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News July 17, 2017 Issue

Clayton Lays Out Principles and Practice Areas for the SEC During His Tenure

Before you build a house, you need a foundation. SEC chairman Jay Clayton, in his first major public speech, on July 12 offered what might be called his foundation principles for how the agency will act during his time in office. He also touched on a few of the specific areas where the SEC is likely to take action.

Clayton provided eight principles. These ranged from restating the three-part mission of the agency (protect investors; maintain fair, orderly and efficient markets; facilitate capital formation) to the more interesting because of their potential. Among this latter category was "regulatory actions drive change, and change can have lasting effects," "effective rulemaking does not end with rule adoption," and "the costs of a rule now often include the cost of demonstrating compliance."

As far as meeting the SEC’s three-part mission, Clayton said that "each tenet of that mission is critical. If we stray from our mission, or emphasize one of the canons without being mindful of the others, companies (large and small), the U.S. capital markets and ultimately the economy will suffer."

Willkie Farr partner and former SEC Division of Investment Management director Barry Barbash said that this statement appears to reemphasize the parts of the mission other than investor protection. "The other two elements – maintaining fair, orderly and efficient markets, and capital formation – have not appeared to be as central to the Commission’s activities in recent years. Investor protection is very important, the new chairman seems to be saying, but so are the other two. He seems to be saying that the Commission should be sure not to emphasize one at the expense of downplaying the others."

Kirkland & Ellis partner and former SEC Division of Investment Management director Norm Champ said that he "applauds Clayton’s focus on all three tenet’s of the SEC’s mission, and I’m confident he will balance a concern for investor protection with the important mandate to facilitate capital formation. I am encouraged by his desire to conduct a careful review of past rules to see if they can be streamlined or updated and, in particular, his commitment to find ways to expand choices for retail investors is quite important."

The speech "seems designed to assure the SEC’s constituents that under Clayton’s stewardship there will be no dramatic shifts of regulatory policy, while at the same time acknowledging concerns of some that the agency has been engaging in regulation beyond its traditional mandate," said Proskauer partner and former SEC Division of Investment Management deputy director Robert Plaze.

Among the likely actions he touched on were the following (see related story on Clayton’s SEC budget testimony, this issue, for further information):

  • Seeking ways to spur capital formation. This is clearly a major theme for Clayton that he has mentioned in several public forums, going back to his nomination hearing (ACA Insight, 4/3/17). "I have been vocal about my desire to enhance the ability of every American to participate in investment opportunities, including through the public markets," he said.
  • Continuing strong enforcement and examination programs. "I fully intend to continue deploying significant resources to root out fraud and shady practices in the markets, particularly in areas where Main Street investors are most exposed," Clayton said. Cybersecurity, pump-and-dump scams, the use of new technologies to "lie, cheat and steal," and attempts to "prey on retirees" were among those he mentioned.
  • Working with the Department of Labor on a fiduciary rule. "With the Department of Labor’s Fiduciary Rule now partially in effect, it is important that the Commission make all reasonable efforts to bring clarity and consistency to this area. It is my hope that we can act in concert with our colleagues at the Department of Labor in a way that best serves the long-term interest of Mr. and Mrs. 401(k)," he said. He noted that the agency in June called for public input on standards of conduct for investment advisers and broker-dealers (ACA Insight, 6/12/17).
  • Reviewing the efficiency, transparency and effectiveness of our fixed income markets. "As waves of baby boomers retire every month and need investment options, fixed income products, which are viewed as a stable place to store hard-earned money, will attract more and more Main Street investors," Clayton said. "Yet, many of those investors may not appreciate that fixed income products are part of markets that differ significantly from the better-known equities markets."
  • Improving disclosure to investors. The SEC already has several initiatives underway to do just that, he said, without going into further specifics. "Regardless of whether investors participate in our markets directly or indirectly, and with or without investment advice, it is clear that they and their advisers must have access to information about potential investments that is easily accessible and meaningful."

The principles

Clayton used his speech, delivered at the Economic Club of New York in New York City, to "share my perspective on the Commission and the principles that should guide where we go from here." Following is a breakdown on those principles that are likely to be of most interest to investment advisers.

  • Regulatory actions drive change, and change can have lasting effects. Clayton made the point that the cumulative effect of regulations, even small ones, may create problems. "Incremental regulatory changes may not seem individually significant, but, in the aggregate, they can dramatically affect the markets," he said. He noted that the disclosure-based regime applied by the SEC, lawmakers and other regulators has worked so well that it now encompasses disclosure "beyond the core concept of materiality." The effects, he suggested, might include an approximate 50 percent decline in the total number of U.S.-listed public companies over the last two decades – note his interest on capital formation here – and "forces us to question whether our analysis should be cumulative as well as incremental."
  • Effective rulemaking does not end with rule adoption. "The Commission should review its rules retrospectively," Clayton said. "We should listen to investors and others about where rules are, or are not, functioning as intended. We cannot be shy about being introspective and self-critical." These statements should be music to the ears of a number of asset management organizations and individuals, among them the Investment Adviser Association, which on May 4 urged Clayton to revisit a number of existing agency rules, including the Advertising Rule, the Custody Rule and the Pay-to-Play Rule (ACA Insight, 6/19/17).
  • The costs of a rule now often include the cost of demonstrating compliance. "Vaguely worded rules can too easily lead to subpar compliance solutions or an overinvestment in control systems," he said. He noted that, as an example, when the SEC requires a chief executive officer to certify that a specific requirement has been met, it can be expected that the CEO’s responsibility will be supported through the chain of command in a demonstrable manner. "This can be an expensive practice that goes well beyond a prudent management and control architecture; when third parties, such as auditors, outside counsel and consultants are involved, the costs – financial costs and, in many ways more important, the cost in terms of time – can skyrocket," Clayton said. "The Commission needs to make sure at the time of adoption that we have a realistic vision for how rules will be implemented as well as how we and others intend to examine for compliance."

In the other principles he listed, Clayton said that coordination between the SEC and other regulatory bodies, such as the CFTC and the Department of Justice, is essential; and that the agency must evolve with the markets as technology and innovation change. "Technology is not just the province of those we regulate," he said. "The SEC has the capability to develop and utilize it, too. We apply sophisticated analytic strategies to detect companies and individuals engaging in suspicious behavior. We are adapting machine learning and artificial intelligence to new functions, such as analyzing regulatory filings." As the agency evolves, however, he said that costs must be kept in mind.