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Senate Banking Committee Hearing with SEC Chairman Clayton

Senate Committee on Banking, Housing, and Urban Affairs

“Oversight of the Securities and Exchange Commission”

Tuesday, December 10, 2019

Key Topics & Takeaways

  • Consolidated Audit Trail: Clayton said that the CAT is a good example of how we should look at a lot of large data projects. He said he agrees with the concern about personally identifiable information, saying the fundamental question is not what data the SEC would like to have, but rather what data is needed to do the job. Clayton explained the SEC is undergoing a process with the SROs and others to “significantly limit” the data to “phonebook information” that will enable the CAT to do its job and function the way it was envisioned. He continued that this will reduce the risk because the data will not be as sensitive. He also noted that it is important for the security protections of the CAT to evolve as the threats evolve. Clayton also said that he is aware of the issue surrounding the allocation of potential liability and is meeting with representatives of the SRO and broker communities to discuss it.
  • Proxy Advisory Rule Proposals: Crapo highlighted the SEC’s proposed changes to proxy rules, asking when the public could expect action, to which Clayton replied the SEC intends for it to be completed within the year. Asked how the proposed rules will ensure proxy firms continue to play an important role in the markets, Clayton agreed that proxies play an important role, saying it is very efficient to “crunch the data” on a collective basis. He explained that the proposals seek to make it clear that solicitation anti-fraud rules apply, saying that materially misleading statements must be addressed and that it is important to improve the accuracy and completeness of the information investors have when making decisions. He added that the proposal makes clear there is no new private right of action.
  • Cryptocurrencies: Clayton said the SEC recognizes that digitization is coming and that it must adapt to continue its mission of promoting investor protection, safety and soundness, and fair markets. Clayton said that there is a great deal of friction in the market that digitization can help reduce. He said that the SEC cannot lose sight of its mission because of new technology, but also cannot only rely on old technology to carry out its mission either. He continued that there has already been a great deal of digitization in the financial system and highlighted that there is a difference between a sovereign-backed medium of exchange and a private medium of exchange.

Witnesses

Opening Statements                   

Chairman Mike Crapo (R-Idaho)

In his opening statement, Crapo said the public must have confidence and trust in the public markets, as well as a wide variety of financial opportunities and the information necessary to make informed investment decisions. He commended the SEC on the final rulemaking package on Regulation Best Interest (Reg BI), saying it strikes the right balance between transparency and preserving access. He also applauded the SEC’s work on the accelerated filer definition and encouraged the SEC to move quickly to provide relief to smaller reporting companies. Crapo said the SEC should consider expanding the ability of small businesses to crowdfund, the accredited investor definition, and the definition of family office. He highlighted concerns about the personally identifiable information (PII) that will be collected by the consolidated audit trail (CAT) and how it will be protected, encouraging the SEC to heed the request by CAT participants to use alternative approaches to PII.

Ranking Member Sherrod Brown (D-Ohio)

In his opening statement, Brown said that the Trump administration has worked to dismantle many of the protections Congress put in place following the financial crisis, which puts families and the economy at risk. He said the SEC’s latest actions will make it harder to hold corporations accountable to investors. Brown opined that the adoption of the SEC’s Reg BI will do “much damage” by not requiring brokerage firms to eliminate conflicts, saying that the SEC should have developed a uniform fiduciary standard to give investors more confidence that investment firms work for the people they serve. Brown also highlighted the SEC’s proposal to amend the whistleblower program, saying it has already had a chilling effect on tips. He continued that the SEC’s recent proposals on proxy advice are a clear example of taking the side of corporate interests over investors by making it more difficult for shareholders to hold executives accountable.

Testimony

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

In his testimony, Clayton said that the interests of long-term investors are front of mind, and modernization has been a key avenue for advancing the SEC’s mission. He highlighted the SEC’s work on Reg BI, saying the rules and interpretations to enhance the quality and transparency of the relationship between investors and their financial professional while preserving access regarding both choice and cost has brought long-overdue rationality and clarity to this important area. He said that the SEC is responding to changing capital markets in which many companies are staying private until they are very large or choosing not to go public at all, adding that the SEC is working to enhance the attractiveness of U.S. public capital markets and to explore how to increase the type and quality of opportunities Main Street investors have. He noted that returning funds to harmed investors continues to be a priority, though there are legal impediments to obtaining funds from bad actors. Clayton said the SEC’s modernization efforts are making a difference for market function and market risk and noted the agency’s increased efforts to engage with investors, entrepreneurs, and other stakeholders more broadly.

Question & Answer

Consolidated Audit Trail

Sen. Kevin Cramer (R-N.D.) said that the CAT is designed to collect sensitive personal financial information for every retail brokerage client in the country, amounting to more than 100 million clients. Cramer continued that 24 self-regulatory organizations (SROs) and 3,000 people will have the ability to not only access the database, but to bulk download into their own systems, asking Clayton what the SEC is doing to protect the CAT against cyber-attacks. Clayton responded that the CAT is a good example of how we should look at a lot of large data projects. He said he agrees with the concern, saying the fundamental question is not what data the SEC would like to have, but rather what data is needed to do the job. Clayton explained the SEC is undergoing a process with the SROs and others to “significantly limit” the data to “phonebook information” that will enable the CAT to do its job and function the way it was envisioned. He continued that this will reduce the risk because the data will not be as sensitive. He also noted that it is important for the security protections of the CAT to evolve as the threats evolve.

Cramer continued his line of questioning on the CAT, inquiring about the CAT Reporter Agreement that will shield the SROs from liability, asking why it is necessary. Clayton responded that he is aware of the issue surrounding the allocation of potential liability and is meeting with representatives of the SRO and broker communities to discuss it.

Sen. Mike Rounds (R-S.D.) expressed concern about data breaches, calling the CAT a prime opportunity for nefarious activities. He highlighted the limitation of liability in the CAT Reporter Agreement, asking whether these rules are fair and whether the SEC will review the liability provisions. Clayton responded that when you allocate responsibility, you generally try to allocate it to the people who can best address the risk and are responsible for it, saying this is something that is on his mind as the SEC proceeds. Rounds encouraged Clayton to consider limiting the amount of data collected and ensure that where there is risk, the blame and responsibility for that risk lie where it should.

Proxy Advisory Rule Proposals

Crapo highlighted the SEC’s proposed changes to proxy rules, asking when the public could expect action, to which Clayton replied the SEC intends for it to be completed within the year. Sen. Thom Tillis (R-N.C.) asked how the proposed rules will ensure proxy firms continue to play an important role in the markets. Clayton agreed that proxies play an important role, saying it is very efficient to “crunch the data” on a collective basis. He explained that the proposals seek to make it clear that solicitation anti-fraud rules apply, saying that materially misleading statements must be addressed and that it is important to improve the accuracy and completeness of the information investors have when making decisions. He added that the proposal makes clear there is no new private right of action.

Brown expressed concern that changes to the proxy rules would make proxy advice more expensive, less independent, less timely and could hurt public pension participants, asking whether the changes could compromise the advice investors are receiving. Clayton said that robust conflict disclosures, when material, benefit investors, saying he remains open to ways to improve accuracy.

Shareholder Proposals

Brown inquired about proposed amendments to shareholder rule proposals, asking Clayton how the SEC justifies limiting shareholders’ ability to push for sensible governance reforms. Clayton said that if a proposal garners enough support, it can stay on the proxy. Sen. Tina Smith (D-Minn.) also asked about the shareholder rule proposals, citing concerns about the validity of the public comments in support of the proposal. Clayton said there is an investigation pending into this issue, noting that he is very interested in hearing directly from individual investors and town halls.

Cryptocurrencies

Crapo asked about Facebook’s proposed Libra cryptocurrency, asking how the SEC and other regulators are working to be responsive to market developments and trends. Clayton said the SEC recognizes that digitization is coming and that it must adapt to continue its mission of promoting investor protection, safety and soundness, and fair markets. Asked by Sen. Catherine Cortez Masto (D-Nev.) if the SEC has the resources to address cryptocurrency issues, Clayton said the SEC can do its job but could put additional resources to good use to address emerging areas.

In response to a question from Rounds on cryptocurrencies and Libra, Clayton said that there is a great deal of friction in the market that digitization can help reduce. He said that the SEC cannot lose sight of its mission because of new technology, but also cannot only rely on old technology to carry out its mission either. He continued that there has already been a great deal of digitization in the financial system and highlighted that there is a difference between a sovereign-backed medium of exchange and a private medium of exchange.

Stock Buybacks

Tillis asked about the consequences of placing limits on stock buybacks. Clayton said it is difficult to answer with precision, but it is a capital allocation decision for boards to make in what they believe is the best long-term interest of their companies.

Senior Investor Protection

Cortez Masto expressed concern about broker-dealers and other financial advisors inheriting money from clients, asking Clayton whether regulators should prohibit this. Clayton declined to comment on the specific issue but said he is concerned about elderly investors, many of whom experience diminished capacity, adding that a trusted financial advisor receiving an inheritance from a client worries him. He highlighted the importance of implementing the Senior Safe Act.

FINRA Rule 4111

Cortez Masto asked about proposed FINRA Rule 4111 to address issues with firms and brokers with a history of fraud or misconduct. Clayton said that although he has not seen the text of the proposed rule, he supports the underlying concept that it is a privilege to work in the U.S. securities markets that should be lost if a person misbehaves.

Private Securities Offering Exemption

Crapo asked what the timeline and next steps are to harmonize the private securities offering exemption. Clayton said the next action would be regarding the accredited investor definition.

Whistleblower Program

Brown asked Clayton to commit to not creating a cap when amending whistleblower awards. Clayton said he would absolutely commit to that, adding that any interpretation of the proposal that includes a cap is misguided and that the program has been very beneficial to investors.

Accounting Firms and the PCAOB

Sen. John Kennedy (R-La.) asked about the Public Company Accounting Oversight Board (PCAOB) and its oversight of companies owned or of interest to the Chinese government. Clayton said these Chinese companies do not generally provide the PCAOB with the paperwork necessary to conduct its oversight function of the audits of these companies, calling this a problem. Clayton continued that the SEC is attempting to remedy this directly and has been working with the four largest audit firms to ensure the audits they are conducting at these firms is of the same high quality as at others. Kennedy highlighted his bill, the Holding Foreign Companies Accountable Act, which would give such companies three years to cooperate with the PCAOB or be delisted. Clayton responded that he will look at the bill, but one issue he could predict would be that just because a company is delisted does not mean U.S. investors will discontinue investing in it. He said delisting would however capture the attention of companies and investors, saying this would be valuable and hopefully encourage compliance.

Asked by Sen. Jack Reed (D-R.I.) asked about legal, institutional and cultural problems at the large accounting firms, asking Clayton if he considers these issues significant and what the SEC can do to address them. Clayton said that he does consider the significant. He said that high quality financial reporting that people can rely on is the bedrock of the financial system and being able to rely on audit quality is essential. He said he is engaged on a regular basis in efforts to improve audit quality through the PCAOB.

Climate-Related Financial Disclosures

Rep. Brain Schatz (D-Hawaii) asked how the SEC is working with the Task Force on Climate-Related Financial Disclosures (TCFD). Clayton explained he is working with various international bodies on this issue, saying market disclosure issues of this type are global, not just domestic. He noted the SEC is examining for the 2010 guidance on climate disclosures.

For more information on this hearing, please click here.

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