For nearly two years, from the end of the Obama administration through the early days of Trump, the Securities and Exchange Commission suffered a personnel crisis.
As commissioners moved on after their terms expired, replacements were blocked by political wrangling, primarily by Democrats demanding assurances of campaign contribution disclosures by public companies.
After former Chairman Mary Jo White made her exit in 2016, in the waning days of the Obama administration, the SEC was down to just Commissioners Kara Stein, a Democrat, and Michael Piwowar, a Republican. Even a simple lunch or trip to the break room could unintentionally trigger an official meeting quorum.
Slowly, but surely, under the new administration, the Commission was restocked. First came Chairman Jay Clayton, followed by Commissioners Hester Peirce and Robert Jackson. With a few months of working as a team under their belts, we are starting to get a clearer view of some of their priorities.
New fiduciary rule
Last month, in the first major effort by the newly configured SEC, it proposed a new fiduciary rule for investment advice, an alternative to a controversial effort to do the same by the Department of Labor.
The Commission’s rulemaking package would: require broker-dealers to act in the best interest of their retail customers; reaffirm and clarify the fiduciary duty owed by investment advisers to their clients; and require broker-dealers and investment advisers to disclose the type of investment professional they are and key facts about their client relationship.
The parameters of that rulemaking effort are coming into greater focus.
Clayton, for example, discussed the proposed rule during a May 2 speech at Temple University.
He identified issues that arise from having “multiple regulators and a lack of regulatory consistency and coordination.”
“There are too many regulatory cooks in the kitchen,” he said. “If you have a portfolio with a few stocks, a couple of mutual funds in a 401(k), and an annuity, then your relationship with your investment professional could be subject to regulation by the SEC, the Financial Industry Regulatory Authority, the Department of Labor, state insurance regulators, state securities regulators, state attorneys general and, if the investment professional is associated with a broker-dealer or investment adviser, bank, federal and/or state banking regulators.”
No one entity has jurisdiction over the entire whole, even though people think of their portfolios as a whole. “Differing standards confuse investors and may impose compliance costs on investment professionals, costs that are passed on to the consumers,” Clayton said. “It is incumbent on us as regulators to work together to ensure a seamless relationship from the perspective of the customer.”
The proposed disclosure rules would require investment professionals to be clear and transparent about the type of professional that they are, the services they provide (and do not provide), the fees they charge, the conflicts of interest they have, and other key information such as any disciplinary history.
“This requirement should enable us to pick a lot of low-hanging fruit—rotten fruit,” Clayton said. “Week in and week out, our enforcement cases show retail investors being victimized by unregistered ‘professionals,’ who are disproportionately likely to be bad guys, or ‘professionals’ with lengthy disciplinary histories that scurry like cockroaches from bucket shop to boiler room.”
Getting rid of ‘middle-market IPO tax’
Amid concerns about the continuing decline over the past decade of private companies entering the public market, many are blaming the compliance costs associated by free-flowing regulatory demands since the enactment of the Sarbanes-Oxley and Dodd-Frank Acts.
Commissioner Jackson is putting a twist on that dialog by advocating the elimination of what he calls “the middle-market IPO tax.”
He shared his views last month at the Greater Cleveland Middle Market Forum.
Jackson’s interest is one informed by personal experience. In 1999, at the peak of the dot-com boom, he was a 22-year-old investment banker “getting his first taste of high finance.”
Every week, he flew to Silicon Valley to pitch “young hotshot companies on the idea of using his firm for their IPO.”
“When I was a banker, we charged a standard fee for a middle-market IPO: 7 percent. We would negotiate a reduced price for large, high-profile companies, where the client’s bargaining power produced a better deal,” he explained. “But for middle-market companies, our fee was always 7 percent. Whatever industry the company was in, whatever its growth profile, however qualified its management team was, if they were a smaller firm, they always paid seven percent.”
Loosely defined, a middle-market firm is larger than a small business, but smaller than a corporate giant. In the middle of the market range, their annual revenues typically fall between $100 million and $3 billion.
“Back in 1999, I assumed that technology and competition would eventually lead bankers to give middle-market companies better pricing on IPOs,” Jackson said. Now an SEC commissioner, he decided to look into the matter. Nothing has changed.
“This requirement should enable us to pick a lot of low-hanging fruit—rotten fruit. Week in and week out, our enforcement cases show retail investors being victimized by unregistered ‘professionals,’ who are disproportionately likely to be bad guys, or ‘professionals’ with lengthy disciplinary histories that scurry like cockroaches from bucket shop to boiler room.”
Jay Clayton, Chairman, SEC
“These days in Washington folks seem convinced that so-called red tape is the reason why smaller companies so rarely go public,” Jackson said. “We’ve even come up with a name for it: ‘burdensome regulation.’ But I think the story is much more complicated than that. It’s high time to ask whether middle-market companies are paying too high a price for access to America’s capital markets.”
When an entrepreneur decides to tap our public markets, they usually need the help of a team of bankers, accountants, and lawyers to navigate the process, he explained, adding “those teams can add a great deal of value for the company and its investors by making sure that the firm is ready for the rigors of being public.” The 7 percent figure, Jackson argues, seems unrelated to the costs of taking a company public.
“In larger IPOs—where the company can use its bargaining power to insist on lower fees—the price of going public is different,” he added. “In fact, nearly half of those companies paid less than 7 percent when going public.” For example, Facebook famously negotiated a fee of just 1.1 percent for its IPO.
With “the deck stacked against them,” it’s “no wonder that middle-market IPOs have been on a steady decline,” he said. “This has had real effects across our economy, which is now dominated by fewer, and larger, public companies than ever before.”
From 1975-1991, one out of two U.S. public companies were worth less than $100 million in inflation-adjusted dollars. Public companies of that size are vanishing: Today that fraction is less than one in four.
The reasons why middle-market companies are vanishing from public view are complex, Jackson conceded. Nevertheless, the “middle-market IPO tax” is bad for ordinary investors.
Jackson urged the Commission to consider “more robust disclosure rules regarding both the direct and indirect costs of an IPO.” In particular, he said, underwriters should disclose and highlight for entrepreneurs and investors the total costs of taking the company public—including the money that will be left on the table as a result of underpricing.
Evaluating fees and the role of SROs
Commissioner Peirce, well known as a foe of over-regulation, used recent remarks to question “the strange role that the Commission plays in directing—and often determining—the evolution of U.S. equity market structure and wondering where it had lost its way.”
She asked: Is there any reason for the Commission to have any role in determining the fees exchanges can charge their members other than to counter incentives created by our own market structure rules?
“Avoiding questions like these allows us as regulators to stay in our comfort zone—a safe space with lots of regulations for us to poke and prod when we are stressed out,” she chided. “We remain secure in our ability to control the levers that tweak market participants’ incentives, fine-tuning them to generate conduct consistent with our vision of an orderly, efficient market.”
Peirce also questioned the quasi-regulatory role of for-profit exchanges that are designated as self-regulatory organizations. The Commission has the authority to approve or disapprove SRO rule changes and to change or abolish those rules.
“Commentators have long noted that self-regulation of an industry can impede competition within that industry, even through apparently beneficial provisions such as codes of conduct,” she said. “Among other things, when SROs are for-profit corporations and compete with at least some of their member broker-dealers, does it make sense for them to play a uniquely prominent role in developing and administering national market system plans?”
State of the IPO marketplace and more
On April 26, SEC Division of Corporation Finance Director William Hinman testified before a House Financial Services sub-committee. Although he is not a commissioner, the regulatory blueprint they develop eventually falls on his shoulders to execute.
As might be expected, he fielded several questions about the state of the IPO marketplace.
“Against the backdrop of a declining number of U.S. public reporting companies, the Division has been looking at ways to make the public company alternative more attractive,” he said. “While there are many reasons why companies may choose not to go public, to go public at a later stage, or to exit the public markets, to the extent we are able to attract more companies to join our public company reporting system and do so at an earlier stage, it will ultimately benefit companies, our markets, and investors.”
Companies that go through the evolution from a private company to a public reporting company “emerge as better companies with better disclosure,” he added.
Hinman said expanding the confidential review process the SEC allows for emerging growth companies (with less than $1 billion a year in revenue) was a good place to start.
In June 2017, the Commission announced it will permit all issuers to submit certain draft registration statements for confidential review.
“We have heard that companies find it much more useful to be able to time the public announcement of their offering closer to the time they actually expect to go to market,” Hinman said. “That gives the company less exposure to market vagaries.”
He added that other priorities include revisiting rules governing proxy requests by investors and what level of ownership they must have in order to do so. “It is a priority for me and the chairman,” he said. Another priority will be wrapping up remaining executive compensation rules (pay versus performance and clawbacks) mandated by the Dodd-Frank Act.
The SEC’s efforts to monitor cyber-security controls will continue unabated. The focus is on “better oversight, better controls, and more focus on insider trading policies,” he said.
A recent update of 2011 Commission guidance “reminded companies that it is very important for them to take cyber-risk into account when they are looking at their disclosure controls,” he said, adding that “more attention will be given to timely disclosures.”
“When a company has cyber-risk as a material risk they face we expect to see disclosures on how their board is overseeing that risk,” he said.