Remarks by Commissioner Uyeda at the Practicing Law Institute’s 55th Annual Institute on Securities Regulation

Thank you, Keir [Gumbs], for that kind introduction. It is nice to see you, Meredith [Cross] and Joan [McKown], all of whom I have known for most, if not all, of my time at the Commission. Congratulations to each of you for chairing what is one of the premier securities regulation conferences in the country.

Yesterday at this conference, leading practitioners and members of the Commission staff discussed a variety of issues affecting public companies. Today, I will add my thoughts. As you might expect, my remarks today reflect my individual views as a Commissioner of the SEC and do not necessarily reflect the views of the full Commission or my fellow Commissioners.

Since becoming Commissioner sixteen months ago, the SEC has finalized five rulemakings affecting public company disclosure – pay versus performance,[1] clawbacks,[2] amendments to rule 10b5-1,[3] share repurchases,[4] and cybersecurity.[5] The Commission also has climate-related disclosure and SPACs as pending proposals[6] and human capital management[7] and corporate board diversity[8] on the rulemaking agenda. Given the current emphasis on additional public company disclosure, I will share four thoughts about disclosure rulemaking.

1. Determining the Purpose of Rules

First, the initial first step of any rulemaking is to answer the question: what problem is the Commission trying to solve?[9] Sometimes, Congress may have directed the Commission to issue a rule. Other times, market events may raise new concerns or vulnerabilities that have not been previously addressed. More recently, for public company disclosure rulemakings, the answer is often that investors desire the additional information.

Protecting investors is part of the Commission’s mission and we should listen to them. However, such demands for disclosure should not be taken at face value. In that respect, the Commission should undertake at least two forms of critical analysis before proceeding.

First, the Commission should evaluate the costs for disclosing the additional information. These costs include direct costs, such as fees paid to attorneys and other outside advisors, as well as opportunity costs, such as management’s time and efforts that could have been focused on other projects accretive to the bottom line. These costs ultimately reduce the company’s earnings that are available to shareholders. The question should not merely be whether investors want the information, but rather to what extent are investors willing to pay for that information.

Investor demand for specific types of information tends not to be universal. Hence, a free rider problem exists when only a few investors desire such information, but the cost of disclosing that information is borne by all shareholders. As a result, the investors who did not seek the information are effectively subsidizing the investors who requested that information.

This free rider problem is worsened when there is a desire to have consistent and comparable information across all public companies.[10] For instance, investors at one company may find certain information important when making an investment decision. However, at a different company, investors might find that type of information to be meaningless because of differences in the company’s industry, business model, or regulatory environment, among other reasons. While consistency and comparability may be nice ideals when considered in a vacuum, the costs to achieve such ideals can be exorbitant.

In rulemaking, the Commission has statutory obligations to consider costs and any effects on efficiency, competition, and capital formation.[11] These obligations are especially important where the costs to prepare the disclosure are significant and mutualized among all investors, but the benefits would accrue only to a select subset.

Second, when considering investors’ demand for disclosure, the Commission should analyze why they are requesting the information from public companies. Being an investor simply means owning stock in a company, but an investor does not necessarily seek certain information to help it value the company’s stock. Investors may have different purposes or reasons for asking for the information. For example, an investor may want the information in order to sell investment products or services based on it. Or an investor may want the information to use in private negotiations with the company. Or an investor may want the information because it seeks to use the disclosure as a means to drive social change.

Using the Commission’s disclosure regime to address social issues under the guise of stock ownership raises concerns. The Commission is an independent regulatory agency, and none of the Commissioners have been elected by the American people. On the other hand, the legislative branch, elected by the voters, has a broad range of powers and authorities for addressing society’s problems. Using the Commission’s disclosure rules to address these social problems is not only ineffective and inefficient, it is also outside of the Commission’s statutory authority and expertise. The Commission must be especially mindful of how it exercises its rulemaking authority due to its limited political accountability.

While it may be difficult to determine the reasons for why certain investors demand particular information from public companies, the Commission has tools to conduct this analysis, including investor testing as authorized by the Dodd-Frank Act.[12] This analysis, together with consideration of the costs of providing the information, can help the Commission identify the specific problem that it is trying to solve at the outset of a rulemaking.

2. Re-proposing Rules

Once the Commission has answered the question of what problem it is trying to solve, it then must conduct an effective rulemaking process. In my view, the notice and comment process of a rulemaking is an invitation to have a conversation between the regulator and the public. Rules should not be adopted without informed engagement with stakeholders. Sometimes, this process starts through public roundtables, requests for information, or an advance notice of proposed rulemaking, before the Commission issues a proposing release. But most times, the engagement does not start until the proposal is posted to the Commission’s website.

This brings me to the second topic. The Commission does not always get the original proposal right and sometimes must contemplate making significant changes to the proposal — a version 2.0 so to speak. In this situation, an important decision to make is whether to re-propose a rule and provide a revised economic analysis. Re-proposing a rule is also appropriate when significant time has passed since the original proposal.[13] However, the Commission has rarely re-proposed rules in recent years, even when both conditions were present. As a case study, let us examine the pay versus performance rule.

The Dodd-Frank Act directed the Commission to adopt a rule requiring public companies to disclose “the relationship between executive compensation actually paid and the financial performance of the [company].”[14] The Commission finalized this rule in August 2022, about two months after I became a Commissioner. As it so happens, I had previously reviewed the proposed rule in April 2015,[15] when I was counsel to Commissioner [Michael] Piwowar. Despite the seven-plus years between proposal and adoption, the only step taken by the Commission in the interim was to reopen the comment period in January 2022 for a brief 30 days.[16] The lack of an updated economic analysis in the reopening notice was notable and not consistent with the Commission’s stated focus on obtaining robust data.[17] Just as troubling is how the final rule significantly changed the calculation of “compensation actually paid” and the treatment of equity awards, without seeking public feedback on this revised methodology.

The implications of this change were reflected in the pay versus performance disclosure during the past proxy season, which was the first one following the rule’s effective date. Approximately 34% of companies subject to the new rule reported a negative amount for the principal executive officer’s “compensation actually paid” in one of the three years included in the new pay versus performance table. [18] Although the statute’s focus is on the relationship between an executive’s “compensation actually paid” and the company’s financial performance, it is hard to believe that Congress would have expected the Commission to adopt a rule where more than one-third of companies explain this relationship by reporting a negative number.

How did these negative numbers come to be? The answer lies in how equity awards are valued as part of the “compensation actually paid.” Under the proposed rule, companies would have used the fair value, as of the vesting date, of any awards that vested during the year.[19] This amount could not have been negative. However, the final rule required companies to use the change in fair value of awards from the beginning of the year though the end of the year or the vest date during the year.[20] If a company’s stock price were to decline during that period, then any associated decline in fair value could result in negative “compensation actually paid.”

In the 2015 proposing release, the Commission discussed the approach of including equity awards based on changes in fair value and noted that such changes could result in a negative number.[21] Of the more than 150 comments received on the rulemaking,[22] only two commenters supported this approach.[23] The only mention of this approach in the 2015 proposing release was as an “implementation alternative”[24] in the economic analysis section.[25] When an alternative is buried deep in the economic analysis, I wonder how widely it was noticed by the public. More importantly, because the 2022 reopening notice lacked an updated economic analysis, commenters were not reminded of this alternative from nearly seven years before. Unsurprisingly, the Commission did not receive a lot of feedback on this alternative during the reopened comment period.

If the Commission had re-proposed the rule in 2022 with the modified calculation of “compensation actually paid” based on changes in fair value, would things have come out differently? While we may never know, doing so would have at least offered market participants an opportunity to focus on the issue. The Commission would then have had a broader set of views on the approach’s advantages and disadvantages. Some commenters might have discussed whether the potential for disclosure of negative “compensation actually paid” is useful to investors.

The takeaway from the Commission’s process for proposing and adopting the pay versus performance rule is a stark reminder not to take procedural shortcuts. This process was far from rulemaking best practices[26] and the consequences are apparent in the results. In reporting on pay versus performance disclosure, one publication questioned whether shareholders might interpret negative “compensation actually paid” as if the CEOs theoretically owed their companies money[27] and another observed that “the new ‘compensation actually paid’ in not compensation actually paid.”[28]

It is bad enough that the disclosure may not be understandable or material,[29] but even worse, preparing the disclosure may impose significant costs on companies. Much of these costs arise from hiring consultants to make the equity award fair value calculations not otherwise required by the Commission’s prior executive compensation rules. According to one trade association survey, over 50% of companies expect to spend at least $40,000 on consultants to make these calculations.[30] A rule that is both costly and ineffective is something that a regulator must avoid.[31]

Hopefully, the Commission will consider learning from the lesson of the pay versus performance rulemaking as it moves forward with other rulemakings, including climate-related disclosure. This proposal has received over 16,000 comments.[32] The volume of comments is not surprising given the proposal’s expansive nature and the hundreds of requests for feedback contained in it. Most commenters did not focus on, or address, every single issue or alternative raised in the proposal. Before the Commission adopts any final rule that significantly deviates from the proposal, it should seriously consider re-proposing the rule with revised rule text and an updated economic analysis. Doing so would provide the public with an opportunity to focus on aspects of the proposal that they did not initially consider, and perhaps more importantly, submit feedback on any revised requirements. Such a re-proposal may ultimately help the Commission craft a better rule for all market participants. The Commission should do everything possible to not promulgate a rule that is costly and ineffective, as doing so might be indicative of a flawed process that raises the question of whether the rule is arbitrary and capricious under the Administrative Procedure Act.

3. Scaling Rules

In the rulemaking process, appropriately scaling the rule’s application to companies based on their size and maturity as a public company is as important as not taking procedural shortcuts. Hence, scaling rules is the third topic.

The Commission introduced scaled disclosure based on a company’s size in 1992 with a category of companies called “small business issuers.”[33] In 2007, the Commission replaced the concept of “small business issuer” with “smaller reporting company.”[34] Currently, a company qualifies as a smaller reporting company if its public float is less than $250 million.[35] A company can also qualify if it generated less than $100 million in annual revenues and had a public float of less than $700 million.[36]

In its 1992 proposal to provide scaled disclosure requirements, the Commission recognized that smaller companies “are disproportionately affected by the complexities in the disclosure requirements.”[37] Despite this longstanding view and commenters’ concerns about outsized costs, the Commission did not provide scaled disclosure relief in its recent rulemakings for cybersecurity,[38] share repurchases,[39] amendments to rule 10b5-1,[40] and clawbacks.[41]

Even if disclosure requirements are not scaled, the Commission could stagger a rule’s compliance date for smaller reporting companies. This approach allows such companies to benefit from the time and efforts of larger companies to comply with the new rules. For example, law firms, auditors, and other advisors may have already gained familiarity with new policies or new disclosure language used by larger clients. Smaller reporting companies using those same advisors may be able to reference those policies and disclosures when they begin to comply with the new rule, thereby reducing costs. Despite these potential benefits, the Commission did not provide staggered compliance dates in the share repurchase[42] and clawbacks[43] rulemakings.

Similar to smaller reporting companies, emerging growth companies can benefit from scaled disclosure requirements. Generally, an emerging growth company is a company that has been public for not more than five fiscal years and has not exceeded $1.235 billion in annual revenues.[44] The primary rationale for scaled disclosure for emerging growth companies is to give them an “on-ramp” for compliance with disclosure requirements as they mature into seasoned public companies.[45] Despite this rationale and past bipartisan Congressional support[46] for emerging growth companies, the Commission similarly did not provide any scaled disclosure in its rulemakings for cybersecurity,[47] share repurchases,[48] amendments to rule 10b5-1,[49] and clawbacks.[50]

While scaling disclosure for smaller reporting companies and emerging growth companies is an important consideration, the Commission should think about whether further scaling is appropriate for other public companies as well. For instance, the Commission should consider applying scaled disclosure using the model of a triangle. Companies at the base of the triangle would be the smallest and least seasoned public companies. The companies in the middle are larger and more seasoned. Finally, the companies at the top of the triangle are the largest seasoned companies. As a company ascends the triangle, it should provide more disclosure to investors.

Using the Commission’s current categories for public companies, smaller reporting companies and emerging growth companies would be at the triangle’s base, accelerated filers would be in the middle, and large accelerated filers would be at the top. This approach considers the disproportionate costs affecting smaller companies and the need to provide an “on-ramp” to newly public companies. It also recognizes that not all seasoned companies are equal in terms of legal and financial reporting personnel, budgets for outside counsel, auditors, and advisors, and board and management time to devote to the Commission’s ever-growing disclosure requirements.

Today, an accelerated filer with a $250 million public float would be subject to the same disclosure requirements as a large accelerated filer with a $250 billion public float. However, the accelerated filer is likely to have much fewer resources to comply with those requirements. By mandating certain disclosure from only large accelerated filers, the triangle approach creates a new “middle class” of public companies. From an investor protection perspective, all public companies would continue to be subject to the Commission’s antifraud rules,[51] as well as the requirement to disclose material information necessary to make any required statement not misleading.[52]

To create this triangular model, the Commission would need to make two changes to existing rules. First, based on the number of companies in each category, the current pool of public companies does not form a triangle. Rather, it forms a distorted hourglass. Approximately 56% of companies are smaller reporting companies or emerging growth companies, 7% are accelerated filers, and 34% are large accelerated filers. [53]

These percentages are not surprising given that the public float threshold of $700 million for qualifying as a large accelerated filer[54] was established in 2005.[55] At the time, approximately 18% of reporting companies had a public float of at least $700 million.[56] Today, the top 18th percentile for reporting companies’ public float is approximately $3.2 billion; if the threshold was adjusted to that amount, over 50% of the current large accelerated filers would no longer be treated as such. [57] Accordingly, to create a triangular structure, the Commission should increase the threshold so that the number of accelerated filers is relatively higher than the number of large accelerated filers.

Additionally, the Commission should evaluate whether to limit certain disclosure only to large accelerated filers. Currently, only one requirement differentiates large accelerated filers – the 60 day deadline for filing Form 10-K.[58] The Commission should review its disclosure requirements and identify rules that should apply only to the largest seasoned companies.

A triangular approach to scaled disclosure reflects the idea that the public markets should not be simplistically divided between small companies and large companies. Establishing a meaningful “middle class” of companies that are subject to many, but not all, of the Commission’s disclosure requirements recognizes the resource constraints that these companies have relative to the largest companies, without sacrificing the federal securities laws’ antifraud protections afforded to all investors.

4. Considering the Cumulative Costs of Rules

The fourth topic is the importance of assessing the cumulative costs – both human and financial – of the Commission’s rules with respect to public company disclosure. When the Commission makes this assessment, it does so in a vacuum and considers only the rulemaking at issue. To obtain a true sense of how much the new regulations will cost public companies, there should be a review of the cumulative costs of all rules.

For public companies with a December 31 year-end, the compliance date of rulemakings covering pay versus performance, clawbacks, amendments to rule 10b5-1, share repurchases, and cybersecurity will take effect between the 2023 proxy season and the 2025 proxy season. Here is a summary of what companies are facing:

• 2023 proxy season: pay versus performance began to apply;[59]
• February 2023: the new requirements for rule 10b5-1 plans and reporting of dispositions by gift on Form 4 began to apply;[60]
• April 2023: the new requirements for Section 16 reporting of rule 10b5-1 plan trades commenced;[61]
• July 2023: disclosure of rule 10b5-1 plans and “non-Rule 10b5-1 trading arrangements” that were adopted or terminated during the prior quarter must be included in Form 10-Q or 10-K;[62]
• December 1, 2023: companies listed on the NYSE and Nasdaq must have adopted their clawback policies;[63]
• December 18, 2023: Form 8-K reporting for material cybersecurity incidents begins;[64]
• 2024 proxy season, including the 2023 Form 10-K:
  • New disclosure of cybersecurity risk management, strategy, and governance;[65]
  • New disclosure of share repurchases, including adoption or termination of rule 10b5-1 plans for issuer share repurchases and reporting of daily repurchase data;[66] and
  • New disclosure of any efforts to claw back compensation and filing of the clawback policy;[67]
• 2025 proxy season, including the 2024 Form 10-K:
  • New disclosure of insider trading policies and procedures and filing of the insider trading policy;[68] and
  • New disclosure of policies relating to the timing of stock option grants and associated tabular disclosure for potential spring-loading and bullet-dodging grants.[69]

If that were not enough for public companies and their advisors, changes to long-standing Commission staff positions on rule 14a-8[70] contributed, in part, to a significant increase in shareholder proposals during the 2023 proxy season,[71] and there may be even more proposals for the upcoming season.

For each rulemaking, the Commission estimates the additional hours that the new requirements will impose on preparing a filing and allocates those hours between internal resources and outside professionals. When computing the costs for outside professionals like law firms, the Commission uses an hourly rate of $600,[72] which I view as unrealistically low. This rate was increased last year, starting with the clawbacks rule adoption.[73] For the sixteen prior years, the hourly rate for computing costs for outside professionals was $400.[74]

Aggregating the hours and costs across the five recently adopted rulemakings, the Commission estimates that the new rules will impose a mere 120 additional internal hours and about $24,000 of outside advisor fees, annually per company.[75] These estimates represent a worst-case scenario where all possible disclosure requirements are triggered, including having a material cybersecurity incident required to be reported on Form 8-K, engaging in share repurchases, adopting or terminating rule 10b5-1 plans, and clawing back compensation. Obtaining an accurate hours and cost estimate across all companies is extremely difficult. However, based on anecdotal feedback from public companies and their advisors, the actual internal hours and outside advisor fees for these rulemakings are likely to be much higher.

Just as the omakase menu at a Michelin-starred sushi restaurant will take longer and cost more to prepare than the mass-produced packages of sushi sold at a grocery store, drafting high-quality disclosure also imposes more time and costs on companies compared to preparing boilerplate disclosure. If the Commission expects to be served non-boilerplate disclosure[76] akin to the same care and attention to detail as a master sushi chef selecting the freshest ingredients at the Toyosu fish market,[77] then it should ensure that its disclosure rules’ hours and cost estimates reflect that quality.

Another way that the Commission may be overwhelming companies’ ability to produce quality disclosure is by setting compliance dates for multiple new disclosure rules over the same one or two proxy seasons. Drafting such disclosure, especially for the first time, requires significant involvement from in-house counsel and other personnel within the company. The Commission estimates that 75% of the hours required to prepare new disclosure falls on company personnel,[78] whose time is generally already constrained during proxy season.[79] When the Commission imposes multiple new disclosure requirements on top of those existing demands, company personnel may be hamstrung in their ability to craft the new disclosure without boilerplate language. Given the tight deadlines and resource constraints, it would not be surprising if companies rely more on boilerplate disclosure that provides little or no benefit to investors.

5. Conclusion

To conclude, the Commission might better accomplish its mission of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation by re-evaluating its approach to rulemaking for public company disclosure. By applying one or more of the considerations I discussed, the Commission can hopefully adopt rules that are effective, not costly, and of benefit to investors, markets, and issuers alike.

Thank you.