying, additionally federal, state, and local campaign finance laws generally require certain categories of political spending to be disclosed by unions and businesses. On the other hand, despite the “critical importance” to shareholders and corporate accountability in general, AFL-CIO pointed out that “[n]o law requires corporations to disclose to their shareholders whether corporate funds have been spent in connection with candidate elections, ballot measures or direct or grassroots lobbying, or donated to other organizations that use those funds for any of those purposes.”

Moreover, AFL-CIO stated that without a rule mandating disclosure, there is a loss of accountability and an inherent risk to shareholders. This is because “[s]enior management and directors may allow their personal political preferences to motivate and influence decisions on corporate political spending, with inadequate regard for their obligations to shareholders and the company’s own success.” Furthermore, shareholders do not have the resources to access information about corporate political spending decisions on their own. AFL-CIO also asserted that the “absence of a uniform and comprehensive disclosure requirement may mislead shareholders about their companies’ political expenditures.” 

AFL-CIO also discussed the Citizens United decision and how it impels the need for prompt disclosure. In Citizens United the Supreme Court eliminated restrictions on independent expenditures by corporations in political campaigns. By doing so, AFL-CIO argued, corporate political spending has predictably increased, which in turn creates an even greater need for disclosure.

AFL-CIO concluded with a discussion of the possible scope of disclosure that should be required. Due to the need for shareholders to have a complete picture of political spending by public companies, AFL-CIO suggested that, in addition to what is already subject to public reporting, the SEC should consider requiring: (1) companies to report their voluntary donations to other entities that engage in political and lobbying activities under certain IRC and IRS provisions (specifically, AFL-CIO pointed to IRC Sections 501(c)(4) and c(6), and IRS Section 527); (2) companies to report their grassroots and direct lobbying spending, whether or not they are subject to disclosure under federal or state lobbying laws; and (3) companies to report all other payments to other entities and individuals that are earmarked for any of these purposes.  

Another letter in support of the proposed rule mandating disclosure of corporate political spending was sent on behalf of the International Brotherhood of Teamsters (“BT”) (the letter is available here). Like AFL-CIO, BT pointed to the need for unified disclosure, and to the fact that there is no federal system that requires political disclosure for publicly traded corporations. However, BT also discussed the tangible and significant financial impact of increased corporate political spending on investors. It asserted that the lack of federal disclosure requirements “leaves investors with few options for determining if a corporation is even adhering to its own self-imposed rules in the first place.” For example, despite FedEx’s “company policy” not to make corporate contributions to groups organized under Section 527 of the Internal Revenue Code with a few exceptions—a policy that was reiterated in a recent proxy statement opposing a shareholder proposal to require disclosure of all political spending—FedEx “made contributions to at least three additional § 527 organizations between 2011 and 2013, totaling $63,400.” Absent disclosure requirements, shareholders are misled and prevented from taking any corrective action when this type of conduct occurs. BT stated that “[i]nvestors should not have to wait for fallout from poor political or advocacy investments in order to hold their corporate governors accountable. They should have the tools to make these investment decisions from the outset.”

BT also proposed that, in order to “effectively identify the business vulnerabilities created by political spending, strong disclosure should be required across all fronts of corporate political activities.” Just as AFL-CIO suggested, BT recommended that disclosure policies include not only direct political spending, “but all issue-based lobbying undertaken on a corporation’s behalf.” Additionally, it requested that the SEC “specifically consider requiring public companies to report their voluntary donations to all other entities that engage in political and lobbying activities under IRC Sections 501(c)4 and c(6), as well as under IRC Section 527, which covers all ‘political organizations’ regardless of how and whether they otherwise register or report their activities.” Finally, BT noted, just like AFL-CIO, the increased need for disclosure requirements post Citizens United


Opposition to Proposed Rulemaking Regarding Mandated Disclosure of Corporate Political Spending

We are discussing possible Rulemaking Regarding Mandated Disclosure of Corporate Political Spending

On August 3, 2011, the Committee on Disclosure of Corporate Political Spending, comprised of ten academics focusing their careers on corporate and securities law issues, called on the SEC to adopt rules requiring public companies to disclose corporate political spending (petition available here). Despite the overwhelming support of the rule, no action has been taken in over three years. According to Bloomberg, on September 4, 2014, the Corporate Reform Coalition renewed the call to the SEC to engage in rulemaking on the matter.  

While the SEC has received over one million comment letters in support of the rule, there are some who stand firm in their support of corporate personhood. Many organizations, including the National Mining Association, the Small Business and Entrepreneurship Counsel, and the Aircraft Owners and Pilots Association, came together to submit one comment letter opposing the rule. Likewise, the American Petroleum Industry (“API”), “the largest trade association for the oil and gas industry in the United States,” has submitted a comment letter expressing opposition to the rule.

The organizations submitting the joint comment letter claim that the rule has no direct impact on shareholder value. Specifically, they claim that fiduciary obligations require corporations to speak out against government policies that could impact the company financially. Like individuals, corporations engage in political activity in order to protect their interests. The disclosure is immaterial, the organizations claim, because it would allow corporations to be attacked for acting in the best interests of shareholders through political contributions. Likewise, these organizations assert that the disclosure is immaterial such that the SEC has no authority to mandate such disclosure.

The organizations also claim that the cost of compliance is significant for both corporations and investors. The disclosures are likely to be used to attack the companies and pressure them to stop engaging in political spending, even where such spending is in support of policies that will benefit the company in the future. The organizations claim that the rule would violate the First Amendment by curtailing corporation’s freedom of speech as recognized by the Supreme Court in Citizens United v. Fed. Election Comm'n, 558 U.S. 310 (2010). API agrees with this position, arguing that shareholders have the right to engage in corporate governance through shareholder proposals. It states that while this right should not be curtailed, mandating disclosure of corporate political activity is entirely at odds with the holding of Citizens United.

The API letter claims that mandated disclosure of corporate political spending is “neither necessary nor desirable and would burden corporations without benefiting shareholders.” In support of its claim that the rule is unnecessary, API discusses the adequacy of existing political spending disclosure requirements. For example, the Federal Election Commission (“FEC”) requires that any “independent expenditure” or “electioneering communication” by a corporation be disclosed to the FEC and subsequently posted on the Internet. Further, all states require some sort of disclosure of corporate political contributions, and many states impose limits on such contributions. Therefore, SEC regulations regarding corporate political spending would be duplicative.

In addition, API expressed concern with the complexity of such disclosure, including the petition’s silence as to what constitutes corporate political spending. If the definition of political spending includes contributions to trade associations, such associations may be subject to “political or economic retaliation for expenditures unrelated to political activity.”

API further maintained the position that adoption of such a rule was premature considering the Shareholder Protection Act, which would have required shareholder approval for political spending, was on the floor of both the Unites States House of Representatives and the Senate.

In sum, many corporations argue that they will be negatively impacted by the adoption of a rule requiring disclosure of corporate political spending. Not only would such a rule curtail freedom of speech, they argue, but it would also impose unnecessary burdens that would discourage companies from advancing governmental policies that would enhance profit-making capabilities—which benefits shareholders. Further, they argue, corporate political spending is already regulated such that any additional rulemaking by the SEC is unnecessary and duplicative.


SEC Rulemaking: Mandatory Corporate Political Expenditure Disclosures Are Invisible

On August 3, 2011, the Committee on Disclosure of Corporate Political Spending, composed of academics, submitted a petition to the Securities and Exchange Commission (“SEC” or “Commission”) requesting that the Commission develop rules requiring public companies to disclose corporate political expenditures. The petition suggested that through required political expenditure disclosures, shareholders can “ ‘determine whether their corporation’s political speech advances the corporation’s interest in making profits,’ and discipline directors and executives who use corporate resources for speech that is inconsistent with shareholder interests.”

The issue with regulating corporate political spending arose after the Supreme Court issued its opinion in Citizens United v. Federal Elections Commission, 558 U.S. 310 (2010), which lifted restrictions on corporate political expenditure. The Court noted, however, that the “[g]overnment may regulate corporate political speech through disclaimer and disclosure requirements,” and that today’s advanced technology would allow prompt disclosure to shareholders and the public. Such disclosure would provide transparency for the electorate to make informed decisions as well as accountability to the shareholders with respect to whether the political expenditures are in the corporation’s best interests.

According to Bloomberg, the SEC has received over one million comments in support of the political spending disclosure rule. Most commentators to the petition have responded by emphasizing the utmost importance of public disclosure in carrying out the SEC’s mission to maintain fair markets and protect investors. Recent anonymous comments highlight the Court’s suggested government regulation through disclosure and requested the Commission to enact a political spending disclosure rule.

The Commission has yet to consider the political spending disclosure rule. The Commission did at one point indicate that a possible rule was on the Commission’s long term rulemaking agenda. The Commission, however, removed the subject from the rulemaking agenda a year later.

According to Reuters, SEC Chair Mary Jo White has not commented on the removal of the initiative from the long term agenda, but has expressed a general opposition to regulating companies in response to societal pressures. The SEC may also have removed the item due to possible uncertainty concerning rulemaking authority. Or the SEC may have removed the item because it felt the legislative branch was better equipped for amending the Exchange Act.