Commercial speech: securities regulation

Trey Drury, Loyola-New Orleans, Disclosure Is Speech: Imposing Meaningful 1st Amendment Restraints on SEC Regulatory Authority. SEC disclosures should be recognized as commercial speech, which would invalidate some but not core regulations. The big hurdle is that the Supreme Court doesn’t agree with Drury, having assumed that it’s ok to regulate securities.

But the Court is wary of suppressing truthful speech and fears paternalism. (I view this as a normative claim – as he notes, the Court has no wariness in suppressing truthful speech when it doesn’t consider it within the bounds of the First Amendment at all.) The Court is willing to take on heavily regulated commercial fields like lawyer advertising and FDA regulations, so the Court should also analyze securities regulation as commercial speech regulation.

The theory of SEC regulation was required disclosure: You’ve got to register unless an exemption applies, e.g. one for small businesses and stock sales.

The type of speech involved is like commercial speech. It’s a corporation proposing a transaction to potential buyers. The SEC is concerned that if a corporation says things inconsistent with its prospectus, that will be misleading and drive up the stock price – which means that the regulations are intimately involved with proposing transactions. Also, the SEC recognizes that markets absorb information. At a first offering you must disclose everything, but later you don’t have to start from scratch – you can point people to prior SEC filings. Moreover, courts have imposed liability for making disclosures that third parties use to trade – they know third parties will make decisions in reliance on disclosures. (I am interested that this explanation of why SEC-regulated speech is commercial speech seems to concede everything the California Supreme Court majority said in Kasky. If you are trying to get your speech considered within the realm of First Amendment-governed speech at all, it makes sense to make this argument; but once within First Amendment-land, I would expect corporate speakers to start arguing for the noncommercial and thus fully protected nature of some if not most of this speech.)

Implications: Investors don’t need the same types of protection normal consumers do. Lacking information, you’re stuck with limited options, like buying prescription drugs from the nearest pharmacy, but in securities you get the benefit of others’ knowledge, through market signals and the consensus price.

There are numerous SEC regulations prohibiting truthful speech, requiring disclosure, and otherwise imposing on speech – the trifecta. Regulations that should be struck down: during the preregistration quiet period, when you’ve determined you’ll offer securities but haven’t yet done it, you can’t make any non-prospectus public disclosures, which means not offering ordinary information. The Google IPO was held up by a Playboy interview with the founders, in which they said innocuous things. Also, the Sarbanes-Oxley regulations banning non-GAAP financial reporting information on things like non-recurring charges, even though investors might want to see what the financial information looks like without the non-recurring charges; the SEC did not evaluate whether providing such information is misleading. Still, the vast majority of securities regulations would be left intact. Mandated positive disclosures are completely fine, like warning labels.

Antony Page, Indiana U., Taking Stock of the First Amendment’s Application to Securities Regulation. Other restrictions on speech in securities: the ban on selective disclosures in private. That’s content based, because it’s determined by its impact on listeners (I’m not sure this is a proper description of the test for content-based restrictions), and it’s not designed to further an antifraud goal. As a result, fewer companies now provide certain kinds of revenue guidance. Likewise, restrictions on general disclosure in private placements are problematic – the restrictions apply even if you don’t allow people to buy and thus don’t cause harm. There are flat bans on certain disclosures. For example, with oil reserves, there are proven (90% chance of recovery) and probable (50-90% chance of recovery) reserves. All else being equal, probable reserves would affect the value of an oil company, but the SEC doesn’t allow disclosure of probable reserves.

There is also compelled speech: certain minority shareholder proposals have to be included in proxy materials. (This sparked a discussion during the comments period – part of the issue of corporate speech is the question of who is speaking. If the managers can suppress shareholder speech, then the company’s resources are speaking for some but not others.) Also, tender offer filing requirements: you have to file any comments made to more than ten people, which can cost $50,000 – this has practical consequences, e.g. a website by an employee opposing a tender offer which gets taken down.

Page, following Fred Schauer, distinguishes between coverage and protection. All normative theories fail to explain the First Amendment’s coverage – nonlegal factors are more important – whereas they often do an ok job explaining what gets protected within the scope of coverage.

What are the coverage arguments about the SEC? An impending SEC/First Amendment collision was predicted 25 years ago, but Page is optimistic that things will change soon. The doctrinal justifications for excluding securities regulation are poor, based in dicta from the infancy of commercial speech doctrine. Other extensively regulated areas of economic activity are not exempt from First Amendment scrutiny – see cases on drugs, gambling and tobacco.

Some argue that securities are different – their value depends on firm-specific information which is hard to verify, making stocks a credence good. With a car, you can inspect and discover fraud much more easily. There are other credence goods, however, without this regulation and presumably covered by the First Amendment (comment: really? Why?). News is a credence good. Education is also a credence good – you have to believe that a law degree is worthwhile. Also, information intermediaries exist in securities as well – auditors and underwriters. Companies can make credible commitments through things like bank monitoring, which adds shareholder value.

If securities are different, why does the SEC allow purchases without information for exempt things like pink sheet stocks, foreign companies, and small offerings?

Some argue that the capital markets would collapse without regulation. But First Amendment coverage doesn’t mean that all regulation would be struck down. Anyway, the empirical evidence about the need for regulation is mixed.

Questions: Is corporate speech different because a corporation is not a person?

Drury and Page agreed that the best foundation for First Amendment protection for corporate speech was the listeners’ interests in receiving truthful information. My reaction: that justification allows more regulation than a speaker-focused theory of First Amendment rights, because the listener’s interests are not aligned with the speaker’s in many cases. Hearer-based claims are used instrumentally by corporate speakers to get within the scope of the First Amendment; once that happens, they start making claims to have independent rights as speakers.