Covering the news of corporate compliance is a ceaseless job, and one to which I sacrifice myself constantly. Therefore, when the Securities Regulation Institute’s annual conference rolled around this week, I immediately headed to the airport. That it is held in sunny San Diego every winter is mere coincidence.
The first day’s discussions were dominated by two debates: a morning session pondering how regulators can, ahem, “resolve” systemic risks to the financial system; and an afternoon session on the future of shareholder access to the proxy system—a future rapidly coming to a reality near you, rest assured. Let me take both in turn, and then note a common theme to both that compliance officers everywhere should watch.
The problem of systemic risk (the polite name for banks too big to fail) is a serious one that, frankly, the Securities and Exchange Commission doesn’t yet know how to solve. Indeed, much of the discussion in the morning grappled with exactly what systemic risk is, where it comes from, and how to corral multiple regulators both inside and outside the United States to manage it in one cohesive approach.
Some of the most piercing comments came from Henry Hu, director of the SEC’s new Division of Risk, Strategy and Financial Innovation. For several years Hu has been raising alarms about the idea of “decoupling,” where derivative financial instruments can distill the economic value of a security from its legal holder and allow them to be controlled by two different people—so while the SEC monitors the legal holder, the real risk of how the derivative might behave resides with some other person who exercises economic control. That divorced dynamic, Hu says, is why so many people failed to understand the true risks of credit default swaps, collateralized debt obligations, and all the other funky instruments that caused so much havoc in 2008.
Hu has clear marching orders from SEC Chairman Mary Schapiro to think about how regulators should manage risk threats like that, and yesterday he gave some clear hints about his thoughts: Regulators need to regulate the practical effects of the risks, not the legal entities that generate them or ostensibly own the offending financial instruments. That means more standardization of what the derivatives are, more centralized clearing facilities to track where they’re going, and so forth—essentially, more regulation of process and outcome, rather than more regulation of required disclosure.
Remember that concept. We’ll be returning to it shortly.
The afternoon was dominated by a lively debate over shareholder access to the proxy statement. The SEC has proposed giving some shareholders the right to place nominations for board director into the proxy statement, and a final rule is expected later this spring. (When? Nobody knows, and none of the SEC officials on hand yesterday offered any clues.) Corporations detest the idea, fearing that director elections will become political free-for-alls with special interest candidates ripping board consensus apart. Shareholder activists love the idea, saying it will give them the power that they, as owners of the company, deserve.
John Olson, a senior partner at the law firm Gibson, Dunn & Crutcher, neatly boiled down Corporate America’s opposition to this: Companies don’t object to “private ordering,” where shareholders or boards can propose and decide for themselves whether to allow proxy access; but they fiercely oppose the SEC forcing all companies to allow proxy access, which “creates a right that you never had before.”
Ann Yerger, executive director of Council of Institutional Investors, countered that proxy access is really about disclosure of all available choices to the shareholder; all director nominees should be listed in the proxy statement, as one single, impartial source of information investors. Her one-liner: “It’s about disclosure, and what voters need to make a voting decision.”
The tie-breaker in this debate was SEC Commissioner Elisse Walter. She admitted that the SEC “is very tied up in knots over whether this is a disclosure rule, or whether it creates a right.” In her observation, Walter said, the proxy process had created so many encumbrances that it now thwarts shareholder efforts to nominate directors. She even described proxy access as “a negative rule,” meaning its intention will be to tell companies “to get out of the way” and let shareholders have access to the proxy.
Walter’s comments are what brings me back to Henry Hu, and his warning that regulators should police the outcome of risks rather merely encourage proper disclosure of risks—because Walter is essentially voicing the same concern, but regarding shareholder power. If the SEC simply allows private ordering, does that really give shareholders adequate opportunity to review all their choices, considering how corporations (with all the resources at their disposal) can shout down opposing shareholders and their nominees? What is the practical effect at the end of the day? The practical effect of private ordering is not much, so corporations should brace themselves for a mandate to allow proxy access.
And they should also start thinking a lot more about the practical effects of SEC rulemaking on many other topics—because, clearly, the new leadership at the SEC is already doing just that.