December 20, 2016

Threats to the SEC’s Independence

Roberta S. Karmel

At the November Business Law Section meeting, former SEC Commissioner Roberta Karmel was the keynote at the Securities Committee Luncheon, and delivered the following remarks about the need to preserve the independence of the SEC.

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The Securities and Exchange Commission (SEC) was created as an independent federal regulatory agency. Its commissioners over the years have been chosen for their expertise and have come from various backgrounds and geographical regions. Throughout the SEC’s long history it has enjoyed great respect from the securities industry, the bar and the public. But the period of the Obama presidency has given rise to a poisonous partisanship that threatens the SEC’s independence and effectiveness. If this continues, the end result will be a lack of respect for the SEC and its extremely important role in policing and overseeing the public securities markets.

The attacks on the SEC’s independence have come from the right, the left, and the D.C. Circuit Court. A substantial segment of the Republican Party sees as its mission the destruction of government agencies, but it has succeeded only in sowing the seeds of disillusion with America and democracy, not only in our country but also abroad. Yet, Democrats have also participated in attacks on the SEC’s independence.

Independence and nonpartisanship were both values in the creation of the SEC and other federal independent agencies, but a greater value was expertise. In today’s complicated, technologically advanced world, expertise is probably needed more than ever in regulation, but populists on the right and left have debunked expertise and shown a lack of respect for government leaders.

In the current highly divisive and partisan world, nominated members of the SEC other than the chair have been paired as Democratic and Republican commissioners—many of whom have a background from the Congressional committees that have oversight over the SEC. President Obama’s first choice of a Democratic commissioner to replace Commissioner Aguilar was torpedoed by Senator Elizabeth Warren because he came from a private law firm. Many stellar SEC commissioners had such a background in the past, and because they were experts and they left their clients at the door, they were able to make significant contributions to the development of securities regulation. These commissioners include: Ray Garrett, Frank Wheat, Richard Smith, and Al Sommer. Recent Republican commissioners, including Kathleen Casey, and the nominee Hester Peirce, have worked for Senator Richard Shelby.

When Senator William Proxmire was head of the Senate Banking Committee, he preferred the appointment of persons with prior experience on the SEC staff. Although I was then in private practice in New York, and that experience was considered one of my strengths by the Carter White House, I was confirmed without difficulty by the Senate Banking Committee headed by Senator Proxmire because I had begun my career on the staff of the SEC New York Regional Office. Two of the other commissioners then were Irving Pollack and Philip Loomis, former SEC staffers and a third, John Evans, had been on the Senate Banking Committee staff. Only the chairman, Harold Williams, a tax lawyer, had experience in the business world. That background did not make him a tool of the business community but an adherent of corporate governance reform.

In my opinion, while a background in government is useful, an agency like the SEC needs some commissioners who have had real world experience in business or the private practice of securities law. Nevertheless, we do not need SEC commissioners who do not believe in the mission of the SEC or who would like to take a hacksaw to all government regulation. I am very afraid that the Trump administration and the Republican Congress will try to destroy the SEC, or in any event, the SEC’s independence.

Today, neither the SEC chair nor the president seems to enjoy the freedom to choose non-partisan candidates who will be confirmed by the Senate. Qualifications are based on ideological correctness rather than expertise. This has led to very contentious and partisan decision making with many 3–2 decisions, or even worse, 2–1 votes, on important issues. Moreover, the selection of commissioners in this manner results in strong dissents designed to enable affected constituencies to appeal rulemaking to the United States Court of Appeals for the District of Columbia Circuit and prevail by upending new regulations. (See, e.g., Nat’l Ass’n of Mfrs. v. SEC, 748 F.3d 359, 363-65, 373 (D.C. Cir. 2014); Am. Petroleum Inst. v. SEC, 953 F. Supp. 2d 5, 8 (D.D.C. 2013). I am not opposed to dissents; I authored a few when I was a commissioner, but these were based on principle, not party. Partisanship has been a historical hallmark of some agencies, like the National Labor Relations Board, where labor and management commissioners are often at odds. It was not traditionally the case at the SEC where the agency’s mission is to police the securities markets and protect investors, and where influence by outside political forces once was rare.

In my opinion, partisanship has undermined the SEC’s mission and credibility and made it very difficult for the SEC to complete rulemaking mandated by statute. It took five years for the SEC to complete the bulk of mandated rulemaking under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), in part because Republicans in the Congress and at the SEC objected to many statutory provisions. In the meantime, Congress passed the JOBS Act, which mandated new deregulatory rules, and again the SEC was slow to pass rules implementing this law because Democrats found it objectionable. When the agency operated in a collegial manner, I believe it was more effective and respected and was able to pass rules without rancor.

In addition, the courts have been politicized. Much of the delay in SEC rulemaking has come from D.C. Circuit Court decisions vacating SEC rulemaking on cost-benefit grounds or other related rationales. Although I think that the SEC should be mindful of the economic effect of its rules on regulated businesses, the inordinately lengthy rulemaking proposals and adopting releases that the SEC has been forced to produce, do not serve the orderly development of the law or the public interest. Furthermore, those politicians who want to repeal regulations may be surprised to discover this process is lengthy and cumbersome just like rulemaking.

Representative Jeb Hensarling’s Financial Choice Act, a likely start for re-regulation of financial services, would severely cripple the SEC. Not only would rulemaking be subject to even more stringent cost-benefit and other constraints than is now the case, but the Enforcement Division would be under the thumb of Congress. Also, the Enforcement Division would have to verify that its actions are within SEC authority and consistent with the Administrative Procedures Act. The economic consequences of a civil penalty on an issuer would have to be considered. This idea of some kind of a cost-benefit analysis for enforcement cases seems ludicrous.

Dodd-Frank had many laudable purposes and most of its provisions were a serious and worthwhile response to the problems that led to the financial meltdown of 2008. But some of its provisions forced the SEC to wade into political quagmires that had little or nothing to do with investor protection. One example is Section 1502 of the Dodd-Frank Act, which mandated that the SEC require registered and reporting companies under the Securities Exchange Act of 1934 to disclose whether conflict minerals from the Democratic Republic of the Congo were necessary to the functionality or production of any of a company’s manufactured goods. The rationale for this provision was that armed groups were financing the DRC’s brutal civil war by exploiting and trading conflict minerals.

Although the D.C. Circuit Court rejected an attack based on an inadequate cost-benefit analysis, of the SEC’s rule passed pursuant to Section 1502, the court did so holding that the SEC had no choice under the statute but to promulgate a disclosure rule. Yet, it observed that “the rule’s benefits would occur half-a-world away in the midst of an opaque conflict about which little reliable information exists, and a concern about a subject about which the Commission has no particular expertise.” (Nat’l Ass’n of Mfrs., 748 F.3d at 369.) The Republicans have campaigned to repeal Dodd-Frank. That would be a terrible mistake, but it certainly could benefit from a bipartisan corrections bill. The Financial Choice Act, referred to already, is not such a bill.

An even more trenchant example of partisan political pressure being exerted on the SEC is conflicting Republican and Democratic reactions to the petition for rulemaking on public company disclosure of political contributions. After the U.S. Supreme Court decided the Citizens United case, the Committee on Disclosure of Political Spending, co-chaired by Professor Lucian Bebchuk of Harvard Law School and Robert J. Jackson of Columbia Law School, sent a petition to the SEC to start a rulemaking proceeding to require disclosure of corporate political contributions (Bebchuck-Jackson Petition). (Citizens United v. Fed. Election Comm’n, 558 U.S. 310 (2010). See also McCutcheon v. Fed. Election Comm’n, 134 S. Ct. 1434 (2014)). In addition, these co-chairs authored a law review article arguing in favor of SEC rulemaking. Lucian A. Bebchuck & Robert J. Jackson, Shining Light on Corporate Political Spending, 101 GEO. L. J. 923, 967 (2013). This petition and its favorable response were prompted in part by a statement in Citizens United by Justice Kennedy. He noted that “with the advent of the Internet, prompt disclosure of expenditures can provide shareholders and citizens with the information needed to hold corporations and elected officials accountable for their positions and supporters.”

There are two different issues involved with regard to disclosure of political spending—campaign contributions and lobbying activities. The SEC has received millions of comments supporting the Bebchuk-Jackson petition from a diverse array of constituents—public interest groups, federal law makers, trade unions, and major investor firms. Yet, there are serious objections to the petition also. Political contribution disclosures are already required to be made to the Federal Election Commission and many highly significant contributions are made by individuals, not public corporations. Lobbying is customarily by trade associations rather than individual corporations. In any event, the issue is essentially political. Some commenters therefore believe that the SEC should have no role regulating campaign finance in the first place. My own view is that Citizens United was a pernicious case, but the SEC should not be required to enforce all worthwhile federal regulations by way of its disclosure rules.

In 2013 and 2014, there were been bills introduced in Congress to compel the SEC to mandate political contribution disclosures, and bills to prevent the SEC from mandating such disclosure. A provision written into the policy riders of the 2016 Omnibus Appropriations bill, passed on December 18, 2015, explicitly prohibits the SEC from using any funds to finalize political contribution disclosure rules during fiscal year 2016. A group of Congressional leaders, led by New York Sen. Charles Schumer, was quick to inform the SEC via an open letter that the language of the bill does not prohibit the Commission from preparing, researching, or investigating potential rules, and urged the SEC to remain committed to the issue.

At least one NGO sought to force the SEC to enact a political contribution disclosure role when the SEC failed to act on its petition for rulemaking. The NGO then sued to compel the SEC to act. On January 4, 2016, Judge Rosemary Collyer dismissed the suit, writing that “Since the SEC has not denied the petition and . . . [the NGO] has not asserted that the SEC failed to act in response to a clear legal duty, it follows that he failed to state a valid APA claim upon which relief can be granted.” (Silberstein v. SEC, 2016 WL 29253 (D.D.C. Jan. 4, 2016)).The decision effectively holds that the SEC is not obligated to respond to petitions by NGOs and private citizens seeking to set the SEC’s rulemaking agenda. As pointed out by former SEC Chair Arthur Levitt in a Wall Street Journal Op Ed, the SEC’s agenda should not be decided by rulemaking petitions.

The furor over the Bebchuk-Jackson political spending petition did not subside after these events. The nominations of two SEC commissioners to fill vacancies has been held up in the Senate by Democrats because they did not testify during their confirmation hearings that they would push forward on a rulemaking advancing the petition. Even worse, Senator Elizabeth Warren, suggested that Chair Mary Jo White be fired as SEC chair by President Obama and demoted to a commissioner because Chair White has refused to engage in rulemaking to compel public companies to disclose their political contributions. Missing from this pique on the part of Senator Warren is the fact that the SEC is prohibited by statute from doing so, a piece of legislation that she voted for.

Senator Warren also criticized Chair White for embarking on a project to streamline SEC disclosure policy and improve public company reporting. In the face of unprecedented and contradictory assignments from Congress for new regulatory and de-regulatory rulemaking, in the Dodd-Frank and JOBS Acts, disclosure reform is an extremely worthwhile project aimed at the agency’s core mission of investor protection. This project was prompted by mandates from Congress in the JOBS Act and the FAST Act, the SEC has been implementing this reform with extensive and thoughtful rulemaking proposals. I hope this project will continue to move forward in the next administration.

The suggestion that the chair of the SEC be fired seems to be an election year gambit. Eight years ago, Senator John McCain asserted that if he were president he would fire the then chair of the SEC for failing to prevent the 2008 financial crisis. The SEC is supposed to be a collegial agency of nonpartisan experts. Instead it has become an agency riven by partisanship due to politicians trying to score points and gain publicity.

Chair Mary Jo White has been criticized by the right and the left which is a tribute to the great job she has done and how much she has accomplished. We owe her a debt of gratitude in serving as SEC chair during such difficult and contentious years.

One of the many threads in the Watergate scandal was an effort by the Nixon White House to interfere with an enforcement case by the SEC against Robert Vesco who had given money to the Nixon campaign. By contrast, when I was a commissioner, the SEC and the comptroller of the currency brought an action against Bert Lance, President Carter’s budget director, without any pressure to defer this case coming from the White House. It is because of cases like this that the independence of the SEC is essential for the agency to accomplish its mission.

The president’s power to remove agency members from office only for “cause” has long been considered a key feature of agency independence by academics Yet, I believe that two other earmarks of independence—agency control of its own litigation and independent funding—are more important as a practical matter. If the SEC did not have the ability to sue anyone the agency believes has violated the securities laws—including high-level political appointees and members of Congress—it would not be as independent as the SEC is today. The effort by the Nixon administration to quash the SEC’s case against Robert Vesco, which I already referred to, led to the resignation of an SEC chair, and was the first serious scandal in which the SEC was ever embroiled. When I was an SEC commissioner, this event resulted in a preoccupation with affirming agency independence from the president, but not from the Congress. Yet, today, it is members of Congress—both Republicans and Democrats—who are threatening the SEC’s independence. Agencies are often criticized for having been captured by the industries they regulate, but agency capture occurs by way of congressional pressure.

In my opinion, independent funding is a key to such agency independence as enjoyed by the Federal Reserve Board. Although the SEC takes more money into the U.S. Treasury than its budget, from registration fees and fines, the SEC budget is subject to annual appropriations by the Congress. Serious efforts to insulate the SEC from partisan and Wall Street interference by giving the agency independent funding authority floundered in Dodd-Frank, due to Democratic opposition. I am very worried that in a Trump administration, the SEC will be starved for funds and unable to perform effectively. I am also worried that the Enforcement Division will become subject to congressional political pressures and be unable to function with integrity.

I believe that everyone in this room, whether Republicans or Democrats cares about the work and reputation of the SEC because the SEC’s work is our work. We need to push back against the destructive partisanship that is fueling so much fury against government and government appointees and employees. It is time to give our government and agencies like the SEC some serious respect and allow them to do the work they were created to accomplish. Yet some of the ideas now being floated would not reform the securities laws or the SEC, but eviscerate them.

I am going to conclude this talk on a personal note. I initially drafted this plea for SEC independence when I thought Hillary Clinton would become president but there would be a Republican Congress and four more years of gridlock. Instead I believe we are going to witness something worse—an administration that wants to build walls of ignorance and bigotry and retreat into isolationism in order to return to the 1950s. But the 1950s were not only a time of lucrative manufacturing jobs; they were also the years of de facto segregation, McCarthyism and anti-intellectualism. I fear the Trump administration will deregulate the capital markets so that they become the province of fraudsters and fail to raise and allocate capital properly.

I have been an internationalist since I was a child and corresponded with pen pals all over the world. I have enjoyed the practice and teaching of securities regulation because it has been a window on to the global capital markets and the world economy. Now I am pessimistic about the continued health of the global capital markets and an international regulatory system to support those markets and world trade.

You and I are part of the elite that is being rejected by Brexit and the followers of Donald Trump. Perhaps we have taken too large a share of the wealth generated by an open economy and open borders. But lower taxes for the rich and closing off immigration will not solve the problems of the people left behind in the American Midwest and elsewhere. Gutting the securities laws will not preserve their meager savings or create new jobs. As lawyers, we need to uphold the rule of law and the administration of justice. As securities lawyers, we need to be watchful of threats to the SEC’s independence and very existence.

Roberta S. Karmel

Professor Karmel is Centennial Professor of Law at Brooklyn Law School, and is an acknowledged expert in international and domestic securities regulation. She is a former Commissioner of the Securities and Exchange Commission, a former Public Director of the New York Stock Exchange, and was in private practice for 30 years. She was also a Fulbright Scholar studying the harmonization of the securities laws in the European Union. She is the author of Life at the Center: Reflections on Fifty Years of Securities Regulation and Regulation by Prosecution: The Securities and Exchange Commission Versus Corporate America, and has widely published articles on securities regulation and international securities law in law reviews and journals. She also authors a bi-monthly column, “Securities Regulation,” that appears in the New York Law Journal. Professor Karmel’s professional activities and affiliations are numerous. She is the Chair Emerita of the Board of Trustees of the Practising Law Institute, a member of the American Law Institute, and a Fellow of the American Bar Foundation. She also served on the ABA’s Presidential Task Force on Financial Markets Regulatory Reform. She previously served as a director of the New York Chapter of the National Association of Corporate Directors and was the Vice-Chair of the International Coordinating Committee of the ABA Business Law Section.