White is questioned on market structure reforms, disclosure of corporate political activity, status of Dodd-Frank swaps rules, fiduciary rule for brokers & advisers

The Senate Banking Committee on June 14, 2016, held an oversight hearing on the Securities and Exchange Commission; the only witness was SEC Chairman Mary Jo White. Hearing testimony is posted here.

In his opening statement, Chairman Richard Shelby (R-AL) said he believes the SEC "should focus on its core mission. This has become more difficult as the Commission has come under increased pressure to expand its mission and cater to special interests," such as attempts to force the SEC to mandate disclosure on climate change and political contributions. Shelby said he expected the SEC would continue to resist "political pressure," as it has in the past. Shelby said the SEC should periodically review the appropriateness of its existing rules. "For example, while the commission has undertaken work to review equity market structure, it is not engaged in a comprehensive review of its rules, even in light of the so-called flash crash, which happened over six years ago," he said. He added that he hoped the SEC will continue to give serious weight to economic analyses of the effects of proposed rules: "If the cost of a rule outweighs its benefit, then the rule should be eliminated. If a rule passes cost/benefit muster, it should then be implemented by the appropriate agency." Shelby said he was also concerned that other agencies, such as the Department of Labor (with its new fiduciary rule for certain brokers) and the Financial Stability Oversight Council (FSOC), with its focus on risks posed by asset managers, were trying to "erode the SEC's jurisdiction" and "could undermine the integrity and function of these markets."

Ranking Member Sherrod Brown (D-OH) said that although several of the SEC rules required by Dodd-Frank have been proposed and some finalized, "many are still incomplete. In particular, the Commission has not finished the derivatives rules under Title VII … and the path of their completion seems unclear." Brown said there are "certain markets, such as credit default swaps, that depend on SEC … until the rules are completed, the SEC and other regulators won't have the benefit of a framework that provides transparency and access to market data." Brown also noted that the SEC has not yet finished work on a Dodd-Frank rule for incentive compensation, which was originally proposed in 2011 and re-proposed in May. "Six years after Wall Street reform became law, this rule still isn't finished," he said.

Brown criticized the Commission for repeatedly reaching settlements with offenders "that seem to have no effect on stopping the problem in the first place," even though White had promised vigorous enforcement. "At what point is the SEC going to stop handing out warnings and start giving tickets?" Brown said the problem was "evident in the waiver process," in which he said the SEC has "routinely granted waivers to banks following a variety of violations that could have resulted in the loss of certain privileges under security laws. Unfortunately, granting those waivers eliminates the significant consequences that could promote better overall compliance at those institutions." Brown closed by noting that a rider placed on the SEC's spending bill for the current year, which prohibits it from adopting any rule requiring companies to disclose their political contributions, "shouldn't prevent you from doing anything at all."

In her prepared statement, SEC Chairman Mary Jo White said the SEC has brought more than 800 enforcement actions during her chairmanship, "an unprecedented number"; and secured over $4 billion in orders directing the payment of penalties in discouragement, "an all-time high" for the agency. She said about two-thirds of the SEC's substantive actions in fiscal 2015 "involve charges against individuals. And we continue to obtain admissions [of guilt] in certain cases, which we have now done in over 40 instances since we changed our settlement protocol." White noted that since the last time she testified, the Commission has advanced major rules addressing key equity market structure issues, the transparency of alternative trading systems and the consolidated audit trail, "while moving forward with a broader assessment of other fundamental changes." She said the SEC has proposed rules to address "the increasingly complex portfolios" in mutual funds and exchange-traded funds, adopted new rules for crowd-funding and smaller securities offerings under Regulation A. She said, however, that the agency's "resources are insufficient. And the cuts and limitations to the SEC's budget that the House bill proposes … seriously imperil the progress we have made and diminish our ability to fulfill our mission."

Questions

Slow progress on swaps, fiduciary rules. In his questions, Ranking Member Brown said the SEC's progress on some rules, such as the Dodd-Frank trading rules for security-based swaps, has been slow and the agency is lagging behind other regulators like the less well-funded CFTC in this effort. Brown said that earlier this year, the Department of Labor was able to finalize its fiduciary rule for brokers, "while the SEC only produced the study" called for by Dodd-Frank. White told him that "what the SEC was given between the Dodd-Frank Act and the JOBS Act, plus all of our various discretionary responsibilities, which are vast. We have undergone in the last few years … a historic level of regulatory activity of great complexity … I'm deeply committed to getting the congressional mandates under both of those statutes, and now the FAST Act, done as promptly as I can. But they need to be done well and they need to last and they need to be adaptable to how our markets change." Regarding the fiduciary rule for brokers, White said Dodd-Frank had given the SEC the rulemaking option "to decide whether to exercise or not. It's not a statutory mandate. Now I've said myself … that I think there should be a uniform fiduciary duty rule coming from the SEC under 913 of the Dodd-Frank Act … The staff has proceeded to develop outlines of recommendations, but it's up to the Commission as a whole as whether to advance that rule and then what its parameter should be." White called the swaps trading rules "a very high priority, certainly to finalize, and we finalized a number of those rules since I was last here. In terms of the reporting and the registration and regulatory mechanisms for dealers, I'm hoping we're done with those by the end of this year."

Other senators also asked White about the Labor Department's fiduciary rule. Mike Rounds (R-SD), after noting disagreements shown in emails between SEC and DOL staffers, asked how the SEC could draft a "uniform" fiduciary rule for brokers "when it appears there are inherent disagreements between the two agencies over the fundamental goals of the rule?" White told him that Labor and the SEC "are separate agencies, so our rules aren't identical even before this rule was adopted in certain areas where our registrants may overlap with theirs." White said the SEC staff gave "substantial … technical assistance to the DOL staff on the … [proposed] rule, including … possible impacts on the availability of reasonably priced advice by brokers, and what the impact would be on the broker model itself." The goal of these exchanges "was not really to reach an agreement, but to make sure that we were giving our best technical assistance and input to the Department of Labor, which then made a decision as to what the proposal should be."

Jon Tester (D-MT) later asked White about the status of the SEC's own fiduciary rulemaking. "I'm certainly committed to getting it done, because I think it's of enormous importance," White said. "But I've also made clear how difficult and long a road that is under section 913 of the Dodd-Frank Act and that I'm one vote." When Tester said it did not sound as if the rule would emerge before the end of the Obama Administration, White said, "I can't give you that commitment, no … It's a longer route than that."

Market structure reforms. In his questions, Mike Crapo (R-ID) asked about the SEC's ongoing project to evaluate and modernize market structure. He said a recent hearing he had chaired showed concern about "the pace of reform efforts and what will be accomplished." He asked what the SEC's main goals for this effort were. White said the market structure project is "a very high priority for me personally." She said she was pleased with the work done so far by the Equity Market Structure Advisory Committee, and noted that the EMSAC had received a recommendation "about the possibility of doing a maker-taker pilot. That's obviously one of the core issues." She said members of an EMSAC panel plan to meet by telephone to make specific recommendations on July 8. White also noted that the SEC in 2014 had approved the Systems Compliance and Integrity (SCI) rule aimed at critical market infrastructures "and enhancing their resiliency and responses to incidents." She said she also expected the SEC "this year, rather imminently" will propose a rule "to provide greater transparency of order routing for institutional orders as well as enhancing the existing disclosures that are made on the retail side."

Crapo asked if, after the July 8 meeting, the EMSAC "would be in a position to take the next action and move forward," and if not then, when? White told him it is "important to do this in a well- designed pilot, because it really does touch on a very important issue where we need the data … I can't give you a specific time, but it is a this-year priority to move that along as soon as we get the recommendation."

Jerry Moran (R-KS) also asked about the market structure issue, asking if the "NMS plan governance model should be reformed to reflect evolution of our markets, and add additional participants as voting members." Moran asked if the SEC has the authority to approve additional market experts as voting participants in the governance of NMS plans. White said, "We actually have recommendations coming from the … the EMSAC on this very subject. But we essentially are in the position of approving a rule filing." She said the subject was being addressed in the EMSAC's Trading Venues Subcommittee and "may be the subject of recommendations."

Mark Warner (D-VA) also asked about governance issues in market structure. Warner said the stock exchanges "are making decisions to make huge capital investments in technology … [that] may give them that fractional-second advantage over others … at some point, speed and the god of liquidity are not always the correct answer." He asked White, "How do we make sure that in terms of market governance we've got all the right parties at the table sorting through these issues?" White said that in terms of high trading speeds, "certainly you get to diminishing returns … [but] I don't think you roll back technology … Sometimes people talk about high-frequency traders as if they're one thing. And they're not. They're not monolithic. They have different strategies, and one of the proposals that the staff is working on is an anti- trading disruption rule, which deals with when markets are particularly vulnerable, liquidity being taken away by virtue of speed."

Disclosure of corporate political activity. In his questions, Jeff Merkley (D-OR) said the SEC had received "a million public comments" in support of a potential rule requiring corporations to disclose their political activities. Merkley said such a rule was on the Commission's agenda when White arrived, "but in October of 2013 you took it off the agenda. Not even to hold the conversations to prepare the way on this." He asked why. White said first that if the political activity issue "is material in the context of a particular company as we sit here today, that would need to be disclosed under the federal securities laws," as well as venues for shareholders to raise issues on their own. She said the average approval rate for such proposals last year was 26%. "In large companies, the number of them that have voluntarily disclosed contributions has grown. I think more than half of the S&P 500 now provide that disclosure voluntarily," she said. White said there was some "misunderstanding" about what she did in reviewing the SEC's "reg flex agenda" when she arrived. Many of the items on the list had been there "for many years and were aspirational … I have prioritized … completing the congressional mandates under the Dodd-Frank Act and the JOBS Act, as well as certain mission-critical initiatives like equity market structure." Merkley was not convinced: "I think for you to unilaterally remove it from the rulemaking agenda was an egregious affront to these core issues of our republic," he said. "It came after political pressure, I think it's unacceptable, I think you should put it back on the agenda."

Robert Menendez (D-NJ) also raised the issue of a rule on political activity, asking, "Are you going to at least prepare and respond to those 1.2 million Americans and nearly 100 members of Congress who believe that you should move forward in this regard?" White said, "The issue of the SEC doing a rulemaking to mandate political disclosures by all public companies is not on our reg-flex agenda … The priorities that we are pursuing … are really the ones that I've outlined since my early days here." Chairman Shelby said such a rule would be "under the basic jurisdiction of the Federal Election Commission."

Charles Schumer (D-NY) also picked up the thread on political disclosures. Money is "pouring in, poisoning our politics, and we don't know where that money comes from," he said. "The shareholders don't know where that money comes from. It is more important than anything else to me before the SEC … A few powerful people can send cascades of money into our system … And you, frankly, are aiding and abetting it, the SEC. I just don't get why corporations that give money shouldn't tell their shareholders. These are major decisions. They have effects on the corporations … I think you're hurting America, and I know you can stay in your narrow little box and say, 'Well, the rules of the SEC are limited and this and that' … But how many other issues have you gotten 1.2 million petitioners calling you? And I wish you would change your mind. I'm just so disappointed."

White said the appropriate venue for shareholders to seek such disclosures was "the 14a-8 shareholder proposal route." Schumer then focused on the question of whether the SEC would simply "start the process" of a rule on political activity, which would still be allowed under the rider Republicans attached to the SEC's spending bill. White said, "The answer is that it is not a subject that is on our current reg-flex agenda because of my priorities, and the priorities of the Committee."

'Information Overload.' In her questions, Elizabeth Warren (D-MA) had what became a contentious exchange with White. "Instead of moving forward on issues intended to help investors, you've actually headed in the opposite direction," she said. Warren faulted White for devoting resources to a Disclosure Effectiveness Initiative in the belief that investors suffer from "information overload," saying, "I've never heard of the idea that investors actually want less information that they're getting." She asked what evidence White had seen to suggest this was a problem. White said the issue had occupied the SEC for years before she arrived, and that the 2012 JOBS Act had required a study of the effectiveness of mandatory disclosures. "There's nothing more important than our disclosure powers," White said. But Warren said White had been influenced by advocates for big businesses. "Let's be honest about this. I cannot find, and you have not produced, a single investor who has complained to the SEC about receiving too much information … So, who wants less information to be disclosed? It's pretty clear the [U.S.] Chamber of Commerce, which represents the giant companies that have to do the disclosing … ."

Warren continued that she is "frustrated that at your direction, the SEC has voluntarily spent two years trying to address a problem that you have no evidence exists … Instead of making up work to help giant corporations the SEC should do its job, starting with the 20 required rules under Dodd-Frank that still aren't fixed, six years after the law was passed. Your job is to look out for investors, but you put the interests of the Chamber of Commerce and their big business members at the top of your priority list. A year ago I called your leadership at the SEC extremely disappointing. Today I am more disappointed than ever." White countered, "And I'm disappointed in your disappointment, and could not disagree any more with your characterization of what we're trying to do to improve our disclosure regime for investors to make it better."

Authority delegated to SEC staff. In his questions, Chairman Shelby noted that the SEC can delegate authority to enforce rules and other powers to its staff, and asked how the commissioners are made aware when that authority is used. White said the SEC has "hundreds and hundreds of day-to-day things that we must do at the commission, so it's very important that the staff have delegated authority to act." She said any commissioner can ask that any action by the staff be reviewed. Shelby suggested the SEC should review existing delegations of authority because they automatically carry forward into the tenure of the next chairman.

Public comment for FSOC / OFR studies. Shelby mentioned that the SEC had posted for public comment a 2013 study on risks posed by asset managers done by the Office of Financial Research (OFR), a process that "highlighted significant flaws" in the study. He asked if White would commit to similarly posting other studies requested by the FSOC. White said, "We did open a comment window [with the OFR study] because we thought it was important to get that public input. If we were in another situation like that and OFR or FSOC itself didn't … post its studies to make it easier for the public to comment, certainly we would seriously consider that again."

Repeat violators. Shelby said the public has raised concerns about repeated violations by SEC-registered firms, noting that a former commissioner had questioned whether such offenders should be allowed to continue participating in the capital markets. He asked when it was appropriate for the SEC to use its power to de-register an entity. White said, "You have to look very carefully at what the violations have been over what period of time, who was involved in them … but there can certainly come a point … where one of our regulated entities should no longer be registered, and I wouldn't hesitate to bring a proceeding to revoke the license."

Section 621 conflict of interest rules. Sen. Merkley asked why the SEC had still not yet proposed rules required by section 621 of Dodd-Frank that would prohibit conflicts of interest among individuals who package and sell asset-backed securities (ABS). White said a draft rule proposed in September 2011 generated "tremendous comments … It's proved to be much more complicated than certainly our experts in the agency envisioned." She said that an issue had come up in December 2015 "as to whether certain Fannie-Freddie guarantees would be handled because of the concern that those securitizations could continue at least under the parameters of the proposal … The staff is working very hard to get a re-proposal done as soon as it can. But it has proven to be very, very difficult to draw the right lines." But Merkley said he didn't think "anybody in America buys that this type of conflict of interest is too difficult. The instructions have gone to the SEC, the SEC has failed the public on this issue."

Waivers for violators. Ranking Member Brown asked White about the waivers the SEC has issued allowing firms that break rules to continue trading in the markets. He said he was particularly concerned about "the lack of transparency in those waivers that are granted that public sees an institution violates the law, asked for a waiver, the SEC issues a short notice approving the waiver … How can you assure us that … everybody in our society will be able to understand more of what's happened?" White said waivers that are granted are publicized on the SEC's website, but not those that are denied. She said the SEC's web site describes "what those criteria are [for approving waivers] and the facts under each one. If there's some enhancement that would make sense, I'm certainly open to considering it."

Business development companies. Sen. Toomey noted that in the House, Rep. Mick Mulvaney (R-SC) has sponsored a bill that passed the Financial Services Committee by a wide margin in November, which would streamline regulations for Business Development Companies (BDCs), including raising their permitted leverage ratio. Toomey said White had expressed concern about the leverage provision and asked her to explain them. White said the bill "doubles the leverage … and it's a higher level of leverage than any counterpart kind of funds have. Second, I think it allows more investment in financial institutions than was originally conceived, and allows investments in registered investment advisers … " Toomey said that while the risk profile increases the exposure, "so does investing in a bank. A bank is a highly leveraged entity. And retail investors are allowed to buy securities on margin." But White said, "There are more issues and risks with respect to this bill than just that." Toomey said retail investors can be exposed to "enormous leverage" through buying options, for example: "This would be a very modest [change] — it's heavily regulated, it's run by professionals, and the upside benefit is very significant."

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