In recent years, the legal rules governing shareholder corporations have vaulted into the headlines. In August 2018, Senator Elizabeth Warren introduced new legislation that would nationalize corporate governance, mandate union representation on corporate boards, and pare back company directors’ fiduciary duties to shareholders. Business as well as political leaders have signaled change: in a January 2020 letter to clients, Larry Fink, the CEO of the world’s largest asset manager, BlackRock, announced that his funds would stop investing in certain sectors under a new commitment to “sustainability.”

Against this backdrop, the federal government’s principal regulator in this space, the Securities and Exchange Commission, has been modifying its rules. In November 2019, the SEC proposed to reform the way the federal regulatory agency oversees the shareholder-proposal process and the proxy advisory firms integral to modern shareholder voting by institutional investors. On July 22 of this year, the SEC finalized one of these rules and issued new guidance for investment advisers’ proxy voting.

The Manhattan Institute is pleased to welcome SEC Commissioner Hester Peirce to discuss these policy changes, as well as her broader vision for the future of U.S. securities regulation. Sworn in on January 11, 2018, Commissioner Peirce has long been a leading thinker about these issues—including as a former contributor to the Manhattan Institute’s legal-policy weblog.

Event Transcript

James Copland:

Hi there, this is James Copland, and I'm happy to welcome everyone to the Manhattan Institute's Event Cast of the afternoon of August the 13th, 2020. It's my pleasure today to host this event and to interview my friend, securities and exchange commissioner, Hester Peirce. Hester and I have been friends since we were at the Yale Law School together, back in the late 1990s. She's been a friend of the Manhattan Institute, used to be a regular contributor on our Point of Law, a web blog that we used to run when she was a researcher at the Mercatus Center at George Mason university.

James Copland:

She's been on a leader on the Securities Exchange Commission the last couple of years, and she's recently been reconfirmed for a full-term going forward. So, she's going to be a commissioner for the SEC through 2025 or so.

James Copland:

She's got a distinguished career before with the SEC both as a staff attorney and as counsel to Paul Atkins, and was previously also a senior counsel for the US Senate Committee on Banking, Housing and Urban Affairs. Welcome commissioner Peirce to our Manhattan-

Hester Peirce:

Thanks, Jim.

James Copland:

... Institute Event Cast today. We're going to be talking today principally about issues of shareholder voting and securities regulation. Shareholder voting of course, is something that's principally substantively governed as a matter of state law of the United States, securities regulation. Falls under the ambit of the Securities Exchange Commission.

James Copland:

What prompted us to ask the commissioner here with us today to speak was recent final rulemaking, formalized rules that the commission did, particularly around the area of proxy advisory firms. I've been writing about this... I wrote about, I think my first Wall Street Journal piece on the proxy advisory firms was back in 2012 and a couple of professors at Stanford; David Larcker and Brian Tayan and I wrote a more extensive report on the question a couple of years ago.

James Copland:

Last November the SEC initiated formal rulemaking and just last month came out with a formal rule involving proxy advisory firms. Just to launch it off for everyone, the people who aren't securities law experts out there, or securities regulation gurus, commissioner, explain to us what do we mean when we talk about a proxy advisory firm? What are these firms, and particularly what made you think, or the other commissioners think that some sort of new SEC oversight was necessary here?

Hester Peirce:

Well, I should start out by spending that the views that I represent are my own views and not necessarily those of the Securities and Exchange Commission or my fellow commissioners. But it's a delight to be here and a delight to see you again, Jim. Proxy voting advice businesses as we call them and in sort of a mouthful in the final rule are entities that essentially, they provide voting advice to shareholders and they can help with the mechanics of voting proxies as well.

Hester Peirce:

They came about in part because of actions that the SEC took, or they got the amount of power that they have in the market, and part, because of actions that we've taken. Specifically in 2003, we adopted a rule that required the disclosure of funds votes. That put a new sense of pressure on advisors to funds to vote their shares. It can be an onerous task.

Hester Peirce:

What did they do? They came to the SEC, they asked, "Is it okay if we outsource?" The SEC said, "Fine, go... " The SEC staff said, "Fine, go ahead and outsource." We ended up in a situation where a lot of voting is now outsourced effectively to proxy voting advice businesses.

Hester Peirce:

Now, advisors play different roles with respect to directing the proxy advisors in what they should be doing in terms of the guidelines that they apply and so forth, but they play a very big role. When we looked at the situation, we said we need to make sure that the rules that we have that apply to people playing this kind of a role in the markets, we want to make sure that they're applying in this instance as well.

Hester Peirce:

There've been a couple of steps taken in recent years. One thing we pulled back those staff, no action letters that allowed this outsourcing to happen without much thought on the part of the investment advisors. But we also took a look at the proxy advisors and said, you're essentially playing a role that's proxy solicitation. So, we want to make sure that you're disclosing to people the conflicts that you have, and that you are allowing the people who are relying on your advice to see if the issuer has any response to what your advice is. Make sure that the people whose vote it ultimately is that they're seeing that response from the issuer as well.

Hester Peirce:

We'd heard quite a lot of concern from folks that the issuers were not confident that the advice that people were getting reflected the facts as they saw them. This way, it makes sure that everyone gets both sides of the story.

James Copland:

Thanks. That makes a lot of sense. I think there's a lot of consistency with some of the new roles and a couple of things that we talked about a couple of years ago. I may have a little feedback here. Explain a little bit more about solicitation. What does solicitation mean in this context? Why is it important to apply that to these firms, and how is that going to change the way you expect they may operate?

Hester Peirce:

Well, I think when you're seeing people in the markets and you're seeing them tell people how to vote their proxies or whether to vote their proxies, we've taken historically a fairly broad view of what solicitation is. What these firms were doing essentially looked to us like they were engaged in solicitation. With that, it means that there are obligations that flow to people who are soliciting votes on proxies.

Hester Peirce:

There are a set of rules that apply, but there are also a set of exceptions that if you meet those exceptions, you don't have to satisfy all of the other rules. What we did here is we worked on that framework and said, "If you're doing these things, if you're disclosing your conflicts, if you're giving the issuer a way to respond then, you fall within that exemption and you don't have to do the more onerous things."

Hester Peirce:

Again, the idea is we're seeing a lot of... When there's a vote, and when the proxy advice firm gives a recommendation, we see a lot of votes automatically recorded in accordance with the proxy advisor's recommendation. This was a recognition of the role that they're playing in the marketplace and trying to work with the systems that they had already themselves started to put in place. I think recognizing the role that they played. The firms themselves that said, "Hey, we need to do some things." They had put in some ability for interaction with the issuers to make sure that they were getting the facts right. Building on that, we adopted this rule

James Copland:

Makes sense. In terms of the conflict of interest, what exactly... Is it mostly a disclosure based rule on conflict of interest? You also put in some notice provisions with the new rule making. Can you explain that a little bit to our audience?

Hester Peirce:

The conflicts provisions are intended to really, as we do in many other areas, we want to make sure that people who are getting advice in this instance understand all the things that are happening in the background. If there are any conflicts that might lead the proxy voting advice business to give advice in one particular direction, that, that will be out there for people to understand and know, and to factor into how they use that advice.

Hester Peirce:

That's very similar to what we do in the area, for example, with investment advisors. We tell them, you have to disclose your conflicts. Think about how you might want to mitigate them. But at least you need to be giving full and fair disclosure. Then on the notice side, again, the idea is if a proxy voting advice business comes out with a piece of proxy voting advice, and the issuer has a response to it, the issuer is given an opportunity essentially to explain its side of the story, to the extent it's different. That's something that the proxy voting advice business has to help to make sure that its clients know that there's this other side of the story out there.

James Copland:

Got it. Got it, makes sense. Now, alongside the formal rule that you put out, you also introduce supplemental guidelines for investment advisors on how they were supposed to do proxy voting. What underlay this, why was it necessary? What's new there? You withdrew some of the old, no action letters that you talked about. What are the investment advisors supposed to be doing now under these new guidelines?

Hester Peirce:

Well, I think it's very important for investment advisors to remember what the purpose of their voting is. They're managing money on behalf of their clients. Their clients might be a fund like a mutual fund, or their clients might be individual clients, but ultimately the vote isn't their vote, it's the fund's vote or the other client's vote.

Hester Peirce:

As with anything else that they're doing for their clients, they need to be doing it carefully. That means if you're relying on third parties to help you do your job, in this case, to do your job voting, then you really need to think about what processes those third parties have in place to make sure that they're doing their job well, so that you know that you're relying on... You're getting good service to help you then provide good service to your clients.

Hester Peirce:

It was really a reminder to investment advisors to think about this carefully in the context of voting. Ultimately, they may decide... They and their clients may sit down together and decide it's not worth our time to spend our time voting. From my perspective, that's totally fine. But if you are going to take on that voting responsibility, then you have to do it with the same fiduciary care that you do the other aspects of your job.

Hester Peirce:

I think given some of the things that have been happening recently, and some of the, I would say misconceptions that some people have, I think it was really important for us to underscore that. Specifically, there's a lot of money now concentrated under the management of a number of very large asset managers. It can be tempting, I think for people who are managing money like that to think about the votes as being their own votes with which they can express their own preferences, but ultimately the vote belongs to the client. So, they're voting for the best interest of the client.

Hester Peirce:

An asset manager that's managing lots of different funds may actually end up voting shares for different funds in different ways, depending on what the objectives of the particular funds at issue are. I really want... From my perspective, why I thought the guidance was important is to get people to really think, okay, this vote is for this client and what's this client's objective, and how does voting as an initial matter fit into it? Should we be thinking a lot about voting for this particular client? If we are, what is the objective that we're trying to further?

James Copland:

We're already getting a few audience questions in and we'll open that up more later, but I do want to just make sure the audience understands. When you talk about an issuer, you're talking about the issuer of the securities, right? You're talking about the corporation that is holding the annual meeting. The SSC's role here is overseeing the proxy statement, really.

James Copland:

The SEC has become this regulator here, although the SEC's mission, as I understand it is principally one about disclosure to the financial markets. The substantive law with a few caveats and exceptions that have been added, but the substantive law is by and large, still a matter of state laws. Isn't that right

Hester Peirce:

Jim, you're taking us back to not first principles, but at least taking us a step back. I think that that's a really good place to go, and I think sometimes we at the SEC and other people, when they're looking at the SEC get a bit confused about what our role should be. I view us primarily as being a regulator of disclosure that corporations make. This is an interesting area because it's an area where states have... Not disclosure, but corporate governance has been an area where states have typically been the primary regulators.

Hester Peirce:

I think that that's an appropriate setup. I think there's a real value to federalism in this area. There are certainly times where it makes sense for the federal government to preempt state law. But I think we have to think carefully about what those instances are.

Hester Peirce:

This has traditionally been an area, chartering, corporate chartering has traditionally been an area that's been reserved to the states, and then the interactions between shareholders and the companies they own is something that state law has traditionally governed. I think that that is an appropriate role for state governments to play, and I think one of the benefits that comes out of that is that you can actually have different models, different states can try different things. We can see what works best, and that isn't something that you necessarily have to lift up to the federal level and have it uniform across the US.

Hester Peirce:

Any time that the SEC steps into this area, I do get nervous because I do think it's one that can take us beyond where our real value add is.

James Copland:

Makes sense. These first principles debates are being currently debated. I want our audience to understand, when we advertise for this Event Cast, we pointed out just about two years ago, Elizabeth Warren, Senator from Massachusetts introduced legislation, which would have required federal charters for large publicly traded corporations.

James Copland:

There's been a longstanding debate dating back at least to the '70s in the literature about whether it's more appropriate for these big corporations to be governed under state corporate law and a federalist structure or through a more centralized system. It is a debate. One of the preeminent corporate law articles talked about it being a race to the bottom. One of your predecessors, Carrie, wrote that article in the early '70s and then someone I clerked for, and we studied under Yale, Ralph Winter wrote the rebuttal saying, "No, it's really a race to the top." For the reasons you're articulating, at least most of the time, because if a state is really hurting the shareholders with its corporate law regime, then the ability to raise capital for the company is going to be affected by that.

James Copland:

There's been a lot of empirical work and it's not a hundred percent decisive, but I think Judge Winter's point of view has largely held the day, but certainly not exclusively depending on who you ask. It's a very interesting sort of debate.

James Copland:

Now, another step back we've got from the audience here, we're talking about voting and we're talking about the voting of shares with these publicly traded corporations. What's actually at stake in these votes? Why should someone out there in the public watching us today be concerned about this voting mechanism and what's going on?

Hester Peirce:

There can be lots of things that are at stake. The votes can range from things like thinking about existential events for a company. A merger, for example, could be something that would be the subject of a vote, or it could be things like executive compensation questions or it could be questions that are put on the ballot by another shareholder that they want you to think about something related to an issue that is important to that particular shareholder. It can range, and some votes frankly go more to the core value of the corporation than other votes do.

James Copland:

Let's talk about that a little bit, because there's a parallel rulemaking going on, I realize you can't comment on the rule making, as it's ongoing. There's not a formal rule yet, unlike the proxy advisory firm rule, but introduce at the same time in November on the shareholder proposals. This is something I've been studying for the last decade, somewhat extensively. The shareholder proposal thing is where the SEC control of the proxy statement, the disclosure in advance of the annual meeting has bled over a little bit substantively into the area of state law, corporate governance, because the SEC has been the gatekeeper for what gets on that proxy ballot and what are the qualifications you need as a shareholder to get something on the ballot.

James Copland:

Some of us who've been critical of this have pointed out that you have very small shareholders playing a disproportionate role here, arguably imposing costs on the rest of the shareholders in the company, certainly imposing some costs, but also in many cases, grabbing a hold of the corporate annual meeting process and pushing the company in various ways along social lines or policy lines or environmental lines, or what have you. What's your basic thinking around this yourself, again, without disclosing where the commission's going?

Hester Peirce:

Well, I think when we put out the proposal, we were responding to the fact that the rule has been on the books for quite some time and the threshold's in place for when, what allows a shareholder to put something on the ballot, essentially, to put something on the proxy? That those thresholds hadn't been really revisited for some time.

Hester Peirce:

We were taking a look that. I think you in your question really underscored something that has influenced the way I think about this, which is that you have shareholder for whom an issue is particularly important, and that shareholder wants other shareholders to think about that issue. Other shareholders have to pay essentially the bill for the proponent shareholder to put something on the ballot.

Hester Peirce:

You might say, "Well, that's not really that big a deal because the price of putting something else on the ballot, isn't really that big of a deal. But I think there's more to it than that. There's the time that executives spend thinking about these kinds of things or potentially responding. Sometimes the company will come in and do a backroom deal with the proponent shareholder to make the proposal go away. That raises all kinds of things really interesting, and I think really challenging questions about is that really how we want corporations to be governed, have a shareholder who has a fairly small stake in the company driving where the company is going?

Hester Peirce:

I think we do have to be careful about that. The goal of the rulemaking... Again, we've gotten tons of comments on this proposal and we're sorting through them. I think, I've really appreciated the fact that people have been very engaged with us on this rulemaking and people feel strongly and in many ways on both sides of this issue. But the idea is trying to get those thresholds right to say, okay, you clearly have held this stock for a long enough time, and you have a big enough stake that you really care about the longterm financial value of this company. It makes sense for you to be able to get something on the ballot.

Hester Peirce:

Or, if you're trying year-after-year to get something considered on the ballot, you have to show that other people are actually interested in your idea. That's what was behind it. But I think, again, the question of what is the SEC's role in this process? When I came to the SEC, I had been here before as a staff attorney, and I remember that my colleagues in corp fin would spend a lot of time every year on this shareholder proposal process, because proponents can try to get something on the proxy and the company can say, "We want to exclude it." They can come to the SEC and get a no action letter saying, "It's okay, you can exclude it." Because there's certain parameters that allow you, or criteria that allow you to exclude a proposal.

Hester Peirce:

This really is a big consumer of staff time at the SEC. I'm thinking, the way you're thinking, Jim, about, wait a minute, is this even something that fits naturally within the SEC's functionality, or is this really a matter of interactions between shareholders and corporations, which one might think would fit a little bit more neatly in the state law category of things?

Hester Peirce:

I'm frustrated because I'm seeing all this SEC staff time that we could be spending reviewing filings and doing other things that clearly fit within our ambit. I'm asking, wait, is this really what we need to be doing? I think I have some more fundamental questions, but that's not really where the proposal goes.

James Copland:

Right. I am aware of that. Just so our audience understands what we're talking about here in terms of scope. Under the existing rules, if you have $2,000 worth of stock and you've held it for at least a year, you can introduce, with certain procedural and other guardrails, you can introduce a shareholder proposal on the ballot. $2,000 isn't a lot when you're talking about Google or Amazon, it's like saying I could put a referendum item for national plebiscite at the next presidential election myself.

James Copland:

There's been this, we want to be open and we want to be open to shareholder dialogue and letting small shareholders have a voice mentality here. But it's not clear to me that that's in the statute. It's been the principle that the SEC's worked on since 1942 when they started doing this. Where the SEC has reversed position significantly over that long run is in the 1970s. Prior to the 1970s, the SEC allowed companies to exclude matters of essentially political economics, general national policy import from the ballot so that you couldn't turn these corporate annual meetings into showcases for various policy political social disputes.

James Copland:

Then in the '70s, essentially the SEC inverted that rule and now, ordinary business items can get excluded from the ballot. You can't tell the company, "We want you to close down this store or not close down that factory, or what have you." But if it is a matter of general policy or economic interest, you can get it on the ballot. What's the thinking there?" I realized there was a DC circuit case, but it didn't force the SEC's hands here. What is the thinking there, or has there just been, it's just inertia at this point, 4.5 decades after the fact?

Hester Peirce:

Well, I was pretty young when that decision was made, so I don't know what the thinking was precisely behind that. But I think there's a lot of interest from shareholders in a lot of these issues. There's certainly a lot of pressure on companies to include things like this. I think we, like other, we're trying to sort through what the right role for us is, and trying to sort through how important something is, and is it of widespread interest? If so, should it be something that we say, "Yeah, you have to include this."

Hester Peirce:

But again, I think it raises a lot of really difficult questions for us, because effectively, we're asking our staff to make really difficult calls on really controversial issues. I worry that we're putting them in a little bit of an unfair position to have to make those kinds of calls. Again, I think some of this stems a little bit from broader issues, thinking about whom should corporate boards and management be responsible, and to whom should they be accountable? Those kinds of things, and I think that these debates merge into one another a little bit.

James Copland:

Yeah. I think certainly that's the case. I mentioned earlier, the legislation introduced by Senator Warren a couple of years ago, in addition to pushing towards a federal charter, one of her ideas is to get rid of that traditional fiduciary duty that is primarily oriented around shareholder value, and instead go towards what folks call a stakeholder model, looking at employees of the general community or et cetera, et cetera, not just shareholders there.

James Copland:

I realized this is a little outside the SEC's end, but just as someone who's thought a lot about these issues, what do you think about that? Not the specific legislation, but just the principles in play?

Hester Peirce:

In some ways it does affect our area too, because if the corporation, if the board and managers are accountable to people other than shareholders, then, what does that mean when we're writing our disclosure rules? Does that mean that groups outside of the shareholders, are we supposed to be thinking about them when we're writing our disclosure rules? I think it's a question we have to at least somewhat grapple with.

Hester Peirce:

My real concern in this area is that when you have one boss, you know what you have to do. If that... In the case of a corporation, traditionally, the boss has been the shareholders. Ultimately your goal... Shareholders can have conflicting views as we see, all the time. Really, what you say is ultimately our goal is to maximize the longterm value of the corporation, because we're assuming that that's going to be the thing that most shareholders want. Absent the situation where the shareholders have specifically gotten together and said, we've got some other objective.

Hester Peirce:

Maximize the value of the corporation. The managers and the board, they know that's their job. In doing that job, they're certainly thinking about their employees. You want to maintain a good, strong, loyal, well-trained, well-paid workforce, because you want to make sure they're doing a good job. You want to stay on good terms with the community you're operating in. You certainly want to keep on the right side of your customers. You're thinking about all of these kinds of things as you're doing the job of serving your shareholder base and maximizing the value of the corporation.

Hester Peirce:

Now, if I'm a manager, I think, well, I think it might be nice to have a couple of different bosses or maybe many different bosses, because then I can really do whatever I want, and I can tell constituency A, well, you might not like it, but I'm doing it for constituency B and they like it. Lo and behold, I'm accountable to no one.

Hester Peirce:

I think that moving away from a shareholder primacy model actually can leave managers and boards the run of the place without being accountable to anyone.

James Copland:

I think that's true, and it's something that I've not only written about, but I also talked about and went beyond just the managers in Senate testimony last year as I started to talk about this, towards the institutional investors. You alluded to that somewhat, this concentration of power in large institutional investing fund families, asset managers with significant stake holdings across the entire stock market now. Some amount of concentration. They have these similar sorts of what economists in this world call agency costs. They had the similar sorts of conflicts where just like we want managers to have a boss, ultimately an institutional asset manager is there as a fiduciary for the clients and trusting the asset manager with money.

James Copland:

But if that institutional investor is largely following the market, and a lot of these now are index funds, which is great for the investor, it keeps costs low and you basically get the total stock market or some approximation of it and follow it. But if they're just doing that, then they're not going to underperform their peers, if they're doing all sorts of things with their client's money.

James Copland:

We've seen some moves in this direction in the last couple of years at least vocalized by say Larry Fink, who's the head of BlackRock, the largest institutional investor in the world talking about various policy goals, particularly around the environment saying they're going to divest from certain types of companies, et cetera.

James Copland:

Now, obviously the SEC shouldn't be out there trying to put a thumb on the scale, but does this concern you at all, and how might we be thinking about it from a policy terms and a legal rulemaking terms?

Hester Peirce:

I think it's important for all of us to remember that we see what looks like concentration of ownership, but it actually isn't because these large asset managers have lots of different funds and those funds are the ones that own the securities. They're the ones that own the pieces of companies. Those funds have different objectives as I was saying earlier, and some objectives might not be consistent with others. You've got lots of different kinds of funds, so they all have different things they're trying to achieve. Some are looking at for short term gains, some longer term gains. Some are green funds. Some are high risk, but potentially high return funds. They're thinking about all different kinds of things.

Hester Peirce:

It's important for us to remind the managers that you can't just view this as a block of stuff that you get to control and that you can get to vote in a way that might make you feel good. That in a way that might be consistent with how you would vote your own shares, if you held them directly. That's fine, you go vote your own shares however you want, those are yours. But remember that the shares you're voting on behalf of funds belong to those funds, and you've got to be clear with the owners of those funds, the investors in those funds, what it is that you're trying to do with the fund.

Hester Peirce:

If you're an index fund, as an example, I think when I'm buying an index fund, I'm buying a passive fund. I'm not buying a fund that's going to be actively involved in managing the companies that it owns. If what you're really trying to do with an index fund is to be an active investor, that's fine too, but you have to then tell people, "We're not a passive index fund, we're something else." And explain what that is.

Hester Peirce:

I think that's where we at the SEC have a role is making sure that asset managers are being very clear with the people that are investing in their funds, or that are hiring them directly to manage their money about what it is they're planning to do and how what they're doing is consistent with what they said they were planning to do.

Hester Peirce:

Otherwise, I think we end up in a situation where I get to manage your money and I get to vote stuff in a way that I might personally feel strongly about, but might not be what ultimately grows your retirement nest egg, as large as it could be.

Hester Peirce:

I think there's a lot of conversation around this now, and I think that's really healthy. I think it's really good that people are thinking about this, and trying to work through these different, as you said, agency issues.

James Copland:

At the other end of the extreme, we've got a good audience question here. The other end of the extreme from some of these passive index funds, you've got these activist investors and different people react differently to this. I guess I'm different than some of the people who worry about short-termism, I'm more of the view that these activist investors can often drive and create value. Unlike these diversified mutual funds that are following the broad stock market, they're taking big bets and gambling that they can turn some of these companies around. But how do you think about that? How should we, as investors interpret vote whipping by activists that are trying to persuade shareholders or proxy advisory firms to vote in a certain way?

Hester Peirce:

I think that activist shareholders have a really important role to play in the markets. You can't have a market that's all passive investors. Active investors go out and they look for these opportunities to increase the value of companies, for example. You alluded to the fact that often it's these active shareholders that may go and try to work with proxy advisors to get them to make a recommendation in a particular direction. That's the kind of conflict that I was talking about earlier. I think that's really important for people who are using those proxy voting advice businesses to understand if they're working with an activist investor, for example, that would obviously be something that you would want to know.

Hester Peirce:

But again, I think investors play a very important disciplining role in the marketplace. They can come in and they can see a company that's being mismanaged, and they can say, "I have a better plan, and I want to sell my fellow shareholders on this better plan. Let's go turn this company around." I think that's a really exciting dynamic part of the capital markets.

James Copland:

I agree. I think we're on the same page there. I've got a good question, I think from the audience now, from someone who I often disagree with, but always, I think thoughtfully a good contributor to the debate, Heidi Welsh, who founded the Sustainable Investments Institute and is big in the sustainability world. She asks, "Do you think that social and environmental shareholder proposals raise material issues, generally?" How would you define materiality? What does materiality mean, first of all, for our audience that's not quite as expert in this, and do you think most of these social and environmental questions fit within that?

Hester Peirce:

I think when you're talking about materiality in our space, you're talking about, first, financial materiality. What would the reasonable investor need to know in order to make a longterm financial decision, essentially? One thing that has happened in a lot of debates, recently, at least, I feel like we've gotten this... ESG has been raised more and more and, and people suggest that that's very important. ESG is very important in their investing decisions.

Hester Peirce:

What I've tried to say is let's think about these as individual items, rather than trying to lump everything into this ESG rubric. I don't mean just picking E apart and S apart and G apart, I mean, tell me what it is you think is important for you to know, or what is this issue that a shareholder wants to have on the proxy, and we can talk about that particular issue.

Hester Peirce:

Some social and environmental things could certainly be material to a company. I would certainly say that, and certainly governance issues can be material to a company. Let's just think about them on an individual level, and let's take... I think the ESG rhetoric doesn't really get anyone that far. It gets everyone very upset either on one side or the other. Why don't we just sit down and you come and tell me what you think is important.

Hester Peirce:

One aspect of materiality that I should have highlighted is that it's a company specific question, and it's a time specific question. What's material for one company may not be material for another. What's material for one company today may not be material 10 years from now. Part of what we try to do when we write our disclosure rules, we like them to be evergreen so that they will work now I'm in the era of COVID and they'll work in 10 years, when, God forbid, we have some other problem.

Hester Peirce:

The idea is to have rules that are principles based, and that each company has to sit down and think, what is it that is material, and that's what they disclose. It's really sometimes hard to find things that are important across all companies, such that you really want to write it into our rule book.

James Copland:

Makes sense. If I hear you right, I hear you saying, the traditional financial materiality analysis is the right one, but there certainly could be social and environmental questions that are financially material depending on the company and the question.

Hester Peirce:

Exactly. That's right.

James Copland:

We've got a question here going outside the United States, and this is outside much of what I know about, but you may know more about. We've got a question from Kyle Wilkins asking if you can discuss the EU's shareholder rights directive too, and explain what that is for those of us like me who don't know that much about it, if you can, and then what that might mean for as firms and how it might impact the SECs work?

Hester Peirce:

Well, I can't speak specifically to that directive because honestly, I'm not an expert in it. What I will say is that, we're in a market now that's global. A lot of decisions that are being made in the EU will certainly have an effect here in the US. I think in Europe and in Asia, they're asking some of the same kinds of questions as we're asking. They're asking, who do corporations really belong to? To whom should they answer?

Hester Peirce:

Those same kinds of issues tend to bleed back here because what European companies are doing, or US asset managers are engaged in Europe, and so they're shareholders in Europe. Those things will affect them as well, and then may flow back here and affect the way things are done here. But I can't speak specifically to what the questioner was really trying to get me to go to.

James Copland:

Okay, let's then step back a little bit, and you're not going to tell Congress what laws to pass. You implement the laws that Congress has passed. But are there areas where the law is unclear or where the SEC could stand to have a little bit better guidance, where if you could advise the folks that are working on the statutes to make your life a little bit easier, or to give you powers, you think you need and don't have or to refine the legal structure that you're operating under?

Hester Peirce:

Well, I think there are always different areas where we need to modernize. Our securities laws are pretty old. You can always think about ways that you might want to modernize. One thing though, that I would say is... This goes back to the theme that's been running throughout this whole conversation. It's really important to remember what the role of the SEC is and the limitations of that role. I really care about our capital markets and I really care about encouraging companies to come into our capital markets, to raise money here in the United States and particularly in our public capital markets, because those are the markets that really retail investors can get access to those markets, they can be part of the growth of those companies, which can be a family transforming thing. If you're talking about wanting to pass wealth down from one generation to the next, you want to have every day Americans participating in our public capital markets.

Hester Peirce:

But companies are much less likely to go public, want to go public in the United States if they know that going public is going to force them to do all kinds of things that don't seem at all related to being a public company. Yes, a company, when it goes public is going to be asked to disclose things that are material. We talked about financial materiality, that's totally understandable. If you don't want to tell people what you're doing, then you shouldn't be public.

Hester Peirce:

But if we ask companies then to go public, and we say, well, today, we're going to ask you to disclose stuff that's financially material, but in two or three years, we might be asking you to disclose whatever it is that is the popular topic of the day, of conversation of the day, and that could be a very expensive thing for you to disclose, and really unrelated to the value of your company.

Hester Peirce:

I think if we're trying to send a welcoming message, we really need to... We the SEC, and then the Congress who's writing the statute needs to bear that in mind, and remember that this stuff all does have a marginal effect on the decision of companies to go public or not.

James Copland:

Makes a lot of sense to me. We had an earlier question on... Well, before I get to that, let me ask you a broader question, a little bit outside the space of what we've been talking about, but something that has been talked about a lot in the circles I travel in and something we see a lot in the shareholder proposal world and something your former colleague obviously was a leader in developing as an academic, Robert Jackson, on the question of politics and disclosures.

James Copland:

Aa number of professors have put a rulemaking petition in with the SEC, seeking to get the SEC involved in getting public companies to disclose more about their lobbying or their political spending or things like this. This was largely fueled by, but not exclusively the citizens united decision that permitted various forms of corporate political spending as protected under the first amendment.

James Copland:

The SEC as a commission to date has resisted that. Obviously, there's been a lot of talk in Congress about it. You're more than aware of it. Now that you've gotten reconfirmed, you may have a little more degrees of freedom to talk about it since it's been such a political hot button, but do you have any thoughts on that, that you're able to share?

Hester Peirce:

Well, given the fact that there is a petition for rule making and also there's an appropriations writer that basically tells us we can't spend money working on this issue. It's really not one that I have a lot to say about.

James Copland:

You can't really say much about it, okay. We also got a question then about political influence with the proxy advisory firms. There's always been talk about that, that they can be politically influenced in some way, shape or form, or at least some of the more social investing funds or the public employee pension funds that have agendas beyond simple share price maximization, perhaps, have leaned on them in a certain way. Did that in any way, go into your thinking on the rulemaking with proxy advisory firms? Do you think if it's an issue that the new rule might help in that regard?

Hester Peirce:

Well, as an initial matter, I should say, I think proxy advice businesses can provide really valuable input and can be very helpful as people are thinking through how they want to vote. They provide a valuable service. In terms of the kind of conflicts that you mentioned, that is exactly what our rule is trying to get at, is if you have one client to whom something is particularly important, and that client is trying to get you to make your recommendation based on that client's particular preferences, then that would be something that you would want to disclose so that other clients could take that into account.

Hester Peirce:

Now, I think what you would hear from the proxy voting advice businesses, is that they've built barriers, they have barriers in place so that clients that might want one thing are not influencing the recommendation on the other side. But those are the kinds of things that we want, both proxy voting advice businesses, and the investment advisors that rely on them to be thinking about, just so that, that kind of problem doesn't arise.

James Copland:

Makes sense to me. Now, the question of capital formation, which is of course, one of your objectives as a commission, as an agency. You just alluded to somewhat, and particularly public capital formation, it's something we've been talking about a lot, there have been a lot of thinking, a lot of discussions around really, since Sarbanes-Oxley was enacted by Congress. Since then, we've seen these sorts of trends in public capitalization, or at least the number of public companies, the number of initial public offerings and et cetera, et cetera. What are you thinking about as a commission on that to the extent it's within your ambit to try to ameliorate that? Again, you've obviously got to follow Congress's lead.

Hester Peirce:

Well, I think it's a complicated problem. There's not one reason for the decline in the number of public companies. There's some good reasons. We've found that a lot of companies are able to raise a lot of capital in the private markets, and that's great that the private markets work well. I think we can do stuff to make the private markets work even better, especially for very small companies that are just starting out and companies that their founders don't have lots of rich family and friends. For those companies, it can be really difficult to raise capital. We can do more on that side.

Hester Peirce:

But in terms of when a company is thinking about going public, one thing that they're thinking about is they want liquidity for their shareholders. They want their shareholders not to be locked in forever, but to have an easy way to buy and sell. We need to make sure that our equity market structure is working appropriately. In some ways our equity markets, I do think they're the best in the world. I think they really do work very well, and especially for larger companies, I think you'll see that they work quite well.

Hester Peirce:

But when you go to the smaller range, you might be a company that's made the decision, okay, we need to get liquidity for our shareholders, we're going to go public. They go public and they say, "Whoa, wait a minute. We found out that we don't necessarily get great liquidity in the public markets." That's something that we're trying to think about a little bit more creatively, is there a way for issuers, for companies to work with the stock exchanges to come up with different ways, maybe of trading smaller companies?

Hester Peirce:

That's one aspect that we're thinking about. We're thinking more generally about some changes to the way we regulate the equity markets that might be good for companies all across the board. Research coverage is another big thing. If a small company goes public and it's not getting research coverage, that's a problem. Is there anything that we can do on that side?

Hester Peirce:

Litigation is also a big issue. A lot of public companies face very expensive shareholder suits, and those can be a good disciplining mechanism, but they can also be something that is so expensive, and even if it's a suit that's non-meritorious the company may feel the need to just settle and move on. That can be an expense that we have to take into account.

Hester Peirce:

Now, what the SEC can do on that, that's an open question, but that may be something that others can think about. We can think about our own disclosure rules. We have quite a bit of leeway given to us by Congress. That's a project that we're engaged in now. Chairman Clayton has really been doing a good job at getting us to think through our rules. Where does it make sense for us to modernize those rules, and really to try to embrace a principles based approach, because as I said earlier, our rules can get out of step with the times very quickly, but if their principals based, then they're much more likely to last over time.

Hester Peirce:

We're trying to pull back some of the very prescriptive things that have been in our rules and trying to give companies a little bit more leeway to think about things and trying to pair back, it's easy over time, duplicative obligations build up. We're trying to remove some of those. Those are some of the ways that we're trying to make it a more welcoming atmosphere for public companies.

James Copland:

All sounds really good to me. If you could tackle the securities litigation thing, it'd be great. It's not like there's an express statutory private right of action in there. It's inferred by the courts. But I can understand the SEC is not going to want to be out in front of that, it would be something they'd probably leave to Congress.

James Copland:

Beyond this, we've talked about a lot of things. There's obviously a lot of stuff you're working on as a commissioner, as a commission, as a staff. You're going to be there now to 2025. You've got a lot of years ahead of you. What is your vision, what would you say are your one or two or three chief objectives that you really want to focus on and change going forward for the SEC?

Hester Peirce:

Well, I think there are a couple of things. One is, and this is something that I've been working on during the couple of years that I've been here, but innovation is something that we need to do a better job with at the SEC. We're seeing this now with crypto. We have not really handled that new technological development particularly well-

James Copland:

What is that, for our general audience? What do you mean when you say crypto?

Hester Peirce:

Well, cryptocurrencies or digital assets is what a lot of people know these as. There's been a lot of activity in this space where people are trying to develop networks and they sell tokens, which then are the coin of the realm on those networks. The problem arises when we treat the sale of those tokens as a securities offering. I say the problem, meaning, in some cases, we're absolutely right, it is a securities offering, but it's been awfully tough for people who are trying to set these networks up to figure out what to do to comply with our securities laws.

Hester Peirce:

I would like us to take this instance where we haven't really been able provide the kind of guidance that we need to provide or provide the kind of framework that would work in this space. Let's take this as a learning opportunity. Let's not only provide guidance in this space that works, but let's also think about how can we be more adept at handling innovation? How can we be more responsive when people come in with a product that they think will be useful for investors?

Hester Peirce:

We need to be able to process that and give them an answer, "Yes or no, you can do this or not." We should not be putting ourselves in the role of a merit regulator, but we should be thinking about it in terms of, you have to comply with our rules, but then you let the market decide whether or not they think your product is good or bad.

Hester Peirce:

That's one thing that I hope to work on. Then we talked about capital formation, but I think that's an area where we will have a lot of work to do, especially coming out of COVID where we've seen so many small businesses have to shut their doors, and it's heartbreaking, and I hope that out of this dark time and difficult period, we'll see a lot of people come forth with new business ideas or try to rebuild businesses that couldn't make it through the crisis.

Hester Peirce:

We need to make sure that our capital formation regulatory framework is one that will work for these small companies, and that will protect investors, but also will allow people with talent and people with great ideas to get access to good pools of capital.

James Copland:

Both sound like really important things. The cryptocurrency stuff is fascinating. I'm not sure I 100% understand it, but I have friends that are in the space and I'm glad you've been taking a lead on that, and of course, capital formation is vitally important. We're nearing the very end of our time here, I think we've got three minutes before we're officially signing off. I don't see any more audience questions. Is there anything else you'd want to share with the broader audience out there, and then I'll wrap us up.

Hester Peirce:

Yeah. Well, I think on the cryptocurrency side of things, there is actually a connection to the things we were talking about at the beginning of the conversation. There are a lot of challenges as we're thinking through to whom new corporations answer, to whom are they accountable? What the cryptocurrency space is saying, let's take this back even further and let's rethink this whole thing even more, by decentralizing, by giving people tokens so that they have a say in this network, you're allowing everyone to participate.

Hester Peirce:

It's a whole new approach to governance, and I think it will challenge a lot of the ways that we do things. It's an exciting area, and I think, especially for some of the people who are active shareholder proponents might want to think about this space too, as maybe another way of organizing entities that they will like. That's a way to get everyone engaged and that's the whole point of those kinds of networks. I think there's a lot of exciting stuff for all of us to be thinking about in the years to come.

James Copland:

Absolutely. Those of you who've been joining us, I really appreciate it. Of course, thank you to Hester Peirce, Commissioner Peirce who's been very generous with her time here. As all of you are aware, just listening to her, she's very clear in explaining these complicated things. Go to her page on the SEC's website, and you can see a lot of her writings. I always go there and learn a lot.

James Copland:

Those who want to hear more about what I say, you can go to Manhattan Institute's, proxymonitor.org website, where we track these shareholder proposals, and it also has a number of my writings there available. I'm going to have a chapter in my book about some of these things, forthcoming. I think the folks here may talk about... They may link to the Manhattan Institute page to buy. If you want to pre-order my book, it's coming out next month, The Unelected is what it's called: How an Unaccountable Elite is Governing America by Encounter Books.

James Copland:

Chapter 13 of the book talks a lot about this whole shareholder proposal process and securities litigation... Securities litigation is earlier, but securities shareholder activism, especially by some of these public employee funds. Of course, you can see, I guess now on the bottom of the screen at the Manhattan Institute, we're a nonprofit so we depend on support. I would invite the guests here who found this interesting and engaging to follow the Manhattan Institute, you can subscribe to our newsletters and you can click on the links that are posted in the comment section there to figure out how to do that.

James Copland:

Again, thanks to all of our audience. If those of you order books through the Manhattan Institute website, I'll try to sign them unless this goes viral, and we get a bunch of people interested in securities regulation, and it's too many for me to do physically. But again, come back to our future Manhattan Institute Event Cast, and particularly, I want to thank my friend, SEC Commissioner Hester Peirce.

Hester Peirce:

Thanks, Jim, and everyone should feel free to reach out to me.

communications@manhattan-institute.org