The Securities and Exchange Commission: a Fort Worth Regional Office Update

The panel tackled timely topics on the SEC’s annual regulatory agenda, discussing key areas of enforcement, proposed rulemaking under new leadership, special purpose acquisition companies (“SPACs”), and individual liability. Vinson & Elkins Partner and former SEC Senior Counsel in the Division of Enforcement Rebecca Fike, Holland & Knight Partner and former SEC Associate Director of Enforcement Jessica Magee, and Senior Managing Director at Ankura and former SEC Assistant Chief Accountant Steve Richards joined Regional Director Peavler on Tuesday’s panel. ExxonMobil Assistant General Counsel and former Director of the Fort Worth Regional Office David Woodcock moderated the panel.

Fike observed that there is “a lot of mystery around how the SEC works,” noting that throughout her transition into the private sector, she is often asked about how cases are assigned and who decides whether to bring enforcement actions. To learn what is going in the SEC’s enforcement program, “look no further than our rulemaking,” said Peavler, as the SEC’s rulemaking is “what is driving the Commission.” According to Peavler, the SEC has been focusing on “environmental, social, and corporate governance (“ESG”), principally climate change-related [rules], SPACs, cyber[security], [and] cryptocurrency . . . .” Magee shared that now, more than ever, public companies are interested in determining which internal controls to prioritize when it seems that everything is a priority for the SEC.

The panel addressed four of the most pressing questions businesses have about the SEC’s inner workings and goals. Woodcock asked the panel for their take on the SEC’s unprecedented rulemaking, inquired about the evolving regulation of SPACs, posed questions about the future of individual responsibility, and requested advice from the panelists for companies faced with an SEC investigation.

What implications does the SEC’s unprecedented rulemaking have for companies today, and what does it mean for companies in the future?

The SEC welcomed new leadership in 2021, including SEC Chair Gary Gensler, Enforcement Director Gurbir Grewal, and Deputy Director Sanjay Wadhwa, which quickly announced an ambitious rulemaking agenda.¹ During the panel, Peavler recognized that the increased pace at which the SEC has proposed new rules has likely surpassed that of the agency following Dodd-Frank or Sarbanes-Oxley. In fact, during Gary Gensler’s first year as SEC chair, the Commission has issued 27 new proposed rules on topics ranging from private funds to cybersecurity to share buybacks and more.² Peavler explained that current rulemaking fills voids in securities laws on issues the agency previously recognized, are policy driven, or that have since developed. He went on to describe the SEC’s rulemaking as important for bringing a lot of what is happening “in the dark” out “into the light,” referencing the fact that federal securities laws were modeled after blue sky laws — prophylactic anti-fraud regulations intended to protect the investing public. Richards noted that this type of shift in rulemaking makes sense given who the modern-day investor is. He explained that the SEC facilitates the disclosure of information for modern-day investors who, by and large, are now millennials interested in attaining climate-related metrics and understanding the related risks in order to make the allocation of capital decision. “It was inevitable, you can argue about when and how . . . but this was always going to happen because [these topics] matter to the investment decision.”

The SEC has had a particularly busy month, announcing proposed rules on cybersecurity and SPACs in the past few weeks.³ On March 21, 2022, the Commission released highly anticipated proposed rules on ESG that, if adopted, would require public companies to disclose extensive information about climate-related risks that may have material impact on their business.⁴ These proposed rules, in particular, have already met criticism for possibly “exceeding the bounds of [the agency’s] statutory authorization” and potentially hurting “investors, the economy, and [the] agency.”⁵ Fike noted she is interested to see how the SEC will make materiality determinations related to ESG disclosures principally because such analysis involves more qualitative than quantitative factors. To this, Peavler explained that there are domestic standards through the EPA which provide the basis for anticipated norms; however, he suggested that much of the analysis will likely be industry-specific, company-specific, and, in some cases. circumstance specific.

Magee and Fike then discussed the implications the SEC’s rulemaking on ESG and other popular issues have for public companies. The panelists agreed that the bottom line when it comes to a new and complex regulatory framework is relatively simple: make sure the company’s actions actually mirror its disclosures.

What does the SEC’s recent rulemaking mean for SPACs?

On March 30, 2022, the SEC formally announced an extensive set of proposed rules governing SPAC transactions.⁶ While the proposed rules were immediately met with harsh criticism, it is no surprise that the SEC has focused its recent rulemaking efforts on regulating the SPAC market. In fact, Chair Gensler remarked in 2021 that SPACs were a likely target for future rulemaking given the considerable difference between the traditional initial public offering (“IPO”) process and SPAC transactions — the former facing significantly more regulation and oversight than the latter — and the notable increase in SPAC transactions since 2020.⁷ The proposed rules seek to align SPAC transactions with traditional IPOs by imposing similar disclosure and procedural requirements on companies targeting the public market through a SPAC transaction. Among other things, the new rules would require: (i) SPAC sponsors to disclose any conflicts of interest and payment incentives; (ii) SPACs to disclose whether they believe their proposed SPAC transactions are fair to investors; and (iii) SPACs to provide investors with disclosure documents at least 20 days before a shareholder meeting.

When asked during the panel whether the Commission dislikes SPACs, Peavler remarked that the SEC does not have an aversion for SPAC transactions. Instead, Peavler maintained that the SEC has targeted SPACs because SPACs are being “sold and presented almost like a short-cut” for private companies seeking to access the public market. As an example, Peavler noted that SPACs allow companies to enter the public market without showing any historic performance metrics, a practice that is prohibited under traditional IPO regulations. The fear, according to Peavler, is that — without proper regulation — companies that could not undertake a traditional IPO are now entering the public market through SPAC transactions. Moreover, these companies are doing so without providing investors the necessary information to make an informed investment decision. The new disclosure rules, Richards added, serve two purposes: they align risks so that sponsors are disincentivized to transact with companies that lack the maturity to enter the public market, and they encourage greater disclosure of information to investors.

Critics have warned that the SEC’s proposed rules would overregulate the SPAC market. One such critic, Commissioner Hester Pierce, noted in a dissenting opinion that the new rules go beyond encouraging proper disclosure and instead threaten to stop the use of SPACs altogether.⁸ When asked whether they believed that the SEC’s regulations would chill the SPAC market, the panelists agreed that this was unlikely. In support of this contention, Magee emphasized that the expedited SPAC process remains the most attractive option for pre-revenue companies that lack the time or resources to undertake a traditional IPO. Fike agreed, adding that the enormous financial upside offered by SPAC transactions far outweighs any current fear of future enforcement, and emphasized that the financial upside of pursuing a SPAC transaction for SPAC sponsors in particular is significant. While the new rules could, and likely will, expand liability for these sponsors, according to Fike, the fear of SEC regulation is unlikely to cause a noticeable decline in the number of SPAC transactions at this time because the SEC has only pursued one enforcement action against a SPAC sponsor to date.  If and when the SEC begins to investigate more sponsors, Fike added, there may be a significant change in the SPAC market, but for now such a change is unlikely.

So what advice did the panelists have for companies interested in going public through a SPAC transaction? Ultimately, the panel agreed that companies must avoid rushing into a SPAC transaction. Instead, Magee noted, companies will need to spend more time assessing whether they are truly ready to go public through a SPAC. This will require accountants and lawyers to have realistic conversations with their clients which, according to Magee, sometimes will mean telling a company “no, you are not ready yet.” While the new SPAC rules are extensive, Fike added, many of them “are already best practices for the better SPACs that are out there.” Therefore, SPACs that dedicate the proper time to due diligence and ensure reasonably accurate public disclosures are less likely to run afoul to the SEC’s new SPAC regulations.

Is the SEC ushering in an era of individual accountability?

The panel then turned to enforcement trends regarding individual accountability, noting a striking difference between the treatment of legal counsel and corporate accountants. The panel discussed Commissioner Allison Herren Lee’s remarks at the Practicing Law Institute’s Corporate Governance master class, advocating for new rulemaking that would set minimum standards of professional conduct for attorneys who counsel public companies and enhance oversight at the firm level.⁹ Commissioner Lee had explained that an issue arises when “lawyers fail as gatekeepers” and provide “goal-directed” reasoning to public companies, resulting in harm to the market in the form of misleading disclosures and the insulation of the responsible bad actors.

During this discussion, Peavler noted that there has been increased use, in some cases informally, of the advice-of-counsel defense, wherein corporate representatives claim that certain actions were approved by company counsel. However, Peavler’s response suggests that such review, if relied upon, must be intentional, often finding it insufficient if counsel was merely present when a decision was made but offered no advice on whether such decision was compliant with the SEC’s rules. The panel then discussed the lack of consequences, as raised by Commissioner Lee’s remarks, for attorneys who may have facilitated wrongdoing. While the SEC does have an “up-the-ladder” reporting obligation which requires attorneys to notify the company’s chief executive officer, chief legal officer, or an appropriate officer of a material violation, Fike noted that Commission has yet to enforce the rule.

In contrast, Richards has noticed a trend toward increased individual responsibility and accountability for accountants. While the schemes used to mislead investors do not change over time, they are often refined. The difference, he finds, is that the SEC has pursued cases today that it had not brought ten years ago, explaining that the SEC and other regulators have increasingly charged accountants for their role in financial reporting cases today due to the high level of scrutiny surrounding compliance. Richards suggested that the trend toward individual accountability may come from Chair Gensler’s focus on compliance and internal controls.

The discussion of internal controls sparked a conversation about the role counsel should play when engaging with the SEC. Magee explained that it is critical for counsel to frame any conversation with SEC enforcement staff about a company’s internal controls around the standard of reasonableness. “An internal controls environment is not meant to be perfect. Perfect is not the goal. Reasonableness is the goal [and] good faith is the goal, but you still have human activity, sometimes rogue actors, sometimes intentional bad acts, sometimes reasonable good faith mistakes . . . .” While it is unclear whether the SEC will issue reform as to individual accountability for attorneys to mirror the increased cases brought against accountants, one thing appears certain — companies should continue to work with counsel to refine and improve internal controls to protect investors against fraud and reporting misstatements.

What advice did the panel have for companies facing an SEC investigation?

When asked what advice the panelists had for companies faced with an SEC investigation, the panelists agreed that cooperation can reap rewards but requires more than it may have in the past. As Fike warned, cooperation does not mean merely obeying a subpoena. Instead, companies must be willing to go above and beyond what is asked of them. Peavler agreed, noting that companies should prepare to walk the SEC through each step of the transaction and show the Commission exactly how the alleged wrong occurred. A company that attempts to conceal or deny any wrongdoing loses all credibility with investigators. And once credibility is lost, Peavler cautioned, it is nearly impossible to regain. The panelists additionally agreed that companies should not rely solely on precedent in trying to negotiation a resolution. According to Richards, companies can no longer point to previous SEC settlements with similar facts and ask for a comparable deal. Fike added that companies and their counsel should treat precedent as a floor and be prepared to explain to the Commission why their unique case deserves a specific result.

Moreover, the actions a company takes before any issues arise or an investigation is initiated are vital. Richards noted that, despite the current evolving regulatory environment, companies “have to get the basics right,” meaning investing proper time into compliance and diligence. If a company does not cover the basics, according to Richards, it is unlikely to receive any leniency or cooperation credit from investigators after an investigation is initiated. Fike and Magee agreed, noting that companies must invest in compliance and diligence now or risk paying the price later.

Finally, the panel concluded by noting that counsel’s role cannot be underestimated, and it starts at the beginning, often with a transaction that may or may not later become subject to an enforcement investigation. Corporate counsel, for instance, must ensure that it keeps detailed records of the due diligence process. This means, Fike noted, that corporate counsel should not rely on memory alone, and instead should document how loose ends are closed out by retaining emails and other written records so that, when engaging with the SEC or any other agency in the future, they can show regulators that due diligence remained a priority and counsel properly investigated the statements that were being made to the public.

While this article summarizes many of the topics explored by last Tuesday’s panel, true insight into the panelists’ thoughts on the current state of SEC regulation can only be gleamed from watching the panelists interact. Specifically, the panel’s discussion and exchange of ideas — as well as the many laughs shared by the group — show that there is not one clear answer, and the application of the SEC’s rules may vary depending on the circumstance.

¹ Press Release, Sec. & Exch. Comm’n,  Gary Gensler Sworn in as Member of the SEC (Apr. 17, 2021), https://www.sec.gov/news/press-release/2021-65; Press Release, Sec. & Exch. Comm’n,  SEC Appoints New Jersey Attorney General Gurbir S. Grewal as Director of Enforcement (June 29, 2021), https://www.sec.gov/news/press-release/2021-114; Press Release, Sec. & Exch. Comm’n,  Sanjay Wadhwa Named Deputy Director of Enforcement Division (Aug. 18, 2021), https://www.sec.gov/news/press-release/2021-157.

² For a complete list of SEC Proposed Rules, visit https://www.sec.gov/rules/proposed.shtml.

³ Press Release, Sec. & Exch. Comm’n,  SEC Proposes Rules on Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure by Public Companies (Mar. 9, 2022), https://www.sec.gov/news/press-release/2022-39; Press Release, Sec. & Exch. Comm’n,  SEC Proposes Rules to Enhance Disclosure and Investor Protection Relating to Special Purpose Acquisition Companies, Shell Companies, and Projections (Mar. 30, 2022), https://www.sec.gov/news/press-release/2022-56.

⁴ Press Release, Sec. & Exch. Comm’n,  SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors (Mar. 21, 2022), https://www.sec.gov/news/press-release/2022-46.

⁵ Hester M. Pierce, Comm’r, U.S. Sec. & Exch. Comm’n, We are Not the Securities and Environment Commission – At Least Not Yet, (Mar. 21, 2022), https://www.sec.gov/news/statement/peirce-climate-disclosure-20220321.

⁶ Press Release, Sec. & Exch. Comm’n,  SEC Proposes Rules to Enhance Disclosure and Investor Protection Relating to Special Purpose Acquisition Companies, Shell Companies, and Projections, supra note 3.

⁷ Gary Gensler, Chair, U.S. Sec. & Exch. Comm’n, Testimony Before the Subcommittee on Financial Services and General Government, U.S. House Appropriations Committee (Mar. 26, 2021), https://www.sec.gov/news/testimony/gensler-2021-05-26.

⁸ Hester M. Peirce, Comm’r, U.S. Sec. & Exch. Comm’n, Damning and Deeming: Dissenting Statement on Shell Companies, Projections, and SPACs Proposal (Mar. 30, 2022), https://www.sec.gov/news/statement/peirce-statement-spac-proposal-033022.

⁹ Allison Herren Lee, Comm’r, U.S. Sec. & Exch. Comm’n, Send Lawyers, Guns and Money: (Over-) Zealous Representation by Corporate Lawyers, Remarks at PLI’s Corporate Governance – A Master Class, (March 4, 2022), https://www.sec.gov/news/speech/lee-remarks-pli-corporate-governance-030422.