House Financial Services Committee Hearing on SEC Oversight

• Regulation Best Interest: Responding to several questions about the SEC’s proposed Regulation Best Interest, Clayton explained that both the investment advisor and broker-dealer model will be required to put the best interests of the client above that of the financial professional, and proposed Form CRS will help customers understand their relationship with their financial professional. Clayton said that all comments are made public and he expects the results of the investor testing will be made public “in some form.”
• Capital Formation: Clayton said that while the availability of private capital is strong, the public capital markets are not, and that he does not want to do anything that will impact private capital while trying to boost the public capital markets. Clayton also said it is an important part of the SEC’s job to ensure that as small business grow, they have access to capital throughout their lifecycles.
• Consolidated Audit Trail: Clayton said that the SEC has a draft work plan from the self-regulatory organizations (SROs) and is making progress on implementation of the Consolidated Audit Trail (CAT). Clayton said that the CAT will make it easier to get data on bad behavior, and that customer reporting information is an important part of the CAT.

• The Honorable Jay Clayton, Chairman, U.S. Securities and Exchange Commission

Rep. Jeb Hensarling (R-Texas), Chairman, House Financial Services Committee
In his opening statement, Hensarling noted that the Securities and Exchange Commission (SEC) has three main objectives: investor protection, the maintenance of fair and orderly markets, and the promotion of capital formation. Hensarling said the SEC’s role in promoting capital formation has been neglected in the recent past, but praised Chairman Clayton for paying more attention to the issue. Hensarling continued that though the economy is currently strong, some “worrying signs” need confrontation: entrepreneurial start-ups hit a 40-year low in 2016, initial public offerings (IPOs) have been on a downward slide, and the bipartisan banking bill S. 2155, though beneficial for small and regional banks, has done little to bolster industry-driving capital markets. He emphasized the need to foster start-ups in order to maintain three percent growth, compete with China’s healthy IPO markets, and provide small scale investors with good opportunities. Hensarling expressed that the upcoming package of capital formation bills offers an important step towards removing barriers to effective capital formation.

Rep. Maxine Waters (D-Calif.), Ranking Member, House Financial Services Committee
In her opening statement, Waters voiced concern about recent actions of the regulatory agencies “to give banks a pass” by weakening the Volcker rule. She noted that the SEC itself recognized the “moral hazard” of proprietary trading and was thus confused as to why the SEC would support a weakening of the current standard. Waters then expressed concern about the SEC’s Regulation Best Interest, noting that it did not create a harmonized fiduciary standard for brokers and investment advisors. She urged Clayton to advance a final proposal that would more effectively protect investors. Waters ended by noting that though she had not been consulted on what bills were going to be included in the capital formation package, she was concerned that they would negatively impact investor protections.

Rep. Bill Huizenga (R-Mich.), Chair, Capital Markets Subcommittee
In his opening statement, Huizenga noted that the benefits of tax reform have already started to materialize and that S. 2155, the Economic Growth, Regulatory Relief and Consumer Protection Act, has begun to provide some regulatory burden relief. He emphasized that such reforms are only the beginning, and that the “one size fits all” securities regulation currently in place have made our capital markets less attractive. Huizenga called on Chairman Clayton to continue modernizing securities regulation in order to increase the flow of capital, create jobs, and spur economic growth.

Rep. Carolyn Maloney (D-N.Y.), Ranking Member, Capital Markets Subcommittee
In her opening statement, Maloney voiced concern over the SEC’s Regulation Best Interest, noting that it did not create a uniform best interest standard for advisors and brokers, even though it has long been known that retail investors do not distinguish between their advice. She questioned the strength of Regulation Best Interest and criticized it for not being as strong as the Department of Labor’s fiduciary rule. Maloney praised the SEC for its involvement with cryptocurrencies, citing the many investors being hurt in the crypto market, and asked Chairman Clayton for clarification on the Loan Rule.

The Honorable Jay Clayton, Chairman, U.S. Securities and Exchange Commission
In his testimony, Chairman Clayton stated that the current fiscal year budget has enabled the SEC to make significant investments in modernizing their technological infrastructure. Clayton said he believes the agency is running effectively and is working for the long-term interests of main street investors to improve standards of conduct for investment professionals, the integrity of our markets, and overall investor protection. Clayton focused on five components that drive the need for the SEC’s FY 2019 budget request: information technology/cybersecurity, capital formation, protection of main street investors, enforcement compliance and inspections, and trading in markets. Clayton reiterated the importance of protecting main street investors and highlighted it as a primary concern.

Capital Formation
Rep. Robert Pittenger (R-N.C.) asked what the SEC’s role is in ensuring small businesses remain the backbone of the American economy. Clayton said he is hopeful the covered funds issue in the Volcker rule will free up capital for small business. Clayton also said it is an important part of the SEC’s job to ensure that as some small business grow into larger entities, they have access to capital throughout their lifecycles. Pittenger asked what action would be most helpful for capital raising for small business. Clayton replied that raising capital from a single source is not costly, but when raising capital from multiple sources, transaction costs are high. Clayton said the SEC is trying to bring that cost down without hurting investor protection.

Hensarling noted there has been a 20-year decline in IPOs and asked what opportunities main street investors are losing out on. Clayton said that although our markets have an “incredible competitive advantage,” capital formation is being impeded and the suite of opportunities available to investors is shrinking as the markets are shrinking. Clayton also said he expects a discussion soon on Section 404(b) of Sarbanes-Oxley and that the thresholds for where the section is applicable should be examined.

Rep. Keith Rothfus (R-Pa.) asked how Congress can help more companies go public. Clayton said that he would like to see the emerging growth company (EGC) on-ramp “modernized” and argued that policymakers should look at ways to facilitate more liquidity in small- and mid-sized companies’ stocks.

Rep. Barry Loudermilk (R-Ga.) asked about the slow pace of IPOs, to which Clayton responded that while the availability of private capital is strong, the public capital markets are not, and that he does not want to do anything that will impact private capital while trying to boost the public capital markets. When Loudermilk asked about the impact of mergers and acquisitions, Clayton stated that when companies join together you may lose the number of companies in the market, but you do not lose the amount of capital.

Rep. Jim Himes (D-Conn.) noted the need for the SEC, FINRA and Congress to have “good competitive capitalism working” in IPO pricing, to which Clayton stated that he shares Himes’ “passion for competitive products.”

Rep. Nydia Velazquez (D-N.Y.) expressed concern that the position for the Advocate for Small Business Capital Formation has not yet been filled. Clayton said they have employed a search firm to assist in finding the right candidate and hopes the position will be filled soon, and that the position should be a permanent voice in the work the SEC does.

There were multiple mentions of the “accredited investor” definition throughout the hearing. Clayton said that the definition needs to be modernized.

Regulation Best Interest
Clayton fielded several questions throughout the hearing about the SEC’s proposed Regulation Best Interest. Waters asked why different financial professionals are held to different standards based on their title. Clayton explained that there are two relationship models: the investment advisor model is a portfolio-based, holistic model, and the broker-dealer model is for a recommendation in a specific area on an episodic basis. Clayton continued that both models will be required to put the best interests of the client above that of the financial professional. Clayton continued that proposed Form CRS will help customers understand their relationship with their financial professional, including how they are paid. Clayton said there is “no conflict-free” advice model, but the proposed regulations will require disclosure and mitigation of any conflicts.

Rep. Ann Wagner (R-Mo.) asked if the SEC has begun investor testing on Regulation Best Interest and if the SEC plans to make the results public. Clayton responded that the Office of the Investor Advocate has begun investor testing and the SEC is also in the process of holding six roundtables across the country to interact with investors. Clayton said that all comments are made public and he expects the results of the investor testing will be made public “in some form.” Wagner also asked if the SEC would need to extend the comment period. Clayton responded that the SEC will determine in August if an extension is needed, but he thinks 90 days is a “good, lengthy comment period.”

Rep. David Scott (D-Ga.) asked if the SEC is the best agency to undertake raising the standard of conduct for financial professionals and harmonizing it across all investment categories and types of advisors, and Clayton said he “firmly believes” it is.

Diversity and Inclusion
Waters expressed her concern about a lack of diversity at public companies, particularly in Silicon Valley. Waters stated that some on the committee would be looking closely at diversity issues going forward, and at ways Congress can make progress in this area. Rep. Greg Meeks (D-N.Y.) asked if the board diversity rule was back on the agenda at the SEC, and if the rule would be enhanced to give investors more information about the composition of their boards. Clayton responded it was on the agenda, and that he expects the rule to move forward in some form.

Cybersecurity
Rep. Blaine Luetkemeyer (R-Mo.) noted that the SEC’s 2016 data breach was not disclosed to the public until the fall of 2017, and asked if the SEC and other federal agencies should be held to the same disclosure standard as the entities they regulate. Clayton said that while disclosure is important, there are national security concerns that apply to federal agencies that weigh against immediate disclosure.

There was discussion throughout the hearing on the SEC’s recently issued guidance on cybersecurity disclosure by public companies. Royce asked if the SEC has observed an increase in cyber risk and attack disclosure since the guidance was issued. Clayton said that he has seen an “improvement” in disclosure about cyber risks and attacks since the guidance was published.

E-Delivery
Rep. Brad Sherman (D-Calif.) commended the SEC for finalizing Rule 30e-3, which changes the default delivery method of mutual fund disclosures from paper to electronic delivery. Sherman asked what more the SEC can do on electronic delivery to benefit investors. Clayton responded that the SEC is looking to modernize rules, including those on communication and modernizing the delivery of data to the investment community, and he soon expects a vote on XBRL.

Gun Control
Rep. Carolyn Maloney (D-N.Y.) asked if Clayton’s SEC votes would be based on whether companies who support the rule have policies related to gun control. Clayton responded that he peruses all rulemakings and all enforcement in the best interest of investors who put into our markets.

Cryptocurrency
Loudermilk stated that while cryptocurrency is used for illicit acts, such as money laundering and human trafficking, blockchain technology should be paid close attention to as it could potentially solve many cybersecurity issues, to which Clayton agreed.

Rep. Warren Davidson (R-Ohio) stated the importance of Congress and the SEC “lead[ing] the way” in clarifying the difference between a security or commodity when it comes to ICOs. Clayton replied that the SEC is bringing clarity to the markets through issuing guidance, but that he will not change existing rules due to having new technology. Davidson then asked why Reg A+ decisions have been delayed, whether they are “going through a different set of scrutiny” for being ICO-type companies. Clayton said that the reason decisions are delayed is usually due to deficient filings that have to be resubmitted.

Securities-Based Swaps
Rep. Frank Lucas (R-Okla.) asked if the SEC is engaging with the CFTC on securities-based swaps. Clayton said they have set up a bilateral process to work through the rules with the hope of harmonizing. Clayton added that if harmonization is not possible, they will seek to at least not have inconsistent rules that would create problems.

Access Fee Pilot
Maloney asked Clayton when the access fee pilot rule would be finalized. Clayton said that the pilot is on the SEC’s “near-term agenda” and would probably be finalized sometime this fall.

FINRA Rule 4210
Rep. Randy Hultgren (R-Ill.) asked about FINRA’s Rule 4210, which would require broker-dealers to collect margin from customers for Covered Agency Transactions, including transactions in the “To-be-announced” market for agency mortgage-backed securities (MBS). Hultgren asked if FINRA has the authority to regulate this way, and if the SEC is aware of the concerns that Rule 4210 will create an uneven playing field in Agency securities. Clayton agreed that FINRA has the authority to regulate broker-dealer conduct and said that margin requirements are part of that regulation. Rep. French Hill (R-Ark.) raised similar concerns about Rule 4210, and Clayton agreed that it is important rules not unevenly impact similar market participants.

Consolidated Audit Trail
Rep. Bill Foster (D-Ill.) asked Clayton to describe the current status of the Consolidated Audit Trail (CAT) and for an update on operational milestones. Clayton said that the SEC has a draft work plan from the self-regulatory organizations (SROs) and is making progress on implementation. Foster then asked for Clayton’s thoughts on how best to identify the beneficial owner of securities or the people who benefit from certain trades. Clayton said that the CAT will make it easier to get data on bad behavior, and that customer reporting information is an important part of the CAT.

Corporate Governance
Rep. Ed Royce (R-Calif.) described the market for proxy advisors as one where two firms have a “stranglehold” on the market. He asked Clayton what the main causes of the duopoly are, and if the duopoly benefits shareholders. Clayton said that the SEC is looking at the role of proxy advisors closely, as they are important for public markets.

Rep. Keith Ellison (D-Minn.) asked Clayton about Commissioner Robert Jackson’s recent call for the SEC to reopen the rules governing stock buybacks. Clayton said that the SEC’s rules cover the disclosure of stock buybacks and other uses of capital by companies, as well as disclosure of when executives sell stock. He did not directly respond to Ellison’s call.

Rep. Keith Rothfus (R-Pa.) asked Clayton for his thoughts on Sarbanes-Oxley and its effectiveness. Clayton said that the 404(b) requirements have a higher relative burden on smaller issuers than on larger ones, and that the SEC staff is looking at 404(b) and will be a subject of discussion at the next open meeting of the Commission.

Floating Net Asset Value
Royce asked Clayton about a bill the Financial Services Committee favorably reported in 2017 that would allow money market funds to use a fixed, instead of floating, net asset value (NAV). Royce asked if Clayton stood by his 2017 comments urging caution about disrupting the floating NAV rule (put in place in 2016) to avoid roiling short-term funding markets. Clayton responded that his stance has not changed.

Non-Bank SIFI Designation
Rep. Bruce Poliquin (R-Maine) brought up H.R. 4061, the Ross-Delaney Financial Stability Oversight Council Improvement Act of 2017. Poliquin asked Clayton to look at the bill’s proposed changes to the SIFI designation process at the FSOC, and Clayton assured him that the concerns of non-banks regarding SIFI designation would be discussed by the FSOC.

Insider Trading
Himes stated that he sent a letter to the Chairman asking for the SEC and FINRA to look at insider trading, noting that the “legal ambiguity” is “inconsistent, unpredictable, and fuzzy,” and asked if Congress should define the crime of insider trading. Clayton replied that he is unsure if a statutory approach would bring more clarity, but that he is happy to discuss it.

Small Business Audit Correction Act of 2018
Hill asked about H.R. 6021, the Small Business Audit Correction Act of 2018, and if Clayton supported the bill and its proposed creation of a permanent waiver for small, non-custodial brokers from the PCAOB’s public audit company requirements. Clayton said “the short answer is yes.”

Volcker Rule
Hill noted that the five Volcker regulators have recently released a new “Volcker 2.0” proposal. Hill asked Clayton if the SEC would diligently read comments on the proposal, and Clayton said the Commission would.

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