On November 2, the House Financial Services Subcommittee on Capital Markets held a hearing entitled “Examining the SEC’s Agenda: Unintended Consequences for U.S. Capital Markets and Investors.” Witnesses in the hearing were:
- Dr. S.P. Kothari, Gordon Y Billard Professor of Accounting and Finance, MIT Sloan School of Management
- Ms. Dalia Blass, Partner, Sullivan & Cromwell LLP
- Mr. Tom Quaadman, Executive Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce
- Mr. Ken Bentsen, President and CEO, SIFMA
- Ms. Amy Borrus, Executive Director, Council of Institutional Investors
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.
Key Takeaways
The following is a summary of the main topics explored in today’s hearing. Each is discussed in further detail in the Discussion section below.
- Questions from Members on both sides of the aisle expressed concern with the Securities and Exchange Commission’s (SEC’s) fast-paced rulemaking agenda, short comment periods for proposed rules, and questioned the SEC’s lack of justification for some of the proposals.
- The equity market structure reforms received backlash from some members for being costly for clients and advisors.
- The custody rule was criticized by some for being too broad, costly, and not coordinated with other regulators such as the Commodities and Futures Trading Commission (CFTC).
- Republican members criticized the SEC’s cost-benefit analysis for proposed rulemakings as they said the analysis inadequately address how the proposals are interconnected. Members also pointed out that the SEC, in general, has not engaged enough with key stakeholders and other federal agencies like the CFTC prior to writing recent proposals.
- The SEC’s consolidated audit trail (CAT) rule was criticized for being unnecessary and costly. Members also expressed concern with the predictive data analytics rule as it could limit the use of helpful technology for broker-dealers and retail participants. Basel III received some backlash for the negative impact it could have on product price and dealer capacity.
SUMMARY
Opening Statements and Testimony
Subcommittee Chairwoman Ann Wagner (R-MO)
- The SEC has taken on a rulemaking agenda at a reckless pace that raises questions of the agency’s ability to determine the implications of their proposals across markets. The SEC has not given stakeholders enough time to respond to rulemakings as the comment periods have been shorter than under previous Commissions. The SEC has ignored Congressional inquiries for information, and they are operating in a way that Congress never intended.
Subcommittee Ranking Member Brad Sherman (D-CA)
- I have concerns about some of the SEC’s proposals, but they are doing a good job in general. The SEC’s climate-related risk disclosure proposal that requires the disclosure of Scope III emissions is a problem. Although it is important to investors to have the necessary material information, it is not feasible to require Scope III emission disclosures as it requires estimates of undisclosed emissions. The conflict-of-interest proposal is well-intentioned but too limited. It is important to allow individuals to take long and short positions in hedges and indexes as long as they did not invent nor control them.
Dr. S.P. Kothari, MIT Sloan School of Management
- There is significant risk that proposed rules will impose more costs on the U.S. economy than benefits. There may be cumulative and interwoven impacts across all the proposed rules that the Commission has not adequately analyzed. Compliance costs to registrants may be particularly burdensome given the breadth of new disclosure requirements such as climate-related risks. Of concern is also the biased and statistically inadequate regression analysis underlying certain Best Execution rules.
Ms. Dalia Blass, Partner, Sullivan & Cromwell LLP
- I am concerned by the pace and scope of the SEC’s rulemaking agenda, as well as the process under which many of these proposals were issued. We are now starting to see interconnections and interdependencies across many of the rules that are not accounted for in the SEC’s economic analysis. The SEC should publish a thorough analysis of the aggregate effects of its proposal as well as re-open comment periods. The SEC should also phase its rulemaking to consider the costs and interconnections of these rules.
Mr. Tom Quaadman, Executive Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce
- Rulemaking at the SEC has been disjointed and rushed and has not allowed appropriate time for stakeholder evaluation or engagement in its proposed rules. There have been inadequate cost-benefit analyses and errors. The SEC is becoming a politicized agency to the detriment of American companies and the competitiveness of U.S. capital markets. The SEC’s share repurchase disclosure did not provide convincing evidence of its necessity. The SEC’s own estimates for each rule, the cost of Clawback, Pay versus Performance, Buybacks, and Universal Proxy final rules taken together will ass new compliance burdens of $6.7 billion for public companies.
Mr. Ken Bentsen, President and CEO, SIFMA
- The SEC’s lack of prioritization and pursuit of novel proposals has crowded other important mandates, such as the pending data security rule for the operation of the CAT which has been pending for over three years. There seems to be no apparent urgency to mandate policies for the security of the critical data that is held in the CAT system.
- The equity market structure proposals would dramatically overhaul U.S. equity market structure and potentially undermine the recent expansion of market access that investors enjoy today.
- The custody rule proposal would impose and shift substantial burdens and costs among advisers, their clients, and qualified custodians without demonstrating that any marginal improvement in asset protection would justify such burdens and costs.
Ms. Amy Borrus, Executive Director, Council of Institutional Investors (CII)
- Chairman Gensler has pursued a sweeping regulatory revamp that spans corporate disclosure, equity market structure and crypto assets. His leadership has greatly advanced the SEC’s tripartite mission of protecting investors; maintaining fair, orderly and efficient markets; and capital formation. The SEC was very responsive to our company’s feedback on the proxy advisor rule, and we will continue to work in cooperation with them.
- CII and many market participants agree that the SEC final rule on Pay versus Performance benefits investors by enhancing their “understand[ing] how . . . pay and performance are aligned.” And we agree with the statement of SEC Commissioner Mark T. Uyeda that “it [was] . . . unacceptable for more than twelve years to elapse before fulfilling a Congressional mandate.”
- Many market participants agree with SEC Chair Gensler that “through [share repurchase disclosures], investors will be able to better assess issuer buyback programs [and] [t]hat is good for investors, issuers, and the markets.
Discussion
Equity Market Structure
Committee Ranking Member Maxine Waters (D-CA): Has the SEC’s proxy advisor rule and its work on market structure helped to protect investors? Borrus: Yes, the proxy advisor rule rolled back necessary provisions and we generally support their market structure proposals.
Lucas (R-OK): How will the SEC’s massive shifts in policy harm capital markets? Quaadman: It will stop businesses from wanting to access the initial public offering markets and having to look for other places; Bensten: Changing our equity market structure will raise costs for retail investors and could end commission-free trading.
Meuser (R-PA): Is the SEC’s volume pricing part of the equity market structure proposal harmful? Bensten: Yes. In their cost-benefit analysis, the SEC has said they cannot determine with certainty the costs or benefit because they do not know how market participants will respond, which exactly why it is premature. The SEC thinks that small broker-dealers are somehow disadvantaged by volume pricing, but we do not observe that.
Consolidated Audit Trail
Hill (R-AR): In relation to CAT, do you think self-regulatory organizations (SROs)s and the SEC can adequately surveil the market today? Is there any limit to the spending on CAT? Bensten: No, there are a lot of issues with the CAT proposal that need to be resolved. We have no line of sight into the budget but understand the cost will get passed on to the clients.
Digital Assets
Nickel (D-NC): I have expressed concern with how Staff Accounting Bulletin 121 would make digital assets less safe. How is preventing the largest capital banks from providing custody to digital assets against the best interests of investors? Bensten: This would drive digital assets outside of regulated sectors as commercial banks would be precluded from providing custody.
Custody Rule
Sherman (D-CA): Is the custody rule well-designed for tangible assets? Bensten: No, the rule is overly broad and undefined.
Nunn (R-IA): How does the custody proposal impact hedging for agricultural interests? Bensten: It does conflict with how futures commission merchants deal with custody issues in the futures markets. This is problematic as agriculture risk-management is the bedrock of our futures industry. The lack of coordination has led to bad rulemaking.
Nunn (R-IA): Do you think that there was any coordination between the CFTC and the SEC in the custody proposal? Kothari: The coordination seems to be significantly reduced compared to when I worked at the SEC. We used to have routine meetings with other agencies. CFTC should have been consulted more on this proposal, as it directly impacts CFTC jurisdiction and their existing structures.
Predictive Data Analytics
Wagner (R-MO): How will the SEC’s predictive data analytics proposal limit retail participation and harm broker-dealers? Blass: This rule would be incredibly hard to comply with, and the educational uses AI brings to broker-dealers and retail participants is at risk.
Lawler (R-NY): Are you concerned that the predictive data analytics rule will hurt retail investors’ ability to become educated and receive information effectively? Kothari: Chair Gensler has been insufficient in conducting cost-benefit analysis of recent SEC rulemakings.
Basel III
Lucas (R-OK): How has uncertainty from the SEC’s Basel III capital requirements impacted capital markets? Bensten: The Basel III endgame proposalwill create a squeeze on market capacity.
Meuser (R-PA): It seems as if the SEC’s Basel III proposal if uninformed and lacks solid reasoning. Why do you think that is? Quaadman: The SEC has not engaged in roundtables, and they have not spoken to enough market investors to understand how their proposals will impact key participants.
Function of the SEC
Wagner (R-MO): Has the SEC been promoting capital formation in their rulemakings? Why is this critical to small businesses? Quaadman: No, and they have not been able to articulate the reason for moving forward on some of their proposals. Small businesses need access to technology and innovation, as well as capital.
Lucas (R-OK): Are our markets sufficiently problematic to necessitate the volume of rulemakings that they have undertaken? Blass: The SEC does not articulate why such drastic changes are necessary in our markets that already function well.
Huizenga (R-MI): Is it true that eighty percent of the SEC’s rulemakings are not Congressionally mandated? Quaadman: Yes.
Huizenga (R-MI): Is the SEC damaging its ability to produce quality work given its rapid pace of rulemaking? Blass: Yes.
Lawler (R-NY): Are you aware of the SEC engaging with market and retail investors in their adoption of recent rules? Blass: Given the aggressive agenda and the small size of the rulemaking committee, they are stretched thin and do not have the time necessary to solicit and process sufficient relevant stakeholder input.
Private Funds
Hill (R-AR): Is the private funds advisors rule necessary? Blass: No, the costs will be extreme, and it will create huge barriers to entry. The SEC has not explained why it is necessary.
Conflicts of Interest in Securitizations
Steil (R-WI): What is the impact of scaling back securitization actives on financial institutions? Bensten: The SEC’s rule on this is broad and it would impact hedging ability.
Nickel (D-NC): How will the proposed rule on conflict of interest and securitization harm markets? Bensten: The rule goes well beyond the intent of Congress to address conflicts of interest, and there are already rules to address these concerns.
Climate-Related Risk Disclosure
Huizenga (R-MI): What issues to you see with the climate-related risk disclosure proposal? Kothari: It should take a more targeted approach and not a blanket approach as every firm is different.
Casten (D-IL): Do you believe that investors need reliable information so they can properly allocate their portfolio to areas that have less risks associated with climate change? Borrus: Yes, and investors need comparable information when it comes to climate disclosure.