House Financial Services Committee Hearing

On May 8, the House Financial Services Subcommittee on Capital Markets held a hearing entitled “Securities and Exchange Commission (SEC) Enforcement: Balancing Deterrence with Due Process.”  Witnesses and legislation considered in the hearing were:

• Mr. Andrew Vollmer, Senior Affiliated Scholar at the Mercatus Center and former SEC Deputy General Counsel

• Mr. Nick Morgan, President and Founder, Investor Choice Advocates Network

• Professor Paul Eckert, Professor of the Practice of Law, College of William & Mary Law School

• Mr. John Reed Stark, President, John Reed Stark Consulting
• H.R. 6695, the “Due Process Restoration Act of 2023, to authorize private parties to compel the Securities and Exchange Commission to seek sanctions by filing civil actions, and for other purposes”
• H.J.Res. ____, providing for congressional disapproval under chapter 8 of title 5, United States Code, of the rule submitted by the Securities and Exchange Commission relating to “Further Definition of ‘As a Part of a Regular Business’ in the Definition of Dealer and Government Securities Dealer in Connection With Certain Liquidity Providers”
• H.R. ____, to clarify what constitutes a violation of the federal securities laws for purposes of determining penalty amounts
• H.R. ____, to clarify the Securities and Exchange Act of 1934 with respect to civil money penalties and the authority to seek disgorgement
• H.R. ____, to repeal the policy of the Securities and Exchange Commission set forth in 17 C.F.R. § 202.5(e)
• H.R. ____, to clarify that, like with actions brought under the Securities Exchange Act of 1934, certain actions filed under the Securities Act of 1933 are required to be heard in federal court
• H.R. ____, to codify the process to obtain waivers from certain disqualifications under the federal securities laws
• H.J.Res. ____, providing for congressional disapproval under chapter 8 of title 5, United States Code, of the rule submitted by the Securities and Exchange Commission relating to “Reporting of Securities Loans”
• H.J.Res. ____, providing for congressional disapproval under chapter 8 of title 5, United States Code, of the rule submitted by the Securities and Exchange Commission relating to “Short Position and Short Activity Reporting by Institutional Investment Managers”
• H.J.Res. ____, providing for congressional disapproval under chapter 8 of title 5, United States Code, of the rule submitted by the Securities and Exchange Commission relating to “Form PF; Reporting Requirements for All Filers and Large Hedge Fund Advisers”

Below is a summary of the hearing prepared by Delta Strategy Group.  It includes several high-level takeaways, followed by summaries of opening statements and witness testimonies and a summary of the Q&A portion of the hearing.

The following summarizes the main topics explored in today’s hearing.  Each is discussed in further detail in the Discussion section below.  

Today’s hearing covered the SEC’s regulation and enforcement policies concerning the use of administrative courts, digital assets, climate disclosures, and artificial intelligence (AI).

Representative Wiley Nickel (D-NC) highlighted concerns about the SEC’s approach to regulation by enforcement, excessive penalties, and the need for regulatory clarity, especially in the digital asset space.  Other Democrats like Ranking Member Maxine Waters (D-CA) called for greater enforcement and higher penalties for the digital asset space.

Generally, Republicans raised concerns about the consequences of excessive regulation and enforcement by the SEC.  Most emphasized the importance of maintaining public trust, fairness, and transparency in SEC actions.  Republicans also generally questioned the SEC’s use of administrative courts, the length of time taken for investigations, and potential abuses of the enforcement process.

Committee Ranking Member Maxine Waters (D-CA)

• Defunding the SEC only empowers fraudsters trying to evade the law.  The crypto industry needs stronger regulations to combat fraud.  The SEC’s Staff Accounting Bulletin Number 121 should remain in place as it provides more security to investors.

Subcommittee Chair Ann Wagner (R-MO)

• Our capital markets benefit from an enforcement division equipped with the tools to detect, punish, and prevent fraud.  However, the SEC’s current trend of regulation by enforcement harms market participants, specifically by implementing policy changes that are not subject to the Administrative Procedures Act.  Under Chair Gensler’s heavy-handed leadership at the SEC, the public’s trust in the SEC will decline further if the problems we highlight today are not addressed.  The SEC should prioritize fairness, transparency, accountability, and trust.  This Committee should be concerned when market participants lose confidence in their regulator, especially when that regulator’s job is to instill faith in our market.

Subcommittee Ranking Member Brad Sherman (D-CA)

• The SEC’s hefty budget, particularly its enforcement division’s $676 million, resulted in nearly $5 billion secured, with a significant portion returned to investors.  I advocate for clear regulation of the digital asset space, despite pushback from the crypto industry.  Congress should grant the SEC absolute jurisdiction over cryptocurrencies, given its expertise in regulating intangible investment assets.  With a surge in whistleblower tips and rewards, the SEC remains committed to robust enforcement efforts.

Mr. Andrew Vollmer, Senior Affiliated Scholar at the Mercatus Center and former SEC Deputy General Counsel

• The courts and the SEC have not developed predictable, consistent, and textually based standards for defining a violation, act, or omission or applying the penalty statutes.  The courts are divided on how to calculate penalty amounts.  The uncertainties should not be left to the courts to resolve because the courts will reach conclusions that are not consistent with the desires of Congress.  SEC administrative enforcement proceedings have been the subject of serious criticism and complaints for decades and now face a serious constitutional attack.
• The SEC should create an objective and balanced investigative record that considers potential wrongdoing and innocent explanations.  The Commissioners should not authorize a proceeding unless they believe a reasonable person would conclude that the SEC is more likely than not to prevail on the facts and the law and believe that a proceeding would serve broad and legitimate enforcement goals.

Mr. Nick Morgan, President and Founder, Investor Choice Advocates Network

• Among many problems, the SEC’s regulation by enforcement policy causes legal uncertainty for people forced to litigate policy matters on a case-by-case basis.  Even when a federal appellate court rules against the SEC on a particular policy, the SEC currently considers itself unconstrained to pursue such rejected policies in other federal courts until it finds judges who will rule differently.

Professor Paul Eckert, Professor of the Practice of Law, College of William & Mary Law School

• The SEC should continue to embrace as a goal two years between the initiation of an investigation and the decision to either initiate an enforcement proceeding or close an investigation without action.  The SEC should restore the policy of permitting a settling entity to request that the Commission consider an offer of settlement that simultaneously addresses both the underlying enforcement action and any related disqualifications. For enforcement actions in which the SEC is a party, there should be a presumption that the SEC enforcement action satisfactorily addresses the misconduct.

Mr. John Reed Stark, President, John Reed Stark Consulting

• While digital asset firms and their supporters may allege the SEC’s Due Process and Fair Notice failures as much as they please, it ultimately falls on the courts to determine whether this is the case.  U.S. securities laws create a financial protective framework to safeguard all people and businesses from the systemic risk created by perilous digital assets, which if entangled into the U.S. financial system, could trigger a financial crisis.  The SEC should police digital assets.

SEC Oversight

Wagner (R-MO):  Why should the SEC funnel more cases to the federal courts?  Morgan:  The respondents of the SEC’s law enforcement should be entitled to a jury trial, and the SEC continues to pursue rejected policies in federal courts until finding judges who rule differently.

Wagner (R-MO):  Does the SEC impose excessive penalties?  Vollmer:  Yes, and excessive penalties are an issue because of the SEC’s ambiguous statutory language.

Wagner (R-MO):  Is the SEC’s approach to regulation by enforcement problematic? Eckert:  Yes, the SEC undervalues the non-enforcement alternatives at their disposal.

Lucas (R-OK):  Why is it important that the SEC have a consistent, predictable enforcement standard?  Morgan:  It gives the SEC an incentive to disclose less information.

Sessions (R-TX):  Can you speak about the length of time it takes the SEC to address an investigation?  Morgan:  The SEC needs to speed their investigative process up.  

Huizenga (R-MI):  Do you believe the SEC is abusing the Wells process? Eckert:  Issues with the Wells process stem from what happens within the Commission staff after the process, particularly in the Wells memorandum where staff may try to dissuade moving forward with a case.

Meuser (R-PA):  How should the SEC’s enforcement division measure its effectiveness, considering the burdens that may drive business away from the U.S.? Is there a more balanced metric than record fines and the number of enforcement actions?  Vollmer:  The SEC should not focus on increasing compliance;  they should explore alternative mechanisms beyond enforcement to achieve greater compliance.

Meuser (R-PA):  SEC Commissioner Peirce recently stated that market participants desire conversations with regulators but refrain due to fear of enforcement.  What are your thoughts on this environment, and how can administrative agencies foster productive dialogue while addressing regulatory concerns? Eckert:  Fear of enforcement can hinder open dialogue between market participants and regulators.

Steil (R-WI):  Does the SEC’s use of administrative courts undermine the public’s trust in the agency?  What actions should Congress take to strengthen market confidence in this regard?  Vollmer:  The use of administrative courts by the SEC undermines public trust, particularly due to differences in process compared to federal courts.  Congress should eliminate the use of administrative proceedings and require all enforcement cases to be brought in federal court.

Nunn (R-IA): Could you please elaborate on the negative consequences when regulators eliminate stakeholders’ input in the regulatory process, especially concerning regulation by enforcement?  Morgan:  Regulation by enforcement creates uncertainty and discourages market participation.

Digital Assets

Sherman (D-CA):  Is there any legitimate purpose for a mixer?  Stark:  No.

Waters (D-CA):  Does the SEC have full authority to regulate the digital asset space?  Stark:  Yes.

Waters (D-CA):  Is it within the SEC’s purview to establish penalties for cryptocurrency markets?  Stark:  Yes, the statutes give the SEC the authority to establish fair punishments, which they have done.

Casten (D-IL):  Until there is more information regarding cryptocurrency mixers and their audit trails, it should be presumed that they are being used for money laundering.

Nickel (D-NC):  What are your thoughts on the current Robinhood case?  Vollmer:  The SEC preempted the regulation of digital currencies with a vague theory about its regulatory jurisdiction.  Congress needs to draft authority to regulate digital currencies to provide clarity and help platforms like Robinhood.

Nickel (D-NC):  Do you think the SEC provides enough regulatory clarity for digital assets, particularly cryptocurrency?  Vollmer:  No.

Nickel (D-NC):  What changes would you suggest to the SEC’s enforcement strategies with digital assets? Vollmer:  The SEC should focus on achieving compliance in less costly and less intimidating ways.

Climate Disclosure

Lucas (R-OK):  The SEC aims to use enforcement cases to signal climate-related policies and procedures to the markets.  This runs the risk of irreversibly harming the SEC’s reputation and damaging the willingness of companies to stay in public markets that everyday investors benefit from.

AI

Lucas (R-OK):  How should the SEC do something about AI?  Vollmer:  The SEC should make sure that investment advisors are using complete and accurate disclosures about their use of AI.

Other

Scott (D-GA):  Is it important for regulators to consider manual trade exceptions in terms of their time frame?  Eckert: I am unsure about the specific requirement of considering manual trade exceptions with shorter time frames, but manual trade processing typically takes longer, especially in the fixed-income markets where paper order tickets and manual trade transactions are still prevalent.