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House Financial Services Subcommittee Hearing with SEC Chairman Clayton on COVID-19 Response

House Financial Services Subcommittee on Investor Protection, Entrepreneurship,

and Capital Markets

“Capital Markets and Emergency Lending in the COVID-19 Era”

Thursday, June 25, 2020

Key Topics & Takeaways

  • Consolidated Audit Trail: Warren Davidson (R-Ohio) discussed the importance of enhancing the cyber and data security of the consolidated audit trail (CAT), noting the sensitivity of the information that will be stored in the database, including personal information and proprietary trade information. Davidson added that this concern is further highlighted by the SEC’s EDGAR system data breach in 2016. Davidson asked Clayton about his concerns regarding bulk downloading, noting that more than 20 self-regulatory organizations (SROs) will be able to bulk download data from the CAT. Clayton acknowledged that this is a complicated problem. He said they should not start with broad access to the data, but rather the SEC should have access to what they need to fulfill their cross-market obligations, and then evaluate what access others need to do their jobs and that access should be scoped consistent with their obligations.
  • Market Data Fees: Jim Himes (D-Conn.) asked Clayton to clarify whether exchanges have more robust information about the nature of trading markets than is publicly available, which Clayton said is a fair assessment. Himes asked what the difference is, other than legality, between an individual paying a corporate insider for more robust non-public information and a trading entity paying an exchange for more robust non-public information. Clayton said the law requires the SEC to look at whether this is fair and reasonable, noting that privately available data has become more robust and the SEC needs to examine whether that gap is fair.
  • Equity Market Structure: Clayton said that equity market structure has become incredibly complex, noting that virtually all trading is electronic and happens in nanoseconds. He continued that it is the SEC’s job to ensure that wait investors pay for trades is fair and reasonable, saying they are looking at both infrastructure and governance in the way data is distributed.
  • Electronic Delivery: Clayton said that it is clear we are living in an electronic communication world, and COVID-19 response has shown the importance of electronic delivery. He added that anyone who wishes to receive paper documents should be able to.
  • Municipal Advisor Exemptive Relief: French Hill (R-Ark.) noted that the SEC recently issued exemptive relief for municipal advisors, asked what led the SEC to take this action via a temporary order rather than the Administrative Procedures Act process. Clayton said their approach was appropriate, noting that the action is very narrow and temporary. He added that should the relief be expanded or extended it would go through the notice and comment process. Hill continued that the municipal markets have functioned well due to the work of the Federal Reserve and Treasury, questioning the necessity on the relief and asking whether the SEC will make public the entities who make direct placements. Clayton responded that he would not commit at this time to making that information public but would consider the request.

Witnesses

Opening Statements                   

Subcommittee Chairman Brad Sherman (D-Calif.)

In his opening statement, Sherman acknowledged the unprecedented volatility the markets have experienced due to COVID-19. In response to this volatility, he outlined his wishes for how the SEC will continue to function throughout this difficult economic period. Sherman stated that he hopes the SEC channels its available resources to focus on addressing the economic difficulties presented by COVID-19 as well as bipartisan issues. Sherman concluded his statement with a summary of the bills being discussed in today’s hearing.

Subcommittee Ranking Member Bill Huizenga (R-Mich.)

In his opening statement, Huizenga highlighted the present opportunity to address the impact of the pandemic and deliberate over how to modernize and adapt moving forward. He focused on the importance of discovering ways to jumpstart the economy, help small businesses, reduce unnecessary regulatory costs as well as improve access to capital markets for both businesses and investors. Huizenga pointed out that the effects of COVID-19 on the economy will likely be long-lasting. However, he added that by reigniting the economy, jumpstarting businesses, and helping Americans return to work, there will continue to be progress.

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

In his opening statement, McHenry advocated for policies dedicated to making the markets stronger, more attractive, and more competitive in order to progress through this current economic challenge. He acknowledged and thanked the Commission for its efforts in stimulating the economy as well as addressing the current needs of both the market and its consumers.

Testimony

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

In his testimony, Clayton spoke about the recent focus of the SEC in ensuring that markets continue to function as expected. He continued that in working towards this goal, the resources of the Commission have been utilized to facilitate timely decision making and disclosures as well as maintain enforcement examination investor protection efforts. Clayton stated that the Commission has worked with other regulators to preserve the capital in our economy to mitigate potential consequences. He acknowledged that although the markets have been extremely volatile in recent months, they have functioned largely as they are designed to do. Clayton said that the Commission continues to monitor prices, market flows, liquidity and availability of credit to ensure the sustained functionality of the markets. Despite the recent focus on COVID-19 related decisions, specifically incidents of fraud, Clayton concluded by stating that the Commission has continued their traditional agency functions during this volatile period of rulemaking and protecting investors.

Question & Answer

Consolidated Audit Trail

Rep. Warren Davidson (R-Ohio) discussed the importance of enhancing the cyber and data security of the consolidated audit trail (CAT), noting the sensitivity of the information that will be stored in the database, including personal information and proprietary trade information. Davidson added that this concern is further highlighted by the SEC’s EDGAR system data breach in 2016. Davidson asked Clayton about his concerns regarding bulk downloading, noting that more than 20 self-regulatory organizations (SROs) will be able to bulk download data from the CAT. Clayton acknowledged that this is a complicated problem. He said they should not start with broad access to the data, but rather the SEC should have access to what they need to fulfill their cross-market obligations, and then evaluate what access others need to do their jobs and that access should be scoped consistent with their obligations.

In response to a question from Davidson about what internal risk controls should be in place at FINRA and the SEC to ensure data health in the CAT, Clayton said the SEC is evaluating those controls and potential risks.

Rep. Bill Foster (D-Ill.) asked what progress has been made on the CAT, particularly regarding international agreements pertaining to international venues. Clayton said the SEC has made substantial progress on this front, saying he believes we will have a completed CAT that functions as intended.

Market Data Fees

Rep. Jim Himes (D-Conn.) asked Clayton to clarify whether exchanges have more robust information about the nature of trading markets than is publicly available, which Clayton said is a fair assessment. Himes asked what the difference is, other than legality, between an individual paying a corporate insider for more robust non-public information and a trading entity paying an exchange for more robust non-public information. Clayton said the law requires the SEC to look at whether this is fair and reasonable, noting that privately available data has become more robust and the SEC needs to examine whether that gap is fair.

Equity Market Structure

Rep. Ann Wagner (R-Mo.) asked Clayton to describe recently proposed changes to equity market structure and how these improvements will be most valuable to Main Street investors. Clayton responded that equity market structure has become incredibly complex, noting that virtually all trading is electronic and happens in nanoseconds. He continued that it is the SEC’s job to ensure that wait investors pay for trades is fair and reasonable, saying they are looking at both infrastructure and governance in the way data is distributed.

Electronic Delivery

Sherman asked about the SEC’s next steps in evaluating the electronic delivery of investment documents. Clayton responded that it is clear we are living in an electronic communication world, and COVID-19 response has shown the importance of electronic delivery. He added that anyone who wishes to receive paper documents should be able to.

Health of Capital Markets

Huizenga asked Clayton for his perspective on the health of the U.S. capital markets. Clayton said they have been able to stabilize the markets and the flow of credit into the economy. He noted that we are still in a period of uncertainty, but he is hopeful that companies will continue to adjust and be able to operate.

Rep. Trey Hollingsworth (R-Ind.) asked Clayton to clarify that if markets are going down it does not necessarily indicate a problem with market function. Clayton said this has been the greatest period of uncertainty he has seen in the real economy, but highlighted that markets performed “incredibly well.” He said that although it required action by the Federal Reserve, Treasury, SEC and the private sector, credit and capital continued to flow throughout the system during this time.

SEC Rulemakings

Committee Chairwoman Maxine Waters (D-Calif.) called on Clayton to halt all rulemakings not related to COID-19 response. Clayton said the SEC is continuing to pursue its regulatory agenda in an “open way” and is continuing to take comments and engage with the public. Wagner asked for further updates on the SEC’s regulatory agenda, to which Clayton replied that he is optimistic that the SEC will be able to complete virtually all items on its regulatory agenda.

ESG

Reps. Juan Vargas (D-Calif.) and McHenry asked Clayton about ESG disclosures. Clayton said he does not believe employing any single ESG metric would make sense, saying there is ambiguity in those metrics and trying to rank them is not effective. He acknowledged that there are ESG factors that are important to investors, saying the SEC will use a principles-based approach to this issue.

Clayton also said the SEC has tried to give companies as much guidance as possible about how to disclose risk regarding COVID-19.

Fraud Risk

Reps. Josh Gottheimer (D-N.J.), Foster and Wagner raised concerns about fraud risk related to the pandemic. Clayton confirmed that the SEC has seen an uptick in fraud, saying that SEC enforcement staff has been proactive in examining these claims. He encouraged investors to only work with professionals and known entities.

Gottheimer highlighted that seniors are at particular risk, asking whether Clayton supports the Senior Security Act, which would create a Senior Investor Task Force at the SEC. Clayton declined to express support for any specific legislation in this area, but said the SEC is focused on protecting seniors from fraud and ensuring they have access to products appropriate for them.

Municipal Advisor Exemptive Relief

Rep. French Hill (R-Ark.) noted that the SEC recently issued exemptive relief for municipal advisors, asked what led the SEC to take this action via a temporary order rather than the Administrative Procedures Act process. Clayton said their approach was appropriate, noting that the action is very narrow and temporary. He added that should the relief be expanded or extended it would go through the notice and comment process. Hill continued that the municipal markets have functioned well due to the work of the Federal Reserve and Treasury, questioning the necessity on the relief and asking whether the SEC will make public the entities who make direct placements. Clayton responded that he would not commit at this time to making that information public but would consider the request.

Commercial MBS Market

Davidson expressed concerns about disruptions and liquidity in the commercial mortgage-backed securities market. Clayton replied that the SEC is working on this issue.

Diversity & Inclusion

Vargas asked about diversity in the financial services industry as a whole and specifically at the SEC. Clayton said that diversity & inclusion has been a focus of his since his arrival at the SEC and while progress has been made there is more work to do. He added that he has integrated the Office of Minority and Women Inclusion (OMWI) into the hiring process and into the identification of individuals to sit on the SEC’s advisory committees.

Chinese Companies

Reps. Anthony Gonzalez (R-Ohio) and Sherman asked about the audit process for Chinese companies on U.S. exchanges. Clayton highlighted that investors should understand that the SEC’s ability to enforce its rules is not uniform around the world and should take that into account when making investment decisions.

Aid for Small Businesses

Huizenga and McHenry asked questions about how to best help struggling small businesses. Clayton noted that small businesses have different capital and operational needs that large public companies, noting that the SEC has adjusted the crowdfunding rules to recognize this difference.

NRSROs

Reps. Steve Stivers (R-Ohio) and Madeleine Dean (D-Pa.) asked Clayton about the nationally recognized statistical rating organizations (NRSROs) and their involvement with the Federal Reserve’s lending facilities. Clayton said he is in dialogue with the Federal Reserve on their use of NRSROs and providing what data they have to the Federal Reserve so it may make informed judgements about which rating agencies are appropriate for which programs. He continued that some of the agencies participate in a wide variety of markets while others participate in more narrow aspects, saying it is important for the Federal Reserve to understand which NRSROs have sufficient experience to participate in the various facilities.

CECL

Rep. Ted Budd (R-N.C.) asked about the current expected credit losses (CECL) accounting standard and whether it has been subjected to comprehensive field testing and economic impact assessments. Clayton explained that CECL’s performance during this time period should be examined, particularly from an investor perspective.

Private Equity & 401(k) Plans

Rep. Sean Casten (D-Ill.) noted that the Department of Labor (DOL) recently issued an information letter under ERISA to allow 401(k) plan sponsors to have private equity as a component of diversified asset allocation funds, asking whether the DOL can make this change without the SEC making a corresponding change to Regulation D. Clayton explained that the information letter was structured such that ERISA plans could not directly invest in private equity, but rather an ERISA plan fiduciary could choose a fund with limited, but not direct, exposure to private equity.

Proxy Advice

Rep. Bryan Steil (R-Wis.) asked about proxy advice. Clayton said that the SEC is trying to ensure that when making an investment decision, investors have the best information available, saying it is clear the current process can be improved. He noted he plans to have a rulemaking finalized on this issue by the end of the fiscal year.

Private Markets

Casten asked about proposed rules to expand exempt offerings in private markets and whether investors will be protected. Clayton said there is currently a wealth test to determine if an investor is sophisticated, saying he does not believe this is the right approach. Clayton said the SEC is looking at whether there are better tests of sophistication, including passing the Series 7 exam.

Closed End Funds

Gonzalez asked whether closed end funds could present an avenue for expanding investment options for Main Street investors. Clayton said the objective is for retail investors to have access to investment opportunities and for that access to have a reasonable cost. He said the SEC is exploring ways to do that and is making progress.

For more information on this hearing, please click here.