New England Biz Law Update
The proper function of a government is to make it easy for the people to do good and difficult for them to do evil.
— Gladstone
In writing this column, I reviewed recent government actions and noticed a clear theme: the federal government is getting more aggressive in business regulation. This is not a surprise, given the political party in power.
To fully explore recent government action would take this entire newspaper; I focus on two key agencies as prime examples.
Anti-trust and the FTC
On July 9, President Biden by executive order directed stricter enforcement of the anti-trust laws. In mid-September, the Federal Trade Commission voted 3-2, along party lines, to rescind Trump-era guidelines for vertical mergers. Immediately thereafter, the chief of the DOJ division announced that it was doing a “careful review” of the guidelines for both vertical and horizontal business combinations.
Democratic FTC Chair Lina Khan explained that the 2020 guidelines “contravened statutory text, and improperly suggesting that efficiencies or procompetitive effects may rescue an otherwise unlawful transaction.” Democratic commissioner Rebecca Slaughter complained that the over-turned guidance had a presumption that vertical deals were generally beneficial.
The two Republican commissioners objected, since now no guidance was extant. That point may be correct, but it also reflects the politicized situation at the FTC.
In the waning days of September, the FTC blogged it would require more information concerning deal impact on labor markets and on businesses outside the immediate vertical, and the effect of investment firm involvement. Look also for the FTC to review large companies gaining strength by series of small acquisitions of companies or patents, transactions that escape FTC review thresholds but if aggregated would require review.
The current drift should be a surprise to no one.
The FTC also has started to ask for names of key employees and for disclosure of information requested between the deal parties, to help FTC staff identify key issues.
Counsel in the anti-trust bar have already encountered such questions, as well as inquiries about deal impact on the environment and corporate governance. The panoply of issues within the “ESG” universe seems on the table. One senior anti-trust attorney queried the commissioners at hearing about any relationship between ESG issues and restriction on competition; press reports indicate that the FTC staff was unable to provide answers. Query also whether staff has expertise to evaluate any answers.
The new SEC
The SEC impacts capital formation, corporate communications, standards of governance, operation of trading markets, and the actions of major public corporations that dominate business and are required to affirmatively disclose everything that is going materially wrong. Below are four examples of recent SEC aggressive regulatory actions.
Crowdfunding. Since 2016, an SEC crowdfunding regulation has allowed small retail investors to invest in risky emerging enterprises, subject to controls on deal maximums and investor limits. In 2020, the annual total amount that could be raised by any crowdfunding company was increased to $5 million, and investor limits were substantially increased.
A key structural element of crowdfunding is that most transactions are conducted over a regulated portal set up by an independent company, which portal controls offering disclosure and mechanics. Such offerings are highly dependent on the practices of such a portal. On Sept. 20, in the first suit against any portal, the SEC alleged in Michigan federal court that one portal was a “gatekeeper,” a word the SEC uses when it wishes to charge breach of a near-fiduciary duty to uphold its law.
The portal was involved in two apparently fraudulent cannabis deals, which might attract governmental scrutiny anyway. But this case can be feared as the start of increased crowdfunding scrutiny; not to mention that attacks on crowdfunding portals could chill capital formation for emerging entities of the type the government wishes to foster.
Funds Voting Proxies. Funds, including ETFs, own about 30 percent of U.S. public equities. Almost half of U. S. households own shares in such funds. Funds vote their portfolio shares, unless they lend out those shares and do not recall them at stockholder meeting time. Current SEC practice requires funds, in Form N-PX, to disclose proxy votes; however, such forms can run 1,000 pages, are opaque in providing information (particularly when filed by managers of numerous different funds), and fail often to disclose specific votes.
On Sept. 29, the SEC proposed for 60-day comment a revised rule to require: clear identification of substantive matters being voted upon; specific formats and tagging so that investors can compare voting among filers; disclosure of whether a fund has recalled shares from loan in order to be able to vote on them.
Among vote categories listed in the rule is one for “ESG.” There also are unclear generalities: how to define “environmental justice”? The proposal raises the issue of SEC intentions; is this part of an agenda to influence the substance of fund voting? If so, is that a regulatory overreach, bearing in mind the current public discussion about holding corporations responsible to constituencies beyond shareholders economic return? One commissioner questioned whether there was embedded intent to effect social policy goals.
Analysis shows that shortly after the SEC clarified that funds could legally lend shares, an exercise that can add millions of dollars to income benefiting investors, institutional lending of shares prior to shareholder meetings increased 58 percent; clearly there is a market for acquiring votes through share borrowing. Commentators and one commissioner suggested that the proposed rule should require not only disclosure of the extent of, but also the economic profit derived from, the lending of shares, so that fund investors can evaluate the pros and cons of share lending.
DEI. The SEC also regulates business through supervision of SROs such as Nasdaq. Nasdaq rules for companies traded on its platform were recently amended, with SEC approval after some delay, to require companies, starting in 2022, to include at least one diverse director in its disclosure of board diversity; starting in 2023, two diverse directors or a public explanation of why not; in 2025 or 2026 (depending on the nature of the company), two diverse directors are almost mandatory.
The question is not the desirability of diversity (justice suggests it, and robust commentary ties economic performance to diversity), nor merely of making disclosure. Since the likely effect of the Nasdaq rule is to stigmatize noncompliant companies, the real question is: Does government have the right to de facto impact this private ordering of the governance of companies? Should investors be free to discount, or not care about, diversity?
Will the New York Stock Exchange be pressed to follow suit? Will the SEC? Note that two states already have mandatory board diversity policies, and others are considering it.
Crypto. Crypto currencies are misunderstood as to social impact, regulatory impact and business impact — and also whether they are securities.
SEC Chair Gensler for months has been presaging SEC rule-making on containing crypto abuses when they present securities law issues. And, there is ample regulatory history recognizing that something can be a security, or not, depending on context. The simplest example is the promissory note: a security when a company sells many of them, but not when you sign one for your home mortgage.
If only the SEC had a clear view of when crypto became a security. Meanwhile, it prosecutes deals where crypto clearly is offered, or used primarily, as an investment medium, and exerts pressure on crypto issuers to play it safe and register issuances “just in case.”
In September, Coinbase, reputedly the largest U.S. crypto exchange, discontinued its proposed crypto lending program based on reported SEC concern; the program would allow customers to lend their holdings in crypto as pegged to the U.S. dollar at 4 percent interest. I note that if you held U.S. dollars and lent them out at interest, you might run into lending, banking, CFPB, usury or fraud laws, but you would never hear from the SEC; and many other companies, not public, are already in the same lending business, or are offering interest payments on deposits of crypto (although reportedly state securities regulators are suing BlockFi and Celsius).
Another push against crypto came from the Department of the Treasury, which in September blacklisted a cryptocurrency platform for allegedly helping cybercriminals collect their ransomware winnings. The fact that the exchange was located in Russia did not likely detract from the U.S. desire to isolate it, but the fundamental regulatory question is whether government is best applied to attacking criminals or trading exchanges.
Some have condemned Treasury, insisting that such an exchange, availed of for illegal purposes, protects the companies victimized by cyber attacks. As a practical matter, business judgment as well as protection of shareholder value may require a legal channel for victims promptly to pay off the crooks. An odd analysis, it runs counter to the logical governmental position that, in the long run, society is much better off stopping crime than saving a few current victims.
Conclusion
I make no judgment on whether government activism is right or wrong, liberal or conservative, Republican or Democratic, old-fashioned or modern. I am identifying themes in current administration actions. The current drift should be a surprise to no one.
Stephen M. Honig practices at Duane Morris in Boston.
