On February 2, 2010, the Securities and Exchange Commission (“SEC”) published an interpretive release (available at http://www.sec.gov/rules/interp/2010/33-9106.pdf) intended to provide guidance on certain existing disclosure rules that may require a company to disclose the impact that business or legal developments related to climate change may have on its business. The release states that it is not intended to create new disclosure obligations, but rather is designed to clarify already existing SEC disclosure rules that require public companies to describe impacts of climate change and climate change related issues.
SEC Deliberation
The interpretive release was approved by a narrow 3-2 vote; drawing dissent from Commissioners Kathleen Casey[1] and Troy Paredes.[2] Commissioner Casey expressed concern that, by issuing this interpretive release, the SEC was indirectly taking a position on the debate over global warming.[3] Commissioner Paredes, on the other hand, noted concern with the requirement that registrants take into account reputational damage resulting from climate change matters. In his opinion such a requirement would only “foster confusion and uncertainty about a company’s required disclosures.”[4] In an SEC press release, Chairman Mary Schapiro reiterated that the SEC has not taken a stance on the issue of global warming, and that this release is intended to assist public companies in satisfying their existing disclosure obligations as they apply to climate change.
An Overview of the SEC’s Guidance on Climate Change Related Disclosures
The interpretive release states that it is intended only to clarify already existing disclosure rules and prefaces the guidance with a lengthy description of existing legislative and regulatory developments related to climate change. The release then goes on to briefly discuss current disclosure rules under Regulation S-K that could require an issuer to discuss climate change matters, including: Item 101 (Description of Business); Item 103 (Legal Proceedings); Item 303 (Management’s Discussion and Analysis); and Item 503(c) (Risk Factors). The interpretive release follows with a discussion of four topic areas that may trigger climate change disclosures pursuant to these existing requirements.
1. Impact of legislation and regulation. The interpretive release states that public companies should disclose the effects of both existing and pending environmental legislation and regulation on their business.
2. International accords. Although the United States is not a signatory to the Kyoto Protocol, some American companies or their subsidiaries may operate in signatory countries. Registrants are advised to consider, and disclose the impact of international accords relating to climate change, to the extent material.
3. Indirect consequences of regulation or business trends. Legal, technological, political and scientific developments regarding climate change may create new opportunities or risks by either creating demand for new products or services, or reducing demand for existing products or services. Such trends or risks may require disclosure in the description of business, MD&A or risk factors. The SEC provides the following examples of developments for consideration by registrants:
4. Physical impacts of climate change. The fourth topic addressed by the release is the physical impact of climate change such as increased storm severity, rising sea levels, changes in arability of farmland, and changes in water availability and quality. The SEC provides the following as examples of these impacts:
Conclusion
The SEC emphasized that it was adopting this interpretive guidance to remind companies of their existing obligations to consider climate change and its consequences as they prepare disclosure documents to be filed. Although the SEC had been petitioned by advocacy groups to specifically require disclosure of an issuer’s “carbon footprint,” the SEC declined to adopt such a requirement. However, the SEC reminds issuers that such disclosure may be necessary, however, to the extent that it is material. The SEC also reminds registrants that where there is a close question as to materiality, registrants should decide in favor of those whom the regulation was designed to protect. Finally, the SEC reminds issuers that climate change regulation is a rapidly developing area and registrants need to regularly assess their potential disclosure obligations given new developments.
The SEC is planning to hold a public roundtable on disclosure regarding climate change matters in the Spring of 2010. The results of the roundtable will be used by the SEC in determining whether additional guidance or rulemaking is appropriate.
[1] Speech by SEC Commissioner: Statement at Open Meeting – Interpretive Release Regarding Disclosure of Climate Change Matters by Commissioner Kathleen L. Casey, dated January 27, 2010 (http://www.sec.gov/news/speech/2010/spch012710klc-climate.htm).
[2] Speech by SEC Commissioner: Statement at Open Meeting – Interpretive Release Regarding Disclosure of Climate Change Matters by Commissioner Troy A. Paredes, dated January 27, 2010 (http://www.sec.gov/news/speech/2010/spch012710tap-climate.htm).
[3] Commissioner Casey states, “this guidance assumes that man made global warming and climate change are occurring as a result of greenhouse gas emissions and are likely to result in physical effects that will affect the businesses of registrants.”
[4] Commissioner Paredes states, “reputational damage… can be quite speculative” and such a requirement will encourage disclosures “that are unlikely to improve investor decision making and may actually distract investors from focusing on more important information.”
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In accepting comments, the Commission heard from a wide array of constituencies. That is not particularly surprising. But what was noticeable was the firm divisions between constituencies, without much in the way of middle ground. It was not unlike the democratic and republican divide on health care.
This could be seen with respect to the proposals concerning disclosure of risks associated with compensation policies for employees. As the Commission noted: "Individual investors, trade unions, institutional investors and pension funds supported the proposals." And the opposition? "Most companies, law firms and bar groups opposed the proposal." It is not unlike access, where the same groups more or less stack up on opposite sides. The result? The Commission "consider[ed] the comments," promptly adopted the "disclosure requirement substantially as proposed with some modifications."
As we have noted, there is increased polarization at the Commission, with the recent guidance on climate change passing by a 3-2 vote. In the debate over corporate governance reform before the Securities and Exchange Commission, there likewise appears to be increased evidence of polarization.
The approach is short sighted. As we noted, the opposition to access ultimately succeeded in getting the Commission to ban access bylaws in December 2007. Access bylaws required a two step process for shareholders to elect directors to the board. First they had to prevail upon shareholders to pass the bylaw. Then, a year later, they could nominate directors but had to again prevail upon shareholders to support them. It was a slow cumbersome process that was likely to rarely result in the election of shareholder nominated directors. Indeed, three companies in 2007 voted on access bylaws and in two cases they failed (passing only at the relatively small company, Cryo-Cell). These instances are discussed in The SEC, Corporate Governance, and Shareholder Access to the Board Room.
The result of polarized opposition was that the membership of the Commission changed and an access proposal was quickly issued that would, if adopted, provide shareholders with the right to insert directly their nominees into the company's proxy statement. In other words, the two step process was eliminated for something much more blunt, and much more direct, than what has originally been proposed. While it will probably not have a material impact on board membership, the current access proposal will have far more than the access bylaw proposal.
Had there been a compromise on the access bylaw process, the Commission likely would not have made this current proposal. The polarization in the end is unfortunate. It entails a reduction in the consensus over the SEC's regulatory approach and leaves open the possibility that regulatory requirements will shift more dramatically each time regime change occurs at the Commission.
]]>Board diversity can be an important societal concern. It can also affect the decision making process. Greater diversity may result in a wider range of views that can be shared with the CEO and other officers in making important decisions. Some countries, such as Norway, have addressed the dearth of diversity (at least with respect to gender) through legal mandate. The country requires that boards of large public companies include at least 40% of each gender, effectively forcing companies to increase the number of women on the board.
Boards in the US are not particularly diverse. They consist of about 13% for women and about 11% for people of color.
As the issue grows in importance, the Commission has delved into the area in a tentative fashion. In suggesting the need to disclose these types of policies, commentators “noted that there appears to be a meaningful relationship between diverse boards and improved corporate financial performance, and that diverse board can help companies more effectively recruit talent and retain staff.”
Companies must now disclose whether and how the nominating committee “considers diversity in identifying nominees” for director. See Item 407(c)(2)(vi). The term was undefined but broadly construed.
The language has two problems. First, by specifically mentioning race, gender and national origin, it omits sexual orientation, even in the category of "expansive." Second, it suggests that diversity is an either/or situation. In fact, companies ought to be required to report their policies with respect to race and gender and have the option of reporting other policies as well.
In any event, this is a first for the Commission. It creates a disclosure requirement that puts the agency in the middle of the debate over board diversity. It will be the data disclosed as a result of this requirement that causes shareholders and investors to put pressure on boards to change the policy and take a more active approach in the diversification of boards.
For more on the SEC and its use of disclosure to affect the corporate governance process, see Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.
]]>One of the interesting changes in Exchange Act Release No. 61175 has been to the requirement that companies report the results of any matter voted upon by shareholders. The disclosure requirements were initially intended to fill a gap in state law. More recently, however, they became requirements designed to affect the tabulation process.
State law does not require companies to reveal the voting results of these meetings. See Exchange Act Release No. 4686 (March 17, 1952)(noting that shareholders “usually are not otherwise fully informed as to the results of security holders' meetings.”). Nor is there any guarantee that the information would be available through an exercise of inspection rights given the excessive pleading standards imposed by Delaware courts.
As early as 1952, the Commission stepped in and filled the void by requiring companies to disclose the results of these meetings in a current report on Form 8-K and, later, in a quarterly or annual report. See Item 4 of Part II to Exchange Act Forms 10-Q and 10-QSB, adopted in Exchange Act Release No. 17524 (Feb. 9, 1981). See also Item 4 of Part I to Exchange Act Forms 10-K and 10-KSB, adopted in Exchange Act Release No. 18524 (March 3, 1982).
Over time, the Commission increased the amount of information that had to be disclosed about voting results. Initially, companies only had to include the totals for directors involved in a contest. With respect to other proposals, only the votes for and withheld needed to be disclosed. The reporting obligations were substantially strengthened in 1992, with companies required to disclose voting results for all nominees and to disclose the number of abstentions and broker non-votes. See Exchange Act Release No. 31326 (Oct. 16, 1992). Non-votes are shares present at the meeting that do not vote on the matter. See Exchange Act Release No. 30849 n. 67 (June 24, 1992)(“In two instances, a shareholder will be deemed present at the meeting for quorum purposes, but will be deemed not to have voted on a particular matter. First, the shareholder may specifically abstain from the vote by registering an abstention vote. Second, a nominee holding shares for beneficial owners may have voted on certain matters at the meeting pursuant to discretionary authority or instructions from the beneficial owners, but with respect to other matters may not have received instructions from the beneficial owner and may not exercise discretionary voting power. Such unvoted shares are termed ‘non-votes.’").
While the requirements largely assured shareholders of complete disclosure of voting results, an important piece of information, they still permitted considerable delay. The need for shareholders to have precise totals more contemporaneously with the vote, however, was unclear. To the extent shareholders knew the actual results, the precise totals would generally not be material. In some cases, the closeness of the vote could invite challenge to the results. Yet it is likely that shareholders will already know the vote was close, with the precise total only adding marginally to the total mix of information.
On the other hand, delay did have one significant substantive affect. It allowed management to delay releasing the results, usually by claiming that the tabulation process was still underway. This permitted management to avoid the consequences of an adverse vote and to consider ways of challenging the tabulation to ensure a more favorable result. All of this could be done in an entirely non-transparent fashion, with management merely having to disclose the final outcome once the next quarterly report had to be filed.
The amendments to the shareholder voting requirements have made this much more difficult. The Commission dropped the requirement from the quarterly/annual reports and adopted Item 5.07 of Regulation 8-K. The results had to be disclosed within four business days of the shareholder meeting. To the extent not finalized, the company still had to disclose preliminary results within that time period and the final results when available. See Item 5.07 of Form 8-K, adopted in Exchange Act Release No. 61175 (Dec. 16, 2009).
The rapid disclosure will likely result in increased transparency in the tabulation process and alter the substantive behavior of management. By forcing rapid disclosure, the Commission has effectively taken away from the company large swathes of time to tabulate the votes. Companies could, in the past, take their time and change the totals with little transparency. By having to quickly report the preliminary totals, companies will communicate to investors the initial totals. More importantly, disclosure of the final numbers will, to the extent significantly different, almost certainly need to be accompanied by an explanation as to why they were made (in order to make the disclosure accurate and complete). The disclosure will, therefore, provide shareholders in at least some instances with a basis for challenging the changes.
It is a level of transparency that currently does not exist in connection with the tabulation process. For more on the SEC and its use of disclosure to affect the corporate governance process, see Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.
]]>The movement can be explained by weaknesses in the state law approach to governance and the incremental shift of governance authority to the Securities and Exchange Commission. Despite some increase in regulatory authority, the SEC has largely had its hands tied in the area, with its authority mostly limited to disclosure. As we have discussed, the SEC has tried to use disclosure to alter the substantive behavior of officers and directors with at best mixed success. See Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure.
The latest salvo in the area was the adoption of new disclosure rules in Exchange Act Release No. 61175 (Dec. 16, 2009). The effort is a fairly blatant attempt to influence to governance process. It touches on hot button issues such as the tabulation of shareholder votes, the separation of chairman/CEO, and the diversity of the board. The new requirements likewise seek to force companies to use independent compensation consultants. They also insert the Commission more deeply into the compensation process, requiring disclosure of compensation practices for those below the top five highest paid officers.
We will explore some of these new requirements in the next several posts.
]]>His main concern, as it had been all along, was with the failure to charge the individuals responsible for any false disclosure. He essentially found that the omitted information (on the bonuses to Merrill employees and the broker's large losses) were material. As he stated:
But when it came to assigning blame to specific officials inside the company or lawyers on the outside, he was in a tough bind. First, the materials provided by the Commission on why the agency chose not to charge individuals were convincing enough. The Commission submitted a memorandum that discussed in some detail the role played by the assorted parties in the process. While one can argue over the conclusions reached, a clear finger of blame did not point to any single person.
Moreover, Judge Rakoff used different accusations by the Attorney General of New York (who is charging individuals in the case) to show that there was in fact a different interpretation that could arise from the same facts. Yet the language quoted from state officials was full of hyperbole (that “Bank of America’s management thought of itself as too big to play by the rules and, just as disturbingly, too big to tell the truth”) rather than legal analysis.
Indeed, in the one instance where the Judge made findings over the disparate positions taken by the two regulators (over the dismissal of the general counsel of Bank of America), he sided with the position taken by the SEC ("Upon review of the underlying materials provided by the parties here and by the Attorney General, the Court concludes that none of the evidence directly contradicts the Bank’s assertion that [the general counsel's] termination was unrelated to the nondisclosures or to his increasing knowledge of Merrill’s losses.").
There was a more fundamental issue here. Other than perhaps require some modifications to the governance provisions (which he did), or seek a bigger penalty (as he described, "it is still very modest in light of the fact that it now covers both cases"), there was little to be gained by not approving the settlement. The Judge could not force the SEC to bring actions against individuals so causing the matter to go to trial would not have changed that.
In the end, his refusal to approve the first settlement resulted in a much improved second settlement. It may not be perfect but all things considered it is a good one.
The judge's opinion is posted on the DU Corporate Governance web site.
]]>As the SEC notes in its complaint, the two parties negotiated, approved and announced the deal terms over a three day period in September 2008. As a result of the terms of the agreement, BofA needed to issue new shares of common stock to provide to Merrill shareholders. To register the shares that were to be exchanged in the merger, BofA filed a Form S-4 in October 2008 that incorporated a proxy statement jointly prepared by BofA and Merrill. BofA and Merrill filed that same joint proxy statement in November 2008 and each mailed copies of the proxy statement to their respective shareholders.
The SEC claims that this proxy statement is false and misleading, in part, because BofA failed to disclose Merrill’s fourth quarter losses. The proxy statement and registration statement described Merrill’s financial condition as of the end of September 2008. The SEC argues, however, that in November 2008 BofA had become aware of $4.5 billion in losses that Merrill had incurred in October 2008. Moreover, in early December 2008, two days before the shareholder vote, BofA received a report from Merrill estimating that Merrill lost $6.4 billion total during October and November.
The SEC’s complaint includes details from discussions beginning in early November 2008 among BofA’s management, in-house counsel and outside counsel. The parties discussed the company’s disclosure obligations with respect to the losses sustained by Merrill. According to the complaint, BofA’s lawyers concluded that “no disclosure was necessary because the projected quarterly loss was within the range of losses that Merrill had sustained in the preceding five quarters” and that the “proxy statement and incorporated filings describing the challenging market environment provided adequate warning to shareholders.” As a result, BofA did not disclose the losses.
Sometime after the shareholder vote, management learned that Merrill’s fourth-quarter net losses would exceed $12 billion. The SEC alleges that at this point, BofA management “considered terminating the merger agreement on the ground that a material change in Merrill’s financial condition had accrued.” Nevertheless, the company continued with the merger without disclosing any of Merrill’s losses. On January 16, 2009, over six weeks past the shareholder vote and two weeks after the merger closed, BofA finally disclosed Merrill’s fourth-quarter performance. Merrill suffered a $15.3 billion net loss in that quarter alone. Consequently, Bank of America’s stock price fell 30% the next day.
The primary materials, including the original complaint and the proposed settlement, can be found on the DU Corporate Governance website.
]]>The addition to the Commission staff of someone with expertise in Delaware law is particularly timely. The SEC has been delving more and more into issues that intersect with state law (see Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure). The SEC's access proposal is the best recent example, a delicate balancing act that preempts state law in some but not all circumstances. Professor Hamermesh will unquestionably provide useful insight into how that should be accomplished.
What the staff of the Commission must make clear, however, is that the expertise is only going to be used to ensure a more effective SEC rule that does not raise unintended concerns under state law. It cannot be used because the Commission wants to engage in a deferential approach towards Delaware law. An example of how the SEC did this was in its decision under the prior Chairman to certify a question to the Delaware Supreme Court on the validity of bylaws that require the company to sometimes repay the costs of an insurgent's proxy contest. The Supreme Court took the issue in apparent violation of its own rules. The result was a disasterous decision for shareholders that made it easier for companies to exclude some proxy proposals under Rule 14a-8. It is authority that we recommended the Commission affirmatively disavow.
As Professor Hamermesh mentioned in the press release from Widener announcing the appointment: “This is a significant step not just for me, but for both the SEC and the State of Delaware in particular." Hopefully the last clause simply refers to the benefit that will accrue to Delaware because of a rule that does not have unintended consequences under its law and not because Delaware (and those who are a proponent of the Delaware model of corporate governance) see this appointment as an avenue to excersise influence over SEC rulemaking and policies.
]]>First, of course, it is, to some degree, a clear victory for the judge. He rejected a $33 million dollar settlement that did not address the failure to disclose the mounting losses by Merrill in connection with shareholder approval of the acquisition. Moreover, the original settlement harmed existing shareholders by imposing a penalty without providing them with any benefits. This settlement not only involves a substantially increased penalty ($150 million) but contains corporate governance provisions that ought to benefit existing shareholders. It is a much improved deal.
Second, Bank of America strenuously argued that it had done absolutely nothing wrong in connection with the first settlement. The settlement therefore looked like government extortion, the price Bank of America had to pay for getting rid of an overbearing government. BofA has not admitted the allegations in the settlement (it merely acknowledged "having been served with the Amended Complaint", entered a general appearance and "admits the Court's jurisdiction over it and over the subject matter of the
Actions."). Nonetheless, the rougher settlement provides greater assurance that the matter was resolved on the merits and not as a result of government coercion.
Third, the failure of the SEC to address the losses by Merrill Lynch in the first case (the complaint only involved issues around the representation that the bank had not approved the bonuses for Merrill when, it was alleged, they in fact had) and the confusion of the reliance on counsel argument suggested that the Agency had not been thorough in its investigation, lending credence to the suggestion by BofA that this case was best explained through government coercion. The SEC has now added in claims about the losses and conducted extensive discovery, including taking depositions of officers and lawyers involved in the matter. The increased thoroughness provides greater assurance that the matter is being decided on the merits and is not a product of government coercion.
In rejecting the first settlement, Judge Rakoff indicated a number of concerns, including the failure to charge individuals. While the Judge may be disappointed in this failure (although the individuals have now been charged by the New York Attorney General), it will not be enough to stop the settlement. The SEC provided its reasons for not charging the individuals and, given the greater effort and thoroughness of the Agency, not to mention the depositions taken of counsel, the Judge will not hold up the settlement on this basis.
]]>These include enhanced auditor review of disclosure procedures and expanded certification requirements for the CEO and CFO (now applicable to the proxy statement). The undertakings require greater involvement of the audit committee of the board in the disclosure process (through the requirement to hire special counsel).
A series of undertakings are also designed to affect the compensation process. The independence requirement for members of the compensation committee have been enhanced (subjecting them to the same standards as the audit committee independence requirement that was adopted in SOX), as has the requirement for the compensation consultants. Shareholders are to receive an advisory vote on compensation (say on pay) and on changes in compensation policies.
The description of the undertakings below comes from the memorandum filed by the SEC (and which will be posted eventually at the DU Corporate Governance web site). We'll venture a prediction on what Judge Rakoff will do in the next post.
As for the legal effects of the release, Commissioner Casey oddly opposed it because it reflected a statement of the law as it currently existed.
In other words, she did not object to any of the legal principles in the release, only that it was written in the context of climate change disclosure. In other words, "there is no credible reason to single out climate change issues for discussion."
Its a strange criticism. While it is true that the release applies a broad set of requirements to a specific type of disclosure, there is nothing new with that. Moreover, to the extent it brings all of the existing requirements into a single place, there is a certain convenience factor that results.
Commissioner Casey's real objection seems to be the belief that by restating the requirements, they will in fact put pressure on companies to make more and better disclosure in the area. As she notes: "Nevertheless, this guidance assumes that man-made global warming and climate change are occurring as a result of greenhouse gas emissions and are likely to result in physical effects that will affect the businesses of registrants."
That may be true. But whatever the cause, disclosure only needs to occur, presumably, where the change in the climate will have a material effect on the company's business. There may be difficulties in quantifying the consequences and in the precise cause of the climate change, but shareholders ought to be informed about the impact of these changes if they will be material.
]]>Paredes objected to several things (including his belief there were more pressing priorities before the Commission and, as a result, "now is not the time for this agency to consider climate change disclosure."). One of them was this statement in the release:
He contended that the requirement would "foster confusion and uncertainty about a company's required disclosures'" His main objection? That "reputational damage . . . can be quite speculative." The result will encourage disclosures "that are unlikely to improve investor decision making and may actually distract investors from focusing on more important information."
The claim that disclosure can result in excessive amounts of information has been raised by Commissioner Paredes before. See Statement by Commissioner Paredes at Open Meeting to Adopt Amendments Regarding Proxy Disclosure Enhancements, Dec. 16, 2009 ("Even as we add new disclosure requirements today, it is important to consider whether other mandated disclosures should be more narrowly focused or otherwise scaled back if they are no longer sufficiently useful to investor decision making"). Moreover, the risk that new requirements will result in boilerplate is always present.
But the substance of the claim is misplaced. Without the benefit of the entire release, there may be more to the statement than is in the remarks by Commissioner Paredes. Yet it looks to be nothing more than an application of qualitative materiality. Moreover, while the statement refers to reputational damage, it specifically indicates that this will only be important where it will have an adverse effect on business operations or finances. In other words, this is about reputational harm that will hurt the bottom line.
To the extent that this was the main objection (there was also one on the impact of disclosure relating the "physical effects of climate change"), it seems like a remarkably small issue that could have been readily clarified by the staff. This suggests that in fact there were other motivations for opposing the guidance. A hint of what that might have been appears in a later paragraph. As Commissioner Paredes notes:
Yet whatever the tone, disclosure apparently is limited to climate change matters that have a material effect on a company's business. In other words, the SEC is not entering the debate on climate change as much as it is telling companies that material, quantifiable consequences of climate change must be disclosed.
Commissioner Paredes apparently views accurate disclosure as something that should be sidelined when the matter is controversial.
Speech by SEC Commissioner:
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Impact of Legislation and Regulation: When assessing potential disclosure obligations, a company should consider whether the impact of certain existing laws and regulations regarding climate change is material. In certain circumstances, a company should also evaluate the potential impact of pending legislation and regulation related to this topic.
Impact of International Accords: A company should consider, and disclose when material, the risks or effects on its business of international accords and treaties relating to climate change.
Indirect Consequences of Regulation or Business Trends: Legal, technological, political and scientific developments regarding climate change may create new opportunities or risks for companies. For instance, a company may face decreased demand for goods that produce significant greenhouse gas emissions or increased demand for goods that result in lower emissions than competing products. As such, a company should consider, for disclosure purposes, the actual or potential indirect consequences it may face due to climate change related regulatory or business trends.
Physical Impacts of Climate Change: Companies should also evaluate for disclosure purposes the actual and potential material impacts of environmental matters on their business.
Mostly the release (as evidenced by the press release) emphasizes the need for companies to disclose the impact of enviornmental/climate change legislation/regulations (and treaties) whenever they can have a material effect on the company. In short, the release looks like little more than a reiteration of the already existing requirement that material effects on business need to be disclosed. If no other place, this would be required disclosure as a trend in the MD&A.
Indeed, the release stressed that the obligations would not "create new legal requirements nor modify existing ones, but are intended to provide clarity and enhance consistency for public companies and their investors."
]]>The difficulty in reaching consensus can be worsened by the existence of representation of both parties on the body. The five person commission is prohibited by law from having more than three persons of the same party. See 15 USC 78d ("Not more than three of such commissioners shall be members of the same political party, and in making appointments members of different political parties shall be appointed alternately as nearly as may be practicable."). Ordinarily, therefore, the party in the White House gets three seats (and a majority) and the party out of power receives the other two (although there have been cases where the non-majority slots went to independents).
Of course, its possible to have appointees who represent both parties but have the same philosophical approach to regulation. In other words, party affiliation isn't by itself a guarantee of diverse viewpoints.
The current Commission, however, does have a diversity of viewpoints that break down along party lines. The Commission currently has a full complement. Schapiro, Walter and Aguilar sit in the democratic slots; Paredes and Casey occupy the republican ones. Four of the current appointees were put on the Commission by President Bush. President Obama has only had a single appointment so far, the chair, Schapiro.
Particularly in the area of corporate governance and corporate disclosure, it looks as if any pretense at consensus no longer exists at the Commission. More decisions seem to be made by a 3-2 vote. Examples? The Amendments to Rule 452 of the NYSE to prohibit discretionary voting by brokers in uncontested elections for the board of directors; the proposed rules giving shareholders the right to access. The most recent is the interpretive guidance on climate change disclosure.
Note that the two dissenting commissioners (always Paredes and Casey) have done so in rules sought by the self regulatory organization (the amendment to Rule 452), rules that were merely proposals (access), and interpretive guidance. Commentary suggests that the interpetive guidance on climate control merely repeats what lawyers already tell their clients. In other words, the two in opposition felt the need to object to a release that largely reiterates rather than changes the law.
This sort of divisiveness is, it seems, increasingly common in the political realm. Now, apparently, it is becoming increasingly common in the administrative realm. One of the consequences is, ironically, a reduction in influence for the dissenters. In shaping access or repealing the limits in Rule 452, a consensus approach would likely give the dissenters influence on the final terms of the regulation. Yet by objecting, particularly at the onset, the dissenters largely make themselves irrelevant to the shaping of the final product. As for the length of time on the commission, Casey's term expires in 2011. Paredes has until 2013.
]]>The SEC charged the Bank with the failure to disclose the losses. The complaint included a single claim under Rule 14a-9 against the company. Omitted was any claim against responsible individuals. The failure involved a step backwards. The pattern over recent years has been to identify disclosure failings then pinpoint the responsible persons. Only in this way can the Commission send a message to persons in comparable positions. Moreover, this case elevates reliance on counsel to an almost absolute defense.
With respect to the $5 billion in losses, outside counsel advised BofA (according to SEC assertions) that the information did not need to be disclosed because it was within the range of losses of prior quarters and because the proxy/registration materials provided "adequate warning." This is an argument that the information was immaterial. To the extent that the SEC is correct that the market expected Merrill to have modest losses or even a gain, this conclusion is problematic. Materiality is any information important to a reasonable shareholder deciding how to vote. Losses substantially greater than what was anticipated would likely meet this threshold.
Interestingly, in opposing the motion to amend the complaint, counsel for BofA did not seriously press the immateriality claim. Instead, it essentially contended that BofA had no duty to update information about Merrill Lynch.
But more importantly, by the time BofA learned that the projected losses were in the vicinity of $7 billion, two days before the meeting, management did not consult outside counsel. Instead, they apparently communicated with inside counsel and were again told that the losses did not need to be disclosed because they were in the range of losses incurred in prior quarters. BofA learned that the projected losses would be somewhere around $7.5 billion the day before the meeting and did not disclose, apparently without consulting anyone.
So why weren't individuals charged? Here is the explanation provided by the SEC press release:
Two things make this conclusion problematic. First, the standard under Rule 14a-9 is not scienter but negligence. The only question is whether corporate officials were negligent in failing to disclose the information. Contending that there needs to be deliberate concealment is wrong.
Second, counsel informed management that the losses did not have to be disclosed. The advise depends upon what counsel knew in providing the advise. The Commission has alleged that the conclusions provided by counsel were incomplete. Certainly, the basis for the advise and the role played by counsel in the non-disclosure require further examination.
In addition to charging individuals, the Commission should have considered causes of action beyond the proxy rules. The Commission should have considered a claim against the Bank for fraud under Rule 10b-5. The facts in the proposed complaint indicated that the losses by Merrill were known within the Bank. In other words, the decision not to disclose was intentional. The only issue is whether there was a duty to disclose and whether the losses were material.
It is unclear exactly who was at fault for failing to disclose the large losses. But it is an issue that demands resolution. The failure to bring claims against individuals sends a message that, with respect to corporate disclosure obligations, it is acceptable to avoid legal responsibilities by simply pointing to counsel. Moreover, it sends a message that the Commission has little interest in exploring the role of counsel in providing the exonerating advice. The failure to bring actions against individuals sends the wrong message with respect to corporate disclosure.
The letters, the new complaint, and other primary materials are posted at the DU Corporate Governance web site.
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