Congressional Hearings
OVERSIGHT OF THE U.S. SECURITIES AND EXCHANGE COMMISSION
Congressional Hearings
SuDoc ClassNumber: Y 4.B 22/3
Congress: Senate
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| AUTHORITYID | CHAMBER | TYPE | COMMITTEENAME |
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| ssbk00 | S | S | Committee on Banking, Housing, and Urban Affairs |
[Senate Hearing 115-429]
[From the U.S. Government Publishing Office]
S. Hrg. 115-429
OVERSIGHT OF THE U.S. SECURITIES AND EXCHANGE COMMISSION
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIFTEENTH CONGRESS
SECOND SESSION
ON
EXAMINING THE WORK AND AGENDA OF THE U.S. SECURITIES AND EXCHANGE
COMMISSION
__________
DECEMBER 11, 2018
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Available at: https: //www.govinfo.gov /
______
U.S. GOVERNMENT PUBLISHING OFFICE
34-221 PDF WASHINGTON : 2019
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
MIKE CRAPO, Idaho, Chairman
RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
DEAN HELLER, Nevada JON TESTER, Montana
TIM SCOTT, South Carolina MARK R. WARNER, Virginia
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada
JERRY MORAN, Kansas DOUG JONES, Alabama
Gregg Richard, Staff Director
Mark Powden, Democratic Staff Director
Jonathan Gould, Chief Counsel
Jenn Deci, Professional Staff Member
Laura Swanson, Democratic Deputy Staff Director
Dawn Ratliff, Chief Clerk
Cameron Ricker, Deputy Clerk
James Guiliano, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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TUESDAY, DECEMBER 11, 2018
Page
Opening statement of Chairman Crapo.............................. 1
Prepared statement........................................... 24
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
Prepared statement....................................... 24
WITNESS
Jay Clayton, Chairman, U.S. Securities and Exchange Commission... 4
Prepared statement........................................... 25
Responses to written questions of:
Senator Brown............................................ 50
Senator Sasse............................................ 53
Senator Cotton........................................... 59
Senator Rounds........................................... 60
Senator Reed............................................. 61
Senator Menendez......................................... 63
Senator Warner........................................... 66
Senator Warren........................................... 68
Senator Cortez Masto..................................... 75
(iii)
OVERSIGHT OF THE U.S. SECURITIES AND EXCHANGE COMMISSION
----------
TUESDAY, DECEMBER 11, 2018
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:04 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Mike Crapo, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN MIKE CRAPO
Chairman Crapo. This hearing will come to order.
Today we will receive testimony from Securities and
Exchange Commission Chairman Jay Clayton regarding the work and
agenda of the SEC.
Your appearance before the Committee, Mr. Chairman, is
appreciated, and it is essential to the oversight of the SEC. I
thank you for your willingness to testify today.
The SEC has a critical mission to protect investors;
maintain fair, orderly, and efficient markets; and facilitate
capital formation.
The SEC plays an important role in public confidence and
trust in our Nation's capital markets. It provides information
to investors to ensure that as Americans prepare for their
futures, they have the information necessary to make informed
investment decisions. I commend the SEC for its work to advance
these missions.
Last week, this Committee held a hearing to discuss the
appropriate role of proxy advisory firms, the shareholder
proposal process, and the level of retail shareholder
participation.
Many Members expressed interest in continuing the
discussion on the appropriate relationship between proxy
advisory firms and market participants as it relates to
shareholder proposals and corporate governance.
I am concerned about the misuse of the proxy voting process
and other aspects of the corporate governance system to
prioritize environmental, social, or political agendas over the
economic interests of end investors.
Last week, you stated your intent to address aspects of our
proxy system, including proxy ``plumbing,'' ownership and
resubmission thresholds for shareholder proposals, and proxy
advisory firms.
Many of the rules governing our proxy system have not been
examined for decades, and I encourage the SEC to take an
aggressive approach assessing the scope and appropriateness of
previous regulatory actions.
Capital markets are also vital to facilitating job growth
and expanding American investment opportunities. This Committee
worked hard in the 115th Congress to pass a number of
bipartisan securities and capital formation bills.
I will continue to work with Members to identify additional
legislative proposals that encourage capital formation and
reduce burdens for small businesses and communities.
The SEC has also taken a number of steps this year to make
it easier for emerging companies to go public while not
discouraging the availability of capital in the private market.
Additionally, this year the SEC proposed Regulation Best
Interest and a related interpretation to establish standards of
conduct for broker-dealers and investment advisers. This is a
significant step forward, and I look forward to seeing a final
rule in the near term.
Finally, the SEC has been proactive in addressing
cryptocurrencies and coin offerings. For example, the
Enforcement Division created a new Cyber Unit this year, which
led efforts to counter fraud against retail investors involved
in initial coin offerings and brought charges against a
bitcoin-denominated platform operating as an unregistered
securities exchange.
I look forward to receiving updates on these and other SEC
initiatives, including your views on when we can expect final
rules in these areas.
Senator Brown.
OPENING STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Chairman Crapo. Welcome, Chair
Clayton. Nice to see you again. Thank you for your service.
Since I assume this will be the last Banking Committee
hearing for this Congress, I would like to express my thanks
and appreciation for the work of Senators Donnelly and Heitkamp
and Corker and Heller over the years. So thanks to all of them.
We have discussed the SEC's enforcement program in previous
hearings and our recent meeting, Chairman Clayton. As you have
highlighted, the SEC has worked hard to return money to harmed
investors. I agree that is an important goal, but enforcement
can begin and end with protecting wealthy investors.
Ten years ago today, Bernie Madoff was arrested. His giant
Ponzi scheme was exposed. There is no doubt that Ponzi schemes
still exist. Your enforcement report shows that SEC is focused
on finding them and punishing the wrongdoers, as you should.
We also know a decade ago Bernie Madoff was far from the
biggest threat to most families. It was Wall Street firms that
had just wrecked our economy. And just as the SEC will continue
to pursue Ponzi schemes, it must also continue to pursue in
many ways the harder, the complex cases against the big banks
when they break the rules and threaten families' homes and
savings. I have said to this Committee a number of times that
my Zip code, 44105, where Connie and I live in Cleveland, had
more foreclosures in the first half of 2007 than any Zip code
in the United States, so I still see the remnants of inaction
and wrong actions by regulators and by Wall Street.
The big banks have not turned into angels over the last 10
years. Last month, German authorities conducted a 2-day raid of
Deutsche Bank's headquarters in a money-laundering and tax
evasion investigation. Last year, both the Fed and New York
State regulators imposed fines totaling more than $500 million
on Deutsche Bank's U.S. entity for anti- money-laundering
violations. And Deutsche Bank is not alone. Similar problems
persist at other banks.
Looking at your Strategic Plan, I see a lot missing. There
is nothing about stock buybacks. There is nothing about
excessive corporate debt. Take a look at what has happened
since the Republican tax overhaul.
Since last year, corporations have announced more than $1
trillion in stock buybacks, $1,000 billion, $1 trillion in
stock buybacks. Take one example. GM has spent more than $10
billion on stock buybacks since 2015. Last month, on the same
day it announced--last month, it announced it is laying off
14,000 workers and closing five plants, including the Chevy
Cruze plant in Lordstown, Ohio. Close to 5,000 lost jobs, 5,000
more jobs in the supply chain at least, and probably another
10,000 jobs in Mahoning Valley. The same day they laid off
shift two several months ago, they announced they were
expanding production in Mexico. Yet the stock buybacks
continue, and executive compensation continues to go up.
The priority of these corporations are clear. Buying back
shares boosts companies' stock prices, which means even bigger
bonuses for corporate executives. Investing in a company's
workers supports the long-term health of the company, but that
is not what Wall Street rewards.
Our economy functioned fine without massive stock buybacks.
The SEC rule facilitating buybacks was adopted 36 years ago,
but since then, the size, the use, the frequency of stock
buybacks has increased dramatically. My colleagues and I have
asked you to take a look at that rule and ask probing questions
as you do it. It is time to question whether it is too easy for
companies to buy back their shares. The GM case shows us the
risks to workers and communities when companies think only
about short-term profits. We should be looking at the record
levels of risky corporate debt and leveraged loans, how that
debt is packaged in collateralized loan obligations, the
complex securities that allow investors to trade pools of
loans. The Fed and the OCC are looking at banks' exposure to
leveraged loans, but they say the risks are manageable and they
are not worried.
We have heard that one before. It was a little over 10
years ago before the economy came crashing down. Leveraged
lending CLO investors include hedge funds, mutual funds, other
market participants under SEC oversight. As the shadow banking
market plays a larger role in leveraged lending, watchdogs
cannot just focus on the big banks. It is your job to worry
when it seems like there is nothing to worry about. And I will
say that again. It is your job to worry when the public seems
to think there is nothing to worry about. That is what
consumers and investors expect so that risks do not buildup
across the financial system.
A decade ago, the regulators in the Bush administration
failed the country, and the price was enormous. The SEC needs
to be closely watching this market not just to make sure
disclosures and credit ratings are adequate, but to complement
the work of the banking regulators. We know the financial
system is more interconnected than ever and the systemic risks
are more likely. Main Street cannot afford for you to stand by
watching Wall Street greed again, every decade perhaps, grow
out of control. Any Strategic Plan for any agency guiding our
economy needs to focus on the American workers who drive
growth, not just wealthy investors.
Thank you.
Chairman Crapo. Thank you, Senator Brown.
And, again, Chairman Clayton, we appreciate you being with
us. You may proceed.
STATEMENT OF JAY CLAYTON, CHAIRMAN, U.S. SECURITIES AND
EXCHANGE COMMISSION
Mr. Clayton. Chairman Crapo, Ranking Member Brown, Members
of the Committee, thank you for the opportunity to testify
before you today about the work of the Securities and Exchange
Commission. On behalf of my fellow Commissioners and the 4,500
women and men of the SEC, I would like to thank this Committee
for its support.
Congress' funding of the agency enables us to improve our
tools and expertise relating to our markets, capital formation,
and protecting Main Street investors. Further, your interest in
and engagement on our rulemaking and other initiatives have
helped us refine and improve these initiatives, often to the
benefit of our long-term Main Street investors. Thank you for
your input.
From a day-to-day management perspective, I see our job as
having four principal areas of focus: One, protecting investors
through forward-looking policies and rulemakings and through
inspections and strong enforcement of our securities laws; two,
monitoring our disclosure-based capital markets and the
numerous market participants, including through oversight of
issuers, gatekeepers, and intermediaries; three, ensuring that
our trading markets function effectively and fairly, including
during times of volatility and price discovery; and, four,
identifying, evaluating, and addressing emerging market risks.
With regard to the fourth category, I want to note several
key risks that are front of my mind.
First, cybersecurity continues to be a pressing threat to
our capital markets and many market participants. The SEC deals
with cybersecurity risk through a number of perspectives, both
within and outside the agency. Combating these challenges will
continue to require significant resources and attention as well
as an understanding that this is both an entity-specific and a
systemic risk.
Second, the potential effects of Brexit on U.S. investors
and securities markets and on global financial markets more
broadly is a matter of increased focus for me and my colleagues
at the SEC. In short, I believe that the potential adverse
effects of a poorly executed Brexit are not well understood
and, in some areas where they are understood, are
underestimated. The SEC's responsibility is primarily related
to the effects of Brexit on our capital markets, and I have
directed the staff to focus on the disclosures companies make
about Brexit and the functioning of our market utilities and
infrastructures.
Third, managing the transition from LIBOR to a new rate
such as SOFR is a significant issue for many market
participants, including Main Street investors, as borrowers,
for example, have consumer credit tied to LIBOR. We and our
colleagues at the Federal Reserve, Treasury Department, and
other financial regulators are monitoring this issue and
working to facilitate a reasonable transition. However, an
effective transition requires participants to take actions well
ahead of year-end 2021 when the bank's itment to submitting the
information used to set LIBOR ends.
Finally, the process for developing and implementing the
Consolidated Audit Trail, or CAT, remains slow and cumbersome
and significantly behind deadlines. According to the SROs,
substantial delivery of the first phase of CAT is now not
expected until 16 months after the initial deadline. While I
believe the CAT should be completed with deliberate speed,
protection of CAT data, particularly any form of PII, remains a
threshold issue for me.
As the SROs continue to make progress in the development
and implementation and operation of the CAT, I believe that the
Commission, the SROs, and the plan processor must continuously
evaluate their approach to the collection, retention, and
protection of PII and other sensitive data. More generally, I
have stated before that the SEC will not retrieve sensitive
information from the CAT unless we need it and believe
appropriate protections are in place to safeguard it.
In closing, I would like to again thank the Committee for
its continued support of the SEC, its mission, and its people.
I would also like to note that my colleague Commissioner Kara
Stein will be leaving us at the end of this year, and I thank
her for her contributions to the Commission and to investors.
I look forward to answering your questions. Thank you.
Chairman Crapo. Thank you, Chairman Clayton.
I will start out on the proxy voting process. That has been
a focus of both the SEC and this Committee recently. In your
testimony, you note that there is consensus on the need for
major overhaul of certain aspects of the proxy voting process,
including proxy plumbing and proxy advisory firms. As staff
recommends comprehensive overhaul proposals, what reforms can
you enact in the short term, if any?
Mr. Clayton. So with respect to proxy, I put this into
three categories, Chair Crapo. First is proxy plumbing. Our
proxy plumbing, the voting from end investor back to the
company, is very complex, and the verification of that process,
the facilitation of that process, does not work as well as it
should. We are looking for short-term fixes. We are looking to
the industry to propose them, so in that area I am looking for
short-term fixes. We do need a long-term overhaul.
In the area of shareholder voting, I believe there are
things that we can do to that process that will not in any way
diminish engagement, but will, what I would say, eliminate
unnecessary processes.
And then in the area of proxy advisers, I think that there
is broad agreement that there are elements of the proxy
advisory, what I will call, ecosystem that can be improved
fairly quickly. And I would be happy to discuss more detailed
views.
Chairman Crapo. All right. I appreciate that. And one last
question from me. The SEC has devoted significant time and
resources to issues surrounding digital assets and
cryptocurrencies. Do you feel that the regulatory framework is
sufficiently in place to provide certainty and predictability
for market participants?
Mr. Clayton. So I want to thank this Committee for holding
a hearing, I think it may have been 9 months ago, on this very
issue as the emergence of ICOs and cryptocurrencies became, I
would say, of broad interest to our investment community. At
the time, Chairman Giancarlo and I noted that we thought the
securities laws functioned well for securities, the commodities
laws functioned well for commodities, and that to the extent
there were cryptoassets that fell outside either of those--for
example, we talked about bitcoin at that hearing--we should
continue to monitor whether other laws such as anti- money-
laundering laws needed to be supplemented. We are continuing to
monitor that, but I very much appreciate this Committee's
attention to it and vigilance.
Chairman Crapo. All right. Thank you very much.
I am going to yield back my time. We do have a vote coming
up sometime after 11, maybe 11:15 or 11:30, so I am going to
yield back 2 minutes to help us meet that deadline. Senator
Brown.
Senator Brown. Not that that is going to spread.
Chairman Crapo. Yeah.
[Laughter.]
Chairman Crapo. No, actually, I am setting a new standard,
3 minutes.
Mr. Clayton. I can hope.
Senator Brown. Thank you, Chairman Crapo.
Recently, banking regulators have noted the risks in the
leveraged lending market, but only well after the market has
reached record highs. We have seen lending move outside the
banking system and fuel the significant increase in
collateralized loan obligations. What is the SEC doing to
monitor the growth of risky loans outside the traditional
banking system?
Mr. Clayton. So what I could say is many months ago--and I
do not want to say too many, but 4 or 5--we started looking at
this issue in detail, and you touched on a number of things
that we should be looking at in your opening remarks, so kind
of from beginning to end, you have got issuers on the one hand,
which, you know, do we have too much leverage at the issuer end
of the spectrum, companies borrowing too much money, too much
increased leverage, all the way through to the end investors,
whether it is mutual funds, pension funds, and the like. And
there are entities in between, including rating agencies, banks
which originate loans, and then what I will call the CLO
packagers who buy the loans from the banks, form the CLOs, and
send them to the end investors.
We are looking at each component of that, and we are
looking at it with two ideas in mind. One is systemic risk. Are
there elements of this market that are going to cause the kind
of systemic issues that you discussed, you know, knock-on
effects?
One thing that we are looking at in particular is will the
change in ratings for these types of securities trigger
substantial selling that would not be picked up by ordinarily
expected demand. If you go from investment grade to below
investment grade, do things like investment restrictions cause
selling where the credit really has not changed that much but
there is nobody there to pick it up? That is one of the many
issues we are looking at.
I can go on for a long time. I do not want to take more of
your time.
Senator Brown. Let me shift. FSOC does not seem as engaged
as many of us would like it to be. They have moved in the wrong
direction by de-designating the insurance companies that were
deemed systemically important, as you know. As a member of
FSOC, what are you doing to push a greater focus on leveraged
lending and the interconnectedness of banks and shadow banks?
Mr. Clayton. Well, the discussion that I was going through,
I would say the components of the CLO--I will call it the CLO
ecosystem--the leveraged lending that is outside of--the
traditional high-yield debt market, bringing our knowledge and,
what I would say, continued analysis of that market to the
other members of the FSOC is one of the things that we are
doing.
Senator Brown. Well, and I am hopeful that--I guess I will
ask you on the record: Will you commit to pursue these
interests with the rest of FSOC? Is that something you will
absolutely plan to do?
Mr. Clayton. I think it is--I generally try not to commit,
but it is easy to commit for that because I am already doing
it.
Senator Brown. OK. I cannot underemphasize the importance
of that. Yesterday former Federal Reserve Chair Janet Yellen
said that corporate debt is at high levels and would prolong
the damage of an economic downturn if it were to come or
whenever it comes, leading to more corporate bankruptcies. I am
inclined to believe her. I hope you and other regulators take
the appropriate action as corporate debt seems to continue to
mount and continues to play the role that it has in this
economy.
Mr. Clayton. Thank you.
Senator Brown. Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman.
Mr. Chairman, thanks for coming back. Good to see you
again. You know, we have discussed in the past, including at a
public hearing, that we have had this amazing decline in the
number of public companies in America, the number of IPOs that
we launch in the United States. I for one think it is a
terrible thing if people are choosing to finance their business
through private capital because of the costs and regulatory
implications of going public. Obviously, a public company
creates an investment opportunity for a Main Street investor.
It creates another vehicle for capital raising. The competition
between the public markets and the private markets has the
effect of lowering the cost of capital. So in any way I can
think about it, very robust public equity markets is a very
good thing for our economy.
I think in the past you have acknowledged that the
regulatory costs of being a public company are probably a
contributing factor to the relative decline and the absolute
decline in public companies. Is that still your view that that
is a contributing factor?
Mr. Clayton. Yes, it is.
Senator Toomey. One of my concerns is that, as we all know,
there is a subset of activist shareholders who engage in
forcing votes, shareholder votes, sometimes repeatedly on
issues that they have no chance of succeeding on. Other times
it is an effort to impose an ESG agenda on a company. Does this
activity contribute, do you think, in any way to companies'
reluctance to go public?
Mr. Clayton. So, look, I think the answer to that question
is do the decision makers who decide whether a company should
go public or not, when they look at that kind of activity, is
it a check mark in the negative box? Yes.
Senator Toomey. OK. That is what I was getting at. Vanguard
is headquartered in Pennsylvania. It is a great, great American
success story, great innovative institution that has made
investing affordable for millions of Main Street investors. But
Jack Bogle, the founder, recently made an interesting
observation. He warned, and I quote, ``If historical trends
continue, a handful of giant institutional investors will one
day hold voting control of virtually every large U.S.
corporation.''
Now, if the trend continues, which is Bogle's caveat,
wouldn't that be a bad thing if a handful of institutional
investors had voting control of virtually every large company
in America?
Mr. Clayton. The short answer to your question is yes. The
broader answer is a continued reduction in the number of public
companies has, I would say, negative effects--I believe has
negative effects that go beyond just opportunities for Main
Street investors to invest. A vibrant public capital market has
a number of other benefits to our society.
Senator Toomey. Yes, I mentioned some of them. I totally
agree. But I do have this concern that we have this regime that
is discouraging companies from going public, and when they do
go public, we have got processes that may result in votes being
cast that are not really well aligned with the interests of the
investors.
One thing just by point of clarification. Former SEC
Commissioner Dan Gallagher was here just last week, and he
reminded us that it is perfectly permissible under existing law
and regulation for a fund manager to come to the conclusion
that it is not in the best interest of their investor clients
to be voting on every proxy matter. That is factually correct,
right? It is not required to have those votes.
Mr. Clayton. I saw former Commissioner Gallagher's
testimony, and I think he described the staff position
appropriately, yes.
Senator Toomey. So one idea that has been floated as a way
to increase the likelihood that when votes are cast they
actually reflect the wishes of the investor who is the ultimate
shareholder is client-directed voting. Do you have an opinion
on the merits of that? And is it your view, are there any
regulatory changes the SEC would need to make in order to
facilitate client-directed voting?
Mr. Clayton. So I do not have a specific opinion today on
client-directed voting. On the core question of are the
intermediaries, fund managers or others, voting shares in the
interests of their clients, that is something that was the
subject of our roundtables. It goes to the question of
regulation of proxy advisers, and it is something that I intend
for the Commission to continue to look at. And I think we can
improve it.
Senator Toomey. So you do not have an opinion on client-
directed voting? Is that what I hear you saying?
Mr. Clayton. I do not have one here today, Senator.
Senator Toomey. That is something I would like to pursue
with you.
Mr. Clayton. Thank you.
Chairman Crapo. Thank you, Senator Toomey. And before I
move to Senator Reed, I would like to notify the Committee the
vote has now been moved up to 11. I would like to finish by
then. I want to congratulate Senator Brown for giving back a
minute and a half and encourage everybody to really stay tight
on your questions.
Senator Reed.
Senator Reed. So you want me to be short.
Chairman Crapo. Yeah. See if you can beat my record. I gave
2 minutes back.
Senator Reed. I will try. Thank you, Mr. Chairman. Thank
you, Chairman Clayton.
Following up on some of the comments that Senator Brown
made about share buybacks, not only is it difficult to look at
GM buy back significant stock and then lay off thousands of
workers, but your whole approach has been for the long-term
Main Street investor. And one of the options that GM had was
investing in innovation, investing in more sophisticated
products, and effectively they chose not to do that. They gave
the money back. So this issue of stock buybacks has several
dimensions, one of which is not investing in the long-term
future of the company. Is that something that concerns you? And
is that something that the SEC can take steps to try to
correct?
Mr. Clayton. Senator Reed, I want to be clear about the
SEC's authority. We do not have authority over capital
allocation, over whether a company chooses to allocate its
capital by distributing it to its shareholders or investing.
But I agree with a number of observers that, in terms of how
companies should communicate what they intend to do with their
capital, we can do a better job around disclosure. So you
have--what are your capital allocation decisions? Our
disclosure rules are based on, I think, historic facts, plant,
property, equipment, how am I going to spend my money on plant,
property, and equipment? In today's economy, I think we should
be driving disclosure more toward human capital, intellectual
property, and the types of advantages we have from things like
supply chain management, distribution management, and our
relationships with other vendors. Those are the things that
drive companies' value today, and I would like to see our
disclosures evolve toward that.
Senator Reed. But in terms of the SEC's role, as I
understand it--and please correct me--36 years ago you could
not have these stock buybacks under SEC rules. Is that----
Mr. Clayton. I do not think that is correct. What happened
36 years ago was the SEC said if you are going to buy back
stock in the market, here is a way you can do it where, if your
intent is not to manipulate--there is no safe harbor if you are
trying to manipulate. But if your intent is not to manipulate
and you do it this way, you can feel comfortable that the
buyback is being done without subjecting you to a claim of
manipulation.
Senator Reed. Essentially what you did is provide a pathway
to buyback which previously was considered somewhat risky
because of the implications of inside information, of timing,
of the self-aggrandizement by the CEOs. So you do have the
authority to look at that rule again.
Mr. Clayton. We do, but I just want to be clear what
authority we have, which is the authority over whether to
provide a pathway where you will not be--you will be presumed
not to be manipulating the stock.
Senator Reed. Well, again----
Mr. Clayton. It is not prohibiting or allowing buybacks.
Senator Reed. Again, I think given what we have seen, you
have to go back and sort of reroute that pathway, not only for
modernization and innovation, but also because the choice for
many individuals, I presume--and if I was in that position, I
would certainly be thinking of this--is if I do a stock
buyback, my stock options suddenly are hugely beneficial to me,
oh, and by the way, my pay based each year is on the value of
the stock, so this could be nothing to do with the
shareholders, nothing to do with the workers, nothing to do
with the future of the company, but it is a very good payday
for me. And that I think goes against, you know, the notion 36
years ago of manipulation.
Mr. Clayton. Let me say I agree that if the purpose of the
buyback is to drive the price up for the benefit of an
individual, that is a problematic situation. And I just want to
say I would encourage compensation committees who set
compensation and structure compensation to look at that issue.
Senator Reed. Well, I have to give at least 20 seconds
back, so I would encourage the SEC, not deferring to the
compensation committees, which are not that rigorous in many
cases, to take strong and appropriate action. Thank you.
Mr. Clayton. Thank you.
Senator Brown [presiding]. Good question. Good assertion.
Senator Rounds.
Senator Rounds. Thank you, and in the interest of following
the Chairman's lead, I will ask just one question, and I will
submit several for the record.
In your written testimony, you discuss the impact of Brexit
on the American markets. From a securities standpoint, I have
been following how Brexit could complicate the ability of
American clearinghouses to compete in the EU and the U.K.
markets. For U.S. clearinghouses to operate in the EU, EU
authorities must determine that U.S. regulatory regimes are
equivalent to the EU's; otherwise, market participants would
face higher capital charges for accessing American markets.
Although the U.S. and the EU agreed that the CFTC's regime
was equivalent in 2016, there has yet to be any determination
for the SEC's regime. Progress in these areas is under threat
thanks to Brexit and legislation pending in the European
Parliament. If that legislation passes, large American clearing
firms would only be allowed to continue operating in the EU if
the EU regulators could jointly supervise them. Such
legislation would violate the 2016 agreement, hurt American
companies and taxpayers by making the market for U.S. Treasury
bonds less liquid and increase the cost of trading derivatives
for farmers and ranchers.
My question is: Can you share your thoughts on the U.S.-EU
clearinghouse issue? And do you foresee any other regulatory
challenges associated with Brexit and clearing securities? And
if so, how would we work to resolve them?
Mr. Clayton. So, Senator, I think your premise described
the issue very well. It is complicated. It requires
international cooperation and recognition, and if we fail to
identify what I will call a smooth path forward, there will be
costs. I have made that clear, Chairman Giancarlo has made that
clear to our European counterparts. I know that they recognize
it. This is part of a broader issue. It is one of the reasons I
am worried about Brexit--there are a number of issues just like
the issue that you describe that seem to get kicked down the
road as the broader issue unfolds.
Senator Rounds. Do you see a format for resolving the
issues?
Mr. Clayton. Pursuing several. Pursuing several.
Senator Rounds. Can you share any thoughts?
Mr. Clayton. I think I should leave it at that out of
respect for the international nature of the negotiations, but
this is very much front of mind.
Senator Rounds. Very good. Thank you. And I will yield back
my 2 minutes and 8 seconds.
Senator Brown. Thank you, Senator.
Senator Menendez.
Senator Menendez. Thank you. Can I take Senator Rounds' 2
minutes and 8 seconds?
[Laughter.]
Senator Menendez. No. Mr. Chairman, thank you for being
here. In your testimony, you state that you have made
protecting Main Street investors a key guiding principle of
your tenure at the SEC. So let me ask you, do you agree that
Main Street investors were harmed by excessive risk taking on
Wall Street in the years leading up to the financial crisis?
Mr. Clayton. I do. I think that excessive risk taking in
our markets--let me just say this: Excessive risk taking in our
markets from my perspective is more likely to have an adverse
effect on Main Street investors than just about any other class
of people.
Senator Menendez. I agree with you. Do you agree that pay
practices at big banks and financial institutions have at times
ignored long-term consequences in favor of rewarding risky
behavior to make short-term gains?
Mr. Clayton. I do not want to make a general statement
about this, but what I will agree with you on this: I think
that your concept is when you take someone's activity and you
bring forward the benefits--so let us say I am working
somewhere and I do something that is going to last for 5 years,
and then I say to you, hey, over the 5 years this is going to
make 100, so pay me based on 100 today--that type of incentive
drives short-term behavior.
Senator Menendez. Do you think Main Street investors might
object to the fact that Wells Fargo CEO Tim Sloan was paid
$17.4 million last year, the same year other regulators
investigated and took actions on scandals relating to the
bank's auto lending, mortgage lending, and investment
management practices?
Mr. Clayton. Senator, I am not going to comment about a
specific institution here in this forum.
Senator Menendez. Well, OK. So do you think Main Street
investors might object to the fact that any CEO would be paid,
you know, tens of millions of dollars after they faced all of
those investigations and all of those consequences for
fraudulent behavior at their institution?
Mr. Clayton. I do think that investors in companies should
have clear disclosure of what the senior executives of those
companies are making, and they should have input through
various engagement processes, including some of the processes
that we have discussed here today.
Senator Menendez. So with that in mind----
Mr. Clayton. Senator, in a word--I am sorry. In a word,
there should be accountability.
Senator Menendez. Good. Why is it then that the Commission
has not made it a priority to finish congressionally mandated
rules to rein in pay practices that put Main Street investors
at risk?
Mr. Clayton. You are speaking about the Dodd-Frank mandates
around pay practices, I believe.
Senator Menendez. Yes.
Mr. Clayton. Yes, I am aware of those. I keep track of the
Dodd-Frank mandates. I am pursuing them, working with my fellow
Commissioners. We proposed rules around some of those. We are
reviewing the comments. We received a number of comments. Some
of them raised very significant issues.
Senator Menendez. Can you give me a timeframe in which you
would expect the Commission actually to be able to promulgate
rules in this regard?
Mr. Clayton. I have the hedging rule on our near-term
agenda. I expect that in the near term. The others I cannot be
as precise.
Senator Menendez. Well, let me just say that if we agree in
principle that runaway executive pay which rewards risk taking
can be harmful to investors and you have a mandate from
Congress to do something about it, it just seems to me that
this should be a priority. It falls right in line with your
Main Street investor priorities, so I hope you will make it
such at the end of the day, and I hope the next time you come
before the Committee, we will have rules promulgated.
Let me ask you one other question. I read your statement
issued on Friday regarding the SEC's difficulties assessing
information about Chinese companies that are listed on U.S.
exchanges. There are 224 companies listed on U.S. exchanges
with a combined market capitalization of $1.8 trillion that are
located in countries, primarily China, that make it difficult
for U.S. regulators to review their financial reporting. This
presents a major risk to U.S. investors who may assume that the
financial reporting of these companies is in line with U.S.
requirements. Moreover, it is fundamentally unfair for Chinese
companies to take advantage of the strength and liquidity of
U.S. capital markets but do not have to play by the rules.
The U.S.-China Economic and Security Review Commission
recommended that Congress consider legislation providing
authority to ban and de-list companies that have refused to
sign reciprocity agreements with the Public Company Accounting
Oversight Board. Despite the SEC and the Board's best efforts
to reach an agreement, it appears unlikely that Beijing will
cooperate.
Would such authority strengthen your hand in negotiations
with your Chinese counterparts?
Mr. Clayton. Let me say this, Senator: I think your
characterization of where we are, where there are information
barriers to us receiving what I would say is the same
information and the PCAOB receiving the same information that
we would expect to receive in other jurisdictions that exist
today, yes. Are we working through those? Yes. I am not
prepared to support a specific remedial action in this forum,
but we need to make progress.
Senator Menendez. I will just close with this. We cannot
continue this process, $1.8 trillion, investors under your own
previous statement about our other line of questions about
transparency, should have transparency to know that these
companies are living up to the standards for which investors
rely upon to make investment decisions.
Mr. Clayton. And that transparency is why we put the
statement out. People should know where we sit today and know
that we need to improve.
Senator Menendez. Yeah, but all I will say is that we do
not know exactly what their accountability is. We just know
that there is an accountability. So at the end of the day, you
should--I would hope the Commission would embrace us giving you
the tools to get the Chinese and other companies similarly
situated to disclose.
Thank you, Mr. Chairman.
Senator Brown. Senator Kennedy.
Senator Kennedy. Mr. Chairman, thanks for being here. I
think you are doing a great job.
Mr. Chairman, would you buy a bond issued by a State if you
did not know whether they were broke or not?
Mr. Clayton. No, I would not.
Senator Kennedy. OK. I read you gave a speech recently. I
was reading it the other night. It was very good. One of your
statistics says the issuers in States, municipalities, et
cetera, who file either annual financial information or audited
financial statements within 12 months of their fiscal year do
so on an average of 188 and 200 days after the end of the
fiscal year. So their financial statements are between 188 and
200 days left. Why is MSRB allowing that to happen? Are they
doing anything over there other than standing around and
sucking on their teeth?
Mr. Clayton. What I will say is this--the reason I gave
that speech is I think this is an area that needs to improve.
The first step in improving it is to make sure that investors
understand that the financial statements they are looking at in
some cases are 18 months old.
Senator Kennedy. Yeah, well, let me----
Mr. Clayton. That is pretty old.
Senator Kennedy. Let us suppose that you are an individual
investor and you want to research the bonds. Aside from the
fact MSRB, which is supposed to regulate themselves, you want
some information about the bond issue or about the State. Are
you aware MSRB charges 60,000 bucks to download bulk data?
Mr. Clayton. Actually, I was not aware of that, Senator.
Senator Kennedy. Would you look into that for me?
Mr. Clayton. I would be happy to.
Senator Kennedy. OK. Do you need disgorgement of ill-gotten
gains to do your job?
Mr. Clayton. I think you are referring to the effects of
the Kokesh Supreme Court decision.
Senator Kennedy. Yes.
Mr. Clayton. I believe that the Kokesh Supreme Court
decision--we need some help. We need some help, because what it
did was it said basically Ponzi schemes and other types of
frauds like that that go on beyond 5 years, we are not able to
reach back and get the money back for people who were a victim
of those schemes, because disgorgement was viewed in that case
as a penalty subject to the 5-year statute of limitations.
Senator Kennedy. And you do not have that authority now?
Mr. Clayton. We do not have the authority in those----
Senator Kennedy. Only Congress can give you that authority.
Mr. Clayton. I am not going be a lawyer here, but yes.
Senator Kennedy. OK. Let me ask you one final question. Are
you familiar with the Stanford case where Allen Stanford stole
$7.2 billion in a Ponzi scheme from about 21,000 people?
Mr. Clayton. Yes.
Senator Kennedy. OK. Well, we are doing great getting the
money back from Bernie Madoff and his people. We have collected
over 75 cents on the dollar. We are not doing as well with
Stanford. We have clawed back $431 million, and the lawyers
took $226 million.
SEC took a position to oppose a motion to eliminate the
restriction to file involuntary bankruptcy which will help the
people get their money back. Why did the SEC do that? And would
you reconsider? I know I am catching you cold. Just trust me.
It would be a good idea.
[Laughter.]
Mr. Clayton. How about I say I trust you?
Senator Kennedy. OK. I am going to yield back 1 minute and
17 seconds, Mr. Chairman.
Chairman Crapo [presiding]. Thank you, Senator Kennedy.
Before I go on, for some of those who have just arrived, we
have a vote at 11 o'clock, and I am encouraging all Members to
shrink down their questioning. Three of them have given back a
minute or two--counting me, four of them have given back a
minute or two. So you do not have to, but please help us get
there.
Senator Warren.
Senator Warren. Thank you, Mr. Chairman. It is good to see
you again, Chairman Clayton.
As you know, right now investment advisers are subject to
what is called a fiduciary standard. That means they are
legally required to put the financial interests of their
clients ahead of their own interests.
Brokers who get a commission for every trade that they make
follow different rules, and, in fact, they can recommend a
product that boosts their own commission even if it is not the
best deal for the customer. And we also know that brokerage
firms artificially create all sorts of perverse incentives to
encourage brokers to make certain recommendations that are very
profitable for the firm or for the broker, even if they are not
real good for the customers. So that is a problem, and in
April, the SEC proposed some new rules for brokers.
Now, Mr. Clayton, as you have told me before, the idea
behind these new rules is to help regular retail investors--you
like to call them ``Mr. and Mrs. 401(k)''--to make informed
choices, right?
Mr. Clayton. That is one component of it. There are several
components of the rules.
Senator Warren. OK, but it is trying to help investors make
informed choices, right? That is what this is about.
Mr. Clayton. Absolutely.
Senator Warren. OK. So one option would simply be to make
brokers subject to the same fiduciary standard that investment
advisers are subject to, but you did not do that. Instead, the
SEC's proposal says that brokers have to act in the best
interests of the client, but then you never define what ``best
interest'' actually means.
So here is where I am stuck. For the proposal to help
customers make good decisions, they need first to understand
the difference between a broker and an investment adviser; and,
second, how the fiduciary standard for investment advisers is
different from the best interest standard for brokers, which is
something you do not define. Do I have that right so far?
Mr. Clayton. I do not think so. I think we are pretty clear
on what the best interest standards--and we are going to be
clear on----
Senator Warren. You are saying you do define it in the
rules?
Mr. Clayton. The best interest standard as we have proposed
means that you as a----
Senator Warren. I am sorry. Is it defined in the rules?
Mr. Clayton. Is there a specific definition that says this
is what it means? No. But there is no specific definition that
says this is what the investment adviser standard means.
Senator Warren. So I just want to be clear then. Anybody
who is trying to figure this out first has to figure out do you
have a broker or an investment adviser, and then, second, they
have to figure out, depending on which one you have, what the
difference is between the fiduciary rule and the best interest
test. Is that right? Otherwise, you cannot----
Mr. Clayton. Almost, because you also have to understand
the relationship. You have got it right, but there are three
components to it. The adviser relationship, the reason it is
important to understand who you are dealing with, whether it is
a broker or an adviser, is the adviser relationship is a
portfolio relationship.
Senator Warren. OK. You have got two, and you are just
telling me it is even more complex than that. All I want to get
to----
Mr. Clayton. That is where we sit today.
Senator Warren. ----you cannot start--I know. And we could
have fixed that by just giving everybody the same rule, but we
did not. So here is the question: You have got to start with
the difference between an investment adviser and a broker. The
SEC has done a study on this, and your own data show that a lot
of investors have no idea what the difference between brokers
and investment advisers is and the legal standards that are
different for each of them. Your Office of the Investor
Advocate commissioned a study of whether investors could figure
out these differences based on the standard disclosures that
you gave them, and the bottom line was they cannot.
I do not have time to go through every example in the
study, but I picked one out. One participant told an
interviewer, after reading side-by-side descriptions of the
best interests and the fiduciary standards, ``I do not know. It
is basically the same language, but the same, they just kind of
word it differently. Yeah, so it is pretty much the same.''
But, of course, the standards are not the same, which is
the whole point here. When your own study shows that
disclosures do not work to help regular investors make informed
decisions, will you move away from a disclosure-based approach
in your final rule and just adopt a uniform fiduciary standard
for both advisers and brokers as Congress instructed in Section
913 of Dodd-Frank?
Mr. Clayton. That is a good summary of where we are.
Senator Warren. Good. Thank you.
Mr. Clayton. Let me tell you what we are doing. It is very
good. Let me tell you what we are doing. The adviser standard--
and I am going to call it the baseline adviser standard because
advisers are allowed to contract around this standard. It is
not well known. This is something that we want people to
understand. The baseline adviser standard is the adviser cannot
put their interests ahead of the client's interests. Now, they
are able to say, you know, but I am going to do these things,
and within informed consent they can cut back on that standard.
That is not well understood. We want that to be understood. But
on the broker side, the fundamental duty is going to be that
the broker cannot put her or his interests ahead of the
client's. So it is the same, but it is a different----
Senator Warren. Well, if it is the same----
Mr. Clayton. ----type of relationship.
Senator Warren. Let me suggest, Mr. Chairman, if it is the
same, just use the same words.
Mr. Clayton. We may do that.
Senator Warren. Because when you are not using the same
words and, in fact, trying to give a description so that people
have to sort out which of the two kinds of people they are
dealing with and how the standards differ from each other, it
means the disclosure is not working.
Look, we have had study after study after study that shows
that pages of disclosures do not work. And even if people read
the disclosures, they cannot make heads nor tails from it. Now
your own study reaches exactly the same conclusion. You know,
the inference I draw from this is that we need a clear, uniform
fiduciary standard for advisers and brokers. It is the only way
to make sure that people who are trying to save for their kids'
college education or their retirement are getting the advice
that is best for them, instead of what is most profitable for
the person giving the advice.
Mr. Clayton. I believe--oh, sorry.
Senator Warren. OK.
Chairman Crapo. We need to shut it down.
Senator Warren. Thank you, Mr. Chairman.
Mr. Clayton. OK. Thank you.
Chairman Crapo. Senator Corker.
Senator Brown. I just want to thank Senators Donnelly and
Corker for their service on this Committee, so thank you, Joe,
very much.
Chairman Crapo. And I join in that.
Senator Corker. Thank you. It has been a great privilege.
It really has.
I am going to be very brief and defer to Senator Cotton
because I know the Chairman and Ranking Member want to have
this end at an appropriate time, and we have got a lot of other
things happening. I have had the opportunity to get to know our
Chairman, both prior to him being confirmed and throughout the
process. I just want to say I am really proud of what he is
trying to do at the SEC. I am proud of his leadership. I know
that he is acting in an independent manner, which I appreciate
very much, and I wish him well as he continues, and all those
on the Committee as you continue to wrestle with issues
relative to our financial system.
And with that, thank you, and I will defer to Cotton.
Chairman Crapo. Thank you.
Senator Cotton.
Senator Cotton. Did not know we get to work that way. Thank
you, Senator Corker.
Chairman Clayton, I want to discuss with you the SEC gag
rule on settlements. It was addressed in a Wall Street Journal
opinion piece on November 14th. Here is how Judge Jed Rakoff
from the Southern District referred to them in 2011: ``The
result is a stew of confusion and hypocrisy unworthy of such a
proud agency as the SEC. The defendant is free to proclaim that
he has never remotely admitted the terrible wrongs alleged by
the SEC, but by gosh, he had better be careful not to deny them
either. Here an agency of the United States is saying, in
effect, although we claim that these defendants have done
terrible things, they refuse to admit it, and we do not propose
to prove it, but will simply resort to gagging their right to
deny it. The disservice to the public inherent in such a
practice is palpable.''
Would you explain to the Committee what public interest the
gag order on discussing settlements with the Commission serves?
Mr. Clayton. It has been an effective means to reach a
settlement that is in the interests of the public. Let me just
say that if we can settle matters quickly, we can move on to
look at other matters. And the no-admit/no-deny approach has
enabled us to get to settlements, to get people their money
back, get bad actors out of the marketplace, and draw a line
under that matter. So it has been an effective means of
pursuing remedies.
Senator Cotton. One might also say it allows a company and
an agency who have both failed in a particular matter to
conceal that failure from the public as well.
Mr. Clayton. It is not the right approach in every matter.
Senator Cotton. So there is a wrinkle in the roll that says
if a defendant who has reached a settlement and is under one of
these orders testifies in a court of law that he is no longer
bound by that gag order, which implies that the gag order might
require him to say something untruthful, what are your thoughts
on that wrinkle?
Mr. Clayton. I think that is a--how would I say this? It is
a result of the unique nature of testifying in those types of
situations.
Senator Cotton. So it is OK to have defendants who have
reached a settlement with the SEC to say things to the public
that might be untruthful but not to say them in court? We are
talking about a prior restraint on speech that is also content-
based, the most disfavored kind of regulations under Supreme
Court First Amendment precedent. They require a compelling
Government interest in the most narrowly tailored means.
Mr. Clayton. Look, we all know that the First Amendment,
you know, does not permit all speech without sanction. You
cannot commit fraud, you know, using words. I think this was
developed in part to restrict somebody who had done prior wrong
or we think had done prior wrong from telling people, ``Pay no
attention to that.'' And when you are dealing with somebody in
the securities industry, their history is something that is of
relevance.
Senator Cotton. Well, they can say that they did not commit
what was alleged against them. They just cannot deny the
allegations that were made. I know this is not a Jay Clayton
initiative. It goes back since before I was born, but it has
come under criticism for a very long time. I mean, do you think
that this gag order has First Amendment problems? You
personally.
Mr. Clayton. Me personally? I think that we have a long
history of people agreeing to restrict certain things that they
can say in the commercial arena.
Senator Cotton. OK. My time has almost expired. Thanks for
the exchange. I think the SEC probably----
Mr. Clayton. I did not know this was going to be a con law
class. I am struggling.
Senator Cotton. I think the SEC should probably reconsider
it. I mean, it was passed at a time in 1972 when First
Amendment precedent was much different and, frankly, more
favorable to the Government than it probably should have been.
I understand the points that you are making about public
interest, but I do think it is quite overbroad. It is not at
all narrowly tailored anymore, and it can undermine other
legitimate public interest.
Mr. Clayton. I understand.
Senator Cotton. Thank you, Mr. Clayton.
Mr. Clayton. Thank you.
Chairman Crapo. Senator Van Hollen.
Senator Van Hollen. Thank you, Mr. Chairman. Welcome, Mr.
Chairman.
I want to pursue some of the questions Senator Reed had on
stock buybacks because the claim that many made at the time
that the big tax cut was passed was that companies were going
to use all this extra money that they got from their tax cuts
to invest in more plant and equipment and wages increasing for
their workers. And the evidence is overwhelming that, in fact,
they are using that money for stock buybacks. We are up to $800
billion in stock buybacks today since the passage of the bill.
Now, we can all debate the merits of a stock buyback, but
as I understand your testimony, you agree that if executives
are using stock buybacks to elevate the price of their stock
and then quickly cash out their own compensation, that would be
a problem from your perspective. Am I understanding you
correctly?
Mr. Clayton. Let me be clear on what I said. Senator Reed
and also others said, you know, if the motivation is driven by
a compensation scheme, I think that is something----
Senator Van Hollen. So let me ask you this----
Mr. Clayton. I think that is something compensation
committees ought to----
Senator Van Hollen. Well, let me ask you this: So there is
mounting evidence that executives are cashing out more
frequently after a stock buyback than before. Well, I mean,
there has been evidence that, in fact, twice as many companies
have insider selling in the 8 days after a buyback announcement
as sell on an ordinary day. Would that trouble you if that was
a pattern?
Mr. Clayton. I saw that stat, and it is kind of
interesting. The question there is: Are the announcements
coincident for the window where they are actually permitted to
sell their stock? So, you know, I think a little more work
needs to be done on that. So if the only time you can sell as
an executive is right after earnings are announced, which is
most--then if you needed to sell as part of your planning, it
is going to be coincident----
Senator Van Hollen. I just--it is possible the data is
wrong, but if the data is correct----
Mr. Clayton. No, I think the data are correct.
Senator Van Hollen. ----you are finding though--but those--
in other words, if it is happening a lot more frequently in
this period in the 8 days after stock buybacks, I think that
would be a problem. But let me just ask you this: Would you be
willing to host a roundtable discussion to look into this
issue?
Mr. Clayton. Let me say this: I am happy to continue to
discuss this issue. I do not want to commit to a roundtable,
but the SEC's role in this is clearly something that people are
focused on. I want to be as clear as I can about what our role
is, so I am happy to continue the conversation to bring
clarity----
Senator Van Hollen. But I understood--and a number of us
wrote you a letter on this. I understand your position with
respect to decisions that have to be made by corporations for
the benefit of their shareholders. But what we appear to be
seeing is a pattern where more executives are cashing out when
they have had stock buybacks, which boosts the price. And that
would be decisions made for their own benefit as opposed to the
stockholders. So I would like to pursue this----
Mr. Clayton. I would be happy to.
Senator Van Hollen. ----because you have, as you know,
hosted a roundtable on something which I think is a lot less of
a priority, which is proxy shareholding. And, you know, where
you have chosen to focus your efforts I think is a little bit
troublesome. But let me just ask you this on shareholder
voting, proxy shareholder voting, because we had an earlier
hearing on this, and I mentioned a statement from T. Rowe
Price, which is a Maryland-based company, that is on both sides
of the shareholder proxy issue. They are an institutional
client to proxy advisory firms, but they are also an issuer
where others use proxies to decide whether to purchase--how to
cast their votes with respect to T. Rowe Price. And what they
say very clearly in this letter is that they think that the
requirements that proxy firms run their advice or proposals or
concerns through the corporations first would actually
significantly diminish the value of that advice to T. Rowe
Price.
Do you agree that we should not be dictating to the market
that these proxy advisers have to somehow show the executives
or the corporations their information before they give it to
the clients who are paying for it?
Mr. Clayton. So I am certainly not wedded to that method of
improving the process. There is an issue in the process, which
is the proxy advisory firm comes out with their analysis, and
the company wants to respond, and you have to look all over the
place. It would be nice if you could see the responses side by
side, or something else like that. But I am not wedded to
running it through the company before it is published.
Senator Van Hollen. OK. I just find it curious. We have had
people advocating here that a firm like T. Rowe Price just does
not know what it is doing and it needs this extra step in order
to make good decisions.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you. We have 10 minutes left in the
vote. I will be glad to recess and come back for those that
want 5 minutes, but I understand that a number of you are
willing to avoid that by just going a couple of minutes.
Senator Moran. Mr. Chairman, I will ask just one question.
Chairman Crapo. OK. Go ahead.
Senator Moran. Chairman Clayton, thank you for being here.
The Consolidated Audit Trail will be the second largest
database in the world, and it will be a repository for both
personally identifiable information and sensitive trade data.
As such, the CAT will be a major target for cybercriminals and
other bad actors. Broker-dealers will be required to report
consumers' personally identifiable information to the CAT and
then rely upon the security measures set up by CAT operators.
What is the SEC doing to require that CAT operators will
provide prompt and accurate notification of a data breach? And
how will the SEC assure that broker-dealers are not held liable
by their customers for data breaches caused by the CAT?
Mr. Clayton. What I can tell you, Senator, is I think all
three significant issues in your question are things we are
focusing on, including whether retail customer PII is actually
going to go into the CAT or whether we are going to do
something, a ``hashing'' is the technical term, and that is
about as much as I know about hashing, to ensure that the data
that goes into the CAT is not PII for those retail investors.
And in terms of issues around liability, I am not going to
speak about who owes what to whom and what the law applies, but
we are sensitive to those issues.
Senator Moran. With the time constraints, perhaps we can
have this conversation in my office or your office as well.
Mr. Clayton. Happy to.
Senator Moran. Thank you, Mr. Chairman.
Mr. Clayton. Thank you.
Chairman Crapo. Thanks, Senator Moran.
Senator Schatz.
Senator Schatz. Thank you, Mr. Chairman. Thank you,
Chairman, for being here.
I want to follow up on a conversation we had just about a
year ago. The SEC issued guidance in 2010 on climate risk. Many
in the investment community like BlackRock and Bloomberg have
called these disclosures inadequate. Currently, less than half
of America's largest companies even make these disclosures. In
October, a group of investors representing $5 trillion in
assets, 15 leading securities law professors sent a petition to
the SEC arguing that improved disclosure rules would increase
market efficiency and that the SEC has the authority to issue
such rules.
Yesterday a group of 415 investors that represent $32
trillion in assets wrote that Governments need to act on
climate change, and they specifically say it is vital that
Governments commit to improve climate-related financial
reporting standards.
I thought we had a good conversation about this. I thought
you expressed a willingness to work on this. I have seen no
evidence that you are working on this, and what little evidence
I have seen goes to the contrary in terms of the shareholder
proposals which are putatively not about climate; it is just
that every example given in raising thresholds for shareholder
action is about climate.
So what are you going to do to make sure that publicly
traded companies disclose climate risk?
Mr. Clayton. So our Division of Corporation Finance, which
reviews public company filings, this is one of the issues that
they are reviewing filings for. They make company-specific
comments, ask company-specific questions. We are doing that. I
have been in discussions with our head of Corp. Fin., Bill
Hinman, about whether we should do more, what that would be.
Senator Schatz. They are sandbagging, and I will leave it
there. We will follow up for the record, and I would like a
meeting in person. I understand that they are working in good
faith, but they view this as an ideological question, and 8
years later, this is very clearly an issue of economics. And
there was a point at which you could say, well, you know, we
cannot measure this, we cannot know this, this is not short
term. None of that is true anymore. All of this is proveably an
economic question, and in the interest of time--I do not mean
to cut you off--I will yield back.
Chairman Crapo. Senator Cortez Masto.
Senator Cortez Masto. Thank you. Chairman, it is good to
see you again. I want to jump back to the best interest
standard that you were talking with Senator Elizabeth Warren
about. First of all, I supported the Department of Labor's
fiduciary standard, and if you do not know, Nevada is the
first, I think, State in the country that passed a State
statute for a fiduciary requirement for broker-dealers. I am
curious with respect to the proposed regulation that was just
introduced by the SEC. Under that proposed regulation, can
brokers create sales incentives for recommending certain
products to its customers, to their customers?
Mr. Clayton. The short answer to your question is some
sales incentives, like growing assets under management or total
assets, you would think you would compensate somebody for
bringing in new customers and growing assets just like happens
in the investment advisory space. But there are some activities
like that that I believe--and I am speaking for myself, not for
the Commission--That I believe are inconsistent with--not
putting your interests ahead of the client's. High-pressure
products, specific sales contests, I have been clear, they do
not work for me. Get this out the door.
Senator Cortez Masto. And I agree with you because--in the
interest of time, I agree with you, but isn't it true that just
any incentive works against the best interest of the client?
Mr. Clayton. Well, I do not think so because if what you
are doing is saying to a broker, ``Hey, if you now have $100
million, for example, and you grow it to $200 million, you
should make more money.'' I think that is OK. That is the way
the investment advisory firm works. If you are managing a
pension plan for someone and you get another pension plan to
manage, you may get paid more. I think that is OK.
Senator Cortez Masto. OK. Let me ask you this: Does the
proposal--can brokers create bonuses for recommending certain
products to customers under this proposal?
Mr. Clayton. I think it depends on the structure.
Senator Cortez Masto. Again, there is another opportunity
for somebody to make money that really, in reality, they are
supposed to be looking at the best interest of the client, but
there is now an incentive for them to make money. And I have
always found--and I was a former Attorney General--that when
you put those incentives there, it really erodes looking out
for the best interest of the client, and that is my concern.
So let me jump to one final thing because in the
conversation with Senator Warren, you talked about the
potential--did I hear you correctly that when she talked about
defining the best interest standard and looking out for that
fiduciary relationship, you said that this proposal may use the
same words for defining a fiduciary? Is that correct? What did
you mean by that?
Mr. Clayton. What I mean is what I just said to you, that
the bedrock principle is that I cannot put my interests ahead
of my client's interests.
Senator Cortez Masto. But that to me is pretty clear, and
so that means no bonus, no incentive, nothing should be looking
out for your own interests over somebody else's. That is my
concern.
Mr. Clayton. They have to get paid.
Senator Cortez Masto. Well, that is different. That is
different.
Mr. Clayton. And I have engaged a lot with investors around
this just to hear what they think, and they recognize that
people should get paid. What they do not want are hidden
incentives or incentives that are clearly inconsistent with
making a recommendation that is in the interest of the client.
Senator Cortez Masto. OK. In the interest of time, I
appreciate you coming here today. Thank you.
Mr. Clayton. Thank you.
Chairman Crapo. Senator Jones.
Senator Jones. Thank you, Mr. Chairman. Chairman Clayton,
thank you for coming today.
Real quickly, you have been outspoken about the need for
disclosures for companies that face unpredictable risk, such as
Brexit, which seems to be becoming more unpredictable by the
hour. Cybersecurity is also another one. Recently, the SEC
issued guidance on cybersecurity disclosures, and I am hoping
that the SEC does not lose focus.
What I want to ask you, there were a couple of your
colleagues that thought that the guidance did not quite go far
enough, and I am just wondering if you could talk briefly about
what you are seeing from companies after the guidance was
issued and if there are other improvements for these
disclosures that you think might be prudent going forward.
Mr. Clayton. I have discussed those issues with my
colleagues and understand--I think that they understand how
difficult it would be to be more precise. For a long time, I
thought that disclosure was not where it should be in terms of
what the real risk was. I think we have seen improvement. We
have seen improvement in, OK, here is the general risk, and we
have seen some improvement in reporting when you have an issue.
And when I say the general risk, how that general risk applies
to your company. I would like to see more disclosure around
what companies are doing to minimize that risk. Are we
collecting less data? Are we looking at how we operate our
business so that, you know, you are less susceptible and are
now not just looking inside the company, but looking at your
vendors and suppliers and data that comes in from the outside
that, if corrupted, creates a risk for you. It is increasing in
terms of sophistication, but we have a ways to go.
Senator Jones. This can be just yes or no. I am assuming it
is a work in progress for the SEC.
Mr. Clayton. This is a work in progress for our economy.
Senator Jones. OK. That is all. Thank you, Mr. Chairman.
Thank you, Chairman Clayton.
Mr. Clayton. Thank you.
Chairman Crapo. Thank you, Senator Jones.
That does wrap up the questioning. Thank you for being here
today, Mr. Chairman. We appreciate the work that you are doing.
For Senators who wish to submit questions for the record,
those questions are due on Tuesday, December 18th, and I
encourage you, Mr. Chairman, to respond to them promptly.
This is our last hearing for this Congress. We have had a
lot of productive hearings, and I thank all of our Senators for
making that happen. I especially want to, as has already been
done, thank Senators Corker, Heller, Heitkamp, and Donnelly for
all the work they have done on this Committee. We will miss
them.
With that, this hearing is adjourned.
[Whereupon, at 11:16 a.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
Today we will receive testimony from Securities and Exchange
Commission Chairman Jay Clayton regarding the work and agenda of the
SEC.
Your appearance before the Committee is essential to our oversight
of the SEC. I thank you for your willingness to testify today.
The SEC has a critical mission to protect investors; maintain fair,
orderly, and efficient markets; facilitate capital formation; and
enforce securities laws.
The SEC plays an important role in public confidence and trust in
our Nation's capital markets.
It provides information to investors to ensure that as Americans
prepare for their futures, they have the information necessary to make
informed investment decisions.
I commend the SEC for its continued work to advance these missions.
Last week, this Committee held a hearing to discuss the appropriate
role of proxy advisory firms, the shareholder proposal process and the
level of retail shareholder participation.
Many Members expressed interest in continuing the discussion on the
appropriate relationship between proxy advisory firms and market
participants as it relates to shareholder proposals and corporate
governance.
I am concerned about the misuse of the proxy voting process and
other aspects of corporate governance to prioritize environmental,
social, or political agendas over the economic interests of end-
investors.
Last week, you stated your intent to address aspects of our proxy
system, including proxy ``plumbing,'' ownership, and resubmission
thresholds for shareholder proposals and proxy advisory firms.
Many of the rules governing our proxy system have not been examined
for decades, and I encourage the SEC to take an aggressive approach
assessing the scope and appropriateness of previous regulatory actions.
Capital markets are vital to facilitating job growth and expanding
American investment opportunities.
This Committee worked hard in the 115th Congress to pass a number
of bipartisan securities and capital formation bills.
I will continue to work with Members to identify additional
legislative proposals that encourage capital formation, and reduce
burdens for small businesses and communities.
The SEC has also taken a number of steps this year to make it
easier for emerging companies to go public while not discouraging the
availability of capital in the private market.
Additionally, this year the SEC proposed Regulation Best Interest
and a related interpretation to establish standards of conduct for
broker-dealers and investment advisers. This is a significant step
forward, and I look forward to seeing a final rule in the near term.
Finally, the SEC has been proactive in addressing cryptocurrencies
and coin offerings.
For example, the Enforcement Division created a new Cyber Unit this
year, which led efforts to counter fraud against retail investors
involved in initial coin offerings and brought charges against a
bitcoin-denominated platform operating as an unregistered securities
exchange.
I look forward to receiving updates on these and other SEC
initiatives, including your views on when we can expect final rules in
these areas.
______
PREPARED STATEMENT OF SENATOR SHERROD BROWN
Thank you Chairman Crapo, and welcome to Chair Clayton.
As I believe this will be the last Banking Committee hearing for
this Congress, I would like to express my thanks and appreciation for
the work of Senators Heitkamp, Donnelly, Corker, and Heller over the
years.
Chair Clayton, we've discussed the SEC's enforcement program in
previous hearings and in our recent meeting. As you've highlighted, the
SEC has worked hard to return money to harmed investors. I agree that
is an important goal, but enforcement can't begin and end with
protecting wealthy investors.
Ten years ago today, Bernie Madoff was arrested and his giant Ponzi
scheme was exposed. There's no doubt that Ponzi schemes still exist,
and your enforcement report shows the SEC is focused on finding them
and punishing the wrongdoers.
But, we also know that a decade ago, Bernie Madoff was far from the
biggest threat to most families. It was Wall Street firms that had just
wrecked our economy. And just as the SEC will continue to pursue Ponzi
schemes, it must also continue to pursue complex cases against the big
banks when they break the rules and threaten families' homes and
savings.
The big banks have not turned into angels over the past 10 years.
Last month, German authorities conducted a 2-day raid of Deutsche
Bank's headquarters in a money laundering and tax evasion
investigation.
Last year, both the Federal Reserve and New York State regulators
imposed fines totaling more than five hundred million dollars on
Deutsche Bank's U.S. entity, for anti- money-laundering violations. And
Deutsche Bank is not alone--similar problems persist at other banks.
Looking at your strategic plan, I frankly see a lot missing--
there's nothing about stock buybacks, and nothing about excessive
corporate debt.
Take a look at what has happened since the Republican tax overhaul.
Since last year, corporations have announced more than one trillion
dollars in stock buybacks.
To take one example, GM has spent more than 10 billion dollars on
stock buybacks since 2015, and last month it announced it's laying off
14,000 workers and closing five plants, including the Chevy Cruze plant
in Lordstown, Ohio. At the same time, it's expanding production in
Mexico.
The priorities of these corporations are clear--buying back shares
can boost a company's stock price, which can mean even bigger bonuses
for corporate executives. Investing in a company's workers supports the
long-term health of the company--but that's not what Wall Street
rewards.
But there's nothing intrinsic to our economy about stock buybacks.
The SEC rule facilitating buybacks was adopted 36 years ago, and since
then, the use, size, and frequency of stock buybacks has increased
dramatically.
My colleagues and I have asked you to take a hard look at that
rule.
It is time to question whether it is too easy for companies to buy
back their shares. The GM case shows us the risks to workers and
communities when companies think only about short-term profits.
We should also be looking at the record levels of risky corporate
debt and leveraged loans, and how that debt is packaged into
collateralized loan obligations--the complex securities that allow
investors to trade pools of loans.
The Federal Reserve and the OCC are looking at banks' exposure to
leveraged loans, but they say the risks are manageable and they are not
worried.
We've heard that one before--it was a little over 10 years ago,
before the economy came crashing down.
Leveraged lending and CLO investors include hedge funds, mutual
funds, and other market participants under SEC oversight. As the shadow
banking market plays a larger role in leveraged lending, watchdogs
can't just focus on the big banks.
It's your job to worry when it seems like there is nothing to worry
about. That's what consumers and investors expect, so that risks don't
build up across the financial system.
The SEC needs to be closely watching this market--not just to make
sure disclosures and credit ratings are adequate, but to complement the
work of the banking regulators. We know the financial system has become
more interconnected and that systemic risks are more likely.
Main Street cannot afford for you to stand by watching Wall Street
greed grow out of control. And any ``strategic plan'' for any agency
guiding our economy needs to focus on the American workers who drive
growth--not just wealthy investors.
Thank you Mr. Chairman.
______
PREPARED STATEMENT OF JAY CLAYTON
Chairman, U.S. Securities and Exchange Commission
December 11, 2018
Chairman Crapo, Ranking Member Brown, and Senators of the
Committee, thank you for the opportunity to testify before you today
about the work of the U.S. Securities and Exchange Commission (SEC or
Commission or Agency). Chairing the Commission is a great privilege,
and I am fortunate to be able to observe firsthand the incredible work
done by the agency's almost 4,500 dedicated staff, approximately 41
percent of whom are outside of Washington, DC, in our 11 regional
offices. \1\
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\1\ The views expressed in this testimony are those of the
Chairman of the U.S. Securities and Exchange Commission and do not
necessarily represent the views of the President, the full Commission,
or any Commissioner.
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Our people are our greatest assets, and they are our direct
connection to the investors we serve. None of the important work
described in this testimony would have been achieved without the
solutions-oriented attorneys, accountants, examiners and economists at
the SEC, whose work, in turn, is made possible thanks to the important,
often behind-the-scenes work of the agency's administrative and
operations personnel. The agency's supervisors and program managers
also play a critical role in ensuring effective and efficient
operations and activities.
Across the SEC, we recognize the importance of our capital markets
to the U.S. economy and millions of diverse American households. Our
people are skilled and committed. They accomplish a great deal with the
resources at their disposal, and they are proud to serve. This
testimony embodies the record of their work over the past year in
pursuit of the SEC's tripartite mission of protecting investors,
maintaining fair, orderly, and efficient markets and facilitating
capital formation.
New Strategic Plan
We recently released our Strategic Plan for 2018-2022, which
outlines three goals that will guide the work of the SEC moving
forward. \2\ I hope you will agree that we have made meaningful
progress over the past year toward satisfying these goals.
---------------------------------------------------------------------------
\2\ See U.S. Sec. and Exch. Comm'n Strategic Plan: Fiscal Years
2018-2022 (Oct. 2018), available at https://www.sec.gov/files/
SEC_Strategic_Plan_FY18-FY22_FINAL.pdf.
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Our first goal, which has been a priority of mine since I became
Chairman, is focusing on the interests of our long-term Main Street
investors. The past year has presented many opportunities for me, my
fellow Commissioners and SEC staff to interact directly with investors
from across the country. Those discussions allowed us to better answer
the question we ask ourselves every day: how does our work benefit the
Main Street investor? Each proposal or action we take is guided by that
principle.
Our second goal--to be innovative and responsive--reflects the
changing nature of our markets. As technological advancements and
commercial developments have changed how our securities markets
operate, the SEC's ability to remain an effective regulator requires
that we continually monitor the market environment and adapt our rules,
regulations and oversight. This maxim applies to nearly every facet of
what we do at the SEC. For example, it drove the establishment of a
Cyber Unit in the Division of Enforcement (Enforcement or Division) in
September 2017, a Fixed Income Market Structure Advisory Committee in
November 2017, and more recently, our new Strategic Hub for Innovation
and Financial Technology (FinHub).
Our third goal--elevating the agency's performance through
technology, data analytics and human capital--embodies our commitment
to maintaining an effective and efficient operation. We are using
technology, analyzing data and promoting information-sharing and
collaboration across the agency, while also maintaining the work
environment that has resulted in consistent high levels of employee
satisfaction. Maintaining a high level of staff engagement, performance
and morale is critical to our ability to execute the SEC's mission. We
are committed to continued investment in both new technology and human
capital.
The Commission's Fiscal Year 2018 Initiatives and Upcoming Agenda
I am proud of what our people have accomplished in Fiscal Year (FY)
2018 and look forward to building on this work as we continually review
and recalibrate our approach to accomplishing the SEC's mission.
Overall, America's historic approach to our capital markets has
produced a remarkably deep pool of capital with unprecedented
participation. It is our Main Street investors and their willingness to
commit their hard-earned money to our capital markets for the long term
that have ensured that the U.S. capital markets have long been the
deepest, most dynamic and most liquid in the world. Their capital
provides businesses with the opportunity to grow and create jobs, and
supplies the capital markets with the funds that give the U.S. economy
a competitive advantage. In turn, our markets have provided American
Main Street investors with better investment opportunities than
comparable investors in other jurisdictions.
To place this historic achievement in perspective, I note that the
United States has approximately 4.4 percent of the world's population,
yet the U.S. markets are the primary home to 56 of the world's 100
largest publicly traded companies, and U.S. households have over $22.4
trillion invested in the world's equity markets. \3\
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\3\ Board of Governors of the Federal Reserve System, 2016 Survey
of Consumer Finances (2016).
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More significantly, at least 52 percent of U.S. households are
invested directly or indirectly in our capital markets. \4\ This level
of retail investor participation stands out against other large
industrialized countries and is especially important to keep in mind as
our Main Street investors--whether they participate in our markets
directly or through an intermediary such as an investment adviser or
broker-dealer--now, more than ever, have a substantial responsibility
to fund their own retirement and other financial needs. As a result of
increased life expectancy and a shift from defined benefit plans (e.g.,
pensions) to defined contribution plans (e.g., 401(k)s and IRAs), the
interests and needs of our Main Street investors have changed.
---------------------------------------------------------------------------
\4\ See Jesse Bricker et al., ``Changes in U.S. Family Finances
From 2013 to 2016: Evidence From the Survey of Consumer Finances'',
Federal Reserve Bulletin, vol. 103 (September 2017), available at
https://www.federalreserve.gov/publications/files/scf17.pdf; see also
Rel. No. 34-83063, Form CRS Relationship Summary; Amendments to Form
ADV; Required Disclosures in Retail Communications and Restrictions on
the use of Certain Names or Titles (Apr. 18, 2018) (for statistics
except the mutual fund data); 2018 Investment Company Fact Book (mutual
fund statistics), available at https://www.ici.org/pdf/
2018_factbook.pdf.
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We are responding to that change. It is our obligation to preserve,
foster, and build on the successful history of our capital markets, and
history and experience demonstrate our work is never complete. Markets
change, and new risks to our markets and investors will emerge. We know
we must continuously assess whether we are focused on the right areas
and doing the right things, keeping the interests of our long-term Main
Street investors top of mind.
My testimony summarizes our important FY2018 initiatives, grouping
them in five areas: (1) the regulatory and policy agenda; (2)
enforcement and compliance; (3) enterprise risk and cybersecurity; (4)
increasing our engagement with investors and other market participants;
and (5) emerging market risks and trends. It also discusses a number of
forward-looking initiatives that we are pursuing as our 2019 near-term
agenda is now publicly available. \5\ Continuing with the themes of
transparency, accountability, and clarity of mission, the 2019 near-
term agenda focuses on the initiatives we reasonably expect to complete
over the next 12 months. I welcome feedback from all interested parties
on areas in need of focus and how we can best allocate our resources.
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\5\ The agenda for 2019 rulemaking was published in the Federal
Register on August 7, 2018, available at https://www.reginfo.gov/
public/do/eAgendaMain?operation=Operation-Get-Agency-Rule-
List¤tPub=true&agencyCode=&showStage=active&agencyCd=3235.; see
also Appendix B.
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Regulatory and Policy Agenda
During my September 2017 testimony, I noted that the near-term
Regulatory Flexibility Act agenda would be streamlined to increase
transparency and accountability to the public and Congress, as well as
to provide greater clarity to our staff. The 2017 agenda embodied a
collective effort, benefiting from the input of my fellow
Commissioners, our division and office heads and many members of our
staff on key questions, including: (1) what initiatives the agency
could reasonably expect to complete over the next 12 months, and (2) of
those initiatives, which ones would have the most positive impact on
our Main Street investors.
During the last year, the Commission advanced 23 of the 26 rules in
the near-term agenda, a good result on both a percentage basis (88
percent) and an absolute basis. \6\
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\6\ See Appendix A. Over the past 10 years, the Commission
completed, on average, approximately one-third of the rules listed on
the near-term agenda.
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In addition, the Commission responded to major events and changes
in the broader regulatory landscape by advancing several other
initiatives not in the original agenda. For example, we issued guidance
to public companies about disclosures of cybersecurity risks and
incidents. \7\ During FY2018, the Commission also responded to a new
congressional mandate from the Economic Growth, Regulatory Relief, and
Consumer Protect Act by expanding a key registration exemption used by
nonreporting companies to issue securities pursuant to compensatory
arrangements, \8\ and provided relief for those affected by Hurricane
Florence. \9\ In addition, to facilitate more accurate, clear, and
timely communications between issuers and shareholders, the staff
released guidance on how to approach near-term financial reporting
uncertainties resulting from tax law changes on the same day the bill
was signed by the President. \10\
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\7\ See Press Release 2018-22, ``SEC Adopts Statement and
Interpretive Guidance on Public Company Cybersecurity Disclosures''
(Feb. 21, 2018), available at https://www.sec.gov/news/press-release/
2018-22.
\8\ Rule 701--``Exempt Offerings Pursuant to Compensatory
Arrangements'', 83 Federal Register 34,940 (July 24, 2018); see also,
``Concept Release on Compensatory Securities Offerings and Sales'', 83
Federal Register 34,958 (July 24, 2018).
\9\ See Press Release 2018-202, ``SEC Provides Regulatory Relief
and Assistance for Hurricane Victims'' (Sept. 19, 2018), available at
https://www.sec.gov/news/press-release/2018-202.
\10\ See Press Release, ``Commission Staff Provides Regulatory
Guidance for Accounting Impacts of the Tax Cuts and Jobs Act'' (Dec.
22, 2017), available at https://www.sec.gov/news/press-release/2017-
237.
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To be sure, statistics--such as an 88 percent completion rate--
often fail to tell more than a narrow story. Main Street investors--the
market participants we have at the front of our minds--will not assess
our work by the number or percentage of rules and initiatives we
complete, but rather will be looking at what our efforts substantively
do for them. With this metric--the interests of our long-term Main
Street investors--in mind, I will discuss in more detail a few examples
of our work in 2018.
Standards of Conduct Proposals
In April 2018, the Commission proposed for public comment a
significant rulemaking package designed to serve Main Street investors
that would: (1) require broker-dealers to act in the best interest of
their retail customers; (2) reaffirm, and in some cases clarify, the
fiduciary duty owed by investment advisers to their clients; and (3)
require both broker-dealers and investment advisers to state clearly
key facts about their relationship, including their financial
incentives. \11\ This package of rulemakings is intended to enhance
investor protection by applying fiduciary principles across the
spectrum of investment advice, bringing the legal requirements and
mandated disclosures of financial professionals in line with investor
expectations.
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\11\ See Press Release 2018-68, ``SEC Proposes To Enhance
Protections and Preserve Choice for Retail Investors in Their
Relationships With Investment Professionals'' (Apr. 18, 2018),
available at https://www.sec.gov/news/press-release/2018-68.
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Broker-dealers and investment advisers both provide investment
advice to retail investors, but their relationships are structured
differently and are subject to different regulatory regimes. However,
it has long been recognized that many investors do not have a firm
grasp of the important differences between broker-dealers and
investment advisers--from differences in the types of services that
they offer and how investors pay for those services, to the regulatory
frameworks that govern their relationships. This confusion could cause
investor harm if, for example, investors fail to select the type of
service that is appropriate for their needs or if conflicts of interest
are not adequately understood and addressed. Our proposals would work
together to better align the standards of conduct and mandated
disclosures for both broker-dealers and investment advisers with what
investors expect of these financial professionals, while preserving
investor access and investor choice.
Specifically, proposed Regulation Best Interest would enhance
broker-dealer standards of conduct by establishing an overarching
obligation requiring broker-dealers to act in the best interests of the
retail customer when making recommendations of any securities
transaction or investment strategy involving securities. Simply put,
under proposed Regulation Best Interest, a broker-dealer cannot put her
or his interests ahead of the retail customer's interests. The proposal
incorporates that key principle and goes beyond and enhances existing
suitability obligations under the Federal securities laws. To meet this
requirement, the broker-dealer would have to satisfy disclosure, care,
and conflict of interest obligations.
Among other things, the obligations under proposed Regulation Best
Interest would put greater emphasis on costs and financial incentives
as factors in evaluating the facts and circumstances of a
recommendation. Additionally, the proposed standard would require
broker-dealers to establish, maintain and enforce written policies and
procedures reasonably designed to identify and eliminate material
conflicts of interest, or disclose and mitigate, material conflicts of
interest related to financial incentives. This is a significant and
critical enhancement as today the Federal securities laws largely
center on conflict disclosure rather than conflict management.
Proposed Regulation Best Interest and its ``best interest''
standard draw upon fiduciary principles in other contexts, including
those underlying an investment adviser's fiduciary duty, recognizing
that while their relationship models differ, both broker-dealers and
investment advisers often provide advice in the face of conflicts of
interest. These common principles are easier to compare given that we
issued as another part of our reform package a proposed interpretation
reaffirming--and, in some cases, clarifying--the fiduciary duty that
investment advisers owe to their clients. This interpretation is
designed to provide advisers and their clients with a reference point
for understanding the obligations of investment advisers to their
clients and, specifically, reaffirms that an investment adviser also
must act in the best interests of her or his client.
While the two standards are based on common principles, under the
proposal, some obligations of broker-dealers and investment advisers
will differ because the relationship models of these financial
professionals differ. But--importantly--the principles are the same,
and I believe the outcomes under both models should be the same: retail
investors receive advice provided with diligence and care that does not
put the financial professional's interests ahead of the investor's
interests. I believe our proposals are designed to make investors get
just that whether they choose a broker-dealer or an investment adviser.
In order to hear first-hand from retail investors who will be
directly impacted by the rulemaking package, the staff organized seven
roundtables across the country to provide Main Street investors the
opportunity to speak directly with me, my fellow Commissioners and
senior SEC staff to tell us about their experiences and views on what
they expect from their financial professionals. I had the opportunity
to lead five of these discussions--in Houston, Atlanta, Miami, Denver,
and Baltimore--and attend another in Washington, DC. These candid,
experience-based conversations were incredibly valuable and are
informing our work moving forward. The transcripts from these
roundtables are included in our public comment file. We also have
invited investors to view samples of the proposed disclosure form to
share their insights and feedback with the Commission by going to
https://www.sec.gov/tell-us. In addition, our Office of the Investor
Advocate engaged RAND Corporation to perform investor testing of the
proposed disclosure form. The results of the investor testing are
available on the SEC's website in order to allow the public to consider
and comment on this supplemental information. \12\
---------------------------------------------------------------------------
\12\ See Press Release 2018-257, ``Investor Testing of the
Proposed Relationship Summary for Investment Advisers and Broker-
Dealers'' (Nov. 7, 2018), available at https://www.sec.gov/news/press-
release/2018-257.
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The staff of the Division of Trading and Markets and the Division
of Investment Management are reviewing all of this information, and the
more than 6,000 comment letters, \13\ as they work diligently together
to develop final rule recommendations.
---------------------------------------------------------------------------
\13\ See Comments on ``Proposed Rule: Regulation Best Interest'',
available at https://www.sec.gov/comments/s7-07-18/s70718.htm. Of the
more than 6,000 comment letters, approximately 3,000 were unique
letters.
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Facilitating Capital Formation
The SEC took meaningful steps during FY2018 to encourage capital
formation for emerging companies seeking to enter our public capital
markets while maintaining, and, in many cases, enhancing investor
protections. Doing so provides greater investment opportunities for
Main Street investors, as it is generally difficult and expensive for
them to invest in private companies. As a result, Main Street investors
may not have the opportunity to participate in the growth phase of
these companies if they choose not to enter our public markets or do so
only later in their life cycle. Additionally, it is my experience that
companies that go through the SEC public registration and offering
process often come out as better companies, providing net benefits to
the company, investors, and our capital markets.
As a result of the July 2017 expansion of the draft registration
statement submission process to all first-time registrants and newly
public companies conducting initial public offerings (IPOs) and
offerings within one year of an IPO, the Division of Corporation
Finance (Corporation Finance) has received draft submissions for more
than 40 IPOs and from more than 75 existing reporting companies that
have utilized the expanded accommodation. This change has given
companies more control over their offering schedules and has limited
their exposure to market volatility and competitive harm--providing a
benefit to their shareholders without diminishing investor protection.
Additionally, in June 2018, the Commission voted to adopt
amendments to the ``smaller reporting company'' definition that expand
the number of companies that can qualify for certain existing scaled
disclosure requirements. \14\ The new definition recognizes that a one-
size regulatory structure for public companies does not fit all and
will allow approximately 1,000 additional companies to benefit from
smaller reporting company status. The amended definition should benefit
both smaller companies, by making the option to join our public markets
more attractive, and Main Street investors, who, in turn, will have
more investment options.
---------------------------------------------------------------------------
\14\ See Press Release 2018-116, ``SEC Expands the Scope of
Smaller Public Companies That Qualify for Scaled Disclosures'' (June
28, 2018), available at https://www.sec.gov/news/press-release/2018-
116.
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The Commission also has taken steps to simplify and update
financial disclosures. In July 2018, we proposed amendments to
financial disclosures to encourage guaranteed debt offerings to be
conducted on a registered rather than a private basis. \15\ I believe
these measures have the potential to save issuers significant time and
expense, enhance the quality of disclosure and increase investor
protection.
---------------------------------------------------------------------------
\15\ See Press Release 2018-143, ``SEC Proposes Rules To Simplify
and Streamline Disclosures in Certain Registered Debt Offerings'' (July
24, 2018), available at https://www.sec.gov/news/press-release/2018-
143.
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Further, in August 2018, the Commission adopted final rules that
simplify and update disclosures by eliminating requirements that are
outdated, overlapping or duplicative of other Commission rules or U.S.
GAAP. \16\ These amendments were part of a larger initiative by
Corporation Finance to review disclosure requirements applicable to
issuers and consider ways to improve the requirements for the benefit
of investors and issuers. While these rule changes may appear
technical, I anticipate that they will yield substantial benefits for
public companies and investors, especially when taken together with
other capital formation initiatives at the Commission. Importantly,
they will not adversely affect the availability of material information
and, in many cases, will enhance the quality of available information
and increase investor protection.
---------------------------------------------------------------------------
\16\ See Press Release 2018-156, ``SEC Adopts Amendments To
Simplify and Update Disclosure Requirements'' (Aug. 17, 2018),
available at https://www.sec.gov/news/press-release/2018-156.
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Corporation Finance has several proposals on the horizon designed
to encourage capital formation for emerging companies seeking to enter
our public capital markets. Specifically, I anticipate the Commission
will consider a proposal to amend the definition of ``accelerated
filer'' that triggers Section 404(b) of the Sarbanes-Oxley Act of 2002,
which requires registrants to provide an auditor attestation report on
internal control over financial reporting, that if adopted will have
the effect of reducing the number of companies that need to provide the
auditor attestation report, while maintaining appropriate investor
protections. \17\ While Section 404(b) has become a familiar, and in
many cases important, component of our public company regulatory
regime, we have heard from market participants and our former Advisory
Committee for Small and Emerging Companies that, particularly for
smaller companies, the costs associated with this requirement can
divert significant capital from the core business needs of companies
without a corresponding investor benefit. I look forward to considering
the staff's recommendations.
---------------------------------------------------------------------------
\17\ See ``Amendments to Smaller Reporting Company Definition'',
83 Federal Register 31,992 (July 10, 2018).
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Additionally, I anticipate that the Commission will consider
expanding the ability of companies that are contemplating raising
capital to ``test-the-waters'' by engaging in communications with
certain potential investors prior to or following the filing of a
registration statement for an IPO. I have seen firsthand how this has
benefited companies considering an IPO, as they are able to engage
investors earlier to explain their business and obtain feedback in
advance of an offering. This also benefits investors and shareholders
as companies are better able to determine the appropriate time for an
offering and to more effectively size and price the offering. I look
forward to the Commission considering this initiative in the coming
year.
Further, I expect that the Commission will consider a proposal, as
required by the Economic Growth, Regulatory Relief, and Consumer
Protection Act, to expand Regulation A offering eligibility to public
reporting companies.
Finally, I believe it is important to encourage long-term
investment in our country. I expect that the Commission will soon
consider a release soliciting input on how we can reduce compliance
burdens on reporting companies with respect to quarterly reports while
maintaining, and in some cases enhancing, investor protections. There
is an ongoing debate regarding our approach to mandated quarterly
reporting and the prevalence of optional quarterly guidance, and
whether our reporting system more generally drives an overly short-term
focus. I encourage all market participants to share their views and to
let us know if there are other aspects of our regulations that drive
short-termism inappropriately.
Beyond our public markets, I anticipate the Commission will take a
fresh look at the exempt offering framework to consider whether changes
should be made to harmonize and streamline the framework. Congress and
the SEC have taken a number of steps to expand the options that small
businesses have to raise capital. Small businesses today have more
options to reach investors within their State using the intrastate
exemption, or tap the ``crowd'' using the power of the Internet through
Regulation Crowdfunding offerings. Small businesses can decide to limit
their offerings to sophisticated investors in reliance on Regulation D,
or open those offerings to retail investors using Regulation A. \18\
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\18\ See ``Remarks on Capital Formation at the Nashville 36/86
Entrepreneurship Festival'' (Aug. 29, 2018), available at https://
www.sec.gov/news/speech/speech-clayton-082918. Since these rules have
gone into effect, small businesses have conducted over 900 offerings
that reported raising more than $90 million collectively using
Regulation Crowdfunding. And there have been over 300 offerings that
reported raising a total in excess of $1 billion pursuant to Regulation
A. Those amounts, however, are eclipsed by the $147 billion reportedly
raised in 2017 using Rule 506(c) of Regulation D, the new exemption
that lifted the ban on general solicitation. And even that is dwarfed
by use of the traditional private placement exemption in Rule 506(b) of
Regulation D to raise over $1.7 trillion in 2017. Id.
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Additionally, pursuant to the Economic Growth, Regulatory Relief,
and Consumer Protection Act, the SEC recently expanded the exemption
that permits private companies to issue securities to employees,
consultants and advisors as compensatory awards--a transaction that
preserves cash for the company's operations and aligns the incentives
of employees with the success of the company--and solicited comment on
further ways to modernize the rules related to these compensatory
arrangements. \19\ The so-called ``gig economy'' has changed how
companies and individuals design alternative work arrangements, and,
therefore, individuals may not be ``employees'' eligible to receive
securities as compensatory awards under our current exemption.
---------------------------------------------------------------------------
\19\ See Press Release 2018-135, ``SEC Adopts Final Rules and
Solicits Public Comment on Ways To Modernize Offerings Pursuant to
Compensatory Arrangements'' (July 18, 2018), available at https://
www.sec.gov/news/press-release/2018-135.
---------------------------------------------------------------------------
While the options to raise capital in exempt offerings have grown
significantly since the JOBS Act, there has not been a comprehensive
review of our exemptive framework to ensure that the system, as a
whole, is rational, accessible, and effective. In fact, I doubt anyone
would have come up with anything close to the complex system we have
today if they were starting with a blank slate. So, I believe we should
take a critical look at our exemption landscape, which can be fairly
described as an elaborate patchwork. \20\ The staff is working on a
concept release that I expect will bring to the forefront these and
other topics on how we can harmonize exempt offerings. Receiving input
from investors, startups, entrepreneurs and other market participants
who have first-hand experience with our framework is extremely
important to make sure we get it right.
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\20\ As we embark on this project, I believe there are several
things we should consider. We should evaluate the level of complexity
of our current exemptive framework for issuers and investors alike, and
consider whether changes should be made to rationalize and streamline
the framework. For example, do we have overlapping exemptions that
create confusion for companies trying to navigate the most efficient
path to raise capital? Are there gaps in our framework that impact the
ability of small businesses to raise capital at key stages of their
business cycle? We also should consider whether current rules that
limit who can invest in certain offerings should be expanded to focus
on the sophistication of the investor, the amount of the investment, or
other criteria rather than just the wealth of the investor. And we
should take a look at whether more can be done to allow issuers to
transition from one exemption to another and, ultimately, to a
registered IPO, without undue friction.
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Improving the Proxy Process
Another significant initiative for 2019 is improving the proxy
process. Last month, the SEC staff held a proxy roundtable to discuss:
(1) the proxy solicitation and voting process; (2) shareholder
engagement through the shareholder proposal process; and (3) the role
of proxy advisory firms. \21\ I was pleased with this solutions-
oriented event, which included a diverse group of panelists
representing the views of investors, companies and other market
participants. While we heard a wide range of views, we saw more
agreement than disagreement, and I believe that we should act to
improve each of these areas.
---------------------------------------------------------------------------
\21\ See November 15, 2018: ``Roundtable on the Proxy Process'',
available at https://www.sec.gov/proxy-roundtable-2018.
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There was consensus among the panelists that the proxy ``plumbing''
needs a major overhaul. I encourage market participants to explore what
such an overhaul would entail and to consider how technology, including
distributed ledger technology, could improve the proxy plumbing. I
realize a major overhaul could take time. So, I believe we should focus
on what the Commission can do in the interim to improve the current
system. The comment box for the roundtable remains open, and I
encourage all those interested in improving the proxy plumbing to share
their thoughts, particularly regarding actionable, interim
improvements.
I also believe it is clear that we should consider reviewing the
ownership and resubmission thresholds and related criteria for
shareholder proposals. The current $2,000 ownership threshold and
related criteria were adopted 20 years ago in 1998, and the
resubmission thresholds have been in place since 1954. A lot has
changed since then. We need to be mindful of these changes, and make
sure our approach to the very important issue of shareholder engagement
reflects the realities of today's markets and today's investors. As I
have said before, when looking at the ownership and resubmission
thresholds and related criteria, we need to consider the interests of
the long-term retail investors who invest directly in public companies
and indirectly through mutual funds, ETFs and other products. With
these long-term, retail investors in mind, we also should consider
whether there are factors, in addition to the amount invested and the
length of time shares are held, that reasonably demonstrate that the
proposing shareholder's interests are aligned with those of a company's
long-term investors.
For proxy advisory firms, I believe there is growing agreement that
the current dynamics among four parties, (1) proxy advisory firms, (2)
investment advisers who employ those firms and have a fiduciary duty to
their investors, (3) issuers, and (4) investors at large, including our
Main Street investors, can be improved. For example, there should be
greater clarity regarding the division of labor, responsibility and
authority between proxy advisors and the investment advisers they
serve. We also need clarity regarding the analytical and decision-
making processes advisers employ, including the extent to which those
analytics are company or industry specific. On this last point, it is
clear to me that some matters put to a shareholder vote can only be
analyzed effectively on a company-specific basis, as opposed to
applying a more general market or industrywide policy.
Finally, there were other issues raised at the roundtable that we
should consider, including: (1) the framework for addressing conflicts
of interests at proxy advisory firms, and (2) ensuring that investors
have effective access to issuer responses to information in certain
reports from proxy advisory firms.
The staff is looking at these and other issues, and I have asked
them to formulate recommendations for the Commission's consideration.
On timing, it is clear to me that these issues will not improve on
their own with time, and I intend to move forward with the staff
recommendations, prioritizing those initiatives that are most likely to
improve the proxy process and our markets for our long-term Main Street
investors.
Modernizing Trading and Market Structure
Another area of focus for the Commission is ensuring fair and
efficient trading markets for our Main Street investors. We know that
transparency is a bedrock of healthy and vibrant markets, and I am
pleased to report that we have taken significant steps to make our
trading markets more transparent.
In July 2018, we adopted amendments that enhance the transparency
requirements governing alternative trading systems, commonly known as
``ATSs.'' \22\ These amendments provide investors, brokers and other
market participants--and the Commission--with increased visibility into
the operations of these important markets for equity trading.
Additionally, last month, the Commission adopted amendments to
Regulation NMS to provide investors with greater transparency
concerning how brokers handle and execute their orders. \23\
---------------------------------------------------------------------------
\22\ See Press Release 2018-136, ``SEC Adopts Rules To Enhance
Transparency and Oversight of Alternative Trading Systems'' (July 18,
2018), available at https://www.sec.gov/news/press-release/2018-136.
\23\ See Press Release 2018-253, ``SEC Adopts Rules That Increase
Information Brokers Must Provide to Investors on Order Handling'' (Nov.
2, 2018), available at https://www.sec.gov/news/press-release/2018-253.
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Further, in March 2018, the Commission proposed a transaction fee
pilot for National Market System (NMS) stocks, which, if adopted, would
provide the Commission with data to help us analyze the effects of
exchange fees and rebates on order routing behavior, execution quality
and our market structure generally. \24\ This topic has received
significant attention ever since the implementation of Regulation NMS.
More recently, the development of a pilot program on transaction fees
was one of the SEC's Equity Market Structure Advisory Committee's most
prominent recommendations to the Commission. \25\ In my view, the
proposed pilot--which I expect the Commission to consider for adoption
in the near future--would lead to a more thorough understanding of
these issues, which would help the Commission make more informed and
effective policy decisions in the future, all to the benefit of retail
investors.
---------------------------------------------------------------------------
\24\ See Press Release 2018-43, ``SEC Proposes Transaction Fee
Pilot for NMS Stocks'' (Mar. 14, 2018), available at https://
www.sec.gov/news/press-release/2018-43.
\25\ See ``Equity Market Structure Advisory Committee,
Recommendation for an Access Fee Pilot'' (July 8, 2016), available at
https://www.sec.gov/spotlight/emsac/recommendation-access-fee-
pilot.pdf.
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Our fixed income markets are also critical to our economy and Main
Street investors, though historically, less attention has been focused
on these relative to the equity markets. With large numbers of
Americans retiring every month and needing investment options, fixed
income products attract more and more Main Street investors. Yet, many
of those investors may not appreciate that fixed income products are
part of markets that differ significantly from the equity markets.
In November 2017, the SEC created the Fixed Income Market Structure
Advisory Committee (FIMSAC) to provide diverse perspectives on the
structure and operations of the U.S. fixed income markets, as well as
advice and recommendations on fixed income market structure. The
Committee has held four public meetings and has provided the Commission
with five thoughtful recommendations on ways to improve our fixed
income markets. \26\ I look forward to an equally successful second
year.
---------------------------------------------------------------------------
\26\ See ``Fixed Income Market Structure Advisory Committee'',
available at https://www.sec.gov/spotlight/fixed-income-advisory-
committee. FIMAC's recommendations include the following: (1) the
development of a pilot program to delay public dissemination for 48
hours of trades in any investment grade corporate bond above $10
million and any high-yield corporate bond above $5 million (requires
Financial Industry Regulatory Authority (FINRA) rulemaking); (2) the
formation of a joint SEC, FINRA, and Municipal Securities Rulemaking
Board (MSRB) working group to review the regulatory framework for
electronic trading platforms in corporate and municipal bonds; (3) the
adoption of a comprehensive classification scheme for exchange traded
products; (4) for the SEC to encourage the formation of an industry
group to promote investor education and work towards the establishment
of a centralized and widely accessible database of key ETF data; and
(5) that the SEC, in conjunction with FINRA, establish a new issue
reference data service for corporate bonds that would be widely
accessible on commercially reasonable terms.
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Finally, new FINRA and MSRB requirements regarding the disclosure
of corporate and municipal bond mark-ups and mark-downs went into
effect, and I am pleased that investors now have substantially greater
transparency into the costs of participating in those markets. I
believe this transparency will increase competition and reduce trading
costs, all to the benefit of Main Street investors.
Consolidated Audit Trail
Another market structure initiative that is garnering significant
staff attention is the implementation of the Consolidated Audit Trail
(CAT). The CAT is designed to provide a single, comprehensive database
that, when fully implemented, will allow regulators to more efficiently
and accurately track trading in equities and options throughout the
U.S. markets. Among other things, the CAT is intended to allow the
Commission to better carry out its oversight responsibility by
improving our ability to reconstruct trading activity following a
market disruption or other event, which in turn would allow us to more
quickly understand the causes of such an event and respond
appropriately.
Under the CAT NMS Plan, the self-regulatory organizations (SROs)--
the national securities exchanges and FINRA--are responsible for
developing and implementing the CAT and were required to begin
reporting data to the CAT by November 15, 2017. The SROs missed that
deadline. While the CAT has now begun receiving equity and options data
with limited functionality, the SROs remain out of compliance with the
CAT NMS Plan today.
The SROs are making some progress, but the development and
implementation process remains slow and cumbersome due largely to what
I believe are project governance and project management issues
experienced by the SROs. While, pursuant to SEC staff requests, the
SROs recently set forth a revised timeline with detailed milestones,
more recently Thesys (the plan processor) informed the SROs that it
does not plan to deliver full functionality of CAT's first phase in
accordance with these milestones. The SROs have reported to our staff
that they currently expect to deliver the first phase of CAT (which,
again, was required to be delivered by November 15, 2017) by March 31,
2019. We remain frustrated with failure of the SROs to meet their
obligations and the delays in the development of the CAT.
I know there are substantial concerns about the protection of
investors' personally identifiable information (PII) that would be
stored in the CAT. I have the same concerns and continue to make the
protection of CAT data, particularly any form of PII, a threshold
issue. In November 2017, I asked the Commission staff to evaluate the
need for PII in the CAT. This evaluation includes consideration of,
among other things, what PII data elements need to be collected and
retained in the CAT in order to achieve the regulatory goals of the
CAT, and how PII in the CAT would be used by the SEC and the SROs. We
are considering what alternatives to the scope of PII that would be
collected and retained by the CAT under the current plan could provide
the Commission and the SROs with the market surveillance and
reconstruction data necessary to conduct our regulatory and enforcement
functions. As I have stated before, as the SROs continue to make
progress in the development, implementation and operation of the CAT, I
believe that the Commission, the SROs and the plan processor must
continuously evaluate their approach to the collection, retention and
protection of PII and other sensitive data. More generally, I have made
it clear that the SEC will not retrieve sensitive information from the
CAT unless we have a regulatory need for the information and believe
appropriate protections to safeguard the information are in place.
Distributed Ledger Technology, Digital Assets, and Initial Coin
Offerings
The Commission and its staff have been focusing a significant
amount of attention and resources on digital assets and initial coin
offerings (ICOs). I am optimistic that developments in distributed
ledger technology can help facilitate capital formation, providing
promising investment opportunities for both institutional and Main
Street Investors. Overall, I believe we have taken a balanced
regulatory approach that both fosters innovation and protects
investors. For example, our staff meets regularly with entrepreneurs
and market professionals interested in developing new and innovative
investment products in compliance with the Federal securities laws.
Recently, Corporation Finance's Director, Bill Hinman, outlined factors
for participants to consider when evaluating whether a digital asset is
a security \27\ and also named a new Associate Director in Corporation
Finance to serve as the Senior Advisor for Digital Assets and
Innovation and coordinate efforts in this area across the agency. \28\
SEC staff is also meeting regularly with staff from other regulatory
agencies to coordinate efforts and identify any areas where additional
regulatory oversight may be needed. Divisions and offices across the
Commission have worked together, as well as with other regulators, to
issue public statements regarding ICOs and virtual currencies. \29\
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\27\ See William Hinman, ``Digital Asset Transactions: When Howey
Met Gary'' (Plastic) (June 14, 2018), available at https://www.sec.gov/
news/speech/speech-hinman-061418.
\28\ See Press Release 2018-102, ``SEC Names Valerie A. Szczepanik
Senior Advisor for Digital Assets and Innovation'' (June 4, 2018),
available at https://www.sec.gov/news/press-release/2018-102.
\29\ See ``Statement on Digital Asset Securities Issuance and
Trading'' (Nov. 16, 2018), available at https://www.sec.gov/news/
public-statement/digital-asset-securites-issuuance-and-trading.
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In an effort to further coordinate the Commission's work on these
important issues, in October of this year the SEC announced the
formation of a FinHub within the agency. \30\ Staffed by
representatives from across the Commission, the FinHub will serve as a
public resource for FinTech-related issues at the SEC, including
matters dealing with distributed ledger technology, automated
investment advice, digital marketplace financing, and artificial
intelligence/machine learning. In addition to serving as a portal for
public engagement, FinHub will also serve as an internal resource
within the SEC, coordinating the agency staff's work on these and other
FinTech-related issues. As the work of FinHub and our other activities
demonstrate, the agency is focused on issues presented by new
technologies, and our door remains open to those who seek to innovate
and raise capital in accordance with the law.
---------------------------------------------------------------------------
\30\ See Press Release 2018-240, ``SEC Launches New Strategic Hub
for Innovation and Financial Technology'' (Oct. 18, 2018), available at
https://www.sec.gov/news/press-release/2018-240.
---------------------------------------------------------------------------
Unfortunately, while some market participants have engaged with our
staff constructively and in good faith with questions about the
application of our Federal securities laws, others have sought to prey
on investors' excitement about cryptocurrencies and ICOs to commit
fraud or other violations of the Federal securities laws. Enforcement
has recently brought a number of landmark cases in this area, and I
have asked the Division's leadership to continue to police these
markets vigorously and recommend enforcement actions against those who
conduct ICOs or engage in other actions relating to digital assets in
violation of the Federal securities laws. The Commission acted swiftly
to crack down on allegedly fraudulent activity in this space,
particularly where the misconduct has targeted Main Street investors.
Regardless of the promise of this technology, those who invest their
hard-earned money in opportunities that fall within the scope of the
Federal securities laws deserve the full protections afforded under
those laws.
Modernizing Asset Management Regulations
In June 2018, the Commission proposed for public comment a new rule
to replace the process of individually issued orders for exemptive
relief for certain exchange traded funds (ETFs). \31\ The proposal is
designed to create a consistent, transparent, and efficient regulatory
framework for ETFs would facilitate greater competition and innovation
among these products. The ETF market, which has a volume of
approximately $3.6 trillion, currently operates under more than 300
individually issued exemptive orders that have varied over time in
wording and terms. I anticipate that the Commission will consider
recommendations to adopt a final ETF rule in the coming year, which
will enable staff to focus more time and attention on novel or unusual
ETF products instead of more routine ETF-related issues.
---------------------------------------------------------------------------
\31\ See Press Release 2018-118, ``SEC Proposes New Approval
Process for Certain Exchange-Traded Funds'' (June 28, 2018), available
at https://www.sec.gov/news/press-release/2018-118.
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The agency is working to promote research in the ETF market and
provide investors greater access to that research. On November 30,
2018, the Commission adopted rules and amendments that are intended to
reduce obstacles to providing research on investment funds in
furtherance of the Fair Access to Investment Research Act of 2017. The
adopted rules seek to harmonize the treatment of investment fund
research with research on other public companies by establishing a safe
harbor for a broker-dealer to publish or distribute research reports on
investment funds under certain conditions. Overall, these rules aim to
promote research on mutual funds, ETFs, registered closed-end funds,
business development companies (BDCs) and similar covered investment
funds and provide investors with greater access to research to aid them
in making investment decisions.
Additionally, the Small Business Credit Availability Act directs
the Commission to revise certain securities offering and proxy rules in
order to harmonize existing registration and reporting requirements to
allow BDCs to be treated in the same manner as public corporate
issuers. The Economic Growth, Regulatory Relief, and Consumer
Protection Act similarly directs the Commission to issue rules to allow
certain registered closed-end funds to use the securities offering and
proxy rules that are available to public corporate issuers. The
Division of Investment Management is working to develop rule
recommendations related to these two bills.
Improving the Investor Experience
The Division of Investment Management is leading a long-term
project to explore modernization of the design, delivery and content of
fund disclosures and other information for the benefit of investors.
These initiatives are an important part of how the Commission can serve
investors in the 21st century. Fund disclosures are especially
important because millions of Americans invest in funds to help them
reach personal financial goals, such as saving for retirement and their
children's educations. As of the end of 2017, over 100 million
individuals representing nearly 60 million households, or 45 percent of
U.S. households, owned funds (generally ETFs or open-ended mutual
funds). \32\
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\32\ ``2018 Investment Company Fact Book'', supra note 4, at ii.
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In June 2018, the Commission issued a request for comment on
enhancing disclosures by mutual funds, ETFs and other types of
investment companies to improve the investor experience and to help
investors make more informed investment decisions (Fund Disclosure
RFC). \33\ The Fund Disclosure RFC seeks input from retail investors
and others on how they use fund disclosures and how they believe funds
can improve disclosures to aid investment decision making. In order to
facilitate retail investor engagement and comment on improving fund
disclosure, the Commission has provided a short Feedback Flier on
Improving Fund Disclosure, which can be viewed and submitted at
www.sec.gov/tell-us.
---------------------------------------------------------------------------
\33\ See Press Release 2018-103, ``SEC Modernizes the Delivery of
Fund Reports and Seeks Public Feedback on Improving Fund Disclosure''
(June 5, 2018), available at https://www.sec.gov/news/press-release/
2018-103.
---------------------------------------------------------------------------
The Commission also adopted a new rule that creates an optional
``notice and access'' method for delivering fund shareholder reports.
\34\ The reforms include protections for those without internet access
or who simply prefer paper by preserving the ability to continue to
receive reports in paper. Under the rule, a fund may deliver its
shareholder reports by making them publicly accessible on a website,
free of charge, and sending investors a paper notice of each report's
availability by mail. To inform investors in advance of this new
delivery method, there is an extended transition period so that the
earliest a fund could begin to rely on the rule would be January 1,
2021. During this time, funds that choose to implement the new delivery
method must provide prominent disclosures in prospectuses and certain
other shareholder documents that will generally notify investors of the
upcoming change in delivery format on a recurring basis for a period of
2 years.
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\34\ Id.
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Security-Based Swaps and Other Interagency Efforts
With respect to our security-based swap regime, the Commission has
finalized many, but not all, of the security-based swap rules mandated
by Title VII of the Dodd-Frank Act. In the coming year, I anticipate
that the Commission will continue with our efforts to lay out a
coherent package of rules to finalize our statutory security-based swap
rulemaking obligations.
As part of this effort, our staff has been actively engaged with
our counterparts at the Commodity Futures Trading Commission (CFTC) to
explore ways to further harmonize our respective security-based swap
rules with the swap rules developed by the CFTC to increase
effectiveness and reduce complexity and costs. I am pleased to note
that earlier this year CFTC Chairman Giancarlo and I executed a
memorandum of understanding (MOU) between our two agencies. \35\ The
MOU explicitly acknowledges where we have shared regulatory interests,
including but not limited to Title VII, and reconfirms our commitment
to work together to facilitate efficient markets for the benefit of all
market participants.
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\35\ See Press Release 2018-114, ``SEC and CFTC Announce Approval
of New MOU'' (June 28, 2018), available at https://www.sec.gov/news/
press-release/2018-114.
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In addition to continued discussions with the CFTC regarding Title
VII harmonization, the Commission and staff has engaged with our fellow
financial regulators to address the key issues in our markets in a
holistic, consistent manner. These efforts will continue, including
efforts to simplify, tailor, and make more effective the Volcker Rule,
cooperate on innovative issues like distributed ledger technology and
digital assets and address emerging risks to the financial sector
through the Financial Stability Oversight Council.
Other Dodd-Frank Act Issues
The Commission also has several other outstanding mandates from the
Dodd-Frank Act. Earlier this year, I addressed how I plan to prioritize
and tackle these remaining responsibilities. \36\ Generally speaking,
in addition to the Title VII regime, there are three categories of
Dodd-Frank Act-mandated rules remaining:
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\36\ See ``Opening Remarks at the Securities Regulation
Institute'' (Jan. 22, 2018), available at https://www.sec.gov/news/
speech/speech-clayton-012218.
1. Executive compensation rules for both public companies and SEC-
regulated entities, for which, as a result of the complexity
and scope of the existing executive compensation disclosure
regime, as well as the nature of the mandates, I believe a
serial approach is likely to be most efficient and best serve
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the SEC's mission;
2. Specialized disclosure rules, such as resource extraction
disclosure, which pose additional challenges, including how the
SEC can meet its obligations under the Administrative Procedure
Act and, in the case of resource extraction, the Congressional
Review Act; and
3. Mandates, some of which overlap with examples given above, for
which market developments--including developments resulting
from shareholder engagement--have, at least in part, mitigated
some of the concerns that motivated the statutory requirements.
\37\ Our rulemaking priorities, as well as the rules
themselves, should reflect these observable developments.
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\37\ For example, several companies already have made public their
policies regarding compensation clawbacks. Some of these policies go
beyond what would be required under Dodd-Frank. We have seen a few
companies attempt to claw back compensation from their executives under
these policies.
Several of these, including hedging disclosure and resource
extraction disclosure, are on the Commission's near-term agenda.
Overall, it is the SEC's obligation to complete the rules mandated by
Congress in Dodd-Frank, and I intend to do so.
Enforcement and Compliance
Pursuing Enforcement Matters That Are Meaningful to Main Street
Investors
The ongoing efforts made by Enforcement to deter misconduct and
punish securities law violators are critical to safeguarding millions
of investors and instilling confidence in the integrity of our markets.
The nature and quality of the SEC's enforcement actions during the last
year speak volumes to the hard work of the women and men of the agency.
The efforts of the Enforcement staff over the past year have made our
capital markets a safer place for investors to put their hard-earned
money to work.
As noted by Enforcement's Co-Directors, Stephanie Avakian and
Steven Peikin, in their Annual Report, our success is best judged both
quantitatively and qualitatively and over various periods of time. \38\
Relevant qualitative factors include, among other things, asking
whether we are: bringing meaningful actions that target the most
serious violations, pursuing individual sanctions in appropriate cases,
obtaining punishments that deter unlawful conduct and returning money
to harmed investors. Based on such an evaluation--and in my opinion by
any measure--Enforcement has been successful. I can assure you that the
Division will continue its vigorous enforcement of the Federal
securities laws and hold bad actors accountable, whether on Main Street
or Wall Street.
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\38\ See U.S. Sec. and Exch. Comm'n, Div. of Enforcement, ``Annual
Report: A Look Back at Fiscal Year 2018'' (Nov. 2, 2018), available at
https://www.sec.gov/files/enforcement-annual-report-2018.pdf.
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I would like to highlight the work of four investor-oriented
enforcement initiatives over the past year that show the Enforcement
staff's commitment to investor protection: (1) the Retail Strategy Task
Force, (2) the Cyber Unit, (3) the Share Class Selection Disclosure
Initiative and (4) Enforcement's work in returning funds to harmed
investors.
In September 2017, the SEC announced the formation of a Retail
Strategy Task Force (RSTF), which has two primary objectives: (1) to
develop data-driven, analytical strategies for identifying practices in
the securities markets that harm retail investors and generating
enforcement matters in these areas; and (2) to collaborate within and
beyond the SEC on retail investor advocacy and outreach. \39\ Each of
these objectives directly impacts the lives of Main Street investors
and involves collaboration between many divisions and offices. We
anticipate that new data-driven approaches will yield significant
efficiencies in case generation and resource allocation by targeting
enforcement efforts where the risks to Main Street investors are the
most significant. Although it has been operative for only a little over
a year, the RSTF has already undertaken a number of lead-generation
initiatives built on the use of data analytics (i.e., promptly
searching for matters to investigate on behalf of retail investors).
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\39\ See Press Release 2017-176, ``SEC Announces Enforcement
Initiatives to Combat Cyber-Based Threats and Protect Retail
Investors'' (Sept. 25, 2017), available at https://www.sec.gov/news/
press-release/2017-176.
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Enforcement also in September 2017 announced the creation of a
Cyber Unit to combat cyber-related threats. The Cyber Unit focuses the
Division's resources and expertise on, among others things, hacking to
obtain material, nonpublic information, violations involving
distributed ledger technology and cyberintrusions. \40\ Together with
the FinHub, discussed above, the resources we have dedicated to the
Cyber Unit's important work demonstrate the high priority that we
continue to place on cyber-related issues affecting investors and our
markets. In its first year, the Cyber Unit led investigations that
resulted in several emergency actions to stop ongoing alleged frauds
against retail investors that involved ICOs, as well as charges against
a bitcoin-denominated platform and its operator for running an
unregistered securities exchange and defrauding users of that exchange.
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\40\ Id.
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Beyond ICOs and digital assets, the Cyber Unit also led important
investigations that resulted in SEC actions involving alleged cyber-
related market manipulations, account takeovers and other cyber-related
trading violations. The cases brought by the SEC in FY2018 included
charges for allegedly scheming to manipulate the price of a stock by
making a phony regulatory filing and for allegedly hacking into over
100 online customer brokerage accounts and making unauthorized trades
to manipulate stock prices and profit from the artificial price
movements.
Additionally, Enforcement expanded its efforts to identify advisers
that did not disclose conflicts as a result of their receipt of
compensation in the form of 12b-1 fees. Prior efforts by Enforcement
and the Office of Compliance Inspections and Examinations (OCIE)
suggested that many investment advisers were not disclosing conflicts
of interest to their retail customers relating to the selection of
more-expensive mutual fund share classes, which involved the receipt of
12b-1 fees, when cheaper alternatives were available. Enforcement
announced a Share Class Selection Disclosure Initiative in February
2018, representing an innovative approach intended to facilitate the
efficient return of money to harmed investors and prompt remediation of
misconduct. \41\
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\41\ See Press Release 2018-15, ``SEC Launches Share Class
Selection Disclosure Initiative To Encourage Self-Reporting and the
Prompt Return of Funds to Investors'' (Feb. 12, 2018), available at
https://www.sec.gov/news/press-release/2018-15.
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Finally, in my view, protecting retail investors also means,
whenever possible, putting money back in their pockets when they are
harmed by violations of the Federal securities laws. In FY2017 and
FY2018, the Commission returned $1.07 billion and $794 million to
harmed investors, respectively. We remain committed to this important
part of our work, and we expect to continue our efforts to return funds
to victims this year as well.
The unanimous Supreme Court decision in Kokesh v. SEC, however, has
impacted our ability to return funds fraudulently taken from Main
Street investors. In Kokesh, the Supreme Court found our use of the
disgorgement remedy operated as a penalty, which time limited the
ability of the Commission to seek disgorgement of ill-gotten gains
beyond a 5-year statute of limitations applicable to penalties.
I do not believe it is productive to debate the merits of the
Kokesh decision. I agree that statutes of limitation serve many
important functions in our legal system, and certain types of actions
as well as penalties and certain other remedies should have reasonable
limitations periods. Civil and criminal authorities, including the SEC,
should do everything in their power to bring appropriate actions
swiftly, and, in our markets, particularly our public markets, the
certainty brought by reasonable limitations periods has value for
investors.
However, as I look across the scope of our actions, including most
notably Ponzi schemes and affinity frauds, I am troubled by the
substantial amount of losses that we may not be able to recover for
retail investors. Said simply, if the fraud is well-concealed and
stretches beyond the 5-year limitations period applicable to penalties,
it is likely that we will not have the ability to recover funds
invested by our retail investors more than 5 years ago. Allowing clever
fraudsters to keep their ill-gotten gains at the expense of our Main
Street investors--particularly those with fewer savings and more to
lose--is inconsistent with basic fairness and undermines the confidence
that our capital markets are fair, efficient and provide Americans with
opportunities for a better future.
I welcome the opportunity to work with Congress to address this
issue to ensure defrauded retail investors can get their investment
dollars back. I believe that any such authority should be narrowly
tailored to that end while being true to the principles embedded in
statutes of limitations.
Protecting Main Street Investors and Improving Investment Options by
Promoting Compliance
Earlier this year, our OCIE published its 2018 examination
priorities, which reflected a continued focus on the SEC's commitment
to protecting retail investors. \42\ In particular, OCIE has looked
closely at products and services offered to retail investors, the
disclosures they receive about those investments and the financial
services professionals who serve them. OCIE has also focused its
attention on several other areas that present heightened risks,
including: (1) compliance and risks in critical market infrastructure,
such as exchanges and clearing agencies; (2) the continued growth of
cryptocurrencies and ICOs; (3) cybersecurity; and (4) anti- money
laundering programs.
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\42\ U.S. Sec. and Exch. Comm'n, Off. of Compliance Inspections
and Examinations, ``2018 Nat'l Exam Program Examination Priorities''
(Feb. 7, 2018), available at https://www.sec.gov/about/offices/ocie/
national-examination-program-priorities-2018.pdf.
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OCIE conducts risk-based examinations of SEC-registered entities,
including broker-dealers, investment advisers, investment companies,
municipal advisors, national securities exchanges, clearing agencies,
transfer agents, and FINRA, among others. During FY2018, OCIE conducted
over 3,150 examinations, an overall increase of 11 percent from FY2017.
This includes a 17 percent coverage ratio for investment advisers--
which increased 13 percent from FY2017, even as the number of
registered investment advisers increased by approximately 5 percent.
OCIE also continued to leverage data analysis to identify potentially
problematic activities and firms as well as to determine how best to
scope the examinations of those activities and firms.
In conjunction with our examination activities, OCIE published a
number of risk alerts to inform registered firms and investors of
common compliance issues we observed. \43\ This year, OCIE risk alerts
addressed topics ranging from municipal advisor examinations to fee and
expense compliance issues for investment advisers. These alerts sharpen
the identification and correction of potentially deficient practices,
maximize the impact of our examination program and better protect the
interests of Main Street investors.
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\43\ U.S. Sec. and Exch. Comm'n, Off. of Compliance Inspections
and Examinations, ``Risk Alerts'', available at https://www.sec.gov/
ocie.
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Enterprise Risk and Cybersecurity
Cybersecurity at the SEC continues to be a top priority. The SEC
and other agencies are the frequent targets of attempts by threat
actors who seek to penetrate our systems, and some of those actors may
be backed by substantial resources. Recognizing the twin realities that
electronic data systems are essential to our mission and no system can
ever be entirely safe from a cyberintrusion, it is incumbent upon us to
devote substantial resources and attention to cybersecurity, including
the protection of PII. Over the past year, we have been focused on a
number of areas for improvement, including with respect to IT
governance and oversight, security controls, risk awareness related to
sensitive data, incident response, and reliance on legacy systems--and
much work remains to be done.
We are closely scrutinizing how we can reduce any potential
exposure of PII contained in SEC systems, including EDGAR. In this
regard, earlier this year, the Commission acted to eliminate the
collection of social security numbers and dates of birth on a number of
EDGAR forms where we concluded that the information was not necessary
to our mission. \44\ Moreover, return copies of test filings are no
longer stored within the EDGAR system. The staff also continues to
explore alternatives to the current approach, including the possibility
of implementing a new electronic disclosure solution.
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\44\ Amendments to Forms and Schedules To Remove Provision of
Certain Personally Identifiable Information, Rel. Nos. 33-10486, 34-
83097, IC-33077 (Apr. 24, 2018), available at https://www.sec.gov/
rules/final/2018/33-10486.pdf.
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The agency has also focused closely on its cybersecurity risk
governance structure. We now have a Chief Risk Officer who helps
coordinate our risk management efforts across the agency. We have
worked to promote a culture that emphasizes the importance of data
security throughout our divisions and offices. The staff has also been
engaging with outside experts to assess and improve our security
controls. For example, on a technical level, these efforts include the
deployment of enhanced security capabilities, additional penetration
testing and code reviews, investment in new technologies and
experienced cybersecurity personnel and acceleration of the transition
of certain legacy information technology systems to modern platforms.
We will also continue to coordinate and partner with both other Federal
agencies to identify and mitigate risks to our information technology
environment and assets.
We also look at cybersecurity from perspectives outside of our
internal risk profile. From an issuer disclosure perspective, it is
important that investors are sufficiently informed about the material
cybersecurity risks and incidents affecting the companies in which they
invest. Earlier this year, the Commission issued interpretive guidance
to assist public companies in preparing these types of disclosures.
\45\ The guidance also emphasized the importance of disclosure controls
and procedures that enable public companies to make accurate and timely
disclosures about material cybersecurity events, as well as policies
that protect against corporate insiders trading in advance of company
disclosures of material cyberincidents. Further, the guidance expanded
on prior staff guidance by addressing the board's oversight functions.
Existing SEC rules require a company to disclose the extent of the
board's role in risk oversight. The guidance noted that this disclosure
should specifically include a discussion of the board's role in
overseeing cybersecurity risk management, to the extent those risks are
material. We are monitoring the market's response to our guidance.
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\45\ Press Release 2018-22, supra note 7.
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From a market oversight perspective, we continue to prioritize
cybersecurity in our examinations of market participants, including
broker-dealers, investment advisers, and critical market infrastructure
entities. In assessing how firms prepare for a cybersecurity threat,
safeguard customer information and detect red flags for potential
identity theft, for example, we have focused on areas including risk
governance, access controls, data loss prevention, vendor management
and training, among others. And given the interconnectedness of our
markets, we will continue to work closely with our counterparts at
other Federal financial regulatory agencies and the international
community to discuss cybersecurity risks and coordinate potential
response efforts.
From an enforcement perspective, as previously mentioned, our Cyber
Unit is dedicated to targeting cyber-related misconduct in our markets,
including failures by issuers to make material disclosures. \46\ And
finally, from an investor education perspective, our Office of Investor
Education and Advocacy has worked hard to inform investors about
cybersecurity hygiene and red flags of cyberfraud, in order to prevent
investors from becoming victims in the first place.
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\46\ See Press Release 2018-71, ``Altaba, Formerly Known as
Yahoo!, Charged With Failing To Disclose Massive Cybersecurity Breach;
Agrees To Pay $35 Million'' (Apr. 24, 2018), available at https://
www.sec.gov/news/press-release/2018-71.
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Increasing Engagement With Investors and Other Market Participants
To effectively fulfill our responsibility to American investors and
markets, it is essential that the SEC maintain an open line of
communication with investors and other market participants. In FY2018,
the SEC substantially increased its engagement with an array of market
participants to help us improve our work and better focus our resources
and efforts.
Engagement With Main Street Investors
Over the past year, SEC staff, my fellow Commissioners and I have
engaged directly with Main Street investors from around the country
through town halls, outreach tours, new digital tools, and other
methods.
In a first-of-its-kind event, on June 13, 2018, the full
Commission--all five Commissioners--and SEC leadership met with more
than 400 members of the public during an investor town hall at the
Georgia State University College of Law in Atlanta, Georgia. This
event, organized by the SEC's Office of the Investor Advocate and the
Atlanta Regional Office, marked the first time the full Commission met
with Main Street investors outside of Washington, DC. During the main
session of the town hall meeting, Commissioners provided a range of
information to investors and answered questions from attendees. My
fellow Commissioners, other SEC leaders and I also participated in
break-out sessions with smaller groups of investors to hear their views
on specific investor-oriented topics such as combating fraud. The
following day, the agency's Investor Advisory Committee hosted a
meeting at the same location, providing another opportunity for the
public to engage with the Commission.
This event kicked off the SEC's ``Tell Us'' campaign, which
included the additional roundtable meetings with retail investors I
mentioned in Houston, Miami, Washington, DC, Philadelphia, Denver, and
Baltimore. As mentioned, to complement these open discussions, the
agency also developed a new ``Tell Us'' website and feedback flier,
specifically designed for Main Street investors to provide feedback on
the proposed disclosures in the standards of conduct proposals without
needing to write a formal letter.
The SEC also conducted investor research and surveys in FY2018 in
order to better understand how investors interact with markets. The
agency conducted eight surveys and conducted four rounds of qualitative
research involving focus groups and one-on-one interviews. In addition
to these events, day in and day out the SEC staff engages with
individual investors as well as with investor groups to promote
awareness of the SEC's work and to solicit feedback.
Empowering Main Street Investors Through Information and Education
Across our seven investor town halls, one common theme--regardless
of demographics and geography--was that investors wished they had known
more about investing and our markets earlier in their lives. This
sentiment was universal and deeply held and, while not entirely within
the purview of the Commission to address, will continue to resonate
with me during my tenure at the Commission.
The SEC promotes informed investment decision making through
education initiatives aimed at providing Main Street investors with a
better understanding of our capital markets and the opportunities and
risks associated with the array of investment choices presented to
them. Our Office of Investor Education and Advocacy spearheads these
efforts and participation extends throughout our divisions and offices.
In FY2018, the SEC conducted over 150 in-person investor education
events focused toward various segments of the population, including
senior citizens, military personnel, younger investors and affinity
groups. In addition to in-person education events, we developed
informative, innovative, and accessible educational initiatives.
A primary focus of our educational efforts is preventing fraud.
Unfortunately, it does not cost much to finance a scam, and it often is
easy for bad actors to reach their targets, particularly over the
internet. If investors know that, as well as some of the hallmarks of
fraud and key questions to ask before they invest or provide personal
information, they are less likely to become victims.
We use a variety of channels to deliver this message to investors.
For example, we created a website to educate the public about frauds
involving ICOs and just how easy it is for bad actors to engineer this
type of fraud--Our HoweyCoins.com mock website promoted a fictional
ICO. \47\ The website was created in-house, very quickly and with few
resources. It attracted over 100,000 people within its first week. We
also published a variety of investor alerts and bulletins to warn Main
Street investors about other possible schemes, including certain using
celebrity endorsements, self-directed individual retirement accounts,
the risks in using credit cards to purchase an investment and the
potential harm resulting from sharing their personal contact
information with online investment promoters.
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\47\ See Press Release 2018-88, ``The SEC Has an Opportunity You
Won't Want To Miss: Act Now!'' (May 16, 2018), available at https://
www.sec.gov/news/press-release/2018-88.
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We also continued to promote our national public service campaign,
``Before You Invest, Investor.gov''. This initiative encourages
investors to research the background of their investment professional.
Our experience demonstrates that working with unlicensed promoters who
have a history of misconduct greatly increases the risk of fraud and
losses. In May 2018, we supplemented this information service with a
new online search tool, the SEC Action Lookup for Individuals--or SALI.
\48\ This tool enables investors to find out if the individual or firm
he or she is dealing with has been sanctioned as a result of SEC
action, for both registered and unregistered individuals. SALI
continues to be updated on an ongoing basis, making it an ever better
resource for Main Street investors. We are encouraged by the fact that
unique page views on Investor.gov increased by 45 percent compared to
FY2017.
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\48\ See Press Release 2018-78, ``SEC Launches Additional Investor
Protection Search Tool'' (May 2, 2018), available at https://
www.sec.gov/news/press-release/2018-78.
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SEC regional offices also engaged in investor initiatives in their
local communities. For example, the San Francisco Regional Office has
conducted extensive outreach to California teachers through its Teacher
Investment Outreach Initiative. This project seeks to help teachers
make informed decisions on investment portfolio options, fees, and
risk. Regional staff, many of whom have personal connections to the
teaching community, created this initiative in response to learning
about the limitations of the investment options offered to public
school teachers under the defined contribution portion of their
retirement plans.
Engagement With Market Participants
Our capital markets are far different today than they were a decade
ago. They are increasingly global and highly data dependent.
Investments are channeled through intermediaries and vehicles, such as
mutual funds and ETFs, to a much greater extent. Our markets also are
ever changing and the pace of that change has increased. It is
essential that the SEC understand the markets of today and continually
prepare for and adjust to market developments. As a result, engagement
with those who participate in our markets extensively, including public
and private companies, institutional investors, broker-dealers and
auditors, as well as those who monitor and oversee markets, including
U.S. and foreign authorities, elected officials and academics, is
essential.
In 2018, the SEC held numerous public roundtables at which the
Commission and SEC staff engaged in an open forum with market
participants on some of the most salient issues affecting our markets
today.
In April, the Division of Trading and Markets hosted a
roundtable on market structure for thinly traded securities,
both equities and exchange-traded products. The panelists
discussed the challenges faced by participants in the market
for thinly traded exchange-listed securities, including small
and medium-sized companies looking to enter our public markets,
and potential actions to address those concerns. The staff is
analyzing a number of the suggestions and comments made at that
roundtable, and, more generally, is considering ways to improve
secondary market liquidity for smaller companies.
In September, the Division of Trading and Markets hosted a
roundtable on regulatory approaches to combating retail
investor fraud. At this event, a broad range of market
participants, regulators, and industry experts shared their
views on potential steps that might be taken to enhance the
ability of regulators, broker-dealers, and others to combat
retail investor fraud.
In October, the Division of Trading and Markets hosted a
roundtable on market data and market access. At this event, a
diverse group of panelists, representative of a broad spectrum
of perspectives and views--including those of exchanges, market
participants and various industry experts--discussed the
current landscape of market data products and market access
services. The panelists also provided views on potential steps
to improve market data products and access services.
In November, the Divisions of Corporation Finance and
Investment Management held a roundtable, discussed above,
focusing on key aspects of the U.S. proxy system.
In addition to events of this type, the leadership in our divisions
and offices, as well as our dedicated staff, is open to hearing from
and meeting with investors and market participants on areas where our
markets are not working as they should or can be improved--particularly
as it relates to our long-term Main Street investors.
Emerging Market Risks and Trends
I want to briefly discuss two risks, in addition to cybersecurity
risks, we are monitoring closely: the impact to reporting companies of
the United Kingdom's exit from the European Union, or ``Brexit''; and
the transition away from the London Interbank Offered Rate, or
``LIBOR,'' as a reference rate for financial contracts. While these are
not the only areas of market risk that the Commission is monitoring,
their impacts are likely significant for American investors.
Brexit
First, the potential effects of Brexit on U.S. investors and
securities markets, and on global financial markets more broadly, is a
matter of increased focus for me and many of my colleagues at the SEC.
To be direct, I am concerned that:
1. The potential adverse effects of Brexit are not well understood
and, in the areas where they are understood, are
underestimated. \49\
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\49\ Chris Giles and Sylvia Pfeifer, ``BoE Sounds Alarm Over No-
Deal Brexit Planning'', Fin. Times, Nov. 29, 2018 (noting that the Bank
of England's Governor Mark Carney says that less than half of the
businesses in the U.K. are not prepared for the risk of a no-deal
Brexit).
2. The actual effects of Brexit will depend on many factors, some of
which may prove to be beyond the control of the U.K. and EU
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authorities.
3. Our markets, at many levels--from multinational companies, to
market infrastructure, to investment products and services--are
international, and the effects of Brexit will be international,
including on U.S. markets and our Main Street investors.
4. The actual effects of Brexit are likely to manifest themselves in
advance of implementation dates and, based on corporate
disclosures, some of those effects are upon us.
5. The actual effects of Brexit will depend in large part on the
ability of U.K., EU, and EU member State officials to provide a
path forward that allows for adjustment without undue
uncertainty, disruption, or cost. That is a tall order that I
believe requires: (a) a broad understanding of market
interdependencies--knowledge that goes well beyond the labor
and financial markets; (b) foresight--people and firms will act
in their own interests and the interests of their shareholders;
and (c) flexibility--miscalculations are inevitable and will
need to be addressed promptly. More generally, limiting the
adverse effects of Brexit requires a willingness of
governmental authorities to look beyond potential immediate,
local economic and other opportunities provided by a blunt
transition and pursue a course that focuses on broad, long-term
economic performance and stability. While many involved in the
Brexit process agree with this perspective, and some important
steps have been taken, \50\ I do not yet see wide acceptance of
this principle.
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\50\ European Commission Communication, ``Preparing for the
Withdrawal of the United Kingdom From the European Union on 30 March
2019: A Contingency Action Plan (Nov. 13, 2018), available at https://
ec.europa.eu/info/publications/communication-preparing-withdrawal-
united-kingdom-european-union-30-march-2019-contingency-action-plan-13-
11-2018_en.
To be clear, these are my personal views, but it is appropriate to
share them as they are reflective of the SEC's approach to Brexit. The
SEC's responsibility is primarily related to the effects of Brexit on
our capital markets. For example, I have directed the staff to focus on
the disclosures companies make about Brexit and the functioning of our
market utilities and other infrastructure.
We have seen a wide range of disclosures, even within the same
industry. Some companies have fairly detailed disclosures about how
Brexit may impact them, while others simply state that Brexit presents
a risk. I would like to see companies providing more robust disclosure
about how management is considering Brexit and the impact it may have
on the company and its operations.
With regard to market utilities and infrastructure, following the
2016 Brexit vote, SEC staff commenced discussions with other U.S.
financial authorities, with our U.K. and EU counterparts, and with
market participants, all with an eye toward identifying and planning
for potential Brexit-related impacts on U.S. investors and markets.
These discussions are ongoing, and I expect their pace to increase.
Transition Away From LIBOR
The second risk that I want to highlight relates to the transition
away from LIBOR as a benchmark reference for short-term interest rates.
LIBOR is used extensively in the U.S. and globally as a benchmark for
various commercial and financial contracts, including interest rate
swaps and other derivatives, as well as floating-rate mortgages and
corporate debt. It is likely, though, that the banks currently
reporting information used to set LIBOR will stop doing so after 2021,
when their commitment to reporting information ends. The Federal
Reserve estimates that in the cash and derivatives markets, there are
approximately $200 trillion in notional transactions referencing U.S.
Dollar LIBOR and that more than $35 trillion will not mature by the end
of 2021. \51\
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\51\ These estimates are as of the end of 2016. Of the $200
trillion in notional exposure, approximately 95 percent relates to
derivatives products. Over $8 trillion of exposure relates to business
loans, consumer loans, floating/variable rate notes, and
securitizations. See ``Second Report of the Alternative Reference Rates
Committee'' (March 2018), available at https://www.newyorkfed.org/
medialibrary/Microsites/arrc/files/2018/ARRC-Second-report.com.
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The Alternative Reference Rate Committee (Committee)--a group
convened by the Federal Reserve that includes major market
participants, and on which SEC staff and other regulators participate--
has proposed an alternative rate to replace U.S. Dollar LIBOR--the
Secured Overnight Financing Rate, or ``SOFR.'' The Committee has
identified benefits to using SOFR as an alternative to LIBOR. For
example, SOFR is based on direct observable transactions and based on a
market with very deep liquidity, reflecting overnight Treasury
repurchase agreement transactions with daily volumes regularly in
excess of $700 billion.
A significant risk for many market participants--whether public
companies who have floating-rate obligations tied to LIBOR, or broker-
dealers, investment companies or investment advisers that have exposure
to LIBOR--is how to manage the transition from LIBOR to a new rate such
as SOFR, particularly with respect to those existing contracts that
will still be outstanding at the end of 2021. Accordingly, although
this is a risk that we are monitoring with our colleagues at the
Federal Reserve, Treasury Department, and other financial regulators,
it is important that market participants plan and act appropriately.
For example, if a market participant manages a portfolio of
floating rate notes based on LIBOR, what happens to the interest rates
of these instruments if LIBOR stops being published? What does the
documentation provide? Does fallback language exist and, if it exists,
does it work correctly in such a situation? If not, will consents be
needed to amend the documentation? Consents can be difficult and costly
to obtain, with cost and difficulty generally correlated with
uncertainty.
In the area of uncertainties, we continue to monitor risks related
to the differences in the structure of SOFR and LIBOR. SOFR is an
overnight rate, and more work needs to be done to develop a SOFR term
structure that will facilitate the transition from term-based LIBOR
rates. \52\
---------------------------------------------------------------------------
\52\ Relying on daily compounding over a 3-month period, for
example, may result in issuers not having certainty about the size of
their interest payment until the end of the period. Also, SOFR does not
correspond one-to-one with LIBOR; LIBOR incorporates a credit risk
premium whereas SOFR is a secured rate. In a transition, a methodology
needs to be developed to determine fair spreads between the two rates.
---------------------------------------------------------------------------
To be clear, a lot of progress has been made to facilitate the
transition from LIBOR to SOFR. We have started to see more SOFR-based
debt issuances, and we have seen promising developments in the SOFR
swaps and futures markets. \53\ But I want to make sure that market
participants are aware of the need to plan for this important
transition, as a lot of the work will fall on them.
---------------------------------------------------------------------------
\53\ For example, trading in SOFR futures in the U.S. commenced in
May. See ``CME Group Announces First Trades of New SOFR Futures'' (May
8, 2018), available at https://www.cmegroup.com/media-room/press-
releases/2018/5/08/cme_group_announcesfirsttradesofnewsofrfutures.html.
The market's first-ever SOFR-linked debt securities were issued in
July, and since then additional issuances have occurred. See ``Fannie
Mae Pioneers Market's First-Ever Secured Overnight Financing Rate
(SOFR) Securities'' (July 26, 2018), available at http://
www.fanniemae.com/portal/media/financial-news/2018/fannie-mae-pioneers-
sofr-securities-6736.html. In addition, central counterparties have
commenced clearing of SOFR swaps. See ``LCH Clears First SOFR Swaps''
(July 18, 2018), available at https://www.lch.com/resources/news/lch-
clears-first-sofr-swaps. See also ``CME Group Announces First OTC SOFR
Swaps Cleared'' (Oct. 9, 2018), available at https://www.cmegroup.com/
media-room/press-releases/2018/10/09/
cme_group_announcesfirstotcsofrswapscleared.html.
---------------------------------------------------------------------------
Conclusion
Thank you for the opportunity to testify today and for the
Committee's continued support of the SEC, its mission and its people. I
look forward to working with each of you to advance our mission to the
benefit of our capital markets and our Main Street investors.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM JAY CLAYTON
Q.1. The Consolidated Audit Trail (CAT) plan processor, Thesys
CAT LLC, announced last month the initiation of reporting by
exchanges and FINRA of order and transaction data. As Trading
and Markets Division Director Redfearn noted, the Master Plan
first phase launch on November 15, 2018, reflects a 1-year
delay from the original plan.
Thesys CAT's press release noted that it ``continues to
work to provide the capabilities required for the first
reporting phase,'' and that it expects to complete full
functionality on or before March 31, 2019.
Given that each successive phase of the CAT was delayed by
at least one year, please explain the significance of the delay
in achieving full functionality described by Thesys CAT and
whether following phases will further delayed.
A.1. The SROs have missed numerous deadlines relating to the
CAT required in the CAT NMS Plan, as well as various milestones
set by the SROs and communicated to the Commission. This
failure to meet these deadlines and milestones has become a
clear pattern over the course of the CAT's development.
As background, shortly after my arrival at the Commission
in May 2017, I was informed by the CEO of Thesys, the firm
engaged by the SROs to build and deliver the CAT, that they
were on track towards launching the CAT for SRO reporting on
November 15, 2017. The SROs were aware of this information.
Similarly, until late summer 2017, the Commission was led to
believe that the November 15, 2017, deadline for SRO reporting
to the CAT was achievable. This information proved to be
incorrect.
In the fall of 2017, when it was readily apparent that
Thesys and the SROs would fail to deliver the CAT as required,
I asked for a revised time table and work plan. The SROs
developed a time table and work plan, which contained a number
of milestones, including SRO reporting to the CAT by November
15, 2018, a year past the deadline in the CAT NMS Plan. The
SROs subsequently informed Commission staff that certain
functionalities that were supposed to be part of that first
phase of reporting would not be available until March 31, 2019.
Shortly after that, it became clear that Phase 1 would not be
complete in March since the SROs announced that they are
transitioning away from Thesys and have selected FINRA to be
the new plan processor. The SROs are currently revising their
master plan.
Further, the SROs have not yet begun collecting data from
industry members. I expect the SROs to work diligently to
ensure that industry member reporting begins as soon as
possible. I have asked the staff to explore potential
amendments to the CAT NMS Plan in light these significant
delays. Compliance with the CAT NMS Plan is the legal
obligation of the SROs. Separately, I have hired Manisha
Kimmel, who has a wealth of experience and expertise in audit
trail reporting, as a Senior Policy Advisor for Regulatory
Reporting. In this capacity, she will coordinate the
Commission's oversight of the SROs' creation and implementation
of the CAT.
Q.2. In your testimony, you discussed the standards for
investment advisers and brokers and the Regulation Best
Interest proposal.
Specifically, you stated that under current standards the
``baseline adviser standard is the adviser cannot put their
interests ahead of the client's interests''. You added that,
``with informed consent they can cut back on that standard.
That is not well understood.''
Please explain what constitutes informed consent in such a
relationship?
How has the SEC evaluated situations where informed consent
was given to allow reducing the adviser's standard of care?
Also, what has the SEC done, or what can it do, to make
sure the potential of a lower standard is better understood?
A.2. In the proposed Commission interpretation of the standard
of conduct for investment advisers, the Commission stated that
the client cannot waive the Federal fiduciary duty. Although
the investment adviser fiduciary duty is not waivable, it is
well established that the terms of the investment adviser
relationship--and therefore the scope of the duty in that
relationship--may be shaped by disclosure and informed consent.
Our proposed interpretation provides further details on this
widely accepted process--that disclosures regarding the scope
and terms of the relationship should be sufficiently specific
so that a client is able to decide whether to provide informed
consent.
This process of scoping the terms of the advisory
relationship, which is regularly effectuated through account
agreements and Form ADV, is widely accepted in the industry and
provides for arrangements such as limited account services and
certain third-party compensation to the investment adviser. Our
proposed relationship summary, if adopted, will increase retail
investor awareness of the material terms of common arrangements
with investment professionals, and the fees and conflicts of
interest that apply. I have been surprised that, with all of
the public dialogue about the fiduciary duty, there is not more
acknowledgment of the fact that the application of that duty
can and does vary depending on the terms of the agreement
between the client and adviser. The proposed requirements of
the relationship summary would highlight the nature of an
advisory relationship and the scope of services that the
investment adviser provides.
We have received a lot of thoughtful comments on the
proposed interpretation of the standard of conduct for
investment advisers and Commission staff is reviewing comments
carefully, engaging further with commenters and thinking about
what next steps it might recommend to the Commission.
Q.3. The Conflict of Interest Obligations in the Regulation
Best Interest proposal requires that: a broker or dealer
establishes, maintains, and enforces written policies and
procedures reasonably designed to identify and at a minimum
disclose, or eliminate, all material conflicts of interest that
are associated with such recommendations.
A broker or dealer establishes, maintains, and enforces
written policies and procedures reasonably designed to identify
and disclose and mitigate, or eliminate, material conflicts of
interest arising from financial incentives associated with such
recommendations.
Please provide examples of ``material conflicts of
interest'' that are distinguishable from ``material conflicts
of interest arising from financial incentives''.
Also, please provide examples of how material conflicts of
interest arising from financial incentives can be mitigated.
A.3. Proposed Regulation Best Interest reflected our concern
that disclosure alone may not be enough when a conflict
involves a financial incentive.
Our proposal would require broker-dealers to establish,
maintain and enforce written policies and procedures reasonably
designed to identify and disclose and mitigate, or eliminate,
material conflicts of interest related to financial incentives,
in addition to the proposed requirement to establish, maintain
and enforce written policies and procedures reasonably designed
to identify and at a minimum disclose or eliminate general
material conflicts of interest.
As a practical matter, the vast majority of broker-dealer
conflicts would likely be ``financial incentives,'' and the
proposed conflict and disclosure obligations would require
broker-dealers to establish, maintain and enforce written
policies and procedures reasonably designed to, at a minimum,
mitigate and disclose those conflicts. The proposal defined
financial incentives broadly to cover a wide variety of
compensation practices established by the broker-dealer,
including quotas, bonuses, sales contests, special awards,
differential, or special compensation, as well as the sale of
proprietary products and effecting transactions in a principal
capacity. So, for example, if a broker-dealer provides
incentives to its representatives to favor one type of large
cap mutual fund over another, under the proposal, the broker-
dealer would need to mitigate that conflict to minimize the
potential for the conflict to taint the recommendation.
The proposal aimed to provide broker-dealers flexibility to
develop and tailor reasonably designed policies and procedures
that include conflict mitigation measures, based on each firm's
circumstances. We gave examples of potential mitigation
measures in the release, such as minimizing compensation
incentives to favor certain products over others and enhanced
supervision of recommendations involving higher compensating
products.
The proposal also acknowledged that some material conflicts
may be too difficult to mitigate and may be more appropriately
avoided entirely or for certain categories of retail customers.
For example: payment or receipt of certain noncash compensation
that presents conflicts of interest for broker-dealers, such as
certain sales contests, trips, prizes, and other similar
bonuses.
The proposal requested comment on whether the Commission
should prohibit receipt of certain noncash compensation. We
have received a lot of thoughtful comments on this issue and
Commission staff is reviewing comments carefully, engaging
further with commenters and developing a recommendation for the
Commission.
I believe the mitigation requirement is a very significant
step forward in aligning the broker-dealer standard of conduct
with retail customers' reasonable expectations. Investors can
generally understand a commission-based model and, if the
commission structure is reasonable and understandable, existing
supervisory requirements supplemented with disclosure would be
sufficient. However, I do not believe a reasonable investor
would expect that disclosure alone would be enough to
effectively reduce the impact of certain sales incentives on a
broker-dealer's recommendations and, therefore, I believe those
incentives would need to be mitigated or eliminated, which is
consistent with what a reasonable retail investor would expect.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
FROM JAY CLAYTON
Q.1. I would like to elaborate on your recent efforts to
increase cybersecurity at the SEC, which you mentioned briefly
in your opening statement. On September 20th you announced the
establishment of a senior-level cybersecurity working group and
the creation of a Chief Risk Officer position.
Can you provide a detailed update on these efforts?
Who participates in the working group and when are
recommendations expected?
A.1. The SEC has appointed a Chief Risk Officer (CRO), Mr.
Gabriel Benincasa, whose background includes significant senior
leadership experience in enterprise risk and compliance in the
financial sector. The SEC's Cybersecurity Working Group's
membership includes senior leadership in the agency's divisions
and major offices, the Chief Operating Officer, Chief
Information Officer, Chief Information Security Officer, and
the Cybersecurity Adviser to the Chairman. The purpose of the
group is to coordinate information sharing, risk and threat
monitoring, incident response and other cross-divisional and
inter-agency efforts. During the past year, the group
coordinated, among other things, an update to the agency's
procedures for handling cybersecurity incidents and
participated in tabletop exercises to train staff on the new
procedures.
Q.2. In your submitted testimony you also indicate that you are
contracting with outside entities to perform penetration
testing.
How were vendors selected for penetration testing and how
often are comprehensive source code reviews being conducted?
A.2. The SEC obtains penetration testing services from
cybersecurity experts at the Department of Homeland Security
(DHS) and the private sector, which allow us to periodically
assess and continuously improve the security of our network and
information systems. The agency's agreement with DHS enables us
to receive operational and technical assistance at no cost. The
agency through our Office of Acquisitions has also leveraged
government-wide acquisition contracts to obtain penetration
testing services from multiple third-party entities, who are
selected based on their ability to provide thorough testing
services. These outside vendors are also required to meet
certain prescriptive personnel security requirements. With
respect to code reviews, the SEC is utilizing such reviews to
assist in our efforts to uplift our EDGAR system as well as
other critical agency systems. To facilitate additional code
review, the SEC's Office of Information Technology has acquired
and is currently integrating the use of newly acquired code
review tools into the agency's application development process.
We expect these tools to be implemented during 2019.
Q.3. Within the SEC's Division of Enforcement, can you
characterize how much enforcement activity takes place within
the newly created Cyber Unit?
Of the 754 enforcement actions and $3.8 billion in
penalties in 2017, how much of this activity was cyber-related?
How much was related to fraud against retail investors of
ICOs?
How much was related to failures by issuers to make
material disclosures?
How many employees are staffing this unit and how
aggressively are they targeting fraud?
A.3. The Division of Enforcement's Cyber Unit centralizes,
leverages and builds upon the significant expertise that the
SEC's Enforcement Division has developed on cyber-related
issues over the past several years. Because cyber is a growing
threat to the markets, this area benefits from specialization,
formalization and enhanced coordination. The Cyber Unit is
staffed by 30 personnel nationwide, and each of the SEC's
regional offices has a liaison to the Unit who serves as a
resource to non-Unit personnel conducting cyber-related
investigations and litigation. The Cyber Unit focuses its
efforts on the following key areas:
Market manipulation schemes involving false
information spread through electronic and social media;
Hacking to obtain material nonpublic information
and trading on that information;
Violations involving distributed ledger technology
and initial coin offerings;
Misconduct perpetrated using the dark web;
Intrusions into retail brokerage accounts; and
Cyber-related threats to trading platforms and
other critical market infrastructure.
Since the formation of the Cyber Unit at the end of FY2017,
the Division's focus on cyber-related misconduct has steadily
increased. In FY2017 and FY2018, the Commission brought a
combined 26 standalone cases, including cases involving ICOs
and digital assets. So far, more than $120 million has been
ordered in 10 of the 26 cases. The other 16 cases are still in
litigation. At the end of FY2018, the Division had more than
225 cyber-related investigations ongoing. These cases and
ongoing investigations are being handled by both Unit and non-
Unit personnel. Thanks to the work of the Cyber Unit and other
staff focusing on these issues, in FY2018 the SEC's enforcement
efforts impacted a number of areas where the Federal securities
laws intersect with cyberissues.
Cyber Unit personnel, as well as other staff of the
Division of Enforcement who are conducting cyber-related
investigations and litigation, are aggressively targeting fraud
and other types of misconduct in this space. For instance, last
year, the SEC brought charges against a second defendant in
connection with a scheme to allegedly manipulate the price of
Fitbit securities through false regulatory filings. \1\ The SEC
also charged a day trader with allegedly participating in a
scheme to access the brokerage accounts of more than 100
unwitting victims and make unauthorized trades to artificially
inflate the stock prices of various companies. \2\ And, at the
end of FY2018, the SEC brought settled proceedings against an
Iowa-based broker-dealer and investment adviser related to its
failures in cybersecurity policies and procedures surrounding a
cyberintrusion that compromised personal information of
thousands of its customers, in violation of Regulations S-P and
S-ID. This was the SEC's first action charging violations of
Regulation S-ID, known as the Identity Theft Red Flags Rule,
which is designed to protect customers from the risk of
identity theft. \3\
---------------------------------------------------------------------------
\1\ Press Release 2018-130, ``SEC Files Additional Charges in
Fitbit Stock Manipulation Scheme'' (July 11, 2018), available at
https://www.sec.gov/news/press-release/2018-130. The first defendant
was charged in 2017. Press Release 2017-107, ``SEC Charges Fake Filer
With Manipulating Fitbit Stock'' (May 19, 2017), available at https://
www.sec.gov/news/press-release/2017-107.
\2\ Press Release 2017-202, ``Day Trader Charged in Brokerage
Account Takeover Scheme'' (Oct. 30, 2017), available at https://
www.sec.gov/news/press-release/2017-202.
\3\ Press Release 2018-213, ``SEC Charges Firm With Deficient
Cybersecurity Procedures'' (Sept. 26, 2018), available at https://
www.sec.gov/news/press-release/2018-213.
---------------------------------------------------------------------------
The Division, including its Cyber Unit, is focused on
issues related to ICOs and digital assets. Many of the cases
that have resulted from this focus have involved allegations of
fraud. Since the Commission's publication of The DAO 21(a)
Report in FY2017, \4\ the Commission has brought 19 actions
involving ICOs, 10 of which involved allegations of fraud, and
has utilized its trading suspension authority to suspend
trading in the stock of over a dozen publicly traded issuers
because of questions concerning, among other things, the
accuracy of assertions regarding their investments in ICOs and
operation of cryptocurrency platforms. \5\
---------------------------------------------------------------------------
\4\ Press Release 2017-131, ``SEC Issues Investigative Report
Concluding DAO Tokens, a Digital Asset, Were Securities; U.S.
Securities Laws May Apply to Offers, Sales, and Trading of Interests in
Virtual Organizations'' (July 25, 2017), available at https://
www.sec.gov/news/press-release/2017-131.
\5\ A full list of the ICO- and cyber-related actions that the
Commission has brought is catalogued on Sec.gov. U.S. Sec. and Exch.
Comm'n, Cyber Enforcement Actions, https://www.sec.gov/spotlight/
cybersecurity-enforcement-actions.
---------------------------------------------------------------------------
Aside from ICOs, fulsome disclosure of cyber-related issues
is a priority. In FY2018, the Commission brought its first
enforcement action involving charges against a public company
for failing to properly inform investors about what was then
the largest known cyberintrusion in history. The SEC's order
found that Yahoo! failed to properly assess the scope, business
impact, or legal implications of the breach, including whether,
when, and how the breach should have been disclosed. To settle
the action, the entity formerly known as Yahoo! agreed to pay a
$35 million penalty. \6\
---------------------------------------------------------------------------
\6\ Press Release 2018-71, ``Altaba, Formerly Known as Yahoo!,
Charged With Failing To Disclose Massive Cybersecurity Breach; Agrees
To Pay $35 Million'' (Apt. 24, 2018), available at https://www.sec.gov/
news/press-release/2018-71.
Q.4. There is no existing requirement in securities law that
explicitly refers to cyber risks, and SEC policy regarding the
necessary disclosure of breaches on the part of public
companies is murky at best. Last month, for example, Marriott
International disclosed a data breach to the SEC that may have
exposed the personal information of up to 500 million guests
and that has been going on undetected since 2014.
How can this process be improved, rather than considering
whether companies are properly disclosing ``material
information'' on a one-off basis?
A.4. In February 2018, the Commission issued interpretative
guidance to assist public companies in preparing disclosures
concerning material cybersecurity risks and incidents. The
guidance highlights the disclosure requirements under the
Federal securities laws that public companies must evaluate
when considering their disclosure obligations with respect to
cybersecurity risks and incidents.
The existing disclosure framework seeks to elicit
disclosure of cybersecurity incidents and risks that are
material to investors in a timely fashion. Generally,
information is material if the information would be viewed by
the reasonable investor as important in making an investment
decision or as having significantly altered the total mix of
information available. As the cybersecurity landscape and the
risks associated with it continue to evolve, the Commission and
staff will continue to evaluate the guidance in light of such
disclosures, the cybersecurity environment, and its impacts on
issuers and the capital markets generally and consider feedback
about whether any further guidance or rules are needed.
Q.5. What oversight authority does the SEC have when a digital
asset is not considered a security, or when there is dispute
about whether an asset meets the definition of a security or
commodity?
A.5. The SEC has jurisdiction over securities, securities
market participants and securities-related conduct. Even if a
digital asset is not a security, the SEC could have
jurisdiction over a particular activity if a digital asset is
used in connection with some securities-related conduct or
product. For example, even when a digital asset is not itself a
security, the SEC has jurisdiction over a security that
references that digital asset, such as a structured note
referencing a digital asset. Whether a token or a digital asset
called a cryptocurrency is a security is determined by applying
long established law, including the Howey test, to the facts
and circumstances of the particular instrument being sold.
As part of the legal framework regulating financial
instruments, the Commodity Exchange Act and the Federal
securities laws contain provisions that determine which
regulatory scheme applies to different financial instruments.
As a general matter, the SEC has jurisdiction over derivatives
(such as options) based on securities. The Commodity Futures
Trading Commission (CFTC) has jurisdiction over swaps, but the
SEC has jurisdiction over swaps based on a single security or
narrow-based security index and has antifraud authority over
swaps based on a broad-based security index. The CFTC and the
SEC have joint jurisdiction over security-futures and share
jurisdiction over mixed swaps. For example, the SEC and the
CFTC would share jurisdiction over a future on a digital asset
that is a security and the SEC would have jurisdiction over an
option or a swap on a digital asset that is a security.
Staff of the CFTC and SEC coordinate and have frequent
discussions about novel products, including in the digital
asset space.
Q.6. When we communicated last February regarding
cryptocurrencies, you indicated that the SEC has generally
developed their regulatory approach on a case-by-case basis,
primarily focusing on fraudulent initial coin offerings (ICOs).
While I believe blockchain technology and virtual currencies
have the potential for positive disruption of our institutions
and processes, one recent study indicated that roughly 80
percent of all ICOs were found to be scams.
You may have seen that this Committee held a hearing in
October considering opposing perspectives on the benefits of
virtual currencies.
Based on your perspective as a regulator, what are the
potential benefits and drawbacks of ICOs?
A.6. Blockchain technology and the creative use of digital
tokens that are recorded on distributed ledgers offer
opportunities for new forms of capital raising and finance, can
facilitate allocations of capital and can reduce the costs of
funding by making that process more efficient. We meet with
industry participants to learn about innovative blockchain
mediated business. We also recognize that much of this promise
is yet to be realized. Although the ICOs we have seen to date
involve the offer and sale of securities, many of those
offerings are not following our securities laws. These unlawful
offerings seek all the benefits of a registered public
offering--such as broad investor solicitation, no investor
sophistication requirement and immediate secondary market
liquidity--and also all the benefits of an exempt private
offering, such as reduced regulatory costs and disclosure
requirements. However, these offerings often are not following
the private placement rules that limit the purchases to high
net-worth or high income investors and are not registered
offerings that must provide investors with full disclosures and
the protections that follow from registration.
This is something we are very focused on, as some of our
recent enforcement actions reflect. The Federal securities laws
provide important market and investor protections in connection
with the offer and sale of securities--regardless of whether
they are called shares of stock or digital assets or tokens. If
you are offering digital asset or tokens that are securities to
U.S. investors, you have two options: (1) comply with an
exemption from registration; or (2) register the offering with
the SEC.
Secondary market activities in the digital asset markets
also raise concerns. As currently operating, trading platforms
in this space often permit the trading of securities but offer
substantially less investor protection than in our traditional
securities markets, with correspondingly greater opportunities
for fraud and manipulation.
Finally, ICO markets span national borders and significant
trading may occur on systems and platforms outside the U.S. As
a result, risks can be amplified, including the risk that
market regulators, like the SEC, may not be able to effectively
pursue bad actors or recover funds.
We are cognizant of both the benefits and risks presented
by this rapidly evolving area. We recognize its potential to
facilitate capital formation--one of our three core missions.
At the same time we continuously balance that goal with our
other two core missions--to protect investors and maintain
fair, orderly and efficient markets.
Q.7. For example, is it fair to say that ICOs have the
potential to expand access to capital for small businesses?
If so, do you have any data that indicates this?
A.7. I have said before that technological innovations have
improved our markets, including through increased competition,
lower barriers to entry and decreased costs for market
participants. Distributed ledger and other emerging
technologies have the potential to further influence and
improve the capital markets and the financial services
industry. Businesses, especially smaller businesses without
efficient access to traditional capital markets, can be aided
by financial technology in raising capital to establish and
finance their operations, thereby allowing them to be more
competitive both domestically and globally. And these
technological innovations can provide investors with new
opportunities to offer support and capital to novel concepts
and ideas.
But technological advancement--including the introduction
of technological developments into our securities offering and
trading infrastructure and the raising of capital to fund
technological advancement--must be pursued in harmony with our
Federal securities laws. These laws reflect our tripartite
mission to protect investors, maintain fair, orderly and
efficient markets and facilitate capital formation. We should
embrace beneficial innovations, including new techniques for
capital raising, but not at the expense of the principles
undermining our well-founded and proven approach to protecting
investors and markets.
We have not performed a quantitative study of this nature;
however, we have implemented a number of initiatives designed
to aid innovators, including those in the distributed ledger
technology space. In October 2018, the SEC announced the
formation of the Strategic Hub for Innovation and Financial
Technology (FinHub), which serves as a public resource for
FinTech-related issues at the SEC, including matters dealing
with distributed ledger technology. The FinHub provides a
portal for industry and the public to engage directly with SEC
staff on innovative ideas and technological developments.
Additionally, the FinHub is a warehouse of information
regarding the SEC's activities and initiatives involving
FinTech and will serve as a platform and clearinghouse for SEC
staff to acquire and disseminate information and FinTech-
related knowledge within the agency.
Q.8. In your testimony, you mention regular meetings with other
agencies to consider areas where additional regulatory
oversight of ICOs and digital assets may be necessary.
Can you provide specific updates on the changes that you
are considering to your policy and oversight of virtual
currencies?
A.8. The SEC will continue to closely coordinate with our
regulatory and law enforcement partners across the globe on
these issues. Through collaborations such as cross-agency
working groups like the Financial Stability Oversight Council's
Digital Assets and DLT Working Group, and in other contexts, we
will continue to explore whether there are regulatory gaps and
consider the appropriate regulatory approach going forward. To
the extent that new issues arise in our markets that the SEC is
unable to address, we will alert Congress to gaps in authority
and request additional authority where necessary.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON
FROM JAY CLAYTON
Q.1. I want to draw your attention to a concerning trend: U.S.-
listed, Cayman-incorporated, Chinese companies continue to
exploit American capital markets at the expense of American
investors. After enjoying the benefits of a U.S. listing, a
controlling Chinese shareholder takes the company private at a
low valuation, then relists in Shanghai or Hong Kong at a
dramatically higher price. Through this scheme, Chinese
shareholders are making billions at the expense of American
minority investors.
What tools does the SEC currently have--or need--to protect
U.S. investors, maintain fair markets, and prevent Chinese
exploitation of take-private transactions?
A.1. Going-private transactions are subject to both Federal and
State (or foreign) law. The Federal securities laws are focused
on the disclosure of material information in a going-private
transaction and the imposition of liability for such
disclosures. State or foreign law (such as Cayman law) governs
the other important issues in a going-private transaction that
your question raises, such as the board of directors' fiduciary
duties (including with respect to the consideration offered in
the transaction), procedural safeguards to address self-dealing
concerns and the requisite security holder votes needed for
approval of the transaction.
Exchange Act Rule 13e-3 is the key SEC rule that governs
going-private transactions. Under the rule, a disclosure
document (Schedule 13E-3) must be publicly filed and delivered
to all security holders of the target company prior to the
closing of the transaction. Schedule 13E-3 requires disclosure
specifically targeted at the fairness of the consideration
offered in a going-private transaction and possible conflicts
of interest, including: (1) the negotiations leading up to the
execution of a transaction agreement, including any alternative
transactions proposed; (2) the purposes of the transaction; (3)
any plans or proposals for the company following the
transaction; (4) historical and pro forma financial statements,
in certain circumstances; and (5) the substantive and
procedural fairness of the transaction to unaffiliated security
holders, including: whether a report or opinion about the
transaction's fairness was received; whether the controlling
security holder reasonably believes the transaction is fair to
unaffiliated security holders; and the factors considered by
the controlling security holder in making this fairness
determination.
This disclosure is subject to staff review and the
liability provisions of Rule 13e-3, which prohibits any
materially false misstatement or omission, and to the general
anti-fraud provisions of the Federal securities laws.
The SEC has pursued securities law violations by foreign-
based issuers involving market manipulation, accounting and
disclosure violations and auditor misconduct, among others. The
SEC has various tools at its disposal for doing so. For
instance, it can conduct investigations to determine whether
any Federal securities laws have been violated, and, if there
is evidence of any violation, it can bring charges in Federal
district court against the entity. To conduct these
investigations, the SEC can utilize tools such as the IOSCO
Multilateral Memorandum of Understanding to obtain documents
and testimony from foreign jurisdictions, as well as leverage
Mutual Legal Assistance Treaties with the assistance of the
U.S. Department of Justice.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS
FROM JAY CLAYTON
Q.1. I understand that the SEC has delegated the authority for
creating accounting standards to the Financial Accounting
Standards Board or FASB. FASB has led the way globally when it
comes to accounting regulation. In light of pressure for the
International Accounting Standards Board to assume a greater
importance compared to FASB or perhaps even replace FASB, this
may be an appropriate time to reevaluate FASB's standard-
setting practices.
To that end it would be helpful to hear your perspective as
to how the SEC estimates the impact of new accounting rules
before they're implemented. The Current Expected Credit Loss
(CECL) and Long Duration Contract rules in particular seem like
they are having adverse consequences that could have been fixed
before the respective rules had been finalized if there had
been a more thorough vetting process.
Is the SEC still accountable for understanding the full
impact of new accounting rules? If so, do you think it's
appropriate to require field testing, stakeholder input, and
cost-benefit analyses before moving forward with new accounting
standards?
A.1. Consistent with Federal law, in 2003 the SEC determined
that the FASB and its parent organization, the Financial
Accounting Foundation (FAF), satisfy the criteria Congress set
forth in Section 108 of the Sarbanes-Oxley Act and,
accordingly, the FASB's financial accounting and reporting
standards are recognized as ``generally accepted'' for purposes
of the Federal securities laws.
As a result, the Commission necessarily oversees the FASB's
activities in order to carry out our responsibilities under the
Federal securities laws in an effective manner and works with
the FAF and the FASB to ensure that the FASB continues to meet
the required characteristics of a designated accounting-
standard setter under the Sarbanes-Oxley Act. At the same time,
we also recognize the importance of the FASB's independence.
I believe the FASB must use independent judgment in setting
accounting standards and not be constrained in its discussion
of issues. This is necessary to ensure that the standards
developed have the highest degree of credibility in the
business and investing communities. The alternative, whereby
FASB sets accounting standards that privilege certain economic
activities or are designed to achieve certain economic results,
could result in many harms, including causing investors to lose
confidence in the accuracy or quality of the reported
information. Such an outcome could hinder our markets and raise
the cost of capital for everyone.
That being said, I believe it is useful for the FASB to
perform field testing, gather stakeholder input and conduct
cost-benefit analyses as it already does as part of its
deliberative process. The process benefits from a two-way
dialogue between the FASB and its constituents, as the FASB
develops standards that meet a specific need with justification
that balances the related costs and benefits. Specifically,
when setting standards, the FASB states that it weighs whether
the expected improvement in the quality of the information
provided to users justifies the cost of preparing and providing
that information.
For example, the CECL outreach included significant
outreach, including meeting with over 200 users of financial
statements, and holding more than 85 meetings and workshops
with preparers (including field work at 25 company locations)
to get direct input on the proposed standard. Overall, I also
remain supportive of all parties engaging in productive
dialogue regarding the new accounting standard to further our
shared goal of maintaining high-quality financial reporting for
the benefit of investors in the U.S. capital markets and
addressing unintended negative consequences.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM JAY CLAYTON
Q.1. Some have criticized the SEC's February 21, 2018,
Cybersecurity Guidance for not being clear enough about when
companies should disclose cybersecurity incidents. In your
testimony, you footnote to an April 24, 2018, SEC press release
announcing that the ``entity formerly known as Yahoo! Inc. has
agreed to pay a $35 million penalty to settle charges that it
misled investors by failing to disclose one of the world's
largest data breaches in which hackers stole personal data
relating to hundreds of millions of user accounts.'' The
release notes that the cyberintrusion occurred in December
2014, but states that ``when Yahoo filed several quarterly and
annual reports during the 2-year period following the breach,
the company failed to disclose the breach or its potential
business impact and legal implications.''
Based on the SEC's 2018 Cybersecurity Guidance, when should
Yahoo have disclosed this breach?
A.1. The Commission's February 2018 Guidance on Public Company
Cybersecurity Disclosures expresses our belief that it is
critical that public companies take all required actions to
inform investors about material cybersecurity risks and
incidents in a timely fashion. The guidance also stresses the
importance for public companies to have disclosure controls and
procedures in place to, among other things, help ensure that
the company makes timely disclosures of material events,
including those related to cybersecurity.
Although our disclosure rules do not specifically refer to
cybersecurity risks and incidents, a number of the requirements
impose an obligation to disclose such risks and incidents
depending on a company's particular circumstances. \1\ In
addition, a company generally must disclose such material
information as may be necessary to make the company's required
disclosures not misleading. Generally, the Commission considers
information to be material if it would be viewed by the
reasonable investor as important in making an investment
decision or as having significantly altered the total mix of
information available. Where a company has become aware of a
material cybersecurity incident or risk, it must make timely
disclosures pursuant to its obligations in periodic or current
reports under the Exchange Act, and in registration statements
under the Securities Act.
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\1\ You note that some have criticized this approach and called
for greater specificity. On occasions where these concerns have been
raised to me, I have requested that those commentators provide specific
language that would address their objectives in a manner consistent
with the Commission's long-standing and proven approach to disclosure
mandates, including materiality. We have not received any such
submissions for consideration.
---------------------------------------------------------------------------
As outlined in its April 24, 2018, order, the Commission
found that when Yahoo filed several quarterly and annual
reports during the 2-year period following the breach, the
company failed to disclose the breach or its potential business
impact and legal implications. Instead, the company's SEC
filings stated that it faced only the risk of, and negative
effects that might flow from, data breaches. The Commission
found that Yahoo! knew, or should have known, that its
disclosures in its annual reports on Form 10-K for the fiscal
years ending December 31, 2014, and December 31, 2015, and in
its quarterly reports on form 10-Q for the first three quarters
of 2015 and the first two quarters of 2016, among other
filings, were materially misleading.
Q.2. You have called for more robust disclosures in certain
instances, such as Brexit related risks. However, according to
a February 2018 GAO report, the ``SEC faces constraints in
reviewing climate-related and other disclosures because it
primarily relies on information that companies provide. SEC
senior staff explained that SEC's Division of Corporation
Finance staff . . . do not have the authority to subpoena
additional information from companies.'' In the same report,
GAO notes that ``in an investigation of Peabody Energy under a
New York State law, the Attorney General of New York State
subpoenaed the company's internal documents and found that
although the company's disclosures denied it had the ability to
reasonably predict the impact of future climate change laws and
regulations on its business, Peabody had made internal market
projections showing severe negative impacts from certain
potential laws and regulations and failed to disclose those
projections to the public.''
How is the SEC addressing the constraints identified in the
GAO report regarding the SEC's ability to review disclosures
effectively?
A.2. In its February 2018 report, the GAO noted that the scope
of a compliance review conducted by our Division of Corporation
Finance differs from the scope of an investigation by our
Division of Enforcement, State attorneys general or other law
enforcement authorities who have authority to require the
production of nonpublic information for law enforcement
purposes. As a result, as GAO noted, the detailed information
companies rely on in making materiality decisions when
providing disclosures in compliance with the Federal securities
laws is generally not available in the course of a compliance
review by SEC Division of Corporate Finance staff.
Regardless of the availability of such information during a
compliance review, the company is subject to provisions in the
Federal securities laws and well established case law precedent
that specify what information it must disclose in its filings.
Our staff approaches each filing review with professional
skepticism and does not, in the normal course, question
disclosures that appear to be in compliance with our rules and
the Federal securities laws. Many of these disclosures are in
response to principles-based requirements based upon
materiality.
The SEC's regulatory, disclosure-based framework is working
as designed. The Commission establishes rules and regulations;
the Commission and staff communicate requirements and encourage
full compliance; the Division of Corporation Finance, through
its selective review of company filings, may question
disclosure decisions, request support for those decisions as it
assesses compliance and may refer instances of material
noncompliance to our Division of Enforcement; and our Division
of Enforcement investigates potential violations, including
exercising the Commission's subpoena authority, after which the
Commission may file an action in Federal district court or
institute an administrative proceeding. Although the GAO stated
that our compliance review staff faces constraints because it
does not have access to all of the information companies use to
determine materiality, the Federal securities laws and well
established case law precedent provide ample incentive for
companies to take these disclosure decisions seriously.
Furthermore, after a thorough evaluation of our filing review
process to assess compliance with the identified disclosure
requirements, the GAO did not have any recommendations for
improving the process or changing the way in which the
Commission delegates or exercises its subpoena power.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR MENENDEZ FROM JAY CLAYTON
Q.1. Please provide a timeline for the SEC's work on the five
remaining executive compensation rules mandated by the Dodd-
Frank Street Reform and Consumer Protection Act.
A.1. On December 18, 2018, the SEC approved final hedging
disclosure rules. Those rules, which were mandated by the Dodd-
Frank Act, require companies to disclose in proxy and
information statements their practices or policies regarding
the ability of employees or directors to engage in certain
hedging transactions with respect to company equity securities.
The remaining Dodd-Frank Act executive compensation
rulemakings are on the Commission's rulemaking agenda, and we
are continuing our work to finalize them. As I noted in my
written testimony, as a result of the complexity and scope of
the existing executive compensation disclosure regime, as well
as the nature of the mandates, I believe a serial approach is
likely to be the most efficient and best serve the SEC's
mission.
Q.2. According to the SEC's joint statement with the PCAOB,
there are 224 companies listed on U.S. exchanges with a
combined market capitalization of $1.8 trillion that are
located in countries, primarily China, that make it difficult
for U.S. regulators to review their financial reporting. This
presents a major risk to U.S. investors who may assume that the
financial reporting of these companies is in line with U.S.
requirements. Moreover, it's fundamentally unfair for Chinese
companies to take advantage of the strength and liquidity of
U.S. capital markets, but not have to play by the rules.
The U.S.-China Economic and Security Review Commission
recommended that Congress consider legislation providing
authority to ban and delist companies that have refused to sign
reciprocity agreements with the Public Company Accounting
Oversight Board.
Despite the SEC and PCAOB's best efforts to reach an
agreement, it appears unlikely that Beijing will cooperate.
Would such authority strengthen your hand in negotiations
with your Chinese counterparts?
A.2. The joint statement by SEC Chief Accountant Wes Bricker,
PCAOB Chairman William D. Duhnke III and me outlines current
challenges facing U.S. regulators to obtain information related
to U.S. listed companies with significant operations in China,
and how they may adversely affect investors in the U.S. markets
and the interests they own in these companies. For example,
these challenges impact the PCAOB's ability to inspect the
audits of these companies in question.
I understand that the PCAOB has been in negotiations with
foreign audit regulators in certain countries, including China,
that currently prevent the PCAOB from carrying out its
inspection process with respect to the audits of companies
based in those countries. I note that even while these
negotiations are continuing, a refusal to cooperate by an audit
firm, either in an inspection or an investigation, could
subject the firm to SEC or PCAOB sanctions and remedial
measures. Having the ability to impose sanctions and remedial
measures certainly may enhance the ability to make further
progress with respect to such negotiations, although the
imposition of such sanctions and remedial measures would
require an assessment of their potential impact on U.S.
investors and the broader capital markets.
As we continue our efforts to obtain appropriate access to
information, I would welcome an opportunity to further discuss
these issues with you and to have SEC staff provide technical
assistance or other information about draft legislation.
Q.3. The statement mentions ``remedial actions involving U.S.-
listed companies'' as a possible consequence for in certain
company-specific issues.
Under existing authorities, what are the specific remedial
actions the SEC and PCAOB could employ to address such issues?
A.3. The joint statement noted that if information barriers
continue to exist, we may consider remedial actions, which
could include, among other things: (1) requiring affected
companies to make additional disclosures to investors; (2)
placing additional restrictions on new securities issuances
from companies with activities in China; and (3) bringing
actions against auditors who do not meet our requirements.
All of these actions have collateral consequences that must
be carefully evaluated as we and the PCAOB seek to meet our
objectives.
Q.4. I noted your recent comments on the implications of Brexit
for our own financial sector.
In light of the recent collapse of the plan to vote on a
Brexit deal last week, will you provide the Commission's
current view of the options facing the U.K. in its dealings
with the EU, with a focus on the implications for the U.K.
financial sector and the risks to the many U.S. banks that base
their European options in the U.K.?
A.4. I continue to be concerned that the effects of Brexit will
be international, including on our U.S. markets and our
investors. I am encouraged by memoranda of understandings
entered into by the European Securities Markets Authority and
the Bank of England and the U.K. Financial Conduct Authority in
February 2019. These agreements are important steps towards
preventing significant disruption of securities and derivatives
transactions in the event that the U.K. exits from the European
Union without a deal in place.
The Commission's responsibility with respect to Brexit is
focused on its potential effects on U.S. investors and
securities markets. The Brexit-related concerns you have
highlighted with the U.K. financial sector will have
international effects given the interconnectedness of our
global financial markets. We are monitoring company disclosure
concerning the potential impact that Brexit may have. This
effort includes monitoring disclosures made by banks and
financial institutions with significant U.K. exposure.
Additionally, we continue to engage and communicate with other
U.S. financial authorities, with our U.K. and EU counterparts,
and with market participants to consider the effects of Brexit
to our market utilities and infrastructure. We will remain
focused on identifying and planning for potential Brexit-
related impacts on U.S. investors and markets.
Q.5. I worked to include the honest broker provision in the
Wall Street Reform law, and our clear intent was for the SEC to
establish a uniform standard of conduct, if warranted by a
study. Despite the 2011 SEC study recommending a uniform
standard of conduct for brokers and investment advisers, the
SEC's recent proposal fails to establish a uniform standard of
conduct for broker-dealers and investment advisers, and it puts
the burden on the customer to understand the difference between
brokers and investment advisers--ignoring the SEC's own
findings.
Moreover, the SEC's own Investor Advisory Committee
recommended in November that everyone--investment advisers and
brokers--be held to a uniform standard.
Will you commit to personally taking another look at the
SEC's 2011 study on the issue as well as the recommendations
from the SEC's Investor Advisory Committee before you move
forward with a formal rule?
A.5. The recommendations of the staff's 2011 study were useful
to us in evaluating how to specifically enhance investor
protection and improve the obligations that apply to broker-
dealers when making recommendations to retail customers. After
considering the staff's recommendations from the 2011 study,
the information that the public has submitted over the years
and our extensive experience regulating broker-dealers and
investment advisers, the Commission proposed an approach
focusing on enhancements to broker-dealer regulation, taking
into consideration the characteristics of the broker-customer
relationship. The broker-dealer relationship generally is
different from the investment adviser-client relationship.
I believe our proposal requires financial professionals,
whether broker-dealers, investment advisers, or both (aka
``dual-hatted persons''), to follow standards of conduct that
reflect key fiduciary principles tailored to the client
relationship. This framework draws from the recommendations of
the 2011 study.
The staff is considering all comments, including
recommendations from the SEC's Investor Advisory Committee and
the SEC 2011 study, as it develops a recommendation for the
Commission.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM JAY CLAYTON
Q.1. SEC Disgorgement--In your written testimony you mentioned
the effects that the Supreme Court case Kokesh v. SEC has had
on the SEC's ability to recover ill-gotten gains from bad
actors and return them to wronged investors. The most recent
SEC enforcement report said that to date the SEC may have to
forgo $900 million in disgorgement from cases filed in the last
year and a half. That's a significant number, particularly in
light of the fact that the SEC recently reported that in its
last fiscal year it collected $3.9 billion in total enforcement
actions returned $794 million to harmed investors in 2018.
Can you describe in more detail how Kokesh is affecting the
SEC's ability to return illegally obtained funds to investors?
Can you explain what this means for the average investor
who is the victim of fraud?
A.1. In Kokesh v. SEC, the Supreme Court held that our claims
for disgorgement are subject to a 5-year statute of
limitations. From a remediation standpoint, I am concerned that
we may be unable to recover a fraudster's illegal profits to
remedy the losses of investors, particularly retail investors,
if they were defrauded in well-concealed and long-running
frauds. Said simply, if the fraud is well-concealed and
stretches beyond the 5-year limitations period applicable to
penalties, it is likely that we will not have the ability to
recover funds invested by our retail investors more than 5
years ago. And our experience under Kokesh is showing that this
already is happening. With respect to matters that have already
been filed, the Division of Enforcement estimates that the
Court's ruling in Kokesh may cause the Commission to forgo up
to approximately $900 million in disgorgement, of which a
substantial amount potentially could have been returned to
retail investors. As we continue to bring new Enforcement
actions, this number is likely to increase.
Q.2. Human Capital Management Disclosure--Earlier this summer I
sent you a letter describing my belief that time is past due
for the SEC to provide more requirements and guidance regarding
human capital management disclosure. Currently, the only data
required to be disclosed under SEC rules are the number of
employees a company has, the median pay of those employees and
the compensation of the CEO. But other information is clearly
important to investors, including the amount spent by the
company on worker training, and average turnover, among others.
Increasing disclosure requirements doesn't mean we have to
impose significant costs on businesses. A Harvard Law School
study finds that a majority of companies in their dataset
already collect a variety of human capital metrics of
increasing interest to investors through their internal
management processes. I appreciate your response to my letter
on this topic and the discussions we've had on it.
Do you agree that human capital management issues are very
important to businesses?
Will you work with me to expand human capital management
disclosure requirements and improve disclosures in this area?
A.2. I appreciate your focus on the importance of human capital
management. As I stated in my response to your letter, I
believe the strength of many of our public companies is due, in
important part, to their human capital.
In February 2019, I shared some thoughts on human capital
disclosure on a call with members of the SEC's Investor
Advisory Committee. Specifically, I expressed that human
capital, like intellectual property, often represents an
essential resource and driver of performance for many of
today's companies. While I am wary of rules or guidance that
would mandate rigid human capital standards or metrics for all
public companies given that each industry, and even each
company within a specific industry, has its own human capital
circumstances, I believe investors would be better served by
understanding the lens through which each company looks at
their human capital. For example, does management focus on the
rate of turnover, the percentage of their workforce with
advanced degrees or relevant experience, the ease or difficulty
of filling open positions, or some other factors? The
principles of materiality, comparability, and efficiency should
be guideposts for human capital disclosure. I have asked the
Investor Advisory Committee for their input and feedback on
what they look for as investors and, when making an investment
decision, what questions they ask issuers relating to human
capital.
Additionally, the Division of Corporation Finance has been
working to evaluate and recommend improvements to our public
company disclosure requirements. I expect human capital
disclosures will be among the issues under consideration. I
have asked the Division of Corporation Finance to consider
feedback from investors, registrants, and other parties, and
make recommendations to the Commission regarding additional
action, as appropriate.
I welcome further engagement with you as we continue as to
consider the best way forward.
Q.3. Volcker Rule--I have a question about the covered funds
section of the Volcker Rule and the recent proposed rulemaking.
Despite very clear legislative intent, banks are prohibited
under the current rule from investing in certain fund
structures that would otherwise be permitted investments if a
bank made a direct investment from its own balance sheet, even
if the fund simply wants to extend credit or make long-term
investments to potential investors (such as startup companies).
Investing through a fund structure supports safety and
soundness due to the ability to diversify risk as well as
ensuring that companies looking to grow and innovate have the
capital that they need. It is clear to me that the agencies
have the legal authority they need since they've already
allowed for certain specific exclusions for permissible
investments in fund structures.
Wouldn't you agree that if a bank can make an investment on
its balance sheet that it should be allowed to make that same
investment through a fund structure?
A.3. Since the adoption of the Volcker Rule in 2013, banking
entities and the agencies charged with implementing the rule
have gained experience through its implementation, including
through examinations. Based on that experience, and in response
to feedback received in the course of administering the Volcker
Rule, we and the other agencies have identified opportunities,
consistent with the statute, for improving the implementation
of the Volcker Rule. In short, we recognize that to effectively
implement the Volcker Rule its terms should reflect our
collective experience with prudential regulation and market
activities.
The amendments we proposed June 2018 included a request for
comment regarding issues relating to the ``covered fund''
definition. Among the requests for comment are requests
generally about whether the definition of ``covered fund''
effectively implements the statute and is appropriately
tailored. We have received many comments responding to these
requests, as well as the multiple other requests about the
``covered fund'' definition. SEC staff is carefully reviewing
these comments and remains engaged in regular and ongoing
dialogue with the staffs at our fellow Federal financial
regulators. I look forward to considering the issues raised,
including concerns about the scope of the ``covered fund''
definition.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM JAY CLAYTON
Q.1. In response to my suggestion that you reduce investor
confusion by using the same language for investment advice
standards that apply to registered investment advisers and for
those that apply to broker-dealers, you indicated that the SEC
is considering doing so, saying that ``we may do that.''
To clarify that statement, will you commit that, in its
finalized form, Regulation Best Interest will comply with
section 913(g) of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, in that ``the standard of conduct for
such broker or dealer with respect to such customer shall be
the same as the standard of conduct applicable to an investment
adviser under section 211 of the Investment Advisers Act of
1940,'' and that broker-dealers and registered investment
advisers will all be required to give advice ``without regard
to [their] financial or other interest?'' \1\
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\1\ https://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-
111publ203.pdf
A.1. We believe our proposal is consistent with the underlying
intent of Section 913, including that a broker-dealer should
not put its interests ahead of the retail customer's interests
when making a recommendation to a retail customer.
Our proposal sets a clear, enhanced standard of conduct for
broker-dealers that is drawn from the principles applicable to
an investment adviser's fiduciary duty. The commonality of
these conduct standards is clear when the requirements of
proposed Regulation Best Interest are compared to the standards
of conduct required of investment advisers under the Advisers
Act.
While the two standards draw from common principles, under
the proposal, their application would differ in practice
because the relationship models of broker-dealers and
investment advisers differ. But--importantly--the overall
principles are the same, and the proposal is designed to make
sure that, at the point in time at which the recommendation or
advice is provided, the analytical process followed by the
financial professional should be the same regardless of whether
the retail investor chooses an investment adviser or broker-
dealer: advice provided with diligence and care by a financial
professional that is prohibited from placing its own interests
ahead of the retail investor's interests.
Q.2. In response to my suggestion that broker-dealers should be
held to the same fiduciary standard that investment advisers
are held to, you stated that, ``Investment Advisers are allowed
to contract around this standard. It's not well known. This is
something that we want people to understand. The baseline
Advisers standard is the Adviser cannot put their interests
ahead of the client's interests. Now, they are able to say `But
I'm going to do these things' and with informed consent, they
can cut back on that standard.''
While investors may consent to limitations on a broker-
dealer's or investment adviser's services, and to the existence
of certain conflicts of interest, do you believe that a
reasonable investor would ever consent to be harmed?
Will you commit that, for both broker-dealers and
investment advisers alike, disclosure and consent to conflicts
of interest will never be deemed to satisfy either a broker-
dealer's or investment adviser's obligations to act in the best
interests of the customer if the advice results in harm to the
investor?
A.2. Under proposed Regulation Best Interest, a broker-dealer
would be required to act in the best interest of the retail
customer when making a recommendation, and would be prohibited
from placing its financial or other interest ahead of the
interest of the retail customer. In order to discharge the
duty, a broker-dealer would need to: first, disclose material
facts relating to its relationship with the customer; second,
enhance its current compliance framework to meet the demands of
a more rigorous best interest standard; and third, eliminate,
or mitigate and disclose, material conflicts of interest
related to financial incentives. In other words, even if a
broker-dealer has mitigated and disclosed its conflicts, it
must still have a reasonable basis to believe that a
recommendation is in the best interest of the retail customer
and the broker-dealer must have written policies and procedures
reasonably designed to prevent it from placing its interests
ahead of the interest of the retail customer.
In the proposed Commission interpretation of the standard
of conduct for investment advisers, the Commission stated that
the client cannot waive the Federal fiduciary duty. Although
the investment adviser fiduciary duty is not waivable, it is
well established that the terms of the investment adviser
relationship--and therefore the scope of the duty in that
relationship--may be shaped by disclosure and informed consent.
Our proposed interpretation provides further details on this
widely accepted process--that disclosures regarding the scope
and terms of the relationship should be sufficiently specific
so that a client is able to decide whether to provide informed
consent.
This process of scoping the terms of the advisory
relationship, which is regularly effectuated through account
agreements and Form ADV, is widely accepted in the industry and
provides for arrangements such as limited account services and
certain third-party compensation to the investment adviser. Our
proposed relationship summary, if adopted, is designed to
increase retail investor awareness of the material terms of
common arrangements with investment professionals, and the fees
and conflicts of interest that apply. I have been surprised
that, with all of the public dialogue about the fiduciary duty,
there is not more acknowledgment of the fact that the
application of that duty can and does vary depending on the
terms of the agreement between the client and adviser. The
proposed requirements of the relationship summary would
highlight the nature of an advisory relationship and the scope
of services that the investment adviser provides.
We have received a lot of thoughtful comments on the
proposed interpretation of the standard of conduct for
investment advisers and Commission staff is reviewing comments
carefully, engaging further with commenters and thinking about
what next steps it might recommend to the Commission.
Q.3. When the SEC proposed the Standards of Conduct for
Investment Professionals Rulemaking Package in April, you
stated that you intend for it to ``rais[e] the standard of
conduct for broker-dealers when they provide recommendations to
retail investors.'' \2\
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\2\ https://www.sec.gov/news/public-statement/clayton-overview-
standards-conduct-investment-professionals-rulemaking
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Please list any broker-dealer practices that are permitted
under current FINRA suitability rules but that would be
prohibited under the SEC's proposal.
A.3. Under current standards, it has been argued that broker-
dealers are permitted to recommend to their retail customer a
product that is suitable but more costly for the customer than
another product that the broker-dealer offers--because the
first product makes the broker-dealer more money.
Proposed Regulation Best Interest would address this
concern. Under proposed Regulation Best Interest, a broker-
dealer, when making a recommendation of a securities
transaction or investment strategy to a retail customer, will
be required to act in the best interest of that customer at the
time the recommendation is made, including the broker-dealer
being prohibited from placing its financial or other interest
ahead of the interest of the retail customer.
The proposal acknowledged that the cost (including fees,
compensation, and other financial incentives) associated with a
recommendation would generally be an important factor in
evaluating whether a recommendation is in the best interest of
a retail customer. Specifically, the proposal noted that in
order to meet its Care Obligation, when a broker-dealer
recommends a more expensive product over another reasonably
available alternative offered by the broker-dealer, the broker-
dealer would need to have a reasonable basis to believe that
the higher cost is justified based on other factors (e.g., the
product's objectives, characteristics, liquidity, risks and
potential benefits, volatility, and likely performance in a
variety of market and economic conditions), in light of the
retail customer's investment profile.
Q.4. In August, you stated that, based on what you heard at a
series of investor roundtables, ``Main Street investors have no
tolerance for certain questionable sales practices such as
high-pressure, product-based sales contests,'' that you believe
``these practices should be eliminated,'' and that their
elimination ``would enhance investor protection but would not
adversely affect investor choice and opportunity.'' \3\
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082218
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Do you believe that firms should be permitted to use other
sales practices that create harmful conflicts of interest,
including sales contests based on total production, bonuses for
recommending certain products, and quotas for sales of certain
products (such as proprietary funds)?
Why or why not?
A.4. I do not believe that broker-dealers or investment
advisers should be permitted to use sales practices that harm
retail investors. As I have stated publicly, I believe that
certain questionable sales practices such as high-pressure,
product-based sales contests should be eliminated. In my view,
eliminating these practices would enhance investor protection
but would not adversely affect investor choice and opportunity.
However, there is an important distinction between compensating
individuals based on broad performance metrics--an important
component of the compensation structure of many professional
services firms that have served clients well--and incentivizing
individuals to recommend a particular product through time-
based quotas, bonuses, or sales contests.
As proposed, Regulation Best Interest would not specify
particular compensation practices as impermissible. Broker-
dealers, however, would be required to act in the best interest
of the retail customer when making recommendations, without
placing the financial or other interest of the broker-dealer
making the recommendation ahead of the interest of the
customer. The proposed rule includes specified requirements to
meet this obligation. Importantly, even if a broker-dealer has
eliminated or appropriately mitigated and disclosed its
conflicts, it still must have a reasonable basis to believe
that its recommendations are in the best interest of the retail
customer.
For example, it would be inconsistent with the Care
Obligation of proposed Regulation Best Interest if the broker-
dealer made the recommendation to a retail customer in order
to: maximize the broker-dealer's compensation (e.g.,
commissions or other fees); further the broker-dealer's
business relationships; satisfy firm sales quotas or other
targets; or win a firm-sponsored sales contest.
To be clear, the proposal acknowledges that broker-dealers
may not be able to appropriately address certain conflicts
through disclosure and mitigation and that such conflicts may
be more appropriately avoided entirely. For example: payment or
receipt of certain noncash compensation that presents conflicts
of interest for broker-dealers, such as certain sales contests,
trips, prizes, and other similar bonuses. The Commission
requested comment on whether the Commission should prohibit
receipt of certain noncash compensation. We have received a lot
of thoughtful comments on this issue, and Commission staff is
reviewing comments carefully, engaging further with commenters
and developing a recommendation to the Commission. In
developing our final rule, I believe we should address the
issues of elimination and mitigation with the goal of better
aligning the legal obligations with retail investors'
reasonable expectations.
Q.5. Will you commit that any final Standards of Conduct for
Investment Professionals rule will prohibit firms from creating
incentives that would result in recommendations based on the
financial interests of the firm or financial professional
rather than the best interests of the investor?
For example, will you commit than any final Standards of
Conduct will prohibit: sales quotas, bonuses for recommending
certain products, and other forms of sales contests; the use of
trips and other awards for meeting production thresholds that
may encourage inappropriate rollover recommendations; and
ratcheted compensation grids, which retroactively and
precipitously increase professionals' compensation?
A.5. I do not believe that broker-dealers should be permitted
to use sales practices that harm retail investors. As I have
stated publicly, I believe that certain questionable sales
practices such as high-pressure, product-based sales contests
should be eliminated. In my view, eliminating these practices
would enhance investor protection but would not adversely
affect investor choice and opportunity.
To be clear, the proposal acknowledges that broker-dealers
may not be able to appropriately address certain conflicts
through disclosure and mitigation and may be more appropriately
avoided entirely. For example: payment or receipt of certain
noncash compensation that presents conflicts of interest for
broker-dealers, such as certain sales contests, trips, prizes,
and other similar bonuses. The Commission requested comment on
whether the Commission should prohibit receipt of certain
noncash compensation. We have received a lot of thoughtful
comments on this issue and Commission staff is reviewing
comments carefully, engaging further with commenters and
developing a recommend to the Commission. In developing our
final rule, I believe we should address the issues of
elimination and mitigation with the goal of better aligning the
legal obligations with investors' reasonable expectations.
Q.6. Will you commit that any final rule will include strong
enforcement mechanisms to enforce such a prohibition, including
a private right-of-action to allow investors to sue advisers
and broker-dealers who cheat them through the use of these
practices?
If not, why not?
A.6. Regulation Best Interest is designed to enhance the
Commission's enforcement mechanisms. We do not believe it would
create any new private right of action or rescission, nor did
we intend for it to do so.
The Commission has experience examining and enforcing
compliance with a variety of obligations under the Federal
securities laws, including existing obligations that are more
principles-based or that are based on facts-and-circumstances,
such as suitability, which is enforced under our anti-fraud
authority.
If Regulation Best Interest is adopted, I would expect our
exam and enforcement staff to assess compliance and potential
violations, as is the case with any rule. Commission staff is
engaging with experienced professionals from our Division of
Enforcement and our Office of Compliance Inspections and
Examinations to help ensure that if Regulation Best Interest is
adopted, compliance with the rule can be efficiently examined
and breaches of the rule can be effectively addressed. We have
encouraged public comment on any potential issues or concerns
and have received a lot of thoughtful comments on this issue,
which Commission staff is considering.
Q.7. Section 913(g) of the Dodd-Frank Act states that, ``The
Commission shall . . . examine and, where appropriate,
promulgate rules prohibiting or restricting certain sales
practices, conflicts of interest, and compensation schemes for
brokers, dealers, and investment advisers that the Commission
deems contrary to the public interest and the protection of
investors.''
The Regulation Best Interest proposal does not include an
in-depth discussion of broker-dealer compensation structures or
a meaningful examination of how certain sales practices,
conflicts of interest, and compensation schemes can be and
often are contrary to the public interest and harmful to
investors. Similarly, the Investment Adviser guidance provided
no discussion of these topics. Has the Commission completed
this Dodd-Frank regulatory requirement elsewhere? If so, please
provide a written copy of your analysis on these matters.
To the extent that the Commission has not satisfied this
regulatory requirement, will you commit to doing so before you
issue a final rule?
A.7. In proposing Regulation Best Interest, the Commission
examined the impact that financial professionals' conflicts of
interest--specifically those caused by financial incentives--
can have on the provision of recommendations to retail
investors. The rule proposing release also discussed certain
existing sales practices and compensation structures, drawing
on a range of sources, including our own experience overseeing
and examining broker-dealers. The Commission recognized the
harm that conflicted recommendations can cause investors and
also discussed that conflicts of interests can be particularly
significant when involving certain types of sales practices and
compensation structures. The staff continues to consider these
issues through the ongoing review of comment letters and
economic studies, as well as discussions with market
participants and investors.
Q.8. The one-on-one interviews conducted as part of the RAND
report on investor testing are an importance source of data for
understanding the ability of the SEC's proposed disclosures to
enable investors to make informed decisions.
Will you commit to publishing full transcripts of these
interviews?
If not, why not?
A.8. The Commission and staff have made significant efforts to
connect directly with investors, including through investor
testing and outreach. The SEC's Office of the Investor Advocate
and the RAND Corporation prepared a research report that sought
to determine how well investors understood the retail market
for investment advice. The report was added to the public
comment file for the Commission's package of rulemakings
regarding standards of conduct for financial professionals on
October 12, 2018.
The SEC's Office of the Investor Advocate also engaged the
RAND Corporation to conduct investor testing of a sample of the
Commission's proposed Form CRS Relationship Summary. On
November 7, 2018, the results of this investor testing were
added to the public comment file. The testing consisted of a
nationwide survey and qualitative one-on-one interviews. In the
report, the RAND Corporation synthesizes its findings from the
one-on-one interview component of the investor testing, noting
that although the one-on-one interviews have certain
limitations, they serve as a valuable complement to the
nationally representative quantitative survey that the RAND
Corporation conducted. At that time, we issued a press release
encouraging the public to submit comments on RAND's investor
testing report by December 7, 2018.
The Commission staff also organized seven roundtables
across the country to provide Main Street investors the
opportunity to speak directly to me, my fellow Commissioners
and senior SEC staff to tell us about what they expect from
financial professionals. These candid, experience-based
conversations were incredibly valuable and are informing the
staff's work moving forward. The transcripts from these
roundtables have been added to the comment files. The
Commission has also invited investors to share their insights
and feedback on the proposed Relationship Summary by going to a
new ``Tell Us'' website. Through these efforts, the Commission
has received nearly 100 individual feedback submissions.
The rules' comment files continue to receive and publish
public comments, and the staff will continue to consider the
rulemaking record as it develops a recommendation.
Q.9. If the SEC's own research, such as the data included in
the RAND report, does not indicate that the SEC's proposed
disclosures serve their intended purpose of enabling investors
to make an informed decision between brokerage and advisory
accounts, will you consider applying a strong, uniform
fiduciary standard across all accounts, so that investors will
be protected regardless of whether they fully understand the
disclosures?
A.9. All of the feedback we have received, including the data
included in the RAND report regarding the proposed disclosure
form, has been very helpful. The staff is considering all
comments and will take them under consideration in developing a
recommendation for the Commission.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM JAY CLAYTON
Q.1. Protecting Investors With ``Best Interest'' Standard--Can
you name one or more broker-dealer practice that is permitted
under current FINRA suitability rules that would be prohibited
under the proposal?
A.1. Under current standards, it has been argued that broker-
dealers are permitted to recommend to their retail customers a
product that is suitable but more costly for the customer than
another similar product that the broker-dealer offers--because
the first product makes the broker-dealer more money.
Proposed Regulation Best Interest would address this
concern. Under proposed Regulation Best Interest, a broker-
dealer, when making a recommendation of a securities
transaction or investment strategy to a retail customer, would
be required to act in the best interest of that customer at the
time the recommendation is made. This would prohibit the
broker-dealer from placing its financial or other interest
ahead of the interest of the retail customer.
The proposal acknowledged that the cost (including fees,
compensation, and other financial incentives) associated with a
recommendation would generally be an important factor in
evaluating whether a recommendation is in the best interest of
a retail customer. Specifically, the proposal noted that when a
broker-dealer recommends a more expensive product over another
reasonably available alternative offered by the broker-dealer,
in order to meet its Care Obligation, the broker-dealer would
need to have a reasonable basis to believe that the higher cost
is justified based on other factors (e.g., the product's
objectives, characteristics, past preference, liquidity, risks
and potential benefits, volatility, and likely performance in a
variety of market and economic conditions), in light of the
retail customer's investment profile.
Q.2. Does this proposal require all financial professionals who
make investment recommendations related to retail customers to
do so as fiduciaries?
A.2. Proposed Regulation Best Interest and its ``best
interest'' standard draws upon principles that apply to
investment advice in other contexts. Simply put, under proposed
Regulation Best Interest, a broker-dealer cannot put her or his
interests ahead of the retail customer's interests. The similar
levels of protection are clear when proposed Regulation Best
Interest is compared to the standards of conduct applicable to
investment advisers.
Specifically, our proposal is designed to enhance broker-
dealer regulation by building upon, and being tailored to, the
unique structure and characteristics of the broker-dealer
relationship with retail customers and existing regulatory
obligations, while taking into consideration and drawing on (to
the extent appropriate) the duties of loyalty and care as
interpreted under the Advisers Act.
Our proposal is designed to make sure that, at the point in
time at which the recommendation or advice is provided, the
analytical process followed by the financial professional
should be the same regardless of whether the retail investor
chooses an investment adviser or broker-dealer: advice provided
with diligence and care by a financial professional that is
prohibited from placing its own interests ahead of the retail
investor's interests. I believe our proposals are designed to
make investors get just that whether they choose a broker-
dealer or an investment adviser. And I believe that they should
have that choice.
Q.3. Does this proposal require financial professionals to
provide retail customers with the best available options?
A.3. Under the proposed Regulation Best Interest's Care
Obligation, a broker-dealer would be required to have a
reasonable basis to believe, based on its diligence and
understanding of the risks and rewards of the recommendation,
and in light of the retail customer's investment profile, that
a recommendation is in the best interest of the retail
customer.
As described in the proposal, the broker-dealer's diligence
and understanding of the risks and rewards of the
recommendation would generally involve consideration of
factors, such as the costs, the investment objectives and
characteristics associated with a product or strategy
(including any special or unusual features, liquidity, risks
and potential benefits, volatility, and likely performance in a
variety of market and economic conditions), as well as the
financial and other benefits to the broker-dealer. The broker-
dealer would be required to match this understanding of the
security or strategy to the particular retail customer to form
a reasonable belief that the security or strategy is in the
retail customer's best interest.
This ``facts and circumstances'' approach is similar to
``best interest'' approaches under other advice standards,
including the fiduciary standard applicable to investment
advisers. These approaches do not specifically define ``best
interest'' but provide principles-based guidelines. Another
similarity with those approaches is the recognition that a
requirement for financial professionals to provide retail
customers with the ``best available option'' or ``perfect
advice'' would create a standard that would be virtually
impossible to meet, particularly with 20-20 hindsight. Instead,
the proposed standard of conduct for broker-dealers requires
the recommendation to be in the best interest of the retail
customer at the time and in the circumstances in which it is
made, which is similar to how I view the duty of care of an
investment adviser.
Q.4. Cryptocurrencies--Will the SEC continue to reject creating
a cryptocurrency-linked ETF?
A.4. Certain national securities exchanges registered with the
SEC have filed proposed rule changes seeking to list and trade
shares of exchange-traded products based on digital assets,
such as bitcoin and ether. The proposed exchange-traded
products have been structured as commodity trusts directly
holding the digital assets, as trusts holding exchange-traded
futures on digital assets, managed funds issuing shares whose
value relates to digital assets, or instruments based on
digital assets held by the fund. Several of these proposals
have been disapproved by the Commission, or by the Division of
Trading and Markets acting pursuant to its delegated authority,
and several have been withdrawn.
To approve an exchange's proposed rule change--such as a
proposal to list a new exchange-traded product--the Commission
must find that the proposed rule change is consistent with the
applicable requirements of the Securities Exchange Act of 1934
(Exchange Act) and the rules and regulations thereunder. The
Commission's Rules of Practice provide that the submitting
exchange bears the burden to demonstrate that its proposed rule
change is consistent with the requirements of the Exchange Act.
The Commission has emphasized in its disapproval orders
that its actions to date regarding digital-asset exchange-
traded products have not rested on an evaluation of whether
bitcoin, or blockchain technology more generally, has utility
or value as an innovation or as an investment.
Instead, the Commission's actions have reflected a finding,
in each case, that the submitting exchange had not met its
burden to demonstrate that the proposal was consistent with the
requirements of the Exchange Act, including Section 6(b)(5),
which requires that the rules of a national securities exchange
be designed to ``prevent fraudulent and manipulative acts and
practices'' and ``protect investors and the public interest.''
The Commission has also specifically noted that bitcoin
markets are in the early stages of their development and that,
over time, regulated bitcoin-related markets may continue to
grow and develop. Should circumstances change in this manner or
in a way that otherwise affects the Commission's analysis under
the Exchange Act, the Commission would then have the
opportunity to consider, among other things, whether a digital-
asset exchange-traded product would be consistent with the
requirements of the Exchange Act.
Q.5. How is the SEC coordinating with State Attorneys General
on oversight of cryptocurrencies?
A.5. Federal and State regulators share an interest in making
sure investors in digital asset securities and related
investment products are appropriately protected. SEC staff have
ongoing interactions with State regulators about securities law
issues involving digital assets that may affect the citizens of
their States. We also communicate about digital asset related
conduct that may be occurring in their States--such as initial
coin offerings (ICOs). Last year, together with former
Commissioners Kara Stein and Michael Piwowar, I commended the
North American Securities Administrators Association on their
release highlighting important issues and concerns relating to
ICOs, among other digital asset products.
Q.6. Have you collaborated on any enforcement actions related
to fraud in cryptocurrencies? Please describe.
A.6. Yes. As a general matter, we closely coordinate with our
domestic and international regulators and law enforcement
partners in this space. The AriseBank ICO matter is one example
of a case involving parallel SEC and criminal investigations.
In that case, two former executives behind an allegedly
fraudulent ICO settled the SEC's charges brought in the
Northern District of Texas. The U.S. Attorney's Office in that
district also brought parallel criminal charges against one of
the executives.
Q.7. Nearly two dozen Nevadans have complained to the Consumer
Financial Protection Bureau about virtual currencies using the
Consumer Complaint Database. The Bureau has nearly 2,000
complaints about virtual currencies in its Consumer Complaint
Database.
Is the SEC collaborating with the Consumer Bureau to
respond to frauds in cryptocurrencies?
A.7. Yes. SEC staff continues to closely coordinate with our
regulatory partners in this space, including with staff of the
CFPB.
Q.8. Has the SEC endorsed any cryptocurrencies?
Does the SEC have any plans to endorse a cryptocurrency as
a valid investment?
A.8. The SEC does not endorse any investments, including
digital assets, and has no plans to do so.
Q.9. Disclosure Rules (Pay Gap)--Wells Fargo announced on
February 1, 2018, that they would voluntarily disclose
disparities in pay broken down by gender and minority status.
They are among a few big banks that already disclose this data,
although not required to by law. The SEC has purview over
similar compensation disclosure regulations (e.g., the CEO-
median worker pay ratio rule or the pay for performance
incentive structures for management).
Since companies are already headed this direction, would
you favor disclosure requirements for publicly traded companies
regarding compensation gaps regarding gender, ethnicity, and
race?
A.9. The Commission's disclosure requirements are rooted in the
concept of materiality, and what a reasonable investor would
consider material today may be different than when those
requirements were first adopted. As such, the SEC regularly
evaluates our existing rules and attempts to ensure that they
have not become outdated. In the context of our disclosure
requirements under Regulation S-K, this means ensuring that
public company disclosures allow investors to make informed
investment decisions.
Materiality will continue to be the touchstone through
which we approach our efforts in this area. I do note that
compensation is an area where the marketplace is continually
active in shaping policies and practices, and the staff and I
regularly engage with investors on compensation disclosure and
related matters. A requirement of the type you cite is not
under consideration. When we consider changes to our approach
to disclosure, I believe it is important to remain mindful
that, while there are many factors that drive the decision of
whether to be a public company, increased disclosure and other
burdens may render alternatives for raising capital, such as
the private markets, increasingly attractive to companies that
only a decade ago would have been all but certain candidates
for the public markets. I would be happy to discuss this issue
with you.
Q.10. Proxy Advisors--Shareholder proposals as early warning
signs about potential problems at a company. For example,
shareholders sought proposals seeking votes to get more
information from Wells Fargo about its employee compensation
system in 2014 and information on predatory lending activities
from Washington Mutual, Merrill Lynch, and Lehman Brothers.
Yet, at the request of those companies, the SEC denied the
proposal under the ``ordinary business exclusion.'' The SEC
agreed to prevent the shareholder proposal from coming to a
vote.
Do you agree that history has shown it can be far more
detrimental to make errors of omission than inclusion when
considering shareholder proposals?
A.10. The SEC's shareholder proposal rule, Rule 14a-8, enables
a shareholder to have a proposal included in a company's proxy
materials for a vote by shareholders if certain requirements
are met. The rule provides a number of procedural and
substantive bases on which a proposal can be excluded from a
company's proxy statement. A company that believes it has a
basis to exclude a proposal may seek the staff's views
regarding whether the staff would recommend enforcement action
to the Commission if the proposal were excluded. In such cases,
the staff carefully evaluates the proposal and the arguments
made by the company and shareholder proponent, if any, to
determine whether it would recommend enforcement action to the
Commission if the company were to exclude the proposal. The
staff applies the requirements of Rule 14a-8 and is not charged
with weighing the merits of a proposal or the underlying policy
issues it may raise when deciding whether the proposal falls
within one or more bases for exclusion under the rule. It is
important to note that the staff's shareholder proposal process
reflects only informal views of the staff regarding whether it
is appropriate for the Commission to take enforcement action
based on a violation of the Commission's proxy rules. The views
expressed by the staff are not binding on the Commission or
other parties and do not and cannot definitively adjudicate the
merits of a company's position with respect to the legality of
a shareholder proposal. Shareholder proponents and issuers have
the ability to seek a more definitive determination from a
court of competent jurisdiction.
Q.11. How will ensure that your legacy at the SEC is not marred
by SEC staff decisions to kill shareholder proposals that
warned us of pending problems?
Like not acting on Wells Fargo incentive pay problems or
WAMU's predatory loans?
A.11. Above all, it is important that the shareholder proposal
process is administered fairly, consistently and without bias,
and the staff is committed to administering the process in this
manner. In evaluating a company's arguments for excluding a
shareholder proposal from its proxy materials, the staff does
not consider the merits of a shareholder proposal or the
underlying policy issues. Instead, the staff's evaluation is
limited to whether there is a basis for excluding the proposal
under Rule 14a-8. Stakeholders are best served when the rule is
administered in such a fair and consistent manner.
As noted above, the staff's shareholder proposal process
reflects only informal views of the staff regarding whether it
is appropriate for the Commission to take enforcement action
based on a violation of the Commission's proxy rules. The views
expressed by the staff are not binding on the Commission or
other parties and do not and cannot definitively adjudicate the
merits of a company's position with respect to the legality of
a shareholder proposal. Shareholder proponents and issuers have
the ability to seek a more definitive determination from a
court of competent jurisdiction.
Q.12. The consensus problem at the SEC's proxy advisors
roundtable was vote accuracy. Proxy votes seem to have a high
incidence of over and under voting as well as absence of retail
investors.
If you engage in any changes to the proxy system, would you
prioritize election accuracy first?
A.12. Improving the proxy process will be a significant SEC
initiative for 2019. The fundamental right of shareholders to
participate in the governance of their companies can be fully
exercised only to the extent shareholders are assured that
their votes are accurately counted. While the current proxy
process has worked well for the vast majority of public company
meetings, legitimate concerns have been raised about the
accuracy and efficiency of the proxy voting process.
Complications and delays in tabulating the final votes at
several recent shareholder meetings highlighted the need for
the SEC to renew its focus on this important area.
The SEC staff's recent proxy roundtable led to a productive
dialogue among issuers, investors, proxy service providers and
others about the current proxy voting process and important
developments since the Commission's 2010 proxy plumbing concept
release. Perhaps most encouraging was the common desire
expressed by all the roundtable participants to work
collaboratively to explore possible improvements to the proxy
process, including through the use of distributed ledger
technology and other promising new innovations. As I noted in
my written testimony, we should focus on what the Commission
can do in the interim to improve the current system, and I
encourage all those interested in improving the proxy plumbing
to share their thoughts, particularly regarding actionable,
interim improvements. As a part of this effort, I have
therefore asked the staff to facilitate discussions among
market participants for possible private-sector solutions and
to formulate recommendations for interim improvements that the
Commission could consider as well.
Q.13. IPOs--Mr. Chairman, you have made boosting Initial Public
Offerings (IPOs) one of your top priorities. The decline in
IPOs is mostly due to mergers and acquisitions, not
regulations. Entrepreneurs can more easily--and profitably--
sell their firms to another corporation or wealthy individual
than going public.
Do you agree that the regressive tax bill that has led to
much higher corporate profits and greater wealth for CEOs and
executives is exacerbating the decline in publicly traded
firms?
Will you take steps to strengthen transparency and investor
protections in the private markets, so investors better
understand the private market? Then, there would be less of a
gap with the public markets?
Have you thought about deploying the tools that the SEC has
to take on monopoly--such as enhanced disclosure of
competition?
Will you commit to use normal administration process for
all your substantive actions regarding IPOs? We need
transparency about what the impact of various rule changes
might be.
A.13. I have long viewed with concern the reduction in the
number of public companies because it has resulted in fewer
investment opportunities for Main Street investors. I believe
we can attribute the reduction to a number of reasons,
including economic and regulatory factors, such as the cost of
compliance. I am not in a position to comment on whether the
Tax Cuts and Jobs Act legislation has affected the decline,
though I would note that this decline has been occurring over a
longer period of time. Based on my review and discussions with
Commission staff, issuers, long-term investors, entrepreneurs
and others, it is clear that the reporting, compliance, and
oversight dynamic between private and public markets, as well
as the costs associated with being a public company, may incent
certain companies to remain private or stay private longer. The
SEC has taken meaningful steps during my tenure to encourage
capital formation for companies seeking to enter our public
capital markets while maintaining, and in many cases, enhancing
investor protections. While we do not take credit for the
numbers, I am encouraged by reports indicating that the number
of IPOs in the United States increased year-over-year from 2016
to 2018 in both volume and dollar amount raised.
One of our upcoming capital formation initiatives is to
look at the private offering framework. The Division of
Corporation Finance is working on a concept release to take a
critical look at our ``patchwork'' private offering system to
see how it can be improved, harmonized, and streamlined, while
at the same maintaining or enhancing investor protection. I
look forward to receiving comments from entrepreneurs,
investors and other market participants on this release.
In furtherance of promoting capital formation, the
Commission promulgates rules and regulations, which have the
force and effect of law. Such rules and regulations generally
take effect only after the Commission publishes a notice of
proposed rulemaking in the Federal Register and adopts a final
rule that considers public comments on the proposal in
accordance with the Administrative Procedure Act. As I stated
in my Statement Regarding SEC Staff Views in September 2018,
any views of the staff of the SEC are nonbinding and create no
enforceable legal rights or obligations of the Commission or
other parties.
With respect to your question on monopoly concerns, the
Federal securities laws do not give the SEC jurisdiction over
antitrust issues. The Commission's disclosure requirements seek
to provide investors with material information in order to make
informed investment decisions. Item 101 of Regulation S-K
requires disclosure on competitive business conditions. The
Division of Corporation Finance selectively reviews filings
both to monitor and to enhance compliance with disclosure
requirements, including the requirements of Item 101 of
Regulation S-K.
Q.14. Enforcement--Individual accountability has a greater
deterrent effect across the market. One such tool to hold
individuals accountable is the so-called ``Yates Memo'' from
the previous Administration. This memo outlined six key steps
prosecutors should take to quote, ``strengthen the pursuit of
individual corporate wrongdoing.'' Last week, the Department of
Justice changed how the Yates Memo was implemented. No longer
would companies seeking cooperation credit need to identify
``all'' individuals ``all'' individuals involved in the
wrongdoing, so long as the companies identify those who were
``substantially involved'' in the misconduct. We are already
seeing this at the Consumer Financial Protection Bureau.
Enforcement actions are taken against firms without naming
those who defrauded consumers.
Does the SEC have any plans to avoid identifying all
individuals involved in misconduct?
A.14. As we have discussed, I strongly believe in the deterrent
effect of enforcement proceedings pursuing individual
accountability and believe that individual accountability
drives behavior more than corporate accountability. I also
recognize that bad actors undermine the hard-earned confidence
that is essential to the efficient operation of our capital
markets.
The Commission considers individual liability in every
case; it is a core principle of our enforcement program and
holding individuals accountable for wrongdoing is a priority
for me. To date, the Commission's enforcement actions have
borne out the premium I place on individual accountability;
during fiscal years 2017 and 2018, the SEC has charged
individuals in more than 70 percent of our stand alone cases.
As I continue to serve as Chairman, I will continue to support
the Enforcement Division's efforts to hold individuals
accountable when it is appropriate to do so under the facts and
the law. To evaluate whether, and how much, to credit entity
self-policing, self-reporting, remediation, and cooperation,
the Commission looks to the criteria described in the Seaboard
21(a) report. \1\ Among the criteria described in the report
are whether the company ``promptly, completely and effectively
disclosed the existence of the misconduct to the public, to
regulators and to self-regulators.'' \2\
---------------------------------------------------------------------------
\1\ U.S. Sec. and Exch. Comm'n, Report of Investigation Pursuant
to Section 21(a) of the Securities Exchange Act of 1934 and Commission
Statement on the Relationship of Cooperation to Agency Enforcement
Decisions, Exchange Act Release No. 44969 (Oct. 23, 2001), available at
http://www.sec.gov/litigation/investreport/34-44969.htm.
\2\ Id.
Q.15. Does the Department of Justice's changes to the Yates
Memo impact your work with your law enforcement partners? If
---------------------------------------------------------------------------
so, how?
A.15. Our work with our law enforcement partners has not been
impacted. In each case, the Commission, acting upon
recommendations from Enforcement staff, makes an independent
decision as to whether the facts and the law support charging
an individual with misconduct and, in cases involving entities,
whether and to what extent to credit self-policing, self-
reporting, remediation, and cooperation.
Q.16. In his famous retirement speech, SEC attorney James
Kidney cautioned against ``bosses who mouthed serious regard
for the mission of the SEC--to be a strong public protector in
the securities market--but their actions were tentative and
fearful in many instances. They see an agency that polices the
broken windows on the street level and rarely goes to the
penthouse floor.''
Are the SEC's investigation resources well-spent and
properly distributed? If not, what challenges remain? What
funding level is needed to properly staff the SEC regarding
investigations, cybersecurity, investor protection, etc.?
A.16. The SEC--agency wide--has approximately 4,400 people.
Approximately 6.3 million people work in the financial services
sector in the United States. We are less than one-one
thousandth of that amount. In order to adequately police this
sector for wrongdoing, it is important that the agency have
adequate resources to do so.
Over the past year, the SEC generally, and the Enforcement
Division specifically, have been focused on maximizing our
impact with the resources we have. The sheer size of the
financial industry and the volume of potential wrongdoing mean
that we will always have to make decisions about where to
allocate our resources and how best to coordinate with other
authorities for the maximum impact.
I believe that the Commission's enforcement resources are
well spent and properly allocated to address key priorities--
retail investor protection (both directly and through
institutional enforcement actions) and the investigation and
prosecution of cyberbased threats--as well as other critical
areas including, but not limited to, investment professional
misconduct, insider trading, market manipulation, and
accounting fraud.
For FY2019, the Commission requested funds for critical
investments in our ability to protect investors by restoring 17
positions for Enforcement to support key enforcement
priorities, including expanding the work of the Cyber Unit and
the Retail Strategy Task Force, and I am pleased that Congress
recently provided those resources. Moving forward, I will
continue working with the Division of Enforcement to evaluate
their resource needs to ensure they can continue vigorously
protecting investors and expect to request additional resources
in FY2020.
Q.17. The President required a hiring freeze at the SEC.
How has this hiring freeze--two years now--made your work
more difficult--from everything from investigating fraud to
strengthening your defenses against cyberattacks?
A.17. The Commission has operated under an agency-wide hiring
freeze since late 2016. Consequently, the Division of
Enforcement's employee and contractor staffing levels have
decreased since the freeze was imposed. The combined number of
positions in the Division and the number of contractors
supporting our investigation and litigation efforts fell by
approximately 10 percent between FY2016 and FY2018. These
reductions in human capital have created challenges for the
Division of Enforcement in staffing, resource allocation, and
prioritizing investigations and litigation. But despite these
challenges, the Division has risen to the challenge and
continued to exhibit significant enforcement-related activity.
On a qualitative basis, which I believe is the most
meaningful basis by which to judge the Division's
effectiveness, the SEC achieved many notable enforcement-
related successes in FY2018--recommending that the Commission
bring significant actions against important individuals and
market participants, achieving successes for retail investors,
fashioning meaningful and effective remedies and relief, and
addressing emerging and developing risks. And, while I believe
that often cited quantitative metrics such as number of cases
filed or the total amounts of fines and penalties assessed, do
not provide, without substantial additional information, a
meaningful measure of the effectiveness of an enforcement
program, FY2018 nonetheless reflected a high level of
enforcement-related activity by the Commission. The Commission
brought 821 actions (490 of which were ``stand alone'' actions)
and obtained judgments and orders totaling more than $3.9
billion in disgorgement and penalties. Significantly, it also
returned $794 million to harmed investors, suspended trading in
the securities of 280 companies, and obtained nearly 550 bars
and suspensions.
While these achievements are a testament to the hardworking
women and men of the Division, with more resources the SEC
could focus more on individual accountability, as individuals
are more likely to litigate and the ensuing litigation is
resource intensive. Moreover, additional resources that we
requested for FY2019 will support two key priorities of the
Division: protecting retail investors and combating cyber-
related threats.
Q.18. How have two recent Supreme Court decisions--Kokesh v.
SEC and Lucia v. United States--made SEC enforcement actions
more difficult?
A.18. The Supreme Court's decisions in Kokesh v. SEC and Lucia
v. SEC have significantly impacted the Commission's enforcement
program. In Kokesh v. SEC, the Supreme Court held that our
claims for disgorgement are subject to a 5-year statute of
limitations. The Supreme Court's holding in Kokesh is obviously
a very significant decision, and one that has limited our
ability to return ill-gotten gains to Main Street investors in
longer running frauds. I do not believe it is productive to
debate the merits of the Kokesh decision. I agree that statutes
of limitation serve many important functions in our legal
system, and certain types of claims should have reasonable
limitations periods. Civil and criminal authorities, including
the SEC, should do everything in their power to bring
appropriate actions swiftly, and, in our markets, particularly
our public markets, the certainty brought by reasonable
limitations periods has value for investors.
However, as I look across the scope of our actions,
including most notably Ponzi schemes and affinity frauds, which
often target retail investors, I am troubled by the substantial
amount of losses that we may not be able to recover for retail
investors. Said simply, if the fraud is well-concealed and
stretches beyond the 5-year limitations period applicable to
penalties, it is likely that we will not have the ability to
recover funds invested by our retail investors more than 5
years ago. Allowing clever fraudsters to keep their ill-gotten
gains at the expense of our Main Street investors--particularly
those with fewer savings and more to lose--is inconsistent with
basic fairness and undermines the confidence that our capital
markets are fair, efficient and provide Americans with
opportunities for a better future.
And, our experience post-Kokesh is showing that this may
already be happening. With respect to matters that have already
been filed, the Division of Enforcement has estimated that the
Court's ruling in Kokesh may cause the Commission to forgo up
to approximately $900 million in disgorgement, of which a
substantial amount potentially could have been returned to
retail investors. I welcome the opportunity to work with
Congress to address this issue to ensure defrauded retail
investors can get their investment dollars back. I believe that
any such authority should be narrowly tailored to that end
while being true to the principles embedded in statutes of
limitations.
In Lucia v. SEC, the Court held that the Commission's
Administrative Law Judges (ALJs) were inferior officers of the
United States who must be appointed in the manner required by
the Appointments Clause of the U.S. Constitution. The Court
held that the SEC's ALJs had not been appointed in a manner
consistent with the Appointments Clause and that the
appropriate remedy for an adjudication tainted with an
appointments violation was a new hearing before a properly
appointed official. Examining the facts of Lucia, the Court
further held that, the adjudication at issue could not occur
before the same ALJ who heard the case, even if she or he had
now received a constitutional appointment. According to the
Court, having already both heard Lucia's case and issued an
initial decision on the merits, she or he could not be expected
to consider the matter as though she or he had not adjudicated
it before. The court ruled that to cure the constitutional
error, another ALJ (or the Commission itself) must hold the new
hearing.
After Lucia, the Commission stayed all pending
administrative proceedings. The Commission lifted the stay on
August 22, 2018, and approximately 200 administrative
proceedings were reassigned at that time. Many of the 200
administrative proceedings have now been substantially
resolved. The remaining reassigned APs will require substantial
litigation resources going forward.
Q.19. The Dodd-Frank Act included a provision (Sec. 954) that
would require public companies to clawback compensation that
were erroneously awarded to executives whenever their companies
had accounting restatements. The SEC proposed a rule in 2015.
What is the status of this rule?
When will it be final?
A.19. Because of the complexity and scope of the SEC's existing
executive compensation disclosure regime, as well as the nature
of the Dodd-Frank Act's executive compensation rule mandates, I
believe a serial approach to these rules is likely to be most
efficient and best serve the SEC's mission. To that end, we
issued final rules in December 2018 to implement Section 955 of
the Dodd-Frank Act to require companies to disclose in proxy
and information statements their practices or policies
regarding the ability of employees or directors to engage in
certain hedging transactions with respect to company equity
securities.
The clawbacks rule and the remaining Dodd-Frank Act
executive compensation rulemakings are on the Commission's
rulemaking agenda, and we are continuing our work to finalize
them. As I noted in my written testimony, several companies
already have made public their policies regarding compensation
clawbacks, and some of these policies go beyond what would be
required under the Dodd-Frank Act. We have seen a few companies
attempt to claw back compensation from their executives under
these policies. Our rulemaking priorities, as well as the rules
themselves, should reflect these observable developments.
Q.20. The Dodd-Frank Wall Street Reform and Consumer Protection
Act included other permissive rules.
What are the status of those rules?
A.20. The Commission has had an active rulemaking calendar in
recent years, focusing on, among other things, the 80 mandatory
rulemaking requirements applicable to the SEC under the Dodd-
Frank Act, congressional mandates in the Economic Growth,
Regulatory Relief, and Consumer Protection Act, and responding
to major events and changes in the broader regulatory landscape
that have required our immediate attention.
With respect to the Dodd-Frank Act, the Commission has
undertaken both mandatory and permissive rulemakings. For
example, the Commission has now completed many, but not all, of
the security-based swap rules mandated by Title VII of the Act,
and I anticipate that in the coming year the Commission will
move forward with a package of rulemakings to complete our
Title VII rulemaking obligations. The Commission also has taken
action on some of the permissive rulemakings under the Act. For
example, the Commission proposed Regulation Best Interest
regarding the standard of conduct for broker-dealers when
making a recommendation of any securities transaction or
investment strategy involving securities to a retail customer.
Q.21. Information in the Market--What is the status of Inline-
XBRL--eXtensible Business Reporting Language--that makes it
easier to search data in an open and interactive way?
A.21. In June 2018, the Commission adopted amendments requiring
the use of Inline XBRL for the submission of operating company
financial statement information and fund risk/return summary
information. The amendments are intended to improve the data's
usefulness, timeliness, and quality, benefiting investors,
other market participants, and other data users. The amendments
are also intended to decrease, over time, the cost of preparing
the data for submission to the Commission.
The amendments will go into effect in phases. Operating
companies that are currently required to submit financial
statement information in XBRL will transition to Inline XBRL on
the following phased basis:
Large accelerated filers that use U.S. GAAP will be
required to comply beginning with fiscal periods ending
on or after June 15, 2019.
Accelerated filers that use U.S. GAAP will be
required to comply beginning with fiscal periods ending
on or after June 15, 2020.
All other filers will be required to comply
beginning with fiscal periods ending on or after June
15, 2021.
Funds that are currently required to submit risk-return
summary information in XBRL will transition to Inline XBRL on
the following phased basis:
Large fund groups (net assets of $1 billion or more
as of the end of their most recent fiscal year) will be
required to comply 2 years after the effective date of
the amendments.
All other funds will be required to comply 3 years
after the effective date of the amendments.
| MEMBERNAME | BIOGUIDEID | GPOID | CHAMBER | PARTY | ROLE | STATE | CONGRESS | AUTHORITYID |
|---|---|---|---|---|---|---|---|---|
| Shelby, Richard C. | S000320 | 8277 | S | R | COMMMEMBER | AL | 115 | 1049 |
| Brown, Sherrod | B000944 | 8309 | S | D | COMMMEMBER | OH | 115 | 136 |
| Moran, Jerry | M000934 | 8307 | S | R | COMMMEMBER | KS | 115 | 1507 |
| Toomey, Pat | T000461 | S | R | COMMMEMBER | PA | 115 | 1594 | |
| Van Hollen, Chris | V000128 | 7983 | S | D | COMMMEMBER | MD | 115 | 1729 |
| Corker, Bob | C001071 | 8294 | S | R | COMMMEMBER | TN | 115 | 1825 |
| Tester, Jon | T000464 | 8258 | S | D | COMMMEMBER | MT | 115 | 1829 |
| Donnelly, Joe | D000607 | 7941 | S | D | COMMMEMBER | IN | 115 | 1850 |
| Heller, Dean | H001041 | 8060 | S | R | COMMMEMBER | NV | 115 | 1863 |
| Warner, Mark R. | W000805 | 8269 | S | D | COMMMEMBER | VA | 115 | 1897 |
| Scott, Tim | S001184 | 8141 | S | R | COMMMEMBER | SC | 115 | 2056 |
| Cotton, Tom | C001095 | S | R | COMMMEMBER | AR | 115 | 2098 | |
| Schatz, Brian | S001194 | S | D | COMMMEMBER | HI | 115 | 2173 | |
| Heitkamp, Heidi | H001069 | S | D | COMMMEMBER | ND | 115 | 2174 | |
| Warren, Elizabeth | W000817 | S | D | COMMMEMBER | MA | 115 | 2182 | |
| Perdue, David | P000612 | S | R | COMMMEMBER | GA | 115 | 2286 | |
| Rounds, Mike | R000605 | S | R | COMMMEMBER | SD | 115 | 2288 | |
| Sasse, Ben | S001197 | S | R | COMMMEMBER | NE | 115 | 2289 | |
| Tillis, Thom | T000476 | S | R | COMMMEMBER | NC | 115 | 2291 | |
| Cortez Masto, Catherine | C001113 | S | D | COMMMEMBER | NV | 115 | 2299 | |
| Kennedy, John | K000393 | S | R | COMMMEMBER | LA | 115 | 2303 | |
| Jones, Doug | J000300 | S | D | COMMMEMBER | AL | 115 | 2364 | |
| Crapo, Mike | C000880 | 8289 | S | R | COMMMEMBER | ID | 115 | 250 |
| Menendez, Robert | M000639 | 8239 | S | D | COMMMEMBER | NJ | 115 | 791 |
| Reed, Jack | R000122 | 8272 | S | D | COMMMEMBER | RI | 115 | 949 |
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