With hundreds of rules already passed and dozens of other rules in the proposal stages, mandates from the Dodd-Frank Wall Street Reform and Consumer Protection Act became an immersive deliberation topic for the Securities and Exchange Commission over the past seven years. Dan Gallagher, now president of Patomak Global Partners, served as a commissioner for the agency from 2011 until 2015. He spoke with C-Suite about the past, present and future of the agency and its relationship to executive compensation and corporate governance.
Daniel Gallagher: I’ve given dozens of speeches on this exact topic, but in a nutshell, for almost six years now, Dodd-Frank has dominated the agenda of the SEC. It was a massive piece of legislation—2,300 pages, or 30 to 40 times larger than Sarbanes-Oxley. Despite its length, Dodd-Frank wasn’t exactly prescriptive—it mostly gave broad mandates for rulemaking to supposedly independent agencies. Many of these rulemakings are just political and have nothing to do with the financial crisis, and these mandates put the agency at 20, 30, 50 times the normal rulemaking rate. There is only so much Commission bandwidth, and it really pushed—and still is pushing—the agency to the extreme.
Dodd-Frank only amended the existing federal securities laws, it’s not like it started everything over, and there are still 75 years of federal law for the SEC to administer. Yet it has dominated the agenda. There were three different chairmen during my time in the SEC, and each of them chose to prioritize Dodd-Frank over other blocking-and-tackling, mission-critical responsibilities.
Gallagher: Dodd-Frank is a single-party piece of legislation, so the SEC is implementing a political document. Key terms were not negotiated between the parties in Congress, and the Commission had to resolve those on its own. Take for example, the conflict minerals disclosure rule. While the ultimate goal may be laudable, no sane human being is going to argue that conflict minerals had anything to do with the financial crisis. The fact that it was even in Dodd-Frank tells you something right there.
There are still a third of the rulemakings left to do, and it’s going to continue to dominate the SEC for years to come.
Gallagher: Like I said about Dodd-Frank generally, these are theories that directly come from vested political interests. Pay ratio is probably the best example, where organized labor was patting itself on the back for including it with no legislative history. AFL-CIO has talked about it on its website as something to “shame” corporations.
We could have done this with a safe harbor where you choose a number—say 1,000 to 1—instead of implementing the rule unilaterally and creating significant costs that companies, investors and shareholders have to bear. The rule states that investors would view the CEO pay ratio as material when casting say on pay votes, and there’s no evidence of that. In fact, it will harm investors as they bear the cost of compliance. For example, if the pay ratio applied just to U.S. employees, that would have cut 90% of the cost.
Gallagher: The question on pay for performance is whether the information given to investors is the right kind of information or even understandable. Instead of spending more time with these questions and thinking about whether the rule makes sense, there was a drive to get it proposed.
We know there is a big debate about TSR [total shareholder return], and we received a lot of negative public comments about it. Given the heated debate we had before it was proposed and the comments coming from a wide range of market participants, I don’t think the Commission will proceed with the rule the way it was proposed, and the agency will take those comments into account because it’s so clearly an issue.
Gallagher: We probably won’t see a final rule this year. It’s already difficult to get things done with three members now, and it’s doubtful you’ll get a full slate in there this year to get it done.
Just like everything else, it will come down to the election, who’s going to be in leadership at all the agencies, and what the White House will think of the rules. There’s only a few months until November, and the chairman usually leaves when the administration changes. If you have a conservative SEC chairman, I can tell you the first task would not be to prioritize this.
That’s why single-party legislation is not meant to last. Without bipartisanship you are subject to the ebb and flow of the election cycle. Sarbanes-Oxley—while it has created its own problems—stands in such stark contrast because it was almost the exact opposite of Dodd-Frank, getting just a couple of “no” votes in all of Congress.
Gallagher: If you go back about 10 years, there was a debate about the competitiveness of U.S. capital markets—New York vs. London. You had economic leaders getting together talking about issues like plaintiffs’ litigation and Sarbanes-Oxley, but the financial crisis hit so these discussions got put on the shelf. The economy was devastated, and now all these restrictions and mandates have come out, and—though the JOBS Act has helped over the last few years—here we are with IPO numbers that are still much lower than they should be.
So why is it so bad? We never addressed the real issues. There is rampant class-action litigation, legacy Sarbanes-Oxley issues, complaints about auditors getting back to micromanagement because they are getting beat up by PCAOB, and 404b debates. Factor in shareholder activism on top of that—and don’t get me wrong, there is good and bad activism—but if you add bad activism to bad legislation to bad market practices and bad rulemakings, it’s more daunting today than it was 10 years ago. People don’t talk about this much, but with the accretion of all these things, you almost wonder why a company would go public.
In industrial history, going public was the ultimate goal, the end game for capitalists who want to create investment opportunities. Now I don’t think it’s the same.
Gallagher: Ironically, it does the opposite of what all the interest groups who push for all these restrictions say they want. It drives investment opportunity solely to the rich. A company who is not going to IPO has millionaire investors rather than the regular Joe. The idea behind the public markets is to democratize investment opportunity.
Gallagher: We’ve seen the large investment funds grow massively, the asset management industry is ballooning, and the amount of money in passive funds is vast. At least among the top tier, they’re doing a lot more. There is scrutiny about over-reliance on proxy advisory firms, and we’re seeing the large institutional investors bring in staff to resource corporate governance research so they don’t just rely on ISS and Glass Lewis anymore. That’s terrific, and it needs to stretch down to lower tiers of the asset management industry. In an era of activism and politically charged decision-making, I don’t see policymakers—at least outside of Congress—stepping up to address the issues, and you need the markets to step up and handle them.
Gallagher: As a threshold matter, the federal government should have no role in corporate governance. Unlike Europe or other countries, we historically have decided to leave corporate governance generally to the states. The trend now, however, is toward more involvement by the SEC—I’ve referred to it as the federalization of corporate governance. So we see a lot of rhetoric about pay practices and boardroom composition, but I don’t think the SEC should have the authority to write rules in these areas, and there is also a reluctance among those who purport to care for the agency to throw it into that social or political fight.
Gallagher: It’s funny, I come at it a little differently. It’s always better to have a full complement of commissioners, but you always hear about the government getting nothing done—well to me, for the last seven years, some of what has been done has been bad, and the idea of doing less bad is a good thing.
In other words, this could be a good opportunity for the agency to take a breath, step back for a moment, and realize that Dodd-Frank had nothing to do with the actual causes of the financial crisis. We’ve already missed most of the rulemaking deadlines by years—it’s like a kid getting their homework in late. At this point, you might as well get it right. Take your time, be deliberative and proceed at a pace that allows you to focus on the core work. Focus on the state of the U.S. equity markets, bubbling problems in corporate fixed income markets and facilitating capital formation. Maybe a big, deep breath is what everyone needs.