Louis Brandeis, before his nomination to the Supreme Court, observed that “sunlight is said to be the best of disinfectants.”
The federal securities laws were built around this concept, that more information to investors is the best protection.
Ten years after Lehman Bros.’ bankruptcy, corporations are pushing to restrict how much, and how frequently, they must provide information. With a strong economy, low unemployment and the stock market near record highs, executives are striking back at rules they believe hamper their ability to make profits — even as they make more than ever. The common complaint is that disclosure requirements force companies to focus on the short term at the expense of making investments that may pay off years later.
President Donald Trump tweeted on Aug. 17 that “some of the world’s top business leaders” want to stop reporting financial information quarterly. He said he would ask the Securities and Exchange Commission to look at requiring disclosure only every six months.
The tweet raises a number of questions. Is less disclosure better for corporate America? If so, are six months the right interval? Could information be released annually, or perhaps just left to the best judgment of corporate managers about what should be disclosed? That is how most private companies, like Uber and Airbnb, are allowed to operate, because they have chosen not to tap the public markets for capital.
Jay Clayton, the SEC’s chairman, has asserted that protecting the “Main Street investor” is a key mission for the agency. But the recent thrust of the SEC appears to be moving away from disclosure and toward allowing companies to put out less information to the investing public.
In a recent meeting about entrepreneurship, Clayton said he wanted to make it easier for retail investors to buy shares in private companies, noting that these can be “pretty risky” but that “people want that.” Private companies have minimal disclosure obligations, which was one reason Elon Musk, the chief executive of Tesla, floated the idea of taking his intensely scrutinized company private.
But much as a child would prefer a dinner without vegetables, giving in to investors who want to buy the latest hot startup is not necessarily a good idea. Just last week, a onetime darling of Silicon Valley, Theranos, announced it would dissolve. The move will cost the high-net-worth individuals and private equity firms that invested in it nearly $1 billion. If Theranos could have tapped into the retail market, a group Clayton has called “Mr. and Ms. 401(k),” the devastation from the company’s collapse would have been far worse.
Lawsuits against management and directors for failing to fulfill their fiduciary duties, or against a company for making faulty or incomplete disclosures, are the best way for shareholders to police companies. These lawsuits are the bane of corporate management.
One way to limit them would be to require that these claims be heard in arbitration rather than as a public class-action lawsuit. But the SEC has long taken the position that federal securities law prohibits a company from requiring that claims be brought in arbitration rather than in federal court. In 2012, the agency kept the Carlyle Group from including an arbitration requirement that would have barred shareholders from filing class-action lawsuits as part of its planned initial public offering.
But the SEC may soften its position on arbitration of shareholder claims. In July 2017, Michael Piwowar, an SEC commissioner at the time, floated the idea that companies could put mandatory arbitration into their charters. Clayton said in a letter to Rep. Carolyn B. Maloney, D-New York, in April that allowing arbitration was “not a priority for me,” although he tempered that by pointing out “it does not mean that it is not worthwhile to analyze.”
Does that mean the idea is dead, or is the SEC just waiting for the right company to request dispensation to limit shareholder access to the courts for challenging management? Once the SEC permits arbitration of claims, companies can be expected to jump on board quickly.
Of course, disclosure is not always perfect. The collapse of Lehman Bros. showed that. A report by the bankruptcy examiner pointed out how the company used an accounting trick, called “Repo 105,” at the end of the first and second quarters in 2008 to make the firm’s financial statements look stronger than they were. Yet neither the SEC nor the Justice Department ever pursued charges related to Lehman’s accounting, so perhaps the questionable tactic was not enough to warrant a claim that investors were defrauded.
Last week, Musk joined a late-night webcast during which he appeared to smoke marijuana along with the host. That is hardly a securities law violation, but the disclosure the same day that the company’s recently appointed chief accounting officer had resigned sent a chill through Wall Street because investors rely on strong internal controls in putting together financial reports.
Management prefers less disclosure on the premise that it can invest for the long term. In an era when activist investors routinely take on corporate boards, such as Third Point’s seeking to remove all 12 directors from Campbell Soup, limiting how frequently a company must release information could also forestall outside challenges, further insulating management.
What is the best protection for shareholders? The SEC does not review whether an investment is a good one, only whether enough information is available to judge the potential risks and rewards. Less disclosure would make that assessment more difficult, and leave investors guessing whether an opportunity is a good one — or a sinkhole for their money.