Is the SEC making a wrong turn by regulating corporate governance?
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In the wake of the recent financial crisis, the Dodd-Frank Act created the SEC Investor Advisory Committee with the stated purpose of advising the SEC on (i) regulatory priorities of the SEC; (ii) issues relating to the regulation of securities products, trading strategies, and fee structures, and the effectiveness of disclosure; (iii) initiatives to protect investor interest; and (iv) initiatives to promote investor confidence and the integrity of the securities marketplace. In other words, the committee is to advise on matters historically within the purview of federal securities laws. While this is fine and good, there is some indication that the SEC may again be considering the use of disclosure rules to indirectly regulate matters that are not federal securities law matters (see, e.g., conflict mineral rules, Iran-related disclosure rules, CEO pay ratio disclosure rules, etc.).

The new potential area of regulation for the SEC may be internal corporate affairs. The committee’s agenda for the October 9, 2014 meeting of the SEC Investor Advisory Committee will include a discussion of issuer adoption of fee-shifting bylaws for intra-corporate litigation. An interesting topic considering such bylaws are matters of state corporate and contract laws, not federal securities laws.

In a prior blog post, I discussed the hot topic of fee-shifting bylaws. The purpose of such bylaw provisions is to require a non-prevailing shareholder to reimburse the corporation for fees incurred in connection with defending the lawsuit. These bylaw provisions gained notoriety in the recent case of ATP Tour, Inc. v. Deutscher Tennis Bund, where the Delaware Supreme Court held that fee-shifting provisions contained in a Delaware non-stock corporation’s bylaws were facially valid if not enacted for an improper purpose. Commentators generally believed that the court’s ruling would apply equally to Delaware stock corporations due to the statutory basis of the court’s ruling.

The general theory is that these fee-shifting provisions may have a deterrent effect on intra corporate litigation and would curb the number of baseless strike suits against publicly held corporations. The Delaware legislature has indicated that it would likely be considering whether legislative action was necessary related to fee-shifting bylaw provisions, but to date, nothing significant has been done on this front.

As Keith Bishop correctly points out in a blog post on this issue, the enforceability of a company’s bylaws is solely a question of state contract and corporate law, not federal securities law. As it relates to the Investor Advisory Committee’s fee-shifting bylaws agenda item, in his words, “[o]ne would have to be either credulous or contumacious to read into this statute a Congressional intent that the Investor Advisory Committee advise and consult with the Securities and Exchange Commission on matters of state contract law.”

I don’t believe there can be any reasonable disagreement with this observation. But the question then becomes, what is the purpose of this agenda item? One answer is that it may merely be a point of discussion on the potential impact to shareholders of public companies and whether and to what extent disclosure of such provisions and their effect on shareholders should be disclosed in periodic filings with the SEC. However, as was seemingly the case with the SEC’s conflict mineral disclosure rules (and which David Scileppi previously discussed here and which Bob Lamm also touched on here), this may be an addition to the list of matters sought to be regulated by the SEC via disclosure requirements. At this point, anything is speculation and we will have to wait and see what comes of the Investor Advisory Committee meeting.