Tuesday, October 31, 2023

Materiality and the SEC's Rulemaking Authority

Over the summer, friend-of-the-BLPB Bernie Sharfman posted a draft paper to SSRN that was the subject of a short colloquy between us.  The paper, The Ascertainable Standards that Define the Boundaries of the SEC's Rulemaking Authority, asserts, among other things, that materiality is one of three "ascertainable policy standards that Congress has placed in the Acts to guide the SEC’s rulemaking discretion."  The reasoning? 

  • "[T]here are multiple references to materiality in the Acts."
  • The SEC's 1972 annual report avers that "[a] basic purpose of the Federal securities laws is to provide disclosure of material financial and other information on companies seeking to raise capital through the public offering of their securities, as well as companies whose securities are already publicly held."
  • "As observed by Professor Ruth Jebe, it is fair to say that materiality 'constitutes the primary framing mechanism for financial reporting.'"

Bernie acknowledges that "there is no explicit statutory language in the Acts that forbids the SEC from promulgating rules requiring non-material disclosures."  I might add that nothing in either the Securities Act of 1933, as amended ("1933 Act"), or the Securities Exchange Act of 1934, as amended ("1934 Act"), explicitly limits the SEC's rulemaking authority to rules qualified by materiality.

Since the U.S. Congress knew to use materiality to qualify some disclosure, enforcement, and other responsibilities under the 1933 Act and the 1934 Act and not others, it easily could have provided an express constraint on the SEC's overall rulemaking authority in that regard.  Arguably, since Congress did not qualify all of the disclosure mandates in the 1933 Act or 1934 Act by materiality, SEC rulemaking that introduces a materiality qualification may be subject to unfavorable scrutiny.  (Congress could then take the view that, if it had meant to restrict the statutory disclosure or other mandates to only those items that are material, it would have said so.)  Yet, overall, Congress has delegated relatively broad authority to the SEC to engage in rule making that serves the investor protection, market integrity maintenance, and capital formation policies underlying the various provisions of the 1933 Act and the 1934 Act.

For example, Schedule A to the 1933 Act sets forth the initial disclosure mandates provided for by Congress for registration statements. See §7(a)(1) of the 1933 Act.  Congress then notes that the SEC "may by rules or regulations provide that any such information or document need not be included in respect of any class of issuers or securities if it finds that the requirement of such information or document is inapplicable to such class and that disclosure fully adequate for the protection of investors is otherwise required to be included within the registration statement."  Id. The disclosure requirements for registration statements are now executed primarily through registration forms adopted by the SEC under the 1933 Act.  In both Schedule A and in the forms of registration statement adopted by the SEC under the 1933 Act, disclosures were or are required that are not expressly qualified by materiality.  In fact, few of the mandatory disclosures in Schedule A are limited only to supplying material information.  The same is true for the initial disclosure mandates applicable to 1934 Act registration statements.  See § 12(b) of the 1934 Act.

There's more I could say, but I will leave it there for now.  As you might guess from the above, I am skeptical, at best, about the argument that materiality is a required constraint on SEC rule making.  I consider Congress's words and actions to be most important in this matter (absent any issues identified under the U.S Constitution).  Your thoughts on the asserted materiality constraint are welcomed.


Joan Heminway, Legislation, Securities Regulation | Permalink


Joan, thank you so much for discussing my new writing. Materiality is a very important policy standard when it comes to SEC disclosure rulemaking. It is not an absolute requirement, but it one that the SEC and a reviewing court cannot ignore. As I said in my paper: Materiality not being an absolute requirement "does not mean that the SEC can ignore the policy constraint of materiality that repeatedly appears in the Acts. By doing so, Congress is sending specific guidance to the SEC that materiality is important in whatever action it takes."

There is also a bigger picture here. As I argue in my paper, materiality is to be viewed as a constraint on the two objectives of the Acts--for the protection of investors (primary objective) and promoting “efficiency, competition, and capital formation.” (secondary objective). Therefore, materiality must be understood in the context of these two objectives: From my paper: As Professor J.W. Verret observed, “how can disclosure that the SEC is unable to demonstrate as material ever further the purposes of investor protection or capital formation?” Moreover, he further observes that “[i]f a rule does not provide material benefit to shareholders, and has significant costs associated with it, it would seem unlikely the SEC could determine that the rule furthered the goals of investor protection, efficiency, competition and capital formation.”

Posted by: Bernard Sharfman | Nov 8, 2023 7:08:19 AM

There is also a revised version of the paper that can be found on SSRN, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4504913 . I have significantly revised the Introduction and to a lesser extent the Abstract. I believe the Introduction will now be significantly more interesting to readers, encouraging them to continue to read the article to completion.

Posted by: Bernard Sharfman | Nov 8, 2023 7:36:59 AM

Hi, Bernie. I am glad you have commented here. I have not disagreement with the first paragraph of your comment, other than the last sentence. It's the second paragraph that I cannot get my arms wrapped around. Specifically, when you say that "materiality is to be viewed as a constraint on the two objectives of the Acts--for the protection of investors (primary objective) and promoting 'efficiency, competition, and capital formation,'" I have trouble sourcing that in the primary doctrine and related legislative and regulatory history and guidance.

When Congress or the U.S. Securities and Exchange Commission wants to qualify a disclosure requirement by importance, it uses the word "materiality" or otherwise offers a term or threshold or metric. If Congress had wanted to constrain all regulatory action on disclosure requirements by materiality, it could have done so. As I offer in my post, many mandatory disclosure requirements are absolute. They allow investors to look at basic comparative information across publicly traded firms and assess, in their own way and for their individualized objectives, what the composite of that information means for their securities trading or voting. Iow, they create their own information mosaics. The disclosure architecture of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, invites that comparison and contrast, which is a benefit to investors, supports fair and efficient markets, and (therefore and maybe otherwise) promotes capital formation. (So, I disagree with J.W.—but neither he nor I is a primary source. We are merely, like you, commentators.)

So, can you cite to doctrine or legislative/regulatory policy to support your position that materiality is a “constraint” on the SEC’s authority notwithstanding the fact that it is scripted into some areas of securities law and regulation and not others? I am doing more work on materiality in insider trading law now, so this dialogue is timely . . . .

Posted by: joanheminway | Nov 8, 2023 7:37:26 AM

Thanks for alerting us to the revised version, Bernie! I look forward to reviewing that. Keep me posted on it overall, so that I can ensure I am citing to the most current version in my work.

Posted by: joanheminway | Nov 8, 2023 7:41:39 AM

Think of it in terms of how a sitting Justice of the Supreme Court would look at materiality. I argue that they would be searching through the statute (or any other regulatory statute) looking for ascertainable standards that support the intelligible principle test of the nondelegation doctrine. If so, they would see repeated references to materiality, as well as the two other ascertainable standards found in both Acts, as supporting the existence of an intelligible principle. As such, these ascertainable standards are to guide the SEC in its rulemaking and the courts in their review of the Acts. It is not necessary for materiality to be referenced in every single section of the Acts. These ascertainable standards permeate the statutes.

Posted by: Bernard Sharfman | Nov 8, 2023 7:55:11 AM

Interesting analysis. Thanks for sharing that. However, I admit that I do not find it persuasive.

Maybe it's just my many years as a practicing lawyer drafting contracts, disclosure documents, and policies . . . . If Congress had wanted to constrain its delegation of authority on required disclosures to only material items, it should, could, and (imv) likely would have done so. I would hope that a court would give effect to the language of the statutes and (where ambiguities exist) to evidence of the policy judgments made in drafting that language. Of course, a legislature can change its judgment on policy over time. But that is its province, not that of the judiciary, imv.

Posted by: joanheminway | Nov 8, 2023 10:05:11 AM

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