Analysis

4 Ways A Biden Election Could Swing SEC Priorities

Law360 (October 20, 2020, 8:12 PM EDT) -- The coming presidential election could usher in significant changes in regulatory priorities at the U.S. Securities and Exchange Commission, a divided agency where many pivotal votes are cast on party lines and measures pass by the thinnest of margins.

The five-member SEC, where three seats are controlled by the president's party, has leaned toward deregulation since President Donald Trump took office. Led by Chairman Jay Clayton, the Republican-majority SEC since 2017 has eased rules on public and private capital raising and trimmed disclosure requirements several times with an eye toward lowering costs on businesses.

The SEC has also weighed in on long-standing corporate governance disputes, narrowly passing new rules that are generally favored by public companies. Regulators this year enacted tighter scrutiny of proxy advisory firms and raised requirements on shareholder ballot proposals

The Clayton-led agency also dived into contentious waters when it raised standards on brokers who sell advice to retail investors, although critics said the rules did not go far enough.

If Democrats take the White House and a new chair is named to lead the SEC in 2021, experts say the agency's focus will likely shift toward tighter regulation. Here's a look at how priorities could change if Democratic nominee Joe Biden, the front-runner in many polls, is elected.

Expect Calls to Beef Up ESG Disclosures

Investments with a focus on a company's commitment to environmental, social or governance matters — or ESG — are all the rage as more institutional investors demand information about a company's social goals, such as plans to mitigate climate risks or improve workforce diversity.

The SEC's Investor Advisory Committee recommended the agency require public companies to issue more thorough disclosures explaining their ESG commitments, citing feedback from asset managers who consider ESG policies important to their investment strategy. Lawyers who advise public companies expect that a Democratic SEC would devote more attention to ESG topics.

"That jumps out as an area that is rife for additional initiatives," said Mintz Levin Cohn Ferris Glovsky and Popeo PC partner Andrew Thorpe, a former counsel at the SEC's Division of Corporation Finance. "I don't think the institutional investment community is happy with the level of disclosure that is out there."

The current SEC has resisted new disclosure mandates, concerned that the term "ESG" is imprecise and can be interpreted so broadly as to extend beyond material issues. Republican Commissioner Hester Peirce has argued that the SEC should stick to its "tried-and-true" disclosure system, which she said is flexible enough to accommodate a wide range of concerns.

Still, the SEC has inched toward addressing investor demands for new levels of disclosure. The SEC in August required companies to increase "human capital" disclosures — or information about their workforces — while allowing individual companies the discretion to determine what is material given that relevant data about labor forces varies from industry to industry.

Democratic Commissioners Caroline Crenshaw and Allison Herren Lee dissented in the 3-2 vote, arguing the SEC should require companies to submit more standardized disclosures on ESG topics so investors can better compare companies. Lee added that ongoing protests against racial injustice amplify the need for stock issuers to disclose more about their diversity practices.

"If we have a new party in charge, ESG investing will become more of a focus area," said Amy Lynch, a former SEC accountant and founder of regulatory consultant firm FrontLine Compliance.

Less Fervor for Expanding Private Markets

For the first time in 38 years, the SEC in August expanded access to private securities by broadening the definition of an accredited investor to include measures of sophistication. Previously, an accredited investor was defined only by wealth and income thresholds, generally at least $200,000 in annual income for an individual and $1 million in net worth, excluding home value.

The agency's 3-2 vote to expand the pool of accredited investors authorized modest changes for now. The SEC agreed to add holders of Series 7, 65, 82 brokerage and advisory licenses, a relatively small population, to the category of accredited investors. But regulators left the door open for further expansion by inviting market participants to suggest additional changes.

The SEC action was split among Republicans who favor giving investors more freedom to invest in the growing market of private securities and Democrats who worry about exposing more investors to opaque private markets, where unregistered securities come with less disclosure. If Democrats take the reins at the SEC, the agency could hit pause on efforts to widen access to private capital.

"That probably wouldn't be top of mind on anyone's agenda going forward," Mayer Brown LLP partner Anna Pinedo said.

Instead, a Democratic SEC could seek more research about private markets. About 70% of capital is raised privately nowadays, according to SEC data, although companies that don't register with the SEC disclose little information compared to public companies. Crenshaw and Lee contend that the lack of visibility into this market makes it hard to assess investor risks.

"In a Democratic-led commission, I expect greater focus on collecting and analyzing data from private markets," said Brownstein Hyatt Farber Schreck LLP shareholder Katelynn Bradley, a former counsel to Democrats on the U.S. House Committee on Financial Services.

Bradley added that a Democratic SEC may be less likely to cheer efforts to let 401(k) plans invest in private equity, as recently proposed by the U.S. Department of Labor. The SEC's Clayton endorsed the idea, saying it would add choices for investors so that their retirement plans could better match professionally managed pensions, which can invest in private equity. Bradley said a Democratic Labor Department would likely perform its own analysis before advancing the idea.

Expect Another Look at Regulation Best Interest

Among the more contentious issues the Clayton-led SEC has tackled in recent years was Regulation Best Interest, which raised standards on brokers who sell advice to retail investors.

Regulation Best Interest requires brokers to disclose conflicts of interest and eliminate certain compensation incentives in an effort to better align brokers' interests with their clients. The prior standard required that brokers' advice simply be considered "suitable" for their clients.

The SEC stopped short of imposing a higher "fiduciary" standard on brokers that applies to registered investment advisers, which some investor groups wanted but that Wall Street groups opposed. Under a fiduciary standard, advisers place their clients' interests ahead of their own.

The June 2019 action passed by a 3-1 vote — the commission had a vacancy at that point — drawing sharp dissent from then-SEC Commissioner Robert Jackson, a Democrat whose term ended in February. Along with some investor advocates, Jackson said the regulation was ambiguous and failed to precisely define the term "best interest."

The battle has also resulted in litigation. Earlier this year, the SEC prevailed in court when a Second Circuit panel rejected complaints filed by eight state attorneys general that the regulation did not do enough to protect to investors. The regulation took effect on June 30.

John Coffee, a professor of law and director of the Center on Corporate Governance at Columbia Law School, said Democrats could revisit this matter if they gain power.

"It was a very weak compromise," Coffee said of the Regulation Best Interest. "Democrats could seek to make brokers recognize a fiduciary duty to their clients."

More Scrutiny of Dual-Class Shares

More companies are going public nowadays through dual-class or multiclass structures, meaning founders retain increased voting power compared with common shares sold to the public.

The idea behind dual-class shares is to provide company leadership the ability to stick to a long-term vision without being swayed by short-term investors demanding quarterly results. Most dual-class structures grant founders a 10-1 voting advantage compared with common shareholders, although some advantages are larger than that or are more complex.

Investor advocates worry that such disparities enable bad corporate governance by insulating executives from accountability to shareholders. When Jackson served on the SEC, he described dual-class shares as a form of "corporate royalty" and called for a compromise that would allow such advantages to expire through a sunset clause after a certain number of years.

SEC Investor Advocate Rick Fleming has also urged the agency to rein in dual-class shares, calling it a "festering wound" on public markets. Fleming's statements came in October 2019, shortly after WeWork's aborted initial public offering. The co-working giant dropped its plans to go public after a backlash from investors for many reasons, including criticism over its corporate governance setup. WeWork initially sought to grant then-CEO Adam Neumann a 20-1 voting advantage.

The current SEC has stayed clear of interfering with companies' voting arrangements on the premise that investors can decide whether to invest in a given company as long as such structures are disclosed. In addition, many issuers that use dual-class structures are fast-growing technology companies, which are often among the most popular IPOs.

While dual-class structures appear unlikely to be eliminated altogether, a middle ground is not out of the question.

Pinedo said a Democratic SEC could require more specific disclosures so that investors better understand the different arrangements. Coffee added that dual-class shares also help provide company management with a defense against takeovers, noting that Democrats are often dubious of takeovers.

"The best hope here might be a sunset provision," Coffee said.

--Editing by Rebecca Flanagan and Jill Coffey.

For a reprint of this article, please contact reprints@law360.com.

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