The SEC's Tenuous, Tentative Case For Preemption

The Securities and Exchange Commission's last week adopted rules requiring the securities exchanges to adopt listing standards requiring listed companies to develop and implement policies providing for the recovery of erroneously awarded incentive-based compensation received by current or former executive officers.  In commenting on the proposed rule, I noted that the rules could conflict with state laws that prohibit employers from recouping compensation from their employees.  The SEC did not duck the issue in its adopting release, asserting "With respect to preemption, as a general matter, listing standards adopted by national securities exchanges and associations at the direction of Congress and the Commission can preempt state laws in certain circumstances."  However, the adopting release falls short of concluding that preemption is a certainty: "Accordingly, issuers should be able to assert that state laws that would prevent or impede recovery are preempted, although the outcomes for any particular state law would depend on the details of that provision."  Issuers can always assert, the money question, of course, is will they prevail?

The SEC was able to cite only one case in support of its claim that issuers should be able to assert preemption - Credit Suisse First Bos. Corp. v. Grunwald, 400 F.3d 1119, 1128 (9th Cir. 2005).  However, that case did not involve listing standards nor did it involve a national securities exchange.  The question in that case was whether California's ethics standards for neutral arbitrators apply to arbitrations conducted in California by the National Association of Securities Dealers.   

Section 221 of the California Labor Code prohibits an employer from collecting or receiving "from an employee any part of wages theretofore paid by said employer to said employee".   In the adopting release, the SEC points out Section 224 "provides that Section 221 'shall in no way make it unlawful for an employer to withhold or divert any portion of an employee’s wages when the employer is required or empowered so to do by state or Federal law.'"  Listing rules do not, and cannot, "empower" an employer to take action nor do they require an employer to take action.  Listing rules do not "empower" employers because they are merely conditions to continued listing on the exchange.  They do not require an employer to take action because a decision to list securities on an exchange is voluntary.  Although there may be consequences, an employer can always decide to delist without violating the law.  Because Congress has not mandated exchange listing, California's law presents no obstacle to federal law.