SEC Drifting Further Away from Its Statutory Mission with Latest “Therapeutic Disclosure” Idea

bainbridgeFeatured Expert Contributor — Corporate Governance/Securities Law

Stephen M. Bainbridge, William D. Warren Distinguished Professor of Law, UCLA School of Law

*Editor’s Note: Washington Legal Foundation is pleased to have Professor Bainbridge joining our roster of WLF Legal Pulse Featured Expert Contributors. Professor Bainbridge is a member of WLF’s Legal Policy Advisory Board. He is a prolific scholar, whose work covers a variety of subjects, but with a strong emphasis on the law and economics of public corporations. He also authors ProfessorBainbridge.com, which over the last ten years has consistently earned ABA Top 100 law blog honors.

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An August 15, 2016 Wall Street Journal opinion piece critiqued the Securities and Exchange Commission’s (SEC) plan to require that public companies, in the words of SEC Chairman Mary Jo White, “include in their proxy statements more meaningful board diversity disclosures on their board members and nominees.”

This sort of disclosure, as Chairman White remarked when discussing another potential SEC disclosure mandate, is “directed at exerting societal pressure on companies to change behavior, rather than to disclose financial information.” So what she’s proposing now with regards to board diversity is known as therapeutic disclosure.

Therapeutic disclosure requirements undoubtedly affect corporate behavior in a substantive way, as the WSJ opinion piece explains. Therapeutic disclosure, however, is also troubling from a legal perspective on at least two levels.

First, seeking to effect substantive goals through disclosure requirements violates the congressional intent behind the federal securities laws. When the New-Deal era Congresses adopted the Securities Act and the Securities Exchange Act, there were three possible statutory approaches under consideration: (1) the fraud model, which would simply prohibit fraud in the sale of securities; (2) the disclosure model, which would allow issuers to sell very risky or even unsound securities, provided they gave buyers enough information to make an informed investment decision; and (3) the blue sky model, pursuant to which the SEC would engage in merit review of a security and its issuer. The federal securities laws adopted a mixture of the first two approaches, but explicitly rejected federal merit review. As such, the substantive behavior of corporate issuers is not within the SEC’s purview.

Second, and even more disturbing, in this case the SEC’s rules overstep the boundaries between the federal and state regulatory spheres. In Business Roundtable v. SEC, the DC Circuit struck down an SEC rule regulating whether companies could have multiple classes of stock having different voting rights. In defending Rule 19c-4, the SEC trotted out its long-standing view that § 14(a) was intended to promote corporate democracy. In striking down the Rule, however, the DC Circuit adopted a much narrower view of the Securities Exchange Act’s purposes. According to the court, federal securities regulation has two principal goals. First, and foremost, it regulates the disclosures shareholders receive. Second, it regulates the procedures by which events such as tender offers and proxy solicitations are conducted. But the Act’s purposes do not include matters such as regulating the substantive aspects of shareholder voting.

Like shareholder voting rights, rules governing board composition have traditionally been supplied by state law. There is simply no provision in the federal securities laws authorizing the SEC to regulate board composition.

When pushing back last year against demands that SEC require corporate disclosure of political expenditures, Chairman White seemed to acknowledge that the SEC has no business using therapeutic disclosure to achieve substantive ends. Yet, she is now prepared to ignore congressional intent and intrude upon state-law oversight of board composition so as to advance a special-interest agenda.

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