By Kent Greenfield

Oct. 26, 2022

As the midterms near, federal regulators are dashing to finalize proposed rules before a likely divided Congress, or Republican-controlled one, dampens political support for their agendas. In their rush, however, these regulators must now be mindful of another key constituency: The Supreme Court’s conservatives—a group not so easily replaced every two years.   

The U.S. Securities and Exchange Commission is high on the list of agencies that a conservative-dominated court could affect. The SEC has been on a recent tear, proposing or finalizing dozens of regulations. Some are minor tweaks to existing rules, but many are quite significant. And their significance alone may pose problems, beyond the threat of unfriendly faces on Capitol Hill.  

In June, the U.S Supreme Court decided West Virginia v. Environmental Protection Agency, striking down an EPA regulation fighting climate change on the grounds that it violated the “major questions doctrine.” The Court had never used that term before, and the criteria the Court used to define it were vague and manipulable. The doctrine’s lack of pedigree gives reason for increasingly cynical Court watchers like myself to see it as a way for the Court’s conservative super-majority to operationalize its skepticism of broader regulation. Its ambiguity may be a feature, rather than a bug, to the Court’s conservatives.  

Going forward, the Court has a tool to strike down any regulation that offends its anti-regulatory sensibilities, with wide-scope rationales. As such, the case is likely to be one of history’s most important rulings on bureaucratic authority.  

In the EPA case, the agency had proposed a regulation that would allow it to force utilities to switch some coal-fired power plants to cleaner technologies. What seemed to bother Chief Justice John Roberts, who wrote the majority opinion, was that the rule was the kind of “major” decision that should be left to Congress. He did not define how major was “major,” but instead focused on how the EPA’s action was unprecedented, that it would implicate a significant portion of the national economy, and that the agency was using old statutory language to regulate risks in new ways. Also relevant was whether Congress had declined to legislate in the way that the agency chose to regulate. Justice Neil Gorsuch added additional criterion in a concurrence: whether the agency was “intruding” in a traditional area of state law.  

Under these criteria, vague as they are, several SEC efforts may now be at risk, in addition to the historic jeopardy of regulators’ agendas steamrolled by an incoming political party.  

The highest-profile initiative from the SEC also involves climate change. Environmental activists have rightly lauded the SEC’s proposal to require companies to increase their disclosure of climate risks. But an attempt such as this by a federal agency to address climate change now faces a new challenge: It is unprecedented, will be costly to implement, and takes action on new risks based on statutory language from the 1930s. And as a practical matter, one need not struggle to imagine how conservative justices feel about climate-change regulation. 

Also newly vulnerable are dozens of significant rules proposed by the SEC during the past year—on proxy voting advice, insider trading, special purpose acquisition companies, and other matters. 

Consider the SEC’s proposed rules for swaps, the financial instruments that some investors use to bet on stocks. The SEC’s suggested rule would require disclosure of such swaps within a day, and to the public. Before the Court’s decision in EPA, the proposal was already under broad attack. But now, the rule’s skeptics have an additional argument: that this rule is an unprecedented intervention in a multi-trillion dollar market, regulating new risks based on old statutory language. The argument is bolstered by the fact that Congress could have authorized such broad disclosure in the 2010 Dodd-Frank Act, but did not.  

Also at risk is the proposed rule on “beneficial” ownership. Such a definition is important for a host of reporting obligations, and the SEC is considering expanding what counts as ownership. But questions of ownership have long been a matter of state concern. Gorsuch may have something to say about the SEC effort to expand the definition.  

The SEC and other regulatory agencies face uncharted territory as they contend with uncertainty at both the political and judicial levels. Should they continue to push for aggressive new regulations, tempting conservative courts to strike them down with the vague and malleable criteria now available to them? Or should they tap the brakes, recast safer proposals, and wait for courts to change politically or define the doctrine more precisely? It’s a Hobson’s choice; there may be no meaningful decision to make. But regulators ignore it at their peril. 

About the author: Kent Greenfield, an expert in constitutional and corporate law, is dean’s distinguished scholar at Boston College Law School. 

Unlikely allies including hedge funds and labor activists oppose a proposal that would force faster disclosures of swap positions.

By Maureen Farrell
March 21, 2022

Unlikely allies, including roughly 80 law and finance professors, as well as hedge funds and labor activists, are pushing back on regulations proposed by the Securities and Exchange Commission around swaps, a type of financial instrument that gives investors a roundabout way to gain access to a stock.

These groups are united by concerns that the proposed regulations could chip away at the market for activist investors, the shareholders who agitate for changes at publicly traded companies. Among the critics are members of corporate boards whom activists could agitate against.

A group including law professors from Harvard, Stanford and Texas A&M Universities was among those that submitted letters to the commission before Monday, the deadline for comments.

In December, the commission proposed rules that would force investors to disclose swap positions they had amassed in companies within one day if they exceeded $300 million, 5 percent of a company or, in certain circumstances, as little as $150 million. The proposal followed the collapse of Archegos Capital Management, which used billions in swaps to make what turned out to be bad bets — a sudden failure that cost global banks billions in losses and roiled the stock market.

Swaps are esoteric financial instruments that get their name from the way they exchange one stream of income for another. They are a central way by which activist investors build up positions in companies before other investors or the target company becomes aware of their interest.

The one-day reporting requirement for swaps in the S.E.C.’s proposal is even shorter than the time in which chief executives must disclose their own trading in their company’s stock; chief executives have two business days to disclose stock purchases or sales.

The law professors and others argue that forcing activist investors to report their positions in swaps so quickly would make it uneconomical to take big positions in companies. They say other investors could immediately trade against them, or corporate boards could swiftly put in place defenses or other attacks against activists trying to build a big enough stake to force changes.

Even the critics of elements of shareholder activism among them, the professors wrote, recognize that “activism can be a means to address corporate underperformance and malfeasance, and hold management and boards of directors accountable to the ultimate owners of targeted companies.”

The professors argued that the S.E.C. could simply ask investors to disclose these positions directly to the commission, not the general public. Activist investors currently have a 10-day window to disclose that they’ve built a stake of more than 5 percent of a company’s stock, which the S.E.C. also recently proposed shortening to five days.

A number of other groups are pushing against the rules or submitting their own letters, including the activist investor Elliott Management, trade industry groups and other investment funds.

Jay Clayton, a former S.E.C. chairman, said he believed that the value of active and activist investing needed to be considered in the proposed rule. “The benefits of passive investing are based on a portfolio approach that captures active investors across the marketplace,” said Mr. Clayton, now the lead independent director of Apollo Global Management. “Activism has emerged as a key component of active investing.”

The S.E.C. declined to comment.

Swaps were a key mechanism through which Archegos, a little-known investment firm, quietly built giant positions in companies, including ViacomCBS and Discover, and saddled banks around the world with billions of dollars in losses last year when the shares of companies in its portfolio declined.

After Archegos imploded, Gary Gensler, the S.E.C. chair, said he and his team were seeking new rules to bring more transparency to the swaps market to prevent a similar meltdown. However, the S.E.C. didn’t mention Archegos in the proposed rules for swaps or specify how the disclosures would minimize the risks to counterparties.

The swaps proposal is one in a flurry of rules from the commission, including rules that hit on disclosures around short-selling activity and hedge funds and private-equity firms.

More transparency sounds good. But advocates might be ignoring the downside.

By Alex Edmans

Updated April 2, 2022 2:00 pm ET

A push by the U.S. Securities and Exchange Commission for more transparency around security-based swap positions might seem, on its face, to be a no-brainer.

After all, the misuse of one type of swap, credit-default swaps, was a major contributor to the global financial crisis of 2007-08. And a second type, total return swaps, contributed to the multibillion-dollar collapse of Archegos Capital Management last year.

There is, however, a potential downside to the SEC’s proposal for increased disclosure of swap positions that might not be immediately apparent: If passed, the rules could severely restrain shareholder activism—a key market mechanism for holding corporate managements accountable, improving governance and creating sustainable value.

Security-based swaps are financial contracts in which counterparties agree to exchange payments based on, say, changes in a stock’s price. They allow investors to obtain economic exposure to an asset without directly owning it and have beneficial uses such as hedging risk. The SEC’s proposed Rule 10B-1 would require additional disclosure of large positions in such instruments, so that investors‘ counterparties and clients understand their full exposure. More transparency is always good, right?

Well, not always. The main barrier to shareholder activism is that the activist bears the cost, but the benefits are shared by all other shareholders and in many cases wider society—the classic free-rider problem. An activist’s gains are limited to its stake in the company. And if the activist buys more than 5%, it is required to disclose its position, which moves the market and hinders it from buying more. A 5% stake, however, is often insufficient to make activism worthwhile, given that it typically takes six to 12 months of research before an activist investor even meets with a company.

Swaps, however, allow a shareholder to increase exposure without revealing it to the world, raising the incentive to engage with a company to improve its performance. If the SEC forces investors to reveal those positions, activists might not be able to obtain enough exposure to make engagement worthwhile.

There are good public-policy reasons why equity positions should be disclosed, but not swaps. Equity comes with voting rights and the potential ability to influence a company, but swaps don’t. What swaps do provide is an economic incentive for an investor to care about a company’s future—similar to an investment firm tying fund-manager pay more closely to long-term performance, without increasing its holdings in the company.

For its part, the SEC says it benefits from robust engagement with the public and will review all comments submitted during the open comment period. Generally, though it responds to comments received as part of the final rule-making and not beforehand, according to a spokesperson.

Benefits of privacy

Why should we worry about reduced activism? Critics claim that activism inflates short-term profit at the expense of long-term value, but rigorous evidence suggests otherwise.

A seminal paper found that hedge-fund activism boosts a stock price by 7% in the short term, and even more in the long term. One concern is that these gains come from financial engineering rather than improvements in operating performance. But a second study, which obtained confidential data on the productivity of individual plants from the U.S. Census Bureau, found that hedge-fund activism leads to increased plant productivity, primarily through raising labor productivity. Workers’ wages don’t fall, and their hours don’t rise. A third paper, which studied investment, found that hedge-fund activism results in lower research-and-development expenditures but increased innovation. More patents are generated and patent quality increases because hedge funds refocus innovation on the most promising projects. When it comes to environmental outcomes, firms targeted by hedge funds reduce toxic chemical emissions and close heavily polluting plants. And the benefits are wider than just the firm in question—they spill over to peer companies, which improve efficiency to avoid becoming targets themselves.

A positive-sum game

While some see stock-market trading as a zero-sum game—if one investor profits, another loses—activism is a positive-sum game in that it grows the pie for both shareholders and society. Turning around an underperforming company is a public good. To encourage the creation of public goods, the creator needs to obtain a return on its investment. We recognize this with patents. After an innovation has been made, we would like it to be freely available—but doing so would remove the incentive to innovate in the first place. Patents enable innovators to generate a sufficient return to justify the investment in the innovation. The private use of swaps plays a similar role for activists. If the SEC needs swap disclosures for its own monitoring purposes, it could keep such information confidential.

Privacy is important not just to encourage activism, but also to help it succeed. Shareholder engagements are increasingly resolved privately, outside the public eye—92% of activist board placements in 2021 were achieved consensually. Private engagement often leads to more amicable and constructive resolutions. Once a situation becomes public, egos are often at play. The company publicly defends the status quo and opposes the activist’s ideas. Then, if discussions later lead to the company agreeing with the activist’s suggestions, management may be unwilling to implement them as it will lose face. Greater disclosure may increase the number of acrimonious public proxy fights, at great cost to shareholders and companies but at great benefit to lawyers and other advisers.

Transparency has many benefits, but constructive dialogues are often best had in private. As the SEC deliberates new rules, it should consider their impact on such discussions, which typically create long-term value for both shareholders and society.

 

The SEC Wants to Stop Activism

By Matt Levine

March 24, 2022, 1:35 PM EDT

Activism

The way activist investing works in the U.S. is generally that an activist investor quietly buys up a chunk of a company’s stock, announces that she owns the stock, and goes to the company’s managers asking them to change something about their strategy or operations. Sometimes the managers agree, there is a productive conversation, the activist helps the company improve, the stock goes up and eventually the activist sells at a profit. Sometimes the managers disagree, and the activist tries to pressure them into doing what she wants. She might wage a public campaign, writing open letters explaining her position. She might talk to other shareholders — big institutional holders who don’t wage activist campaigns themselves but who own a lot of stock — to persuade them that she is right. If lots of shareholders agree with her, but the managers still don’t, she might launch a proxy fight: She will nominate some people to the company’s board of directors and try to get them elected to replace some of the existing directors. If enough other shareholders vote with her, her candidates will win and join the board and presumably do the things she wants. Hopefully the things she wants are good and the stock will go up and she will sell at a profit.

Sometimes this doesn’t work: Managers ignore the activist, other shareholders disagree with her, she loses the proxy fight, etc. Other times it sort of works, but is bad: The company does what the activist wants, or at least enough to make shareholders satisfied, but it turns out to be wrong and the stock goes down.

In general though it seems obviously good that activism exists. For one thing, it often does make companies more valuable: An activist shareholder, who owns a big chunk of the company and only makes money if the stock goes up, will sometimes have better incentives and motivations than a chief executive officer who owns less of the company and collects a large salary even if the stock goes down.

More fundamentally, though, activism is one of the few ways that shareholders can exercise real power over the companies that they theoretically own. As we often discuss around here, if a company’s board and managers want to ignore their shareholders, they mostly can. The only ways that shareholders in the U.S. can actually fire the board and CEO of a public company are (1) a proxy fight or (2) a hostile takeover.

They don’t do that very often. But this is the background that makes other, softer forms of pressure work. If BlackRock Inc. calls up a company and says “we are a big shareholder and we’d like you to reduce your greenhouse gas emissions,” the executives will generally listen to BlackRock and care what it thinks, because they know that, if they don’t, BlackRock will become disgruntled, and if enough big shareholders become disgruntled enough an activist might show up and win a proxy fight. (Sometimes the disgruntled big institutional shareholders will quietly invite an activist to show up; this is informally called an “RFA,” or “request for activist.”) There just isn’t that much that BlackRock can do on its own: The board controls the company, board elections are not competitive (outside of proxy fights) and most of what shareholders vote on is non-binding; BlackRock has a lot of shares, and so a lot of votes, but it can’t do much with them. But if an activist shows up, BlackRock — or other shareholders — can vote out the board. And the managers know that, which is why they feel the need to keep shareholders happy.

“Keep shareholders happy” is a very generic goal. Historically it meant things like having high profits. Later it meant things like doing stock buybacks. Increasingly, it means doing good environmental, social and governance things, as big shareholders become more diversified and more focused on ESG. And when companies don’t do the ESG things that shareholders want, there will be ESG activists and proxy fights, because activism is the enforcement mechanism that shareholders use to influence companies.

Recently, though, the U.S. Securities and Exchange Commission has proposed some rules to … stop activism? This seems bad, and also like a strange priority for the SEC to have.

Even stranger is SEC Chair Gary Gensler’s stated reason for getting rid of activism. Gensler thinks activism is bad because:

Activists buy stock in the target company quietly, before they do activism;

When they do activism — or even when they just announce their plans to do activism, or just announce that they bought stock — the stock goes up;

The people who sold them their stock, before the activism, don’t get the benefit of that stock-price increase.

Or in his words, from January:

“I would anticipate we’d have something on that,” Gensler said, adding that he is worried about “information asymmetry.” …

“It’s material nonpublic information that there’s an activist acquiring stock, who has an intent to influence and generally speaking, there’s a pop if you look at the economics from the day they announced … there’s usually a pop in the stock at least single-digit percent,” Gensler said. “So the selling shareholders during those days don’t have some material information.”

This is a weird complaint! If an activist buys 5% of the stock quietly, and then announces that she owns the stock, and the stock goes up, she gets 5% of the gains — and the other shareholders, the moms and pops and index funds and corporate insiders and whoever else, get the other 95%. Yes the shareholders who sold her the stock missed out on the gains, but they sold the stock voluntarily. Yes there was an “information asymmetry,” in that the activist knew she was buying the stock to do activism and the selling shareholders did not, but there is a similar information asymmetry in every stock transaction: When I buy stock, I know who the buyer is (me) and why I am buying, but the person selling me the stock does not.

Also though: If you get rid of activism, then activism won’t ever cause stock-price increases (because it won’t happen), so nobody will get the benefit of it! The 95% of shareholders who would have benefited from activism won’t, and the 5% who would have missed out will still miss out.

I am being a bit hyperbolic, but not, I think, that hyperbolic. Gensler seems to have decided that it’s bad that an activist can buy a lot of stock in secret, and would like to crack down on it, so new rules will require activists to disclose their presence and intentions before buying too much stock. This is something that corporate managers and their lawyers have wanted for years — my old law firm, Wachtell, Lipton, Rosen & Katz, has been pushing it for over a decade — but it is bad for activists. It is expensive to do activism, run proxy fights, etc., and activists do it because they can make money. They make money by buying at the pre-activism price, hopefully pushing the price up, and then selling at the post-activism price. If they have to do most of their buying at the post-activism price, then they can’t make money so they won’t do activism.

There are two different SEC rule proposals that are designed to accomplish this. The more obvious one is the proposal to change the beneficial ownership reporting rules that govern when investors need to disclose their stock holdings. (Activists disclose their holdings on a form called Schedule 13D, and these are often called the “13D rules.”) The way the rules work now is that, if you acquire 5% or more of a company’s stock, you need to disclose your holdings within 10 days. This gives you time to go above 5%: If you acquire 5% of the stock on Day 1, you can buy some more on Days 2, 3, etc., until you file your Schedule 13D on Day 10. So you might own 9% or more of the stock by then. (Activists tend not to go above 10%.) The SEC proposal would cut this down to five days. Gensler:

Investors currently can withhold market moving information from other shareholders for 10 days after crossing the 5 percent threshold before filing a Schedule 13D, which creates an information asymmetry between these investors and other shareholders. The filing of Schedule 13D can have a material impact on a company’s share price, so it is important that shareholders get that information sooner.

This is a change, but not a particularly important one; most activists don’t actually use the full 10 days anyway.

The subtler but more important change is the SEC’s proposal to require public disclosure of swaps positions. A total return swap is a contract between a bank and an investor (a hedge fund, etc.) referencing some underlying stock 1 ; the bank agrees to pay the investor however much the stock goes up, and the investor agrees to pay the bank however much it goes down. 2  This gives the investor a position that is economically equivalent to owning the stock: She makes money if the stock goes up and loses money if it goes down. But she does not actually own the stock. (The banks will often hedge these swaps by buying the stock for themselves, though this is not contractually required or always true.)

Late last year the SEC proposed a new rule “to require any person with a large security-based swap position to publicly report certain information related to the position.” We talked about it at the time; the SEC’s discussion of the rule focused on (1) weird stuff in the market for credit default swaps and (2) the blowup at Archegos Capital Management, which lost a lot of money using total return swaps. The SEC’s proposed rule says that if you buy more than $300 million of a stock on swap, 3  you have to publicly disclose your position within one business day. There seems to be a vague idea that this would somehow have prevented the Archegos blowup, though I am not sure how. (The concern with Archegos was that nobody knew about all of its swaps positions, but that seems false — in fact its bankers were quite aware of its huge concentrated positions — and in any case the SEC already has rules requiring reporting of swap positions to the SEC, though not to the public.)

But this rule is also very bad for activists. Many activists, when they are quietly buying up stock in a target company, don’t actually buy stock. Instead they buy the stock on swap. There are various reasons to do this — you can potentially get better financial and leverage terms from a swap than from buying the stock directly — but there is one particularly important one. There is a U.S. antitrust rule (the Hart-Scott-Rodino Act, or HSR) that requires activists to notify the target company and wait 30 days before buying more than $101 million of a company’s stock. Here is a summary, from a comment letter filed this week on the SEC’s proposal by a group called the Council for Investor Rights and Corporate Accountability 4 :

Under current law, the HSR Act generally prohibits an activist investor from acquiring voting securities with a value in excess of $101 million without making a filing with the appropriate governmental agency, notifying the target company of the making of such filing, and waiting a period of at least 30 days before it can continue to acquire additional voting securities of the issuer. In many cases, this notification threshold is well below the minimum position size that an activist investor needs to acquire to make the investment of its time, resources and capital worthwhile. The HSR Act, however, is focused solely on the acquisition of voting securities and therefore activist investors have long used [swaps], typically cash-settled [swaps], to accumulate their desired sufficient economic position without the need to make an HSR Act filing. The Proposed Rule would make this long-standing approach irrelevant, as it would compel public disclosure of the [swaps] position thereby tipping management and the board of directors of the target company to the investment and allowing them to take measures (including possible public disclosure to run up the stock price) to the detriment of the activist investor.

Here is another comment letter from Elliott Investment Management LP, which does a lot of activism:

In our activist investments, as well as our non-activist investments, our firm frequently acquires cash-settled [swaps] as part of the overall mix of securities in a given position. This approach allows us to buy a portion of our position and gain economic exposure without triggering the kind of “herding” behavior that often accompanies public disclosure, and without notifying the company before our ideas have fully matured. The Proposed Rule will eliminate that approach. Instead, the new disclosure regime contemplated by the Proposed Rule gives activist investors three potential paths: (1) purchasing cash-settled [swaps] up to the new (and very low) reporting threshold, or triggering a filing that would significantly limit the prospect of a sufficiently profitable investment (with concomitant loss of confidentiality, and thus of intellectual property) far earlier than is currently the case, (2) acquiring common stock and triggering a notification under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 at what, for most public companies, is a de minimis level of ownership, or (3) deciding to stop pursuing activist opportunities entirely.

By forcing investors to choose one of these paths, the new disclosure regime will have a perverse chilling effect on exactly the kind of engagement with companies that is most likely to create value for all shareholders and the U.S. market generally. If an activist with a successful track record of creating sustainable value is forced to make a public disclosure prematurely, then “herding” behavior by new entrants into the stock may make the securities too expensive, preventing an economically worthwhile position from being built and thereby pricing the activist out of the investment.

And here is a comment letter from Harvard Law School professor Lucian Bebchuk:

For hedge fund activists that accumulate economic positions in a target with significant market value through equity swaps, the Equity Swap Rule would lead to disclosure of the activist’s potential interest in engaging with the company at a much earlier time and stage of accumulation than under current rules. Disclosure at such an early stage would curtail the ability of such activists to accumulate a position prior to their initial disclosure. Such early disclosure would also enable management to start engaging in defensive actions much earlier than under current rules. Altogether, for such activists, the Equity Swap Rule would substantially reduce their payoffs and considerably discourage their activities.

Activists worry that, if they can’t buy more than $300 million of stock on swap (roughly 1% of the median S&P 500 company), or more than $101 million in actual stock, they will not be able to quietly build a meaningful position in a large public company. They will have to disclose their involvement before buying most of their position, which will push up the price of that position, which will make it uneconomical to do activism. If the expected value of Elliott’s activism in a $20 billion company is $4 billion, and Elliott can buy 5% of the stock at the pre-activism price ($1 billion worth) and then do the activism, it will in expectation make a 20% return on its investment ($200 million) and other shareholders will make $3.8 billion. If Elliott has to disclose its intentions first, the stock will trade up 20% to reflect the expected value of Elliott’s involvement, Elliott will have to pay $1.2 billion for its position, and in expectation it won’t make any money. 5  So it won’t do the trade.

This concern is perhaps a bit exaggerated: You can still buy a little stock quietly, and you could imagine finding ways around the rule. In the SEC’s rule proposals there is a strange distinction between “swaps,” which are covered by the proposed swaps rule and have to be disclosed one business day after you reach $300 million, and “cash-settled derivatives,” which are covered by the proposed 13D changes and have to be disclosed five business days after you reach 5% of the stock. A swap is a cash-settled derivative, and there is no sensible reason why you would distinguish between these things. Presumably banks and hedge funds will try to find ways to characterize their trades as “cash-settled derivatives” rather than “swaps.” (My understanding — not legal advice! — is that if you call a thing a “cash-settled forward,” it will count as a swap, but if you call it a “cash-settled call option with a strike price of $0.10,” it will count as a derivative. Those are all the same thing, economically.)

Meanwhile the proposed 13D rules also seem bad for activists. Not so much because they require disclosure of 5% stock ownership within five days, but because they change how the SEC thinks about “groups.” A group, as a technical term in securities law, is bad. You don’t want to be in a group. If two shareholders are part of a group with each other, then their share ownership is added up for the purposes of the 13D rules; if I own 3% and you own 3% and we are a group then we’re over 5% and have to disclose our stake. We have to file our Schedule 13D jointly, which means that we’re both responsible for what it says about how many shares we each own and what our plans are. Even worse, if our shares add up to more than 10%, we are subject to Section 16 rules, which limit our ability to sell the stock.

Here is how the SEC currently defines a “group”:

When two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer, the group formed thereby shall be deemed to have acquired beneficial ownership, for purposes of sections 13(d) and (g) of the Act, as of the date of such agreement, of all equity securities of that issuer beneficially owned by any such persons.

The SEC’s new proposal would get rid of the words “agree to,” because “an agreement is not a necessary element of group formation”:

These amendments would make clear that the determination as to whether two or more persons are acting as a group does not depend solely on the presence of an express agreement and that, depending on the particular facts and circumstances, concerted actions by two or more persons for the purpose of acquiring, holding or disposing of securities of an issuer are sufficient to constitute the formation of a group.

I don’t particularly know what that means, and I don’t think anyone else does either. But it is vaguer than the previous rule, and thus more dangerous. In particular: One thing that activists do, when they are trying to make changes at a company, is call up other shareholders — big institutional shareholders who don’t do activism but who have a lot of votes — and try to persuade them. An activist is not going to, like, sign an agreement with BlackRock or Vanguard saying that they will work together, but they might try to talk to BlackRock and say “this is why you should vote with us.” Under the old rules, they could do that. Under the new rules, where any “concerted actions” create a group, it might be riskier for BlackRock to talk to activists. Preventing shareholders from talking to each other is bad for activism. It is also just bad for shareholders: If the managers can keep the shareholders separated, then they have more power to ignore them.

Another part of the new rules would “specify that if a person, in advance of filing a Schedule 13D, discloses to any other person that such filing will be made and such other person acquires securities in the covered class for which the Schedule 13D will be filed, those persons shall be deemed to have formed a group.” The SEC refers to this as “tipping”: If I tell you that I’m going to do activism in a stock, and you go buy the stock before I disclose my activism, then that seems unfair to everyone else, so the SEC will treat us as a group as a sort of punishment. Again, though, this seems designed to scare the BlackRocks of the world away from talking to activists: If BlackRock meets with an activist, and the activist says “we were thinking of doing activism in Company X, what do you think,” then is BlackRock locked up from trading in Company X? If it buys Company X shares, is it in a group with the activist? What if BlackRock puts out a “request for activist” in Company X? If the company’s managers want to fight back against the activist, can they demand records of everyone the activist talked to in the month before buying her position? The safer move for big institutional investors might just be to avoid talking to activists, which will make activism much harder.

Overall the effect of these rules seems to be to stop activists from (1) making money from activism and (2) talking to other shareholders. And so there will be less activism, and corporate managers will have more ability to do what they want without listening to shareholders.

This is weird! We talked this week about the SEC’s huge new proposed climate disclosure regime for public companies. Basically shareholders of public companies increasingly pressure them to do better on environmental, social and governance issues, and the SEC has decided that that is good. So it is helping shareholders get some of what they want from companies (climate disclosure), and giving the shareholders more tools to pressure the companies to do more of what they want (lower emissions, etc.). At the same time, though, it is reducing shareholders’ ability to actually pressure companies: It is making activism harder, which makes it easier for corporate managers to ignore shareholders. The shareholders can have the ESG things that the SEC wants, but not the ESG things that they want.

Nickel

If you are a commodities trader, and you short nickel, and there is a short squeeze and the price of nickel rises from about $25,000 a ton to $40,000, $80,000, eventually over $100,000 a ton, you will get increasingly frantic margin calls from your brokers. At some point they will say “this is just too much risk, you need to cover some of your position by buying back some nickel.” You will not like this advice, because it is very expensive to buy nickel at $100,000 a ton, and if you buy it back now you will have lost a lot of money on your short bet. “No thank you,” you might reply. “I’d prefer to wait until nickel is back at $25,000 a ton; then I’ll buy it back.”

Your brokers will not like this answer, because, you know, that’s not how this works! Sure yes if the price goes down you will be happier to cover your short, but the price went up, and you need to cover your short now. “I’ll wait until the short squeeze ends to cover my short” just fundamentally misunderstands short squeezes.

Unless you are the world’s biggest nickel producer and have a short position so enormous that it endangers the solvency of a bunch of brokers, in which case, sure, why not, take as much time as you need, we’ll even cancel some trades and shut down the exchange for you if that helps:

The Chinese tycoon whose big short bet on nickel was the focus of an unprecedented short squeeze has covered some of his position, according to people familiar with the matter.

Xiang Guangda, the owner of nickel and stainless-steel giant Tsingshan Holding Group Co., bought contracts on the London Metal Exchange to reduce his short bet as the nickel market briefly unfroze this week, the people said, asking not to be identified as the information wasn’t public.

The move reduces the size of the potential pain for Xiang and his banks as nickel prices soar once again — prices on the LME are up more than 30% over the past two days. However, the businessman and his allies have only reduced a portion of their total short position, and still hold large bets on falling prices, the people said. …

Tsingshan and its peers have covered tens of thousands of tons of their short positions, one of the people said. Xiang had short holdings of over 150,000 tons when the market was halted on March 8, and his business and trading partners held additional large short positions on top of that. …

Xiang previously told his banks that he didn’t want reduce his short position, Bloomberg reported March 10.

However, the nickel price has dropped sharply since then, falling as low as $26,675 a ton this week, compared with a closing price of $48,078 a ton on March 7 — the last day of trading that the LME allowed to stand when it closed the market.

He “told his banks that he didn’t want to reduce his short position,” I love it. “Owe your banker [150 tons of nickel] and you are at his mercy; owe him [150,000 tons] and the position is reversed.”

Anyway after trading limit-down last Wednesday, Thursday and Friday and this Monday, nickel “surged by the exchange’s daily limit of 15% on both Wednesday and Thursday” this week. At basically no point — except Tuesday — did the price of LME nickel reflect supply and demand. Last week the price was artificially high so no one wanted to buy; this week the price finally got low enough for the short sellers to cover, but then they all wanted to cover at once, it went up again, and the exchange stopped trading. What a hilarious market.

Rubles for gas

We talked yesterday about Vladimir Putin’s plan to make European countries pay for Russian gas in rubles rather than euros. I was not so sure about the macroeconomics there — the Europeans get the rubles by paying for them in euros, no? — but, whatever, fine. I am also not so sure about the contractual regime. Bloomberg News reports:

For the utilities who buy gas from Gazprom, the demand to pay in rubles could lead to disputes and contract negotiations, threatening to disrupt the smooth supply of gas to the region. Europe gets about 40% of it gas from Russia and is already grappling with fallout of record prices this winter. German energy giants Uniper SE and RWE AG declined to comment, as did Italy’s Eni SpA.

“If Gazprom refuses to deliver gas when buyers pay their invoices in the original contract currency, usually euros, buyers may bring the case to arbitration,” said Anise Ganbold, an analyst at Aurora Energy Research.

And here is the Financial Times:

Contracts for Russian pipeline gas exports to Europe are typically denominated in euros. Russian media has previously reported that most already include an option to pay in roubles but several European gas analysts thought it was unlikely that supply contracts would include that clause. Without such a provision, contracts would have to be renegotiated.

Vinicius Romano, senior analyst at Rystad Energy, said that “insisting on rouble payments may give buyers cause to re-open other aspects of their contracts, such as the duration, and simply speed up their exit from Russian gas altogether”.

Alfred Stern, chief executive of OMV, the Austrian petrochemicals group, told local media that it would continue to pay for Russian gas in euros and the contract did not allow for a change to roubles.

And the chairman of French utility group Engie also said its contracts did not include an option to pay in roubles.

I don’t know? I feel like normal commercial relationships are a little bit suspended here, when Russia has invaded a European country? Like if you are a client of Gazprom and they start invoicing you in rubles, your choices are (1) pay the rubles, (2) stop getting the gas, or (3) pay in euros and see if they’re bluffing. The choice depends on how much you need the gas and how much you think Gazprom needs the rubles (or euros); it does not really depend that much on what your contract says. You can go to arbitration if you want, but if the decisions of an arbitrator were binding on Vladimir Putin the entire situation would be very different.

 

Institutional investors view the Securities and Exchange Commission’s proposed rules for proxy advisory firms and shareholder resolutions much differently than the business community.

In November, the agency voted to put forth proposed rules that would require proxy advisory firms to disclose more about their process and potential conflicts of interest and give companies the opportunity to make revisions before making final recommendations to clients. Separately, the thresholds for submitting proposals, and subsequently resubmitting them would be raised, making it likely that fewer proposals will be introduced or appear on ballots.

On one hand, Michael Garland, assistant comptroller, corporate governance and responsible investment in the office of New York City Comptroller Scott M. Stringer, the fiduciary for the five pension funds within the $215.5 billion New York City Retirement Systems, said in a statement that the two SEC proposals “will only serve to insulate management and directors from accountability to shareholders.”

On the other, Erik Rust, Washington-based director of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, favors both proposals. “You’re hopefully going to see proposals come from investors that have a long-term interest in the company and aren’t trying to influence short-termism or activist or specialized interest,” he said.

A study from MSCI Inc. released earlier this month examined more than 2,300 shareholder proposals that went to a vote at U.S. companies from 2015 to 2019. It found that 30.9% of proposals were submitted by individual investors. It also found that 55.3% of the proposals submitted by those individual investors obtained “significant support,” defined as winning more than 30% of total votes cast.

Ric Marshall, Portland, Maine-based executive director on the ESG research team at MSCI, said that support dispels the notion that shareholder proposals are simply filed by gadfly investors. “If these were just nuisance filings, if these were just frivolous requests, they wouldn’t get that kind of support from what’s obviously a much more sizable part of the investor community,” Mr. Marshall said.

He understands

SEC Commissioner Elad Roisman, a Republican who is leading the commission’s efforts of proxy issues, voted for the proposals, including allowing companies to review proxy recommendations before they’re finalized. But in a speech March 10 at a Council of Institutional Investors conference in Washington, Mr. Roisman said that based on feedback from stakeholders that utilize proxy advisory firm services, he understands “that there is concern that these days devoted to issuer pre-review could disrupt current voting practices.”

“I take this feedback seriously, and I am certainly open to considering other ways to accomplish the policy goals of improving the total mix of information available to the marketplace and enhancing fairness and transparency in the voting process,” he added.

Glass, Lewis & Co., which along with Institutional Shareholder Services Inc. controls about 97% of the proxy advisory market, said in a statement that the firm continues to engage with the SEC on the proposals. “We have expressed our concerns to the SEC about the proposed rules, particularly the effect they could have on the time our clients need to use our proxy research and analysis to make critical stewardship decisions,” it stated.

Patti Brammer, corporate governance officer of the $100.2 billion Ohio Public Employees Retirement System, is concerned the proposals, as written, would negatively impact the independence of proxy recommendations. Moreover, she said if costs were to rise as a result of new regulations, issuers should bear some of the burden.

“We don’t want to see any increased cost to institutional investors for implementing anything that we haven’t found to be a problem,” she said. “We’re a public entity and have to prudently administer our funds. Our resources are not unlimited.”

Mr. Rust said that if enacted, the proposals will greatly help the proxy-voting system. “You’re going to see a lot more high-quality information and transparency around how the voting recommendations are produced by proxy advisory firms,” he said. “That’s beneficial for public companies as well as investors.”

The SEC comment period for its proxy proposals closed in February and a final rule is expected this year.

When developing health, safety, consumer and environmental protections, agencies depend upon truthful feedback from the public. But lately, corporate malefactors are misleading federal agencies through manipulated public comments.

It’s suspicious when small business owners fight against basic protections from bad investment advice; when teachers, veterans and retirees want shareholders kept in the dark about corporate political spending; or when academics attack basic science and tout long-discredited studies.

When we scratch the surface of these ostensibly grassroots efforts, we often find thinly disguised fakery: astroturfing operations created by corporations.

Earlier this year, I testified at a House Financial Services Oversight and Investigations Subcommittee hearing on how prevalent these deceptive industry tactics have become. Consider a few well-documented examples.

Anti-Shareholder “Activists”

For years, business interests have sought to limit the ability of shareholders to bring resolutions before annual meetings, such as resolutions requiring companies to disclose their political spending. At a Nov. 5, 2019 meeting on proposals to roll back shareholder rights, U.S. Securities and Exchange Commission Chairman Jay Clayton cited seven letters supposedly from regular people claiming that shareholder activism undermined their interests and calling for the censorship of proxy firms that advise shareholders on whether to back these resolutions.

It turns out those letters were “the product of a misleading – and laughably clumsy – public relations campaign by corporate interests,” according to an investigation by Bloomberg. The letters were orchestrated by 60 Plus, which is funded by the National Association of Manufacturers and the Koch Brothers’ money.

A letter from a retired teacher? She never wrote it, although the signature was hers. Letters from military veterans? They were the brother and cousin of the chairman of 60 Plus. The letter from the retired couple? Their son-in-law runs 60 Plus.

Fake Experts Peddling False Claims

In 2019, Public Citizen published a detailed examination of George Washington University’s Koch-funded Regulatory Studies Center (RSC). The RSC regularly comments on regulatory measures, purporting to offer objective and unbiased analysis.

Yet 96 percent of its public comments recommend less regulation than the proposal or the status quo, and three out four comments were authored by someone with ties to other Koch funded groups. The report also unearthed numerous instances of RSC writers imparting deceptive or false information to regulators – such as grossly misstating the scope of regulation, exaggerating its annual growth and citing discredited studies on its costs.

The RSC’s writings often focus on environmental matters that have material implications for Koch Industries, opposing proposals to reduce pollution or combat the climate crisis. Trump administration regulators have acted on many of RSC’s polluter-friendly ideas, such as reducing the costs attributed to greenhouse gases and raising the bar for new energy efficiency standards.

The Chamber’s Pawns

In 2016, a handful of small business owners became the public face of Wall Street’s opposition to the U.S. Department of Labor’s proposed fiduciary rule, guaranteeing that financial advisers provide retirement savers with investment advice in their best interest. The existing rules allowed conflicts of interest that cost investors an estimated $17 billion annually.

Public Citizen contacted the small business owners featured in the U.S. Chamber of Commerce’s campaign against the fiduciary rule. One out of four turned out to be lobbyists for the brokerage industry or officials of the Chamber itself – evidently listed to pad the number of critics. One was even a government official.

The rest fared little better when faced with even minimal scrutiny. One California small business owner, who said the current system helped grow her business over the past 12 years, admitted she had only one employee. A person identified as a “human resources” officer was linked to a firm that no longer existed except as a website. And a Chicago nonprofit leader had no view on the fiduciary rule, didn’t realize he was listed as an opponent and upon finding out asked the Chamber to remove his name.

Trust, But Verify

These are just a few of the known attempts by industry to mislead regulators and rewrite the rules in their favor. The problem of fake industry comments has become so pervasive that Congress, inspectors general, law enforcement, the media and regulators themselves need to take it far more seriously.

If agencies paid closer attention to public comments on all sides of any rulemaking, some of the manipulation and malfeasance might be uncovered. At a minimum, before citing public comments to justify rulemakings or touting them in testimony, agency officials should make a good faith effort to verify their authenticity. It’s the least they can do.

Regulatory agencies provide a valuable service to the public by issuing and implementing safeguards. It’s essential that they deal in truthful feedback from real people.

Naylor is the financial policy advocate for Public Citizen.

A top Senate Democrat is calling for federal financial regulators to shelve all their rulemaking projects that aren’t directly related to the COVID-19 pandemic, saying their attentions right now need to be on protecting the financial system and mitigating economic fallout from the outbreak.

In a letter dated Tuesday, the Senate Banking Committee’s ranking member Sherrod Brown, D-Ohio, urged the Federal Reserve Board to halt its pre-existing rulemaking work and “instead focus and prioritize actions on activities related to the economic risks posed to markets” by the novel coronavirus.

Brown made similar requests in letters addressed to the heads of the Consumer Financial Protection Bureau, Federal Deposit Insurance Corp., Federal Housing Finance Agency, Office of the Comptroller of the Currency, National Credit Union Administration and U.S. Securities and Exchange Commission.

“The COVID-19 virus threatens both the health of the public and the economy,” Brown wrote. “In light of this crisis, I urge you to place an immediate moratorium on rulemakings not related to the crisis at hand until the COVID-19 virus has been fully addressed by our financial and public health agencies.”

Federal financial regulators had a number of significant rulemaking initiatives underway before the pandemic struck, including projects to wrap up revisions to the Volcker Rule’s restrictions on banks’ fund investment activities, issuing first-of-their-kind consumer protection rules for the debt collection industry and overhauling Community Reinvestment Act regulations for the first time in years.

Comment periods on proposals associated with those three projects are in fact set to end in the coming weeks, but with the nation gripped by the COVID-19 outbreak, Brown said the agencies should expect that the public won’t have the bandwidth to provide “meaningful” feedback on anything but pandemic-related rulemaking proposals.

Brown said the regulators should also be concentrating on “providing reliable guidance and responding to the health and economic effects of this crisis rather than on processing other rulemakings.”

“During this period, all rulemakings and comment periods closing after March 1, 2020, that are not related to the virus response or other imminent health, safety or national security threats should be suspended or extended for at least 45 days,” Brown urged.

In addition to the financial regulators, Brown called on the U.S. Department of Housing and Urban Development to similarly table any pending rulemakings that aren’t tied to the pandemic response effort.

The agency’s energies would be better spent right now on “advancing the public health and worker protections, increasing access to nutrition services, enhancing our nation’s safety, and protecting the financial needs of individuals and families facing economic hardship as a result of the virus and response,” Brown said.

In a statement to Law360, a HUD spokesperson pushed back on Brown’s letter.

“Senator Brown should spend less time playing politics with the coronavirus, and instead focus his energies on quickly approving the economic stimulus the president has called for,” the spokesperson said.

Spokespeople for the Fed and the FDIC said their agencies plan to respond to Brown directly. An SEC spokesperson declined to comment. Representatives for the other agencies did not immediately return requests for comment late Tuesday.

The SEC’s attempt to impose new regulations on proxy advisory firms has triggered some “pretty harsh” feedback, a top official said.

Ted Yu, chief of the Securities and Exchange Commission’s mergers and acquisitions office, said Thursday that the agency’s proxy firm proposal is the most controversial of its recent rulemaking. The rule would place more restrictions on Institutional Shareholder Services Inc. and Glass, Lewis & Co., which the business community has said have too much power over companies’ corporate governance.

The commission has received thousands of letters in connection with its proposal and a roundtable discussion on proxy firms. Opposition has come from Amazon.com Inc. workers, activist investor Carl Icahn, and others.

“Folks have pretty strong views on this,” Yu said while video conferencing into a panel discussion at a corporate law conference in New Orleans. “It takes a thick skin to read all these letters sometimes.”

Not All Bad

The comments aren’t all negative, however.

The U.S Chamber of Commerce, General Motors Co., and Garmin Ltd. have voiced at least some approval. Praise has even come from individual investors, though some of their support has raised questions.
SEC Chairman Jay Clayton said in December he was looking into claims that the 60 Plus Association senior advocacy group helped write and send questionable letters supporting new rules for proxy firms.

He mentioned some of the comments when announcing the proposal in November, but some people whose names were on the letters said they didn’t submit them, Bloomberg News reported.

The agency also has received dozens of letters backing its proxy firm plan after a YouTube video from conservative activists encouraged “real Americans” to show Clayton their support.

Commenter Concerns

From the opponents, one of the most prevalent concerns the commission has heard about the proposal so far is that allowing public companies to review reports from advisory firms before release could cut into the time investors get to review them and vote.

“We’re aware of that and we will definitely take it into consideration,” Yu said.

According to Yu, there were a couple of “misconceptions” reflected in the written comments.

Some commenters argued that the rulemaking would generate a new source of liability for proxy advisers, causing them to be sued more regularly.

The SEC would say this isn’t correct, Yu said, adding that the agency doesn’t view this as adding additional liability. Comment letters also laid out concerns that the rule would impair the independence of the advisers and their reports.

But “independence is not impaired here,” Yu said. “We’re working hard on this rulemaking,” and are looking to complete it within the year, he added. “So stay tuned.

Investor protections are under threat, and the culprit is the Securities and Exchange Commission. Catering to the pleas of corporate interest groups, the SEC is moving quickly to impose new regulations on proxy advisor firms that will undermine a well-established, market-based system that has served investors, companies, and the U.S. equity market for decades.

As state treasurers, we are responsible for safeguarding and investing billions of dollars on behalf of taxpayers, pensioners, college savers, and units of government. As we seek to provide the highest level of service, stewardship, and financial value to our beneficiaries, our offices routinely vote on proxy ballot items. These votes involve fundamental business decisions, including the election of board directors; executive compensation; and environmental, social, and governance risks and opportunities. Proxy voting is a critical means for investors—the actual owners of these companies—to signal issues of concern, hold corporate leaders accountable, and protect their assets.

However, on November 5, 2019, the SEC proposed new rules that represent an unnecessary, unprecedented, and destructive intrusion on the relationship between investors and their advisors.

Institutional investors rely on proxy advisors, like Institutional Shareholder Services and Glass Lewis, to provide timely, independent recommendations on proxy ballot items that require votes every year at tens of thousands of companies around the world.

Proxy advisors have recently been accused, without specific examples, of altering director nominee recommendations at the secret direction of a small cabal of their clients. Advisors are retained to provide independent, evidence-based analysis to their clients, and it is difficult to discern a motive for any advisor to disregard its responsibility to the vast majority of clients who pay for objective reviews at the behest of a tiny fraction of that group. Proxy advisors have helped inform investors, and ultimately corporate leadership, as they develop and institutionalize best practices. These markets worked through corporate democracy, without government intervention.

The SEC appears to believe that proxy advisors have become too powerful and needlessly sway voting decisions. We disagree. Proxy advisors serve at the behest of investors, not vice versa. Proxy advisor firms have developed policies and recommendations that reflect the views of their clients on important issues such as staggered boards, executive compensation, and dual class voting. The information provided drives vote decisions that have helped improve many facets of corporate governance for decades.

Despite the plodding pace of change, corporate insiders bristle at the accountability that the proxy voting system has created. Public company lawyers and bankers, industry trade groups, and corporations have lobbied the SEC to put a stop to the practice.

The approval of these proposed changes will have significant detrimental consequences. Among the many negative impacts could be reckless, unnecessary, and prolonged litigation causing proxy advisors to shirk from delivering their most candid assessments—the exact product that investors pay for and expect from advisors. Increased costs will be borne by proxy advisors’ shareholder clients and their beneficiaries—the very people the SEC is duty-bound to protect.

The SEC’s proposed rules would invite public companies to sue proxy advisors and create a chilling effect on independent perspective. The proposed rules would require proxy advisors to give public companies two advanced drafts of proxy advisors’ reports before investors get access to the advice for which they paid.

Paving the way for securities litigation in the context of proxy advice is a troubling idea. Giving companies a preview of proxy advisors’ recommendations and the ability to interfere with that advice before their paying customers get that information makes that bad idea much worse.

Likewise, investors deserve to receive clear, unbiased advice. It is just as much in the interest of shareholders as it is in the interest of advisors to firmly oppose the proposed rules. There is widespread opposition to this proposal from these investors, who are the actual clients of the advisory firms.

The claim that proxy advice is rife with errors is based on flimsy evidence. Analysis by the Council of Institutional Investors indicates that errors in proxy advice are extremely rare, estimated at less than 1%.

Holding corporate managers accountable through corporate democracy in the age of Big Tech, climate disasters, and political polarization is a challenge in and of itself. Obstructing proxy advisors by increasing litigation costs and allowing corporate interference with shareholders’ research will make it nearly impossible for investors to engage with companies responsible in part for some of the most complex issues of our time. The SEC should facilitate, rather than hinder, market-based accountability mechanisms.

The writers are the state treasurers of Illinois (Michael Frerichs), Pennsylvania (Joe Torsella), Rhode Island (Seth Magaziner), and Connecticut (Shawn Wooden).