To quote ’60s songstress Joni Mitchell: “You don’t know what you’ve got, ’til it’s gone.”
She assuredly never had government employees in mind, but the famous lyric cuts to a rediscovered truth during the ongoing government shutdown. Many in corporate America may never realize how much they rely on government services, and the manpower that make them happen, until they are no longer readily available.
As you read this, the current government shutdown, triggered on Dec. 22 amid a funding battle over President Trump’s desire to build a southern border wall, is now the longest in U.S. history. Day-by-day, there are emerging tales of shutdown-related woes hitting the corporate world. Companies that were once able to rely on clear and specific rules, policies, and staff guidance are left in a vacuum, forced to make assumptions and lesser-of-evils decisions regarding capital formation, shareholder relations, operational decisions, and a host of other matters once dependent on regulator relationships.
Pharmaceutical companies, especially those dependent on new drug launches, are in healthcare limbo because approvals by the Food and Drug Administration will likely screech to a halt when its remaining reserve of funding from “user fees” dries up in early February. The National Labor Relations Board is effectively shuttered, aside for “emergency” situations, and nearly all hearings and investigations have ground to a halt.
Southwest Airlines’ ready-to-roll plan to introduce flights to Hawaii is on hold pending approval from the Federal Aviation Administration. A similar delay is affecting Delta’s integration of new aircrafts to its fleet. E-verify, an online service run by the Social Security Administration and Homeland Security to collect I-9 documentation from employers, is offline for the foreseeable future even though they would otherwise need to report that data within three days of a new hire.
One potential winner: Facebook. The shutdown has slowed and delayed a record-setting fine the Federal Trade Commission is reportedly gearing up to levy against the social media giant for its cavalier use of users’ data.
Fee-funded bank regulators, including the Federal Reserve-budgeted Consumer Financial Protection Bureau, are exempt from the shutdown and resulting furloughs because they are not subject to the Congressional appropriations process.
The SEC’s skeleton crew
Among the hardest hit agencies, one causing substantial hand-wringing by companies and shareholders alike is the Securities and Exchange Commission. In reducing its functions to what it considers those “vital to a basic level of government functioning,” it has furloughed roughly 94 percent of its workforce, dropping from a normal compliment of more than 4,300 employees to less than 300.
Until further notice, the Commission will have “a very limited number of staff members available” to respond to emergency situations involving market integrity and investor protection. Non-essential staffers are otherwise prohibited, by law, from reading and responding to letters, phone calls, and e-mails.
The SEC Divisions of Corporation Finance, Investment Management, and Trading and Markets are not currently processing filings, providing interpretive advice, or issuing no-action letters. The Commission is also not managing new or pending registration statements or applications for exemptive relief and related waivers.
The SEC’s contingency plan does call for the continuing operation of its online EDGAR filing system. It will accept registration statements, offering statements, and other filings. During the shutdown, however, CorpFin will not be able to declare registration statements effective.
Limited staff in the Division of Corporation Finance are also available to answer questions relating to fee calculations for filings. They will not, however, respond to other questions.
“Every day the shutdown continues, and the SEC staff remain at home, the risks to U.S. markets increase. This is not akin to closing a gift shop at Yosemite during the dead of winter. It is more akin to closing the neighborhood police station during a power outage, and if it continues, could have disastrous consequences for us all.”
John Reed Stark, Founder, John Reed Stark Consulting
During the shutdown, the Division of Investment Management “will not be in a position to act upon any requests for acceleration of the effective date of a pending registration statement or qualification of a pending offering statement until the SEC receives appropriations to fund its operations,” the Commission says.
A significant percentage of filings submitted by registered investment companies are in the form of post-effective amendments to registration statements. Many of these filings become effective automatically either immediately upon filing or following the passage of a certain number of days. “These filings will become effective automatically after the entire time period set forth in the applicable rules until the SEC returns to open and operational status,” a recent advisory says.
The SEC’s Office of Investor Education and Advocacy will have a limited number of staff available to review investor complaints submitted through its investor complaint form, but will be unable to directly respond to complaints, questions, or requests for information.
As for rulemaking, the Commission will continue to accept comment letters during the federal government shutdown, but limited staff means delays in posting them online. Among the anticipated rulemaking delayed by the shutdown is Regulation Best Interest, an effort to create fiduciary-like standards for broker-dealers and investment advisors. Financial regulations, including proposals to scale back the Volcker rule and other regulatory burdens on smaller-sized banks and credit unions, are similarly hampered by staffing restrictions at the White House’s Office of Information and Regulatory Affairs.
Exams by the SEC’s Office of Compliance, Inspections, and Examinations are another casualty of the shutdown and are on hold. OCIE is normally responsible for overseeing more than 13,200 investment advisors and 3,800 broker-dealers. Its National Exam Program, in a normal operating environment, is touted as a means to ensure market integrity, improve compliance, monitor risk, and combat fraud.
A limited number of staff will be on duty to handle “emergency enforcement matters.” Just don’t expect anything that even resembles normal efforts. The SEC recently announced that it will stay “all pending administrative proceedings” before either an administrative law judge or the Commission.
Mike Piazza, a partner at law firm McDermott Will & Emery and a former SEC attorney, worries that one of the long-term effects of the government shutdown is on SEC staff morale.
“More than a few SEC enforcement staffers were convinced the shutdown would end when the new Congress was sworn in. The fact that all sides appear to be digging in their heels has deflated those hopes,” he says. “Investigations are stalled, and necessarily there will be a ramp-up period once the SEC reopens. New investigations are in limbo. Once the SEC does reopen, everything will be backed up.”
Companies looking for resolution of SEC matters in Q1 “are having to plan for a settlement later in the year,” he adds. “This impacts their business planning, hiring, investments, and business expansion.”
Rep. Maxine Waters (D-Calif.), newly seated chairman of the House Financial Services Committee, also fears that the shutdown is harming the integrity of U.S. financial markets.
“This President has all but closed the doors of the SEC, furloughing 94 percent of the agency and essentially providing fraudsters and schemers with a free pass to swindle investors and small businesses,” she said in a recent statement. “With such a skeleton crew of less than 300 staff, the SEC cannot possibly oversee the activities of the over 26,000 registered entities, such as investment advisers, broker-dealers, and stock exchanges.”
The importance of the SEC goes beyond ensuring the rule of law, she added. “Businesses that are looking to enter the public stock markets may have to delay their Initial Public Offerings because the SEC cannot approve their documents. Businesses seeking guidance from the SEC are left in legal limbo until the Commission can get back to work.”
Those concerns were echoed by John Reed Stark of John Reed Stark Consulting, a data breach response and digital compliance firm. He served for nearly 20 years in the SEC’s Enforcement Division.
“Never in SEC history has there occurred such a dramatic disruption of all active SEC enforcement actions,” Stark wrote in a recent commentary posted on his LinkedIn page. “The known and unknown consequences of such a national enforcement withdrawal are unprecedented and will only become worse as the shutdown continues. One thing for certain, the backlogs created by the SEC shutdown may take months or even years to clear out.”
“Every day the shutdown continues, and the SEC staff remain at home, the risks to U.S. markets increase,” he added. “This is not akin to closing a gift shop at Yosemite during the dead of winter. It is more akin to closing the neighborhood police station during a power outage, and if it continues, could have disastrous consequences for us all."
Raising Cain over raising capital
In recent years, many market observers have bemoaned an ever-decreasing number of initial public offerings. Efforts to bolster capital formation have started to pay off, with Uber and Lyft among the companies taking advantage of a relatively new process that allows the submission of submitting confidential filings for Commission review ahead of a formal, public filing.
IPO registration statements, in a normal environment, are carefully reviewed by SEC staff to ensure they comply with all applicable rules and accounting standards. Once revisions are made, staff will issue an order declaring the effectiveness of the registration statement, clearing a path for the offering.
These processes, along with filing traditional S-1 registration filings and prospectus statements, are jeopardized by the shutdown. The Commission is forced to put all IPO reviews on the back burner, because there is no one available to review them and advance them.
“Even though EDGAR is still open, the extensive lineup of expected IPOs in 2019 and other transactional matters could become backlogged if the government shutdown continues,” says Jay Knight, former special counsel in the SEC’s Division of Corporate Finance and current head of the law firm Bass, Berry & Sims’ Capital Markets Subgroup.
The shutdown, he says, “is progressively becoming more concerning to companies, especially those that are involved in capital market activity or that are in the shareholder proposal process for their upcoming proxy season and deciding whether or not to admit a shareholder proposal. Normally, the SEC staff will weigh in [and, if it sees fit, issue no-action relief for blocking non-qualifying shareholder proposals]. Now, there's not staff available to process even normal, routine requests.”
In planning for the shutdown, CorpFin issued a series of “frequently asked questions,” Knight explains. One of them suggested companies might want to consider removing the “delaying amendment” from their registration statement if the SEC isn’t open and fully operational. By doing so, Section 8(a) of the Securities Act gives the SEC 20 calendar days after a filing to review the registration statement before it automatically goes effective.
If the government shutdown continues to impede capital formation and M&A activity, Knight wonders how many companies will explore this strategy and how agency amendments would proceed if the government reopens within that 20-day timeframe.
“If you remove your delaying amendment, you can't take advantage of certain rules that allow more efficient pricing mechanisms for your filing,” he says. “There is a Catch-22. If you pull your delaying amendment in order to get your S-1 effective, you are not able to rely on the typical rules that IPOs use to price their offering.”
Although companies are forced to be creative, Knight doesn’t expect to see many companies following the lead of Slack and Spotify and their pursuit of a “direct listing.” That process involves bypassing traditional investment bankers and institutional investors; existing private shareholders would be allowed to openly sell their shares. He doesn’t see this process gaining steam as an alternative to IPO delays.
“It is a very unique way that a very small number of companies can even try,” he says. “You pretty much have to already have a wide investor appetite before you even go out in order to get a stabilized price. Even with it, you still have forms that are typically reviewed and need to be made effective by SEC staff.”
Nevertheless, the efforts of Slack and Spotify highlight the current need for corporate creativity. “All options are on the table,” Knight says. “Things that normally are not even a consideration are now, because you don’t have the usual rules that would apply. Companies need capital.”