Further to yesterday's Society Alert, in his remarks yesterday at the Economic Club of New York, in conjunction with expressing eight principles that will guide his SEC chairmanship, SEC Chair Jay Clayton expressed support for the SEC's historic material disclosure-based approach to regulation, citing the Supreme Court's TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976) (with reference also to Basic Inc. v. Levinson, 485 U.S. 224 (1988)), for its guidance on materiality that the SEC should follow: “An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.…Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”
He also reiterated his concerns about the shrinking public capital markets - highlighting in particular the cumulative adverse effect on companies' determinations whether to go and remain public resulting from disclosure mandates that extend beyond "materiality" and other regulatory burdens. Here is a key excerpt:
D. Principle #4: Regulatory actions drive change, and change can have lasting effects.
Incremental regulatory changes may not seem individually significant, but, in the aggregate, they can dramatically affect the markets. For example, our public company disclosure and trading system is an incredibly powerful, efficient, and reliable means of making investment opportunities available to the general public. In fact, this disclosure-based regime has worked so well that we — not just the SEC, but lawmakers and other regulators — have slowly but significantly expanded the scope of required disclosures beyond the core concept of materiality. Those actions have been justified by regulators and lawmakers alike, often based on discrete, direct and indirect benefits to specific shareholders or other constituencies. And it has often been concluded that these benefits outweigh the marginal costs that are spread over a broad shareholder base.
But the roughly 50% decline in the total number of U.S.-listed public companies over the last two decades forces us to question whether our analysis should be cumulative as well as incremental. I believe it should be. As a data point, over this period, studies show the median word-count for SEC filings has more than doubled, yet readability of those documents is at an all-time low.
While there are many factors that drive the decision of whether to be a public company, increased disclosure and other burdens may render alternatives for raising capital, such as the private markets, increasingly attractive to companies that only a decade ago would have been all but certain candidates for the public markets. And, fewer small and medium-sized public companies may mean less liquid trading markets for those that remain public. Regardless of the cause, the reduction in the number of U.S.-listed public companies is a serious issue for our markets and the country more generally. To the extent companies are eschewing our public markets, the vast majority of Main Street investors will be unable to participate in their growth. The potential lasting effects of such an outcome to the economy and society are, in two words, not good.
Clayton's remarks also displayed a refreshing keen sensitivity to and understanding of the direct and indirect costs companies incur in effecting and complying on an ongoing basis with new regulations, signifying an increased focus during his tenure on the practical implications associated with the SEC's rulemaking activities. Here are key excerpts from his Principles #5 and #7:
E. Principle #5: As markets evolve, so must the SEC.
As the SEC evolves alongside the markets, however, we must remember that implementing regulatory change has costs. Companies spend significant resources building systems of compliance, hiring personnel to operate those systems, seeking legal advice concerning the design and effectiveness of those systems, and adapting the systems as regulations change. Shareholders and customers bear these costs, which is something that should not be taken lightly, lest we lose our credibility as regulators.
G. Principle #7: The costs of a rule now often include the cost of demonstrating compliance.
Rules are meant to be followed, and the public depends on regulators to make sure that happens. It is incumbent on the Commission to write rules so that those subject to them can ascertain how to comply and — now more than ever — how to demonstrate that compliance. Vaguely worded rules can too easily lead to subpar compliance solutions or an over-investment in control systems. We must recognize practical costs that are sure to arise. For example, when the SEC requires a Chief Executive Officer to make a certification that a specific requirement has been met, while he or she retains ultimate responsibility, realistically, it should be expected that the responsibility will be supported through the chain of command in a demonstrable manner. This can be an expensive practice that goes well beyond a prudent management and control architecture; when third parties, such as auditors, outside counsel, and consultants, are involved, the costs — financial costs and, in many ways more important, the cost in terms of time — can skyrocket. This may be the appropriate regulatory approach, and to be clear, in some areas I think it is. However, the Commission needs to make sure at the time of adoption that we have a realistic vision for how rules will be implemented as well as how we and others intend to examine for compliance.