As 2016 draws to a close, the Securities and Exchange Commission’s Office of the Investor Advocate is presenting its priorities and goals for the year ahead.
The OIA was established at the SEC in February 2014, when Rick Fleming was appointed as the Commission's first Investor Advocate.
The Office’s 2017 forecast comes from a report mandated by Congress. “In broad terms, we will focus on public company disclosure, equity market structure, municipal market reforms, accounting and auditing issues, corporate governance, and fund fees and expenses,” it says.
Some items on the agenda are new this year. For example, it will begin to consider whether investors understand the fees and expenses they pay for an array of products and service providers, including funds, investment advisers, and broker-dealers. As part of this initiative, it will explore whether the various fees and expenses could be disclosed more effectively.
For many of these and other, ongoing, issues, “it would be useful to have better data to inform the policymaking process,” the report notes. To this end, OIA is consulting with the SEC’s Division of Economic and Risk Analysis and other divisions and offices to lay the foundation for increased utilization of investor testing. It has issued a Request for Information and hopes to finalize a contract with one or more vendors in the near term. “This will give the Commission a variety of tools, such as surveys, A/B testing, and focus group testing, to evaluate the efficacy of policy choices or potential benefits to investors from proposed regulations,” the report says.
“I believe our efforts to enhance the use of investor testing will help to alleviate a significant shortcoming of the traditional rulemaking process,” Fleming noted. The traditional process, whereby a proposed rule is published in the Federal Register for public comment, “tends to favor those industry participants who can retain professionals to track rulemakings, absorb the hundreds of pages of complex text, and respond to the hundreds of questions that are posed.”
“Unfortunately, the voices of individual investors and consumers tend to be under-represented in this process, even though their interests should be paramount,” he says. “Thus, it is imperative that policymakers more actively seek to engage investors in order to properly evaluate policy options, and investor testing will give the Commission an opportunity to do so.”
For several reasons, “it seems unrealistic to expect individual investors to participate in the ‘public’ comment process,” the OIA report adds. “The average person has little or no awareness of rule proposals at the SEC, and even highly engaged investors would struggle to find the time to read 341 pages and submit meaningful comments to 340 questions. Moreover, issuers of securities and their representatives have strong incentives to comment about proposed disclosure rules that may impact them in a significant way, but individual investors have little incentive to comment because the impact on individual investors is broadly dispersed.”
To counteract this “structural imbalance in the public comment process,” OIA is looking to enhance engagement with investors in Fiscal Year 2017. This will include individuals who invest for themselves, as well as the individuals who make the actual buy and sell decisions on behalf of institutional investors such as mutual funds and pension funds. It will attempt to determine what investment strategies are used, what sources of information and data are relied upon (including the SEC’s EDGAR system), and what data points are most useful and least useful for their purposes. This information is intended to help formulate investor testing initiatives and provide more extensive and reliable data about investor behavior.
While debates about the content of disclosure are worthwhile, “a more important issue is the delivery of the disclosure,” the report says. In 2017, it will encourage Commission staff to adopt user-friendly technologies that will allow for the layering of information so that investors will immediately see the most important information and have the capability to drill down for greater detail.
“It is also important to keep in mind that every investor benefits from disclosure, even if the investor does not read a word of it,” Fleming wrote. “This is because the disclosure performs an important price-setting function in the markets, as sophisticated buyers and sellers of securities digest all material information to decide whether to buy or sell at a given price. For this price-setting mechanism to function efficiently, analysts and other market participants must have ready access to all available material information.”
To improve the accessibility of disclosure for sophisticated users, the Commission has taken significant strides to increase the use of structured data for public company filings. More can be done to enhance its accuracy and give users better tools to mine the data, OIA says.
Scaling disclosure requirements
Frequently, lawmakers and regulators are faced with the question of whether to “scale” regulations so that smaller companies are required to satisfy fewer requirements.
While proponents see this as a way to help smaller businesses reduce the costs and burdens of regulatory requirements, OIA says the “trend toward scaling presents a significant risk to investors and deserves much closer examination.”
During FY 2017, OIA will examine whether the existing disclosure requirements are already inherently less onerous for smaller companies because they are either not applicable or require less explanation. It will also consider whether smaller companies carry higher risks of default or investor losses, which would suggest that the value of disclosure is actually higher for investors in these companies.
OIA will also consider issues involving shareholder rights and corporate governance and “ look for ways to remove any obstacles to shareholders in voting proxies and to protect shareholder rights in submitting and voting on shareholder proposals.”
It “will also consider whether proposed changes to exchange listing standards adequately protect the interests of public shareholders, including those that require listed companies to provide shareholders a voice in corporate actions that significantly impact their interests,” the report says.
Listing standards regarding shareholder approval
The Exchange Act requires that the rules of a national securities exchange be designed to protect investors and the public interest.
Among the qualitative listing standards, exchange-listed companies are generally required to obtain shareholder approval prior to certain corporate actions, such as the issuance of additional shares under certain circumstances. For example, the current shareholder approval rules for Nasdaq generally require companies to obtain approval from shareholders prior to issuing securities in connection with certain acquisitions, equity-based compensation plans, changes of control, and certain private placements.
“Our Office has become concerned about a potential ‘race to the bottom’ by the exchanges, whereby they lower either quantitative or qualitative listing standards in order to attract more companies to list with them, potentially to the detriment of the market and shareholders,” Fleming wrote. In particular, OIA has observed “troubling signs” with respect to qualitative listing standards that would otherwise require shareholder approval for certain corporate actions. Recent proposals by the New York Stock Exchange and Nasdaq suggest “that this crucial shareholder protection could be threatened.”
Among OIA’s concerns is that board or independent committee approval may not be an effective substitute for approval by shareholders, whose interests are directly impacted by economic and ownership dilution. In Fiscal Year 2017, it intends to continue reviewing changes to the listing standards of the national securities exchanges, particularly those that would further deteriorate the rights of shareholders to approve corporate actions that significantly impact their financial interests.