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House Financial Services Committee SEC Oversight Hearing

House Financial Services Committee

“Oversight of the Securities and Exchange Commission: Wall Street’s Cop on the Beat”

Tuesday, September 24, 2019

Key Topics & Takeaways

  • Consolidated Audit Trail: Asked whether the SEC supported the SRO’s proposal, Clayton answered that he does not feel the SEC needs much more information beyond name, year of birth and account details, and that eliminating some other fields would not impact the SEC’s ability to regulate markets. Peirce commented that the SEC already has a system in place, the blue sheet system, that allows it to get the information it needs, and she worries that collecting investor information for the CAT database would create an “extremely attractive target.”
  • Derivatives: Asked about the cross-border application of derivatives rules required under Dodd-Frank and harmonization between the SEC and the Commodity Futures Trading Commission (CFTC), Clayton called it a difficult issue, saying he is working with colleagues at the CFTC to “draw the line in a way that makes sense” for the involved parties and address systemic risk. He noted that other areas for harmonization include inspections and reporting.
  • Regulation Best Interest: Asked whether Reg BI weakens existing law and poses more risk to investors, Jackson replied that he dissented when the rule was adopted because the law should be clear that when there is a conflict of interest the investor should come first. Asked to respond to criticisms of Reg BI, Clayton said that there are “overarching” obligations for broker-dealers and investment advisers to put their clients’ interests first, as well as disclosure obligations, care obligations, conflict mitigation obligations, and policies and procedures obligations.
  • Statute of Limitations: Asked about the effect of the Kokesh v. SEC decision on the SEC and investors, Clayton replied that it was adverse for defrauded investors and the markets generally, saying that he “want(s) to see a fix” for the Kokesh issue and that it is a focus of the SEC to address wrongdoing “swiftly and decisively.”

Witnesses

Opening Statements

Chairwoman Maxine Waters (D-Calif.)

In her opening statement, Waters noted the importance of the Committee hearing from each commissioner, as each holds a vote on critical regulatory and enforcement matters. Waters stated that the Securities and Exchange Commission (SEC) is not fulfilling its mission as Wall Street’s cop, noting such issues as the Volcker Rule, executive compensation, and Regulation Best Interest (Reg BI). Waters continued that existing securities laws have loopholes that corporate insiders are taking advantage of, particularly the 8-K trading gap. Waters added that the Kokesh v. SEC Supreme Court decision limited the SEC’s ability to recover wrongful gains from fraudsters, saying that stronger rules are needed to protect investors and punish bad actors.

Ranking Member Patrick McHenry (R-N.C.)

In his opening statement, McHenry noted that the SEC has a “critical” three-part mission: to protect investors; to maintain fair, orderly and efficient markets; and to facilitate capital formation. He added that without capital formation, the first two pillars “could not exist.” McHenry stressed the importance of helping investors by making the markets stronger, more attractive and more competitive. McHenry said that expanding mandatory disclosures would add to regulatory costs, make it more expensive and onerous for companies to go public, and weaken the market, depriving investors of opportunities. McHenry said he encourages efforts to expand investor access, reduce regulatory barriers and increase competitiveness.

Rep. Carolyn Maloney (D-N.Y.)

In her opening statement, Maloney stressed that the most important action the SEC has recently taken was finalizing Reg BI in June. Maloney said that while it was intended to raise the standard of conduct for broker-dealers, the rule is “far too weak” and also weakened the fiduciary standards for investment advisers, calling this “completely unnecessary.”

Testimony

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

In his testimony, Clayton said the interests of Main Street investors are “front of mind,” including returning funds to harmed investors, enhancing investor protection and improving access to investment opportunities. Clayton noted that in June the SEC adopted Reg BI, a “long overdue” package of rules and interpretations to “require candor” and impose other responsibilities on broker-dealers and investment advisers in their dealings with Main Street investors. He continued that for the first time, regardless of whether a financial professional is a broker-dealer or investment adviser, the customer is entitled to a recommendation in their best interest that does not put the interest of the financial professional ahead of the investor. He said this rulemaking package was informed by decades of expertise and unprecedented direct stakeholder engagement.

Clayton said that there have been substantial changes in the markets over the last two decades, including that private markets now outpace public markets in many measures. He said that the attractiveness of U.S. public markets must increase, and the SEC must explore whether it can help increase opportunities for Main Street investors in private markets while maintaining investor protection.

The Honorable Robert J. Jackson Jr., Commissioner, U.S. Securities and Exchange Commission

In his testimony, Jackson highlighted a number of areas where closing gaps in existing securities law would be “especially critical” for investors. Jackson said disclosure rules have not kept up with the pace of today’s markets, particularly concerning the 8-K trading gap, and expressed his gratitude that the Committee has taken up legislation to address this issue. Jackson also noted that current rules incentivize corporate insiders to pursue stock buybacks that maximize executive pay but “make no sense” for ordinary investors, adding that SEC rules should not incentivize such buybacks. Jackson stated that the SEC should consider giving investors much more transparency into how public companies spend their money on politics as a significant amount of corporate political spending is not disclosed under current law. Jackson said disclosure is the solution to this issue, noting that more than 1.2 million Americans have written to the Commission urging the adoption of rules to address this.

The Honorable Hester M. Peirce, Commissioner, U.S. Securities and Exchange Commission

In her testimony, Peirce said she applies three principles when carrying out her duties: that investor protection is more than protecting against fraud, and also includes protecting opportunities; that enforcement is important, but regulation is the key to the SEC’s work; and that as regulators, the commissioners cannot and do not know everything. She noted the importance of compliance and enforcement actions to ensure that institutions and individuals are fulfilling their roles to benefit investors and the markets. Peirce stressed the importance of investors having clear, adequate and truthful information, saying investors are the ones best situated to decide which products suit their needs and goals and that the SEC should not impose unnecessary limits on opportunities for investors to buy products. Peirce said that the SEC is working to codify exemptive orders and review no-actions to determine where a permanent framework is necessary. Peirce also highlighted that the SEC must “take a second look” at the Consolidated Audit Trail (CAT) and whether it is right for a government regulator to collect purchase and sale information on every U.S. retail investor regardless of whether they have been accused of wrongdoing.

The Honorable Elad L. Roisman, Commissioner, U.S. Securities and Exchange Commission

In his testimony, Roisman said the U.S. capital markets are the envy of the world and that the importance of the SEC cannot be overstated. He highlighted the importance of maintaining fair, orderly and efficient markets, saying that market integrity is a high priority. Roisman added that the SEC closely assesses how the markets are working, whether they work as intended, and whether there is room for improvement, particularly in areas such as senior investor protection, capital formation, issuers’ ability to conduct registered public offerings, the proxy process and issues faced by small businesses.

The Honorable Allison Herren Lee, Commissioner, U.S. Securities and Exchange Commission

In her testimony, Lee said it is the job of the SEC to protect and strengthen the economic wellbeing of Americans and American businesses, saying that the SEC’s highly complex issues and rules should be analyzed through this lens. She noted that the Committee has identified a number of critical issues for discussion, including the amount of capital raised in public versus private markets, the importance of ensuring public companies disclose in the most effective manner possible the information investors need to make informed decisions, enforcement and the SEC’s ability to retrieve money from fraudsters, digital assets, and the role of intermediaries in the markets. She said that it is important for the SEC to be held accountable by the public, the entities it regulates and Congress.

Question & Answer

Regulation Best Interest

Maloney asked Jackson whether Reg BI weakens existing law and poses more risk to investors. Jackson replied that he dissented when the rule was adopted because the law should be clear that when there is a conflict of interest the investor should come first, but that the adopted rule created a “muddled standard.” Asked by Maloney how to correct this, Jackson said the SEC should use its authority under Section 913G of the Dodd-Frank Act to set a strong uniform standard regarding investment advice.

Rep. Al Green (D-Texas) asked whether investment advisers are true fiduciaries. Jackson replied that he dissented when the Commission voted on Reg BI because he did not feel the final rule was clear enough on this question. Clayton, however, stated that the rule made clear “for the first time” that neither investment advisors or broker-dealers can put their interests ahead of the client’s.

Rep. Bill Huizenga (R-Mich.) asked Clayton to respond to criticisms of Reg BI. Clayton said it is not a “watered down” rule, and that in fact there are “overarching” obligations for broker-dealers and investment advisers to put their clients’ interests first, as well as disclosure obligations, care obligations, conflict mitigation obligations, and policies and procedures obligations.

Statute of Limitations

Rep. French Hill (R-Ark.) expressed his support for H.R. 4344, which would extend from 5 to 14 years the statute of limitations on the SEC’s authority to pursue claims for disgorgement. He commented that he was “not keen” on extending to 14 years and would have preferred 10, but ultimately supported the compromise.

Rep. Ben McAdams (D-Utah), the sponsor of the legislation, asked about the effect of the Kokesh v. SEC decision on the SEC and investors. Clayton replied that it was adverse for defrauded investors and the markets generally, saying that he “want(s) to see a fix” for the Kokesh issue and that it is a focus of the SEC to address wrongdoing “swiftly and decisively.”

Consolidated Audit Trail

Hill voiced his concerns over the CAT, likening it to the previous CARDS proposal that he opposed and questioning the need for the government to “micromanage” with a new market surveillance tool.

Rep. Barry Loudermilk (R-Ga.) called cybersecurity the “greatest threat” to American businesses, investors and consumers, and commented that we often overlook a “basic premise” of cybersecurity – that you “don’t have to secure what don’t have” and that information that is not absolutely needed should not be kept. He pointed out that the CAT database of personal and transaction information would be a prime target for bad actors, nation states and criminals, and welcomed a proposal from the SROs to limit personal information collection to name, year of birth and address. He asked whether the SEC supported the SRO’s proposal. Clayton answered that he does not feel the SEC needs much more information beyond name, year of birth and account details, and that eliminating some other fields would not impact the SEC’s ability to regulate markets.

Peirce commented that the SEC already has a system in place, the blue sheet system, that allows it to get the information it needs, and she worries that collecting investor information for the CAT database would create an “extremely attractive target.”

Rep. Warren Davidson (R-Ohio) noted that last Congress he proposed the Market Data Protection Act, which passed the House but not the Senate and would have required the SEC, the Financial Industry Regulatory Authority (FINRA) and the CAT operator to implement internal risk control mechanisms before the CAT could accept any market data. He said he was encouraged by direction of the SEC on limiting the collection of PII and suggested that blockchain technology could play a role in addressing data security concerns.

Rep. Bill Foster (D-Ill.) asked Clayton to provide an update on the implementation of the CAT. Clayton acknowledged that the CAT is behind schedule, but that the SEC and SROs have coalesced around a schedule with 3-4 milestones.

Foster asked if the SEC plans on using a unique identifier for market participants. Clayton said the SEC wants to have enough information to understand where a trade is coming from and that it has settled on a unique identifier. Foster added that international cooperation will be needed to ensure that no one can use multiple identifiers from other countries, saying that unless regulators must be able to recognize the ultimate beneficial owners or else regulation would not work. Clayton said there is no specific plan to address this, but that it is an important issue.

Capital Formation

McHenry highlighted that there are fewer public listings today than 20 years ago. Clayton called this a “big concern,” noting that the SEC’s oversight of private markets is not the same as that of public markets. Asked if investors can be confident their investments are protected, Clayton said that the SEC must be cognizant of how it regulates private versus public markets. He added that public market rules need to be fair, and if the rules incentivize companies to stay private, Main Street investors cannot fully participate.

Hill urged the SEC to focus on lowering the costs of companies going public and reducing burdens that would impose new costs.

Rep. Scott Tipton (R-Colo.) said he was pleased to see that the SEC had established its Office of the Advocate for Small Business Capital Formation (OASB) and asked about the role of the office. Clayton explained that the OASB is very important to the Commission and that it would consider regulatory impediments that can be lifted without jeopardizing investor protection and explore the elements of an environment that drives small business capital formation, particularly in the “middle of the country” where he said entrepreneurship is “anemic” compared to the coasts.

Derivatives

Rep. Frank Lucas (R-Okla.) asked about the cross-border application of derivatives rules required under Dodd-Frank and harmonization between the SEC and the Commodity Futures Trading Commission (CFTC). Clayton called it a difficult issue, saying he is working with colleagues at the CFTC to “draw the line in a way that makes sense” for the involved parties and address systemic risk. He noted that other areas for harmonization include inspections and reporting.

CECL

Reps. Brad Sherman (D-Calif.), Blaine Luetkemeyer (R-Mo.) and John Rose (R-Tenn.) asked about the current expected credit loss (CECL) accounting standard. Luetkemeyer asked whether the SEC has asked the Office of Financial Research (OFR) to study the proposal. Clayton replied that it has not, but he agreed that if there was a belief that something would have an adverse effect on the economy it should be examined, adding that it was a “wise step” for the Financial Accounting Standards Board (FASB) to evaluate the initial implementation. Clayton said he would not specifically commit to asking the OFR to conduct a study, but will continue to discuss the issue within the Financial Stability Oversight Council (FSOC).

Repo Market

Rep. Gregory Meeks (D-N.Y.) noted that interest rates in the repo market “skyrocketed” in the previous week and the Federal Reserve announced it would inject $400 billion into the market. He explained that in 2010, the SEC proposed a short-term borrowing rule regarding repo liabilities and asked if the SEC should finalize this disclosure rule. Clayton responded that understanding liquidity needs is essential to good oversight, but since that rule was proposed a number of disclosure requirements instituted at the SEC and other regulators have addressed many of the underlying issues. He added that liquidity in the repo market is something the SEC should continue looking at.

Diversity

Meeks asked about the SEC’s voluntary diversity assessment disclosure, noting that it has a response rate of five percent. Clayton replied that he has met with the director of the SEC’s Office of Minority and Women Inclusion (OMWI) on several occasions and they are working together to improve the response rate. Rep. Juan Vargas (D-Calif.) asked the commissioners if they consider diversity to be a valuable asset to a company. Lee replied that she does, adding that more disclosure at the board level and workforce level would be valuable to investors. Jackson agreed, saying it is a “scandal” that the goal that women hold 30 percent of board seats in the U.S. has not yet been reached, and adding that diversity should be encouraged at all levels within public companies.

Stock Buybacks

Rep. Lacy Clay (D-Mo.) asked whether stock buybacks should be curtailed. Jackson replied that research shows buybacks allow executives an opportunity to cash out their personal shares, creating a “conflict of interest problem” that deserves attention. Jackson noted that the SEC has not reviewed stock buyback rules in over a decade, calling for a review and comment period on the issue.

Rep. Bryan Steil (R-Wis.) called stock buybacks a capital allocation issue, asking whether this is a question for the SEC or for private company management. Clayton agreed that it is not within the SEC’s purview to judge whether a company engages in a stock buyback, but it is the SEC’s duty to ensure a buyback does not result in market manipulation.

Leveraged Lending

Rep. Andy Barr (R-Ky.) asked about leveraged lending and how the SEC oversees such activities and shares information with prudential regulators. Clayton said that the economy is more credit-based, but the amount of credit provided directly from the banking sector has gotten relatively smaller. He said the SEC has discussed the issue with the Federal Reserve, Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), among other regulators. Barr asked, given the SEC’s oversight of investment advisers, if Clayton sees this as a systemic issue, to which Clayton replied that he does not.

LIBOR

Rep. David Scott (D-Ga.) commented on the importance of the London Interbank Offered Rate (LIBOR), noting that it underlies $400 trillion in contracts globally, and asked about the impacts of the transition away from LIBOR to alternative reference rates. Clayton replied that the LIBOR transition is an issue that requires regulators’ attention, and that shifting to an alternative rate will cause “some friction” and policymakers must work to reduce this friction as much as possible.

Financial Education

Scott discussed the importance of financial education, noting that up to 60 million people in the U.S. are unbanked or underbanked and that “less than 17” state school boards and associations require courses to promote financial education. Clayton said he agreed on the importance of financial literacy and education.

Fintech

Scott asked Peirce about the harmonization of regulatory approaches to financial technology (fintech). Peirce responded that there has been significant activity outside the U.S., and that she aims to bring more regulator clarity in the U.S. so that fintech innovation can take place domestically.

Regulatory Review

Tipton asked Peirce about the need to review regulations to see if they are working as intended, commenting that while he wants “to have guardrails in place,” he does not want overly burdensome rules. Peirce replied that the SEC is exploring whether it can eliminate duplicative requirements, streamline existing requirements, and consider more principles-based requirements that would continue to be effective over time. She said all this could make a big difference for companies trying to raise capital.

Data Privacy

Tipton asked whether the SEC is looking into developing more data privacy regulations that would help Americans understand what can be done with their data regardless of their state of residence. Clayton said the SEC has not considered any federal preemption of states’ data privacy laws, but agreed that Tipton had raised a good point.

Digital Assets

Waters expressed concerns about Facebook’s proposed Libra cryptocurrency. Clayton said that while cryptocurrencies have benefits, there is also a great deal of risk, particularly when they are not regulated in the same way as they operate, whether as a security, currency, or payment system. McHenry also expressed concerns about Libra, to which Peirce replied that companies have work to do to ensure they are complying with the rules, adding that she would like to see the SEC be “more forward-thinking” regarding how the Commission accommodates the unique aspects of digital assets.

Green commented on Facebook’s Libra cryptocurrency and dividends that would be paid out from the interest earned in the Libra reserve account, and asked whether this would make Libra a security. Clayton answered that many lawyers have probably “spent a lot of time” looking at this question, and while he declined to make a judgment at this time, agreed that Green has articulated some of the issues that the SEC would have to consider.

Rep. Emmanuel Cleaver (D-Mo.) noted a statement from Facebook that its Libra digital currency would not be launched until regulatory concerns have been addressed. He asked whether the SEC has communicated any specific concerns to Facebook, to which Clayton replied that any company launching a digital asset that might look like a security should “come talk to us.”

Davidson said the current company-by-company approach to assessing digital assets lacks regulatory clarity and is leading to capital fleeing to other jurisdictions. He argued that the U.S. needs a simple set of rules that would apply equally to all firms. He said the SEC should not only be concerned about fraud, but also consider the opportunity that digital assets could represent. He noted that he proposed H.R. 2144, the Token Taxonomy Act, to provide such a simple set of rules. Peirce agreed that having a clear law would enable people to make decisions, and that the SEC could use its enforcement powers based on such a law.

Rep. Ted Budd (R-N.C.) noted that in April the SEC’s Strategic Hub for Innovation and Financial Technology (FinHUB) published a framework for analyzing whether a digital asset is a security, which included 60+ factors to consider. He asked whether the guidance has resolved market participants’ most pressing questions, and whether the SEC should have also indicated how it would weigh these factors. Peirce replied that she has heard from people that they would like to see the weighting of the factors, and added that the guidance was well-intentioned but that it did “muddy the waters.”

Budd asked when market participants could expect an exhaustive overview of the law so they could get the regulatory certainty needed to innovate and create jobs. Peirce said she was hoping to create “some sort of safe harbor,” which she thinks is the best way to provide clarity, but is open to other suggestions.

Insider Trading

Waters raised the issue of insider trading, asking why it is important to market integrity to fix loopholes in current law, particularly SEC Rule 10b5-1. Jackson said that it is a good area for the SEC to review, as the rule was adopted “some time ago.”

Rep. Jim Himes (D-Conn.) commented that there is no statutory prohibition on insider trading and that the SEC’s authority to prosecute is based on case law that is “far from a solid foundation.” He noted that the Committee had approved his bill, H.R. 2534, which would make insider trading a federal crime, and that he continues to work with the SEC and the minority to reach a compromise on the legislation. He asked whether requiring insider trading to be prosecuted only as laid out in his bill, rather than also relying on the SEC’s anti-manipulation and anti-fraud authority, would help or hamper the Commission’s ability to prosecute insider trading cases. Clayton replied that Himes has done a “terrific job” but that he would not want to lose the body of law that has been built up over the years. Jackson agreed that it would be better to build on long standing case law, which would help achieve greater clarity.

Arbitration

Foster noted that the House recently passed H.R. 123, the Forced Arbitration Injustice Repeal Act (FAIR Act), and that he has sponsored the Investor Choice Act to prohibit public companies from requiring mandatory arbitration in shareholder disputes. He asked Jackson to explain why allowing individual enforcement of securities laws in courts is good for the public. Jackson answered that public and private enforcement of securities laws both help to ensure investors are protected, and that the amounts of money returned from private lawsuits is “quite substantial.”

Foster commented that “few, if any” public companies actually require mandatory arbitration in their governing documents, and so his bill would only codify long-standing practice. Jackson stated that he would support legislation that would send a clear message to companies.

Proxy Advisory Firms

Rep. Ted Budd (R-N.C.) stated that proxy advisory firms have gained “extraordinary and unchecked powers” over the years and that he is concerned shareholders and fiduciaries are relying on recommendations that can contain factual errors. He said recent SEC guidance is an important first step, but urged the Commission to expand efforts to ensure proxy advisory firms act in a transparent manner. Clayton answered that roundtables held last year provided significant input to the SEC and that “our proxy plumbing” is not where it should be and rules for “overall hygiene” are needed. Roisman added that the guidance was an important first step but that the Commission would be looking at possible further action.

Reps. Lance Gooden (R-Texas) and Steil asked about efforts to increase transparency about how proxy firms reach their conclusions and address conflicts of interest. Jackson said there is already some transparency about conflicts, and Roisman added that if proxy firms are responsible for taking a vote on behalf of retail investors, they have to act in the best interest of their clients. Lee, Jackson, Clayton and Peirce all commented that disclosures of conflicts of interest are important.

ESG Disclosures

Reps. Sean Casten (D-Ill.), Katie Porter (D-Calif.), Vargas, Huizenga and Barr asked about environmental, social, and governance (ESG) issues. Asked by Casten whether companies should provide quantitative disclosure about their climate risks, Jackson said the best way to hold companies accountable is to quantify decisions and disclose that to shareholders, adding that it is difficult for investors to understand the risks they face and the sustainability of corporate decisions without such disclosures. Clayton added that he encourages shareholder engagement on this issue.

Vargas asked about proposed changes to Regulation S-K and why the proposal might be problematic for investors. Lee said the SEC heard from financial professionals managing trillions of dollars of investments that such disclosures are important parameters to consider when making investment decisions based on the long-term sustainability and value-building efforts inside a company. She said that comparability of disclosures is important for investors.

Asked whether ESG matters should be deemed “de facto” material, Clayton said that as markets change, what is considered material changes, so a principles-based approach to disclosure is important. Jackson added that when it comes to what is considered material, investors decide.

Senior Investor Protection

Rep. Josh Gottheimer (D-N.J.) discussed senior investor protection issues and asked the panel for their thoughts on H.R. 1876, the Senior Security Act of 2019, which would create a task force at the SEC to study senior investor issues. Clayton agreed that everything possible should be done to protect seniors from fraud and said he would support having such a task force report to him on the issue. Jackson added that the SEC must do everything it can on this issue, and Peirce said that the issue is complicated, so a task force would be helpful.

For more information on this hearing, please click here.