Clayton says outreach on agency's recently proposed best interest rule for brokers will include forums in Atlanta, Denver, Houston, and Miami.

The House Appropriations Committee's Financial Services and General Government Subcommittee on April 25, 2018, held a hearing on the SEC's fiscal 2019 budget request. The only witness was SEC Chairman Jay Clayton. Materials from the hearing are posted here.

In his opening statement, subcommittee Chairman Tom Graves (R-GA) said he was encouraged to see that the SEC last week had voted to propose a Best Interest Standard for broker dealers, acknowledging that Clayton wanted to address this issue in his testimony. "As you begin this 90-day public comment period, I look forward to hearing more about … how this is just going to positively impact our constituents across the country," Graves said.

Subcommittee Ranking Member Mike Quigley (D-IL) said the SEC's budget request for fiscal 2019 is just under $1.7 billion, including $37 million to finance a new lease procurement for the New York Regional Office. Quigley called the request "a negligible increase to base funding of just $6 million above the enacted fiscal year 2018 spending." He said that while he was pleased to see that the SEC intends to retain funds appropriated last year to strengthen its cybersecurity infrastructure, "I was disappointed that your request does not seek to bolster resources for enforcement staff to a level I believe is needed," because "the core of the SEC's work is enforcement and examination … Your budget provides for an overall staffing level that is 1% lower than the current year, and a steeper, 3.5%, decline in [full-time equivalents] when compared to 2017 … frankly, your proposal will still leave the enforcement division with dozens fewer staff than when the hiring freeze began."

In his prepared statement, SEC Chairman Jay Clayton thanked the subcommittee for its support, saying Congress' recent funding will enable the SEC to make significant investments. He said the FY 2019 request "will enable us to start lifting our hiring freeze and support 100 new hires" to address Clayton's five high-priority areas. Those areas of focus are: 1) allowing the SEC to make investments to modernize its IT infrastructure and improved its cybersecurity risk profile. 2) Doing more to "enhance capital formation in our public and private capital markets, and particularly for mid-sized, small, and emerging companies." 3) In the area of investor protection, Clayton said that last week, the SEC had voted to propose "a comprehensive package designed to address retail investor confusion and potential harm in their relationship with investment professionals." The rules package would "significantly enhance retail investor protection while preserving access in terms of both availability and cost to a variety of types of investment services and investment products. " He said the forthcoming public-comment process would include investor roundtables in Atlanta, Denver, Houston and Miami. 4) For enforcement, Clayton said the budget request would support priorities such as expanding the work of a new "cyber unit" and the SEC's retail strategy task force, and allow advances in the SEC's examinations of investment advisers. He said the SEC had increased examinations of IAs "by more than 40% in fiscal year '17 to approximately 15% of all SEC-registered investment advisers." 5) Allowing the Trading and markets Division to focus more on "equity and fixed-income market structure, analysis of clearing agencies, broker dealers, cybersecurity and electronic trading."

Questions

Proxy advisory firms. Chairman Graves said the subcommittee had heard complaints from several companies regarding proxy advisory firms, and asked for an update on "when the commission will be taking an important first step to address this issue and others like that, and reopening the comment file on the 2010 proxy 'plumbing.' " Clayton said the proxy area is "in need of at least some modernization. You will not see it on my short-term agenda, but that doesn't mean we're not thinking about it. It is on our long-term agenda." He said the corporate governance landscape has changed because there is a greater concentration of shareholder holdings, greater access to the proxy by shareholders and the emergence of proxy advisory firms: "Those are all things we should examine." He said some recent proxy contests and the amount of time necessary to resolve them had demonstrated that proxy "plumbing" is "out of date … We're looking at them, and I would say stay tuned for action," but he added that this was not something the SEC can get done this year.

Best interest standard for brokers. Graves asked if Clayton could go into more depth about how the public process surrounding last week's proposed Regulation Best Interest for brokers will play out, and "what kind of push-back you might receive." Clayton said, "I don't think there's any doubt in anyone's mind that action is required in this area, and action that coordinates across the various agencies that regulate the relationship between an investment professional and their client," whether they are advisers or brokers. "We have the Department of Labor, we have state securities regulators, we have the SEC, we have FINRA, we have state insurance regulators, we have banking regulators, all in this space. I think we all also agree that the duty that … should owe to a client should match that client's expectations," and that the client ought to be able to understand it.

Clayton added, "I think we all also agree that that relationship should be governed by fiduciary principles. Now, we've called it the best interest standard, but I want to be clear: for broker dealers, there are fiduciary principles embodied in that best interest standard. In fact, those fiduciary principles are, I believe, the same as the fiduciary principles that are embodied in the investment adviser standard." He continued, "We've recognized that the relationship between an investment adviser and their client is a different type of relationship than a broker dealer and their client, but we've sought to harmonize the actual duties that are owed, recognizing those differences. And I look forward to engagement with all groups as we proceed across the rulemaking."

Decline in enforcement actions. In his questions, Ranking Member Quigley said 2017 saw a decline in both the total number of enforcement actions by the SEC and the amount of penalties assessed. "Total penalties imposed in '17 declined from $1.2 billion in 2016 to $832 million, a fall of nearly 35%," he said. "An outsider's perspective of your enforcement actions to date could give the appearance that your agency is going after smaller fish instead of misconduct conducted by bigger-fish firms." He asked if Clayton could "explain what seems to be a change in enforcement strategy," quoting a Georgetown University study from last year that found that "cases brought against entities, as opposed to individuals, have dropped from 47% in the first half of 2017 to 34% in the second half of the fiscal year, after you took the helm," and the median fine imposed had dropped by more than a third, from about $110,000 between 2007 and 2013 to about $70,000.

Clayton said that study did not include the fact that "the gestation period for our cases is 22 to 24 months. That means the cases that are being reported on in '17, you know, are, from a median perspective, the ones that were started in '15. The ones that were reported in '18 are the ones that started in '16. So those statistics actually reflect … [mostly] enforcement decisions that were made before I arrived at the commission … There has been no letup in terms of enforcement." Clayton mentioned a number of new hires in the division, saying he had "no doubt that they are pursuing bad actors." As for specific actions, "I am happy that we are pursuing individuals as opposed to entities. I think that individual actions have greater deterrence … When I talk to people in the private sector, and I caution them to be careful, I don't point to a particular company, I point to an individual." But he said enforcement actions against companies would continue and cited the significant fine imposed earlier this week on Altaba, the company formerly known as Yahoo, for its cybersecurity breach.

Cryptocurrencies. In his questions, Chris Stewart (R-UT) asked if cryptocurrencies like Bitcoin provide economic utility, and who their appropriate regulator and "regulating scheme" should be. Clayton told him that Bitcoin, as a replacement for currency, "has been determined by most people to not be a security. Then there are tokens, which are used to finance projects. I've been on the record saying there are very few … tokens that aren't securities. To the extent something is a security, we should regulate it as a security, and our securities regulations are disclosure-based." Clayton said this area "has grown substantially without the usual … respect for the law that you would expect to see in financial markets … To the extent that we don't have jurisdiction, to the extent that it's not a security, we need to look at these currencies, because our laws didn't anticipate them. Our laws anticipated sovereign-backed currencies." Stewart said he would prefer for the SEC to "lean into" the problem rather than "wait for something that gets people's attention, and then draws upon Congress and others to respond to it when we're really not prepared."

Examining investment advisers. In his questions, Sanford Bishop (D-GA) said that in its fiscal 2019 budget request, the SEC "observed that nearly 35% of all SEC-registered investment advisers have never been examined, and that the population of advisers registered with the SEC continues to grow." He asked how the SEC plans to fix that shortfall. Clayton said the SEC's Office of Compliance has shifted to "a risk-based prioritization of who we examine and what areas we examine for, using data analytics." He said the advisers who go unexamined "are the ones that rank as less risky in our analysis, but we are making efforts to reduce that number, and we're making efforts to increase the number of firms that we examine annually. We went to 15% this year, which was up 40% over the last couple of years."

Dodd-Frank Rules for swap dealers. In his questions, David Young (R-IA) said the SEC has yet to finalize all of its Dodd-Frank Title VII rules for security-based swap dealers, unlike the CFTC, which has had its registration regime effectively in place for about five years. "This lack of finalization has led to some uncertainty," he said, asking if Clayton had "a timeline where this is going, and are you watching what the CFTC has done in trying to get rid of some of those duplicative requirements … ?" Clayton said, "Do I have a specific timeline that would be precise enough to discuss? No. Do I have an initiative? Yes. I'm very happy that Commissioner [Hester] Peirce, who joined us recently, has agreed to oversee our efforts to move forward with Title VII rulemaking … in coordination, and where possible, harmonization with the CFTC … We've had several bilateral meetings, and I expect to see progress in this area."

Climate risk disclosures. In his questions, Matt Cartwright (D-PA) said he was concerned about what he called the SEC's lack of enforcement of its own 2010 guidance on climate disclosure. "You repeatedly stressed the importance of disclosing climate risks when you were at Sullivan & Cromwell," he told Clayton. "When the 2010 guidance was released, the SEC issued around 50 comment letters to companies that had provided insufficient disclosure of climate risk, but it's been years at the SEC since they've issued a single letter … What evidence can you provide that you are taking climate risk disclosure seriously at the SEC right now?"

Clayton said the SEC takes all of its disclosure mandates seriously. "The discussion around climate risk disclosure misses some of that point. The disclosure should be to your investors and what climate-related issues might affect your company," he said. "There are many industries for which it's not a material risk at all, and there are industries for which it is clearly a material risk, but it's a risk that depends on many factors outside of the control of the company itself … I don't think you should take the lack of an enforcement action as somehow indifference from the SEC in this area … If there are cases where companies have had adverse effects on their shareholders as a result of climate matters, and they haven't disclosed them, and they knew about them, we should be investigating those."

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