SEC Commissioner Calls for Revision of Stock Buyback Rules

SEC Commissioner Robert J. Jackson Jr. advocated for the review and revision of SEC rules to limit executives from using stock buybacks to cash out at the expense of investors. Mr. Jackson was responding, in part, to the “unprecedented wave of buybacks” following the Trump Administration’s Tax Bill in December 2017.

In a speech at the Center for American Progress, Mr. Jackson expressed concern that current rules incentivize corporate executives to pursue “short-term stock-price spikes rather than long-term growth.” According to Mr. Jackson, the current regulatory approach is based on the belief that paying executives in stock incentivizes them to create long-term sustainable value. However, Mr. Jackson argued, that theory “only works when executives are required to hold the stock over the long term.” Mr. Jackson stated that sponsors of the recent Tax Bill believed incorrectly that the deduction would encourage corporations to invest that money in innovation or into their workforce. He observed that within the first quarter of 2018, American corporations bought back a record $178 billion in stock instead, often causing a spike in the companies’ share prices. During that same period, Mr. Jackson found, executives in those companies sold more of their own shares shortly after a buyback announcement than before, and without a requirement for the contemporaneous disclosure of their actions.

Mr. Jackson urged the SEC to (i) amend its buyback rules to deny “safe harbor” from securities-fraud liability to companies that allow executives to cash out during a buyback, and (ii) encourage corporate executives to “keep their skin in the game for the long term.” Mr. Jackson also called on corporate boards and their counsel to analyze the “implications of a buyback for the link between pay and performance” of their executives.

Additionally, Mr. Jackson requested an open comment period to allow the SEC to review stock buyback rules.

Lofchie Comment: The role of an SEC commissioner is to establish securities law policy, not to rewrite tax policy. Tax policy is driven by considerations that are somewhat larger than executive stock buybacks. From an economic standpoint, Commissioner Jackson’s observation that companies used the reduction in taxes to buy back their stocks, largely from U.S. investors, as opposed to investing in “innovation,” is an inconsequential one. If money sitting overseas is returned to U.S. investors, those investors can buy consumer goods (boosting the economy), invest in other companies (boosting the economy) or put their money in the bank (saving and bringing down the cost of lending). Buying back stock is not a destructive act.

As to securities law policy, the Commissioner first questions whether issuers should be prevented from making false assertions that they intend to buy back stock. Though that concern is somewhat inconsistent with the Commissioner’s assertion that issuers really were buying back massive amounts of stock, it seems perfectly reasonable for the SEC to investigate whether issuers may falsely assert that they will buy back their own stock when they have no intention of doing so. Second, the Commissioner expresses concern that executives who receive stock as part of their compensation resell it (an economically rational move, for example, assuming it would diversify the executive’s total investments), rather than maintaining their investment in their companies. The relevant question is whether there should be a mandatory period of time for which executives should be required to hold stock that they receive as part of their compensation. Assuming that this is a question for the SEC to answer, rather than one that should be left to each corporate board, the question would have relevance as to any executive holding corporate stock. Tying the issue to corporate buybacks diminishes the universality of the issue.

In short, the Commissioner could better advance his recommendations if he did so by arguing from a policy basis that is founded on the mission of the SEC, rather than by using uncertain claims (albeit claims worth looking into) as justification for what appears to be a partisan attack on the tax law.

SEC Chief Accountant Details Recommendations for Improving Quality of Financial Reporting

SEC Chief Accountant Wesley Bricker described his recommendations to improve and sustain the quality of financial reporting.

In remarks at the Institute of Chartered Accountants in England and Wales, Mr. Bricker asserted that the integrity of the financial reporting process remains crucial to the strength of our capital markets. He noted that in our highly connected world of global investing, technologies that help retail investors may also provide opportunities for fraudulent activity. To maintain the quality of financial reporting and reduce risk to investors, Mr. Bricker recommended:

  • minimizing expectation gaps between the levels of expected performance and actual performance by investors and accountants;
  • keeping general purpose financial reporting separate from reports with different objectives, such as special purpose financial reports;
  • promoting the financial education and literacy of members of the financial reporting structure; and
  • encouraging collaboration among participants in the financial reporting structure.

Mr. Bricker also highlighted the importance of audit regulators and audit standard-setters in maintaining the structure of financial reporting. Mr. Bricker recommended ensuring the quality of international audit-related standards, which impact (i) U.S. investors and asset managers with foreign equity and long-term debt securities, and (ii) U.S.-based multinational companies.

SEC Chair Says Bitcoin Are Not Securities

SEC Chair Jay Clayton asserted that bitcoin and other cryptocurrencies that are replacements for U.S. dollars or other sovereign (fiat) currencies do not constitute securities under federal securities laws (see Securities Act Section 2(a)(1); Exchange Act Section 3(a)(10)).

In an interview on CNBC, Mr. Clayton contrasted cryptocurrencies with other blockchain technologies, such as tokens, in which money is invested in a venture in exchange for a direct return on the token, or for the ability to earn a return by selling the token on a secondary market. These types of tokens are considered securities, and both their issuance via initial coin offerings (“ICOs”) and their trading on an exchange are subject to SEC registration and oversight. Mr. Clayton said that if an unregistered ICO is to be conducted via an unregistered private placement, the SEC will expect adherence to the private placement rules.

Mr. Clayton ruled out amending the statutory definition of securities to expressly address cryptocurrencies and other blockchain technologies, saying that the SEC would not “do any violence to the traditional definition of security that has worked for a long time.” He also declined to comment on whether various specific bitcoin alternatives, or “Altcoins” – such as Ethereum and Ripple – constituted securities, saying instead that the analysis of each was effectively case-specific.

When asked about the current bitcoin futures market and what criteria issuers would need to meet in order to start a bitcoin exchange-traded fund, Mr. Clayton cited guidance from the Division of Investment Management on features the SEC will look for – such as accurate pricing and asset verification – before approving any asset class.

SEC Addresses Delivery of Mutual Fund Documents to Shareholders

The SEC approved a rule and two requests for comments relating to mutual fund disclosure. The SEC voted to (i) adopt a new rule that will implement an optional, online delivery method for fund shareholder reports, (ii) request input from fund investors on how to enhance fund disclosures and (iii) request feedback on the processing fees charged by broker-dealers and other intermediaries for the delivery of fund materials.

First, the SEC adopted ICA Rule 30e-3, which provides funds with an optional “notice and access” method for delivery of shareholder reports by making such reports available on a website specified in a notice to investors. The rule requires funds relying on Rule 30e-3 to, among other things:

  • provide the current shareholder report and the most recent prior shareholder report on a publicly accessible website, free of charge;
  • make quarterly holdings available for the last fiscal year;
  • ensure the accessibility of reports, including their format and location;
  • issue a paper notice that the online report is available with instructions for accessing it;
  • provide a free paper copy of the shareholder report upon request; and
  • allow investors to elect to receive all future reports on paper.

SEC Chair Jay Clayton stated that the final rule contains several changes to the proposed rule aimed at improving investor protections, such as (i) an extended transition period and (ii) more flexibility in communications with investors. SEC Commissioner Kara M. Stein criticized the rule for requiring an extra step for an investor to select paper delivery, warning that it may be “too high” a hurdle for some. She advised the SEC to view the rule as a pilot program and reevaluate its effectiveness after it has been implemented. Funds will be allowed to rely on the new rule beginning January 1, 2021. In general, funds will be required to provide shareholders with two years’ notice if relying on the rule before January 1, 2022.

Second, the SEC issued a request for comments, particularly from individual investors, on how to improve the “delivery, design and content of fund disclosures.” The SEC is seeking comments on, among other things, preferred methods of delivery and the modernization of disclosure requirements.

Third, the SEC requested comments on the current framework for processing fees charged by broker-dealers and intermediaries for delivering fund shareholder reports and other materials to investors. The SEC is requesting comments on:

  • the assessment of the processing fees;
  • the transparency of these fees;
  • remittances received by financial intermediaries for delivery of fund documents;
  • whether the structure and level of processing fees should be set by another entity; and
  • fees in cases where intermediaries are paid shareholder servicing fees separately from fund assets.

Comments on the two requests must be submitted by October 31, 2018.

Lofchie Comment: This should be the first among several steps that the SEC takes to make it easier for regulated firms to electronically deliver all documents. By way of example, broker-dealers should be able to assume, in the absence of client objection, that they may deliver all required disclosure documents electronically.

The printing and transmission of paper documents, many of which go right into the wastebasket, is expensive and wasteful (and anti-green).

SEC Allows Temporary Delay of Mutual Fund Proceed Disbursements to Protect Vulnerable Adults

The SEC Division of Investment Management (the “Division”) granted no-action relief permitting mutual funds and their SEC-registered transfer agents to delay disbursement of proceeds from the mutual fund accounts of elderly or otherwise vulnerable adult shareholders (“Specified Adults“) if financial exploitation is suspected.

As previously covered, FINRA recently issued a rule allowing a FINRA member broker-dealer to place a temporary hold on the disbursement of funds or securities from a Specified Adult’s account if the relevant broker-dealer has a “reasonable belief” that the account holder is being financially exploited. In a letter to the Division, the Investment Company Institute stated that a mutual fund’s transfer agent “may be best positioned” to spot the financial exploitation of Specified Adult shareholders, since the transfer agent serves as the point of contact for shareholders. In response, the Division agreed not to recommend enforcement action against mutual funds or their SEC-registered transfer agents if they delay for more than seven days the disbursement of redemption proceeds under circumstances leading to the reasonable belief that financial exploitation “has occurred, is occurring, has been attempted, or will be attempted.”

Lofchie Comment: Given the legal uncertainty of the FINRA Rule (it is not clear how it can override either SEC requirements or state law requirements), the SEC should also issue at least a no-action letter or, better, still, a formal exemption from SEC rules regarding customer funds that would expressly permit broker-dealers to put a hold on customer funds where abuse is suspected.

The Fed’s Balance Sheet, 1942-1975

Two students of CFS Special Counselor Steve Hanke have digitized the Federal Reserve System’s weekly balance sheet from 1942 to 1975, accompanying the data with some basic analysis of how assets and liabilities changed over the period. Particularly noteworthy is the behavior of the Fed’s gold reserves, since the period includes the establishment, operation, and end of the Bretton Woods version of the international gold standard.

Two of Hanke’s previous students digitized the balance sheet from its start in 1914 to 1941. The recent digitization, by Cecilia Bao and Emma Paine, is part of their working paper, “Insights from the Federal Reserve’s Weekly Balance Sheet, 1941-1975,” no. 104 in the Studies in Applied Economics series that Hanke edits. The earlier paper, which I blogged about in a previous post, is no. 73 in the series. Both papers and their accompanying spreadsheet workbooks can be accessed from this page. A third paper to be released later this summer will bring the data and analysis up to the present. I read and commented on drafts of all three papers.

SEC Names Acting Chief Risk Officer

The SEC named Julie A. Erhardt as Acting Chief Risk Officer (“CRO”). She will serve in this capacity until the SEC “completes its search” for a permanent CRO.

In her new role, Ms. Erhardt will coordinate “efforts to identify, monitor, and mitigate key risks across the Commission’s divisions and offices,” and will serve as an adviser on the “Commission’s operational risks and controls.”

Ms. Erhardt has been Deputy Chief Accountant at the SEC since 2004, working on issuer financial reporting to investors. Prior to joining the SEC, she was a partner in the former accounting firm Arthur Andersen.

FRB Proposes Changes to Volcker Rule

The Board of Governors of the Federal Reserve System (“FRB”) issued a proposal aimed at simplifying and tailoring compliance with the Volcker Rule. It is the first major overhaul of the Volcker Rule since regulations were adopted in late 2013.

The proposal, which remains subject to public comment, was developed in coordination with the Office of the Comptroller of the Currency, the FDIC, the SEC and the CFTC. In a statement, FRB Vice Chair for Supervision Randal K. Quarles called the proposal a “best first effort at simplifying and tailoring the Volcker rule,” noting that it does not represent the “completion of [the FRB’s] work.”

A detailed analysis of the proposal will be available shortly.