Did Commissioner Gallagher Violate SEC Rules?

Professor Tamar Frankel is Professor of Law at Boston University School of Law. This post offers a critique of a paper by Commissioner Daniel Gallagher and Professor Joseph A. Grundfest, described on the Forum here. Additional critiques of the paper by Professor Jonathan Macey are available on the Forum here, here and here. A reply post to Professor Macey authored by Professor Grundfest and endorsed by Commissioner Gallagher is available on the Forum here.

Recently SEC Commissioner Daniel M. Gallagher issued a paper, titled Did Harvard Violate Federal Securities Law? (described on the Forum here and in a WSJ article here). The paper, co-authored with Professor Joseph Grundfest, expressed the Commissioner’s opinions regarding shareholder proposals and the Harvard Law School clinic that assisted public pension funds filing those proposals in the previous three years. The Commissioner did not mince his words. In his opinion, Harvard University and its clinic violated the securities laws by assisting proponents that failed to include references to academic studies contrary to the views of those proponents. The Commissioner was clearly presenting a threat to the University and its clinic. However, his statements also raise a number of questions about his own behavior.

To begin with, the Commissioner should have recognized that, as Professor Macey has shown in a series of posts (available on the Forum here, here, and here), his accusations are without merit and the proposals were entirely consistent with current SEC rules, policies and practices. Furthermore, in making his accusations, the Commissioner deviated from standard SEC procedures and practices.

I am unaware of any case in which a sitting SEC Commissioner released a paper accusing particular individuals or organizations of legal violations, and urging enforcement action and/or private suits against them, or used such public accusations as an instrument for urging other Commissioners or the SEC staff to change their policy. In a recent comment to the New York Times, Harvey Pitt brought up as a possible precedent a 1974 speech by then-Commissioner A.A. Sommer who expressed concerns about “going-private” transactions. However, Sommer’s speech (available on the SEC website here) did not mention (let alone accuse) any particular individuals or organizations (the only mention of any names in the Speech is in footnote citations to past court cases). There is a big difference between discussing general policy problems, which SEC Commissioners should be doing, and attacking or urging actions against particular individuals and organizations, which SEC Commissioners should not be doing.

The SEC Canon of Ethics (available here), which is binding on SEC Commissioners, warns SEC officials to be wary of using their “power to defame and destroy”. The Cannon of Ethics guides SEC officials to avoid defaming individuals or organizations. The Canon provides:

“§ 200.66 Investigations. The power to investigate carries with it the power to defame and destroy. In determining to exercise their investigatory power, members should concern themselves only with the facts known to them and the reasonable inferences from those facts. A member should never suggest, vote for, or participate in an investigation aimed at a particular individual for reasons of animus, prejudice or vindictiveness. The requirements of the particular case alone should induce the exercise of the investigatory power, and no public pronouncement of the pendency of such an investigation should be made in the absence of reasonable evidence that the law has been violated and that the public welfare demand it.”

To repeat: “[N]o public pronouncement of the pendency of such an investigation should be made in the absence of reasonable evidence that the law has been violated and that the public welfare demand it.” If Commissioner Gallagher expected the SEC and its staff to have a future investigation of the proposals the SRP assisted, the Canon of Ethics require him to avoid making public pronouncements about such a case. Of course, Commissioner Gallagher might well not expect such an investigation: Professor Grundfest has admitted that the disagreement which he and Commissioner Gallagher have, is really with the SEC and its staff, and that the SEC staff would have not found the SRP proposals deficient under its long-held policy. Therefore, Commissioner Gallagher might well have operated under the assumption that the SEC investigation and enforcement action he urged would in fact not take place. In such a case, however, issuing publicly a paper that urges enforcement action against particular individuals or organizations that the Commissioner knows or assumes would not be taking place raises questions of whether, contrary to the Canon of Ethics, the Commissioner’s actions might have been motivated by “animus, prejudice or vindictiveness” against these individuals and organizations.

These questions and concerns are exacerbated by the announcement made in a recent post (available on the Forum here) that Commissioner Gallagher’s and Professor Grundfest’s plan to publish new allegations to replace those discredited by Professor Jonathan Macey. After Professor Macey demonstrated that Commissioner Gallagher failed to notice facts that undermine the assumptions of his own analysis, a post, authored by Professor Grundfest and endorsed by Commissioner Gallagher, announced the authors’ new plan. The announced plan is to issue a revision of the authors’ paper. This revision will develop accusations of securities law violations points that the original version of the paper mentioned only in passing, and explicitly chose not to use as a basis for the original paper’s assertion of securities law violations. Commissioner Gallagher’s purpose seems to be to continue accusing the SRP proposals with new allegations that he himself chose not to make in the paper’s initial version. Engaging in this type of a public pursuit of particular individuals and organizations raises serious questions whether the Commissioner complies with the SEC’s Canon of Ethics.

Of course, the Commissioner may have a different view about fairness and ethics than is reflected in the SEC’s Canon of Ethics and standard procedures. Nonetheless, he is bound by SEC rules, including the SEC’s binding Canon of Ethics. He seems to have determined that he is not so bound. But so long as the Commissioner occupies his important governmental position, the Commissioner’s statements raise a serious question as to whether he is acting appropriately as a Commissioner and if he acted with “animus, prejudice or vindictiveness.”

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  1. Robert Barker
    Posted Wednesday, January 7, 2015 at 9:58 am | Permalink

    The Canon cited has nothing to do with the comments made by Commissioner Gallagher. It does not appear anywhere that Gallagher felt that Harvard would be investigated for its partisan conduct. It is precisely because there is not remotely likely to be an investigation into this kind of conduct that it needs to be discussed.

    The SEC’s mandate is not generally in the area of corporate governance, but in disclosure. As Roberta Romano has noted, Sarbanes-Oxley and Dodd-Frank are attempts to federalize corporate governance, at least for listed companies. The SEC’s mandate is not to object to leveraged buyouts, as Harvey Pitt noted, or to compensation that seems excessive to some, or even to self-dealing transactions. The SECs job is to make sure that disclosure is fair and impartial. That means, for example, that the SEC can mandate disclosure about executive compensation, and under Dodd-Frank, even the required ratio information (if the SEC can ever figure out what Dodd and Frank meant), but it cannot argue in favor of lower executive compensation. That is a matter of contract and the application of the rules of the governing documents of the applicable entity.

    In this regard, it seems evident that Harvard has violated the spirit of the securities laws at the very least, in taking biased and partisan approaches favoring one-sided shareholder proposals. Those proposals may or may not be relevant to the internal governance of the entity, but any academic approach should be consistent with law and unbiased. It does not appear to violate any code of ethics of Harvard University, but the code of ethics of the University appears more inward focused than outward focused, and like the code of ethics of MIT and other institutions, is not particularly well-suited to prosecuting false or biased testimony under the guise of advanced learning.

    Given no other forum for this debate, that no SEC investigation is on the horizon, and that the University does not appear willing to investigate its own conduct in an impartial way, I applaud Commissioner Gallagher for raising the issue in the manner that he and former Commissioner Grundfest did. It seems that it is not the Commissioners who are acting with animus, prejudice, or vindictiveness, but the students and faculty of Harvard University.

  2. Ed Durkin
    Posted Thursday, January 8, 2015 at 2:46 pm | Permalink

    This heated debate about the clarity of the supporting statements in board declassification shareholder proposals advanced by the Harvard Shareholder Rights Project and associated pension funds could potentially bear fruit. If the Harvard Project is guilty of anything it is the lack of intellectual curiosity about the impact of classified boards on corporate performance. Their advocacy relies too heavily on stale and limited issue research. However, with that said, the cited shortcomings of the supporting statements in question make no difference in the vote outcomes on the classified board proposals. The reality is that most voters, particularly institutional investors and their proxy advisory firms, have established voting positions on decades-old governance issues such as declassifying boards. Therein lies the real problem.

    As financial and capital markets evolve, it’s critically important to the health of our national economy and the corporations and investors in those markets that corporate owners regularly refresh their thinking on important corporate governance issues. Unfortunately, despite the solid research on classified boards cited by Commissioner Gallagher and Professor Grundfest there has been little or no new thinking about the role that classified boards might play in a corporate governance structure designed to advance long-term corporate value creation. The potentially valuable contribution of the Gallagher-Grundfest advocacy is not the legal or reputational challenges to the Harvard Project they construct; rather it is that their work might stimulate a long overdue re-evaluation of the role of classified boards in a modern corporate governance formulation.

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