Securities Mosaic® Blogwatch
August 21, 2019
Addressing Economic Insecurity: Why Social Insurance Is Better Than Corporate Governance Reform
by Jeffrey N. Gordon

The question that emerges from proposals to elevate a corporation’s “purpose,”[1] the call for co-determination in Senator Warren’s Accountable Capitalism Act and now the Business Roundtable’s purported elevation of stakeholder interests, is whether corporate governance is capable of playing the important role in addressing social problems that some have posited.  Such an approach seems to suggest that the social challenges we face can be dealt with at the level of the firm – that is, by specific corporations and their boards.  This assumption seems to animate the argument for firm-specific tailoring of corporate governance in light of distinct corporate missions.

The alternative perspective is that the fundamental issues are more clearly viewed as the economic and social effects of a dynamic and global market economy in which companies operate and are forced to compete.  And so rather than focusing on the firm as the unit of greatest concern, and assuming that companies themselves are responsible for, say, retraining workers whose skills have become obsolete, whose human capital has depreciated, I think the real issue is one of social insurance, of ensuring that we have the right form of government match to ensure the preservation and, where possible, the reinvigoration, of human potential over the lifetime of employees.  Designing and implementing this kind of insurance is critically important in a dynamic economy like ours – an economy in which no single firm is able to offer thick enough insurance, including income preservation insurance, to compensate workers, especially aging workers, for the shrinking job security associated with technological change and obsolescence.[2]

So, to me the big question here is: What is the right form of government match for the economy we have?

As I see it, the current malaise consists of three elements: inequality, economic insecurity, and slow economic growth.  Corporate governance has to do with the way power is exercised within the firm. Although the legal framework of corporate governance has remained stable for a very long time, the implications – or the actual workings and effectiveness – of that framework have varied greatly during the decades that I’ve been in law teaching.  The observed changes in corporate governance are at bottom the result of major changes in corporate ownership. The dispersed ownership of the Berle-Means corporation of yesteryear gave managers effective control.  In those days, collective action problems muted shareholder voice.  Today, the re-concentration of ownership into the hands of institutional investors means that shareholder activism can effectively challenge managerial prerogative.  So, it’s the interaction between the legal framework and ownership that creates the corporate governance environment.

My focus will be on economic insecurity.  Presumably, there is a strong corporate governance feature to the risk of downsizing and layoffs.  By contrast, although inequality is also a serious problem, I think that corporate governance plays a secondary role in its creation and persistence.  Although Thomas Piketty’s research identified executive compensation as a major source of inequality, I think the more fundamental sources of inequality are quite different.  They relate, first, to the structural changes in the nature of work and the different ways that some firms succeed and others do not; and second, the wealth effects associated with the rise of the private economy.

David Autor’s work, for example, on the “superstar firm” shows large inequality across companies in the compensation of people with the same jobs.[3]  Successful firms, “superstars,” pay more. The secretaries at Google, for example, would be extremely well paid.    More generally, the high compensation that tech firms pay their armies of software engineers has exacerbated the sense of inequality throughout the Bay Area. And along with Autor, I would argue that the compensation consequences of disparate levels of economic success across firms and industries is a more profound driver of inequality than high levels of CEO compensation or rewarding corporate efforts to increase profits by controlling labor costs.  And so, from this perspective, addressing inequality is not fundamentally a corporate governance issue.

Perhaps an even more important source of inequality is the growing shift of economic activity from public to private firms, in which income and wealth are increasingly concentrated in the hands of modern day capitalists.[4]  This trend, documented by public finance economists using U.S. tax data, is not obviously connected to corporate governance of the large public corporation. Tax policy that favors pass-through entities accelerates this trend.

In a YouTube video that went viral, Dutch historian Rutger Bregman told a Davos audience  that the way to address inequality is “taxes” – particularly, estate taxes – and all the rest is beside the point.  Tax policy is the first-best way to address inequality, not a focus on firm level decision-making.

Similarly, I don’t think that corporate governance has much to say about slow economic growth, though purported corporate governance defects have been blamed.  Assertions that stock buybacks produce cutbacks in R&D and prevent significant investments that would promote an economic boom are contradicted by the careful marshalling of evidence by Jesse Fried and Charles Wang in a recent issue of the Harvard Business Review and related work. Their research indicates that buybacks occur predominantly in those economic sectors where the ROI is low, meaning that managers (and companies) are returning money to the shareholders because they don’t have good investments to make on their own.[5]

There are of course other explanations for this slow growth.  Robert Gordon, for example, argues that the really big inventions – like electricity – aren’t going to happen again.  And alongside something like the invention of automobiles, the Internet just doesn’t really cut it.[6]  But from casual conversation, I think many business executives don’t share Gordon’s pessimism.

One plausible argument focuses on the negative effect on growth of erratic government policy, which can make it difficult for companies to contemplate significant investments with long-term payoffs.  For example, the fiscal austerity policies that were widely followed after the outbreak of the financial crisis exacerbated and prolonged the Great Recession in the U.S. and Western Europe; during those years companies focused on survival not expansion.  Four years ago, we weren’t sure if the Euro was going to survive; what’s the right payoff horizon facing that risk?  And the abrupt U.S. turn toward economic nationalism and neo-mercantilism by the Trump administration surely disrupts long-term planning and investment.[7]

It also seems to me that many politicians who attack buybacks are really looking for companies to provide a kind of Keynesian stimulus – that is, a way to drive the economy by spending not government funds, but more shareholder capital, to promote a boom.  Whether shareholders get a competitive return on that investment is the least of politicians’ concerns – though it does seem to matter to shareholders.  In short, the rate of economic growth turns on factors other than firm-specific levers of corporate governance.

If there’s a big idea here, it’s that the investing environment has produced a profound risk shift.  There’s been a risk shift away from the shareholders, who now can and do diversify away all firm-specific and idiosyncratic risks, and toward employees and all the other stakeholders who benefit from and indeed depend on the existence and stability of particular corporations.  The result of this dynamic, as mediated through corporate governance, has been to shift risk from shareholders onto the employees, who are far less able to bear that risk and insure against it.  Employee payoffs are firm-specific; not so for the diversified shareholder.  Companies are subject to strong pressure from product and capital markets; corporate governance, viewed as the way that companies are funded and managed, is the mechanism by which those external market pressures are transmitted to their employees.  And this creates the economic insecurity that is not so much about governance but instead, about social insurance.  It’s not something that companies can address acting alone.

The resulting policy prescription focuses on the need for a new match between government and enterprise – one that recognizes the role of government, perhaps in collaboration with the private sector, in renewing human potential as a lifetime concern.  Innovations in  government support for human capital development have, historically, been a mainstay of U.S. growth. For example,  the “high school” movement of a century ago, which expanded education support beyond elementary school, and the post-World War II GI bill, which expanded support through college and beyond, have been critical elements of U.S. comparative advantage.[8]

Given that companies today are not able to provide the kind of  insurance they once did, the right move is further innovation in government support for human capital development, towards maintaining lifetime human potential. This is not primarily a redistribution of wealth but a more effective allocation of social resources designed to increase social wealth.  The economic rationale for layoffs, after all, is that they preserve or increase value by preventing companies from wasting resources – potentially valuable human capital – that might be put to higher-value uses.

That at least is the theory of “constructive” layoffs.  But in the modern economy with technological change and obsolescence, layoffs tend to mean a very large, if not complete, loss of firm-specific investments by displaced employees.  The aim of the government match I’m envisioning is an ongoing investment in our workforce, a rebuilding of the human capital that has been lost.  And the ultimate purpose of this match is to make society as a whole more productive in dealing with some of the demographic issues that the U.S. and other countries are now facing.[9]

Here is one quick final point about the interesting position of the Vanguards and BlackRocks, the indexed asset managers, of the world with respect to such a policy proposal.  The product they offer is not a firm-specific investment, but a low-cost diversified portfolio of all companies in the economy.  And if that’s your product, the only way that you can improve the outcomes for your investors is by increasing expected returns and lowering systematic risk across the portfolio as a whole—that is, the entire economy.

Now, how could institutional investors mitigate systematic risk?  If you think that some of the disruption we see at the individual firm level creates political risks to stability – and we’ve seen evidence of that in the political realm – then stability-seeking becomes one way that a diversified investor can reduce the level of systematic risk.  So if you think that some system of broader social insurance, particularly this maintenance of human potential over a lifetime, will not only increase expected returns across the portfolio (across the economy) but will also mitigate certain sort of socio-political risk, then the question is, what position should the asset managers play in moving towards this consensus?  These so-called “universal investors” hold the shares of all the companies.  They have the vision to perceive what’s going on.  The question is, how involved will they be in politics, and what does that do to their business model?

The investment diversification point bears emphasis, because it is key to understanding the world in which we live, in particular the “profound risk shift” referred to previously. It was a Nobel Prize-winning idea that investors should aim to maximize their utility by achieving the highest risk-adjusted expected returns, meaning attention to risk as well as returns, “Modern Portfolio Theory,” or MPT. The follow-on investment strategy is portfolio diversification, which minimizes firm-specific idiosyncratic risk.

The implications of MPT begin with how investors should invest but extend to how firms should conduct their business. Investors want companies to be aggressive in taking business risks, while being willing to accept the greater risk that such companies will fail.  Diversified investors are risk-neutral with respect to the failure of any particularly firm, not risk-averse, and want firms to operate accordingly.

What are the consequences for other parties to the firm?  Creditors of the firm can adjust to such increased risk-taking by, say, charging higher interest rates or insisting on lower leverage.  The managers of the firm can also adjust; after all, we pay them in stock-based pay, which encourages them to take these risks.  Increasing managers’ upside will thus make them risk-neutral or even risk-seeking.  But it’s the employees who are unable to adjust to the extra risk arising from the changed incentives that diversification provides shareholders to encourage more corporate risk-taking.[10]

Think about the way that the organization of companies has changed in the past 50 or 60 years.  The conglomerates of the 1950s and 1960s proved to be failures, in significant part because investors who wanted diversification could get it at the portfolio level.  Such investors don’t need, and so won’t pay up for, diversification at the firm level; and as had become clear by the end of the 1970s, firm-level diversification introduces new expenses and other inefficiencies.  It requires managers to oversee a broad range of businesses, many of them with no operating synergies.  And it’s “managerialist” in the sense that the size and scope achieved by this kind of empire-building, which has the effect of reducing efficiency and value, actually benefits managers because it buffers performance variation across the firm’s diverse businesses.

Who else ends up being protected through the diversification of a conglomerate?  It’s really the employees, because the resulting diversification of the profits and operating cash flow means that the conglomerate will be less likely than a focused-business firm to lay off employees of a unit that’s in trouble.  Cash flows in a conglomerate can be reallocated to protect a failing unit; employees can be shifted to more profitable divisions within the firm.

But starting in the early 1980s, the decades-long process of dismantling the conglomerate structure by corporate raiders and LBO firms helped bring about this major shift of risk from the shareholders to employees – a change that is partly attributable to investors’ growing reliance on low-cost diversification methods.  With the rise of hostile takeovers in the 1980s – and running more or less continuously to today’s shareholder activists – we have seen the unfolding of a high-powered governance system whose main goal is to eliminate corporate “slack,” or inefficiency, as seen from a shareholder point of view.

The big difference between today and the 1970s and even the 1980s is that the amount of slack, or value left on the table that it would take to trigger corrective action is much less today. The dispersion of share ownership once meant that collective action problems could be overcome only through the expensive mechanism of a hostile takeover bid, in which a buyer faced all the risk of a misjudged opportunity.  Today’s reconcentration of ownership has invigorated the proxy battle, which can be pursued at much lower cost than a hostile bid and for which a shareholder activist bears only the risk of its toehold stake, not 100 percent ownership. The consequence is that companies have much less margin for what is perceived as strategic or operational shortfalls.

Investors’ diversification has made profound changes in not only how parties invest, but in what shareholders want from firms, and how firms are structured and operate – all in pursuit of the highest risk-adjusted returns. As a consequence, we now have a system that is extremely efficient in the utilization of resources.  But one regrettable, though  inevitable, effect of such efficiency is the shifting of risk from shareholders to employees.  And, again, I don’t see any way for companies to insure employees against this kind of risk.  Hence my call for a government solution.  If we’re going to have this high-powered governance system, then I think we also need government to play a bigger role in helping retrain employees. And this is not a problem that neo-mercantilism can solve.  With domestic companies like Walmart, Amazon, and Netflix completely disrupting the way business is done, a disproportionate share of the risk of change is being borne by employees.

At the very least, then, this is a call for a rethinking of social insurance, a call for a kind of lifetime human potential insurance.  Now, this is not a codetermination strategy or an argument against shareholder primacy.  Those won’t solve the problem.  And we can view this not as an issue of fairness or redistribution or part of the safety net – although those are all legitimate framings of the problem – but rather as an economic question of the optimal kind and amount of investment in retraining workers, in reinvesting in workers whose skills have been made obsolete, whose prior human capital investment has been dissipated.  It’s the way the world has turned that’s created the problem, and the solution requires a different sort of match between government and enterprise.


[1] Colin Mayer, Prosperity (2019).

[2] For elaboration of this perspective, see Jeffrey Gordon, “Is Corporate Governance a First Order Cause of the Current Malaise?”, 6 J. British Academy (Supp, Iss. 1) (“Reforming Business for the 21st Century” ) (Dec. 2018).

[3] David Autor, David Dorn, Lawrence F. Katz, Christina Patterson, and John Van Reenen. 2017. “The Fall of the Labor Share and the Rise of Superstar Firms.”

[4] See, e.g., Mathew Smith, Own Zidar, Eric Zwick, “Top Wealth in the United States: New Estimates and Implications for Taxing the Rich,”  WP July 2019, available at; Mathew Smith, Danny Yagan, Owen Zidar, and Eric Zwick, “Capitalists in the Twenty-First Century” (forthcoming 2020 QJE);  Michael Cooper et al, “Business in the United States: Who Owns It, and How Much Tax Do They Pay?”  30(1) Tax Policy and the Economy 91 (2016).

[5] Jesse Fried & Charles Wang, “Are Buybacks Really Shortchanging Investment,” Harvard Business Review (March-April 2018), 88-95.

[6] Robert J. Gordon, The Demise of U.S. Economic Growth: Restatement, Rebuttal, and Reflections (NBER 2014),

[7] See, e.g., Neil Irwin, “Is a New Recession Imminent? Here’s How One Could Happen,” NY Times, A.1, cols 5-6 (Aug. 18, 2019).

[8] E.g., Claudia Goldin, “America’s Graduation from High School: The Evolution and Spread of Secondary Schooling in the Twentieth Century”, 58 Journal of Economic History 345 (1998).

[9] The U.S. experience with retraining program programs, mostly pilots and experiments, has not been positive.  Yet the U.S. spend the 2d lowest amount of OECD countries on “active labor market programs” as a share of GDP, one tenth the amount spent by Denmark, for example.  Such U.S. expenditures are also almost entirely front-loaded. Council of Economic Advisers, Addressing America’s Reskilling Challenge (July 2018), at 8 (fig. 3), 10 (fig. 4). It seems fair to say that the U.S. has not made a serious investment in over-coming the barriers to retraining and lifetime human capital re-investment.

[10] While there is some evidence of wage differentials in jobs that present foreseeable safety or health risks, I am unaware of comparable evidence of compensating risk differentials for jobs/industries because of unexpected layoffs and job loss.  In start-ups and other businesses where the failure rate is high, compensation in form (stock options) and amount sometimes anticipates the expected risk, but in many industries the business shock is not readily foreseeable and thus not ex ante compensable.  Additionally, limited bargaining power and general labor market conditions may limit risk-based compensation. Indeed, an uncertain business environment may be a factor in holding down wages, a kind of reverse “efficiency wage,” in which employees attempt to mitigate layoff risk by accepting  wages below marginal labor product, a highly imperfect form of self-insurance.

This post comes to us from Jeffrey N. Gordon, the Richard Paul Richman Professor of Law at Columbia Law School. It is based on his talk at the Columbia Law School Symposium on Corporate Governance, “Counter-Narratives,” and responds in part to the book, Prosperity, by Professor Colin Mayer.

August 21, 2019
SEC Data Analysis in Insider Trading Investigations
by Daniel M. Hawke

Recent SEC enforcement actions charging senior lawyers at Apple and SeaWorld with insider trading provide reason to dust off company insider trading policies and assess whether updates or additional training are needed.  As sanctuaries for corporate America’s most valuable confidential information, law departments are among the first places that regulators look when trying to determine the source of a trader’s material nonpublic information.

Insider trading enforcement remains a cornerstone of the SEC’s enforcement program.  Over the past ten years, the SEC has significantly enhanced its insider trading surveillance, detection and investigative capabilities.   Through the adoption of new investigative approaches and the development of new technology, the SEC staff has indicated that it has the ability to connect “patterns of trading to sources of material nonpublic information” as never before.  The implication of this ability is that not only can the SEC use trading data to establish potential relationships among and between traders, but it can use relationship information to deduce whether they have sources of prohibited information who are common to them.  According to the SEC, it uses “data analysis tools to detect suspicious patterns such as improbably successful trading across different securities over time.”

And yet, despite these capabilities, people continue to engage in insider trading believing, apparently, that there is little chance their illicit trading will be detected.

Such was the case of Fei Yan, the husband of a corporate law firm associate.  In August, 2018, the SEC charged Yan with insider trading for trading stock and options ahead of two corporate transactions on which his wife and her law firm were working.  According to the SEC staff, Yan “allegedly searched the internet for ‘how sec detect unusual trade’ before making a trade that the agency flagged as suspicious through data analysis.”  In describing how it connected Yan’s trades to information obtained from his wife (who was not charged), the SEC staff stated that “Yan attempted to evade detection by researching prior SEC cases against insider traders and using a brokerage account in a different name, but we identified profitable trades in deals advised by the same law firm and traced them back to him.”

The Market Abuse Unit and Its Analysis and Detection Center

In 2010, the SEC’s Division of Enforcement established five specialized units.  One of those units — the Market Abuse Unit (MAU)– was tasked with developing new investigative approaches to insider trading enforcement.  A goal of the MAU was  to identify “patterns, connections and relationships among traders and institutions at the outset of investigations,” and to develop and implement “automated trading data analysis” that would provide the SEC with a strategic advantage in the manner in which it conducts trading investigations.

To fulfill its mandate, the MAU established the Analysis and Detection Center (A&D Center), a virtual, decentralized group within the MAU comprised of industry specialists who possess unique quantitative and analytical skill sets.  In testimony before Congress in November 2015, then-SEC Chair Mary Jo White testified that “[e]nforcement staff is also implementing new analytical tools to detect suspicious trading patterns to assist with insider trading and market manipulation investigations.”


A key technological initiative of the MAU’s A&D Center is ARTEMIS, the Advanced Relational Trading Enforcement Metrics Investigation System.  According to the SEC, ARTEMIS focuses “on the analysis of suspicious trading patterns and relationships among multiple traders.”  The SEC has stated that “ARTEMIS combines about 10 billion equity and options trade records from SEC and FINRA and uses advanced analytics, created by Division staff, to rank trades bases on different metrics.”

The Enforcement staff can use ARTEMIS not only to identify new suspicious trades but also to find “previously undetected traders who might be involved in an existing investigation.”  It does this, according to then-Commissioner Michael Piwowar, by combining “historical trading and account holder data with other data sources to enable longitudinal, multi-issuer and multi-trader data analyses.”

While the SEC does not say what metrics it uses to rank traders, the fact that it is employing sophisticated statistical analysis to identify hard-to-detect trading significantly increases the likelihood that a person who trades on material nonpublic information will be identified, even where they go to great lengths to avoid detection.  For example, in connection with a 2017 insider trading case involving seven individuals who generated millions in profits by trading on confidential information on 30 impending corporate deals, the SEC stated that “[d]ata analysis allowed the SEC’s enforcement staff to uncover the illicit trading despite the traders’ alleged use of shell companies, code words and an encrypted, self-destructing messaging application to evade detection.

The Trader-Based Approach to Insider Trading Investigations

Armed with its ARTEMIS technology, the SEC has also adopted new investigative approaches.  Historically, the Division of Enforcement utilized a “security-based” approach to investigating insider trading.  In a “security-based” approach, the SEC reacts to news about a merger, acquisition or corporate earnings announcement involving a particular issuer and then conducts an investigation to identify individuals whose trading in that specific security is suspicious.

With the formation of the MAU in 2010, the Division of Enforcement began to consider new, proactive approaches to how insider trading investigations are done.  Using what is called a “trader-based” approach, the MAU focuses not on a particular issuer but on traders whose trading activity indicates that they have multiple securities that are common to them.  The MAU then looks for patterns of trading in multiple securities among traders who may be acting concert or have common sources of material nonpublic information.  For instance, in announcing an August 2015 case against 32 defendants involving an international hacking scheme,  Chair White stated that “[w]e now have new technological tools and investigative approaches that allow us not only to pinpoint suspicious trading across multiple securities but also to identify relationships among traders.”

Implications for Legal Departments

The SEC has never been more effective at detecting and investigating insider trading than it is today.  Recent actions against senior lawyers in large, well-known companies suggest that insider trading by in-house lawyers may be on the rise.  If true, this could have serious implications for legal departments and the companies they serve.  For example, in early May, 2019, the SEC brought an insider trading action against the life-long friend and house guest of the general counsel at Cintas Corporation who, unbeknownst to the lawyer, stole information from the lawyer’s home office concerning an impending acquisition.

While the lawyer was plainly a victim of his friend’s misconduct and there was no suggestion of wrongdoing by him, the case raised questions about whether in-house lawyers in general are doing enough to protect the material nonpublic information entrusted to them.  It is only a matter of time before the SEC begins to question whether corporate insider trading policies are reasonably designed and whether companies are doing enough to train their employees on compliance with the insider trading laws.  Given the SEC’s increasing use of data analysis in insider trading investigations, it is foreseeable that we will see more enforcement actions where lawyers either traded on, or were the common sources of, material nonpublic information.

This post comes to us from Daniel M. Hawke, a partner at Arnold & Porter, the former chief of the SEC’s Market Abuse Unit, and the former director of the SEC’s Philadelphia Regional Office. It is reprinted with permission from the August 1, 2019 issue of Corporate Counsel. © 2019 ALM Media Properties, LLC. Further duplication without permission is prohibited.  All rights reserved.

August 21, 2019
Remarks at SECs Small Business Capital Formation Advisory Committee Meeting
by Jay Clayton, U.S. Securities and Exchange Commission

Thank you Carla [Garrett], members of the Small Business Capital Formation Advisory Committee, Martha [Miller], and the staff in the Office of the Advocate for Small Business Capital Formation for holding the second meeting of the Committee outside of Washington, DC. [1] It demonstrates a clear commitment to capital formation across the country. I thank you for your thoughtful and pragmatic exploration of how our rules, regulations, and policies impact small businesses and their investors, including smaller public companies. In that vein, a very big thank you to our host, Creighton University, for the warm welcome to Omaha, NE.

Your agenda today is packed with substantive topics that I believe can have a very positive impact on smaller companies and their investors. This morning you already heard from the staff in the Division of Corporation Finance about the SEC’s Concept Release on Harmonization of Securities Offering Exemptions. [2] The concept release is the first step in what I hope will be a much needed reform of our exemptive offering framework, which I have referred to before as an elaborate patchwork. [3] I understand that this morning was also the first step for the work of the Committee in this area and that you will continue to consider how we can harmonize and make more effective our exemptions from registration at a future meeting of the Committee. The opportunity for improvement is stark. Private capital raising is now outpacing capital raising in our public markets, yet our Main Street investors have no effective access to investments in private capital offerings. Further, the availability of private capital is geographically skewed and, as we discussed at your first meeting, significantly favors companies with valuations in excess of $50 million. I look forward to your work in this area. In the meantime, I encourage everyone, including small businesses and their investors, to send us their comments and share their suggestions for how we can improve the exemptive offering framework.


This morning you also discussed our proposed amendments to the financial reporting requirements for acquisitions and dispositions of businesses, including Rules 3-05, 3-14 and Article 11 of Regulation S-X. [4] I am pleased you are tackling this topic, especially since I realize that it is not an easy one. So let me be clear about what I hope we can achieve with these amendments. First and foremost, we need to ensure that investors receive the financial information they need to understand the potential effects of significant acquisitions or dispositions. Second, I believe we can deliver for investors while eliminating unnecessary costs and burdens imposed by the current rules that, in my experience, can and do frustrate attractive acquisitions and dispositions, including those involving small businesses. The proposed rules reflect the expertise of the staff in the Division of Corporation Finance gained through years of experience working with these rules. I commend them for their work.

The last topic on your agenda today is also a direct result of the efforts of the Corporation Finance staff. Bill [Hinman], you and your staff have been busy. In May, the SEC proposed amendments to more appropriately tailor the accelerated and large accelerated filer definitions. [5] Under the proposed amendments, smaller reporting companies with less than $100 million in revenues would not be required to obtain an attestation of their internal control over financial reporting (ICFR) from an independent outside auditor. Importantly, the proposed amendments would not change key investor protections from the Sarbanes-Oxley Act of 2002, such as independent audit committee requirements, CEO and CFO certifications of financial reports, or the requirement that companies continue to establish, maintain, and assess the effectiveness of their ICFR. And, of course, the financial statements of those companies would continue to be audited by an independent outside auditor. What the proposed rules would do is allow these lower-revenue companies, many of which are biotech and healthcare companies, and their investors to benefit from more tailored control requirements so they will be able to redirect savings in growing their companies. We are not proposing these changes in isolation—we are building from the experience we have gained since the JOBS Act of 2012 exempted companies with less than $1 billion in annual gross revenues from the ICFR attestation requirement during the first five years after their IPO. In many cases, the proposed rules would simply extend this widely lauded JOBS Act exemption beyond the five year window for lower revenue companies.

I look forward to your discussion this afternoon. Thank you.



My words are my own and do not necessarily reflect the views of my fellow Commissioners or the SEC staff. (go back)


Concept Release on Harmonization of Securities Offering Exemptions, 84 FR 30460 (June 26, 2019).(go back)


See Chairman Jay Clayton, Remarks on Capital Formation at the Nashville 36|86 Entrepreneurship Festival (Aug. 29. 2018), available at back)


Amendments to Financial Disclosures about Acquired and Disposed Businesses, 84 FR 24600 (May 28, 2019).(go back)


Amendments to the Accelerated Filer and Large Accelerated Filer Definitions, 84 FR 24876 (May 29, 2019).(go back)
August 21, 2019
Stakeholder Corporate Governance Business Roundtable and Council of Institutional Investors
by Martin Lipton, Wachtell Lipton

The failure of the Council of Institutional Investors to join the Business Roundtable in rejecting shareholder primacy and embracing stakeholder corporate governance is misguided. The argument that protection of stakeholders other than shareholders should be left to government regulation is an even more serious mistake. It would lead to state corporatism or socialism.

The failure to recognize the existential threats of inequality and climate change, not only to business corporations but also to asset managers, institutional investors and all shareholders, will invariably lead to legislation that will regulate not only corporations but also investors and take from them the ability to use their voting power to influence the corporations in which they invest. Inequality and climate change will not be mitigated without adherence to the BRT governance principles not just by members of the BRT, but by all business corporations.

The BRT did not dismiss shareholders as “simply” providers of capital. To the contrary, the BRT principles recognize the fundamental importance of shareholders to the company, and commit the company to transparency and engagement with its shareholders to obtain their views of the company’s strategy, operations, and prospects.


From a legal standpoint, stakeholder corporate governance recognizes that the management and board of directors’ primary fiduciary duty is to promote the long-term value of the corporation and is not primarily to maximize shareholder wealth. To fulfill that duty, the board of directors uses its business judgment in reconciling competing interests among the stakeholders – employees, customers, suppliers, the environment, communities and shareholders. If the directors are not conflicted and use due care in reconciling the competing interests of the stakeholders, and in doing so seek to promote long-term value, they will have the protection of the business judgment rule and the courts will defer to their decisions without second-guessing them. This would be the case even in the absence of the BRT principles.

The BRT principles are critical to preserving our corporate system which relies on the integrity of managements and boards of directors and on free and open markets. Shareholder primacy was ill-conceived in the first place and has utterly failed to provide for the needs of all stakeholders. The alternative is state corporatism in the form of legislation like Senator Warren’s Accountable Capitalism Act. Not many members of the CII would prefer that.

The American corporate business system created the greatest economy ever. Short-termism, lack of investment, junk bond-financed hostile takeovers, and activist instigated financial engineering will destroy it. The BRT action is an important start in preserving it. Asset managers and asset owners (and CII) should support it, for their benefit and the benefit of all.

August 21, 2019
The Future or Fancy? An Empirical Study of Public Benefit Corporations
by James Hicks, Michael Dorff, Steven Davidoff Solomon

The public benefit corporation (“PBC”) is one of the hottest developments in corporate law. The sine qua non of this new form is that directors are permitted under their fiduciary duties to consider purposes other than profit in decision-making. The PBC has thus been described as different from the traditional corporation, which in some measure must be devoted solely to a for-profit motive. The PBC has been hailed as the “new corporate form”: one that permits a corporation to both earn money and serve a social purpose.

While there has been significant hype and theoretical consideration of this new form, to date there has been little empirical study. Critics of the PBC argue that it will be used for “purpose washing,” merely advocating a public purpose for public relations purposes while still maintaining a purely for-profit motive. Critics also argue that the current corporate form has enough latitude to serve multiple purposes. Advocates counter that the PBC will do nothing less than transform the U.S. capital markets, arguing that the profit maximization norm has contributed to a litany of preventable social ills, from global warming to income inequality, and from declining job stability to political corruption. By incorporating values other than profit-seeking into a company’s “DNA,” proponents assert, the law can tame capitalism’s worst excesses while retaining its many virtues.


But these are theories, and not only is there no empirical study of either of these arguments, there is a lack of data on more simple metrics such as PBC foundation and formation. We aim to close this gap by conducting an empirical study of early-stage investment in PBCs. Our strategy is to examine the universe of PBC formations and the types of investment they receive. We do so through early-stage investment, which consists of the usual range of angel investors, accelerators and incubators, venture capital funds, and private equity. Together, these present an interesting test case for PBC funding, because the investors themselves often have profit-maximizing incentives and fiduciary duties. By examining early-stage investment we can discern whether for-profit investment is occurring in PBCs, and if so, whether it is different in kind from traditional VC investment. This allows us to assess the development of PBCs, and the potential for future large-scale investment and utilization of the forms by mainstream companies. This study of early-stage investment also provides some evidence on how PBCs are being used: are they serving wider purposes, or are simply purpose-washing devices?

We collect by hand a database of all Delaware-registered PBCs that received investment between 2013 and 2018. This amounts to a small but not insignificant number of companies (n = 97). We then examine the type and scope of early stage investment in these companies. We find that early stage investment in PBCs is significant (over $1 billion), and includes well-known companies such as Allbirds, Lemonade, and Numi Tea. Moreover, we find that PBCs are being funded over a wide range of mostly consumer-focused industries (banking, food, education, technology, and more), by traditional, for-profit venture capital investment firms. Our evidence suggests that PBC round sizes are slightly smaller than their purely profit-seeking peers, but that on average investment occurs at similar stages to traditional start-ups.

Our results confirm that PBCs are being utilized as for-profit investment vehicles at a low but steady rate. PBCs are attracting investment—they are not an utter failure. We find that significant investments in PBCs tend to be in consumer-focused companies. At first blush this supports the purpose-washing hypothesis, but we also consider alternative possible explanations.

We conclude by drawing some new theories on the future of investment in PBCs. We theorize that PBCs still have significant hurdles to widespread adoption or usage. One of the primary drawbacks to widespread use of PBCs is the lack of case law on the scope of fiduciary duties and certainty of board action under the new statute. The investment patterns and flows that we find show that this has not deterred investment, but also that the PBC has not garnered unmitigated support from the VC community.

We theorize that, based on our results, PBC status is a secondary driver of early-stage investment and, by proxy, more widespread for-profit investment. VCs and other investors appear willing to tolerate the PBC’s wider purpose, but want to ensure some for-profit motive, and they focus on consumer-facing companies where PBC status is more likely to buttress a profit purpose. We believe the consequence is that the widespread use of the PBC remains some way off, but that there is groundwork being laid for more significant adoption. This will only come once there is a greater network of companies and lawyers familiar with the form and willing to have their companies opt-in to the PBC framework. Until then, PBCs are likely to be the purview of small and start-up businesses and, when utilized by for-profit companies, we suspect the social purpose will remain secondary to their for-profit motive.

Part I examines the use and scope of PBCs and provides background on the different theories of investors’ willingness to participate with these relatively new forms. Part II provides our empirical analysis. Part III builds on our empirical analysis to offer a theory for the future development and growth of PBCs. Ultimately, we draw a mixed view of PBCs, one that sees them neither as the form of the future nor as a mere fancy. Instead, this is an emerging corporate form that is very early in its lifecycle, awaiting more significant networks to develop to support its growth. If these networks develop, PBCs may attract much wider usage than is currently the case.

The complete paper is available here.

August 21, 2019
SEC Claims “Gifts for Donations” Offer was Sham
by Tom Gorman

Offering frauds have long been a staple of the Commission’s enforcement division. These cases, which often target specific groups, also fit comfortably within the current “main street” investor focus of the division since the promoter often targeted small, unsophisticated investors. Many are built on “too good to be true tales” of virtually instant wealth from a no or little risk opportunity because of some unique situation, development or product. Seldom are they built on ‘gifts” or “donations.” Yet those two elements are the keys to the latest offering fraud case filed by the agency. SEC v. Crystal World Holdings, Inc., Civil Action No. 1:19-cv-02490 (D.D.C. Filed August 19, 2019).

Crystal, along with The New Sports Economy Institute and Christopher Paul Rabalais are named as defendants in the Commission’s complaint. Chrystal is a holding company that owns intellectual property related to the experimental sports marketplace website platform known as AllSportsMarket. The firm is based in Washington D.C. Its stated goal is to become a world-wide 24-hour exchange for sports trading instruments. The Institute is a non-profit with offices in Pasadena. It is seeking a royalty-free intellectual property licensing agreement with Crystal. Both firm firms were organized by Mr. Rabalais.

Over a five-year period, beginning in mid-July 2014 and continuing through April 2019, members Crystal and the Institute offered common and preferred shares of Crystal to the public in the United States, Canada, Europe and Australia. About $1.5 million was received from investors. The shares were offered using mailing lists, e-mail and a website.

The Crystal shares were offered as “gifts.” In return investors made “donations.” Investors were told that there were plans to register the Crystal shares with the SEC in the future. Once the shares became registered the price would increase. Accordingly, now is the time acquire them, according to the representations. The documents reciting this claim carried the SEC’s seal without authorization.

Defendants made a series of misrepresentations in connection with offering of the Crystal shares which included:

Registration “When I receive [your email confirmation], your shares will be recorded in the official stock database that will be used to register your shares. . .” with the SEC, the complaint states;

No transfers: “No transfers allowed at this point. That must happen after SEC registrations . . .” and

Preparations: “We’ve been carefully putting everything in order so that our company stock can be registered with the SEC early next year.”

These and other representations made by Defendants were false. No effort was ever made to register the shares with the SEC. Indeed, the “gift-donation model employed by Defendants presented a false appearance of fact regarding . . .” the Crystal shares, according to the complaint. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a)(2) and (3). The case is pending.

August 21, 2019
Inline XBRL: Corp Fin Issues 9 CDIs
by Broc Romanek

In response to the mechanical questions about how to handle the Inline XBRL for’34 Act filings – including the exhibit index – Corp Fin issued a set of 9 CDIs yesterday in the area. Hopefully, this will be the last time I ever blog about Inline XBRL…

By the way, the new CDIs don’t show up under “What’s New” on the Corp Fin page. And the way the relatively new CDI section is constructed, the only way to sleuth which CDIs are new – when the SEC pushes out an email indicating there is something new – is to click on each section of the CDIs and look at the “update” date. Something for which I receive a handful of complaints from members each time a new set of CDIs is issued…

SEC Brings First Reg FD Case In Nearly Six Years

Yesterday, the SEC brought this Reg FD enforcement case against TherapeuticsMD based on its sharing of material, nonpublic information with sell-side analysts without also disclosing the same to the public. This should be one of the least controversial FD actions the SEC has brought – with pretty clear “selective disclosure” violations of FD on two occasions. Really egregious conduct including the fact that the company didn’t have FD policies or procedures. The company was fined $200k…

The SEC hadn’t brought a Reg FD case since September 2013 (the SEC never did bring a Reg FD enforcement action against Elon Musk for his tweets last year) – here’s a list of the 16 SEC enforcement actions involving Reg FD over the years…

Mandatory Gender Quotas for Boards: California Gets Sued

As noted in this press release, Judical Watch has sued the State of California over its new law that requires up to three women being placed on the boards of companies incorporated in that state. The primary claim of the lawsuit is that the law is unconstitutional. Here’s an article from the “Sacramento Bee” – and see this Cooley blog

Broc Romanek

8/21/2019 posts

CLS Blue Sky Blog: Addressing Economic Insecurity: Why Social Insurance Is Better Than Corporate Governance Reform
CLS Blue Sky Blog: SEC Data Analysis in Insider Trading Investigations
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Remarks at SECs Small Business Capital Formation Advisory Committee Meeting
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Stakeholder Corporate Governance Business Roundtable and Council of Institutional Investors
The Harvard Law School Forum on Corporate Governance and Financial Regulation: The Future or Fancy? An Empirical Study of Public Benefit Corporations
SEC Actions Blog: SEC Claims “Gifts for Donations” Offer was Sham Blog: Inline XBRL: Corp Fin Issues 9 CDIs

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