April 26, 2018

House Appropriations Subcommittee on Financial Services and General Government “FY 2019 U.S. Securities and Exchange Commission”

Key Topics & Takeaways

  • Regulation Best Interest: Clayton discussed the newly proposed Regulation Best Interest. Clayton explained that the duty an investment professional owes their client should match the client’s expectations, and a client should be able to understand that duty and the relationship, and that relationship should be governed by fiduciary principles.
  • Cybersecurity: Clayton fielded multiple questions on cybersecurity, saying that the SEC’s approach has been a mix of reactionary and proactive measures, including a comprehensive review to identify vulnerabilities. Clayton noted they are coordinating with other federal regulators, as well as many large financial institutions.
  • Securities-Based Swaps Rule: Clayton declined to give a specific timeline for the finalization of Title VII rules for securities-based swap dealers, and said they are working in coordination with the CFTC where possible. 

Witness

Opening Statements

Chairman Tom Graves (R-Ga.), Subcommittee on Financial Services and General Government

In his opening statement, Graves said it was an “exciting time” for the U.S. economy, noting that Congress has enacted tax reform, unemployment is at a 17-year low, millions of new jobs have been created, and small business optimism is at an “all-time high.” Graves noted, however, that there are still challenges, including the growing threat of cyber attacks and the necessity of keeping the markets open and fair for everyone, which contributes to the ability of businesses to secure capital to hire, invest, innovate, and deliver economic opportunities. Graves made particular mention of the Securities and Exchange Commission’s (SEC’s) recent proposal of Regulation Best Interest, saying that he looks forward to hearing more about it and how it will impact constituents across the country.

Ranking Member Mike Quigley (D-Ill.), Subcommittee on Financial Services and General Government

In his opening statement, Quigley highlighted that the SEC is responsible for promoting investor protection and education, as well as overseeing the capital markets. Quigley noted the SEC’s FY2019 budget request is a “negligible” increase to current base funding, but that it does not seek to bolster resources for enforcement staff. Quigley said that he is encouraged that the SEC is beginning to restore personnel following a hiring freeze, but there are still dozens fewer staff than when the freeze began, concluding that it is important the SEC is armed with the resources necessary to carry out its mission.

Testimony

The Honorable Jay Clayton, Chairman, Securities and Exchange Commission

In his testimony, Clayton said the SEC has made significant investments to further modernize the SEC’s cybersecurity infrastructure and monitor its risk profile. Clayton said that tens of millions of Americans invest in the U.S. securities markets, and serving the long-term interests of those investors also serves America’s interests at large. Clayton noted that the SEC has started to lift its hiring freeze and has so far had 100 new hires. Clayton then walked through the SEC’s top priorities, which included information technology (IT) and cyber modernizations, capital formation, enforcement, compliance and examinations, trading and markets, and leasing.

Clayton also noted that one important priority is protecting access to investments and opportunities for main street investors, pointing to the recently proposed Regulation Best Interest, which Clayton described as a “comprehensive package” designed to address retail investor confusion and potential harm regarding their relationships with investment professionals. Clayton said the regulation would “significantly enhance” retail investor protection while preserving access to investment services and products, both in terms of availability and cost.

Question & Answer

Regulation Best Interest

Graves asked for a more in-depth explanation of the newly proposed Regulation Best Interest. Clayton responded that there is no doubt that action is required in this area, and that coordination is required across regulators. Clayton continued that the duty an investment professional owes their client should match the client’s expectations, and a client should be able to understand that duty and the relationship. Clayton said that relationship should be governed by fiduciary principles, and that Regulation Best Interest will embody core fiduciary principles for broker-dealers. Clayton said the SEC recognizes the differences between an investment advisor and a broker-dealer and has sought to harmonize the duties owed by each.

Rep. Herrera Beutler (R-Wash.) noted that proposed Regulation Best Interest takes a tailored approach, taking into account the differences in business models between investment advisors and broker-dealers, and asked if the SEC intends to continue taking a tailored approach, to which Clayton responded that they will. Herrera Beutler also asked Clayton to expand on the issue of titling in the proposal and whether the SEC will issue guidance on what investment professionals should call themselves if not “advisors.” Clayton said it is an area he wants to hear public comments on, saying that titling and the relationship summary both attempt to address investor confusion, but he is open to hearing more ideas in this area. 

Cybersecurity

Rep. David Young (R-Iowa) asked if the SEC’s approach to cybersecurity is reactive or proactive and for a general update on the status of the SEC’s cybersecurity measures. Clayton responded that the SEC’s approach has been a mix of reactionary and proactive measures, including a comprehensive review to identify vulnerabilities. Clayton also said the SEC is reviewing what personal identifiable information (PII) it takes in,  eliminating the collection of PII where it is not necessary.

Rep. John Moolenaar (R-Mich.) asked what the SEC is doing to address cybersecurity risks and how it is collaborating with the private sector. Clayton said the SEC is looking at cybersecurity disclosures and is particularly looking at market utilities, inspecting those entities for their ability to deal with cyber attacks and risks. Clayton noted they are coordinating with other federal regulators, as well as many large financial institutions that have invested heavily in their cybersecurity and have been helpful in terms of risk assessment and on a more informal basis. 

Cryptocurrencies

Rep. Chris Stewart (R-Utah) asked about the role of cryptocurrencies as an economic utility and their proper regulation. Clayton said they undoubtedly have economic utility and “great promise,” and clarified there are different types of crypto assets: one is a replacement for currency, such as bitcoin, and tokens, which are treated as securities. Clayton continued that to the extent a crypto asset is a security, it should be regulated as a security in a disclosure-based regime. Clayton noted that most do not clearly present themselves as either a currency or a security, and this area has grown substantially “without the usual respect for the rule of law” that one would expect to see in financial markets. Clayton also noted that our laws did not anticipate cryptocurrencies, so those that do not operate like a security do not have a clear regulator like sovereign-backed currencies do. 

Securities-Based Swaps Rule

Young said that the SEC has yet to finalize the Title VII rules for securities-based swap dealers, which has led to uncertainty in the markets. Young asked for a timeline, and if the SEC is looking at what the Commodity Futures Trading Commission (CFTC) has done in their space to avoid duplicative requirements. Clayton declined to give a specific timeline, noting that he is happy SEC Commissioner Hester Peirce has agreed to oversee efforts to move forward with Title VII rulemaking. Clayton continued that they are working in coordination where possible and will continue to look to harmonize with the CFTC. 

SEC Enforcement

Quigley noted that 2017 saw a decline in enforcement actions and penalties assessed, asking for an explanation for what seems to be a “change in enforcement strategy.” Clayton explained that because the gestation period for most cases is 22-24 months, most of the current statistics were for cases that began before his tenure and reassured the subcommittee that there has been “no let-up” in enforcement and that the SEC continues to pursue “bad actors.” 

Diversity & Inclusion

Rep. Sanford Bishop (D-Ga.) asked what Clayton is doing to promote diversity and inclusion at the SEC and in the financial services industry. Clayton responded that internally at the SEC, they are doing well overall in minority representation but “could do better” at leadership levels. Clayton said that in terms of the entities the SEC regulates, he supports disclosures of material information, but does not see the role of the SEC to be micromanaging “social policy.”

For more information on this hearing, please click here.