HFSC SEC’s Agenda Hearing – November 2nd 2023
House Committee on Financial Services
Subcommittee on Capital Markets
Examining the SEC’s Agenda: Unintended Consequences for U.S. Capital Markets and Investors
Thursday, November 2, 2023
Topline
- Republicans blasted the SEC for proposing rules that have no legislative mandate.
- Democrats defended Chair Gensler and the SEC, especially over criticism of the Commission’s proposed climate disclosures.
- Members of both parties expressed concerns over the SEC’s proposed rule on conflicts of interest and securitization.
Witnesses
- Ken Bentsen, President and CEO, SIFMA
- Dalia Blass, Partner, Sullivan & Cromwell LLP
- Dr. S.P. Kothari, Gordon Y Billard Professor of Accounting and Finance, MIT Sloan School of Management
- Tom Quaadman, Executive Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce
- Amy Borrus, Executive Director, Council of Institutional Investors
Opening Statements
Subcommittee Chair Ann Wagner (R-Mo.)
In her opening statement, Chair Wagner began by saying that the SEC’s work is vital to the upkeep of US capital markets, which are the deepest and most liquid capital markets in the world. She went on to say that our capital markets are among the most regulated sectors of our economy, which underscores the need for the SEC to carefully and responsibly fulfill its duties as a regulator. Wagner explained that any transformative changes to markets must be meticulously crafted and vetted to account for cumulative effects of rulemakings, as well as directed by Congress. She said the subcommittee has expressed serious bipartisan concerns with the SEC’s rulemakings through a string of hearings where various SEC officials testified.
Wagner then said she would explore the most harmful aspect of the SEC’s rulemaking process, first pointing to the SEC’s rapid rulemaking pace which undercuts its ability to understand the cumulative effects of their rules. The second issue she spoke about was the current SEC’s shortening of public comment periods for proposed rules which makes it difficult for commenters to provide meaningful feedback on rulemaking. The third issue Wagner raised was the SEC’s apparent disregard for Congressional concern and inquiries which undermines trust in the regulatory process and raises accountability questions. The fourth and final issue she spoke about was the fact that previous hearings with SEC officials made it clear that the SEC was exceeding its mandate, especially with rules relating to environmental and social policies.
Subcommittee Ranking Member Brad Sherman (D-Calif.)
In his opening statement, Ranking Member Sherman began by saying the biggest risk to the SEC is the impending government shutdown should Congress be unable to fund the government by the November 17th deadline. Sherman explained that in such a scenario, no initial public offerings (IPOs) or additional stock and bond issuances for established firms could happen and the SEC would be unable to carry out its enforcement duties, leaving our capital markets vulnerable. He went on to say the SEC is doing many things right, pointing to the SEC’s effectiveness in cracking down on crypto schemes funneling money to bad actors around the world. Sherman then spoke to ESG and its importance given increasing interest among investors in having material ESG information to make investment decisions. He did admit that Scope 3 is a problem given its lack of feasibility. Sherman explained that because company value has shifted off the balance sheet, additional disclosures in areas like human capital are important. He then criticized the swing pricing proposal form the SEC saying that it harms retail investors and is effectively a junk fee. Sherman finished by saying that he has issues with the SEC, but that in general the SEC is doing a good job and that many of their proposals are well intentioned and need to be properly limited.
Testimony
Ken Bentsen, President, and CEO, SIFMA
In his testimony, Bentsen began by highlighting the importance of US capital markets, saying they are the envy of the world and that an attribute that is unique to the US is that 75% of commercial activity in the US is financed through our capital markets. Bentsen went on to say that this makes it critical for regulators to tailor policies to address legitimate concerns without harming or disrupting markets. He then explained that the high volume and speed of regulatory change proposed by the Commission could result in negative consequences for the real economy. He also pointed out that truncated timelines for multiple overlapping rule proposals inhibit stakeholders’ abilities to analyze the collective impact of the proposals which can lead to poorly constructed rules and serious negative consequences for our capital markets. He said that there is justification for some rules, including the SEC’s proposal to transition the securities settlement cycle from two days to one, or rules mandated by the Dodd-Frank Act.
Bentsen then spoke to the fact that the SEC’s aggressive rulemaking agenda has crowded out other important mandates that have yet to be finalized. Bentsen explained that the SEC’s rush to implement so many rules will be difficult for industry to comply with and is not conducive to effective and enduring policy making. Bentsen offered the example of this issue, highlighting the Commission’s equity market structure proposals which, compared with the past equity market structure changes, have not received the same deliberative process, and lack clear direction from Congress. Bentsen then said there is no analysis on what the proposals’ cumulative effect on markets would be if more than one was adopted, which is contrary to the multiple previous administration’s OMB guidance. Bentsen then highlighted opposition to all the equity market structure proposals, except the proposal to update rule 605 which has not been updated since its inception in 2000 and is a natural starting point for the future. Bentsen finished by saying the Commission needs to focus on maintaining healthy markets and that rushing to do too much too quickly could result in poor policy outcomes and overwhelm market infrastructure.
Dalia Blass, Partner, Sullivan & Cromwell LLP
In her testimony, Blass discussed her concerns with the pace and scope of the SEC’s rulemaking agenda. She explained that the SEC has issued an unprecedented number of rule proposals which have the potential to fundamentally alter the capital markets. Blass said these proposals were issued with inadequate comment periods and without adequate explanation or analysis from the Commission about why they are necessary. She added that some of the proposed rules have substantive and procedural flaws, fail to show an accurate understanding of the markets, and rely on speculative statements. Blass concluded by urging the SEC to publish a thorough analysis of the cumulative effect of its interconnected proposals and reopen comment periods, as U.S. capital markets rely on regulatory predictability and clarity.
Dr. S.P. Kothari, Gordon Y Billard Professor of Accounting and Finance, MIT Sloan School of Management
In his testimony, Kothari warned that the deficiencies in the SEC’s cost-benefit analysis pose risks that would exceed the benefits of the proposed rules and harm the competitiveness of the U.S. capital markets. He cited the Commission proposed new rules affecting the reporting and management of the private funds industry as an example, noting the Commission’s analysis did not fully consider the market context for private funds. Kothari explained that by ignoring this context, the Commission’s economic analysis failed to consider how market participants would react to proposed rules and prohibitions. He continued that the proposed Regulation Best Execution relied on a fundamentally flawed and biased economic analysis, while the SEC also failed to provide an adequate cost-benefit analysis for the climate proposals. Kothari warned that increased compliance costs can be detrimental to the competitiveness of U.S. public capital markets and lead to effects such as dissuading foreign firms from registering in U.S. capital markets or motivate firms to remain private. He concluded that there is a concerning lack of rigor and completeness in the Commission’s economic analysis of its proposed rules.
Tom Quaadman, Executive Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce
In his testimony, Quaadman noted the SEC has had a negative capital formation agenda since 2001.
He discussed the SEC’s repeal of the proxy advisory firm rule, which he said allowed two foreign-owned firms to drive corporate governance policy in the U.S. Quaadman lamented the gutting of shareholder proposal thresholds, which he said emboldened gadfly investors and activists. He stated that everyone who has a 401k plan has benefited from stock buybacks and criticized the activist Public Company Accounting Oversight Board (PCAOB) and Staff Legal Bulletin No. 14L for injecting political discussion into the boardroom. Quaadman concluded by urging the SEC to look past the views of activist investors and address the needs of the marketplace for all investors.
Amy Borrus, Executive Director, Council of Institutional Investors
In her testimony, Borrus noted that Gary Gensler has pursued a sweeping regulatory revamp that spans corporate disclosure, equity market structure and crypto assets. She explained that from CII’s perspective, Chair Gensler’s leadership has greatly advanced the SEC’s tripartite mission of protecting investors; maintaining fair, orderly, and efficient markets; and capital formation. Borrus said CII and its members are especially heartened that many of the reforms Chair Gensler has spearheaded align with longstanding CII policies that strengthen corporate governance of U.S. public companies. She cited the Commission’s adoption of a rule to require the use of a “universal proxy card” in director election contests as an example, explaining that the rule established a more level playing field for shareholders voting by proxy rather than in person at a company’s annual meeting. Borrus also commended the Commission for adopting amendments to Rule 10b5-1.40, which she said benefited investors by better protecting them from misuse of Rule 10b5-1 trading plans and by enhancing public confidence in corporate management and the fairness of the capital markets.
Question & Answer
Predictive Data Analytics Rule
Wagner noted she is concerned about the SEC’s predictive data analytics proposed rule and the negative effects it will have on innovation and retail investors. She explained that the scope of the proposal is extremely broad and could be applied to virtually any technology used by broker dealers and investment advisors.
Wagner then asked Blass about the SEC’s predictive data analytics rule, specifically its effects in innovation and retail investor participation. Blass responded saying that proposal reaches far beyond artificial intelligence and would even cover excel spreadsheets, potentially curbing the use of traditional tools used by advisers and investors to manage risk and financial wellness. Wagner followed up asking about the proposals’ effect on smaller firms. Blass said small firms would have a difficult time complying and pointed out the SEC even admits in the proposal that aspects of the proposal may be impractical or impossible to comply with the proposal.
Rep. Mike Lawler (R-N.Y.) asked if Kothari is concerned that the predictive data analytics proposed rule has completely ignored all of the benefits that technology provides retail investors. Kothari said the SEC’s economic analysis has been deficient in determining cost estimates and benefits of this technology.
Conflicts of Interest in Securitization
Sherman then asked Bentsen how the SEC’s conflicts of interest rule would impede traditional investments people make. Bentsen responded saying it would impact prime brokerage and the institutional market and could result in firms pulling back some services. Bentsen also said the proposal would force firms to police their clients, which is really the job of the SEC.
Rep. Wiley Nickel (D-N.C.) asked Bentsen what harm the conflicts of interest in securitization proposal will cause markets and why it’s important for the proposal to be narrowly tailored. Bentsen responded saying that the securitization market is incredibly important and the proposal at is overly broad, going far beyond its original mandate in Dodd-Frank and would be very difficult for firms to comply with forcing them to curtail their activities.
Rep. Bryan Steil (R-Wisc.) asked what would happen if some of the largest financial institutions scaled back securitization activities or stepped away from the securitization business lines altogether. Bentsen said the rule Steil is referring to is overly broad and explained that pulling back credit will impact price. Steil said the rule will make loans more expensive for everyday Americans.
Proposed Climate Disclosures
Rep. Bill Huizenga (R-Mich.) asked Kothari if he stood by his previous negative analysis of the climate disclosure proposal and how we manage our way through the proposal’s issues. Kothari said he stands by the analysis and said that regulation is a solution in search of a problem, and that there is no evidence of a climate risk being posed to investors yet.
Rep. Sean Casten (D-Ill.) asked Borrus if investors need reliable information about a company’s climate risks so they can allocate their portfolio. Borrus said that is what she is hearing from her members. She noted the SEC has a role to play ensuring there is standardization because investors need comparable information on which to make decisions.
Casten explained that many U.S. companies are regulated in other countries and in California. He said Congress can’t complain about the fact that other people led on climate disclosures if it stops the SEC from acting. Casten said a failure to act would defer leadership to other countries.
Rep. Maxine Waters (D-Calif.) asked if Chair Gensler has done a good job living up to the priorities that working families and retirees care about. She asked if any particular SEC rulemakings come to mind that positively address the issues of proxy voting, market structure, and climate disclosures. Borrus said yes, explaining that investors need consistent, comparable, and decision-useful information about climate risks and opportunities to inform their investment and proxy voting decisions. Waters affirmed that Chair Gensler has done a great job of protecting investors.
Custody Rule
Sherman asked Bentsen if the SEC’s safeguarding rule is well designed, especially for tangible assets like real estate. Bentsen responded no, saying the rule is overly broad, upends the existing custodial relationships, and is contrary to how prudential regulators handle these issues.
Rep. Zach Nunn (R-Iowa) asked Kothari how the SEC interacts with other agencies in rulemakings specifically pointing to the custody proposal, which Chair Gensler claimed to have coordinated with the CFTC on, but only mentions agriculture once. Kothari said that when he was at the SEC, he would engage other agencies very frequently on a variety of rule makings and that the SEC only mentioning agriculture once in the custody proposal is very strange. Nunn then asked Bentsen about the effects of the SEC’s custody proposal on the agricultural industry. Bentsen responded saying agriculture risk management is the bedrock of the US futures industry and that the proposal conflicts with how futures commission merchants deal with custody issues.
Open-End Fund Liquidity
Wagner asked Bentsen about how SEC’s open end fund liquidity proposal would limit investment strategies for retail investors and what impact that would have on retail investors. Bentsen said the proposal liquidity risk management aspect would make it difficult for many types of mutual funds to operate due to the level of cash a fund would have to keep, pointing to corporate loan funds and small cap funds as examples.
Equity Market Structure
Meuser asked Bentsen and Quaadman if the original equity market structure proposals and the new volume pricing proposal are a good plan. Bentsen responded saying that it likely won’t have the SEC’s desired effect and went on to say the SEC itself admitted to not knowing what the cost-benefit of their equity market structure proposals will be because they are unsure of how market participants will react to the rules. Quaadman said he shares those concerns and pointed to a report that these regulations along with regulations from the banking sector would increase financing costs.
Regulatory Uncertainty and SEC Criticism
Rep. Frank Lucas (R-Okla.) asked Bentsen about how uncertainty stemming from SEC proposals and the Basel III endgame proposal impacts the resilience of capital markets and how industry is responding. Bentsen responded saying that Basel III endgame proposal raises capital requirements on the trading book by 70% and in conjunction with the stress testing regime, creates a double counting effect. Bentsen went on to explain that given the importance of large banks in the underwriting and trading market of traditional assets, there will be a squeeze on market capacity and raising capital will be more difficult across the board.
Lucas asked Blass what deficiencies the SEC is responding to with its high volume of rulemaking. Blass responded that the Commission does not effectively articulate the reasons behind why it has proposed rules at the number and pace it has but said that information would be helpful for stakeholders to understand.
Lucas then asked Quaadman and Bentsen about the negative impacts on capital markets when the SEC takes on so many regulatory changes. Quaadman said it makes US capital markets less appealing for businesses looking to IPO and endangers the US’s ability to be the end point for global capital. Bentsen said that all the rules the SEC has put forward are not in isolation and said that it is important to look at the cumulative effects of SEC rules on the markets.
Huizenga asked Blass if the SEC is doing damage to its ability to do its important work. Blass said that with the onslaught of rules, resources are finite, and we could risk getting to a jurisdiction where there is no compliance with the rules because it is impossible to comply. She also said we could get to a place where there is a regulator created systemic risk because we break something in the market.
Casten asked Quaadman given how many US companies are affected by EU regulations, shouldn’t the US have a seat at that table. Quaadman responded that he agrees and that the extraterritorial impact of the EU’s rules puts American firms at a competitive disadvantage.
Other SEC Proposals
Wagner asked Quaadman if he could name any initiatives undertaken by the SEC to promote capital formation. Quaadman said the answer is no and in fact the SEC has had a negative impact on capital formation. Wagner then asked why it’s important for the SEC to promote capital formation especially for small businesses. Quaadman said that it’s important for firms to have access to capital for innovative technology and it allows investors on Mainstreet to benefit from it.
Sherman asked Quaadman what the SEC should do regarding the effects of AFFEs on business development companies. Quaadman said the SEC should either exempt the AFFE disclosure or allow for tabular footnote disclosure because they would prevent business development companies from providing capital to Mainstreet.
Nickel brought up the recent GAO decision to qualify SAB 121 as a rule and asked Bentsen how preventing the most highly regulated banks from providing custody for digital assets is in the best interest of investors and how providing these services would make the digital assets eco system even safer. Bentsen said that SAB 121 prevented publicly traded banks from providing custody to digital assets, driving digital assets out of the regulatory environment and that the GAO made the right decision.
Nickel asked about the data around the common counter argument to E-Delivery that seniors are uncomfortable using and accessing technology. Bentsen said that surveys conducted indicated that three quarters of investors prefer some or all their documentation to be sent via e-delivery.
Huizenga asked Quaadman about the difference between a footnote and an exemption with regards to AFFE requirements. Quaadman said a full exemption would be better, but a footnote does avoid the double counting issue.
Speaking about the Consolidated Audit Trail (CAT), Rep. French Hill (R-Ark.) asked Bentsen if he thinks the SEC’s ability to surveil the market is inadequate. Bentsen said no and that there are many issues with CAT and that the SEC should prioritize finalizing the CAT data privacy rule. Hill then pointed out the costs of running the CAT were increasing and asked if there is any end to that spending. Bentsen said that Hill is right and that ultimately the increased costs will be passed on to broker-dealers who have no authority but all the costs.
Hill asked Blass if forcing private funds to disclose information as if they’re public companies is overkill. Blass responded that there is no explanation for why this is rule is necessary, that the associated costs will be extreme, and the rule will have a large impact on smaller advisers who tend to be women and minority owned and create tremendous barriers to entry.
Steil asked Quaadman if there is an example other than the SEC’s proxy advisor reforms rule where the SEC undid a rule before it even took effect. Quaadman said no and noted that the proxy advisor reforms were the result of a near decade long effort that spanned across administrations to reach consensus. Steil asked if the SEC acting in this manner impacts its credibility. Quaadman replied yes and said it impacts their rulemaking and enforcement capacities. Steil then said he was particularly concerned with Staff Legal Bulletin No. 14L and asked if “widespread public debate” and “broad societal impact” are clearly defined terms in securities law. Quaadman said no and that in their letter to the SEC the Chamber of Commerce highlighted issues with this thinking.
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