SEC Oversight Hearing

Senate Committee on Banking, Housing, and Urban Affairs

Oversight of the U.S. Securities and Exchange Commission

Tuesday, September 14, 2021

 

Witnesses

• Gary Gensler, Chair, U.S. Securities and Exchange Commission

 

Opening Statements
Chairman Sherrod Brown (D-Ohio)
In his opening statement, Brown discussed the disconnect between the stock market and the real economy and the impact of the pandemic. He also discussed pandemic related fraud, the Securities and Exchange Commission’s (SEC) work to combat predatory behavior, and the rise of special purpose acquisition companies (SPAC). He charged Gensler with ensuring that efficient markets are balanced with strong enforcement, critiqued actions by the previous Administration, and praised efforts by the current Administration.

Ranking Member Pat Toomey (R-Penn.)
In his opening statement, Toomey discussed the SEC’s bipartisan history of administering securities laws and his previous comments and worries about Gensler, which he believes have come to fruition. He then critiqued Gensler’s work so far, including Gensler’s criticism of payment for order flow (PFOF) and mobile trading applications. Toomey also discussed cryptocurrency, whether cryptocurrency is a security for regulatory purposes, and the lack of SEC guidance on this question.

Testimony
Gary Gensler, Chair, U.S. Securities and Exchange Commission
In his testimony, Gensler touched on three main areas of focus for the SEC. First, regarding market structure, he has asked staff to look at five projects across the capital markets: the Treasury market, non-Treasury fixed income markets, equity markets, security-based swaps, and crypto asset markets. The second issue he flagged is technology, focusing mostly data analytics and crypto assets. Gensler said there is currently not enough investor protection in crypto finance, issuance, trading, or lending, and called it the “Wild West” or “buyer beware” that existed before the securities laws were enacted. He said this asset class is rife with fraud, scams, and abuse in certain applications and asked SEC staff to work with fellow regulators along two tracks: how to work with other financial regulators under current authorities to best bring investor protection to these markets, and what gaps exist that Congress can help the SEC fill. The final area of focus Gensler flagged was issuer disclosure, and he said today’s investors are looking for consistent, comparable, and decision-useful disclosures around climate risk, human capital, and cybersecurity. He added that he asked staff to develop proposals for the Commission’s consideration on these potential disclosures and they will be put out to public comment to have robust public discussion as to what information matters most to investors in these areas.

Question & Answer
SPACs
Brown asked what risks SPAC markets have highlighted this year. Gensler said the main risks are to investors and the disclosures to the investors. He asked SEC staff to come up with recommendations. Gensler also said a big issue is that most institutional investors are selling their shares at the de-SPAC transaction, leaving retail investors holding the significant cost of the bankers and promoters. He said they are looking at greater disclosures and if there are inherent conflicts of interest throughout the SPAC process and that they plan to put it out for notice and comment.

Executive Compensation
Brown asked why it is important to have strong rules about executive compensation and to disclose the relationship between executive pay and financial performance. Gensler said if there is a material misstatement or omission in the financials, and they need to be restated, the executive should give up the performance-based compensation if it was based on faulty numbers.

Cybersecurity
Sen. Jack Reed (D-R.I.) mentioned his efforts to pass Cybersecurity Disclosure Act and asked if the framework in S.808 is appropriate for dealing with cyber issues. Tester asked for the list of cybersecurity requirements the SEC is looking at implementing. Gensler said he has asked staff to explore two workstreams, including one about company disclosures and looking at “cyber hygiene” or how a company manages its risk. He said the second effort is to look at incident reporting and what a company says to the public when a breach occurs. Gensler said they are looking at Reed’s bill and would potentially include it as a recommendation.

Treasury Markets
Reed asked about any efforts to look into Treasury markets and mentioned the volatility in March 2020. Gensler said the Treasury market issue is a main area he is hoping will have bipartisanship and noted he is working the Federal Reserve Chair Powell and Treasury Secretary Yellen to bring more resiliency and safety to markets to lower the cost to taxpayers.

Sen. Jon Ossoff (D-Ga.) asked about money market funds and Treasury markets presenting risks. Gensler said the functioning of Treasury markets has presented risks nearly three times (October 2014, Fall 2019, and Spring 2020), and he hopes to create more resilience in the central clearing of that market and bring high frequency trading firms into that remit. He said money market reform is also on the docket and hopes to look at the liquidity rules in that market as well as open-end bond funds.

Payment for Order Flow
Reed asked if the SEC is evaluating whether the PFOF practice is fair to consumers. Sens. Tim Scott (R-S.C.) and Thom Tillis (R-N.C.) asked Gensler about his critique of PFOF. Gensler said he asked staff to look at the inherent conflicts of PFOF and rebates on the stock exchanges, arguing they make the markets less efficient. He said retail investors may not be getting best execution, even if they may be seeing a little price improvement but also that it is potentially being measured against the wrong instrument. He said it is harder to get best execution when not competing order to order. Tillis asked if retail brokers should be able to route orders to the market. Gensler said he asked staff to look at the whole national market structure and added that all changes including rebate, tick size, and national best offer, should be on the table. Gensler discussed ensuring competition in the market, access to retail investors, and said that the cost of investing can be improved, but that costs still exist with PFOF.

Gamification
Tillis asked how Gensler would describe gamification and if government should prevent it. Gensler said the role of the SEC is to protect investors, so the question is whether conflicts arise. Tillis asked if restrictions on gamification would be applied to any other lottery or gamified ventures. Gensler responded by highlighting how market participants could be marketing to different parties differently.

Sen. Catherine Cortez Masto (D-Nev.) asked Gensler to talk about his concerns with gamification and the SEC’s progress on the issue. Gensler said the SEC is about to put out a GameStop report and has asked for public comment on gamification. He added that on gamification, the issue is if the data analytics are maximizing the platform’s revenues, that may conflict with user investment returns. He also said that trading applications are not free, despite zero commission trading.

Diversity
Sens. Bob Menendez (D-N.J.) and Raphael Warnock (D-Ga.) asked Gensler about the SEC Asset Management Advisory Committee’s recommendations on diversity. Gensler said he asked staff to look at those and other recommendations but would not commit to a timeline on Commission consideration. Gensler also referenced disclosure regimes as a tool to increase diversity. Warnock asked what the SEC is doing or could do to encourage investor capital funds to look outside their geographical area for investment and opportunity. Gensler said the SEC encourages competition by lowering the cost of raising money for small entrepreneurs.

Political Spending
Sen. Jon Tester (D-Mont.) said billions of dollars are going into the political system in an untransparent way and that the SEC has the power to require companies to disclosure corporate political spending. Tester and Menendez asked if shareholders should have access to that material information. Gensler said to the extent that investors want to see that information, and they are seeing that this is the case, they will put it out for notice and comment. Menendez asked if shareholders of companies that make public pledges expect their companies to act in a manner consistent with those pledges. Gensler said that idea is at the bedrock of securities law including in the Securities Act of 1933.

Remote Inspections
Menendez asked if the SEC plans to extend remote inspections given the spread of the Delta variant. Gensler said that the SEC is looking at extending remote inspections due to the health realities of the pandemic.

Cryptocurrency
Toomey said the SEC needs to provide more clarity and a sufficient definition with how they would apply the Howey test and added that stablecoins do not have an inherent expectation of profit, questioning how they can be considered securities. Gensler said some are investment contracts, some are not, and that some tokens have been deemed commodities, but many of them are securities. He added that he is not against cryptocurrency but thinks it is best for investors if cryptocurrency assets are inside the investor protection regime and within a public policy framework for anti-money laundering and tax compliance.

Sen. Elizabeth Warren (D-Mass.) criticized the volatility of cryptocurrency and asked if cryptocurrency presents a path to financial inclusion. Gensler said no and that cryptocurrency sounds like a highly speculative asset class.

Sen. Steve Daines (R-Mont.) asked what the SEC’s process is to provide guidance on cryptocurrency and what outcome is to be expected from companies meeting with the SEC. Gensler said there is a registration process for securities and that there are ways to work with the SEC in this process. Daines asked what role Gensler sees the CFTC playing with respect to oversight of the cryptocurrency sector. Gensler said he believes the CFTC has an enforcement authority on commodities, not regulatory authority like the SEC.

Cortez Masto asked if the SEC is equipped to keep pace with the cryptocurrency market and what the Senate Banking Committee can do to help. Gensler said that the SEC could use more funding and that Congress can weigh in legislatively on several issues in that space.

China
Sen. John Kennedy (R-La.) asked about the Holding Foreign Companies Accountable Act and reducing the compliance window from three years to two and asked Gensler if he would support the Senate in pushing the House to pass this change. Gensler said he will support it. Daines asked what the SEC is doing to ensure that Americans’ personal information is not transferred to the Chinese government. Gensler said it is an important issue to protect Americans’ personal information. Sen. Chris Van Hollen (D-Md.) asked Gensler to expand on his statements about reviewing Chinese companies listed on U.S. exchanges. Gensler said we should enhance the disclosures of public Chinese companies.

Climate Risk
Tester said it is irresponsible to not look at the impacts of climate change on the economy and asked Gensler how he views his role a regulator regarding the impacts of climate change. Gensler said his role is about bringing consistent, comparable disclosures where investors want it. Sen. Tina Smith (D-Minn.) asked why climate risk disclosure is an important priority for investors. Kennedy asked why disclosures about climate change would be imposed on companies. Gensler said there can be physical risks and transition risks that investors are demanding disclosures on, and that the SEC has a responsibility to help bring consistency and comparability to climate risk disclosure if it is wanted.

Ossoff asked Gensler how climate change affects the SEC’s mission to protect investors and facilitate capital formation. Gensler said they are taking up two initiatives: increasing ESG disclosures and standards of greenhouse gas emissions; and on the fund management side, looking more into funds that claim to be “green”, “sustainable”, or “carbon-free”. Cortez Masto asked what was meant that investors should know what is “under the hood” of green or sustainable funds. Gensler said that investors should know what is behind the marketing of green or sustainability and that there should be a standard for that marketing.

Front Running
Tillis discussed provisions used by the SEC to prosecute individuals for front running and asked if the practice of frontrunning is illegal. Gensler said frontrunning is against the rules Tillis described and against the rules of the exchanges.

Fraud Prevention
Warnock asked what tools and resources Congress can use to protect retail investors from fraud. Gensler said the SEC needs more funding to match or exceed its 2016 funding level and bring more individuals into the investor protection remit.

Whistleblower Protections
Van Hollen mentioned a whistleblower case in which the SEC did not compensate the whistleblower because the company in question went bankrupt and the SEC was not able to collect from the company. He asked if the SEC can ensure that the whistleblower can get what he normally would, and if not, if the SEC could work with the Senator on legislation to correct that issue in order to properly incentivize whistleblowers. Gensler agreed and said he looks forward to working with Van Hollen on the matter but that he is unsure whether a change in law is required.

Innovation Protections
Sen. Cynthia Lummis (R-Wy.) mentioned innovation and asked how to improve the use of no-action relief. Gensler said whether it is in the cryptocurrency space or other innovative spaces, he wants people to come in and talk to the SEC about things like custody rules or transfer agents. Lummis asked how to right-size the protection around innovation. Gensler said it is the core of the policy framework to ensure the public is not defrauded and that if you hold someone’s asset, you do not misuse or abuse it. He added that when it comes to trading platforms, allowing more competition brings more efficiency to the markets.

Investing in Human Capital
Brown asked why it is important to have disclosure standards that are consistent across companies about how they treat their workers. Gensler said investing in workforce and human capital is critical to the valuation of a company and that the SEC will put it out for public comment and see what investors have to say.

Sen. Mark Warner (D-Va.) asked Gensler for his thoughts on creating a research and development tax credit equivalent for companies that invest in upscaling low or moderate-pay workers. Gensler said human capital is a critical asset and the SEC has looked closely at Warner’s bill, and they want to put it out for notice to see if investors also want this information.

LIBOR
Ossoff asked Gensler what the greatest systemic risks are to the U.S. financial system. Gensler said the current biggest risk is healthcare, but also mentioned the transition away from London Interbank Offered Rate (LIBOR), though being handled well, is something that still presents a risk to the U.S.

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