On Tuesday, SEC Chair Gary Gensler testified for over four hours (without a break!) before the thousands (it seemed) of members of the House Committee on Financial Services. His formal testimony covered a number of topics on the SEC’s agenda that Gensler (and others) have addressed numerous times in past: market structure and equity markets, predictive analytics, crypto, issuer disclosure, China, SPACs and Rule 10b5-1 plans and was remarkably similar to his formal testimony in September before the Senate Committee on Banking, Housing and Urban Affairs. (See, e.g., this PubCo post and this PubCo post.) If you followed any of the coverage of Gensler’s testimony before the Senate committee (see this PubCo post), there was a Groundhog-Day feel to much of the questioning, but the five-minute limitation on questioning (because there are thousands of House committee members) did not really offer much opportunity for in-depth conversation about anything.
(Based on my notes, so standards caveats apply.)
One piece of news from Gensler was that SEC proposals on climate, human capital and now also cybersecurity disclosure were in the works but were unlikely to meet the October timeframe targeted in the SEC Reg-Flex agenda (see this PubCo post), nor were they likely to meet the more recently identified target of year-end; the timing might actually slip into early next year. He also indicated that the SEC was planning to move forward with some of the Dodd-Frank mandates remaining from 2010, including pay versus performance, listing standards for recovery of erroneously awarded compensation and monthly public disclosure regarding short sales. The SEC also recently proposed rule amendments implementing the Dodd-Frank requirement that institutional investment managers report how they voted on say on pay. And don’t forget that Corp Fin is also considering whether to recommend that further amendments to the Dodd-Frank resource extraction rules adopted (for the third time) in December 2020.
Debt ceiling. Some of the committee members pressed Gensler on what his expectations were if the debt ceiling were not raised, a concern that now appears to be delayed until December. Gensler responded that we would be in uncharted waters with a whole lot of significant uncertainties given that treasuries underpin our financial markets. It’s unclear what the effect would be on mortgages, banks and money markets, and we could see some system “breakages”—although it was hard to predict what exactly would break. We should also expect substantial volatility in the markets, even a few days before the event. Not to mention that markets can do things that we don’t expect, he said.
Climate. As in the Senate hearing, there was no shortage of accusations that the SEC was using investor protection as a guise to limit investor choice, politicize the securities laws and implement a liberal agenda. The securities laws are not the right place to address climate change or racial inequity, said one representative. ESG disclosure, one representative asserted, was another effort by the Democrats to enact their liberal agenda through regulators when they can’t pass it through Congress. Several representatives observed that there is a general materiality requirement imposed under SEC rules, implying that that should cover it. Gensler replied that the SEC was responding to investor demand for climate disclosure and seeking full and fair disclosure within the SEC’s chalk lines. The SEC can play a role in helping to provide disclosure that is consistent, comparable and decision-useful. Maybe, one representative objected, but in 2020, there were 140 ESG proposals and all but six were defeated.
One representative renewed the debate about the SEC’s materiality standard, indicating his hope that the SEC would retain a financial materiality standard and challenging Gensler on his prior repeated argument that the SEC would view information as material to the extent that reasonable investors want to see it as part of the total mix of information. (See, e.g., this PubCo post.) In this representative’s view, Gensler was relying on the desires for ESG expressed by institutional investors, which, he believed, just wanted to name and shame disfavored, politically incorrect industries. But that missed the mark, he argued, because institutional investors don’t really represent retail investors. Retail investors care about returns and information they need to make capital allocation decisions—they don’t care about ESG, he contended. Gensler responded that institutions are representative in that they are required to satisfy their fiduciary duties to their clients.
But there were also a number of more specific issues raised. One representative stressed the importance of scientific expertise in developing climate disclosure rules and asked whether the SEC had climate scientists on staff or is consulting with other parts of government, such as NOAA, the EPA and the DOE. Gensler said that the staff is looking at both qualitative disclosure about governance and strategy as well as quantitative disclosure about GHG emissions. He acknowledged that the SEC’s expertise was in disclosure consistency and comparability (i.e., no mention of climate scientists) and reported that the staff was in conversation with other relevant agencies. The representative also asked whether the SEC was considering the impact on smaller companies in connection with its climate disclosure proposal. Gensler responded that the staff was looking at possible phase-ins related to company size and types of disclosure. The representative also noted that a recent TCFD analysis had questioned the viability of the Scope 1, 2 and 3 metrics and recommended other changes. Gensler confirmed that the SEC was looking at all sources of emissions, not just Scope 1, 2 and 3. Another representative expressed concerns about potential liability in light of the subjective and untested nature of climate metrics; he feared that the disclosures would be hijacked as fodder for frivolous litigation. A couple of representatives hoped that the SEC would address investor protection in the context of companies characterizing themselves as “green” with no particular basis or advertising a climate target that can’t be verified. On that same point, another representative noted that a “green” fund comprising companies that correlated at a level of .977 with companies in the S&P 500 might raise some questions.
PCAOB. One representative accused Gensler of politicizing the PCAOB by removing the PCAOB chair, William D. Duhnke III. (See this PubCo post.) Another asked Gensler about his basis for the removal. Gensler replied that his basis was a Supreme Court case, the same basis relied on by his immediate predecessor, former SEC Chair Jay Clayton, in removing PCAOB members. The representative advised Gensler that he had introduced a bill to eliminate the PCAOB and fold it into the SEC. Be honest, he argued, PCAOB members are political appointments to a political organization.
Crypto. There was no end to questioning about crypto. Gensler reiterated his view that the SEC’s authorities on whether crypto was a security were clear based on the Howey test, and that many types of crypto would fit the definition of security and should be within the remit of the SEC. Most are not really currencies or stores of value, he contended. But, Gensler suggested, companies that have questions or think adjustments should be made to the rules should come in and have a discussion with the staff. Some representatives disagreed with Gensler’s conclusion that most types of crypto were securities. Some also continued to advocate for more clarity to encourage the growth of this market (in the U.S. and not overseas).
One representative observed that crypto presented an exciting opportunity for the “unbanked and underbanked.” He noted that those who do well in the crypto space are a much more diverse group of players than in the traditional finance world. As a result, he viewed crypto as an enabling wealth-creation opportunity. In discussions he has had with participants in the space, they would like to come in and discuss their products with the SEC, but they fear enforcement action, particularly in light of some comments suggesting that the SEC may harbor a presumption of guilt. As a result, they were reluctant to accept the Chair’s invitation to come in for a discussion.
Several new bills (and one from 2018) were mentioned, one based on the work of SEC Commissioner Hester Peirce and another that would create an “investment contract asset.” There were several demands for more clarity on crypto. Gensler indicated that the SEC didn’t need much new authority to regulate crypto, but that Congress might be helpful with coordinating and filling the gaps regarding crypto regulation among the SEC, CFTC and banking authorities.
When asked if he would ban crypto altogether as has occurred in some other countries, Gensler said that his approach was different: his focus was on adherence by the industry to investor protection, anti-money laundering and tax laws. Congress, he added, would probably need to legislate to impose a ban. Gensler likened some types of crypto currencies to “poker chips in a casino” and suggested that they could become a systemic risk.
Payment for order flow. This was another hot topic for the committee. One representative questioned Gensler about his charge that payment for order flow can result in conflicts of interest and worse prices for retail investors, that is, a failure to provide “best execution.” She cited one firm that received PFOF but showed price improvement for its customers. Gensler responded that, in his view, the “measuring stick” used in that case is off—the measurement is made against the national best bid and offer, which does not include complete information (no visibility into the dark markets or even all of the NYSE and Nasdaq). She then asked about his comment regarding a possible ban on PFOF. Wouldn’t that put an end to commission-free trading? She would not favor that result. Gensler responded that some brokers offer commission-free trading without PFOF. In addition, he said, commission-free trading is never really free; there’s always an inside cost. His goal was more efficient, more competitive markets, as well as addressing conflicts of interest. One suggestion offered by a representative was to require more transparency to allow better statistical evaluations of platforms. However, Gensler said that some countries have actually banned PFOF, and Gensler was not certain that transparency alone would address the issue.
Another representative suggested that elimination of PFOF and possibly commission-free trading might create new barriers to retail participation in the financial markets, especially among women and minorities. One representative observed that commission-free trading was a ‘cynically misleading concept,” and that the real issue that deserved attention was the difference between the prices available to institutional investors and those available to retail traders.
Guidance. Some members raised as an issue the SEC’s use of guidance in some cases to avoid implementation of prior rules. For example, they argued, the SEC guidance regarding the whistleblower rules attempted to nullify the rules and change policy just through a policy statement, not through the notice-and-comment process. They worried about the precedent set. (See this PubCo post.) Gensler indicated that he had asked the staff to take another look at those rules to see if they would recommend changes to be included in a proposal. These representatives stressed that guidance shouldn’t be used as a way to avoid the notice-and-comment process, noting that Clayton and the SEC staff under Clayton always emphasized that guidance was not binding or enforceable. (See this PubCo post.) Although Gensler would not make a statement about guidance comparable to one issued by Clayton, he instead responded that guidance is an important tool for interpretation within the rules, a tool that has been used for decades. He added that he really liked the notice-and-comment process.
As discussed in Compliance Week, the role of guidance, sometimes referred to by critics as “regulatory dark matter,” has been “one of the more contentious debates in compliance and legislative circles.” Critics argue that “over time ‘guidance’ has taken on a life of its own and either supplanted rulemaking or wedged resulting rules into previously unintended and unexpected matters.” The article identifies as reflective of this debate, for example, the 2016 “Better Way” plan for rulemaking reform issued by then-House Speaker Paul Ryan, which “urged regulators to ‘rein in the use of guidance.’” The article also highlights a 2000 D.C. Circuit Court case, Appalachian Power Co. v. EPA, which invalidated guidance that the court viewed to have been treated as tantamount to law without the benefit of “notice and comment, without public participation, and without publication in the Federal Register.” (See this PubCo post.)
In 2018, Clayton issued a statement intended to make clear the importance of the distinction between SEC rules and regulations—which are adopted in accordance with the APA, have the effect of law and are enforceable by the SEC—and staff guidance, such as the CDIs and various letters and speeches, which is nonbinding and not enforceable by the SEC or others. Clayton underscored that the SEC must “keep this important distinction in mind,” noting that he had instructed the Directors of Enforcement and Compliance Inspections and Examinations to “further emphasize this distinction to their staff.” He encouraged public engagement on staff statements and staff documents “with the recognition that it is the Commission and only the Commission that adopts rules and regulations that have the force and effect of law.” (See this PubCo post.)
Other. Other topics touched on included the treasury market, China, private equity, diversity, SPACs, the absence of admissions in SEC settlements, stock buybacks and Rule 10b-18, AI and data analytics, the consolidated audit trail, and insider trading