Editor: Based on the SEC’s recent speeches and actions, will the SEC take a more aggressive stance in prosecuting minor violations and more actively pursue officers and directors who fail to discharge their fiduciary responsibilities?
Tinnen: Yes. SEC Chair Mary Jo White has consistently made it clear that it is her intention to pursue minor violations. In October 2013, she referred to the policing tactics of Mayor Giuliani and the “broken windows” theory as her paradigm for SEC enforcement and stated “…minor violations that are overlooked or ignored can feed bigger ones, and, perhaps more importantly, can foster a culture where laws are increasingly treated as toothless guidelines.” As a former U.S. attorney, I believe that it is important to her to pursue even the smallest infractions.
While SEC brought fewer actions in 2013 than in 2012, Chair White was quick to highlight that during 2013 the SEC brought actions against nearly two dozen firms for improperly participating in public offerings of stocks soon after selling short those same stocks. In those cases, the staff obtained disgorgement of the defendants’ profits, which ranged from as low as $4,000 to more than $2.5 million.
In a speech in May 2014, Chair White also noted that since the beginning of the 2011 fiscal year, the SEC has charged individuals in 83 percent of its actions, clearly dispelling any misconception that there is a preference to pursue corporations.
Chair White has also mentioned that there would also be greater emphasis on international and cross-agency cooperation, and under her leadership the SEC has changed its long-standing “no admit/no deny settlement policy,” which did not require certain wrongdoers to publicly admit what they did. She has a new focus on going after “gatekeepers.” Obviously, this includes attorneys as well as their clients. She has also creatively used Section 20(b) and 20(e) of the Exchange Act to penalize professionals who indirectly violate laws or aid and abet violations. She is also using tons of technology. I do think, given that this is her focus and it takes time to build the cases, we will see an increase in cases involving minor violations.
Editor: What trends do you see affecting the role of proxy advisors?
Tinnen: Many institutional investors largely outsource their voting decisions to proxy advisors relying on SEC no-action letters, which effectively relieved them of a duty to prove they have voted proxies in the best interests of their clients if they adopt a policy to vote their clients’ securities based upon the recommendations of an independent third party. This encourages funds to seek proxy advisor advice rather than doing the analytical work themselves.
The power of ISS and Glass Lewis has increased in recent years because mutual funds have become a larger force in investing, holding a substantial majority of the assets of the 1,000 largest public companies.
A December 2013 roundtable on proxy advisors led to the SEC putting out Staff Advisory Bulletin 20 on June 30, 2014, that provides guidance but places no new rules or obligations on proxy advisors or investment advisors. The guidance does not require investment advisors to disclose conflicts of interest, but does state that investment advisors should, no less frequently than annually, review their proxy voting policies and procedures to ensure that they are reasonably designed to result in proxies being voted in the best interests of their clients.
Proxy advisors have been under scrutiny for quite some time, but the SEC does not appear to have the appetite to reverse the power that the SEC has bestowed on proxy advisory firms. As former chairman Harvey Pitt said, “Proxy advisory firms are unregulated; more significantly, they operate without any applicable standards – either externally imposed or self-imposed – and do not formally subscribe to well-defined ethical precepts, while cavalierly rejecting private sector requests for transparency in the formulation of their proxy advice, as well as increased accountability for the recommendations that they make.”
I don’t think that we’ll see a diminution in their role. However, the scrutiny of their activities will persist particularly since ISS, one of the leading proxy advisors, has been purchased by Vestar Capital. Glass Lewis was also sold and is now owned by Ontario Teachers’ Pension Plan. In both cases, this presents interesting and new dilemmas about their conflicts or potential conflicts. It calls into question whether or not their actions are wholly based on what’s best for investors or partly on their own needs and desires.
Editor: Do you expect to see the SEC providing more incentives to whistleblowers? Do you expect a loosening of standards for whistleblowers?
Tinnen: Not likely. The SEC rules went into effect in August 2011. They provide for payments of 10 to 30 percent of the sanctions where the whistleblower voluntarily provides original information about a violation of the federal securities laws that leads to a successful enforcement action in which the SEC recovers monetary sanctions over $1 million.
Announced payouts to whistleblowers so far in 2014 are well below the amount announced for 2013. During Fiscal Year 2013, the SEC made over $14 million in award payments to whistleblowers. Announced whistleblower payments so far in 2014 are only $1,425,000.
Complaints in 2013 did exceed tips in 2012 (about 3,238 versus 3,001), however, one would expect complaints to decline as more employees are encouraged to disclose through the company’s internal reporting mechanism.
I don’t expect a loosening of standards for whistleblowers. As a matter of policy, the Dodd-Frank Act and the SEC regulations that have followed were largely designed to foster transparency. This purpose is served if whistleblowers are encouraged to use the up-the-ladder company complaint systems, even if no bounties are paid as a result. From an enforcement standpoint, it is preferable for the staff and much more efficient for the public investors at-large for companies to self-report and pay any applicable fines rather than the staff initiating enforcement proceedings, exhausting resources to litigate, and, if successful, collecting funds from companies (and therefore the shareholders of such companies) to distribute to whistleblowers.
Editor: Do you expect to see a broadening of the SEC’s role in setting corporate governance standards?
Tinnen: Not in the near future. Commissioner Luis Aguilar has been particularly vocal about the importance of corporate governance and the need for additional measures. In June 2014, he spoke about potential corporate governance requirements relating to cybersecurity. This could be an area that could gain more traction, particularly if there are more public data breaches. In March 2014, Commissioner Daniel M. Gallagher spoke about significant modifications to proxy rules that determine when and if a shareholder proposal is required to be included in a company’s proxy statement. Commissioner Gallagher’s thoughts about changing the shareholder proposal rules would have a huge impact; however, I think there’s probably not a lot of appetite to make such significant changes.
Editor: What have been the results of Dodd-Frank’s “say-on-pay” provision thus far during this proxy season?
Tinnen: Interestingly, 91 percent of companies have received a greater than 70 percent vote in favor of their existing compensation arrangements. The large number of favorable votes is somewhat surprising in that there is still a lot of focus and public outcry about excessive compensation for executives of large firms. Only 24 companies have failed twice to get a majority since 2011. We are advising companies and their compensation advisors to be very diligent in their review and decision making related to their compensation programs and also to fully disclose (or even over-disclose) when possible in their proxy disclosure because of the litigation potential. None of our clients have failed to receive approval of their say-on-pay proposals, however, some have received immediate feedback from shareholders (some negative) about their compensation packages. Given the fact that plaintiffs’ firms read every line of the proxy statement, it is very important that the disclosure be thorough and accurate.
Some companies have received demand letters from plaintiffs’ firms that have alleged breaches of fiduciary duty related to the compensation of named executive officers. I don’t think that it was ever the intention of Congress, when it enacted the “say-on-pay” vote, to change or modify state law director duties pertaining to the compensation of executive officers or otherwise. However, there have definitely been more than a few plaintiffs’ firms that have come out with the contrary view that the compensation practices of certain firms are in themselves breaches of fiduciary duty, regardless of whether or not their directors are independent and the shareholders of such companies have approved the compensation for the prior year. Plaintiffs’ firms are jumping at this as an opportunity, which imposes a risk and presents a challenge for companies.
Editor: Will there be an expansion of SEC theories of liability for aiding and abetting and “causing” violations of the securities laws?
Tinnen: Yes. I think that the Chair has made clear that she will use all tools at her disposal, including pursuit of violations through “gatekeepers.” I’m not sure if we should characterize the use of such theories as an expansion of the law, but rather the expansion of the use of a previously underutilized resource (Section 20(b) of the Exchange Act) to implicate those who assist parties in a violation. She has made it clear that she will use this as a tool and therefore gatekeepers, such as attorneys, auditors and broker-dealers, among others, are on notice of the risk and, hopefully, in the best position to mitigate such risk. There is no doubt that pursuing actions indirectly through associated parties may also ultimately serve as another means to provide aggrieved shareholders with another means to get restitution.
Editor: Will the SEC become as active a regulator of the debt markers as it has historically been in the equity markets?
Tinnen: I don’t think that it will because of the profile of debt investors. The debt markets are dominated by large institutional investors. The general premise of most SEC rules is that the caveat emptor applies in markets dominated by very sophisticated parties. For example, a large mutual company, like Northwestern Mutual, invests billions of dollars per month in debt markets. It is a very sophisticated investor with investment managers and legal teams to do the diligence on those investments. The SEC is less interested in expending its limited resources to protect those types of institutions when there are so many mom-and-pop types of investors buying equities. However, given the decentralization and less-than-transparent intermediation of fixed income markets, the Chair has stated her desire to institute robust best execution rules for the municipal securities markets and also issue rules by the end of this year regarding disclosure of markups in “riskless principal” transactions for both corporate and municipal bonds.
Published August 22, 2014.