SEC Chair Mary Jo White summarized historical and recent developments in SEC equity market structure rulemakings.

Chair White emphasized that regulators must fully understand the evolving marketplace in light of technological advancements. She said that regulators must precisely identify the issues before making fundamental changes and fully assess the likely consequences of doing so. She highlighted a number of targeted initiatives aimed at improving market structure, including: (i) ensuring the operational integrity of critical market infrastructures; (ii) improving market transparency and disclosures; and (iii) constructing more effective markets for smaller companies.

Among other rulemaking developments, Chair White noted that she expects the SEC will “consider very soon” a proposal to provide customer-specific institutional order routing disclosures and targeted enhancements to existing order routing disclosures for retail customers.

Chair White delivered her remarks before the SEC Historical Society.

Lofchie Comment: It is not obvious that the problems smaller companies are facing today are primarily a result of our market structure. Two more obvious problems may be (i) the heavy burden of regulation that is generally associated with a company going public; and (ii) the particularly heavy regulation of investment research, which may make it too expensive (and lacking any profit opportunities) to publish research on small companies.

The SEC awarded more than $3.5 million to a company employee whose “tip bolstered an ongoing investigation with additional evidence of wrongdoing that strengthened the SEC’s case.” The Order stated that “the Claimant’s information caused Enforcement staff to focus on [redacted] when staff might otherwise not have done so, and this evidentiary development strengthened the Commission’s case by meaningfully increasing Enforcement staff’s leverage during the settlement negotiations. As such, Claimant’s information significantly contributed to the successful enforcement of the Covered Action within the meaning of Rule 21F-4(c)(2).”

Lofchie Comment: This case may be the first in which a whistleblower award was granted to an employee who did not produce evidence that initiated a case, but rather evidence that furthered an ongoing investigation of which the employee was aware. For those who find the concept of whistleblower payments troubling, at least in the case of whistleblowers who do not first raise the issue within their own organization, this case should raise the level of discomfort. In effect, the SEC offers a bounty to employees to provide unfavorable information about their employer without resolving the matter internally.

To even the playing field, perhaps private litigants should be able to offer payoffs to government employees who come forward with evidence pointing to weaknesses in the government’s evidence. Why should government activities be conducted without the guards against improper behavior that apply to private activities?

The Office of Financial Research (“OFR”) issued guidance to regulators for collecting comprehensive and high-quality data for financial stability analysis, market monitoring, and policymaking. The guidance covers (i) the preparation of data, (ii) data transmission processes, (iii) data quality and (iv) common pitfalls in regulatory data collection.

The guidance recommends the following practices for regulators:

• define the business purpose for collecting data,
• design a template in order to establish the standard for developing data collection,
• develop clear and precise definitions, and
• create specifications for the data collection process.

Lofchie Comment: Here are a few more recommendations to add to the OFR’s list: (i) consider the costs of collecting the information, (ii) determine whether the means of requesting information are standardized adequately to yield comparable data from different sources, (iii) determine whether the means of transmitting the information actually exist, (iv) ascertain whether there is a way to store the information, (v) confirm that a method is in place for assessing the success or failure of the information program (and whether it should be modified or abandoned), and (vi) consider whether the information already may be available from other sources, such as from other agencies. In other words, consider the practicalities when seeking to collect data. As an example of what not to do, please review the experience of Form PF.

At an open meeting, the SEC decided to issue a concept release for comments on modernizing certain business and financial disclosure requirements in Regulation S-K.

SEC Chair Mary Jo White asserted that the concept release (i) considers the history and purpose of disclosure requirements, (ii) establishes an accessible framework for achieving a better understanding of customers’ and investors’ experiences with disclosure requirements, and whether investors are receiving adequate information, and (iii) seeks broad input from all constituencies. Chair White stressed that the SEC’s work on disclosure effectiveness “obviously does not stop with this release.”

SEC Commissioner Kara M. Stein voted to support the concept release as a “step towards starting the dialogue on how to modernize and improve the [SEC’s] disclosure framework,” but argued that “it is only a tentative first step.” Commissioner Stein asserted that the Concept Release failed to address the following issues:

• the “fundamentally different” views of investors in 2016 as compared to those of investors from over 30 years ago, when the main requirements of Regulation S-K were adopted originally;
• the “antiquated” form-based system used by the SEC, and whether the Electronic Data Gathering Analysis and Retrieval system should be reimagined;
• whether SEC rules should be changed to address abuses in the presentation of supplemental non-GAAP disclosures, which may mislead investors, and to address other corporate governance and transparency issues;
• whether environmental, social and corporate governance measures should be required in company disclosures; and
• whether the disclosure regime should incentivize registrants to provide quality information to the market before allowing them the “privilege” of scaled disclosure.

SEC Commissioner Michael S. Piwowar expressed support for the concept release, but also opined that the SEC “has still not done enough to provide fair, efficient and robust capital markets.” Additionally, he emphasized the “pivotal role” of “materiality” in Regulation S-K examination by the SEC.

“Materiality” plays a pivotal role in understanding the disclosure obligations under the federal securities laws. It is not sufficient that information might merely be useful. Nor is it sufficient that only some investors might find a bit of information to be important. Rather, as Justice Thurgood Marshall wrote for a unanimous Supreme Court in the seminal case of TSC Industries v. Northway [426 U.S. 438, 445 (1976)], “[t]he question of materiality, it is universally agreed, is an objective one, involving the significance of an omitted or misrepresented fact to a reasonable investor.” This is an objective legal standard, not a subjective political one. While certain shareholders may have their own particular pet interests, the reasonable investor standard prevents an individual investor from hijacking corporate resources to serve their own specific agenda.

Commissioner Piwowar urged regulators to keep in mind certain requirements in the Fixing America’s Surface Transportation Act, which address the concerns first raised by Justice Marshall, when they implement subsequent Regulation S-K reforms. Commissioner Piwowar noted that these requirements instruct the SEC to (i) examine how information can be disseminated to investors by using a company-by-company approach that avoids the use of boilerplate language or static requirements, and (ii) explore methods for discouraging repetition and the disclosure of immaterial information.

Lofchie Comment: The fundamental debate between Commissioners Stein and Piwowar concerns the SEC’s social disclosure requirements, which Commissioner Stein claims will effect a “modernized disclosure regime [that addresses such matters as] . . . diversity and inclusion.” Commissioner Stein believes that “[t]oday, investors make their decisions based on an array of information, which goes beyond mere profit and loss” – a situation that in her view contrasts sharply with that of the past, when such social-value information “may not have been material to an investor at all in 1982.” The opposing view to Commissioner Stein’s is this the requirement to provide such information is not coming from investors at all and is being used primarily to further a political agenda.

The most reasonable way to respond to Commissioner Stein’s question is to allow the investors in any particular company to answer it. Let the company ask regularly in proxy statements whether its shareholders want it to make such disclosures. Presumably, the investors will vote either to mandate such disclosures, if they believe that the market finds them desirable, or against such disclosures, if they believe them to be a waste of corporate resources. It would not be surprising if investors in 2016 proved to be more similar than dissimilar to investors in 1982. That said, if the intent of Commissioner Stein is to allow investors to express their true selves, then she should allow them to vote according to their wishes.