[Senate Hearing 115-406]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 115-406


         LEGISLATIVE PROPOSALS TO EXAMINE CORPORATE GOVERNANCE

=======================================================================

                                HEARING

                               BEFORE THE

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED FIFTEENTH CONGRESS

                             SECOND SESSION

                                   ON

        EXAMINING LEGISLATIVE PROPOSALS ON CORPORATE GOVERNANCE
                               __________

                             JUNE 28, 2018
                               __________

  
  
  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs
                 
                 
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               Available at: https: //www.govinfo.gov/
                              ___________


                    U.S. GOVERNMENT PUBLISHING OFFICE
                    
33-408 PDF                WASHINGTON : 2020




            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      MIKE CRAPO, Idaho, Chairman

RICHARD C. SHELBY, Alabama           SHERROD BROWN, Ohio
BOB CORKER, Tennessee                JACK REED, Rhode Island
PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
DEAN HELLER, Nevada                  JON TESTER, Montana
TIM SCOTT, South Carolina            MARK R. WARNER, Virginia
BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana
DAVID PERDUE, Georgia                BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina          CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana              CATHERINE CORTEZ MASTO, Nevada
JERRY MORAN, Kansas                  DOUG JONES, Alabama

                     Gregg Richard, Staff Director
                 Mark Powden, Democratic Staff Director
                      Elad Roisman, Chief Counsel
                      Kristine Johnson, Economist
                     Jonathan Gould, Senior Counsel
                 Elisha Tuku, Democratic Chief Counsel
            Laura Swanson, Democratic Deputy Staff Director
                       Dawn Ratliff, Chief Clerk
                      Cameron Ricker, Deputy Clerk
                     James Guiliano, Hearing Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor

                                  (ii)



                            C O N T E N T S

                              ----------                              

                        THURSDAY, JUNE 28, 2018

                                                                   Page

Opening statement of Chairman Crapo..............................     1
    Prepared statement...........................................    33

Opening statements, comments, or prepared statements of:
    Senator Brown................................................     1

                               WITNESSES

Thomas Quaadman, Executive Vice President, Center of Capital 
  Markets Competitiveness, U.S. Chamber of Congress..............     3
    Prepared statement...........................................    33
    Responses to written questions of:
        Senator Brown............................................    59
        Senator Sasse............................................    62
        Senator Cortez Masto.....................................    66
Darla C. Stuckey, President and CEO, Society for Corporate 
  Governance.....................................................     5
    Prepared statement...........................................    41
    Responses to written questions of:
        Senator Brown............................................    70
        Senator Cortez Masto.....................................   108
John C. Coates IV, John F. Cogan, Jr. Professor of Law and 
  Economics, Harvard Law School..................................     7
    Prepared statement...........................................    48
    Responses to written questions of:
        Senator Brown............................................   108
        Senator Van Hollen.......................................   109
        Senator Cortez Masto.....................................   110
Damon A. Silvers, Director of Policy and Special Counsel, AFL-CIO     8
    Prepared statement...........................................    53

              Additional Material Supplied for the Record

Letter, report, and email submitted by Thomas Quaadman...........   112
Letters, statements, and reports submitted by Chairman Crapo.....   193
Letters, statements, and reports submitted by Senator Brown......   251
Letter submitted by Senator Toomey...............................   380
Letters submitted by Senator Scott...............................   382
Article, letters, and statements submitted by Senator Reed.......   390
News article submitted by Senator Tillis.........................   416

                                 (iii)

 
         LEGISLATIVE PROPOSALS TO EXAMINE CORPORATE GOVERNANCE

                              ----------                              


                        THURSDAY, JUNE 28, 2018

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:02 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Mike Crapo, Chairman of the 
Committee, presiding.

            OPENING STATEMENT OF CHAIRMAN MIKE CRAPO

    Chairman Crapo. The Committee will come to order.
    Today's hearing will focus on several legislative proposals 
to improve corporate governance.
    As with Tuesday's hearing on capital formation proposals, I 
intend to work with Senator Brown and with other Senators on 
the Banking Committee to identify and move legislative 
proposals through the Senate. Although some of the bills which 
we have been discussing today have also been discussed and 
considered in the House, most have not.
    Today's hearing will mark a first step for those we have 
not yet considered or were recently introduced.
    Among other things, the bills that we will discuss today 
would expand the definition of accredited investor, shorten the 
Schedule 13D filing window and increase disclosure of short 
positions, require FINRA to create a relief fund to cover 
unpaid arbitration awards to investors, draw attention to 
cybersecurity experience at the board level, address concerns 
that a gap exists between the time a firm learns of material 
nonpublic information and its disclosure, and highlight the 
unique challenges to rural area small businesses.
    Finally, several Members have expressed interest in 
addressing the role of proxy advisory firms, and we will 
discuss a bill which the House has already considered and 
passed.
    I look forward to hearing from our witnesses on these 
legislative proposals, and if there are ways to modify these 
bills to gain bipartisan support, I encourage it.
    We have received some initial feedback on these bills, 
which will be entered into the record, without objection.
    Chairman Crapo. Senator Brown.

               STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. Thank you, Mr. Chairman.
    Welcome, all four of you as witnesses. Thank you for 
joining us. We will continue our discussion of bills sponsored 
by Banking, Housing, and Urban Affairs Committee Members, this 
time focusing on corporate governance.
    All too often, it seems corporate boards and executives 
focus more on preserving their job and maximizing and enhancing 
their compensation than on investing in their companies and 
their workers, and their communities.
    Instead of investing in real businesses in real towns that 
create jobs and build communities, they spend billions buying 
back stocks and handing out CEO bonuses.
    Take Wells Fargo, despite being continually mired in spin, 
controversy, and scandal, they boosted their CEO's pay by 36 
percent last year to $17 million. That is 291 times the median 
worker's salary at the bank, as tellers, on the average, 
nationally still make less than $13 an hour.
    The short-term focus is painfully obvious when you consider 
that last year's tax bill sparked a record level of stock 
buybacks, $480 billion since it passed. Think about that, 
almost half a trillion dollars, $480 billion.
    The record level of buybacks is troubling on its own, but I 
am even more concerned in light of SEC Commissioner Jackson's 
recent findings that executives were much more likely to sell 
their stock right after a buyback announcement than at other 
times. That does not sound like building long-term value to me.
    This is where shareholders play a key oversight role over 
public companies, and institutional investors, those with the 
strongest voice, can be essential in holding company management 
accountable. Shareholders of all sizes deserve to have every 
tool available to make sure executives are thinking beyond 
their self-interest and managing for the long-term good of the 
company.
    But we cannot just depend on shareholders. The system needs 
protections to ensure corporate managers are honest and address 
difficult issues.
    I am particularly concerned about a proposed bill, the 
Corporate Governance Reform and Transparency Act, which would 
create structural obstacles for shareholders to hold corporate 
management accountable. The bill would make it harder for 
public retirement systems, including some in my State of Ohio, 
to use research and analysis from proxy advisors to manage 
investments for hardworking Americans. Why would we want to do 
that if we really care about those investors and those 
communities and those retirement systems?
    It is ironic, Mr. Chairman, that some of the same people 
who want to expand the definition of accredited investor, 
confident that somebody with a million dollars in assets can 
make good investment decisions on startup companies, do not 
think the very sophisticated managers of tens of billions of 
dollars of assets, pension plans, for instance, can tell 
whether the investment advice they are buying is worth what 
they are paying.
    I have letters opposing that bill, Mr. Chairman. I would 
like to submit them for the record, the bill H.R. 4015 letters 
from the Ohio Public Employees Retirement System, the State 
Teachers Retirement System of Ohio, and others, if I----
    Chairman Crapo. Without objection.
    Senator Brown. Thank you, Mr. Chairman.
    We should be pushing for more shareholder engagement and 
oversight, for more transparency, not less. Some of the 
proposals we will discuss today improve transparency.
    Senator Jack Reed's bill would promote more disclosure on 
cybersecurity. I thank the Senator from Rhode Island for that.
    Senator Van Hollen's proposal would require companies to 
close loopholes to prevent insider trading. I thank the Senator 
from Maryland for that.
    These types of measures require company management to 
upgrade their practices and disclosures to the markets. As I 
said at our earlier hearing this week, if we focus on passing 
laws that enhance investor confidence instead of undermining 
it, we end up helping those businesses too. It is good for 
shareholders, good for workers, good for communities.
    Thank you, Mr. Chairman.
    Chairman Crapo. Thank you, Senator Brown.
    And today's witnesses are Mr. Thomas Quaadman, Executive 
Vice President of the U.S. Chamber Center of Capital Markets 
Competitiveness; Ms. Darla C. Stuckey, President and CEO of the 
Society for Corporate Governance; Professor John C. Coates IV, 
John F. Cogan Jr. Professor of Law and Economics at Harvard Law 
School; and Mr. Damon A. Silvers, Policy Director and Special 
Counsel at the American Federation of Labor and Congress of 
Industrial Organizations.
    I appreciate all of you being here with us today. Your 
written testimony has been entered into the record, and we 
encourage you each to pay close attention to the clock as the 
Senators will have lots of questions they want to ask you.
    With that, Mr. Quaadman, you may proceed.

 STATEMENT OF THOMAS QUAADMAN, EXECUTIVE VICE PRESIDENT, CENTER 
  OF CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER OF CONGRESS

    Mr. Quaadman. Thank you, Chairman Crapo, Ranking Member 
Brown, Members of the Committee. Thank you for holding this 
hearing today.
    We have a crisis of entrepreneurship in the United States, 
and indeed, we have a calcification of startups in the United 
States. Business creating rates have not rebounded from the 
Great Recession. Three counties in the United States have more 
businesses that go out of business than are created, and 50 
percent of all startups in the United States occur in 20 
counties. We are literally missing hundreds of thousands of 
businesses that we historically would have created had this not 
happened.
    But we also have a precipitous decline in number of public 
companies that started in 1996. We have less than half the 
number of public companies today than we did then. We have 
relatively the same as we did in 1982. In other words, the 
gains of the Reagan and Clinton administrations have been wiped 
out.
    More needs to--the JOBS Act has arrested the decline of the 
number of public companies, but more needs to be done to 
reverse these trends, and we need to put in place policies that 
will help businesses start and grow from small to large. The 
hearing this week are an important step forward; however, the 
recent reports about the rise of Chinese venture capital show 
that we do not have luxury of time.
    The Chamber strongly supports the Corporate Governance 
Reform and Transparency Act. We have two proxy advisory firms 
that control 97 percent of the business. They are, de facto, 
standard setters of corporate governance. Each has a unique 
conflict of interest. Both have black box processes and systems 
and a failure to fix errors. All of this combines to materially 
impact the ability of investors to get the essential 
information that they need.
    Firms have even, in one case, overturned the express rule 
of Congress and silenced investors for their own pecuniary 
interests. Advice should be accurate and linked to a client's 
fiduciary duty and economic return. While the 2014 guidance was 
helpful, the SEC has not exerted oversight, and we think it is 
important for Congress to mandate it.
    We have some concerns with the Cybersecurity Disclosure 
Act. Cybersecurity is a top priority for businesses; however, 
businesses get very conflicting messages from different 
Government agencies. The SEC guidance on disclosure is somewhat 
helpful. We think that there is more that needs to be done 
there. However, this bill would require board expertise in 
cyber. It would start to pigeonhole different types of 
expertise in boards. It conflates the role of management and a 
board of directors, and indeed, it lacks the recognition that 
there is a relatively small number of people with cyber 
experience, and we do not even know if they can perform the 
other fiduciary duties of a board member.
    We also have some concerns with the Brokaw Act. Short 
selling is a necessary market function for liquidity purposes. 
We have raised issues before with abuses to short selling, such 
as naked short selling or short-and-distort campaigns.
    13D filings, we understand the desire to maybe modernize 
those; however, modernization of 13D filings can also bleed 
into 13F and 13G filings, which can directly, adversely impact 
401(k)s. Therefore, we believe it is important for both of 
these issues that maybe there should be an SEC study rather 
than mandated requirements.
    We also understand and want to work with Senator Van Hollen 
on the 8-K Trading Gap Act of 2018. We also agree that there 
needs to be strong policies to combat insider training; 
however, we have some concerns on the window between when an 
event happens and when it is deemed to be material. We want to 
work with Senator Van Hollen on how to clarify that.
    We strongly support the Fair Investment Opportunities for 
Professional Experts Act. We believe that these rules should be 
modernized. It is long overdue, and the SEC is not active.
    We have some concerns with the Compensation for Cheated 
Investors Act. We understand the issue and agree that those who
receive an arbitration award should be able to collect on that; 
however, this is a small problem related to the larger picture.
    And that we believe that there should be some time elapsed 
to allow for the FINRA transparency rules to take hold; 
however, we would be willing to work with both Senators Warren 
and Kennedy to maybe see if SIPC would ben alternative.
    We also strongly support the Expanded Access to Capital for 
Rural Job Creators Act, introduced by Senator Jones. We think 
this would be an important step forward to help bring 
entrepreneurship to rural areas.
    Thank you, Mr. Chairman. I am happy to take any questions 
you may have.
    Chairman Crapo. Thank you.
    Ms. Stuckey.

 STATEMENT OF DARLA C. STUCKEY, PRESIDENT AND CEO, SOCIETY FOR 
                      CORPORATE GOVERNANCE

    Ms. Stuckey. Chairman Crapo, Ranking Member Brown, Members 
of the Committee, my name is Darla Stuckey. I am the President 
and CEO of the Society for Corporate Governance. We appreciate 
the opportunity to present our views on legislation before this 
Committee.
    We are a professional membership association of corporate 
secretaries and in-house counsel, and other governance 
professionals, representing about a thousand public companies.
    As Tom said, public company ownership is on the decline. In 
1997, there were about 7,100 U.S. public companies, now fewer 
than 3,600.
    While there are a range of factors causing this, two of the 
bills this Committee has before it can improve the climate for 
public ownership--H.R. 4015, the Corporate Governance Reform 
and Transparency Act, and S. 1744, the Brokaw Act.
    H.R. 4015, which has passed the House, addresses the role 
of proxy advisory firms who serve institutional investors. They 
operate with very little oversight. H.R. 4015 would provide 
badly needed improvements to the accuracy and transparency of 
these firms.
    The proxy advisory market is dominated by two firms--
Institutional Shareholder Services, or ISS, and Glass Lewis. 
For the uninitiated, these firms advise investors on how they 
should vote their shares at annual meetings as well as in 
corporate contests.
    While recommending how an investor should vote may sound 
unimportant, the reality is far different. ISS and Glass Lewis 
analyze and recommend, for example, on composition of the 
board, executive compensation, and a diverse range of 
shareholder proposals. In fact, our members report that as much 
as 20 to 30 percent of their total shareholder votes are swayed 
by ISS and Glass Lewis.
    These firms also own and control the software platforms 
that investors actually use to vote. They are indispensable to 
the institutional proxy voters.
    But summarizing proxy statements in a short period of time 
makes errors inevitable. You may have heard that real factual 
errors do not exist because companies do not complain about 
them to the SEC. I am here to tell you that is not the case. 
They do exist. ISS is the dominant provider of these services, 
but only S&P 500 companies see their reports before they are 
issued. They have typically 2 days to review and correct any 
mistakes. The rest of the 2,500-plus companies that exist do 
not see them.
    Glass Lewis recommendations are not made available in 
advance at all. The inability to see draft reports in advance 
can have dire consequences. Once a firm issues its 
recommendation to its
investor clients, the vote is in within a matter of days, and 
the changing of a vote is almost impossible.
    I have a story about a small-cap transportation company, it 
happens to have a union, that highlights many problems that 
H.R. 4015 would fix. In May 2016, 2 weeks before their annual 
meeting, this company received an ISS report with an against 
recommendation on its say-on-pay. It was based on a factual 
error in their bonus plan calculation. Because the company is a 
small cap, it did not see the ISS report before it went to 
shareholders. The company scrambled to get the error corrected 
and a positive recommendation. ISS acknowledged the error but 
refused to correct it.
    Despite the company's effort to contact their actual 
shareholders about the recommendation, they failed. Their vote 
was 49.8 percent. After the vote, the company did more 
shareholder outreach, but no shareholder asked for changes to 
the bonus plan. The company then disclosed its outreach efforts 
in its next year's proxy.
    That next season, ISS issued another report, again, 
incredibly recommending against the company's say-on-pay. ISS 
simply did not believe the disclosure in the proxy that no 
shareholders had asked for changes to their bonus plan when it 
was based on a mistake, anyway.
    To add insult to injury, ISS also recommended a vote 
against four directors on the compensation committee, one of 
whom was the only female board member at the time, and another 
of whom was one of two racially diverse members.
    Thanks to above-and-beyond shareholder outreach that 
spring, the company got their four directors reelected at a 60 
to 70 percent rate, but for the second year in a row, they lost 
say-on-pay at a very low rate of 32 percent.
    This year, after extensive outreach to shareholders and 
with ISS and Glass Lewis, their say-on-pay vote was recommended 
in favor, and it was approved. And their directors were 
overwhelmingly reelected at 97 to 99 percent, so there is the 
gap.
    This story demonstrates the influence of proxy advisory 
firms and the need for crucial regulation. We support its 
passage. We do understand that institutional investors and the 
proxy advisory firms themselves oppose the bill because of cost 
concerns for their clients. We are willing to work with the 
Committee to improve the legislation in a manner that 
accomplishes these goals.
    Let me now turn to S.R. 1744, the Brokaw Act. There is no 
doubt that some activists create shareholder value, and the 
Society is not seeking to stifle activist investing. However, 
we do seek to level the playing field on the disclosure rules. 
Activists have 10 days to file a 13D after they have 
accumulated 5 percent of a company's stock. This means 10 days 
more to accumulate as much as they want, and sometimes through 
derivative positions that are unknown to the company.
    S.R. 1744 shortens the time to 4 days and ensures that 
securities positions taken by activists are transparent. This 
is good public policy. We support the bill and the 
modernization.
    There are two other bills before the Committee that could 
discourage companies from going and remaining public, and the 
Society opposes them in their current form--S. 536 and the 8-K 
Training Gap Act.
    I see I am running out of time, but I am happy to answer 
questions. Thank you.
    Chairman Crapo. Thank you very much.
    Professor Coates.

STATEMENT OF JOHN C. COATES IV, JOHN F. COGAN, JR. PROFESSOR OF 
             LAW AND ECONOMICS, HARVARD LAW SCHOOL

    Mr. Coates. Chairman Crapo, Ranking Member Brown, and 
Members, thank you for the opportunity to be able to comment 
on, I am happy to see, a bipartisan set of fairly focused 
proposals on how to improve corporate governance, and I commend 
the overall agenda for that reason.
    One word about me. Before I came to Harvard, I practiced as 
a partner at Wachtell Lipton Rosen & Katz in New York, where I 
wrote 8-K proxies, 13Ds, and I only mention that because I want 
to emphasize that my views here are based in part on my 
research and teaching, but also on personal experience. I have 
some familiarity directly with the law's effects in this area.
    Endorsements. I endorse the cybersecurity bill. It is a 
real problem. It is getting worse. We are playing catchup 
across the board, big companies and Government alike. This is 
the gentlest of disclosure obligations. It is hard to think of 
something that could be more gentle. It simply asks boards to 
say, ``Do you have a cyber expert or not? And if not, why 
not?'' So, contrary to suggestions to the contrary, it does not 
mandate experts on the board. It simply asks boards to explain 
why they do not have one. The answer could be because there are 
none available, or it could be because we have other resources 
that are better.
    So if it is given to be gentle why do I have favor, why is 
it going to have any impact, well, here is something to know 
about proxy statements. Proxy statements are read by boards. 
Among all the SEC documents that the boards nominally have 
oversight of, they are among the most carefully read. The 
reason is because the proxy statements are about the board 
members. So they, being human, read them carefully because it 
is about them.
    So that slight tweak to what they have to engage in, in the 
disclosure process, I think will help nudge those companies 
that have not already begun to take cyber seriously, and 
unfortunately, there still are some companies out there that 
are not facing up to the risks that they face.
    One last word on this bill, there is maybe going to be some 
suggestion that there is a slippery slope and there is all 
kinds of risks and that cyber is one of them and so on. I 
really do want to emphasize that cyber is unique. Other than 
financial risk, where we already have an obligation for boards 
to say do they have financial expertise on the board or not, 
other than financial risk, cyber risk is, I believe, the one 
type of risk that is almost universal among public companies. 
It is very hard to think of a public company in this network 
age that is not at least somewhat exposed to cyber risk.
    Unlike environmental risks, labor risks that my friend here 
cares about, which do affect some sectors significantly, I 
think cyber affects the entirety. So that is why this is not a 
slippery slope to every kind of risk being addressed in the 
proxy statement. So that is my endorsement.
    I also endorse the 8-K bill. I can talk more about that in 
Q&A.
    I also very much endorse adding the voice of rural small 
business to the SEC's advisory community. I grew up in Virginia 
and spent a lot of time on farms in South Central Virginia, and 
I think there is a distinct voice that is missing at the SEC.
    I also endorse the Brokaw Act. I have the same concern 
about discouraging shorts. I think there is a tradeoff 
involving short sales, and adding disclosure obligations is 
going to burden the ability of some shorts to function, to 
unveil fraud and find real problems at companies.
    On the other hand, it is a little hard to understand why if 
you have a fairly big net short position and you are disclosing 
your long people, you do not have to disclose the short 
position.
    So I would recommend adopting this bill but adding a sunset 
to it and forcing the SEC to study the effects on shorts over 
the next couple of years, and then the bill would die at that 
point, unless the SEC came back to you and said it was working 
the way we expect it to. So that would be my recommendation 
there.
    Last minute. I endorse the goal also of the FINRA bill. It 
is outrageous that investors who have proven fraud can still 
not get recoveries, particularly if the targets of the fraud 
action simply quit the brokerage industry and moved over to 
investment and advisory industry where FINRA has no oversight. 
And that is a real problem.
    Again, I have a slight concern that I would suggest the 
Committee think about, which is FINRA alone does not have full 
power over this industry, and I would suggest giving it to the 
SEC rather than to FINRA. If you want to stick with FINRA, then 
at least allow the SEC a year to come up with its own solution 
before the FINRA solution kicks in.
    I oppose H.R. 4015. I think it flunks a cost-benefit test, 
as written. I am happy to take questions about why in the 
remaining time.
    Thank you.
    Chairman Crapo. Thank you.
    Mr. Silvers.

 STATEMENT OF DAMON A. SILVERS, DIRECTOR OF POLICY AND SPECIAL 
                        COUNSEL, AFL-CIO

    Mr. Silvers. Thank you, Chairman Crapo, and good morning, 
Mr. Chairman, Ranking Member Brown, and Members of the 
Committee. My name is Damon Silvers. I am the Policy Director 
and Special Counsel for the AFL-CIO, America's labor 
federation. We represent 55 national unions, over 12 million 
people, on behalf of which $7 trillion of benefit funds are 
invested in the world's capital markets.
    Like my fellow witnesses, it is an honor to be here with 
you and in particular to take up such a thoughtful and 
carefully structured agenda.
    Each of the bills under consideration in this hearing fits 
with-
in the following three questions: one, how to effectively 
protect
investors from the threat of self-dealing by the experts they 
hire to help them manage their money; two, how to ensure a 
level playing field for all investors in capital markets where 
information moves instantaneously and where big data means big 
power and big money; three, how to prevent the recurrence of 
the dynamic that led to the financial crisis of 2007 and 2008 
where large parts of the financial system became unregulated 
and/or opaque with catastrophic consequences.
    With those three issues and goals in mind, the remainder of 
my testimony will address each of the bills under consideration 
in turn, briefly.
    First, and most importantly on the agenda this morning, 
H.R. 4015, the Corporate Governance Reform and Transparency 
Act, effectively gives corporations, CEOs, and boards the 
ability to control the people who are supposed to be holding 
them accountable. This is a very serious threat to any 
possibility of addressing the dynamics that Ranking Member 
Brown spoke to in his opening remarks.
    The way this bill would do this would be, A, by creating a 
set of substantive regulatory obligations of a kind that no 
other investment advisor has to live within, and, B, by 
enabling companies to delay the vote recommendations and, thus, 
be able to essentially engage in coercive processes with the 
proxy advisory firms around any recommendation that was 
contrary to what the executives wanted, including votes on 
their own executive pay packages.
    The AFL-CIO does believe that proxy advisors should be 
regulated like other investment advisors, and we would not 
oppose a bill that required them to register, which is not 
currently the law. But we do very much oppose the notion that 
they should be subject to a separate and punitive set of 
regulations, which is exactly what this bill does. It seeks to 
punish them for doing their jobs and to impose upon them a 
regulatory scheme designed to make them disloyal to their 
clients, among which are our members' pension funds.
    Moving on to S. 2756, the Fair Investment Opportunities for 
Professional Experts Act, this addresses the issue of who is an 
accredited investor, who is allowed to invest in substantially 
unregulated private offerings.
    The $1 million asset threshold that is core to this, 
together with several income thresholds, was originally set by 
rule in 1982 and has not been updated since then.
    The bill does have an indexing provision, which we agree 
with, but the current baseline of the bill is far too low to 
act as a starting point and essentially would add to the 
problems that some of the other witnesses talked about in the 
public markets, so we oppose this bill.
    The Brokaw Act, S. 1744, shortens the window between when 
an investor acquires a 5 percent stake and when they have to 
file and requires short selling to be disclosed. This makes 
eminent sense, and we support this bill. It prevents 
manipulation.
    The Compensation for Cheated Investors Act, S. 2499, 
requires FINRA to ensure that the damage awards made to 
investors are actually paid, and if necessary, to use FINRA's 
revenue from fines to do so.
    Between 2012 and 2016, there were almost $200 million in 
unpaid damage awards from FINRA.
    This would make sure investors defrauded by brokers are 
actually able to collect the full amount of the award and would 
increase accountability and public trust in the financial 
system and broker-dealers. Passing S. 2499 is in the interest 
of investors and in the interest of maintaining and improving 
the integrity of our securities laws.
    The S. 536, the Cybersecurity Disclosure Act, was discussed 
in some detail by my colleague, Professor Coates, and we view 
this as, again, a commonsense thing. The commission should have 
addressed this. In their absence, we support the bill.
    We also support adding a language encouraging the Investor 
Advocate to think about rural issues, particularly in light of 
rising natural disasters and the cost of climate change.
    Finally, the 8-K Trading Gap Act of 2018 is similar to the 
Brokaw Act. It really addresses the ability to engage in 
manipulations, given modern-day data around 8-K filings. It is 
very much in investors' interest. We support it.
    So, in conclusion, you have in front of you a group of 
bills that are thoughtful and protect investors, and you have 
two bills that are dangerous. And one in particular, the one 
addressing proxy firms, is essentially--would--essentially 
defeat the corporate governance system, and we very strongly 
urge the defeat of that bill.
    Thank you very much.
    Chairman Crapo. Thank you very much, Mr. Silvers.
    I will begin the questioning, and I would like to start 
with you, Mr. Quaadman. The Brokaw Act would require investors 
to disclose short positions, and several of you have mentioned 
this issue with regard to it. Many institutional investors, 
such as pension funds, endowments, and foundations use short 
selling as a tool to manage risk and reduce the overall 
economic exposure of an investment portfolio. Short selling 
also plays an important role in providing market liquidity and 
facilitating price discovery.
    Could you comment a little further on the likely impact of 
such disclosures on the markets and the use of short selling as 
a risk management tool?
    Mr. Quaadman. Sure. Short selling is an extremely important 
tool for participants in the marketplace to be able to hedge 
their positions, and it is also important for liquidity 
purposes as well.
    The challenge that there is in terms of the disclosures 
that are outlined here is that there are proprietary trading 
platforms that would be exposed. There are a variety of 
different methods, then, that could potentially harm investors.
    So that is why we think if there is abuses, that is where 
we need to make sure that there is a light shined there, but we 
think it is more important for the SEC maybe to take a closer 
look at this rather than to start to mandate disclosures 
themselves.
    Chairman Crapo. Thank you.
    Professor Coates, you mentioned you had some thoughts on 
the short selling aspect of the Brokaw Act. Could you clarify 
those as well?
    Mr. Coates. Yes. I agree generally, although I will note 
the short disclosures would principally be in the 13D 
component, which most institutional investors would not need to 
comply with because their positions are passive and not 
intended to influence companies.
    I do agree. Still, even in the very active space, I worry 
that disclosure could discourage some shorts from taking 
aggressive short positions against companies that do have 
problems, and shorts have played a major role in uncovering 
serious frauds in the past 5 years.
    But having said that, I honestly do not think the SEC 
currently is equipped to learn much more than we could discuss 
today. So I would encourage a deliberate attempt to see what 
happened and, again, sunset the rules so that it is not going 
to remain there permanently if it is causing problems, but to 
proceed and direct the SEC to study in fact what happens.
    Cost-benefit analysis, which I told you I endorse and the 
Chamber is very much in favor of, is a great idea in theory, 
but in order to really learn about the markets, you actually 
have to be willing to change sometimes. And I think this is a 
change worth making.
    Chairman Crapo. Thank you.
    Ms. Stuckey, a question on proxy advisors. In testimony 
before the House Financial Services Committee last week, SEC 
Chairman Clayton discussed shareholder engagement and the proxy 
process. In that context, he stated that the SEC should analyze 
whether the voices of long-term retail investors are being 
underrepresented, misrepresented, or selectively represented in 
corporate governance.
    What is your view on whether and how long-term retail 
investors are being represented on corporate governance matters 
and the role of proxy advisory firms in that representation?
    Ms. Stuckey. Thank you, Chairman Crapo. Thank you, Chairman 
Crapo.
    Chairman Crapo. It will come on.
    Ms. Stuckey. Is it on?
    Chairman Crapo. Yes.
    Ms. Stuckey. Thank you. Sorry for that.
    If you are talking about Mr. and Mrs. 401(k) as long-term 
retail shareholders, they are represented by investment 
managers who largely vote with ISS and Glass Lewis. So they are 
being swept up in everything we talked about with proxy 
advisory firms.
    They do not particularly want their companies wasting time 
trying to fix mistakes after the company has already written 
its own regulated SEC proxy statement.
    I think that long-term retail shareholders really want 
their companies focused on strategy, competition, and 
innovation and cyber.
    So the only other way that sort of the whole problem with 
proxy advisor, if it a disincentive to companies going public, 
then you have got long-term retail shareholders that do not 
have the same investment opportunity to invest in more 
companies, which we think is a problem.
    Public, State, and private pension beneficiaries as well 
have no individual voice. Does any pension fund check with 
their beneficial owners before they vote, how they should vote 
on a particular shareholder proposal, say climate-related? I do 
not know if they check with their teachers and their firemen 
and their policemen, but I can imagine that there are many 
individuals that would be appalled at the way their votes are 
being cast. Basically, they are disintermediated.
    Chairman Crapo. Thank you.
    Senator Brown.
    Senator Brown. Thank you.
    Professor Coates, I would like to ask you about proxy 
advisors. Your testimony suggests the Corporate Governance 
Reform and Transparency Act should be renamed the ``Proxy 
Advisor Regulation Act.'' Describe, if you would, briefly the 
procedural barriers the bill would create for shareholders and 
the proxy advisors that they have hired.
    Mr. Coates. Sure. I think with a high-level admirable goal 
of trying to address potential conflicts at the proxy advisors, 
the way the bill was written, however, somewhat remarkably, 
given its origins, it expects Government to fix this problem by 
creating a bureaucracy at the SEC that would have fairly 
significant costs that it would pass along in the form of 
regulation, compliance officers, required ombudsmen, need to 
prove the efficacy and knowledge base of the advice that is 
being given, which is a type of regulatory requirement that is 
found nowhere else in the securities markets. Broker-dealers do 
not have to prove that they have an adequate basis for every 
recommendation they have.
    There is significant cost associated with--and fixed cost. 
Let me emphasize fixed minimum cost associated with complying 
with the regime that is envisioned by this bill, which would 
discourage competition, not enhance it. So if you do not like 
there only being two, this would only make things worse.
    And more basically, it is surprising to me that the 
sponsors of the bill do not recognize that under existing law, 
State law, and existing SEC law, the advisors could be sued by 
their clients if they are committing fraud or otherwise 
breaching their duties to their clients. And so this is a place 
where I am kind of inclined with the Chamber's normal position, 
which is we should really find the problem with the existing 
legal regime before adding more regulatory burdens on the 
system.
    Senator Brown. Thank you.
    And following, Mr. Silvers, describe how the changes in the 
bill, what impact it would have on a large shareholder like the 
Ohio Public Employees Retirement System and its ability to hold 
management accountable.
    Mr. Silvers. Senator, the issue that pension funds face is 
that they are fully diversified in generally very long-term 
holdings in the equities market. They hold typically hundreds 
of stocks, and they have a fiduciary duty under both ERISA, the 
tax laws, and the relevant State laws to manage their assets. 
And the proxy vote is an asset. They have a fiduciary duty to 
manage their assets with expert advice.
    Proxy voting firms are like other forms of investment 
management, provide expert advice on corporate governance to 
pension funds, enabling them to fulfill their duties.
    Critical to that process is that the advisors have to be 
loyal to the pension fund. Expertise is one part of the 
fiduciary duty; the other part is loyalty. This bill 
compromises the loyalty issue significantly by enmeshing the 
advisor in a process of interacting with the very people whom 
the corporate governance process is designed to hold 
accountable. It puts the proxy advisory firm on both sides of 
the principal-agent problem.
    On the one hand, it compromises the substance of the 
relationship between the advisor and the client.
    Second, as Professor Coates said, it adds a layer of 
significant cost to what is otherwise a de minimis expense and 
one that provides substantial value in terms of votes that 
could affect the overall value of the securities involved, and 
so there is a cost issue.
    There is finally an issue that Professor Coates raised 
briefly but I think is really worth hammering on here, which is 
that our entire securities law system and our pension law 
system, no one is required to get it right substantively as a 
legal matter. This is also true in corporate law. No one is 
held legally responsible for not making a mistake. People are 
held responsible for due care, and they are held responsible 
for loyalty, but not for perfection. And the fact that that 
kind of standard is sort of weaved into this bill is really 
telling you that the purpose of this bill is to prevent the 
corporate governance system from functioning.
    Senator Brown. Thank you.
    I have only a few seconds. I want to ask for very short 
answers from Professor Coates and Mr. Silvers on the Brokaw 
Act. The Act put in place 50 years ago requires shareholders to 
report when they own a significant stake in a company. How will 
this bill help with transparency?
    Let's start with you, Professor Coates, and I apologize, 
but as briefly as you can and then Mr. Silvers.
    Mr. Coates. So 10 days, which is how long you have to file 
a 13D, is in today's environment an eternity, and it will 
shorten the amount of time before a filing has to be made. 
Derivatives economically are equivalent to the positions that 
normal stockownership provides, and right now, they are left 
out of 13D. So those two ways are the ways that it would 
enhance transparency.
    Senator Brown. Mr. Silvers.
    Mr. Silvers. Senator, I agree with what John said. I just 
want to talk to the short-selling issue.
    The whole point of this regime is to give investors who are 
not 5 percent holders, who are not in a potentially control 
position, knowledge about what is going on and what people are 
doing potentially to control the company that they have 
invested in.
    There is no way to understand what is going on if you do 
not understand what the short position is of the potentially 
controlling investor.
    In my view, the concerns that have been raised, to wit 
about in general will this provision affect the ability of 
short sellers to operate and the ability of short sellers to 
play their legitimate function, I think is misplaced.
    Senator Brown. Thank you.
    Chairman Crapo. Thank you.
    Senator Toomey.
    Senator Toomey. Thanks, Mr. Chairman.
    I just since returned, but I would just point out that 
there are some significant differences between a short position 
and a long position. A short position, for instance, you are 
subject to unlimited price risk, whereas a long position, you 
cannot go below zero. But there is no limit to how high a short 
position can go against someone.
    Also, a short needs to be able to borrow the security. A 
long position does not have that problem.
    And then, finally, I would point out that a short position 
does not entitle you to voting rights. So they are 
qualitatively very different, and I think we should proceed 
pretty cautiously for those reasons and others.
    Let me touch on a few of the bills, and I appreciate this 
hearing. I think we have got some very worthwhile legislation 
to consider. One of them is S. 2756. That is a bipartisan bill, 
and the idea here is that we would acknowledge knowledge and 
expertise as grounds for being an accredited investor.
    Let us be clear, right? The asset test and the income test 
that we currently use is a proxy for understanding the risk 
that you are going to be taking. Well, if you are a financial 
industry expert because it is your job, then that certainly is 
relevant experience. So I support this legislation.
    The Family Office Technical Corrections Act is in a similar 
vein. What it would simply do is ensure that family members 
whose savings are managed through a family office are treated 
as accredited investors, and I think this just makes sense. It 
is not one of the bills under consideration at this hearing 
directly, but it has passed the House with a voice vote.
    And I have got a letter from Private Investor Coalition in 
support of this. I would ask that that be included in the 
record.
    Chairman Crapo. Without objection.
    Senator Toomey. And I would ask the Chairman to consider 
including this really important technical change in any package 
we might advance.
    I do want to talk a little bit about S. 2499, the 
Compensation for Cheated Investors Act. My understanding is 
this legislation would create a fund funded by broker-dealers' 
fines, which are currently used to fund FINRA. So if that money 
were no longer available for that purpose and were instead used 
to compensate victims of fraud, then presumably the fees would 
have to go up that the innocent broker-dealers would have to 
pay into FINRA.
    So I am sympathetic to the problem. Obviously, if somebody 
has been cheated, they ought to be made whole, but I am a 
little concerned that socializing this cost means spreading it 
among perfectly upstanding firms that have not done anything 
wrong to cover that which is done by bad actors.
    And I further worry that this legislation could put a 
target on the backs, especially of smaller broker-dealers that 
may not have the funds to effectively defend themselves because 
there would be a backstop that somebody could go after that 
could encourage a wave of litigation.
    And so, Mr. Quaadman, I would just ask, are these--do you 
share any of these concerns, or do you have other concerns 
about this legislation?
    Mr. Quaadman. No. We share those concerns.
    First off, we also have to recognize we are talking about a 
relatively small number of cases, I think 44, and even if you 
then take out those cases that maybe had gotten compensated 
somewhere else, we are talking about less than 30. So we are 
concerned that, one, if you start to use fines in this way, you 
are going to start to incentivize for more fines. It is going 
to take some resources away from FINRA.
    We also share your concerns as well that if you are going 
to socialize the cost of good actors, it is going to subsidize 
bad actors, and that is why we think it might be more 
appropriate to use the SIPC as maybe a vehicle to maybe take 
care of this.
    But we also think, too, that while it has taken a while to 
take care of these issues, FINRA has taken some actions here, 
and we need to see how those take hold.
    Senator Toomey. Thank you.
    Let me just move on quickly to the proxy advisory firms, of 
which really are two that dominate the marketplace. One, ISS 
generates considerable revenue from the consulting services it 
provides to companies about proxy votes, while at the same time 
advising institutional investors how to vote on those very same 
issues.
    It seems like a glaring conflict of interest if in fact 
they are receiving revenue or seeking revenue from a business, 
while at the same time advising investors how to vote the 
shares of a proxy.
    Question. Do you see it as a fundamental conflict that is 
problematic?
    Mr. Quaadman. Yes, we do. And, in fact, I have an email 
here--I will be happy to submit it for the record--of a 
solicitation for a company where the consulting service 
basically approaches a company to say, ``You are going to get a 
better score if you use us as your consultants.''
    I think, too, we also have to understand that Glass Lewis 
has a separate conflict of interest as well because they are 
actually owned by two activist pension funds as well.
    So we have to understand that proxy advice at its very core 
is to provide data to those investors so that they can make 
that independent judgment. They are not going to--but it has 
been used by others just to totally outsource their corporate 
governance functions.
    We have addressed issues like this before credit rating 
agencies and financial analysts, and we should do it here.
    Senator Toomey. [Presiding.] Thank you.
    Senator Reed. I guess you are in charge.
    Senator Toomey. Am I in charge? Are you up next?
    Senator Reed. I am.
    Senator Toomey. Well, I see I have run out of town. The 
Senator from Rhode Island.
    Senator Reed. Well, thank you, the Senator from 
Pennsylvania by way of Rhode Island. Thank you.
    I want to just take a few moments to talk about my bill. I 
have talked to the Chairman. He has given me a little 
discretion, which is basically cybersecurity is I believe the 
most significant and universal threat that every company and 
enterprise in this country faces, and it is going to get worse. 
And it is not just a threat to the bottom line of companies. It 
is a national security threat.
    I serve on the Armed Services Committee as a Ranking 
Member. I was stunned when we had General McDew, who is 
commander of Transportation Command. Transportation Command is 
the major agency in DoD that contracts with all the aircraft, 
all the ships, all the logistical to move men and material and 
personnel into war zones and to anyplace in the world.
    And here is what General McDew said:

        Cyber is the number one threat to the U.S. Transportation 
        Command, but I believe it is the number one threat to the 
        Nation. In our headquarters, cyber is the commander's business, 
        but not everywhere across our country is cyber a CEO's 
        business. In our cyber roundtables, which is one of the things 
        we are doing to raise our level of awareness, some of the CEOs, 
        chief security officers, cannot even get to see the board. They 
        cannot even see the CEO. So that is a problem.

    In the essence of this legislation, which is the mildest 
form of disclosure, it is not mandatory. It does not require a 
person to be on the board with a cyber degree. It asks the 
company in two lines to describe what they are doing.
    We have companies today that we will depend upon in an 
emergency that may have been fully infiltrated by a cyber 
threat, and they are completely unaware. And their CEOs are not 
aware because there is nothing to make them sit down and say, 
``Hey, I've got to pay attention to cyber.'' This is the 
mildest form, when they read that proxy statement and say, 
``Oh, yeah. Boy, we have to think about cyber,'' otherwise it 
will not happen. It is not happening.
    That is why you have Equifax problems. By the way, it has 
just been announced today that Equifax has settled with State 
Attorney Generals, and one of the things they have agreed to 
do, boost board oversight of cybersecurity because they failed, 
and they are not the only company that has failed and that is 
failing right now. And we are simply saying tell your 
shareholders what you are doing. You can do anything you like. 
You can hire a company. You can have a director, et cetera, 
this is not mandatory. This is disclosure.
    This Act is bipartisan. Senator Collins, Senator McCain, 
Senator Warner, this is something that is absolutely critical. 
And I should say Senator Warner is the Ranking Member of the 
Intelligence Committee, and I think he brings that expertise to 
this support for this bill also.
    The Cybersecurity Disclosure Act is supported by not only 
Professor Coates and Mr. Silvers--thank you--but the Alabama 
Securities Director Joseph P. Borg on behalf of the National--
or North American Securities Administrators Association, the 
National Association of State Treasurers, the California Public 
Employees Retirement System, the Bipartisan Policy Center, 
Professor Jack Coffee of Columbia, and the law firm of K&L 
Gates, which is a very distinguished Washington firm. And I 
would like, whoever is the Ranking Member, to include those 
letters in the record.
    Senator Cotton. [Presiding.] Sure.
    Senator Reed. Thank you.
    [Laughter.]
    Senator Reed. Thank you, Senator.
    Senator Cotton. Watch out. I am driving the bus now.
    Senator Reed. Yeah, OK.
    So I just think this is incredibly important. You know, I 
fear that months, weeks, years from now, there is going to be a 
cyber disaster, and we are all going to look back and say, 
``Gee, if only we had done something.'' Now is the chance to do 
it.
    Now, Ms. Stuckey, in your written testimony you say even 
the Council of Institutional Investors does not subscribe to 
the idea that all boards need a resident cyber expert. Is that 
correct? Are You aware that the Council of Institutional 
Investors supports my legislation?
    Ms. Stuckey. I was not.
    Senator Reed. Well, you should be.
    Ms. Stuckey. You are right.
    Senator Reed. Yes, you should because your testimony seems 
a little illogical when you are citing someone criticizing the 
bill that actually supports, and in fact, yesterday they sent a 
letter that said the Council of Institutional Investors 
strongly supports the stated goal of a bill to promote 
transparency and the oversight of cybersecurity risk of 
publicly traded companies. We are optimistic that S. 536 may 
have the potential of being pursued in a thoughtful bipartisan 
manner that is responsive to views of investors.
    So your source is one of my biggest boosters. Thank you.
    And we make that part of the record too, Mr. Chairman?
    Senator Cotton. Sure.
    Senator Reed. Thank you.
    Now, Mr. Quaadman, you have made the point that this 
effectively mandates a director. That is wrong. This does not. 
Professor Coates pointed out, with his experience, not as an 
attorney, but in fact a lawyer.
    I think it is interesting to note that in February 2018, 
the report by the Trump Council of Economic of Advisors, they 
said, and I quote, ``Mandatory disclosure requirements were 
previously shown to incentivize firms to adopt better 
cybersecurity measures,'' and that is precisely what we are 
going today. So I would hope you would take that back for the 
record.
    Professor Coates, you have been listening. Can you comment 
any further about your views on the bill?
    Mr. Coates. Just to reiterate that the boards in this 
country are, in my experience, reasonably firm and strong-
willed, and if they do not think they need a cyber expert on 
their board, I do not think this bill, which only requires them 
to say do they or do they not, and if not, why not, will force 
them to take one on.
    I will note that a similar type of encouragement in 
Sarbanes-Oxley addressed financial experts, and there are 90 or 
so New York Stock Exchange companies that still are happy to 
not have a financial expert on their board, and they will 
explain why in their proxy statement.
    So it is not as if this really does force a one-size-fits-
all solution. There are one-size-fits-all solutions, and I 
really do worry that if there is another Equifax or similar 
event, we will end up with a one-size-fits-all regulatory 
regime. This bill, I would like to think, would head that off.
    Thank you.
    Senator Reed. Well, I appreciate that, and again, 
unfortunately, based on an experience that Senator Cotton and I 
share position on the Armed Services Committee and also on the 
Intelligence Committee, and cybersecurity is something that is 
not a passing fancy. And as you pointed out previously, 
Professor Coates, it affects every enterprise in this country. 
It is not like a labor issue or environmental issue where the 
company has nothing to do with that. So this would be a waste 
of their time.
    Every company--I mean, look back at some of the big 
intrusions, the Target intrusion of a few years ago. It was an 
HVAC contractor who they got in through. In fact, frankly, my 
sense is if they are coming after us, they will not be right 
through the front door of the companies that are doing all the 
right things. It will be the companies that need the reminder 
to think about cybersecurity.
    So, with that, Mr. Chairman, I would yield my time. Thank 
you.
    Senator Cotton. Thank you, Senator Reed.
    I will just continue on that topic. Abstracting away from 
any particular legislation, though, Mr. Coates, I want to 
address a point you made in your testimony where you said that 
you think based not only on your experience as a scholar, but 
as a practicing lawyer and someone who still advises Government 
agencies that the cyber threat is nearly unique among all 
threats that our companies and investors face. Could you 
elaborate a little bit more on that?
    Mr. Coates. Sure. There are a variety of other kinds of 
risks that some investors would like boards to take on; 
environment, for example. And they are real, and they are 
important, but they only do affect a subset of public 
companies. There are many companies that really do not have a 
meaningful exposure to climate change risk, other than the way 
that we all do as humans on the planet.
    Cyber is different than that in the sense that it is 
practically impossible to function as a meaningful business 
without your employees using these things, these cell phones, 
and these cell phones expose you. Your perimeter of security 
around your basic information systems is exposed every time one 
of your employees communicates to and from outside the company, 
and inside the company. So it is very difficult actually to 
come up with examples of companies that are not exposed to 
cyber risk, and it is a core risk. It is the kind of risk that 
can produce theft. It can produce fraud. It can produce 
longstanding corruption of data, and all of those things are 
going to have direct financial impacts on the company, its 
investors, and its customers.
    So, as I say, I am mindful that there is a worry that 
disclosure-based governance can start to cover more and more 
and more, and there is a worry that where do we stop and where 
do we draw lines. And really, the point I am trying to make on 
cyber is, this is a clear difference for this type of risk for 
many other kinds of governance concerns that other people might 
have. That is all.
    Senator Cotton. Thank you for that.
    I want to turn now to legislation I have introduced with 
Senator Jones, the Small Business Audit Correction Act. It was 
not on the list of bills today, but, Mr. Quaadman, your 
organization, the Chamber, sent a letter just in the last day 
or two about our legislation. So I would just like to say a few 
words about it and get your thoughts. The bill would correct 
what I think are one of the unintended consequences of the 
Dodd-Frank Law, namely the massive increase in audit costs for 
small noncustodial broker-dealers. In response to the Madoff 
scandal, Congress decided to extend public company accounting 
oversight board audit requirements to all broker-dealers. In 
hindsight, I think Congress pretty clearly overshot the mark 
when they included small noncustodial firms, that is, firms 
that do not hold customer assets, and thus, could not even pull 
off a Madoff-like scam if they wanted to.
    This requirement may seem harmless or obscure, but in fact 
it has increased the cost for small broker-dealers quite a bit.
    One Arkansas broker has told me that his audit costs have 
gone from $6,000 to $30,000, and he only has five employees.
    That is why our legislation would make a simple change. It 
would exempt these small privately held noncustodial firms in 
good standing from the board audit requirement and allow them 
to file their financial statements according to the GAAS 
standards they used just a few years ago. I think the current 
audit requirements are like trying to put a square peg into a 
round hole, which is to say they do not fit, and they will 
always be high-priced.
    It is true that regulators at the SEC and FINRA could 
relieve some of the compliance burdens themselves, but they 
could also reverse that decision later on. Our small brokers 
deserve regulatory certainty. They can only come with a change 
in the law, and these regulators have acknowledged that aspects 
of the problem can really only be solved by changing that law. 
They have told us that our hands are somewhat tied by the 
statute.
    So, as I said, Mr. Quaadman, your organization sent a 
letter earlier this week to our Committee to support the 
legislation. Could you talk about why you feel these small 
noncustodial firms and, more importantly, their customers would 
benefit from the passage of this legislation and the return of 
right-size auditing standards?
    Mr. Quaadman. Thank you, Senator Cotton. Thank you for 
introducing the bill.
    I think it is important to remember, first off, that the 
PCOB, the first two acronym letters are for public company. 
Most of the broker-dealers you are talking about are not public 
companies, and there has always been a problem when you try and 
put public company controls on to private companies.
    So if your bill were to pass, those broker-dealers would 
still be subject to GAAS, as you mentioned, and that those 
standards are specifically designed for private companies.
    Additionally, those that have custodial accounts are going 
to be treated differently.
    And furthermore, I would also say, too, the easiest way to 
find a Ponzi scheme is to take the bank records and to take the 
revenue statements of a firm and to match them up, and that 
information is still going to be available for the regulators. 
So we think this is a good way to rebalance the system.
    Senator Cotton. Thank you for that answer.
    My time has expired. I want to thank the witnesses for 
their testimony. I particularly want to thank Professor John 
Coates, who was my teacher in law school. I hope that my 
performance does not reflect poorly on your teaching skills, 
Mr. Coates, and let the record reflect he was an outstanding 
professor.
    Senator Jones.
    Senator Jones. Thank you, Mr. Chairman, and thank you for 
bringing up our bill that is not part of this hearing today, 
but I think is a very, very important bill. And I am pleased to 
be working with you on that.
    I would like to talk just a moment. We briefly mentioned a 
little bit--I think everybody is generally in support of a bill 
that I introduced with Senators Heller, Heitkamp, and Kennedy 
concerning the Expanding Access to Capital for Rural Job 
Creators. That is, I believe, another one of those niches that 
often gets overlooked.
    We have so much rural businesses in my State or rural areas 
for businesses that are not capitalizing, and, Mr. Quaadman, I 
noticed that in your testimony, I was struck--I did not know 
the specific statistic--that since the financial crisis, half 
of the new business creation has occurred over 20 counties out 
of just literally thousands of counties in the United States.
    So this bill is going to create a spot, and I would like 
to--you know, particularly if you could maybe just expand a 
little bit and talk about the unique challenges for raising 
capital that our rural and small businesses face today.
    I think just anyone can do that. I will start with you, Mr. 
Quaadman, but I really want to kind of get this on the record a 
little bit about why this is an important bill.
    Mr. Quaadman. Sure. I think, number one, I think it is a 
credit to this Committee that, first off, the passive of S. 
2155, which provided regulatory relief to large community banks 
and regional banks, is important because those banks are very 
important liquidity providers in rural areas.
    However, we are still seeing a dearth of business 
creation--when we talk about the Heartland of the country and 
the rural areas, I mean the coastlines are doing fine. Those 20 
counties, you could sort of figure out where they are. It is 
not a surprise.
    So we think it is important to incentivize the ability of 
capital to go out into the different areas of the country. We 
think some of the work that Steve Case and J.D. Vance are doing 
in this area are very important, but I think your bill will 
help to make sure that this gets the appropriate policy 
discussion within the SEC and that we could start to make sure 
that the policies are not going to benignly ignore business 
owners in rural areas.
    So we think this is an important step forward, and we are 
happy to support it and work with you on it.
    Senator Jones. Great. Thank you.
    Professor Coates, do you have anything, or Ms. Stuckey, do 
you want to----
    Mr. Coates. So I endorse your bill. I think the SEC does 
have a tendency, for understandable reasons, to focus on the 
major capital markets and the major centers of capital 
formation, which mostly are not rural, and yet the laws and 
regulations that it passes and the bodies that it oversees, 
like FINRA, regulate the entire country. And I do think there 
are probably ways in which the laws and regulations could be 
better tailored for businesses trying to raise capital in 
remote areas.
    I would say the network that creates cyber risk actually 
does create the potential for small and relatively 
geographically remote companies to go global, and as a result, 
I do think there is the possibility of a resurgence in rural 
job creation, but it will take some effort and some time. And I 
suspect it is going to need more than the SEC, but I do think 
having the SEC think about it will help.
    Senator Jones. Ms. Stuckey, I did not mean to skip over 
you. If you want to briefly mention that, anything that you 
need to add.
    Ms. Stuckey. I did not include this in my testimony, purely 
because I did not have time to raise it with my members. So we 
do not have a--the Society does not have an official position, 
but we were generally for capital formation. And I cannot 
really imagine why we would oppose this, so long as the SEC has 
the bandwidth to deal with it.
    Senator Jones. Mr. Silvers, do you got any thoughts?
    Mr. Silvers. Just, well, we think this is a good idea, but 
in doing so, I think, Senator, we would suggest both to you and 
to the Advocate, whom this bill was directed toward, that it is 
very hard to do anything really helpful for small business and 
small business in rural areas without taking into account 
issues of market concentration, both in the markets that 
issuers are in and in the financial markets themselves.
    There has been dramatic concentration in the financial 
markets, and it is our somewhat uninformed guess that that has 
not been a good thing for rural business.
    Senator Jones. All right. Thank you.
    I want to just in my remaining time just thank Senators 
Heller and Heitkamp for their work creating this Advocate 
position, but also noting that the SEC has yet to fill that. So 
I am hoping that we can do that.
    And just one quick follow-up, Professor Coates, to what you 
said. We have been--especially in my office, we have been 
strongly, strongly trying to push for more rural broadband and 
internet, high-speed internet access, because to be able to get 
global, you are not going to be able to do that if you still 
have dial-up, which so many counties in this country still 
have. So thank you for that comment as well as in reinforcing 
the need of rural broadband.
    So thank you all for your testimony today. It was very 
informative.
    Thank you, Mr. Chairman.
    Senator Toomey. [Presiding.] I think Senator Cortez Masto 
is up.
    Senator Cortez Masto. Thank you. And also, I want to thank 
all of you. This has been a great conversation this morning.
    I also want to thank the Chair and Ranking Member for 
considering S. 2756, the Fair Investment Opportunities for 
Professional Experts Act.
    I was pleased to lead this bill with Senator Tillis, and I 
also want to thank Senators Heitkamp, Peters, Toomey, and 
Heller, who cosponsored it.
    The bill--and I would like to talk a little bit about it 
because it tries to establish a balance. Change policy to 
expand the overall pool of accredited investors, but also 
reduce the proportion, qualifying solely by virtue of income 
and wealth alone.
    I know, Professor Coates, you have concerns about this 
bill, but I also know--and thank you for your service on the 
SEC's Investor Advisory Committee. Do you know why the SEC did 
not follow the IAC's recommendation to raise the threshold? 
Because I know that is what you and Mr. Silvers talked about. 
That was your concern. So can you address that? Why was it 
not--because it has not been looked at since 1982, and I think 
you said that in your testimony as well. So I would be curious 
if you have any insight into that.
    And then also, if you have any thoughts on what income and 
wealth thresholds do you think would--it should be increased to 
that would protect unsophisticated but wealthy people from 
being ripped off.
    Mr. Coates. So I can only speculate about the SEC. I will 
say that for reasons--it may not seem like a politically 
fraught topic, but actually, it really is because the precise 
scope of who can be an accredited investor will directly affect 
business models. And the precise decision about what kinds of 
education and practice experience will count will directly 
affect business models. So there is a real financial interest 
in exactly where the lines are drawn, and I think the SEC has 
had a lot on its plate over the last 10 years, and that was one 
battle they--I am speculating--decided to defer on and let you 
guys who are specialists at resolving political disputes 
resolve.
    So, on your second question--and by the way, I actually am 
very much in favor of moving more toward experience and 
education----
    Senator Cortez Masto. OK.
    Mr. Coates.----rather than relying on, as Senator Toomey 
said, the crude rule of net worth and income as the basis for 
it because it really does not match very well in practice 
sophistication.
    So I am all in favor of expanding the pool, but I do think 
we need to recognize that when the dollar thresholds were set a 
long time ago, we have now basically expanded by--I forget 
exactly the number, but something from less than 2 percent to 
more than 6 percent of the population.
    So my suggestion would be just to go back to the 
percentage, which can easily be derived--actually, the SEC 
report gives you the numbers, and so expand on the professional 
side, but contract on the pure net worth side would be my 
suggestion and then index it. So, anyway, that is my 
suggestion.
    Senator Cortez Masto. Thank you.
    Mr. Silvers, do you--because I know you had concerns 
similarly.
    Mr. Silvers. Yes. Well, two points about this, Senator. 
First, my view is very similar to John's in terms of both how 
you might address the thresholds and the directionality we 
should be going in here.
    At the current threshold level, it picks up a fair number 
of union members that I can tell you would absolutely say ``we 
are not experts.''
    Senator Cortez Masto. Right.
    Mr. Silvers. Right. But there is a second point here, 
Senator, that I think is really worth thinking hard about, and 
it goes back to something that Mr. Quaadman talked about in his 
testimony, which is the balance between the private markets and 
the public markets as sources of capital for our firms.
    There has been a notable shift toward the private markets, 
and that has consequences in terms of how much information is 
available to investors and to the general public and the 
policymakers.
    And the question of whether or not investors are really 
getting the level of protection, transparency, and market 
efficiency out of private markets that traditionally they have 
gotten out of public markets is a question that has not gotten 
enough attention.
    Part of the reason why this shift has occurred is because 
we have made the private markets much more like the public 
markets in terms of the ability to access capital. Whether that 
is a good idea in the absence of comparable levels of investor 
protection and transparency, again, I think is an under-
investigated question.
    If you move these numbers or if you lock them in, if you 
lock them in by statute at levels that are pretty low or if you 
have measures of expertise that are not real measures--and we 
know that qualitative things can sometimes be easily gamed. If 
you do that, you are enhancing this aspect of the imbalance 
between public and private markets, and if our concern is that 
we want more companies moving into public markets, that is 
probably not--we are pushing in the opposite direction.
    The precise answers here, they are not obvious, but it is 
important to understand the stakes involved and some of the 
considerations that this Committee might want to look at.
    Senator Cortez Masto. But you would agree that the wealth 
threshold is too low?
    Mr. Silvers. Oh, absolutely. As Professor Coates said and 
as in my written testimony, it has not moved since 1982.
    Senator Cortez Masto. Right.
    Mr. Silvers. It is a third--it is picking up three times 
the percentage of the population, and I would just note 
anecdotally, the kinds of people whom it is picking up are not 
experts.
    Senator Cortez Masto. Right, right. Thank you.
    And I notice my time is up.
    Let me just say this, looking at the bills that we have 
talked about today, as I review them and will continue to. I 
can tell you right now I have concerns for the conversation 
that we had with H.R. 4015, but do support the Cybersecurity 
Disclosure Act of 2017 and Expanding Access to Capital for 
Rural Job Creators Act.
    Thank you again for the conversation.
    Chairman Crapo. [Presiding.] Senator Scott, you are up.
    Senator Scott. Oh. Thank you, Mr. Chairman. Good timing. 
Thank you, Mr. Chairman.
    Good morning to the panel. I hope you guys are doing well.
    Management at publicly owned companies should be held 
accountable by their shareholders. That said, I think it is 
important to maintain the balance between both sides, and I 
question whether those scales are beginning to tip.
    But two proxy advisors control up to 38 percent on average 
of shareholder votes in the United States. That is a massive 
choke hold that would seem to deserve an increased level of 
oversight, and that is not to mention one of the proxy advisors 
offering consulting services.
    It seems obvious that a firm that overwhelmingly dictates 
how investors vote their shares should not also be pitching 
companies on how to improve their corporate governance results.
    I will go to Ms. Stuckey first and then Mr. Quaadman. Can 
you expand upon the conflict of interest presented by ISS doing 
recommendations for one side and consulting for the other side?
    Ms. Stuckey. Thank you, Senator. Yes, I can.
    You are right. The conflicts are legion with ISS. For a 
fee, you can have ISS help you draft your proxy if you are an 
issuer. If you are an investor, you buy their research and 
recommendations. If you are a hedge fund, you can also buy 
their consulting services, and then they will vote on your 
proxy contest.
    If you are a shareholder proponent that needs to make sure 
they can get a proposal and that will pass muster under the SEC 
rules, there are even people at ISS that will help you write 
that, and then they also vote on those shareholder proposals.
    I do not know how to say it any more clearly. It is a nice 
business.
    Senator Scott. Mr. Quaadman.
    Mr. Quaadman. Senator Scott, I would echo Ms. Stuckey's 
answer.
    I would also say--and I mentioned this in an early answer. 
You know, we will submit for the record an email which many of 
our members get, where from the consulting side of ISS, it 
says, you know, if you use our service, you will get a better 
score.
    I would also want to add as well, Glass Lewis also has a 
significant conflict of interest. They are owned by two 
activist pension funds, and I think it is important to note 
that neither firm issues any statements as to whether or not a 
client is a shareholder proponent.
    And neither does Glass Lewis, you know, disclose if they 
have a financial interest in a firm, which they said recently 
in a letter back to this Committee, they would only do if it is 
a publicly disclosed position.
    So I think there is significant conflicts of interest here. 
As I said earlier, this is something that we have dealt with, 
with credit rating agencies, with financial analysts, and it is 
long, long overdue for this to be addressed here as well.
    Senator Scott. Thank you for your answers.
    Thank you, Mr. Chairman.
    Chairman Crapo. Thank you, Senator.
    Senator Van Hollen.
    Senator Van Hollen. Thank you, Mr. Chairman. Thank all of 
you for being here. I had to leave, but I heard your original 
testimony. I have some questions on the 8-K Trading Gap bill.
    Professor Coates and Mr. Silvers, thank you for your 
support for that bill and your testimony.
    Mr. Quaadman, I appreciate you also willing to work with 
us. You raised an issue in your statement, which I do not think 
is really part of the bill. You said that you want to make sure 
that we clarify when an event happens and when it becomes 
material, and here is the thing. This bill does not get into 
this, into that question. Maybe we should as a Committee; maybe 
we should not. But this bill does not do that.
    What this bill says is once the company has made the 
determination that something is material, that is when the 4-
day clock starts ticking for the filing of the disclosure. And 
what this bill says is during that period of time, there should 
not be people trading because they have already made the 
decision that this is relevant information, and they should not 
be taking advantage of that with insider trading. Do you agree 
with me on that?
    Mr. Quaadman. Yes.
    The issue that we raised was that if there is an event that 
happens, the company has 4 business days then to make a 
decision as to whether an issue is material.
    Now, you have some companies where you have 10b-15 
automatic stock selling or purchasing. You have others that do 
not. So, in our view, in reading the bill, at least in the 
version that we received, that we think that there needs to be 
maybe some clarity because you could have senior executives who 
are a part of that decisionmaking process, where we think there 
might be something that needs to be addressed. There are other 
senior executives who are not a part of that decisionmaking 
process as well.
    So we think there is just some--there is a little bit of a 
gray area that we would like to sit down and maybe talk to you 
about.
    Senator Van Hollen. Well, I am always happy to talk.
    It seems to me that once the decision has been made--and as 
I understand the 8-K disclosure requirement, that there is a 4-
day time period between the actual determination by the company 
that is obviously material and then they have to disclose it.
    I am not sure, and I--when Mr. Clayton was before the 
Committee, he agreed that he did not see any reason why during 
that 4-day period any executives should be trading stock, 
unless they had sort of a prescheduled purchase agreement. And 
the bill addresses that issue. It specifically carves out an 
exemption for people who had already had a scheduled plan. Is 
there any problem----
    Mr. Quaadman. No, no. And, as I said, no, we recognize 
that.
    I think where there maybe needs to be some clarity, because 
it also talks about material nonpublic information as well, and 
every company is always in control of material nonpublic 
information, right? If you are Apple and you have your plans 
for your next phone, that is material nonpublic information. So 
I think that is why there is just a matter of clarity because 
you can have an event that happens that you do not--that there 
is a decision made that it is not material.
    So the question is, do you then create such a limited 
period of time that people can sell their stocks or not? So 
that is why I said we perfectly agree if there is a decision 
made, there should not be any sort of trading going on, but I 
think there is just that little bit of a vague area during that 
4-day period that we would just like to maybe sit down and go 
over.
    Senator Van Hollen. I am happy to do that. I mean, the 
intent here is once the determination has been made that it is 
material----
    Mr. Quaadman. We agree with----
    Senator Van Hollen. You agree with that?
    Mr. Quaadman. We agree with your intent and want to work 
with you on it.
    Senator Van Hollen. Ms. Stuckey, do you agree as well?
    Ms. Stuckey. Yes, I agree with your intent, and my only 
basis for not supporting it at this point is because we are of 
the view that the trading windows are closed. As soon as a 
company decides that they have material nonpublic information, 
like you said, there may be outlier companies. The brief time I 
had and the members I spoke to, they said, ``We always close 
our trading window, and this does not happen.'' However, we are 
happy to work with you because there may be companies where 
that does not happen.
    Senator Van Hollen. Yes. I think there may be folks who may 
not be your members where this is happening.
    There have been a number of studies that show that there--
trading does happen during this 4-day period, and that clearly 
is trading at a time when the company executives are privy to 
information that the public does not have. So I look forward to 
working with you on that.
    The last thing I will say, Mr. Chairman, is that Senator 
Baldwin and I and the Ranking Member Brown and other Members 
are going to be asking Mr. Clayton and the SEC to look into the 
issue of the 10b-18 safe harbor protection that was put in 
place many years ago with regard to stock buybacks.
    There is obviously--you know, there can be good reasons 
sometimes for stock buybacks. We understand that, but we have 
seen like a trillion dollars of stock buybacks, and there are a 
lot of concerns raised about the potential for a conflict of 
interest and again insider information with respect to stock 
buybacks.
    And I may pose a question for the record for all of you to 
respond.
    Thank you.
    Chairman Crapo. Thank you.
    Senator Tillis.
    Senator Tillis. Thank you, Mr. Chairman.
    Thank you all for being here, and I think Senator Cortez 
Masto asked some questions related to one area, so I will not 
go back to that.
    One question that I had were the no-action letters that 
were issued, the two in question by the SEC in 2004. Ms. 
Stuckey or Mr. Quaadman--did I pronounce that right?
    Mr. Quaadman. Yes.
    Senator Tillis. Can you give me your opinion on the--
whether or not the withdrawal of those would be positive and 
why?
    Ms. Stuckey. I think they would be positive, and let me 
just mention that as Mr. Silvers seemed to indicate that--well, 
those letters are what created the proxy advisory firms as they 
exist today. Those letters were put out to rid companies of 
another kind of conflict. Instead, they have created the 
conflicts that we now have.
    The other important part of those letters is it gave 
investment managers an out if they hired an independent third 
party, but what happens is it seems like--it seems like the 
view of some people that the proxy advisory firms are there 
solely to hold the companies to account. I thought that was the 
role of the SEC, and that is where the line is blurring. The 
proxy advisory firms have become the de facto regulators. So I 
just wanted to make that point from the earlier testimony. It 
is really troublesome.
    Withdrawing the letters, we believe would really help the 
situation and force the investment advisors that do have the 
wherewithal to vote shares like they do, which is many of the 
large companies already vote. They are not actually the people 
that rely so heavily on proxy advisory firms, and it would go 
back to the system before these proxy advisors existed.
    Mr. Quaadman. Senator Tillis, that is a great question. 
Number one, we believe that proxy advice should be data-driven. 
It should be related to the fiduciary duty of their clients, 
and it should also be based on shareholder return. That means 
it needs to be objective.
    The issue with the no-action letters is that the proxy 
advisory firms do not have to disclose a conflict of interest. 
Their clients do not have to ask about a conflict of interest. 
So this actually allows for the firms to operate in a way that 
they do.
    We believe this has created very serious problems with 
proxy advice. I have letters I can submit for the record. One 
is from Abbott Labs, where they provided a 22-page letter to 
ISS citing material shortfalls in their reports, and they 
refused to want to even meet with Abbott Labs or to even issue 
a corrected report.
    I have a list of 130 supplemental filings filed with the 
SEC listing shortfalls in ISS and Glass Lewis reports that were 
not addressed.
    So we think that the withdrawal to no-action letters will 
put more teeth into SB20, and that that will then actually 
allow for efficient and appropriate SEC oversight over the 
advisory firms.
    Senator Tillis. Thank you.
    Another piece--and I think some of the Members have 
expressed their concerns over--you are familiar with CFIUS, I 
assume?
    Mr. Quaadman. Yep.
    Senator Tillis. Some of their concerns about this being 
another pathway into influencing U.S. firms through moves to 
affect who is the CEO, who is on the board, certain policies. 
Do you have any insights you can give me where you think that 
is a valid concern and what we should do about it?
    Mr. Quaadman. Yes. So proxy advice--you know, proxy advisor 
reports are--for some firms, some of the larger firms, they 
have their independent due diligent systems, so it is one data 
piece as many.
    However, the reason why we always are talking about the 
academic reports, it is to show that there is 38 percent 
control, is that there are some firms that just totally 
outsource.
    The reason why I think--the point that you raise is a very 
interesting one, and I want to reflect on that some more--is 
that we have one of the advisory firms that is owned by two 
Canadian active pension funds.
    Senator Tillis. Right.
    Mr. Quaadman. So that one is if we are talking about the 
total mix of information as being provided to investors and 
there are shortfalls or there are problems in putting that 
together, that then becomes a problem that we have one that is 
controlled by foreign entities.
    Senator Tillis. Yes. You know, the CFIUS construct does not 
apply directly to this.
    Mr. Quaadman. Yes.
    Senator Tillis. But once we implement CFIUS, which will be 
negotiated out in the NDA conference and you close some of the 
gateways through the CFIUS process, then people are going to be 
looking for other ways to actually influence U.S. businesses. 
That is why I think we do need to actually consider it.
    The only other thing is that I know that in the written 
testimony, there was some comment made about how the bill that 
we are trying to get support for here that had support in the 
House affects competition. Is not it really true that right now 
we have a duopoly between Glass Lewis and ISS? Do we have any 
real concept of competition in this space?
    Mr. Quaadman. There was an effort made 10 years ago or so 
where PGI tried to come in as an entrant, and they only lasted 
a couple years. A couple years ago, there was Proxy Mosaic also 
tried to enter in and failed. There are a couple of smaller 
firms.
    That is one of the reasons why I have raised this in the 
hearing, that this is very similar to credit rating agencies 
and why we need to take a very close look at it because if they 
are going to be the de facto standard setters of corporate 
governance, we need to make sure there is appropriate 
oversight.
    Senator Tillis. Thank you, Mr. Chair.
    Chairman Crapo. Thank you.
    Senator Heitkamp.
    Senator Heitkamp. Thank you, Mr. Chairman.
    I want to just comment a little bit about the requirement 
for SEC to include someone with rural business experience.
    We have not yet gotten a nominee for that position. One of 
the reasons is I probably have put a lot of pressure on the 
Chairman to look not just at the coast, but look at the 
Midwest. And I think they are searching to try and get not only 
that big-to-little experience, but also a regional experience 
as well. And so I know that he is working hard to make that 
happen.
    I want to go ahead and turn now to, again, the issue of 
proxy advisory firms. Where I think that there may be Members 
here who have reservations about the House bill, I do not think 
that you can listen to this testimony and not think that we 
need to have a discussion about some of the flaws that are 
embedded in the current system.
    And so I am just going to ask some of the kind of baseline 
questions to just get the facts out there, and a lot of this 
discussion has already taken place. But we know that right now, 
there is no regulatory apparatus that applies to all proxy 
advisory firms. They are functionally unregulated in many ways 
like the rating agencies before----
    Mr. Silvers. Senator, I think that is not quite right. 
While they are not required to register as investment advisors 
and, thus, are not in that frame--and as I said in my 
testimony, we would actually be supportive of requiring them to 
be in that space because that is what they do. They provide 
investment advice. That they are enmeshed, as Professor Coates 
said earlier--they are enmeshed in both a variety of State law 
regimes and in the--and to the extent that they are providing 
advice and guidance to pension funds, they are enmeshed in the 
regime of fiduciary duty involving pension funds.
    Senator Heitkamp. OK. So maybe looking broader beyond 
Federal regulation, looking to State regulation, looking at 
what their roles are depending upon who they are functioning 
for. So that is a fair point, I think.
    Let us go beyond the fiduciary relationships that you just 
discussed. Broadly, is it not true that proxy advisory firms do 
not owe a fiduciary obligation to shareholders writ large? Is 
that not--anyone want to disagree with that?
    Mr. Quaadman. Senator Heitkamp, I would just say that the 
clients to the advisory firms do, and that the advice that they 
are providing to clients is important for that. And if those 
clients are going to outsource their voting functions to those 
firms, then there is a much larger issue at play there.
    Senator Heitkamp. OK.
    Mr. Silvers?
    Mr. Silvers. Senator, I think you are raising a really 
critical question that has to be carefully parsed. The proxy 
advisory firms typically, either by contract or through 
operation of State law or pension law, they typically owe some 
kind of duty to their client.
    Their clients, to the extent that they are institutions, 
obviously owe fiduciary duties to their underlying investors, 
and in their relationship with the proxy advisory firm, they 
have to be compliant with their fiduciary duties to their 
ultimate investors.
    What this bill, I think, really confuses in a very 
dangerous way, it suggests that the investors somehow owe a 
duty to or are required to consult with the corporation in the 
course of fulfilling their fiduciary duties to their beneficial 
holders.
    The only investors that owe a fiduciary duty to the firms 
they invest in are controlling investors--so, for example, 
Fidelity invests in Exxon. Fidelity does not owe a fiduciary 
duty to Exxon, and people who give advice to Fidelity do not 
owe a fiduciary duty to Exxon.
    Senator Heitkamp. I understand what you are saying, but I 
think that no one benefits when the advice is not vetted, when 
the advice is not accurate, when the information and dialogue 
that is being provided has no way of being corrected when 
mistakes are made. That does not benefit anyone in this system 
to not--I mean, I think Mr. Quaadman gave an example of Abbott 
Labs. I think anyone who might be on the other side of that 
thinks that what we ought to be talking about is how do we make 
sure the correct information enters the marketplace as people 
are making investment decisions. That is really the whole 
reason for this entire regulatory regime that we have created, 
is to give accurate information to people who are investors.
    Professor Coates, I think you wanted to share a comment 
here.
    Mr. Coates. Yes, just very briefly. Abbott has its own 
mouth too, and they put out a proxy statement. And the normal 
way in which we have disputes resolved about certain kinds of 
information is to have more speech.
    Anyone giving advice in a public way, soliciting proxies is 
subject to anti-fraud rules enforced by the SEC. So if ISS were 
to put out a report knowingly falsely or negligently falsely, 
they would have liability for it. So I just want to be clear 
that if they deliberately misrepresent facts, they are going to 
be subject to liability.
    Senator Heitkamp. Yes.
    Mr. Coates. Now, I do think the conflict problems are a 
different issue, but I think on basic factual disputes, we have 
an amply
robust system for getting the information out there for 
investors, in my opinion.
    Senator Heitkamp. Do you mind, Mr. Chairman, if Mr. 
Quaadman responds to that?
    Mr. Quaadman. I think--look, the issue here is you have the 
two firms control about 38 percent of the vote. So if you talk 
to CEOs or those--once the ISS or Glass Lewis recommendation 
comes out, 30 percent of the votes come in in 24 hours. So that 
means that there is a high correlation, which has been showed 
academically that there are a number of investment firms that 
are just outsourcing their votes to those firms. And this is 
what ISS and Glass Lewis in some of the response to the Banking 
Committee here were saying were custom policies.
    So if you have an instance where--and I think the Abbott 
Labs' letter is instructive, but as I said, we have got about 
130 other examples. If there are 22 pages of material 
misstatements and they are brought to the attention of an 
advisory firm and that advisory firm refuses to meet on it, 
refuses to issue a new report on it, then those investment 
advisors that are outsourcing their entire voting function to 
an advisory firm are actually endangering what their fiduciary 
duties are to their clients or to their investors.
    So this is where there is a--you know, there is a 
tremendous shortfall in oversight of corporate governance.
    Senator Heitkamp. Yes.
    Thank you, Mr. Chairman, for indulging some additional 
answers.
    But, I mean, I guess the point that I want to make is that 
this is an area that I think needs to be reviewed. I do not 
know that we have the right solution, but I think there is an 
opportunity here to find that commonality of interest and at 
least figure out what part of this we can all agree on needs to 
be fixed and then what part we need to have more transparency 
on.
    And so I look forward to an ongoing discussion about this 
issue into the future, but very complicated, but also an 
opportunity, I think, to look at some mutual reforms that we 
could all agree on across the spectrum.
    Chairman Crapo. Thank you.
    And Senator Toomey has asked for one last opportunity to 
ask a few questions.
    Senator Toomey. Second round.
    Chairman Crapo. Yes.
    Senator Toomey. Thank you, Mr. Chairman.
    Chairman Crapo. Quick, quick, quick.
    Senator Toomey. I will be quick. Thank you.
    Though we had some brief discussion and at times we have 
touched on this idea that there has been a relative shift in 
funding to private markets and away from public markets, and it 
strikes me that it is entirely possible that a contributing 
factor to this shift could be a really substantial increase in 
the challenges and risks and pitfalls of being a public company 
now and the corporate governance that comes with that.
    And so what I think might be a case in point--and I want to 
raise this issue--is what seems to be a movement in the 
direction on the part of some in this environmental, social, 
and corporate governance investing or known as ESG investing.
    Now, let me be very clear. I have absolutely no 
reservations whatsoever with somebody who decides that they are 
going to create a fund dedicated to a particular type of 
investment, and if that is investment that is motivated by 
social or cultural goals and it is fully disclosed to investors 
and investors choose to participate, then knock yourself out. I 
have absolutely no reservations.
    What concerns me is cases where maybe advisors or fund 
managers or minority activist investors are trying to use the 
corporate governance voting mechanism as a way to advance a 
social and cultural agenda that may be inconsistent with many 
investors' wishes and may be inconsistent with maximizing what 
is best for the investors generally.
    For instance, the Manhattan Institute published a report in 
September of 2015, and they found that pension funds that 
engaged in social issues, shareholder proposal activism, that 
those investments are associated with lower values for the 
firms in which they invest.
    Likewise, there was a 2017 academic study commissioned by 
the National Association of Manufacturers that found that 
activist proposals detract from shareholder value.
    So I guess my question--I will start with Mr. Quaadman. 
First of all, as just a sort of subjective question is the 
proxy--is that the appropriate place to litigate what can be 
contentious social and cultural issues in America?
    Mr. Quaadman. No. The duty of the board is to--they have a 
fiduciary duty to their investors. So the problem with--you 
know, you have to break down ESG into its component parts. 
Governance is always an issue. Environmental depends on the 
business or the industry can be an issue. The problem is social 
because if we are going to allow for broad-based social issues 
to be debated in directors--and there is a school of thought 
that is emerging that if Washington cannot handle a problem, 
let us go to the public companies, and then let us start to 
debate it--you know, let us start to push is there--that means 
we are going to take boards away from that fiduciary duty. They 
are going to become debating societies.
    And if we look as split as our country is on many important 
issues, that is going to be thrown right into the board room, 
and they are not going to be focused on what they should be 
focused on.
    Senator Toomey. I would just say I can imagine--and I know 
of issues that are in the environmental and governance space 
that are also really ultimately social and culturally debated 
issues.
    But, Ms. Stuckey, I wonder if you have any thoughts on 
this.
    Ms. Stuckey. I agree with Tom on that.
    We also see our private company members growing and our 
public company members shrinking, but you are absolutely right. 
And Tom is right. Why should a board be spending time on the 
social issues when they should be dealing with cybersecurity?
    And, also, why--there clearly is a competitive disadvantage 
to be a public company these days because of all the 
regulation. I mean, you think of activism. You think of more 
and more disclosure, so I would agree.
    Senator Toomey. So if there is documented evidence that 
suggests that there is a category of criteria that promoting--
promoting this category results in a lower return to investors, 
then anybody advising that would be failing to live up to their 
fiduciary obligations, would not they?
    Mr. Quaadman. Yes. And I would say if you also take a look 
at the issue of public pension plans, those that have the 
lowest--the lowest performing, the taxpayer has to make up that 
difference.
    Senator Toomey. Right.
    Mr. Quaadman. And, you know, what we are also seeing here--
because I agree with your statement earlier. Look, there is a 
market-driven--there could be a market-driven approach here. If 
you want to have an ESG fund, go ahead. Go right at it. Well, I 
think we should also be very cognizant of the European Union is 
actively looking at a sustainable finance directive that will 
look to place ESG from a top-down approach and do it very 
broadly.
    And the reason why I raise this in terms of concern, as we 
looked at with GDPR and other areas, the European Union is 
looking to be a global standards setter. So I think we need to 
be very concerned here that public companies in Europe are a 
much different animal than they are here in the United States, 
and if we start to see that migrate, ESG migrate because of the 
European Union, I think we are going to be in some--we are 
going to be in a pretty difficult--we are going to see more and 
more public companies become private.
    Senator Toomey. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Crapo. Thank you, Senator Toomey. I agree with the 
concern you raise, and it is obviously one among many that we 
are trying to address here.
    I also want to thank the witnesses. I thought we had a very 
good and thoughtful discussion, and I personally got a lot of 
helpful insights into the legislation we are looking at. And 
you definitely helped us as we try to put together a package of 
corporate governance reforms that will improve and strengthen 
circumstances in the United States.
    With that, I would note for all the Senators who wish to 
submit additional questions--and you may get some questions 
from the Senators who were not here and even those who were--
that they need to submit those questions by Friday, July 6th. 
And I encourage the witnesses to respond to those questions, if 
you please would, as quickly as you can.
    And, again, thank you very much for giving us your time and 
your expertise and advice here, and with that, this hearing is 
adjourned.
    [Whereupon, at 11:38 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                  PREPARED STATEMENT OF CHAIRMAN CRAPO
    Today's hearing will focus on several legislative proposals to 
improve corporate governance.
    As with Tuesday's hearing on capital formation proposals, I intend 
to work with Ranking Member Brown and with other Senators on the 
Banking Committee to identify and move legislative proposals through 
the Senate.
    Although some of the bills which we will be discussing today have 
also been discussed and considered in the House, most have not.
    Today's hearing will mark a first step for those we have not yet 
considered or were recently introduced. Among other things, the bills 
that we will discuss today would:

    expand the definition of accredited investor;

    shorten the Schedule 13D filing window and increase 
        disclosure of short positions;

    require FINRA to create a relief fund to cover unpaid 
        arbitration awards to investors;

    draw attention to cybersecurity experience at the board 
        level;

    address concerns that a gap exists between the time a firm 
        learns of material nonpublic information and its disclosure; 
        and

    highlight the unique challenges to rural area small 
        businesses.

Finally, several Members have expressed interest in addressing the role 
of proxy advisory firms, and we will discuss a bill which the House has 
already considered and passed.
    I look forward to hearing from our witnesses on these legislative 
proposals, and whether there are ways to modify these bills to gain 
bipartisan support.
    We have received some initial feedback on these bills, which will 
be entered into the record.
                                 ______
                                 
                 PREPARED STATEMENT OF THOMAS QUAADMAN
 Executive Vice President, Center for Capital Markets Competitiveness, 
                        U.S. Chamber of Commerce
                             June 28, 2018
        The U.S. Chamber of Commerce is the world's largest business 
        federation, representing the interests of more than three 
        million businesses of all sizes, sectors, and regions, as well 
        as State and local chambers and industry associations. The 
        Chamber is dedicated to promoting, protecting, and defending 
        America's free enterprise system.

        More than 96 percent of Chamber member companies have fewer 
        than 100 employees, and many of the Nation's largest companies 
        are also active members. We are therefore cognizant not only of 
        the challenges facing smaller businesses, but also those facing 
        the business community at large.

        Besides representing a cross-section of the American business 
        community with respect to the number of employees, major 
        classifications of American business--e.g., manufacturing, 
        retailing, services, construction, wholesalers, and finance--
        are represented. The Chamber has membership in all 50 States.

        The Chamber's international reach is substantial as well. We 
        believe that global interdependence provides opportunities, not 
        threats. In addition to the American Chambers of Commerce 
        abroad, an increasing number of our members engage in the 
        export and import of both goods and services and have ongoing 
        investment activities. The Chamber favors strengthened 
        international competitiveness and opposes artificial U.S. and 
        foreign barriers to international business.
                                 ______
                                 

    Chairman Crapo, Ranking Member Brown, and Members of the Committee 
on Banking, Housing and Urban Affairs: my name is Tom Quaadman, 
Executive Vice President of the Center for Capital Markets 
Competitiveness (``CCMC'') at the U.S. Chamber of Commerce 
(``Chamber''). Thank you for the opportunity to testify today regarding 
the important topic of corporate governance and to discuss the 
Chamber's views regarding a number of legislative proposals.
    The Chamber has long been concerned that the public company 
regulatory model in the United States has failed to keep up with the 
times, as evidenced by the significant drop in the number of public 
companies over the last two decades. The United States is now home to 
roughly half the number of public companies than those that existed in 
the mid-1990s, and the overall number of public listings has little 
changed from 1983.\1\ While there is no single reason behind this 
decline, what is clear is that the overall regulatory burden--coupled 
with a steady rise in special interest activism--has made an initial 
public offering (``IPO'') increasingly unattractive. In short, we need 
new policies that will make it more attractive for businesses to go and 
stay public.
---------------------------------------------------------------------------
    \1\ ``America's Roster of Public Companies is Shrinking Before our 
Eyes.'' Wall Street Journal, January 6, 2017. https://www.wsj.com/
articles/americas-roster-of-public-companies-is-shrinking-before-our-
eyes-1483545879.
---------------------------------------------------------------------------
    The public company model has been a key source of strength and 
growth, which has made the American economy the strongest and most 
prosperous in world history. When businesses go public, jobs are 
created and new centers of wealth are formed. During the 1980s and 
1990s, stories of the Microsoft executive assistant or the UPS driver 
becoming a millionaire were not uncommon after a company went through 
the IPO process. A 2012 study done by the Kaufmann Foundation found 
that for the 2,766 companies that went through the IPO process between 
1996 and 2010, employment cumulatively increased by 2.2 million 
jobs.\2\ Other benefits also accrue to companies when they go public, 
such as revenue growth.
---------------------------------------------------------------------------
    \2\ Post-IPO Employment and Revenue Growth for U.S. IPOs June 1996-
2010, http://innovation.ucdavis.edu/people/publications/kenney-m.-
patton-d.-ritter-j.-2012.-post-ipo-employment-and-revenue-growth.
---------------------------------------------------------------------------
    The public capital markets are also not static and help to support 
innovation. Only about 12 percent of the Fortune 500 companies in 1955 
were still on the list in 2014, while the other 88 percent have either 
gone bankrupt, merged, or fallen out of the Fortune 500.\3\ This system 
of creative destruction has forced businesses to change with the times, 
or be replaced by new entrants with innovative ideas and products to 
meet the needs of consumers and an ever changing market place.
---------------------------------------------------------------------------
    \3\ Mark Perry, AEIdeas, August 18, 2014.
---------------------------------------------------------------------------
    From 1996-2016, the number of public companies dropped in 19 of 20 
years. The 1 year where there was an increase is attributable to the 
passage of the Jumpstart our Business Startups Act of 2012 (``JOBS 
Act''). Title I of the JOBS Act included provisions known as the IPO 
``on-ramp,'' consisting of scaled disclosure and other requirements for 
emerging growth companies (EGCs). These provisions had an immediate 
effect on the IPO market: in 2013--the first full calendar year after 
the JOBS Act was passed--226 IPOs were listed in the United States (the 
highest number since 2004), followed by 291 in 2014.\4\ Importantly, 
the JOBS Act has demonstrated that the rules that apply to public 
companies can be scaled appropriately without compromising important 
investor protections.
---------------------------------------------------------------------------
    \4\ https://www.sec.gov/info/smallbus/acsec/giovannetti-
presentation-acsec-021517.pdf.
---------------------------------------------------------------------------
    However, the JOBS Act was just a start. In recent years, the 
Chamber has issued a number of reports and recommendations calling upon 
the Securities and Exchange Commission (SEC) and Congress to do more to 
help companies go public. Many of these reports and recommendations 
involve fundamental issues of corporate governance including 
disclosure, proxy voting, and shareholder proposals. The Chamber's 
reports include:

    2013: Best Practices and Core Principles for the 
        Development, Dispensation, and Receipt of Proxy Advice, a 
        report that helped kick-start an important debate over the 
        broken proxy advisory system in the United States;

    2014: Corporate Disclosure Effectiveness: Ensuring a 
        Balanced System that Informs and Protects Investors and 
        Facilitates Capital Formation, a report that included two dozen 
        specific recommendations to modernize the SEC's disclosure 
        regime;

    2017: Essential Information: Modernizing Our Corporate 
        Disclosure System, which emphasized the importance of the 
        longstanding ``materiality'' standard for corporate disclosure;

    2017: Shareholder Proposal Reform: The Need to Protect 
        Investors and Promote the Long-Term Value of Public Companies, 
        which outlined seven recommendations on how to fix the outdated 
        shareholder proposal system under Rule 14a-8 of the Securities 
        Exchange Act.

And most recently, the Chamber--along with seven other organizations--
issued a report entitled Expanding the On-Ramp: Recommendations to Help 
More Companies Go and Stay Public, which included 22 recommendations 
that would expand upon the success of the JOBS Act. While the Chamber 
is pleased that many of our recommendations have been acted upon either 
by Congress or the SEC, there is still much room for progress.
Sarbanes-Oxley, Dodd-Frank, and the ``Federalization'' of Corporate 
        Governance
    Traditionally, corporate governance was structured under the State 
laws where a business is incorporated, as well as the by-laws of the 
corporation. This system allowed directors and shareholders to create 
governance structures that fit the needs of individual businesses and 
its investors.
    From the time of the New Deal up until the passage of the 2002 
Sarbanes-Oxley Act, with some exception in the area of compensation, 
the role of securities laws was a disclosure-based regime intended for 
investors to have the material information needed to make informed 
investment decisions.
    Sarbanes-Oxley started a trend toward ``Federalizing'' corporate 
governance by placing the Federal Government in a more predominant 
role. For example, Sarbanes-Oxley created specific requirements for the 
composition of a company's audit committee as well as its operation. It 
also created a quasi-regulatory body in the Public Company Accounting 
Oversight Board (``PCAOB''), an entity with expansive authority and 
tremendous influence over the manner in which public companies are 
operated.
    This trend was exacerbated by the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (``Dodd-Frank''), which mandated new rules on 
compensation committee independence, pay versus performance, 
compensation disclosures, claw-back policies, incentive compensation 
rules for financial firms, ``say-on-pay'' votes, new disclosure 
regarding the Chairman and CEO structures, conflict minerals 
disclosures, resource extraction disclosures, and mine safety report 
disclosures. Furthermore, the Investor Advisory Committee at the SEC--
created by Dodd-Frank--has produced recommendations that would further 
expand the use of Federal mandates, such as the mandated use of 
universal proxy ballots in contested director elections.
    In a post-Dodd-Frank world, some groups have sought to exploit 
Federal securities laws to advance social or political objectives. 
Bills have been introduced--though not passed--to require human 
trafficking disclosures, political and lobbying spending disclosures, 
and other issues that are best left addressed outside the securities 
laws. Policymakers should take steps to ensure that disclosure 
requirements always meet the test of the Supreme Court-articulated 
materiality standard, otherwise investors risk becoming inundated with 
information that does not inform their voting and investment decisions.
The Challenges of Being Public Today
    The legislative mandates of Sarbanes-Oxley and the Dodd-Frank Act 
have been coupled with the exponential growth of the proxy statement 
and corporate disclosures. Furthermore, the SEC has largely failed or 
been unable to provide oversight over proxy advisory firms, modernize 
corporate disclosures, and update information delivery systems, or 
reform proxy plumbing systems. The SEC has also gradually receded from 
its duty as a gate keeper of shareholder proposals under Rule 14a-8, 
which has allowed agenda-driven items to work their way into board 
rooms and shareholder meetings. This condition has allowed a small 
group of special interests to dominate the shareholder proposal process 
and frustrate the views of a majority of shareholders. Concurrently, 
businesses are facing increasing pressure to disclose and engage 
shareholders on environmental, social, and governance issues, many of 
which investors have deemed immaterial.
    It is little wonder why companies that are deciding to go public 
are increasingly doing so in nontraditional ways. For example, many 
companies have recently decided to go public under a dual-share class 
structure that limits voting rights to only certain investors. While 
such corporate structures have generated criticisms, many of these 
companies have completed successful IPOs with heavy investor interest, 
and some offerings have been oversubscribed. Instead of requiring 
businesses to submit to a myopic view of how a corporation should be 
structured, companies should be free to choose their own structure, and 
investors should be free to choose where they want to place their 
money. If you don't like the corporate structure, don't buy the stock. 
The markets will help determine if the business got it right or not.
    Under the more Federalized system, rather than a company's board 
determining the long-term strategy of success, boards are increasingly 
bogged down with
mandated regulatory compliance issues. Corporations are being forced 
into a ``one size fits all'' model that is more expensive, provides 
less opportunity to grow, and makes it more difficult to run a 
business.
    There have been beneficial developments that have occurred over the 
past several decades. Shareholders are more empowered and 
communications between businesses and investors have increased. 
Businesses are understanding that they must increase board diversity on 
their own rather than have a mandate imposed upon them.
    Nevertheless, the U.S. public company system--which is still the 
global gold standard by far, has been increasingly turning into a net 
negative. As a result, businesses and investors are walking away from 
an ever shrinking public company pie. America's entrepreneurs are just 
as comfortable staying private, or being acquired as they are going 
through the IPO process.
    We appreciate that the Committee has called today's hearing to 
gather thoughts on a number of bills related to corporate governance. 
Our comments on these legislative proposals are included below.
H.R. 4015, the Corporate Governance Reform and Transparency Act
    Effective and transparent corporate governance systems that 
encourage shareholder communication and participation are a key 
ingredient for public companies to grow, and for their investors and 
workers to prosper. Institutional investors may invest in large numbers 
of public companies. Therefore, the due diligence associated with proxy 
voting--learning and understanding the issues around director elections 
or shareholder proposals--is costly, complex, and burdensome. The proxy 
advisory industry emerged to help institutional investors fulfill these 
obligations by researching proxy matters and providing voting 
recommendations to clients.
    The proxy advisory industry has been dominated for some time by 
only two firms: Institutional Shareholder Services (``ISS'') and Glass 
Lewis. These two firms control roughly 97 percent of the proxy advice 
market and by some estimates can ``control'' up to 38 percent of the 
shareholder vote,\5\ because some clients of ISS and Glass Lewis 
automatically follow their recommendations. As a result, ISS and Glass 
Lewis are in many ways the de facto standard setters for corporate 
governance in the United States.
---------------------------------------------------------------------------
    \5\ ISS 24.7 percent Glass Lewis 12.9 percent Source: Ertimur, 
Yonca, Ferri, Fabrizio and Oesch, David Shareholder Votes and Proxy 
Advisors: Estimates from Say-on-Pay (February 25, 2013).
---------------------------------------------------------------------------
    Notwithstanding their influence and market power, both ISS and 
Glass Lewis operate with a startling lack of transparency, rampant 
conflicts of interest, and have been prone to make significant errors 
when developing vote recommendations. The Chamber's 2013 report, Best 
Practices and Core Principles for the Development, Dispensation, and 
Receipt of Proxy Advice, was intended to address many of these 
fundamental flaws of the two firms. The Chamber developed these best 
practices and core principles to improve corporate governance by 
ensuring that proxy advisory firms:

    Are free of conflicts of interest that could influence vote 
        recommendations;

    Ensure that reports are factually correct and establish a 
        fair and reasonable process for correcting errors;

    Produce vote recommendations and policy standards that are 
        supported by data driven procedures and methodologies that tie 
        recommendations to shareholder value;

    Allow for a robust dialogue between proxy advisory firms 
        and stakeholders when developing policy standards and vote 
        recommendations;

    Provide vote recommendations to reflect the individual 
        condition, status, and structure for each company and not 
        employ ``one size fits all'' voting advice; and

    Provide for communication with public companies to prevent 
        factual errors and better understand the facts surrounding the 
        financial condition and governance of a company.

    Following the release of this report, congressional hearings were 
held and the SEC held a roundtable on proxy advisory firms on December 
5, 2013. In June 2014, the SEC's staff issued Staff Legal Bulletin 20 
\6\ which marked the first time that the SEC exerted oversight over 
proxy advisory firms while providing institutional investors with 
valuable guidance on how to use proxy advice.
---------------------------------------------------------------------------
    \6\ https://www.sec.gov/interps/legal/cfslb20.htm.
---------------------------------------------------------------------------
    However, the Chamber has found that many of the longstanding issues 
with these two firms remain. For example, ISS continues to operate a 
consulting division to provide advice to companies as to how they can 
achieve better ISS corporate governance ratings. ISS's ownership of 
both a research division and a consulting arm--accepting fees from both 
the institutional investors who receive their proxy voting advice as 
well as from the public companies that are the subject of their voting 
advice--has been a focal point for criticism that conflicts of interest 
inherent in this business model.
    While Glass Lewis does not operate a consulting division, its 
ownership structure presents a unique conflict of interest. Glass Lewis 
is owned by an activist institutional investor--the Ontario Teachers' 
Pension Plan and the Alberta Investment Management Corporation. The 
Chamber brought to the attention of the SEC examples of where this 
ownership structure has presented conflicts related to Glass Lewis 
voting recommendations.\7\
---------------------------------------------------------------------------
    \7\ See e.g., Letter of May 30, 2012 to SEC Chair Mary Schapiro 
http://www.centerforcapitalmarkets.com/wp-content/uploads/2010/04/2012-
5.30-Glass Lewis-letter-release.pdf.
---------------------------------------------------------------------------
    Additionally, proxy advisory firms have not taken steps to ensure 
that their recommendations are developed based on clear, objective, and 
empirically based analysis. With ISS companies often times may only be 
given a few hours to respond to an ISS recommendation and, for example, 
point out if ISS has made an error in developing the recommendation. 
Even more troubling, Glass Lewis appears to have no clear process or 
procedures for providing companies with ample time to respond to 
recommendations.
    H.R. 4015 would address many of these problems by building upon the 
2014 SEC staff guidance by requiring proxy advisory firms to register 
with the SEC and to become more transparent with the public about their 
methodologies and conflicts of interest.
    Under the legislation, proxy advisory firms would need to develop 
clear procedures and methodologies for the development of voting 
recommendations, which would allow for fair due process in the system. 
Firms would also have to both disclose and manage any conflicts of 
interest they have, including whether they engage in any ancillary 
services (such as a consulting arm) that present a direct conflict to 
their research work.
    Proxy advisors would also have to demonstrate that they have the 
capability and expertise to provide empirically based and objective 
vote recommendations. ISS, for example, currently has only about 1,000 
total employees covering 40,000 shareholder meetings in more than 100 
countries. Glass Lewis has roughly 360 employees issuing approximately 
20,000 research reports annually. Both firms have been prone to making 
flaws in assumptions or outright factual errors in many of their 
recommendations. H.R. 4015 would help promote a system of fact-based 
proxy advice and improve the quality of information that investors 
receive.
    Additionally, H.R. 4015 directs the SEC to withdraw two no-action 
letters issued in 2004 to Egan-Jones and ISS. As a practical matter, 
these no-action letters had the effect of allowing a registered 
investment advisor to rely on a proxy advisory firm's general policies 
and procedures regarding conflicts of interest--as opposed to any 
specific conflict that a proxy advisory firm may have in relation to a 
voting recommendation. The Egan-Jones and ISS no-action letters have 
therefore helped to further entrench the position of proxy advisory 
firms, while doing little to mitigate actual conflicts of interest as 
they relate to particular proxy recommendations.
    H.R. 4015 is a logical next step in the wake of the 2014 SEC staff 
guidance. The Chamber strongly supports this legislation and urges the 
Committee to advance a companion Senate bill as swiftly as possible.
S. 536, the Cybersecurity Disclosure Act.
    There is no question that cybersecurity has become a critical issue 
for both businesses and Government. Illicit activity on the part of 
cybercriminals and other threat actors represents a grave danger to the 
economy and capital markets. While we are generally supportive of 
efforts to enhance cybersecurity, we believe that the Cybersecurity 
Disclosure Act misses the mark.
    Regulators have worked aggressively to deal with cyber threats. The 
SEC has become very aggressive in its regulatory efforts, and we 
generally support these activities intentioned to keep our capital 
markets safe. The SEC's Division of Enforcement recently formed a 
dedicated Cyber Unit, and has been actively pursuing cases involving 
cybersecurity and data security. Even before the formation of the Cyber 
Unit, the SEC began to bring a series of cases against broker-dealers, 
investment advisers, and other market intermediaries for violations of 
SEC rules regarding safeguarding of customer data involving hacks and 
other cybersecurity shortcomings.\8\ To its credit, FINRA (the 
Financial Industry Regulatory Authority), which also regulates the 
conduct of securities broker-dealers, has likewise been highly engaged 
on the issue.\9\
---------------------------------------------------------------------------
    \8\ A lengthy list of SEC cybersecurity enforcement cases appears 
at https://www.sec.gov/spotlight/cybersecurity-enforcement-actions.
    \9\ See FINRA's web page describing these efforts at http://
www.finra.org/industry/cybersecurity.
---------------------------------------------------------------------------
    The SEC also recently issued Commission-level guidance (the 
``Guidance'') that clearly lays out the disclosure expectations for 
public companies on this important topic.\10\ Central to the Guidance 
is the concept that material cybersecurity risks must be disclosed to 
investors. The Guidance also encourages public companies to adopt 
comprehensive policies and procedures related to cybersecurity and to 
assess their compliance regularly, including the sufficiency of their 
disclosure controls and procedures as they relate to cybersecurity 
disclosure. To that end, the SEC urges companies to assess whether they 
have sufficient disclosure controls and procedures in place to ensure 
that relevant information about cybersecurity risks and incidents is 
processed and reported to the appropriate personnel, including up the 
corporate ladder, to enable senior management to make disclosure 
decisions and certifications. Additionally, the Guidance recommends 
that public companies adopt policies and procedures designed to 
prohibit directors, officers, and other corporate insiders from trading 
on the basis of material nonpublic information about cybersecurity 
risks and incidents.
---------------------------------------------------------------------------
    \10\ The complete text of the Commission Statement and Guidance on 
Public Company Cybersecurity Disclosures is available at https://
www.federalregister.gov/documents/2018/02/26/2018-03858/commission-
statement-and-guidance-on-public-company-cybersecurity-disclosures.
---------------------------------------------------------------------------
    Of particular relevance to today's hearing, existing SEC 
regulations already require a public company to disclose the extent of 
its board's role in the risk oversight of the company.\11\ To the 
extent cybersecurity risks are material to a company's business, the 
Guidance makes clear that this disclosure should include the nature of 
the board's role in overseeing the management of that risk. 
Additionally, the Guidance reiterates the SEC's view that disclosures 
regarding a company's cybersecurity risk management program and how the 
board of directors engages with management on cybersecurity issues will 
allow investors to assess how a board of directors is discharging its 
risk oversight responsibility.
---------------------------------------------------------------------------
    \11\ For example, see Item 407(h) of Regulation S-K and Item 7 of 
Schedule 14A.
---------------------------------------------------------------------------
    Investors have also begun to express concerns to public company 
boards and management over cybersecurity risks and disclosures. 
According to Pricewater-
houseCooper's most recent Global Investor Survey,\12\ cyber threats 
were the most common concern of investors when asked to rank potential 
business, economic, policy, social, and environmental threats to a 
company's growth prospects. Not surprisingly, cybersecurity 
preparedness has become a common topic of discussion among public 
companies and their investors during shareholder engagement sessions.
---------------------------------------------------------------------------
    \12\ https://www.pwc.com/gx/en/ceo-survey/2018/deep-dives/pwc-
global-investor-survey-2018.pdf.
---------------------------------------------------------------------------
    We believe existing SEC regulations and market practices already 
provide the kinds of disclosure that the Cybersecurity Disclosure Act 
seeks to address. We believe that policymakers must focus on 
strengthening public-private cooperation to proactively protect against 
cyberattacks as opposed to taking a ``blame the victim'' approach.
    Moreover, companies are sometimes subjected to competing directives 
from different Government agencies regarding cyberattacks. For example, 
a company may be advised by a law enforcement or national security body 
to not disclose an ongoing cyber breach so that the source of the 
attack may be discovered. Such guidance could find itself in conflict 
with a company's obligation to inform its investors that it has been 
hacked. Agencies should coordinate with one another to ensure that a 
company complying with one agency's directive does not find itself out 
of compliance with another agency.
    Companies take cybersecurity very seriously and are generally 
proactive in taking steps to mitigate or respond to threats. 
Effectively requiring companies to have a board member with cyber 
expertise will not make companies any more or less responsive to cyber 
threats.
S. 1744, the Brokaw Act
    We do not believe it is wise for Congress to consider S. 1744 at 
this point.
    In its current form, the Brokaw Act would direct the SEC to amend 
the Section 13(d) reporting rules in a number of notable ways. First, 
the Brokaw Act would reduce the 10-day filing deadline for an initial 
Schedule 13D filing to four business days. Second, it would require the 
disclosure of short positions over 5 percent on Schedule 13D. Third, it 
would expand the definition of beneficial ownership to include a direct 
or indirect pecuniary interest, in addition to voting or dispositive 
power. As a practical matter, in making this determination, investors 
would therefore have to include shares held in swaps and other cash-
settled derivatives, not merely equity securities or securities 
convertible into equity securities. Finally, the Brokaw Act would 
specifically require the disclosure of activity by hedge funds and 
groups of hedge funds under Section 13(d). The explicit inclusion of 
``hedge fund'' in the definition of ``persons'' is a clear signal that 
the SEC is directed to pay close attention to activist investors and to 
concerted activity among them.
    There remains a vigorous debate among market participants about the 
propriety of the Brokaw Act. On one side of the issue, its supporters 
contend that the Act would bring an additional layer of transparency to 
capital markets, particularly as it concerns public disclosure of short 
positions.
    On the other hand, we have heard from many institutional investors 
that the Brokaw Act's accelerated Schedule 13D reporting requirements 
and new short position disclosures would have a chilling effect on 
proprietary investment strategies.
    Many investors contend that they would change their market behavior 
as a result, which over the longer term could impede liquidity and 
price discovery.
    The Chamber has long called on the SEC to address abusive practices 
related to short sales, including our call to put an end to ``naked 
short selling.'' We also have very serious concerns regarding ``short-
and-distort'' schemes, which involve spreading false or misleading 
information about a company in order to drive its stock price down and 
return a profit for the short seller. However, we are sympathetic to 
concerns that adoption of a broad short sale disclosure regime could 
hamper a legitimate market activity that increases liquidity and price 
discovery.
    Even if the SEC were to determine that a new short-sale disclosure 
regime is in the public interest, the Chamber has doubts as to whether 
modeling such a regime on Schedule 13D reporting would prove optimal. 
The current legislation makes no distinction between a short seller who 
has taken a net short position in a company because they believe the 
stock will decline in value, and a short seller who may short the 
company as a hedge against an existing long position. Making such a 
distinction would require Congress or the SEC to determine the 
motivation and investment strategy of market participants--a difficult, 
if not impossible, task that speaks to the complexities of adopting a 
short sale disclosure regime.
    We support continued study of issues related to short selling, and 
urge the SEC to take the lead in assessing whether future modifications 
to its rules on these issues are necessary or prudent.
S.__, the 8-K Trading Gap Act of 2018
    The Chamber believes it is important to root out bad actors from 
capital markets. However, we do not believe the 8-K Trading Gap Act 
will prevent future insider trading activity.
    First, it is already unlawful to trade on the basis of material, 
nonpublic information (MNPI) in violation of a fiduciary duty. 
Corporate insiders may not trade or make tips on the basis of MNPI 
learned during the course of employment. A bad actor who has determined 
to violate the Federal securities laws by engaging in conduct as 
serious as insider trading is not likely to be deterred by a second, 
redundant prohibition against the same misconduct that is found in an 
employer's internal policies, procedures, and controls.
    Second, the Act assumes that all Form 8-K events are certain on Day 
1 of what is often a four-business-day reporting cycle, but decisions 
may take several days and consultations with counsel. In many cases, a 
public company will not determine to file until closer to the reporting 
deadline of Day 4.
    If this timing problem raises several questions and the company is 
unsure of the reporting status on Days 1, 2, and 3, how is it going to 
develop policies and procedures to bar insiders from trading? And how 
would insiders even know they are blacked out if their employer has not 
provided notice to them? What if the company unintentionally misses a 
filing deadline and the company makes a late filing months later? What 
are the consequences then? How do policies, procedures, and controls 
address these kinds of hypotheticals in any realistic, enforceable way?
S. 2756, the Fair Investment Opportunities for Professional Experts Act
    The Chamber supports the Fair Investment Opportunities for 
Professional Experts Act, which is an innovative way to expand 
accredited investor definitions in a limited manner to bring more 
sophisticated investors into the marketplace.
    It is appropriate to put in place requirements and tests that 
correctly define persons who have the sophistication to invest in 
complex vehicles and have the ability to withstand loss. Asset and 
income tests are objective standards that have served well in 
determining who should be allowed the designation of accredited 
investors.
    Still, one may not meet these objective tests but could still fit 
the criteria of a sophisticated investor. Such a person, in limited 
circumstances, could be considered an accredited investor. If that 
issue is addressed appropriately, more investors can access markets and 
the potential for capital formation for businesses can be expanded.
    However, other factors should be allowed to be considered.
    Presumably an individual who has met the educational and licensing 
requirements to sell securities and investments could be deemed to be 
of such a level of sophistication that they should be considered to be 
an accredited investor. This is also an objective test that could be 
easily codified. Accordingly, we support the Act's provisions that 
would lead to this result.
    We also support the idea that SEC should, through notice and 
comment rulemaking, consider other ways to expand the accredited 
investor definition.
S. 2499, Compensation for Cheated Investors Act
    Arbitration is an important means for customers to resolve 
disputes, and it provides significant benefits to consumers, investors, 
and businesses. Arbitration forums can provide investors or other 
injured parties with accessible and fair procedures for obtaining 
redress for claims that cannot be vindicated in court. Current FINRA 
rules do not mandate that arbitration be the sole forum for investors 
to resolve disputes with brokerages, however FINRA does require that 
arbitration be used if it has been requested by an investor.
    According to FINRA statistics, in 2016, 2,457 arbitration cases 
involved customer disputes, but only 16 percent of these cases resulted 
in the customer being awarded compensation. Seventy-one percent settled 
prior to the award, while another 9 percent were withdrawn.\13\ This 
distribution of arbitration outcomes has remained fairly consistent 
over the years, and a relatively low number of cases each year end up 
as unpaid customer arbitration awards. For example, there were 44 such 
cases in 2016.\14\ Furthermore, 13 of the 44 unpaid arbitration award 
cases in 2016 involved a pre-award settlement between the customer and 
a brokerage firm.\15\ Other cases of unpaid arbitration awards may 
include situations involving brokerage firms that are inactive or no 
longer active or registered with FINRA, meaning that FINRA no longer 
has jurisdiction over the firm.
---------------------------------------------------------------------------
    \13\ Discussion Paper--FINRA Perspectives on Customer Recovery 
available at http://www.finra.org/sites/default/files/
finra_perspectives_on_customer_recovery.pdf.
    \14\ Id. at 6.
    \15\ Id. at 9.
---------------------------------------------------------------------------
    FINRA's Customer Code states that unless a brokerage firm has a 
bona fide reason for nonpayment of an arbitration award, the firm must 
pay the award within 30 days. Firms that do not pay within 30 days risk 
being penalized or suspended by FINRA. The Chamber fully supports such 
regulatory mechanisms that ensure customers or investors receive the 
full amount of arbitration awards granted to them.
    However, we are concerned that S. 2499, the Compensation for 
Cheated Investors Act would do more harm than good for investors. The 
legislation creates an open-ended ``FINRA Relief Fund'' that is to be 
funded in part by ``sources determined by FINRA.'' The Relief Fund 
would ostensibly be created in order to compensate customers that have 
not received arbitration awards they are entitled to.
    The legislation could effectively allow FINRA to assess firms that 
have done nothing wrong in order to pay out arbitration awards that 
have been awarded due to the activities of bad actors. It would also 
establish what amounts to an insurance fund that has no actuarial basis 
whatsoever for the amounts that should be assessed on FINRA members in 
order to properly fund it, which will likely lead to the fund becoming 
insolvent in the future.
    More troubling, the legislation would empower bad actors by 
ensuring them there is a backstop in place--paid for by somebody else--
to compensate investors they have cheated. S. 2499 also does not 
contemplate or take into account the existing Securities Investor 
Protection Corporation (SIPC) regime that was created to compensate 
investors in the event of a broker liquidation. We believe that these 
issues make S. 2499 inherently flawed, and would urge the Committee to 
reject the legislation.
S. 2953, the Expanding Access to Capital for Rural Job Creators Act
    The Chamber supports this legislation, which would expand the focus 
of the Office of the Advocate for Small Business Capital Formation at 
the SEC to include ways to increase capital access for rural-area small 
businesses.
    A 2016 report from the Economic Innovation group found that half of 
all post-recession business creation in the United States occurred 
across only 20 counties, and that many rural areas missed out on 
economic growth following the financial
crisis.\16\ S. 2953 is an incremental but important step that will help 
focus the SEC on the needs of businesses in rural communities.
---------------------------------------------------------------------------
    \16\ https://eig.org/wp-content/uploads/2016/05/
recoverygrowthreport.pdf.
---------------------------------------------------------------------------
Conclusion
    The Chamber appreciates the opportunity to provide perspective on 
these important issues on behalf of our member companies, and we 
commend the Senate Banking Committee for holding this important 
hearing. I would be happy to answer any questions you may have.
                                 ______
                                 
                 PREPARED STATEMENT OF DARLA C. STUCKEY
          President and CEO, Society for Corporate Governance
                             June 28, 2018
    Chairman Crapo, Ranking Member Brown, and Members of the Committee, 
my name is Darla Stuckey, and I am the President and CEO of the Society 
for Corporate Governance. The Society appreciates the opportunity to 
present its views on corporate governance legislation before the 
Committee.
    Founded in 1946, the Society is a professional membership 
association of more than 3,600 corporate secretaries, in-house counsel, 
and other governance professionals and service providers to the 
industry who serve approximately 1,200 entities, including about 1,000 
public companies of almost every size and industry across the United 
States.
    Society members are responsible for supporting the work of 
corporate boards of directors, their committees, and the executive 
managements of their companies on corporate governance and disclosure. 
Our members generally are responsible for their companies' compliance 
with the securities laws and regulations, corporate law, and stock 
exchange listing requirements.
The Decline of Public Company Ownership
    A fundamental mission of the Society is to advocate for legislative 
and regulatory changes that will relieve some of the burdens that 
discourage companies from becoming and remaining public companies. 
There are a wide range of forces that discourage investors and the 
companies they own from going and remaining public. In 1997, there were 
approximately 7,100 public companies in the United States. Now there 
are fewer than 3,600.
    The decline in public ownership should concern every American. 
Growing wealth inequality has many drivers, but fewer public companies 
means fewer investment opportunities for average American investors. 
This is particularly troubling when one considers that a significant 
amount of wealth is generated by a company shortly after that company 
goes public. Think of the opportunities that ordinary American savers 
have missed out in just the last few years. In fact, companies are 
staying private longer. In a study published on August 8, 2017, by Jay 
R. Ritter, Cordell Professor of Finance at the University of Florida, a 
company's median age for an IPO in 1999-2000 was 5 years, while from 
2001-2016 it was 11 years.\1\ In 2016, 74 companies became public at a 
median age of 10 years.\2\
---------------------------------------------------------------------------
    \1\ Jay R. Ritter, ``Initial Public Offerings: Updated 
Statistics,'' University of Florida, at 11, August 8, 2017, available 
at https://site.warrington.ufl.edu/ritter/files/2017/08/IPOs2016
Statistics.pdf.
    \2\ Id. This was the lowest number of IPOs since 2009.
---------------------------------------------------------------------------
    As I said, there are a range of factors discouraging public 
ownership of companies. But the Committee has before it two bills that 
can directly and concretely improve the climate for public ownership, 
H.R. 4015, the Corporate Governance Reform and Transparency Act; and S. 
1744, the Brokaw Act. I will discuss each individually.
H.R. 4015, ``Corporate Governance Reform and Transparency Act''
    H.R. 4015, which has passed the U.S. House of Representatives, 
addresses the role and activities of the private firms providing proxy 
advisory services to institutional investors. These entities--called 
proxy advisory firms--operate with very little regulation or oversight. 
H.R. 4015 would provide badly needed improvements to the accuracy and 
processes of these firms.
Background on Proxy Advisory Firms
    The proxy advisory market is dominated by two firms--Institutional 
Shareholder Services, or ISS, and Glass Lewis. For the uninitiated, 
proxy advisory firms play an important role in the capital markets by 
advising investors how they should vote their proxies. This involves 
preparing recommendations to institutional investors who hold shares in 
companies--sometimes very large amounts--whether they should (or should 
not) vote for a particular director, approve the CEO's compensation, 
and/or how the investor should vote on shareholder proposals. These 
shareholder proposals can range from an amendment to a company's by-
laws to a new climate change policy.
    While simply recommending how an investor should vote may sound 
somewhat unimportant, the reality is far different. ISS and Glass Lewis 
recommendations are the single most influential pronouncement on the 
composition of a public company's board, its executive compensation 
policies, and an increasingly diverse range of shareholder proposals. 
In fact, anecdotal evidence from some of our member companies 
consistently shows that as much as 30 percent of the total shareholder 
votes are cast within 24 hours of the ISS and Glass Lewis 
recommendations being released to their clients.
    In our view, proxy advisory firms exert outsized influence in the 
proxy voting process. These firms own and control the software 
platforms that send investor votes to the tabulator for a shareholder 
meeting, so they can be counted. The combination of generating proxy 
voting recommendations and controlling the physical infrastructure 
through which the votes are cast (sometimes with voting decisions made 
by the institutional investors and sometimes by default if no client 
voting decisions are made) are what give proxy advisory firms their 
importance and give rise to the imperative that these firms ``get it 
right.''
Accuracy and Accountability Problems with Proxy Advisory Firms
    Proxy advisory firms make proxy recommendations on literally every 
public company in the United States and thousands of public companies 
in Europe and Asia. This is a large and labor-intensive task. The scale 
and complexity of making proxy voting recommendations for thousands and 
thousands of companies during ``proxy season'' effectively requires 
proxy advisors to do all their analysis from February to June. With 
almost all of the recommendations coming out in a 6-8 week period.
    Reading and accurately digesting thousands of proxy statements, 
annual reports, and--increasingly--corporate social responsibility 
statements in a condensed period makes errors inevitable. Compounding 
this problem is the fact that many companies are not able to see the 
proxy advisors' reports about themselves until after each report has 
been issued. For any company not in the S&P 500, the only way it can 
see the report is to subscribe to the proxy advisor's service.\3\
---------------------------------------------------------------------------
    \3\ ISS permits companies in the S&P 500 to have 24-48 hours to 
review their reports before they are issued, with no subscription 
required. Smaller companies must pay to receive them. Glass Lewis uses 
a factual database that companies can access, but does not provide 
draft reports to any company of any size for review before issuance.
---------------------------------------------------------------------------
    It is true that ISS and Glass Lewis will send the underlying data 
for their reports to some companies for their review. But the analysis 
and final recommendations are not known, and errors occur during this 
process. S&P 500 companies are given their reports in advance by ISS, 
but companies only have 1 or 2 days (frequently over a weekend) to 
review before the recommendations are released publicly. There is often 
not enough time for companies to review what is arguably the most 
important corporate governance recommendation about that company each 
year.
One Small Cap Company's Multi-Year Battle with Factual Errors
    An inability to review draft reports from proxy advisory firms 
means that companies who want factual errors corrected are often unable 
to get a response from proxy advisory firms until it is too late, i.e., 
after investors have voted on the basis of a recommendation relying on 
inaccurate information.
    A very real example of this problem comes from a Society member 
that works for a small-cap company in the transportation industry. The 
company's story highlights a multitude of problems that the provisions 
of H.R. 4015 would fix:

        In May 2016, we received an ISS report with an `against' 
        recommendation regarding say-on-pay that was based on a 
        material factual error. The ISS personnel incorrectly concluded 
        that under our annual bonus plan, we set the financial metric 
        goal for the 2015 fiscal year lower than the actual
        results we had obtained in 2014. This was simply untrue--this 
        was not a matter of methodology or interpretation, but a clear 
        mathematical mistake.

        As a small-cap company, unlike larger companies, we are not 
        given a `preview' of our report from ISS, so we received this 
        report just 2 weeks prior to our May 2016 annual meeting. We 
        quickly utilized all of the methods available to us to try to 
        get the error corrected and the recommendation
        reversed. Although ISS acknowledged the error, they declined to 
        issue either a correction or a revised report.

        We engaged in robust shareholder outreach as we have for many 
        years, and while the shareholders who were able to speak with 
        us quickly understood the mistake and supported our say-on-pay 
        [proposal], we were not able to have meetings with all the 
        shareholders we reached out to due to the extremely busy proxy 
        `in-season' and a large portion of our shareholders being 
        quantitative or passive firms who outsource their voting to 
        proxy advisory firms. The result was that our 2016 say-on-pay 
        [proposal] narrowly failed with a 49.8 percent favorable vote 
        outcome.

        We engaged in extensive `offseason' shareholder outreach during 
        the fall of 2016, reaching out to shareholders representing 
        over 75 percent of our outstanding shares, and, while 
        shareholders offered small governance-related suggestions such 
        as proxy access, none expressed any wish to see specific 
        changes in our executive pay program; some instructed us to 
        `fix' our ISS recommendation and then they would be sure to 
        vote in support. We promptly added proxy access, and disclosed 
        our outreach efforts and feedback in our April 2017 proxy 
        statement fully and accurately.

        In May 2017, ISS issued their report, again recommending 
        against our say-on-pay, alleging that due to our prior year's 
        low vote outcome, our shareholders must have demanded extensive 
        pay program changes that our compensation committee ignored. 
        This was simply factually untrue.

        Due to ISS' programmatic rules, a second consecutive year meant 
        ISS not only recommended against say-on-pay but against the re-
        election of our four-member compensation committee, including a 
        new committee member who was not even on the board at the time 
        compensation decisions were being made. This meant that four 
        members of our 10-member board who had been key drivers of an 
        extraordinary 2016 business year that saw a transformative 
        transaction with a global e-commerce company and a 26 percent 
        shareholder return were at risk of nonre-election due to proxy 
        advisory errors and formulaic inflexibility. Moreover, the 
        board members being recommended against included at the time 
        the sole female member of our board and one of our two racially 
        diverse board members.

        Thanks to above-and-beyond shareholder outreach efforts we were 
        able to get the compensation committee members re-elected but 
        received only 32 percent in favor of our say-on-pay vote in May 
        2017.

        Through a combination of extensive pro-active compensation 
        program changes and at-length engagement with ISS and Glass 
        Lewis in the fall of 2017, this May we received `for' 
        recommendations from both firms in reports which were 
        fortunately finally absent material factual errors (ISS' report 
        still has an error regarding our perquisite program which we 
        are attempting to fix). This recommendation resulted in a 94 
        percent favorable say-on-pay vote this year, demonstrating the 
        outsize influence of proxy advisory firms and the crucial need 
        for regulation that ensures shareholders who rely on proxy 
        firms' recommendations are relying on accurate data. (emphasis 
        added).
Other Problems with Proxy Advisory Firm Practices
    In addition to the problems discussed above, proxy advisory firms 
use a ``one-size-fits-all'' approach that imposes the same standards on 
all public companies, instead of evaluating the specific facts and 
circumstances of each company they evaluate. This has the effect of 
homogenizing corporate governance practices for the benefit of the 
proxy advisory firms themselves and not for other stakeholders in the 
proxy process. In fact, one proxy advisory firm, ISS, told a large-cap 
Society member its proxy access bylaw that was the subject of a 
shareholder proposal did not comport with ``best practices'' and that 
it would recommend against management, even though over 90 percent of 
such bylaws have the same provisions as the one on the ballot. When 
pressed about how ISS could not identify this bylaw amendment as a best 
practice, the ISS corporate sales team member said that ``for ISS best 
practice is the preferred practice by ISS.'' In short, ISS sets the 
standard.
    Proxy advisory firms also operate without providing adequate 
transparency into their internal standards, procedures, and 
methodologies. These firms are basically ``black boxes,'' operating 
with little accountability or input into their internal processes.
    Conflicts of interest within these firms also need to be addressed. 
One of the firms--ISS--provides corporate governance and executive 
compensation consulting services to public companies, in addition to 
providing voting recommendations to its institutional clients on the 
same companies. A common practice is for a company to get a call from 
the ISS corporate consulting sales force with a pitch that--for a 
price--they can miraculously fix any problems that company has had with 
a previous vote. Indeed, for an even higher price, a company can get 
even more service, including language explaining elements of an annual 
bonus plan in a company's Compensation Discussion and Analysis section. 
And, even more recently, ISS now has an environmental scorecard it 
pitches to companies showing negative results, and, when asked what 
forms the basis of the score, companies are told they can learn about 
it if they pay $35,000 to ISS.
    Another conflict that exists is proxy advisory firms providing 
voting recommendations on shareholder proposals submitted to companies 
by their institutional investor clients. These conflicts need to be 
specifically and prominently disclosed to
clients of proxy advisory firms so that they may evaluate this 
information in the context of the firms' voting recommendations. Not 
only do the firms recommend on their own clients' proposals, one of the 
firms, ISS, has a service for investors to help them craft proposals 
that will pass muster under SEC rules.
The Fiduciary Responsibilities of Institutional Investors
    One of the reasons that proxy advisory firms have become so 
powerful is the belief that every vote is an asset and that asset 
managers must vote every item on a ballot in order to satisfy their 
fiduciary duty to their clients, and their clients' beneficiaries. SEC 
and Department of Labor rules and guidance confirm that a proxy vote is 
an asset and that institutional investors owe fiduciary duties to their 
clients, investors, and beneficiaries with respect to the voting 
process.
    While some have interpreted these rules and guidance to mean they 
must vote each and every item on a proxy card, this is not the case. 
Rather, institutions should weigh the cost of voting certain items 
against the benefits of voting on those items. Clearly, not every item 
on a ballot must be voted if the manager in his or her judgment 
believes it costs more to understand and vote on an item that the vote 
is worth.
    Practically speaking, however, no investment manager will say to 
his or her clients that they didn't exercise their right to vote. So 
they hire proxy advisory firms at the lowest cost possible and then 
report that they voted each of their positions (although not the number 
of shares)--even if they have little interest or expertise in executive 
compensation or environmental issues, for example. This would be the 
case typically with smaller passive investors, or quantitative fund 
managers, or those who simply own one stock as a hedge against another 
position.
    Again, the outsize influence of proxy advisory firms is due to the 
many institutional investors and their third-party managers who choose 
to reduce costs by not having in-house proxy staffs to analyze and vote 
at shareholder meetings.
    This is not the group of asset managers that public companies 
typically engage with and it is not the group of asset managers and 
owners who lobby and advocate against legislative proposals like H.R. 
4015. That group--consisting of large asset managers like BlackRock, 
Vanguard, T. Rowe Price, State Street Global Advisors, TIAA-CREF, BNY 
Mellon, Capital Group, and other household names--manage their voting 
process by using proxy advisory firms as one of many data points, 
typically as a screen or filter, and they conduct a deeper analysis on 
particular companies that fall outside parameters that they have set. 
These firms also have ``custom guidelines'' that they instruct the 
proxy advisory firms to use when voting their shares. In addition, 
these institutions engage with companies directly and make their own 
voting policies transparent and available to issuers.
    However, there are smaller institutional investors and managers 
that do typically ``outsource'' their voting decisions to proxy 
advisory firms that provide automated voting services. This is a way to 
fulfill what they believe to be their compliance obligations with 
respect to proxy voting at the lowest cost. Together, these small 
managers add up.
    A number of these small managers adopt ISS and Glass Lewis 
``default'' voting guidelines and policies and then let the proxy firms 
apply these policies by generating electronic ballots that reflect 
these default positions for each shareholder meeting. As a technical 
matter, the client has the right to override a particular ISS or Glass 
Lewis voting recommendation. However, most of these ballots are left
untouched and submitted automatically without any client input or 
decision. This ``robo-voting'' process results in as much as 20 percent 
of votes that are cast automatically within 24-48 hours of the issuance 
of ISS and Glass Lewis reports on a company in advance of a shareholder 
meeting.
    In all these cases, the result is an outsourcing of voting 
responsibilities to a nonfiduciary.
SEC Actions to Address Proxy Advisory Firm Issues
    The SEC has taken a few steps to address the role and activities of 
proxy advisory firms. The agency evaluated the proxy system in 2009 and 
issued a wide-ranging Concept Release in 2010. In December 2013, the 
SEC held a Roundtable on Proxy Advisory Services to discuss many of 
these issues. The Society testified at that Roundtable.
    The SEC followed up its Roundtable by issuing Staff Legal Bulletin 
20 in June 2014, which provided guidance to institutional investors 
about their obligations under the Investment Advisers Act and 
established several standards for proxy advisory firms to adhere to, 
under the Securities Exchange Act of 1934. Institutions can and do use 
proxy advisory firms, so long as they insure the voting is done in 
accordance with their own fiduciary duties.
    While these were excellent first steps in addressing these 
problems, more needs to be done.
The Need for Legislation to Establish a Regulatory Framework Applicable 
        to Proxy Advisory Firms
    Proxy advisory firms exist because of well-intentioned regulatory 
action that nevertheless has resulted in many different unintended 
consequences. One consequence is that the proxy advisory industry is 
subject to an incomplete and harmful regulatory framework. As an 
example, the largest proxy firm, ISS has chosen to register under the 
Investment Advisers Act of 1940. However, the SEC's rules for 
investment advisors do not reflect the unique role that proxy advisory 
firms perform in the proxy voting process. Proxy advisory firms do not 
select securities for their clients or provide investment advice in the 
way a typical asset manager does. Instead, these firms recommend how to 
vote at shareholder meetings and, as described above, automate the 
voting process for their clients.
    The second biggest proxy advisory firm, Glass Lewis, is not 
registered as an investment advisor (or under any other securities 
statute). As a nonregistered entity, Glass Lewis is not subject to the 
provisions of the Investment Advisers Act, or any other SEC regulation.
    Additionally, the SEC has created an exemption from its proxy rules 
for proxy advisory firms, so they are not required to abide by 
solicitation and disclosure rules that apply to other proxy 
participants. Thus, their recommendation reports, in contrast to 
company proxy materials, are not always available to issuers unless 
they pay for them, and they are not subject to any outside review or 
oversight, even after annual meetings.
    This unworkable regulatory system should not be permitted to 
continue, and these firms should be subject to more robust oversight by 
the SEC and the institutional investors that rely on them. This can be 
accomplished by developing a targeted regulatory framework that 
reflects the unique role that proxy advisory firms perform in the proxy 
voting process.
    Along with considering greater regulatory oversight of proxy 
advisory firms, the SEC and Department of Labor should review the 
existing framework applicable to the use of proxy advisory firms by 
institutional investors. This review should include the Egan Jones and 
ISS no-action letters that were issued by the SEC staff in 2004.\4\ The 
SEC and Department of Labor should ensure that institutional investors 
are exercising sufficient oversight over their use of proxy advisory 
services, in a manner consistent with their fiduciary duties.
---------------------------------------------------------------------------
    \4\ See Egan Jones Proxy Services, May 27, 2004; and Institutional 
Shareholder Services, Inc., September 15, 2004.
---------------------------------------------------------------------------
    H.R. 4015 addresses many of the concerns raised by public companies 
and other participants in the U.S. proxy system. It requires the proxy 
advisory firms to register with the SEC. It requires these firms to be 
more transparent about their internal standards, procedures, and 
methodologies. It provides companies with a mechanism to review draft 
reports before they are issued. It also provides companies with a 
process to correct mistakes. And, finally, the bill authorizes the SEC 
to regulate and/or prohibit the conflicts of interest that exist in 
proxy advisory firms.
    For these reasons, the Society strongly supports H.R. 4015 and 
urges its passage through the Committee on Banking, Housing, and Urban 
Affairs.
    We do understand that several institutional investors and the proxy 
advisory firms themselves have opposed H.R. 4015 because of concerns 
about the increased costs that the requirements of the bill may impose 
on these firms and their institutional clients. The Society understands 
the need that institutional investors and their proxy voters have for 
summaries and analyses of proxy materials, particularly those who hold 
every U.S. equity and are required to vote thousands of meetings each 
year. The Society is mindful of these concerns and is more than willing 
to work with the Committee to improve the legislation in a manner that 
accomplishes its goals, while also reducing its compliance costs.
H.R. 1744, ``Brokaw Act''
    Another disincentive to public ownership of companies is the burden 
of being subject to attacks by activist investors, a number of whom 
have short-term agendas.
    There is no doubt that some activists create longer-term 
shareholder value and the Society is not seeking to stifle activist 
investing. The Society does not believe, however, that there is a level 
playing field between activists and companies. Companies are required 
by securities laws to publicly disclose material information within 4 
days. Activist investors, on the other hand, have 10 days to file a 
Schedule 13D, disclosing the material fact that they have acquired 5 
percent of a particular company's stock.
    This 10-day window has been the subject of criticism for allowing 
too much time for activist investors to accumulate large positions in 
public companies--sometimes through undisclosed derivative positions--
before being required to disclose anything publicly. As an example, 
former SEC Chair Mary Schapiro noted in 2011 that many feel that the 
10-day reporting deadline ``[r]esults in secret accumulation of 
securities; [r]esults in material information being reported to the 
marketplace in an untimely fashion; and [a]llows 13D filers to trade 
ahead of market-moving information and maximize profit, perhaps at the 
expense of uninformed security holders and derivative 
counterparties.''\5\
---------------------------------------------------------------------------
    \5\ Chairman Mary L. Schapiro, ``Remarks at the Transatlantic 
Corporate Governance Dialogue, U.S. Securities and Exchange Commission, 
December 15, 2011, available at https://www.sec.gov/news/speech/2011/
spch121511mls.htm.
---------------------------------------------------------------------------
    S. 1744 would equalize these reporting timeframes and make other 
necessary modernizations.
    The SEC has not updated its 13D disclosure requirements in several 
decades and, in fact, this year is the 50th anniversary of the 
enactment of the Williams Act, which established this regulatory 
framework. S. 1744 would update these SEC requirements by closing 
certain loopholes and ensuring that securities positions taken by 
activist investors are more transparent to companies and to the capital 
markets.
    The Brokaw Act--named for a village in Wisconsin that went bankrupt 
in part due to the actions of a group of hedge funds that pressured the 
Wausau Paper Company in 2011--would make three changes to the SEC's 
13(d) disclosure rules. First, it would direct the SEC to shorten the 
deadline for disclosing an ownership interest from 10 days to 4 days, 
which is the current deadline for companies filing an 8-K report. The 
original 10-day deadline was developed when snail mail was the primary 
form of written communication, and this deadline has been eclipsed by 
the rise of electronic communication and the rapid speed in which 
securities are currently traded.
    Some have argued that the 10 days was a careful balance drawn at 
the time to give investors an advantage over potentially entrenched 
management. A lot has changed on that front in 50 years and the 
argument that the legislative history of the Williams Act requires the 
10 days for activists to have an advantage is longer relevant. 
Shareholder rights and shareholder engagement have come of age. In 
fact, so much so that we see a decrease in the number of private 
companies willing to take advantage of the public markets, and we see 
those who do go public institute stock classes to alleviate the burdens 
of activism and other shareholder empowerment mechanisms.
    Second, the bill would require disclosure of any short or 
derivative positions that cross the 5 percent threshold, something that 
does not occur today. This closes a significant loophole that otherwise 
permits investors to accumulate large short and/or derivative positions 
in a security without any public disclosure.
    And third, the bill would expand the 13(d) reporting requirement to 
include hedge funds and other activist investors that are coordinating 
activities for the purpose of seeking control or influence over a 
public company.
    The Society has been working with the original sponsor of the 
Brokaw Act, Senator Tammy Baldwin of Wisconsin. This Act is now co-
sponsored by Senator Perdue of Georgia and it represents good public 
policy for both public companies and their investors. We urge the 
Committee to pass this legislation to update and modernize the 13(d) 
disclosure regime.
    Let me now turn to two bills before the Committee that could 
further discourage companies from going or remaining public, and that 
the Society opposes in their current form, S. 536, the Cybersecurity 
Disclosure Act, and the 8-K Trading Gap Act.
S. 536, ``Cybersecurity Disclosure Act''
    S. 536 requires public companies to disclose if they have a board 
member with expertise or experience in cybersecurity and to describe in 
detail the nature of that expertise or experience. If there isn't a 
cybersecurity expert on a board, a company will have to disclose ``what 
other cybersecurity steps taken by the reporting company were taken 
into account by such persons responsible for identifying and evaluating 
nominees'' for such board positions.
    The Society generally believes that having special interest 
directors is not a good practice. First, there are not enough cyber 
``experts'' around to serve on every board. Even if there were, it is 
unlikely they would agree to serve as an expert because a board member 
is only an overseer and not in control of all corporate affairs. He or 
she can only determine if management has organized and spent the 
resources to protect the company from cyber breaches given the type of 
data it has, the costs required to be expended, and the likelihood of 
success.
    In addition, this bill is not necessary because director 
qualifications in the proxy already describe a person's experience and 
background. Anyone reading a proxy would be able to tell if a board has 
someone with cyber expertise as a member. A bill like this could lead 
to requirements that boards appoint other special interest directors.
    This bill also creates a false presumption that a cyber expert 
director is required to effect appropriate board oversight. Concerns 
expressed by a Society member about encouraging a single-issue director 
are illustrative:

        Of course, we want our public companies' boards to have the 
        requisite skills to deal with all sorts of issues. However, 
        specifying the types of skills that a company's board must have 
        strikes me as the ultimate one-size-fits-all approach and has 
        no logical limits.

        Should every public company have an expert on revenue 
        recognition? Related-party transactions? Has anyone thought 
        through the consequences of having a board comprised of one-
        issue experts who may not have any other applicable skill sets? 
        And would a cyber-expert want to be on a board, given that he 
        or she would likely be blamed (and possibly sued) if the 
        company had a breach or other cyber problem?\6\
---------------------------------------------------------------------------
    \6\ Robert B. Lamm, ``Beware when the legislature is in session,'' 
The Securities Edge, March 19, 2017, available at https://
www.thesecuritiesedge.com/2017/03/beware-when-the-legislature-is-in-
session/.

Further, in its 2016 guidance for investors to assess the adequacy of 
their portfolio company boards' cybersecurity oversight, even the 
Council of Institutional Investors doesn't subscribe to the view that 
---------------------------------------------------------------------------
all boards need a resident cyber expert:

        Cybersecurity is an integral component of a board's role in 
        risk oversight. Directors have the authority, capacity and 
        responsibility to make pivotal contributions in this area by 
        ensuring adequate resources and management expertise are 
        allocated to robust cyber risk management policies and 
        practices, and ensuring disclosure fairly and accurately 
        portrays material cyber risks and incidents.

        To achieve these objectives, directors need not develop 
        advanced technical expertise. Nor do directors need to support 
        unrestrained capital spending on any project with a `cyber' 
        prefix.\7\ (emphasis added)
---------------------------------------------------------------------------
    \7\ Council of Institutional Investors, ``Prioritizing 
Cybersecurity,'' at 1, April 2016, available at https://www.cii.org/
files/publications/misc/4-27-16%20Prioritizing%20Cybersecurity.pdf.
---------------------------------------------------------------------------
S.__, ``8-K Trading Gap Act''
    The 8-K Trading Gap Act requires the SEC to issue new rules 
prohibiting insider trading during a ``covered period.'' The term 
``covered period'' is defined as the period between: (1) the date when 
material nonpublic information is known to officers and directors of a 
company; and (2) the date when the information is disclosed to the 
public through an 8-K or other SEC filing.
    The Society believes this bill is unnecessary and could lead to 
unintended consequences. It is already illegal to trade on material 
nonpublic information, and
recent SEC guidance has confirmed existing law for circumstances 
involving cybersecurity. In addition, public companies uniformly have 
insider trading policies that require pre-clearance and strictly 
regulate trading in a company's securities by
employees, including executive officers and directors of a company. 
These are conservative risk management policies that apply broadly, and 
they typically have two levels of protection: (1) a trading window that 
is closed (a.k.a. ``blackout period'') when the company is in 
possession of material nonpublic information; and (2) a pre-clearance 
procedure for more senior executives whereby no trading is allowed 
unless cleared by the senior legal officer of the company.
    In order to determine whether the company has material nonpublic 
information, companies have internal processes for information to be 
communicated up the chain of command so that appropriate decisions can 
be made. This reporting up the chain is a common practice in public 
companies and it runs through several internal mechanisms within 
companies, including preparation of SEC reports, financial statements, 
etc.
    A practical difficulty with this bill is how best to make the 
judgment call about whether a particular piece of cybersecurity 
information (or a situation) involves material nonpublic information, 
especially in an evolving situation where a company is trying to 
determine the difference between an intrusion and a breach.
    First, a company must determine if the information is nonpublic. 
This sounds easier than it is, as the information must be analyzed in 
light of the company's current public disclosures (e.g., its risk 
factors and MD&A).
    Second, a judgment must be made as to whether the information is 
material. This is typically the most difficult judgment to be made; in 
these situations, an expected value analysis needs to be conducted, 
i.e., would the event be material if it occurred and what is the 
likelihood that the event will occur? This analysis is made more 
difficult when, as in the case of a cyber-attack, it is often not clear 
for some time what the event itself is. It could be a meaningless 
intrusion, or a significant one.
    For example, is the event when an issuer's computer system detects 
an intrusion; is it when the first employee learns about the 
intrusions; is it when the company makes a determination that the 
intrusion could be material; or is it when the company makes a 
determination that the intrusion is actually material?
    These difficult judgment calls also apply to other evolving 
circumstances, such as an internal investigation, a negotiation over 
the continued employment of a senior executive, or a merger and 
acquisition transaction.
    Trying to fix the problem of trading when there is the potential 
for material nonpublic information within a company would be fixing the 
problem by killing an ant with a bazooka. Companies are in a difficult 
position here as there is always potential material nonpublic 
information inside a company. In the case of cyber intrusions, a 
company would have to keep the trading window closed permanently. The 
net effect could be, at worst, that insiders could never sell their 
stock, or, at best, they would be severely limited in doing so. This 
would be a strong disincentive for those making a decision to take a 
company public, or to remain public. Moreover, because many companies 
compensate their employees with some form of equity, to align their 
interests with those of all shareholders, a reduction in the ability 
for employees to sell their company equity would be problematic and 
could lead to a de-equitization of America's workforce.
    For all these reasons, the Society believes that current laws and 
conservative risk management policies by companies are adequately 
preventing executive insider trading between the time that material 
nonpublic information is determined and the time when a public filing 
is made.
Conclusion
    Thank you for the opportunity to present the views of the Society 
on these important legislative proposals affecting corporate 
governance. I am happy to answer any questions you may have about these 
proposals.
                                 ______
                                 
                PREPARED STATEMENT OF JOHN C. COATES IV
 John F. Cogan, Jr. Professor of Law and Economics, Harvard Law School
                             June 28, 2018
    Chairman Crapo, Ranking Member Brown, and Members of the Committee, 
I thank you for inviting me to testify. Effective corporate governance 
is a crucial foundation for economic growth, and by providing 
accountability and legitimacy to large-scale businesses, it is a core 
part of America's success story. I am honored to have been asked to 
participate. The Committee asked for comment on the role that law plays 
in corporate and shareholder disclosures and governance, and how they 
could be improved. After answering those questions, I comment on five 
of the seven bills that are the focus of today's hearing, although I am 
happy to take questions about any of the bills.
Background and Credentials
    By way of background, prior to joining Harvard, I was a partner 
practicing securities and corporate law at one of the Nation's most 
prestigious law firms, Wachtell Lipton Rosen & Katz. I drafted proxy 
statements, annual reports, and prospectuses, worked with SEC staff, 
managed shareholder meetings, and advised on most of the governance 
topics before the Committee. As an advisor, I had to assist boards 
respond to shareholder pressures in the absence of good information. In 
short, I have lived the experience of coping with disclosure 
obligations, as well as their absence.
    At Harvard, I teach, research and write about corporate law and 
governance in both the law school and the business school, as well as 
in executive education sessions with directors, CEOs, and general 
counsels. I co-authored a foundational ``core reading'' on corporate 
governance designed for all MBAs.\1\ I am on the SEC's Investor 
Advisory Committee, and I am also serving as a monitor for the DOJ and 
a compliance consultant to the SEC.
---------------------------------------------------------------------------
    \1\ John C. Coates and Suraj Srinivasan, Corporate Governance, Core 
Reading, Harvard Business Publishing (2018 forthcoming).
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General Remarks on Corporate Governance
    Law--and the subset of law known as regulation--has always played 
an important role in corporate governance, and it continues to do so. 
Corporations are creatures of law; without an act of Government, no 
corporation would exist. Initially, corporate charters included 
Government-imposed terms that some would now label regulation, 
including terms about who is authorized to act for a company, how 
disputes among corporate officials are to be resolved, and the relative 
powers of investors, boards, officers, and other agents, including 
rights of access to information. The features of limited liability, 
legal personality (including the right to sue), and indefinite lifespan 
represent, in essence, economic subsidies--they facilitate capital 
formation and economic activity that would not occur without corporate 
law.
    Today, reflecting a traditional embrace of separation of powers, 
those terms are set out in an array of locations. They include:

    Federal statutes such as

      the Foreign Corrupt Practices Act,

      the Williams Act, and

      the Investment Company Act of 1940,

    SEC, DOL, and IRS regulations,

    State corporate statutes,

    court decisions interpreting purposefully vague standards 
        of conduct,

    stock exchange listing standards (which function as 
        regulation),

    corporate charters and bylaws,

    corporate governance principles and codes of ethics (which, 
        once adopted, function like regulation in many respects),

    academic treatises (relied up on by courts on occasion), 
        and

    increasingly, codes of best practices, stewardship codes, 
        voting policies and governance positions taken by large index 
        funds, other mutual funds, pension funds and proxy advisors 
        (which reflect and reinforce governance norms).

As this list suggests, law pervades corporate governance.

    Most of these laws allow ample room for variation and 
experimentation. The United States has never imposed ``one size fits 
all'' regulation in corporate governance. The most contentious part of 
the Sarbanes-Oxley Act (section 404), for example, permits companies to 
comply or disclose.\2\ Companies are not required to do what audit 
firms think is necessary for an effective control system, if companies 
are prepared to disclose the disagreement and live with the market 
consequences, which a substantial number of companies choose to do. 
Still, the law provides the basic framework within which governance is 
negotiated.
---------------------------------------------------------------------------
    \2\ John C. Coates, The Goals and Promise of the Sarbanes-Oxley 
Act, 21 J. Econ. Persp. 91 (Winter 2007); John C. Coates and Suraj 
Srinivasan, SOX After Ten Years: A Multidisciplinary Review, 28:3 
Accounting Horizons 627 (2014).
---------------------------------------------------------------------------
    The core part of that framework--although not the only one--
consists of disclosure obligations. Disclosure has many virtues. 
Disclosure enhances legitimacy. It assures the public generally that 
State-created and State-subsidized corporations such as Apple, AT&T, 
and Facebook, with their enormous power and resources, are also working 
in the public interest. Disclosure is necessary for accountability. It 
allows investors and enforcement officials to hold corporate agents 
responsible for theft, fraud, or violations of other laws. Disclosure 
provides a basis for lawmakers to evaluate whether current laws are 
doing what they are intended to do. These lawmakers include Congress, 
the SEC, and ultimately, in a democracy, the public. Is existing law, 
for example, minimizing the production of ``externalities''--harms on 
third parties not in a position to protect themselves? Disclosure 
provides a foundation for improving law over time.
    As an economic matter, disclosure enhances the best allocation of 
resources for sustained growth. Basic theorems of economics that 
undergird our Nation's preference for free trade commonly assume among 
other things those trading are on the same informational playing field 
(no ``asymmetric information''). Disclosure helps move toward that 
ideal. While voluntary disclosure is common and valuable, well-designed 
disclosure laws also add value. They create standards, ensure 
comparability across companies, add enforcement tools, and greatly 
improve the credibility and reliability of the disclosures.
    Disclosure laws are also among the least intrusive and costly forms 
of regulation. They are not a panacea. They have costs, although those 
costs are often overestimated. Generally, those costs fall--often 
dramatically--over time.\3\ But disclosure is a mild and often clearly 
socially efficient means to address specific problems. This is 
especially true when disclosure is compared to mandatory conduct rules, 
structural laws such as activity bans (even if coupled with 
exemptions), State ownership, or political governance. The public has a 
tendency to demand legal change in response to crises, market crashes 
or corporate scandals. Those responses can be prescriptive, especially 
if the behavior involved took place in the dark. Disclosure reduces 
paranoia, and moderates reactions.
---------------------------------------------------------------------------
    \3\ See Coates and Srinivasan, supra note 2; see also John C. 
Coates, Toward Better Cost-Benefit Analysis: An Essay on Regulatory 
Management, 78 Law and Contemporary Problems 1 (2015); John C. Coates, 
Cost-Benefit Analysis of Financial Regulation: Case Studies and 
Implications, 124 Yale Law Journal 882 (2014-2015).
---------------------------------------------------------------------------
    Even if information disclosed is not readily understood by the 
public, or even by most investors, the role of sunlight in deterring 
misconduct is too well known to elaborate. Disclosures can be processed 
by analysts, who can then provide summaries and recommendations to 
others. For example, as I have written about with Glenn Hubbard--who 
served as Chairman for President George W. Bush's Council of Economic 
Advisors and who currently Co-Chairs the Committee on Capital Markets 
Regulation--the Investment Company Act is one of the most successful 
disclosure laws of all time.\4\ It requires disclosure of much 
information that few investors ever learn about directly. But the 
disclosures are consumed, analyzed and simplified by financial advisors 
and intermediaries such as Morningstar. The United States has the most 
successful fund industry in the world, thanks in significant part to 
mandatory disclosure laws.
---------------------------------------------------------------------------
    \4\ John C. Coates and R. Glenn Hubbard, Competition in the Mutual 
Fund Industry: Evidence and Implications for Policy, 33 J. Corp. L. 151 
(2008); see also John C. Coates, Reforming the Taxation and Regulation 
of Mutual Funds: A Comparative Legal and Economic Analysis, 1 J. Legal 
Anal. 591 (Summer 2009).
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Five Specific Bills
    I turn now to five of the bills before the Committee.
Cybersecurity Disclosure Act (S. 536)
    I support the Cybersecurity Disclosure Act (S. 536). On the basic 
issue of cyber-risk, I will not detail here what I expect the Committee 
already knows: cyber-attacks are more frequent and consequential each 
year; they are producing more and more harms to the public and 
investors; and, as SEC Chair Jay Clayton testified, they are not well 
understood by American investors.\5\
---------------------------------------------------------------------------
    \5\ John McCrank, SEC Chief Says Cyber-Crime Risks are Substantial, 
Systemic, Reuters, September 5, 2017, http://www.reuters.com/article/
us-sec-enforcement/sec-chief-says-cyber-crime-risks-are-substantial-
systemic-idUSKCN1BH094.
---------------------------------------------------------------------------
    What I will emphasize is that cyber-risk is, among the many kinds 
of risks that companies face, nearly unique. Cyber-risk is intense, 
ever-changing and growing. But unlike other kinds of risks, cyber-risk 
is general to all companies. Only basic financial risks affect more 
companies. In fact, while there are some sectors (retail, financial 
services, and telecom) where cyber-risk is most acute, it is hard to 
identify any major public companies that are not faced with significant 
cyber-risks. This is why cyber-risk warrants special public policy 
attention, and why a modest disclosure law aimed at cyber-risk is not a 
slippery slope to overly burdensome disclosures about all kinds of 
risks.
    S. 536 is well designed. It does not attempt to second-guess SEC 
guidance and rules regarding disclosures generally, or even as to 
cyber-risk overall. The bill
simply asks publicly traded companies to disclose whether a 
cybersecurity expert is on the board of directors, and if not, why one 
is not necessary. To be clear, the bill does not require every publicly 
traded company to have a cybersecurity expert on its board. Publicly 
traded companies will still decide for themselves how to tailor their 
resources to their cybersecurity needs and disclose what they have 
decided. Some companies may choose to hire outside cyber consultants. 
Some may choose to boost cybersecurity expertise on staff. And some may 
decide to have a cybersecurity expert on the board of directors.
    The disclosure required would typically amount to a sentence or 
two. The disclosure would be contained in a particular type of 
document--annual proxy statements--that are among the documents that I 
know from experience are regularly and carefully read by boards of 
directors. Proxy statements are how directors are re-elected each year. 
They describe the directors themselves, what committees they are on, 
and how they function as a board. Being human, directors tend to read 
things about themselves more carefully than other disclosures. Given 
this, the bill would gently remind boards to take direct responsibility 
for cybersecurity, by focusing them on board-level resources regarding 
cyber-risk, and through that reminder, on cyber-resources more 
generally.
    In short, no board would have to change its composition in 
response, and it preserves flexibility for companies to respond to 
cyber threats in a tailored and cost-effective way. It would not 
require disclosure of sensitive or proprietary information, and so 
would not increase the risk of cyber-attacks. It would be extremely low 
cost--the board is already required under SEC rules and guidance to 
disclose its role in risk oversight, including oversight of material 
cyber-risks. The bill would simply flip the switch on whether the topic 
needs to be explicitly addressed in proxy statements, so boards could 
not fail to engage the issue, as, unfortunately, many still do, despite 
SEC guidance and numerous high-profile examples of cyber-attacks.
8-K Trading Gap Act
    I also favor the 8-K Trading Gap Act, with one suggested 
modification. Current rules permit insiders to game disclosure rules 
and reap unwarranted windfalls by trading in company stock in the 
window between the moment a material ``current event'' requiring 
disclosure occurs, and the moment that the disclosure is actually made. 
Such trading may already violate SEC Rule 10b-5. But enforcement of 
Rule 10b-5--an intentionally broad anti-fraud standard--is restrained 
by available SEC resources and the magnitude of expected recoveries in 
private litigation. The proposed bill would enact a bright-line ban on 
such trading. It would have relatively modest effects on nonfraudulent 
trading, as the trading could occur after a company makes required 
disclosure, the timing of which is within the company's control. It 
also exempts trades under pre-committed 10b-5-1 trading plans, further 
allowing insiders to achieve liquidity and diversification on a fair 
basis that does not disadvantage other investors.
    The one suggestion I would make is to lengthen the ``covered 
period'' as defined in the bill by one trading day. Information takes 
some time to be reflected in market prices. Forms 8-K can be filed late 
in a day. The market and public investors generally should have one 
full trading day to digest the information in a Form 8-K before having 
to worry that insiders are on the other side of the trade. While I 
would still favor the bill without this modification, this modest 
change would more effectively accomplish its purposes, without imposing 
unnecessary costs on insiders or companies.
Proxy Advisor Regulation Act (H.R. 4015)
    The third bill on which I offer comment is formally titled the 
``Corporate Governance Reform and Transparency Act of 2017,'' but in 
the spirit of fair disclosure, it should be renamed the ``Proxy Advisor 
Regulation Act,'' because that is in fact what it is--a bill to 
regulate proxy advisors--and its current title provides no useful 
information as to its contents. Proxy advisors are indeed the sole 
target of the bill. In general, as a background fact, no one is 
required by law or regulation to consult a proxy advisor. To my 
knowledge, there are no regulatory or legal barriers to entry for new 
entrants to compete with the existing advisors. Of course, there is the 
usual requirement in a market economy that someone offer better 
services at a lower cost.
    As a result, on the substance of the bill, I find myself puzzled. 
The bill states that its goals are to ``to improve the quality of proxy 
advisory firms,'' and to ``foster accountability, transparency, 
responsiveness, and competition in the proxy advisory firm industry.'' 
Those are worthy goals.
    The puzzle is why these goals are important as a target of 
regulation in the proxy advisory industry, and how the bill is meant to 
accomplish those goals. I am unaware of a clamor from investors for 
regulation of proxy advisors. Usually evidence of market failure is a 
pre-requisite for regulation--here, that would presumably consist of 
evidence of the inability of investor-clients of advisory firms to 
obtain information by directly asking for it. Alternatively, disclosure 
laws may be needed for comparability or enforcement purposes. There are 
so few proxy advisors, and their recommendations are under such 
constant scrutiny, that it seems unclear at best how those goals would 
be advanced by new regulations enforced by the SEC.
    It is also a puzzle how its provisions could possibly pass a cost/
benefit test to accomplish those goals, even if one thought the bill 
could accomplish those goals. Some parts of the bill--e.g., the 
requirement to have an ombudsman and a compliance officer--seem worthy 
in the abstract, but have the distinct characteristic of ``one size 
fits all.'' That is usually not a phrase of praise in the corporate 
governance arena.\6\ Would a new entrant in the proxy advisory services 
market need a full time ombudsman or compliance officer? If not, then 
that requirement would deter rather than enhance competition.
---------------------------------------------------------------------------
    \6\ Cf. Society for Corporate Governance, Inc., Statement on 
Corporate Governance (``the Society is skeptical of one-size-fits-all 
governance prescriptions'').
---------------------------------------------------------------------------
    A ban on modifying recommendations based on whether companies buy 
other services from the advisor also seems like a worthy specific goal. 
Is it best addressed in a Federal statute? The conduct so prohibited on 
its face sounds like garden-variety fraud or deceptive sales practices, 
something the States are long used to regulating in a variety of areas. 
Are the pension funds and other clients of proxy advisors not capable 
of enlisting State attorneys general or other enforcement allies if 
they suspect systematic deception of that kind? They seem able to 
protect their own interests from fraud or quasi-fraud with existing 
laws in other areas of their business.
    And the final puzzle is why its sponsors and supporters believe 
that a Federal statute and mandatory regulation would do more to 
accomplish these goals as applied to proxy advisory firms than they 
would as applied to public company boards of directors, who routinely 
face conflicts of interest, or index fund advisors, who routinely make 
voting decisions on behalf of others without publishing their 
methodologies.
    To be clear, I am open minded about what well-designed regulation 
can accomplish. Indeed, as outlined above, well-designed disclosure 
laws can achieve a great deal, including accountability, transparency, 
responsiveness, and (in some contexts) competition. But this bill is 
not limited to disclosure, and it is not clear that the disclosures it 
requires are well-suited to its goals, or are the least costly means of 
accomplishing the same objectives. Substantially more evidence should 
be in hand before mandating new regulations of this kind. I am unaware 
of any reliable economic evidence that would suggest that the net 
benefits of the bill would exceed its costs, which would be 
substantial.
    Take, for example, the requirement that a proxy advisory firm be 
required to register with the SEC for simply providing proxy advice. 
Registration requirements are not to be mandated lightly. They impose 
more burdens on new entrants than on incumbents. They therefore also 
risk reducing competition, not increasing it.
    One element of the registration form that the SEC would not have 
authority to drop under the bill is a requirement that the proxy firm 
disclose ``the procedures and methodologies that the applicant uses in 
developing proxy voting recommendations,'' and the SEC would be 
required to make that information publicly available. Since procedures 
and methodologies are essentially trade secrets, the bill would destroy 
existing or new proxy firms' ability to protect their intellectual 
property. New competitors will have no way to recover investments in 
research and development of better procedures or methods. How would 
such a requirement make the industry more competitive?
    I would not want to reject out of hand the idea that some 
regulation of proxy advisors might be warranted--particularly 
concerning conflicts of interests. I could imagine that some light 
touch disclosure rules, informational barrier requirements, or back-up 
enforcement might help alleviate concerns that the concentrated market 
for proxy advice was susceptive of abuse through that channel. If the 
SEC believes it lacks resources or authority to hold hearings and 
ultimately develop such a regulatory approach, there might be a clear 
need for Federal legislation. Absent that, I would recommend--in the 
language of academic publishing--a ``revise and resubmit'' decision on 
this bill.
Fair Investment Opportunities for Professional Experts Act (S. 2756)
    This bill does three things. First, it substantially removes 
discretion from the SEC to alter the definition of ``accredited 
investor'' based on net worth and income, by moving the current 
definition into a statute and out of a rule. Second, it inflation-
adjusts the current definition. Third, it directs the SEC to consider 
education, job, or professional experience (among other things) in 
potentially expanding the definition.
    On the overall topic of how to define ``accredited investor'' and 
why it matters, I commend to this Committee the advice of the SEC's 
Investor Advisory Committee.\7\ That advice was developed before I 
joined that Committee, but it is good advice, it was carefully 
considered, and it is advice that I endorse. I also commend to this 
Committee the research conducted by the SEC's Division of Economic and 
Risk Analysis, which lays out many consequences of different policy 
choices available here.\8\ I note, finally, that the SEC is required to 
review the definition of accredited investor every 4 years under the 
Dodd-Frank Act.\9\
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    \7\ See https://www.sec.gov/spotlight/investor-advisory-committee-
2012/investment-advisor-accredited-definition.pdf.
    \8\ See https://www.sec.gov/corpfin/reportspubs/special-studies/
review-definition-of-accredited-investor-12-18-2015.pdf.
    \9\ Dodd-Frank Act, section 413(b)(2).
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    Based on that information, I conclude that the second and third 
effects are good ideas. The first is not. The current net worth and 
income thresholds have been eroded by inflation for 30 years. They are, 
as a result, too low.\10\ To lock them into the statute now would 
durably expose a large number of financially vulnerable Americans to 
the heightened fraud risk that unregistered offerings create.
---------------------------------------------------------------------------
    \10\ John Coates and Robert Pozen, Bill to Help Businesses Raise 
Capital Goes Too Far, Wash. Post (Mar. 12, 2012).
---------------------------------------------------------------------------
    While inflation-adjusting the thresholds is a good idea, doing so 
would be a good idea to do so in a statute only if the current levels 
were a reasonable proxy for financial resilience, literacy, and 
sophistication. It is a good idea to add the financially educated and 
financial professionals to the pool of potential private-placement 
investors. Net worth and income have always been imperfect proxies for 
sophistication. It is also a good idea to delegate to the SEC, as the 
bill does, the precise way in which education and experience should 
play into a broadened definition. Some consideration should be given to 
ways that the definition could assure that even educated or experienced 
investors have financial resources to absorb losses that routinely 
accompany investment.
Expanding Access to Capital for Rural Job Creators Act (S. 2953)
    I favor having the SEC receive advice about the interests of small 
businesses based in rural areas. In an era of increasing distrust and 
distance between rural and urban parts of this country, fostering more 
communication and understanding across an array of policy areas is 
increasingly important. Small businesses in rural areas are less likely 
to be able to raise capital in conventional ways than other businesses. 
Although rural area population is declining, relative to cities and 
suburbs, rural areas remain home to 60 million Americans, and a greater 
share of rural workers have jobs in small businesses than other areas.
                                 ______
                                 
                 PREPARED STATEMENT OF DAMON A. SILVERS
            Director of Policy and Special Counsel, AFL-CIO
                             June 28, 2018
    Good morning, Chairman Crapo, Ranking Member Brown, and Members of 
the Committee. My name is Damon Silvers, and I am the Policy Director 
and Special Counsel for the AFL-CIO, America's labor federation 
representing 55 national and international labor unions and more than 
12 million working people.
    The AFL-CIO has since its founding seen ensuring the retirement 
security of working people as a central mission of the labor movement--
both through our advocacy for Social Security and Medicare and through 
collective bargaining with employers. Today collectively bargained 
retirement plans account for more than $7 trillion of invested capital 
in this country. While the ownership of stocks and bonds remains 
predominantly in the hands of the wealthiest Americans, working people 
are major investors through our benefit funds, and our retirement 
security is bound up with the health of the financial system. Our 
members are major investors and their retirement security is bound up 
with the health of the financial system. For these reasons the labor 
movement has been actively engaged for decades in promoting effective, 
commonsense regulation of our capital markets.
    Following the financial crisis that began in 2007, it was clear 
that our system of financial regulation had been dangerously weakened 
by laws that exempted large parts of the financial system from 
effective regulation, and in other cases created opportunities for 
regulatory arbitrage. While the Dodd-Frank Act addressed many of these 
weaknesses, at the time of the passage of the Act investor advocates 
recognized there was much left to be done. Among the key issues that 
remained were----

  1)  How to effectively protect investors from the threat of self-
        dealing by the experts they hire to help them manage their 
        money.

  2)  How to ensure a level playing field for all investors in capital 
        markets where information moves instantaneously and where big 
        data means big power and big money.

  3)  How to prevent the reoccurrence of the dynamic that led to the 
        financial crisis of large parts of the financial system 
        becoming unregulated and/or opaque?

Each of the bills under consideration in this hearing fits within these 
three questions. Some of these bills would productively address these 
challenges, others would make these challenges worse for investors.
    The remainder of my testimony will address each of the bills under 
consideration in turn.
H.R. 4015--Corporate Governance Reform and Transparency Act of 2017
    The Corporate Governance Reform and Transparency Act would create a 
special regulatory regime for firms that advise investors on how to 
exercise their voting rights as stockholders. The bill claims to foster 
``accountability, transparency, responsiveness, and competition in the 
proxy advisory firm industry,'' while in reality it will interfere with 
shareholders' access to impartial analysis and undermine shareholders' 
ability to hold corporate management accountable. This bill would 
create conflicts of interest where none now exist, and treat proxy 
advisory firms differently than other asset managers. Having the right 
to vote and exercise other corporate governance rights is at the heart 
of what it means to be a shareholder. Pension funds in particular have 
a legal duty under ERISA, the Internal Revenue Code, and State law to 
obtain expert, independent advice in the management of all their plan 
assets, including voting rights. Pension funds and other institutional 
investors rely on proxy advisory firms to sort through the thousands of 
pages of complex financial reporting that issuers send to shareholders 
every proxy season. Limited time and resources makes the kind of 
intensive analysis performed by proxy advisory firms prohibitively 
difficult and costly for many institutional investors to review the 
massive amounts of information involved in voting proxies for large, 
diversified investors.
    The United States Department of Treasury (Treasury) 2017 report to 
the President on ``A Financial System that Creates Economic 
Opportunities, Capital Markets'' found that ``institutional investors, 
who pay for proxy advice and are responsible for voting decisions, find 
the services valuable, especially in sorting through the lengthy and 
significant disclosures contained in proxy statements.'' After 
extensive review of the industry, Treasury did not recommend any 
legislative changes governing proxy advisory firms.
    Despite these findings, H.R. 4015 effectively gives corporations' 
CEO's and boards the ability to control the people who are supposed to 
be holding them accountable. The bill would do this by enabling 
companies to delay vote recommendations. Corporate executives would 
then be able to object to any proxy voting recommendation that is 
contrary to their own preferences, including votes on their own 
executive compensation packages.
    Institutional investors and associations, including the National 
Association of State Treasurers and the Council of Institutional 
Investors oppose this bill. It would increase costs for investors, 
compromise the quality and reliability of information, and reduce board 
accountability to investors.
    The AFL-CIO does believe that proxy advisors should be regulated 
like other investment advisors, and would not oppose a requirement that 
they register as such. However we strongly oppose H.R. 4015 because 
this bill appears to punish proxy advisors for doing their job and 
seeks to impose upon them a regulatory scheme designed to make them 
disloyal to their clients, among which are our members' pension funds.
S. 2756--Fair Investment Opportunities for Professional Experts Act
    This legislation would codify the current Securities and Exchange 
Commission (SEC) definition of ``accredited investor'' The bill defines 
accredited investors to include individuals or couples with a net worth 
of $1 million excluding their primary residence, individuals with an 
income above $200,000 in each of the last 2 years, or couples with a 
joint income above $300,000 in each of the last 2 years. This 
effectively makes many Main Street retirement savers, particularly in 
high income areas, ``accredited investors''.
    This issue is a critical component of the way our securities laws 
defines public markets versus private markets. We are concerned 
generally that private markets have increasingly been defined in law 
and regulation in ways that make them
essentially the same as public markets in terms of the scale of the 
markets and in terms of who is actually exposed to risk, but without 
the transparency and investor protection systems that have been built 
up in the public markets. S. 2756 would accelerate this trend.
    This is because the definition of ``accredited investor'' is 
crucial in securities laws to determine whether a transaction qualifies 
for the private offering exemption from investor protection 
requirements. The Supreme Court limits this exemption ``to those who 
are shown to be able to fend for themselves.''\1\ In other words, 
accredited investors are those individuals who do not need the 
registration and disclosure protections afforded by the Securities Act 
of 1933, because they would be able to evaluate potentially risky and 
illiquid private offerings without the investor protections provided in 
a public offering.
---------------------------------------------------------------------------
    \1\ See: Securities and Exchange Commission v. Ralston-Purina Co.
---------------------------------------------------------------------------
    The SEC's Investor Advisory Committee (IAC) has found that the 
current accredited investor definition based on financial thresholds is 
inadequate to protect mom and pop investors, and has opposed codifying 
this definition in law, instead advocating for a new rulemaking that 
would improve the definition to permit more sophisticated investors to 
access private offerings while better protecting less sophisticated 
retirees.\2\ The State securities administrators (North American 
Securities Administrators Association, or NASAA) also oppose codifying 
this low net-worth threshold.\3\
---------------------------------------------------------------------------
    \2\ See: Recommendation of the Investor Advisory Committee: 
Accredited Investor Definition (October 9, 2014). Available at http://
bit.ly/22HoUHw.
    \3\ North American Securities Administrators Association, ``Letter 
from NASAA President and Alabama Securities Director Joseph P. Borg to 
the HFSC Chair and Ranking Member regarding markup of H.R. 3758, H.R. 
477, H.R. 3857, H.R. 2201, and H.R. 1585,'' October 11, 2017. Available 
at http://bit.ly/2xK1Lag.
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    The $1 million asset threshold was originally set by rule in 1982 
and has not been updated since then. Even with the inflation 
adjustments the bill requires every 3 years, the definition would make 
Main Street retirement savers ``accredited investors'' simply because 
they have saved for retirement. While we support indexing the net-worth 
threshold, the current baseline is far too low to act as a starting 
point. These individuals are often dependent on their retirement 
savings to survive and cannot easily recoup large investment losses.
    The Fair Investment Opportunities for Professional Experts Act 
codifies a weakness in current investor protections and would require 
average retirees to be able to evaluate the risk of financial 
instruments as well as trained, experienced investment professionals.
    For the above stated reasons, we urge you to oppose this bill.
S. 1744--Brokaw Act
    In 1968, Congress passed the Williams Act to require investors to 
publicly disclose when they accrue a large ownership stake in a public 
company. The purpose of the Act was to end corporate raiders' ability 
to make cash tender offers to shareholders without any need to disclose 
their identities, intentions or report anything to the SEC. The 
Williams Act amended the Securities Exchange Act of 1934 to require 
that investors file public disclosures with the SEC within 10 days of 
acquiring a 5 percent or more stake in a public company. In the 50 
years since the Williams Act was passed, there have been substantial 
changes in trading activities and technology. The Brokaw Act is a 
necessary and timely update to the disclosures required in Section 
13(d) of the Exchange Act that accounts for trading behaviors that have 
emerged in recent decades and market expectations related to the speed 
of information access.
    Currently, there is a 10-day window between when an investor 
crosses the 5 percent ownership threshold of a company and when that 
beneficial ownership position must be disclosed with a 13D filing. 
Since the Williams Act passed in 1968, evolution in information 
technology has created an appropriate expectation among investors that 
they will have access to information much more quickly. SEC disclosure 
forms are now filed electronically, which makes disclosure faster and 
easier for issuers. As a result, we believe the shorter filing window 
proposed in the Brokaw Act for 13D filings is necessary and 
appropriate.
    Empirical evidence shows an abnormally high level of trading inside 
of that 10-day window, which is best explained as the action of traders 
with knowledge of the hedge funds' positions. This trading activity is 
likely to be attributable to groups of sophisticated hedge fund 
investors, known as ``wolf packs,'' that communicate in the period 
between which they begin accumulating their position and the 13D filing 
is made. These groups take positions in the company with the 
expectation that the stock price will jump once the 13D is filed. These 
``wolf packs'' can currently exceed the 5 percent ownership threshold 
collectively without triggering any disclosure requirements at all.
    Finally, activist investors can manipulate the process by secretly 
taking net short positions. In other words, they use their long 
(public) position to boost the stock price in the near term while 
investing far more in a short (nonpublic) position. Thus their net 
position is actually a bet against the company but their public 
position looks favorable. Activist investors often engage in public 
campaigns to influence stock prices. Additional transparency in this 
area would help investors by providing insight into the incentives of 
the hedge funds and the messages they are promoting about a company's 
prospects.
    The Brokaw Act addresses three major gaps in the current legal 
framework related to the requirements that investors disclose when they 
accrue large ownership positions in a public company. First, it 
shortens the 10-day window between crossing the 5 percent ownership 
threshold and the required 13D filing--the period when trading activity 
spikes--down to 2 days. Second, it reforms the definition of ``groups'' 
under section 13(d) so that so-called wolf packs, groups of short-term 
investors seeking cash payouts, can trigger the collective ownership 
threshold collectively. Finally, the bill extends section 13(d) to 
require disclosure of ``net short'' positions, that is, investors would 
have to disclose their full position, preventing them from profiting 
off a large hidden short position while taking a public long position 
to boost the stock price.
    The reforms proposed in the Brokaw Act are commonsense changes to 
address each of these problems. They adapt the existing securities laws 
to cover current practices and are essential for the strength of our 
markets and capital formation.
S. 2499--Compensation for Cheated Investors Act
    One of the central flaws in our current system of securities 
regulation is the weak and inconsistent nature of the regulation of 
individuals and firms that provide investment advice. As an economic 
matter, broker-dealers, insurance agents, and investment advisors all 
provide investment advice. There should be a single standard of 
fiduciary duty that blocks self-interested behavior by all three types 
of advisors, and this duty should be heightened when retirement assets 
or other ERISA assets are at stake. But in our current system, there 
are significant differences in how these three types of advice 
providers are regulated, and how the regulations are enforced.
    One particularly egregious problem that has resulted from this 
system is that when duties to investors are enforced by regulators, 
defendants are able to avoid paying damage awards, and are able to move 
among the three types of advice provider without consequence. Consumer 
protections mean nothing if regulators are unable to guarantee that 
defrauded consumers are made whole.
    In the case of broker-dealer misconduct, a disturbing number of 
damage awards to investors by regulators and the courts never reach the 
harmed investors. The Financial Industry Regulatory Authority's (FINRA) 
Dispute Resolution Task Force found that in 2013 more than $62 million 
in arbitration awards to consumers went unpaid, with a large number of 
unpaid awards assessed against broker-dealers who had become inactive 
since the complaint was issued.\4\ Between 2012 and 2016 unpaid FINRA 
arbitration awards totaled nearly $200 million.\5\
---------------------------------------------------------------------------
    \4\ FINRA Dispute Resolution Task Force, Final Report and 
Recommendations of the FINRA Dispute Resolution Task Force, 50 (2015), 
available at https://www.finra.org/sites/default/files/Final-DR-task-
force-report.pdf.
    \5\ FINRA, Discussion Paper--FINRA Perspectives on Customer 
Recovery, 7 (Feb. 8, 2018), available at file:///C:/Users/slewis/
Downloads/finra_perspectives_on_customer_recov-
ery.pdf.
---------------------------------------------------------------------------
    The compensation for Cheated Investors Act would make sure 
investors defrauded by brokers are able to collect the full amount of 
the award owed them while increasing accountability and public trust in 
the financial system and broker-dealers.
    This bill would require FINRA to establish a compensation fund for 
defrauded investors who have not been able to collect from brokers even 
after winning arbitration or court judgment. The fund would be 
supported by fines and penalties charged to FINRA-regulated broker-
dealers. Greater transparency for consumers is also incorporated into 
the bill in the form of an annual report to be published by FINRA 
detailing the number and value of arbitrations, awards, and unpaid 
claims. FINRA already collects this data and shares it with other 
regulators. Sharing it with the public will help improve confidence in 
the financial system without significant costs to regulators, broker-
dealers, or investors.
    FINRA has acknowledged the problem of unpaid awards and a recent 
discussion paper from FINRA staff included such an approach in their 
list of potential measures to address unpaid claims.\6\ This bill gives 
FINRA substantial latitude in administering its basic mandate, and we 
believe FINRA should work with the bill's sponsors to ensure that if 
the bill passed that its implementation was maximally effective both 
from the perspective of seeing to it that awards were paid and from the 
perspective of FINRA's effectiveness as a self-regulatory body.
---------------------------------------------------------------------------
    \6\ FINRA, Discussion Paper--FINRA Perspectives on Customer 
Recovery (Feb. 8, 2018), available at https://www.finra.org/sites/
default/files/finra_perspectives_on_customer_recov-
ery.pdf.
---------------------------------------------------------------------------
    Ensuring that awards are actually paid is a basic test of FINRA as 
a self-regulatory body. This bill is the consequence of FINRA failing 
to pass that test. But in reality what S. 2499 really does is give 
FINRA another chance to get it right, while at the same time making 
clear that FINRA cannot continue to ignore the problem. Passing S. 2499 
is in the interests of investors and in the interest of maintaining and 
improving the integrity of our securities laws.
S. 536--Cybersecurity Disclosure Act of 2017
    The need for the board and upper management responsibility for 
corporate cybersecurity is, by now, an accepted part of running a 
business. Data breaches have cost consumers and investors millions in 
recent years.
    This bill directs the SEC to mandate issuer disclosure of whether 
any board members have expertise or experience in cybersecurity and to 
detail that expertise/experience; if no board member has cyber 
expertise, the company must disclose how cybersecurity factors were 
taken into account in selecting board members.
    At a time when cybersecurity compromises can cause significant 
financial and reputational damage to businesses, investors have a 
reasonable expectation that publicly traded companies invest in 
protecting employees' and consumers' data as well as proprietary 
business information and internal communications. But as matters stand 
today investors have no real way to be sure companies are actually 
doing any of these things. This bill requires the SEC to promulgate 
rules that require companies to be transparent about what they are 
doing, and to do so within the context of the securities laws where 
misrepresenting what they are doing would subject officers and 
directors to liability.
    Again, like the issue of FINRA not ensuring awards are paid, this 
is an issue that the Commission should long ago have addressed through 
rulemaking. But in the absence of Commission action around the issue of 
cybersecurity at the board level, S. 536 creates a workable framework 
for ensuring investors are properly informed about the seriousness with 
which their companies are taking these risks.
S. 2953--Expanding Access to Capital for Rural Job Creators Act
    S. 2953 amends the list of entities the SEC Advocate for Small 
Business Capital Formation considers in its duties. The first change 
mandates the Advocate ``identify problems that small businesses have 
with securing access to capital, including any unique challenges to 
minority-owned small businesses, women-owned small businesses, and 
small businesses affected by hurricanes or other natural disasters.'' 
The second change requires the Advocate report annually ``a summary of 
the most serious issues encountered by small businesses and small 
business investors, including any unique issues encountered by 
minority-owned small businesses, women-owned small businesses, and 
small businesses affected by hurricanes or other natural disasters and 
their investors, during the reporting period.''
    These changes are sensible ones in light of the challenges faced by 
minority, women-owned and rural small businesses, and the extraordinary 
challenges faced by small business owners in many parts of this country 
as a result of natural disasters and the growing costs of climate 
change.
    We note however that for this mandate to actually be helpful to 
small business requires that the SEC Advocate effectively distinguish 
between the interests of actual small businesses and the interests of 
large firms, which are increasingly dominant in the U.S. economy and in 
the U.S. capital markets. This is an area that deserves more thoughtful 
and sustained oversight by this Committee.
    With that important reservation we support S. 2953.
8-K Trading Gap Act of 2018 (Van Hollen)
    This bill addresses another problem involving inside information. 
Similar to the gaps in securities laws addressed by the Brokaw Act, 
this bill seeks to expand the language of current legislation to cover 
actions clearly prohibited by the spirit and intent of the legislation.
    In this case, there is a 4-day gap between when an issuer 
determines that it is in possession of material nonpublic information 
and when it must file Form 8-K making that information public. This gap 
provides opportunities for insiders to trade on that information--
evading the clear intent of the law.
    This practice was confirmed by a research report published by a 
group of Harvard and Columbia professors in 2015 that coined the term, 
the ``8-K Trading Gap.'' It looked at a dataset of over 15,000 Form 8-
Ks and tracked insiders' trading transactions within the window before 
the disclosure was filed. Unsurprisingly, it found that insiders could 
almost always anticipate the direction of any price movement following 
an 8-K announcement. Additionally, they found ``systematic abnormal 
returns of 42 basis points on average, per trade, from trades by 
insiders during the 8-K gap.'' And further, if insiders engaged in an 
open-market purchase of their own company's stock, they earned even 
larger abnormal returns of 163 basis points, which is of course far 
higher on an annualized basis.\7\
---------------------------------------------------------------------------
    \7\ Cohen, Alma and Jackson, Robert J. and Mitts, Joshua, The 8-K 
Trading Gap (September 7, 2015). Columbia Law and Economics Working 
Paper No. 524. Available at SSRN: https://ssrn.com/abstract=2657877 or 
http://dx.doi.org/10.2139/ssrn.2657877.
---------------------------------------------------------------------------
    This bill directs the SEC to issue rules to restrict officers and 
directors from profiting by trading on inside information during the 8-
K trading gap. Again, this is a commonsense reform that merely extends 
the current legal framework to cover current abuses.
Conclusion
    The AFL-CIO commends the Committee for holding this hearing that in 
every respect addresses serious issues in capital markets regulation. 
Investors will benefit if loopholes can be closed that encourage self-
dealing and insider trading. Investors will also benefit from 
legislation that encourages regulatory bodies as diverse as FINRA and 
the Office of the Small Business Advocate at the SEC to be more 
effective in doing their jobs. However, we strongly oppose the two 
bills in front of you, H.R. 4015 and S. 2756, that propose to weaken 
investor protections and the ability of our corporate governance system 
to perform its function of encouraging the managements of public 
companies to act in the long-term best interest of the corporations and 
their shareholders that they serve.
    Thank you again for the opportunity to testify today, and I welcome 
your questions.

  RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN FROM THOMAS 
                            QUAADMAN

Q.1.a. Your written testimony discussing the Fair Investment 
Opportunities for Professional Experts Act, S. 2756, states, 
``[a]sset and income tests are objective standards that have 
served well in determining who should be allowed the 
designation of accredited investors.'' The current asset and 
income tests were established in the original adoption of 
Regulation D in 1982, with limited changes since then.
    Without adjustment for the passage of time or the impact of 
inflation, the income and net worth thresholds now capture a 
greater portion of investors than in 1982.
    Please estimate the percentage of investors that would have 
qualified as accredited investors (i) in 1982 and (ii) as of 
the most recent practicable year-end using each of (a) the 
income test (for an individual) and (b) the net worth test. 
Please explain any assumptions made in estimating the number of 
investors or determining time periods, etc.

A.1.a. Section 413(b)(2)(A) of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (the ``Dodd-Frank Act'') 
directs the SEC to review the accredited investor definition as 
it relates to natural persons every 4 years. The SEC determines 
whether it should modify or adjust the definition for the 
protection of investors, in the public interest and in light of 
the economy. Section 413(b)(2)(A) specifies that this review 
shall be conducted no earlier than 4 years after enactment of 
the Dodd-Frank Act and every 4 years after that. The SEC staff 
issued the first report under Section 413 on December 18, 2015, 
entitled Report on the Review of the Definition of ``Accredited 
Investor'' (the ``Report'').\1\
---------------------------------------------------------------------------
    \1\ https://www.sec.gov/files/review-definition-of-accredited-
investor-12-18-2015.pdf. While the Chamber does not necessarily agree 
with all the policy recommendations contained in the Report, it 
provides a wealth of qualitative and quantitative analysis concerning 
the accredited investor definition.
---------------------------------------------------------------------------
    Section X of the Report considers how revising the 
standards for qualifying as an accredited investor would alter 
the size and composition of the pool of accredited investors 
that are natural persons. The Federal Reserve Board's (``FRB'') 
Survey of Consumer Finances (the ``SCF'') for 1983 and 2013 
provided the underlying household data for this analysis. FRB 
conducts the SCF every 3 years, and it provides insights into 
household income and net worth.\2\ According to the Report the 
population in 1983 included approximately 83.9 million 
households and in 2013 included approximately 122.5 million 
households.
---------------------------------------------------------------------------
    \2\ https://www.federalreserve.gov/econres/scfindex.htm. The 2016 
SCF is the most recent survey conducted; the Report relies on 2013 
data.
---------------------------------------------------------------------------
    In 1983, an estimated 440,000 U.S. households (0.5 percent 
of all households) met the $200,000 individual income 
threshold. In 2013, 8.07 million U.S. households (6.6 percent 
of all households) met the $200,000 individual income 
threshold.
    Similarly, the SEC staff estimated in 1983 that 1.42 
million U.S. households (1.7 percent of all households) met the 
$1,000,000 net worth threshold. In 2013, 9.22 million U.S. 
households (7.5 percent of all households) met the $1,000,000 
net worth threshold.
    As the Report notes, Section 413(a) of the Dodd-Frank Act 
excluded the value of a person's primary residence from the 
$1,000,000 net worth calculation and directed the SEC to adjust 
similarly any accredited investor net worth standard in its 
rules. In 2011, the SEC revised Rules 215 and 501 to exclude 
any positive equity individuals have in their primary 
residences. The SCF statistics described in the preceding two 
paragraphs do not give effect to this change in methodology for 
determining net worth. Because some investors reached the 
$1,000,000 threshold only by including the value of their 
primary residence, the impact of the rule change was to reduce 
the total pool of eligible investors who relied on the net 
worth test.

Q.1.b. In addition, please provide inflation-adjusted estimates 
of the $200,000 annual income test and $1,000,000 net worth 
test, beginning from 1982 to year-end 2017. Please explain the 
inflation measure used and any other assumptions.

A.1.b. Using the Bureau of Labor Statistics' online Consumer 
Price Index (CPI) Inflation Calculator,\3\ we calculated the 
amounts as follows measuring from the month of December in each 
year:
---------------------------------------------------------------------------
    \3\ https://data.bls.gov/cgi-bin/cpicalc.pl.
    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
    
    The inflation adjustments in the preceding chart do not 
account for the SEC's 2011 change in methodology for 
determining net worth (excluding positive equity in a primary 
residence). Amounts rely on a base number of $1,000,000 without 
regard to what assets constitute that amount.
    The Bureau of Economic Analysis in the Department of 
Commerce also maintains a Personal Consumption Expenditures 
(PCE) Price Index that, when used for inflation adjustment, 
usually produces lower results than the CPI calculation.

Q.2. You were asked about the Small Business Audit Correction 
Act, S. 3004, which would allow certain brokers or dealers 
defined under the bill to use auditors that are exempt from 
Public Company Accounting Oversight Board registration and 
supervision.
    How many brokers or dealers do you believe would be covered 
by the definition in the bill?

A.2. The Small Business Audit Correction Act (S. 3004) would 
narrowly exempt privately held, noncustodial broker-dealers 
from a requirement that a firm registered with the Public 
Company Accounting Oversight Board (PCAOB) audits those 
privately held dealers. The 2010 Dodd-Frank Act expanded the 
mission of the PCAOB by granting it the authority to oversee 
and examine the audits of SEC-registered broker-dealers. 
However, this provision of the Dodd-Frank Act failed to 
recognize the unique business models and corporate structures 
of certain broker-dealers different from the types of systemic 
threats to the financial system that Congress intended Dodd-
Frank to address. Specifically, broker-dealers that are not 
carrying brokers, i.e., do not hold client funds in custody, 
and which do not issue stock to the public, have a very 
different risk profile than large and interconnected brokers.
    S. 3004 would not exempt a noncustodial, privately held 
broker from audits--it simply provides that such brokers need 
not use a PCAOB-registered firm to conduct an annual audit. 
Audit standards that apply to PCAOB registered firms are 
designed for large, publicly traded businesses and are not 
appropriate for small and closely held entities. Furthermore, 
the exemption afforded certain broker-dealers under S. 3004 is 
entirely optional--if the shareholders and customers of such 
entities continued to demand PCAOB-registered auditors, nothing 
in this legislation precludes from doing so. Responsiveness to 
the needs and concerns of market participants is preferential 
to top-down mandates that fail to account for the diverse 
makeup of regulated entities.
    To the best of our knowledge, current publicly available 
data does not provide for a specific number of broker-dealers 
that would meet the definition under S. 3004. We expect that 
the types of entities who would be eligible for this exemption 
would be small broker-dealers that operate in a diverse set of 
communities across the country. Data from the Financial 
Industry Regulatory Authority (FINRA) demonstrates that the 
vast majority of registered broker-dealers are considered 
``small'' (less than 150 registered representatives), and we 
expect that firms that would benefit from S. 3004 would fall 
into that category.\4\ Additionally, the overall
number of broker-dealers in the United States has steadily 
declined--from 3,969 in 2008 to 3,132 in 2017. Rising 
regulatory costs may have led to this decline and to increased 
industry consolidation. We believe S. 3004 would help address 
some of those concerns.
---------------------------------------------------------------------------
    \4\ 2018 FINRA Industry Snapshot.

Q.3. Does the definition in the bill capture brokers or dealers 
in one or more of the following categories: active high-
frequency trading or principal trading firms, sophisticated 
market-maker firms, private placement brokers, dealers in the 
to-be-announced (TBA) for mortgage-backed securities market, 
and alternative trading system routing brokers, in addition to 
---------------------------------------------------------------------------
retail customer-facing brokers or dealers?

A.3. The legislation provides the PCAOB need not oversee 
auditors of privately held, noncustodial brokers in good 
standing, and that those auditors do not need to abide by PCAOB 
standards when auditing such brokers. It does not exempt 
brokers that meet this definition from any or all audits. 
Because the definition included in S. 3004 does not contemplate 
certain lines of business that a broker may engage in, publicly 
available data does not provide a definitive answer as to 
specific included or excluded lines of business.
                                ------                                


  RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE FROM THOMAS 
                            QUAADMAN

Q.1. As policymakers how should we strike the right balance 
between encouraging firms to go public and improving the 
private capital markets?

A.1. In one of the more troubling recent developments in the 
IPO market, not only are fewer companies willing to go public, 
but those that do tend to go public much later in their 
lifecycle. Instead of young, fast growing companies that need 
the public markets to grow, many IPOs in recent years have been 
of relatively large and established companies, and the IPO 
process is largely a liquidity event for company founders. This 
has two main effects: 1) It has become clear that the public 
markets are more inhospitable for small companies than in the 
past; 2) ``Main Street'' investors now invest in later stage 
companies after institutional or accredited investors have 
earned many of the early stage gains. As a result, households 
have fewer opportunities to create sustainable wealth over the 
long term.
    We believe there are many actions policymakers can take to 
help improve the public company model, particularly for smaller 
companies. Earlier this year the Chamber, along with seven 
other organizations, released a report with 22 recommendations 
for how to help more companies go and stay public.\1\ We 
believe that this is a multifaceted regulatory issue that 
covers overall reporting burdens and costs for public 
companies, market structure concerns, as well as financial 
reporting issues that policymakers need to be address.
---------------------------------------------------------------------------
    \1\ https://www.centerforcapitalmarkets.com/wp-content/uploads/
2018/04/IPO-Report_EX-
PANDING-THE-ON-RAMP.pdf.
---------------------------------------------------------------------------
    In terms of private capital markets, the strength and depth 
of these markets has certainly increased in recent years. Many 
contributing factors are outside the realm of Congress or the 
SEC, such as low interest rates and the growth of sovereign 
wealth and private equity funds. These factors--low interest 
rates in particular--have fueled an M&A boom in the private 
markets that have made a buyout a more attractive option than 
going public for many growing companies.
    However, we believe that policymakers should not always 
count on the private markets being this robust. While companies 
should not go public before they are ready, we believe that 
many artificial regulatory barriers make staying private a more 
attractive option. We believe that removing some of these 
barriers would give companies more financing options, which 
should be the ultimate goal of policymakers.

Q.2. Are the private capital markets currently high-
functioning? If not, where are the biggest potential areas for 
improvement?

A.2. We believe that the private capital markets are very high 
functioning for many companies, particularly for those in the 
midmarket or for larger companies that seek to acquire other 
businesses. However, we believe policymakers can make several 
improvements to help small and startup businesses acquire the 
capital they need to grow. Several such improvements are 
included in the JOBS and Investor Confidence Act, which 
recently passed the House of Representatives.
    That legislation includes provisions that would clarify 
some of the general solicitation rules stemming from the 2012 
Jumpstart our Business Startups (JOBS) Act, and would expand 
the definition of an ``accredited investor.'' We believe that 
these provisions and others would help young, early stage 
companies raise capital from a broad pool of investors and 
would ultimately lead to greater economic growth and job 
creation.

Q.3. I'm concerned about the increasingly uneven geographic 
distribution of growth. As the Economic Innovation Group has 
found, economic growth is largely clustered in the most 
prosperous areas, instead of evenly distributed across areas 
like the Great Plains and the Midwest. Would increasing access 
to equity and crowdfunded debt improve the geographic 
distribution of new firms?

A.3. We agree with your concerns. The Economic Innovation 
Group's 2016 study \2\ found that roughly 50 percent of new 
business startups in the post-recession period occurred in only 
20 counties in the United States. Business formation has 
largely occurred only in coastal areas, leaving behind broad 
swaths of the country. Additionally, many post-crisis rules 
have hindered bank lending, particularly to small businesses. 
The Federal Reserve's 2016 survey of small businesses found 
that 60 percent of applicants received less than the amount for 
which they applied, while 24 percent were unable to obtain any 
financing at all.\3\ New, innovative ideas such as crowdfunding 
can help businesses raise capital from their communities and 
from investors around the country.
---------------------------------------------------------------------------
    \2\ https://eig.org/wp-content/uploads/2016/05/
recoverygrowthreport.pdf.
    \3\ Federal Reserve Banks, 2016 Small Business Credit Survey: 
Report on Employer Firms (Apr. 2017), available at https://
www.newyorkfed.org/medialibrary/media/smallbusiness/2016/SBCS-Report-
EmployerFirms-2016.pdf.

Q.4. When do new and smaller firms tend to rely upon access to 
equity or crowdfunded debt instead of a traditional bank loan? 
For example, some have suggested that technology-based firms 
rely more upon equity while main street companies like 
restaurants more rely upon bank loans. What are the biggest 
hurdles new and smaller firms have--regulatorily or otherwise--
---------------------------------------------------------------------------
in accessing equity and crowdfunded debt?

A.4. Companies seeking a high level of growth but that need an 
infusion of capital to meet customer demands or to invest in 
production tend to favor equity financing, which is typically 
significantly more expensive than debt financing. In the 
securities space, regulatory hurdles make it difficult for 
businesses to access equity financing. One such hurdle is the 
limited pool of ``accredited'' investors who are eligible to 
invest in certain private offerings.
    Current SEC rules deem only those that meet certain asset 
or net income thresholds as ``accredited.'' Expanding that 
definition to include those that can demonstrate a certain 
level of financial sophistication would expand the pool of 
investors and capital available to growing businesses. Allowing 
special purpose vehicles (SPVs) to pool investors in a 
crowdfunding offering (significantly reducing recordkeeping and 
other costs) is another potential solution. The House-passed 
JOBS and Investor Confidence Act includes such a solution.

Q.5. Is there currently sufficient clarity about the conditions 
under which an offering by a small business issuer would 
qualify as a ``transactions by an issuer not involving any 
public offering'' under Section 4(a)(2) of the Securities Act? 
Are small businesses able to acquire such clarity without 
paying a meaningful amount in legal fees?

A.5. Attorneys who practice securities law believe there is 
sufficient clarity on these issues. The seminal case on Section 
4(a)(2) is the Supreme Court's 1953 decision in SEC v. Ralston 
Purina Co.\4\ In that case, the Court laid out a series of 
factors that regulators must balance to make the critical 
inquiry of whether a private offering exists. Numerous 
subsequent lower court opinions over the past six decades have 
further fleshed out these criteria.
---------------------------------------------------------------------------
    \4\ 346 US 119 (1953).
---------------------------------------------------------------------------
    However, the test is necessarily a subjective one and, 
unlike a private offering under the SEC's Regulation D, an 
offering conducted under the statutory exemption in Section 
4(a)(2) does not receive the benefit of blue sky (State 
securities law) preemption under the National Securities 
Markets Improvements Act of 1996. An issuer relying on Section 
4(a)(2) must also find an exemption from registration in each 
State in which it makes an offering, or qualify the offering 
with the applicable State securities regulator. This can be an 
expensive and time-consuming process. For these reasons, most 
securities lawyers prefer to rely on the Regulation D safe 
harbor instead of the statutory exemption when conducting a 
private offering on behalf of an early stage or smaller 
business.
    While securities lawyers understand these parameters fairly 
well, the criteria are not necessarily intuitive and the 
average small business owner is not likely to be knowledgeable 
of their intricacies. It is a daunting task to research the 
criteria on one's own without the aid of an attorney, 
particularly as it concerns State securities law requirements. 
Many of the lower-cost attorneys who focus on smaller 
businesses are not knowledgeable about securities law, or 
choose not to practice it due to hefty insurance premiums that 
errors and omissions (E&O) insurance carriers assess against 
lawyers who practice securities law. Accordingly, many small 
business owners are not able to retain low-cost, competent 
securities counsel.
    We understand that the SEC frequently receives inquiries 
from small business owners seeking to understand the securities 
laws as they apply to their businesses. Because the SEC cannot 
provide legal advice to the public, its ability to respond to 
these inquiries is somewhat limited. However, the SEC has 
informed us that these inquiries commonly involve small 
business owners seeking to complete a ``friends and family'' 
fundraising for seed or growth capital. Congress could provide 
relief by expanding the Securities Act of 1933 to exempt 
offerings for close friends and family members of small 
business owners, insofar as such offerings do not always meet 
the criteria of Section 4(a)(2) as the courts or the SEC's 
Regulation D safe harbor have laid out.
    Although we are sensitive to the fact that State securities 
law preemption is a delicate issue, preempting the registration 
and qualification provisions of State securities law (but not 
the antifraud authority of blue sky regulators) would also 
simplify the offering process for small business owners.

Q.6. Representative Emmer's bill, H.R. 2201, the Micro Offering 
Safe Harbor Act would ``exempt certain micro-offerings from: 
(1) State regulation of securities offerings, and (2) Federal 
prohibitions related to interstate solicitation.''\5\ Such 
offerings could be worth up to $500,000, have 35 participants, 
and involve an instance where the ``purchaser has a substantive 
pre-existing relationship with the issuer . . . ''\6\ How would 
you evaluate this legislation? If you have concerns with this 
legislation, how would you ideally address them?
---------------------------------------------------------------------------
    \5\ https://www.congress.gov/bill/115th-congress/house-bill/2201.
    \6\ https://www.congress.gov/bill/115th-congress/house-bill/2201.

A.6. The Chamber strongly supports this legislation, which 
would provide a regulatory regime for a tailored and narrow 
type of securities offering. Attorney, accounting, and other 
costs for such small offerings can be daunting enough to small 
businesses that they often refrain from raising the capital 
they need to expand. We believe that H.R. 2201 properly 
balances both capital formation and investor protection 
concerns and we urge Congress to pass it as swiftly as 
---------------------------------------------------------------------------
possible.

Q.7.a. How viable is conducting an offering under the SEC's 
Regulation Crowdfunding, particularly for new and smaller 
businesses? What about for businesses that are not located in 
the top five largest cities? What about for smaller offering 
sizes? If smaller offering sizes tend to be less viable, how 
large must an offering be to be viable?

Q.7.b.Would there be merit to increasing the offering limit for 
Regulation Crowdfunding issuers, from $1 million? Why or why 
not? If so, what should the limit be? For example, the 2017 SEC 
Government-Business Forum on Small Business Capital Formation 
recommended raising the limit to $5 million.

A.7.a.-b. As the SEC's Division of Economic Risk and Analysis 
reported, as of February 2017, 75 percent of completed 
crowdfunding offerings have occurred across only four States 
(CA, TX, MA, and DE).\7\ During the period covered in this 
report (5/16/2016-12/31/2016), there were 163 unique 
crowdfunding offerings, with a median amount raised of 
$171,000. These statistics indicate that the total impact of 
Title III of the JOBS Act remains somewhat muted, given the 
relatively low number of crowdfunding offerings initiated and 
amounts raised.
---------------------------------------------------------------------------
    \7\ U.S. securities-based crowdfunding under Title III of the JOBS 
Act, SEC Division of Economic and Risk Analysis. February 28, 2017, at 
18. Covers period from May 16, 2016-December 31, 2016.
---------------------------------------------------------------------------
    We do believe that the arbitrary cap on the amount that 
businesses can raise during a 12-month period ($1 million) 
ultimately serves as a disincentive to commence a crowdfunding 
offering. In many cases, businesses must seek the advice of 
outside counsel in order to ensure compliance with all 
crowdfunding rules and may be required to obtain audited 
financial statements for an offering over $500,000. Legal and 
audit costs can be significant, and when compared with the 
relatively low amount companies are able to raise via 
crowdfunding, costs associated with an offering can become a 
disincentive to use Regulation CF.
    We believe that increasing the $1 million limit could 
ultimately make crowdfunding a more attractive means of 
obtaining financing. We also support changes included in the 
House-passed JOBS And Investor Confidence Act that would allow 
special purpose vehicles (SPVs) to pool individuals together to 
invest in crowdfunding offerings.
    We also believe that since the SEC adopted its crowdfunding 
rules in 2015 and that equity crowdfunding is a new capital
formation concept, it will take time for market participants to 
learn how to use Regulation CF for their benefit. This, coupled 
with the changes included in the JOBS and Investor Confidence 
Act and a potential increase in the offering amount allowed, 
would ultimately help Title III of the JOBS Act reach its full 
potential.
                                ------                                


  RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORTEZ MASTO FROM 
                        THOMAS QUAADMAN

S. 2756, Fair Investment Opportunities for Professional Experts Act 
        (Accredited Investor Bill)
Q.1. In recent months, we read about how millionaires like 
Rupert Murdoch, the Waltons, and the DeVos's each lost a 
hundred million dollars or more when they invested in Theranos. 
One of many red flags was the absence of an audited financial 
statement which one would think a sophisticated investor would 
demand before shelling over $125 million dollars.
    The bill requires the SEC develop a test for financial 
sophistication for accredited investors who do not meet the 
income or wealth threshold.

Q.1.a. Is a test a reasonable requirement to help investors 
better protect themselves?

A.1.a. The SEC's current rules for defining an ``accredited 
investor'' only allow the SEC to deem individuals accredited 
based on certain asset and income levels. An accredited 
individual must have at least $200,000 in annual income 
($300,000 for couples), or must have a net worth of $1 million 
(excluding the value of an individual's primary residence). 
This definition may be both under- and over-inclusive: It 
excludes individuals that have income and assets that fall 
below the thresholds, but who may be financially savvy and 
fully capable of understanding the risks and awards associated 
with private placements. However, it could include individuals 
that may be extremely wealthy but who do not have any 
understanding of basic financial or investment concepts. Put 
simply, we do not believe that an individual's financial status 
presents a complete picture as to their ability to invest 
wisely and in a manner that will not expose them to serious 
financial risk.
    Furthermore, as former SEC Commissioner Michael Piwowar has 
noted, allowing a household to invest in both private and 
public
offerings could ultimately have the effect of reducing that 
household's overall portfolio risk, as long as their assets 
have a low correlation with one another.\1\ We agree with 
Commissioner Piwowar's sentiments and believe that opening up 
the private markets to greater investment will ultimately 
benefit not just issuers but also households that will have 
more opportunities to create wealth.
---------------------------------------------------------------------------
    \1\ Acting Chairman Michael S. Piwowar, Remarks at the ``SEC 
Speaks'' Conference 2017: Remembering the Forgotten Investor. February 
24, 2017.
---------------------------------------------------------------------------
    We believe that some type of test or other mechanism to 
determine the investment understanding of an individual--as 
envisioned by S. 2756--is an appropriate requirement that will 
help protect investors and ensure that the SEC will only 
accredit those who are able to demonstrate investment 
knowledge. It should be noted that the Financial Industry 
Regulatory Authority (FINRA) administers several exams in order 
to license professionals to, for example, sell securities or 
oversee those who do. Individuals that take these exams must be 
able to demonstrate a strong understanding of financial markets 
and investment concepts. An exam designed to do the same for 
individuals looking to invest in private offerings could be an 
effective means of responsibly expanding the number of 
accredited investors in the United States.

Q.1.b. If so, what do you think should be in such a test?

A.1.b. S. 2756 envisions that potential accredited investors 
should be able to demonstrate a ``reasonable level of relevant 
financial expertise'' that includes an ability to understand 
voting rights, economic rights, and disclosure obligations of a 
private issuer, the basic components of a financial statement, 
and the investment risk associated with a private investment.
    Furthermore, the courts over the years have ascribed a 
number of factors to help define a ``reasonable investor.'' For 
example, courts have indicated that reasonable investors should 
be:

  1. LAble to complete basic mathematical calculations.

  2. LFamiliar with the basic operation of a securities margin 
        account.

  3. LAble to understand the time value of money and basic 
        principles of diversification.

  4. LAware of what free cash and securities may be used to 
        earn interest

  5. LAble to read and understand risk factors and other 
        disclosures plainly presented in a prospectus.

  6. LAble to ``grasp the probabilistic significance'' of 
        merger negotiations.

  7. LGenerally aware of macroeconomic conditions.\2\
---------------------------------------------------------------------------
    \2\ See, e.g., In re Merck & Co., Inc. Securities Litigation, 432 
F.3d 261, 270 (3d Cir. 2005); Levitin v. PaineWebber, Inc., 159 F.3d 
698, 702 (2d Cir. 1997); In re Donald J. Trump Casino Securities 
Litigation, 7 F.3d 357, 371-77 (3d Cir. 1993); Dodds v. Cigna 
Securities, Inc., 12 F.3d 346, 351 (2d Cir. 1993); Flamm v. Eberstadt, 
814 F.2d 1169, 1175 (7th Cir. 1987); Zerman v. Ball, 735 F.2d 15, 21 
(2d Cir. 1984); Ash v. LFE Corp., 525 F.2d 215, 219 (3d Cir. 1975).

We believe that many of these concepts--in addition to the 
factors already included in S. 2756--would be appropriate to 
---------------------------------------------------------------------------
consider in such a test.

Q.1.c. How should the test ensure that biases do not arise?

A.1.c. We believe that the focus should be on determining one's 
financial sophistication based upon objective investment 
topics, whatever entity will develop and administer such a 
test. The provisions included in S. 2756--coupled with court-
articulated factors that define a ``reasonable investor'' would 
be an appropriate starting point.

Q.1.d. Do you think the SEC should permit other firms to 
develop, teach and administer tests? If so, what would be the 
benefits and concerns of a third-party testing system?

A.1.d. The SEC currently delegates certain examination 
authority to self-regulatory organizations. For example, FINRA 
develops and administers dozens of examinations for individuals 
employed in the securities industry.
    A third-party testing system could be a cost-effective and 
efficient way to administer examinations. Such a third party 
must be independent and must be able to demonstrate that it has 
the ability and expertise to administer examinations in a fair 
and objective manner. Under such an arrangement, the SEC may 
choose to retain some authority. For example, the SEC could 
assist with the development of exam questions (and update 
questions and topics as necessary), then assign the third party 
to administer the test, record results, and furnish the results 
to the SEC. We believe that S. 2756 as currently written 
provides the SEC with sufficient flexibility to determine the 
best manner in which to utilize third parties.

Q.2. As you know, my State of Nevada is one of the leading 
States for retiree in-migration. Many of these retirees, and 
many working Nevada residents, are counting on their pensions 
from State, teacher or labor union pension funds. Several of 
these large pension fund managers, including the SEIU which has 
about 18,000 members in Nevada, have publicly opposed H.R. 
4015. They have raised concerns that it will interfere with the 
independent advice that they rely on from proxy advisors.
    Why should the Congress undermine the fiduciary 
responsibility and interfere with the contractual relationship 
of proxy advisors to their clients by requiring these proxy 
advisors to show their data and recommendations to the 
companies under review, even before their clients get to see 
them?

A.2. Under existing law and SEC regulation, proxy advisory 
firms do not owe any underlying fiduciary duty to any party. 
Institutional Shareholder Services (ISS) claims that its status 
as a registered investment advisor (RIA) requires it to act as 
a fiduciary to its investor clients, but not its corporate 
clients. However, Glass Lewis is not registered in any capacity 
with the SEC. Put simply, no existing law or regulation 
requires a proxy advisory firm to owe a fiduciary duty to 
anyone.
    In the context of proxy advice and proxy voting, the actual 
fiduciary duty lies with institutional investment managers who 
are
required to vote proxies in the best interests of their 
shareholders. Past SEC actions have effectively allowed 
investment managers to outsource this responsibility to third 
parties such as proxy advisory firms. Two no-action letters the 
SEC issued in 2004 to Egan-Jones and to ISS allowed investment 
managers to ``cleanse'' any conflict of interest related to a 
particular proxy issue by relying on a proxy advisor firm for a 
vote recommendation. The no-action letters also allowed an 
investment manager to rely solely on a proxy advisory firm's 
general policies and procedures pertaining to conflicts of 
interest, as opposed to any specific conflicts around a 
specific company or issue.
    This has enabled rampant conflicts of interest in the proxy 
advisory firm industry. For example, ISS runs a consulting 
business for corporate clients in addition to its voting 
recommendation business, which is an inherent conflict of 
interest. An activist Canadian pension plan owns Glass Lewis 
that has taken positions on proxy issues at U.S. companies.
    Since proxy advisory firms have no underlying duty or 
applicable regulatory regime, they face little or no 
consequences for poor business practices. Public companies 
often tell us that they are granted an insufficient amount of 
time to respond to a draft voting recommendation, even in cases 
where the recommendation includes factual errors or flaws in 
methodology. For example, a survey the U.S. Chamber and Nasdaq 
conducted in 2017 found that a majority of public companies 
surveyed were only given 1 or 2 days to review and respond to a 
proxy advisory firm recommendation.\3\ Small and mid-size 
companies usually have no chance to respond to a recommendation 
from either Glass Lewis or ISS.
---------------------------------------------------------------------------
    \3\ http://www.centerforcapitalmarkets.com/wp-content/uploads/2017/
07/FINAL-CCMC-Survey.docx.pdf?x48633.
---------------------------------------------------------------------------
    This opaque system--which has resulted in multiple errors 
and mistakes in recommendations--is ultimately harmful to 
investors as it leads to bad information in the marketplace. We 
believe that the modest requirement in H.R. 4015 to grant at 
least 3 days for companies to respond to a recommendation is an 
entirely reasonable expectation, and there is nothing in the 
legislation that would require a proxy advisory firm to 
incorporate the feedback it received from a company into its 
recommendation.
    Proxy advisory firms also do not have the proper resources 
to analyze appropriately the tens of thousands of director 
elections and shareholder proposals they issue reports on. The 
combination of a lack of resources, faulty reports, failure to 
fix errors, and conflicts of interest adversely affects the 
useful information available to investors. This can lead to a 
faulty decisionmaking process that can generate lower returns 
for the retirees mentioned in the question, and the entities 
that help them attain a secure retirement.
                                ------                                


 RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN FROM DARLA C. 
                            STUCKEY

Q.1. You stated, ``[i]f you are talking about Mr. and Mrs. 
401(k) as long-term retail shareholders, they are represented 
by investment managers who largely vote with ISS and Glass 
Lewis,'' and ``[p]ublic, State, and private pension 
beneficiaries as well have no individual voice.''
    Does any pension fund check with their beneficial owners 
before they vote how they should vote on a particular 
shareholder proposal, say climate-related?

A.1. I am not aware that this happens. Please see study from 
Spectrem Group [attached] for further information on pensioners 
and their views on how their assets are managed.

Q.2. Putting aside proposals related to corporate social 
responsibility, do investment managers regularly consult 
individual 401(k) investors, or pension plan participants, on 
voting decisions relating to the securities held in their funds 
or plans for corporate actions such as mergers? Please describe 
any such mechanisms or voting processes and identify the funds 
or plans that have consulted ultimate beneficial owners on 
corporate actions or shareholder votes.

A.2. I am not aware that this happens.

Q.3. In what ways to do companies seek out the views of 
ultimate beneficial owners (e.g., individual 401(k) investors 
or pension plan participants) on corporate actions or 
shareholder votes? Please provide relevant examples, if any.

A.3. Companies know their own 401(k) beneficiaries and 
communicate with them generally as employees or former 
employees. I am not aware that they seek out the views of those 
individuals on shareholder votes. However, they do have a 
fiduciary duty to vote in accordance with what they think is 
best for all shareholders including 401(k) plan beneficiaries. 
With respect to companies seeking out the views of the 
beneficial owners of their stock held in other company-
sponsored 401(k) plans or pensions, those individuals are not 
known to the company because typically shares are held through 
indexes or mutual funds whose managers vote the shares.
    EX. If I own a Mutual Fund ``A'' large cap growth fund in 
my personal Society 401(k) which owns Google stock, Google 
would never know me or be able to solicit my input on voting. 
Rather, the Mutual Fund A would vote those Google shares.

Q.4. Your testimony discussed a transportation company's 
interaction with ISS over a recommendation on a say-on-pay 
vote.

Q.4.a. Generally, what is the result of a failed say-on-pay 
vote? What were the consequences for the company you mentioned? 
Did the company benefit from its shareholder outreach?

Q.4.b. Would the representatives of that company be willing to 
provide the Banking Committee detailed information regarding 
the error and the facts of its case?

A.4.a.-b. A shareholder vote on executive compensation is 
required by section 951 of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act, which added section 14A to the 
Securities Exchange Act of 1934. Pursuant to section 14A(c), 
the shareholder vote is not binding on the issuer or the board 
of directors. Nonetheless, the reputational effects of a failed 
vote on executive compensation can be significant. As described 
in my testimony, the effect on this company primarily related 
to potential implications for shareholder approval of board 
members and damage to the company's shareholder relations, 
which required extensive outreach efforts. Although the 
shareholder outreach was beneficial, ISS's factual error forced 
the company to devote efforts to informing shareholders of 
ISS's error, which risked crowding out other important 
corporate matters.
    The company provided the example to the Society for 
Corporate Governance on the condition that the company not be 
identified. My written testimony contains additional detailed 
information regarding the error and the facts of this case.
                                ------                                

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

  RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORTEZ MASTO FROM 
                        DARLA C. STUCKEY

S. 2756, Fair Investment Opportunities for Professional Experts Act 
        (Accredited Investor Bill)
Q.1. In recent months, we read about how millionaires like 
Rupert Murdoch, the Waltons, and the DeVos's each lost a 
hundred million dollars or more when they invested in Theranos. 
One of many red flags was the absence of an audited financial 
statement which one would think a sophisticated investor would 
demand before shelling over $125 million dollars.

Q.1.a. The bill requires that the SEC develop a test for 
financial sophistication for accredited investors who do not 
meet the income or wealth threshold. Is a test a reasonable 
requirement to help investors better protect themselves?

Q.1.b. If so, what do you think should be in such a test?

Q.1.c. How should the test ensure that biases do not arise?

Q.1.d. Do you think the SEC should permit other firms to 
develop, teach and administer tests? If so, what would be the 
benefits and concerns of a third-party testing system?

A.1.a.-d. The Society does not have a position on this bill.
                                ------                                


 RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN FROM JOHN C. 
                           COATES IV

Q.1. The Small Business Audit Correction Act, S. 3004, would 
allow certain brokers or dealers defined under the bill to use 
auditors that are exempt from Public Company Accounting 
Oversight Board registration and supervision.
    How many brokers or dealers do you believe would be covered 
by the definition in the bill?

A.1. The great majority of broker-dealer firms would be 
covered. The primary restrictions are that the firms have fewer 
than 150 registered representatives, are noncustody firms, and 
clear through another firm. Roughly 3,400 of FINRA's roughly 
3,700 member firms have fewer than 150 registered reps. The 
vast majority of broker-dealers, and an even larger percentage 
of small broker-dealers, do not maintain custody of client 
securities and are not self-clearing. While I am not aware of a 
public dataset that could answer this question precisely, it 
would be reasonable to believe that more than 3000 broker-
dealers would be covered by the definition in the bill.

Q.2. Does that definition in the bill capture brokers or 
dealers in one or more of the following categories: active 
high-frequency trading or principal trading firms, 
sophisticated market-maker firms, private placement brokers, 
dealers in the to-be-announced (TBA) for mortgage-backed 
securities market, and alternative trading system routing 
brokers, in addition to retail customer facing brokers or 
dealers?

A.2. Yes. Many of the kinds of firms listed in the question 
would be covered by the definition in the bill.

Q.3. At the hearing, proxy advisors were identified as 
contributing to the decline in the number of public companies.
    Do you know of any evidence or studies that support this 
claim?

A.3. No. The best studies of the decline of the number of U.S. 
public companies focus on large-scale economic shifts, such as 
an increase in economies of scale in many industries, and the 
relative increase in the availability of capital in the private 
equity markets. The single best recent study is that Xiaohui 
Gao, Jay R. Ritter, and Zhongyan Zhu, entitled ``Where Have all 
the IPOs Gone?,'' 48 J. Fin. Quant. Anal. 1663-1692 (2013), 
available at https://tinyurl.com/yba6sw9j. It concludes:

        Regulatory changes aimed at increasing the number of IPOs are 
        likely to have minor effects, since the decline in IPOs is not 
        due to a broken IPO market, but because small independent 
        companies are not necessarily the profit-maximizing form of 
        organization.

                                ------                                


RESPONSES TO WRITTEN QUESTIONS OF SENATOR VAN HOLLEN FROM JOHN 
                          C. COATES IV

Q.1. In your testimony you say that H.R. 4015, Corporate 
Governance Reform and Transparency Act of 2017, would create 
conflicts of interest for firms that use proxy advisory 
services. Please elaborate on this. What is the problem that 
H.R. 4015 is trying to solve?

A.1. Proxy advisory firms face potential conflicts of interest 
if they have other lines of business (as with ISS) or owners 
(as with Glass Lewis). Basic disclosure and information-barrier 
regulation can address conflicts of interest, as in many other 
settings. Well-designed, light touch regulation of conflicts 
would seem to me a possibly admirable goal for a statute 
addressing proxy advisory firms. However, as I testified, I do 
not believe that H.R. 4105 as currently drafted does that. It 
would impose unnecessary costs without adequately demonstrated 
benefits.

Q.2. Some have tried to pinpoint the root causes of decreases 
in IPOs. Please discuss what factors have been at play with 
regard to the decrease in IPOs.

A.2. The best studies of the decline of the number of U.S. 
public companies focus on large-scale economic shifts, such as 
an increase in economies of scale in many industries, and the 
relative increase in the availability of capital in the private 
equity markets. The single best recent study is that Xiaohui 
Gao, Jay R. Ritter, and Zhongyan Zhu, entitled ``Where Have all 
the IPOs Gone?,'' 48 J. Fin. Quant. Anal. 1663-1692 (2013), 
available at https://tinyurl.com/yba6sw9j. It concludes:

        Regulatory changes aimed at increasing the number of IPOs are 
        likely to have minor effects, since the decline in IPOs is not 
        due to a broken IPO market, but because small independent 
        companies are not necessarily the profit-maximizing form of 
        organization.

    I am aware of no reliable research to suggest proxy 
advisory firms have played a meaningful role in the decline in 
IPOs. It is hard to see how proxy advisory firms could have 
done so. It should be noted that firms can elect dual-class 
structures at the time of an IPO, which would make the prospect 
of shareholder voting--whether or not informed by proxy 
advisory firms--unimportant. Dual-class IPOs have been 
increasing in recent years, but not enough to offset the 
overall decline, which is driven by economic and not regulatory 
or governance factors.
                                ------                                


  RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORTEZ MASTO FROM 
                       JOHN C. COATES IV

S. 2756, Fair Investment Opportunities for Professional Experts Act 
        (Accredited Investor Bill)
Q.1. In recent months, we read about how millionaires like 
Rupert Murdoch, the Waltons, and the DeVos's each lost a 
hundred million dollars or more when they invested in Theranos. 
One of many red flags was the absence of an audited financial 
statement which one would think a sophisticated investor would 
demand before shelling over $125 million dollars.

Q.1.a. The bill requires the SEC to develop a test for 
financial sophistication for accredited investors who do not 
meet the income or wealth threshold. Is a test a reasonable 
requirement to help investors better protect themselves?

A.1.a. I would not view such a test as a way for investors to 
better protect themselves. Rather, such a test would be a way 
to evaluate whether some investors are already able to protect 
themselves. If well-designed, such a test would be more likely 
to distinguish such investors from others than the current 
asset/income thresholds, which even if at a reasonable level 
would be a crude measure, and are out of date.

Q.1.b. If so, what do you think should be in such a test?

A.1.b. Sophisticated investors able to protect themselves are 
at least knowledgeable about finance, accounting, financial 
statement analysis, and the institutions and regulations of the 
financial industry. Designing a test of such topics would be a 
challenging and somewhat time-consuming task, as it would 
require balancing the need to fairly test relevant knowledge 
(both theoretical and as applied to typical investment 
decisions) against the need to not have the test be so lengthy 
or detailed as to deter sophisticated investors from attempting 
to take it. But could be done. While it would not need to be as 
comprehensive as existing regulatory examinations for 
individuals to become ``registered reps'' (the ``Series 7'' 
exam) or certified financial planners or analysts, it could 
draw on those exams and tests for material and topics.

Q.1.c. How should the test ensure that biases do not arise?

A.1.c. To some extent, cognitive biases--such as over-optimism 
or unjustified self-confidence, or attribution of luck in the 
financial markets to skill--are inevitable. Even the most 
sophisticated investors are subject to them. Standard tests of 
financial knowledge are not generally viewed as creating or 
worsening biases. If a concern is that third parties would 
``teach to the test'' and through that process increase or 
worsen biases, then that could be addressed by varying or 
randomizing elements of the test--as with SATs--
so that no one could design a curriculum that would both 
adequately prepare someone for the test and simultaneously 
increase or worsen biases in the process. In any event, whether 
a test (or the teaching to prepare for it) worsens biases is 
itself capable of being tested, and the results could be used 
to refine the test over time.

Q.1.d. Do you think the SEC should permit other firms to 
develop, teach and administer tests? If so, what would be the 
benefits and concerns of a third-party testing system?

A.1.d. I would prefer a dedicated unit with an adequately 
funded SEC oversee the design, testing, and administration of 
any such test. While for-profit private actors may be likely to 
work more quickly and competition provides good incentives in 
many contexts, the world of education is dominated by public 
institutions and nonprofits for reasons that would carry over 
to this area. I would worry that for-profit private test 
designers (and trade associations and many other organizations 
that are formally nonprofits as well) might have conflicts of 
interest in designing the tests. (I would expect third parties 
to then provide curricula to prepare investors to take such a 
test, but they should not be privy to the actual contents of 
the test.) If the SEC chose, it could seek to rely on third 
parties--appropriately screened through customary RFP process 
that would include consideration of potential conflicts of 
interest. But I would leave that to the SEC to choose, rather 
than directing that in a statute.

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