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Oversight of the SEC’s Division of Corporation Finance

House Committee on Financial Services

Subcommittee on Capital Markets

Oversight of the SEC’s Division of Corporation Finance

Tuesday, July 18, 2023

 

Topline

  • Republicans questioned whether the Division’s proposed rulemakings adhered to the SEC’s mission of facilitating capital formation.
  • Republicans pressed Gerding on the impact of the SEC’s proposed climate risk disclosure rule while Democrats defended the materiality of climate-related risk.

Witnesses

  • Erik Gerding, Director, Division of Corporation Finance, U.S. Securities and Exchange Commission

Opening Statements

Subcommittee Chairwoman Ann Wagner (R-Mo.)

In her opening statement, Wagner explained that the SEC’s primary role is to maintain fair, orderly, and efficient markets while protecting investors, and discussed how the recent actions of the Division of Corporate Finance deviated from the Commission’s mission. She cited excessive regulations impeding the growth of small and medium-sized companies and costly disclosure regulations harming companies by hindering their expansion. Wagner called for the prioritization of the interest of retail investors, noting that excessive regulatory and compliance costs create barriers to entering the public market. Wagner concluded that Democrats view private market growth as problematic.

 

Subcommittee Ranking Member Brad Sherman (D-Calif.)

In his opening statement, Sherman said shareholders should be given the information necessary to decide where to invest their money. He noted climate investors represent a growing portion of those who are investing their capital, and warned these investors will turn to Europe if American companies fail to disclose climate information. Sherman went on to say other disclosures should be considered as well, including disclosures on workforce information and on reliance to China. Sherman concluded by citing his concerns that ordinary hedging of interest rate risk might be regarded as violating the conflict-of-interest rules.

 

Full Committee Ranking Member Maxine Waters (D-Calif.)

In her opening statement, Waters explained Republicans don’t like that the SEC wants investors to have information about companies they want to invest in. She went on to say the Division of Corporation Finance plays a critical role in reviewing the disclosures public companies issue so that investors can understand the financial risk of their actual or potential investments.

 

Testimony

Erik Gerding, Director, Division of Corporation Finance, U.S. Securities and Exchange Commission

In his testimony, Gerding emphasized that the mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. He explained that the Division of Corporation Finance seeks to ensure that investors are provided with the material information needed to make informed investments. Gerding continued, saying that the Division concentrates significant resources on disclosures that appear to be materially deficient or lack clarity. He concluded by explaining how the Division of Corporation Finance recommends new rules or changes to the existing rules to improve investor protection and facilitate capital formation.

 

Question & Answer

Proposed SEC Rulemakings

Referencing the SEC’s proposed amendments to rules that would narrow the grounds under which companies may exclude shareholder proposals from their proxy statements, Wagner asked why SEC staff are operating as if proposed amendments are already finalized. In this specific case, Wagner pointed to the fact the SEC made decisions on “no-action” requests using the proposed approach. Gerding said the Division of Corporation Finance recommended changes to Rule 14a-8 on the resubmission of substantial duplication and other grounds for exclusion. He added that until that rule is finalized, the SEC will follow existing rules.

Sherman asked if the SEC’s proposed regulations clearly state that the promoter of an asset-based security could hedge their interest rate risks. Gerding said there are exemptions for hedging, bona-fide market making, and liquidity commitments. He noted a proposed rule would address conflicts of interest by certain market participants, while also defining conflicts of interest.

Rep. Dan Meuser (R-Pa.) asked which of the SEC’s eleven proposed rulemakings would advance the Commission’s mandate to facilitate capital formation. Gerding said all the rules his division recommends fall within the Commission’s statutory mandate of investor protection, capital formation, and promoting fair and orderly markets. Meuser asked if industry agrees with Gerding’s analysis. Gerding said the Commission takes the comments they receive seriously, which helps the SEC produce better policies.

Rep. Mike Lawler (R-N.Y.) asked what criteria the Division of Corporation Finance uses to determine whether an issue has a broad societal impact. Gerding said staff considers whether a particular matter has become a question of widespread public debate.

Rep. Zach Nunn (R-Iowa) asked how many of the SEC’s rulemaking proposals are specifically focused on capital formation. Gerding said all the SEC’s rulemaking proposals focus on aspects of the Commission’s statutory authority.

Rep. Andrew Garbarino (R-Ny.) asked if the Division worked with or received technical assistance from other agencies such as CISA on the implementation of your proposed cybersecurity disclosure rules and how the proposed rules might interact with existing regulations and laws. Gerding responded saying that the Division consulted with various federal agencies including CISA.

Rep. Emmanuel Cleaver (D-Mo.) expressed concerns the SEC’s conflicts of interest rules could capture mortgage insurance-linked notes and asked if Gerding had worked through this concern. Gerding said he had the letter from Rep. Cleaver and Rep. Luetkemeyer and that he did not want to prejudge any facts as he is not sure the financial product mentioned by Cleaver would be covered by the rule.

 

 

Proposed SEC Climate Risk Disclosure Rule

Wagner asked how companies can provide comparability and the standardized disclosures the SEC’s proposed climate risk disclosure rule will require. Gerding said the climate risk disclosure proposal is about disclosing risk to investors. He noted that risk is about future losses, which is the type of information investors need.

Sherman asked if the climate disclosure rule would require companies to predict temperatures for the next decade, as Republicans suggested. Gerding said no. Sherman asked if companies would have to disclose their own emissions from the prior fiscal year. Gerding said the climate risk disclosure rules include risk metric requirements for public companies, including greenhouse gas emissions.

Rep. Frank Lucas (R-Okla.) asked if the SEC worked with other agencies that undertake climate-related rulemaking. Gerding said the SEC consults many federal agencies but clarified that their rulemaking recommendations are based on their statutory authorities and comments the Commission receives in response to the proposed rulemaking.

Lucas asked if the SEC conducted an analysis to determine the volume of private businesses that could be forced out of the supply chain because of the proposed rule. Gerding said the climate risk disclosure proposal would apply only to public companies, while acknowledging that there may be some disclosure requirements for public companies that would impact private companies.

Lucas asked if companies are already required to disclose climate-related information if it’s material to their public operations. Gerding said this is a common misconception, as SEC rules don’t require public companies to disclose everything material.

Rep. Stephen Lynch (D-Mass.) asked if the information required by the proposed rule would enable investors and shareholders to make better business operations decisions. Gerding noted that is the SEC’s mission and explained that their rules are intended to provide investors with information to aid their investments.

Lynch asked if the information required by the proposed rule takes a proactive approach to mitigating climate change risk. Gerding said the proposed climate change disclosure rule would give investors information about climate risks to make investment decisions.

Rep. Sean Casten (D-Ill.) asked what definition of materiality guides the SEC in its rulemakings. Gerding said the SEC follows the definition articulated by the Supreme Court. Casten asked why the SEC believes the proposed climate risk rule fits the Court’s definition of materiality. Gerding explained that the climate risk disclosure proposal is aimed at providing investors with disclosures for them to analyze and make investment decisions.

Casten asked what percentage of the comments received were favorable to the rule. Gerding said the Commission received a lot of comments that supported the rule, but also received comments that opposed the rule.

Casten asked if SEC registrants are already disclosing sufficiently material climate-related risk in their filings. Gerding said the Commission has seen companies make disclosures on those matters, but noted those disclosures are not consistent or comparable. He explained this lack of consistency is part of the reason for the overall rule.

 

Scope 3 Emissions

Lucas asked for the number of companies with Scope 3 targets. Gerding said he didn’t have the number.

Rep. David Scott (D-Ga.) asked if Gerding could see a scenario where large publicly traded companies that fall under Scope 3 decide to seek data from small agriculture suppliers to meet Scope 3 reporting requirements. Gerding said the proposed climate risk disclosure rule includes several provisions that would allow companies required to disclose Scope 3 emissions to use assumptions, methodologies, and tools other than getting disclosures from suppliers and customers.

Scott asked if Scope 3 requirements could have unintended consequences impacting the size of loans from financial institutions to small family farmers and ranchers. Gerding said the requirement includes a materiality qualifier that would potentially limit the number of disclosure requirements that companies would have to make.

Scott asked about potential adjustments to Scope 3 requirements. Gerding said he couldn’t speculate on what future Commission action would look like.

Nunn asked if small businesses that are not registered with the SEC would be compelled to collect and submit information because of the proposed Scope 3 requirement. Gerding said the climate risk disclosure proposal only requires disclosures from publicly registered companies. Nunn asked if those businesses would face additional costs under the proposed regulation. Gerding said the climate risk disclosure proposal includes an extensive economic analysis.

Rep. Pete Sessions (R-Tx.) called the Scope 3 requirements an outlandish proposal and accused the SEC of abusing its discretion delegated to it by Congress to undermine the attractiveness of US capital markets.

 

Exchange Act Rule 10c-1

Rep. Wiley Nickel (D-N.C.) asked how important securitization is with regards to mortgage lending. Gerding said it’s very important. Nickel then asked about the resulting impact on the liquidity and stability of the housing market if firms are unable to participate in securitization due to an overly broad rule, like Exchange Act Rule 10c-1. Gerding explained that the SEC solicited comments on the proposed rule and conducted an extensive economic analysis.

Nickel asked if the SEC conducted a cost-benefit analysis on how Exchange Act Rule 10c-1 would impact affordable housing. Gerding said the economic analysis included analysis of many securitization markets.

Nickel asked if the SEC considered tailoring the rule to ensure that affordability barriers are not an issue.

Gerding said the Commission received several comments which raised this as a concern. He said the Commission would keep those in mind as they provide any recommendations.

 

Proxy Advisory Firms

Wagner asked if proxy advisory firms should be able to omit material information or provide misinformation without being held accountable. Gerding said the 2020 proxy voting advisory business provisions remain in effect.

Rep. Bill Huizenga (R-Mich.) asked if Gerding was aware that proxy firms do not undertake independent legal analysis of shareholder proposals. Gerding said his Division does not take positions on underlying shareholder proposals.

Rep. Bryan Steil (R-Wi.) asked if the SEC examined the legality of shareholder proposals, adding that the HFSC had witnesses from proxy advisory groups testify earlier that they did not look at the legality of these proposals and that the SEC does. Gerding responded saying the SEC does not offer opinions on the legality of individual proposals. Steil said it is important to place some control on proxy advisory.

 

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