U.S. capital markets, financial intermediaries, and U.S. corporations (both public and private) have grown weary as a result of a regulatory assault by the U.S. Securities and Exchange Commission (SEC) during the past three years. During this period, the SEC has hastily adopted various new rules that have the potential to upend U.S. capital markets without regard to decades-long industry practices and settled law. The breakneck speed, non-legislative-driven breadth, and disregard of the economic consequences and market disruption of the SEC’s rulemaking activities undermine the public’s confidence in the SEC. This article provides an overview of what’s wrong with the SEC’s recently adopted rules, the limitations on the SEC’s powers and authority, and the steps that lawyers advising affected companies should consider taking.

About the SEC

The SEC is an independent federal agency, established pursuant to the Securities Exchange Act of 1934 and headed by a five-member commission. The commissioners are appointed by the U.S. President and confirmed by the Senate. The president designates one commissioner as the chair. The mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

The U.S. has the largest, most sophisticated, and most innovative capital markets in the world. U.S. capital markets represent about 40% of the global capital market. A record 67 million U.S. families held direct and indirect stock holdings in 2019.

Federal securities laws task the SEC with a broad and diverse set of responsibilities, including to:

• Oversee annual trading of approximately $118 trillion in U.S. equity markets, $2.8 trillion in exchange-traded equity options, and $237 trillion in the fixed-income markets;

• Selectively review the disclosures and financial statements of approximately 5,248 exchange-listed public companies with an aggregate market capitalization of $51 trillion;

• Oversee the activities of more than 29,000 registered entities, including investment advisers, mutual funds, exchange-traded funds, broker-dealers, and transfer agents, who collectively employ at least 1 million individuals in the United States; and

• Oversee 24 national securities exchanges, 9 credit rating agencies, 7 active registered clearing agencies, the Public Company Accounting Oversight Board, the Financial Industry Regulatory Authority, the Municipal Securities Rulemaking Board, the Securities Investor Protection Corporation, and the Financial Accounting Standards Board.

The SEC has a major role to play and the power and authority to significantly affect important financial activity.

Leadership and Strategic Priorities of the SEC

The SEC is led by Gary Gensler. Gensler was confirmed by the U.S. Senate to serve as chair of the SEC on April 14, 2021, and sworn in on April 17, 2021. Gensler came to the SEC with a reputation as an aggressive rule-maker, earned as the chair of the Commodity Futures Trading Commission (CFTC) after the 2008 financial crisis. The 2010 Dodd-Frank Act required the CFTC to issue more than 60 rules in response to the economic downturn. Gensler finished most before he left in 2014.

The SEC’s strategic plan states that the SEC is focused on three goals that advance its mission:

• Protect the investing public against fraud, manipulation, and misconduct;

• Develop and implement a robust regulatory framework that keeps pace with evolving markets, business models, and technologies; and

• Support a skilled workforce that is diverse, equitable, and inclusive and is fully equipped to advance agency objectives.

Although all three goals might be important, it is the SEC’s view of a “robust regulatory framework” that has drawn much negative attention from the investment community over the past three years.

The SEC proposed and voted on more than 60 regulatory actions over the last two years, including 46 proposals and 14 final-rule adoptions. About half of them have come with 5-0 votes. Many of the other rules have been approved with only three commissioners voting in favor of the rules. Opposing commissioners have not been shy with their scathing dissents of the rules approved by their fellow commissioners, and the atmosphere seems to resemble that of the U.S. Congress.

This represents a dramatic increase in the pace of rulemaking from the previous two chairs of the SEC, who finalized 22 rules and 43 rules, respectively. In addition, the average public-comment period for SEC rule proposals during Gensler’s tenure has been only 46 days (measured from the date a proposal is published in the Federal Register). That is nearly 20% fewer days than the average comment period during the previous two chairs’ tenures. The number of new rules and the breadth of such rules is particularly surprising given that there are no mandates such as Sarbanes-Oxley or Dodd-Frank to drive the SEC’s rulemaking agenda.

What’s Wrong with the SEC’s Rules?

Many of the SEC’s new rules are administrative and were adopted with very little fanfare or consternation from capital markets. Examples of these include rules for the adoption of the updated EDGAR Filer Manual and for extending Form 144 EDGAR filing hours.

However, the SEC’s sweeping rules regarding private fund advisers, cybersecurity disclosures, and climate change and environmental disclosures have been met with much opposition and typically have one or more of the following six shortcomings.

1) Overhaul of Longstanding Existing Rules. Instead of taking a tailored approach to new disclosure or compliance matters, over the past three years, the SEC has repeatedly proposed new rules that impose unprecedented and unforeseeable new obligations on market participants. The climate disclosure rules, for example, taken as a whole, would impose a vast and costly new reporting regime on public companies that dwarfs even Sarbanes-Oxley implementation costs and would transform periodic SEC reports from filings that center on the financial and operating performance of companies into filings that, in notable respects, resemble what an environmental regulator might or does require.

2) Adoption of Rules Beyond the SEC’s Statutory Authority. The creation of many of the recently adopted or proposed SEC rules is subject to criticism on the basis that the SEC exceeded its statutory authority. Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc. is an often-cited case in administrative law.¹ It provides a framework for determining when a federal court must defer to an agency’s interpretation of a statute it administers. If the statute is clear about an issue, the court will interpret the statute according to its terms, no matter the agency’s views. But if the statute is ambiguous, the court will defer to the agency’s interpretation if the interpretation is reasonable. The rationale for Chevron deference is that Congress at least implicitly intends for the agency administering a statute (rather than Article III judges) to fill in any ambiguities. Chevron deference might have the consequence of enabling agencies to overstep their authority by treating vague language or doubtful gaps in a statute as authorization for actions that the agencies favor but that Congress never intended.

Increasingly, the U.S. Supreme Court has invoked the nondeferential “major-questions” doctrine (which requires agencies to identify a clear congressional statement authorizing decisions of substantial political and economic import) to displace Chevron deference. In 2022, the Court expressly approved of the major-questions doctrine in West Virginia v. EPA, in which the Court opined that an administrative agency has no power to make decisions on “major questions” of extraordinary economic and political significance unless Congress “clearly” gave it such authority.²

The SEC does not have general authority to impose climate-related and environmental-focused regulation. There is no statutory ambiguity that the SEC has cured in the past three years. There is no statutory basis for the SEC’s rulemaking on most of the controversial rules that it has adopted over the past three years, all of which relate to topics that fall into the category of being “major decisions.” Each fall and spring, the SEC publishes an overview of its regulatory agenda. The most recently published agenda included, among other topics, incentive-based compensation arrangements, corporate board diversity, disclosure of payments by resource extraction issuers and human capital management disclosure and climate change disclosure. Even when the SEC adopts rules that are explicitly dictated by statute, the SEC must be careful to narrowly tailor such rules. The SEC should show greater restraint when delving into major questions that it has no mandate to pursue.

3) Assumption that More Disclosure Equals Better Disclosure. Several of the SEC’s proposed rules ignore and substantially revise the longstanding and traditional conception of materiality.

The U.S. Supreme Court defines information as material if there is “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.”³ This definition has served as the legal standard of materiality for decades under the federal securities laws. This approach has advanced the best interests of investors, encouraged capital formation, and helped ensure the integrity of U.S. capital markets. Recent SEC rules often call for the disclosure of granular data and information that is required to be provided even if such information is immaterial under the standard the Supreme Court handed down decades ago.

Several of the SEC’s recent rules mandate extensive additional disclosure of immaterial information that is not useful to investors. Putting aside the significant burdens that this places on public companies to collect, prepare, and validate the new disclosures, there is substantial doubt that these new requirements lead to a better understanding of the complicated topics by investors. To the contrary, adoption of new rules without thoughtful analysis as to the additional benefits and value of such disclosure increases the likelihood that investors will be inundated with immaterial information that diminishes their capacity to make effective investment decisions and creates unnecessary confusion and misunderstanding. Annual reports on Form 10-K are often more than 150 pages based on current rules. Increasing the amount of disclosure by 25-50 pages without justification is harmful to investors.

4) First Amendment Questions. The SEC’s disclosure rules raise serious First Amendment issues that should be addressed. The First Amendment imposes important limits on the government’s ability to compel speech, including disclosure mandates under the federal securities laws. Led by the U.S. Chamber of Commerce, in May 2023 several groups sued to vacate the SEC’s rules on share repurchases, arguing that the requirement that companies disclose their rationale for repurchasing stock shares violates the First Amendment’s protections against compelled speech.

On Dec. 19, 2023, the U.S. Court of Appeals for the Fifth Circuit vacated the SEC’s share repurchase rules. The court had previously ordered the SEC to correct certain defects in the rules by November 30. When the SEC was unable to meet this deadline, the petitioners asked the court to vacate the rule and ultimately prevailed.

5) Disregard of Cost of Compliance. The SEC’s recent rules might discourage companies from entering or remaining in the public markets. For example, based on the vast cost and complexity of the new climate-reporting regime; the possibility of needing to divert managerial resources from other elements of the business, including resources needed to implement actions that reduce greenhouse gases emissions; and the opportunity for increased shareholder activism, many private companies will avoid accessing the public markets, limiting opportunities for retail investors to participate in the next generation of public company value creation. Many existing U.S.-listed public companies are likely to reach a similar conclusion and pursue efforts to exit the U.S. public markets while also avoiding transactional opportunities that could create value for shareholders, such as potential mergers, if pursuing such opportunities would require them to become subject to SEC-mandated disclosure obligations.

The National Association of Manufacturers recently issued a study that shows the macroeconomic impact of federal regulations. The total cost of federal regulations in 2022 was an estimated $3.079 trillion, an amount equal to 12% of U.S. gross domestic product and larger than the manufacturing sector’s entire economic output. SEC regulations are just a small part of the overall regulatory picture; however, they are an important and visible component of such costs.

Economic analyses in the SEC’s proposing releases are incomplete and routinely substantially underestimate compliance costs. For example, the adopting release for the SEC’s climate change rules included an estimate of the annual costs over the first six years of compliance to be $640,000 ($180,000 for internal costs and $460,000 for outside professional costs), while annual costs in subsequent years are estimated to be $530,000 ($150,000 for internal costs and $380,000 for outside professional costs). For smaller reporting registrants, the costs in the first year of compliance were estimated to be $490,000 ($140,000 for internal costs and $350,000 for outside professional costs), while annual costs in subsequent years are estimated to be $420,000 ($120,000 for internal costs and $300,000 for outside professional costs). These costs were expected to decrease over time for various reasons, including increased institutional knowledge, operational efficiency, and competition within the market for relevant services.

The Society for Corporate Governance submitted a letter to the SEC in response to the climate change rulemaking that provided a breakdown of climate-related disclosure costs for seven unnamed large cap firms across six different industries. The number of employees that the companies predicted would be needed to comply with the climate-related disclosure requirements ranged from two to 20 full-time equivalent employees. One large-cap firm in the energy industry reported that its reporting process involved 40 employees and six months of nearly full-time participation by 20 core team members. Employee hours spent on climate reporting ranged from 7,500 to 10,000 annually. Fees for external advisory services ranged from $50,000 to $1.35 million annually. This small sample set of data indicates that it is likely that the SEC’s estimate of compliance costs is far less than the actual costs to public companies.

6) Faulty Assumptions to Justify Actions. To justify its actions, the SEC has on occasion resorted to presenting an image of failed markets desperately in need of a prescriptive regulatory solution. For example, the SEC adopting release for its overhaul of private fund regulations includes a lengthy discussion about how private fund advisers and large investors wield undue bargaining and coordination power in negotiations over terms, and investors cannot simply withdraw from those negotiations. This rulemaking ignores the negotiating power and sophistication of private fund investors. Private fund investors are wealthy individuals and sophisticated institutions. Institutional investors – university endowments, pension funds, insurance companies, and sovereign wealth funds, to name several – are well represented by highly qualified professionals in their search for and negotiations with private fund advisers.

The new private fund rules banned well-established practices and outlawed mutually acceptable, negotiated investing terms with the goal of instituting rules that would more properly be suited for advisers working with unsophisticated retail investors. The SEC release ignored the fact that private fund assets have increased over the past decade, in large part because private fund assets have outperformed the public asset equivalents. Investors will not be able to waive the rule’s protections even if doing so would secure something better for them.

Adoption of rules based on faulty assumptions harms investors, advisers, and the economy. Advisers are likely to exit the market and, if so, competition will be reduced. If advisers choose not to serve private funds, companies throughout the economy will be affected because private funds are an essential source of capital.

Adoption of new rules without thoughtful analysis as to the additional benefits and value of such disclosure increases the likelihood that investors will be inundated with immaterial information that diminishes their capacity to make effective investment decisions and creates unnecessary confusion and misunderstanding.

What Can Businesses and Their Counsel Do?

First and foremost, counsel should keep businesses they work with apprised of proposed rules and final rules. It is advisable for companies to sign up at https://service.govdelivery.com/accounts/USSEC/subscriber/new to receive alerts from the SEC when new rules are adopted.

Second, it is advisable to submit comment letters, either independently or together with industry groups, to share clients’ concerns about proposed rules. The staff reviews each comment letter, and often final rules reflect the sentiments of market participants that have voiced their support for, or objection to, specific provisions of proposed rules.

The comment periods for recent SEC proposed rules have been extremely short, so time is of the essence. Attorneys should submit only information that they wish to make available publicly. To locate rules open for comment, browse the “Proposed Rules” section under “Regulation.” The online form can be accessed through the “Submit comments” link. Attachments to the form can be included. Comments can be emailed to rule-comments@sec.gov. The subject line of the message must include the file number for the rule. This is the number that begins “S7-”, “SR-”, or “4-”. If attaching a document, commenters should indicate the format or software used (for example, PDF, Word Perfect, MS Word, or ASCII text) to create the attachment.

Third, if the rule implications are significant enough, it can be worthwhile to challenge rules in courts. As alluded to above, private parties have successfully fought SEC rules in federal courts, resulting in certain SEC rules being vacated or remanded for modification. The significant costs associated with initiating a lawsuit are only warranted in situations in which the likelihood of success is high and the money saved by not having to comply with the rule is substantial.

Lastly, clients may consider lobbying their Congressional representatives to act on matters of particular concern. Congress has typically acted in the aftermath of catastrophic events such as the Depression (the Securities Act of 1933 and the Securities Exchange Act of 1934), Enron (Sarbanes-Oxley), and the 2008 great financial crisis (Dodd-Frank). However, less sweeping changes to laws may be adopted outside of the context of market meltdowns. Even proposals to modify procedures at the SEC, for example, requiring unanimous approval of commissioners could have a meaningful effect on the quality of rulemaking by the agency.

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Endnotes

1 Chevron U.S.A. Inc. v. Natural Res. Def. Council Inc., 467 U.S. 837 (1984).

2 West Vir. v. EPA, 597 U.S. 697 (2022).

3 BasicInc. v. Levinson, 485 U.S. 224 (1988).