In a much talked about speech to the Economic Club of New York on July 12, 2017, SEC Chairman Jay Clayton set forth his thoughts on SEC policy, including a list of guiding principles for his tenure. Chair Clayton’s underlying theme is the furtherance of opportunities and protection of Main Street investors, a welcome viewpoint from the securities markets’ top regulator. This was Chair Clayton’s first public speech in his new role and follows Commissioner Michael Piwowar’s recent remarks to the SEC-NYU Dialogue on Securities Market Regulation largely related to the U.S. IPO market. For a summary of Commissioner Piwowar’s speech, read HERE.
Chair Clayton outlined a list of eight guiding principles for the SEC.
#1: The SEC’s Mission is its touchstone
As described by Chair Clayton, the SEC has a three part mission: (i) to protect investors; (ii) to maintain fair, orderly and efficient markets, and (iii) to facilitate capital formation. Chair Clayton stresses that it is important to give each part of the three-part mission equal priority. For more information on the role and purpose of the SEC, see HERE.
#2: SEC Analysis Starts and ends with the long-term interests of the Main Street investor
According to Clayton, an assessment of whether the SEC is being true to its three-part mission requires an analysis of the long-term interests of the Main Street investors, including individual retirement accounts. This involves reviewing actions in light of the impact on investment opportunities, benefits and disclosure information for “Mr. and Mrs. 401(k).”
#3: The SEC’s historic approach to regulation is sound
As I’ve written about many times, disclosure and materiality have been at the center of the SEC’s historic regulatory approach. Chair Clayton reiterates that point. The SEC does not conduct merit reviews of filings and registration statements but rather focuses on whether the disclosures provided by a company provide potential investors and the marketplace with the information necessary to make an informed investment decision. For more information on disclosure requirements and recent initiatives, see HERE and HERE.
In addition to disclosure rules, the SEC places heightened responsibility on the individuals and people that actively participate in the securities markets. The SEC has made it a priority to review and pursue enforcement actions, where appropriate, against securities exchanges, clearing agencies, broker-dealers and investment advisors. In that regard, the SEC has historically and will continue to enforce antifraud provisions. Clayton states that “wholesale changes to the Commissions’ fundamental regulatory approach would not make sense.”
#4: Regulatory actions drive change, and change can have lasting effects
Under the fourth principle, Clayton continues to speak of the benefits of the disclosure-based system for public company capital markets. However, he does note that over time, new disclosure rules have been added on to the old, based on determinations beyond materiality, and that the SEC now needs to conduct a cumulative and not just incremental view of the disclosure rules and regulations.
Clayton specifically points to the much talked about decline in the number of IPO’s over the last two decades. He also points out that the median word count for SEC filings has more than doubled in over the same period, and that reports lack readability. Clayton points out, and I agree, that fewer small and medium-sized public companies affects the liquidity and trading for all public companies in that size range. A reduction of U.S. listed public companies is a serious issue for the U.S. economy and an improvement in this regard is a clear priority to the SEC.
For more on the SEC’s ongoing Disclosure Effectiveness program, see the further reading section at the end of this blog.
#5: As markets evolve, so must the SEC
Technology and innovation are constantly disrupting the way in which markets work and investors transact. Chair Clayton is well aware that the SEC must keep up with these changes and “strive to ensure that our rules and operations reflect the realities of our capital markets.” Clayton sees this as an opportunity to make improvements and efficiencies.
The SEC itself has utilized technology to improve its own systems, including through the use of algorithms and analytics to detect companies and individuals engaged in suspicious behavior. The SEC is adapting machine learning and artificial intelligence to new functions, including analyzing regulatory filings. On the other side, the SEC has to be aware of the costs involved with implementing these changes, versus the benefits derived.
#6: Effective rulemaking does not end with rule adoption
The SEC has developed robust processes for obtaining public input (comments) and performing economic analysis related to its rulemaking. Clayton is committed to ensuring that the SEC perform rigorous economic analysis in both the proposed and adoption stages of new rules. Clayton is aware of the principle of unintended consequences in rulemaking and is committed to ensuring that rules be reviewed retrospectively as well. Clayton states, “[W]e should listen to investors and others about where rules are, or are not, functioning as intended.”
Although Clayton does not get into specifics, certainly changes are necessary in the disclosure requirements, fiduciary rule, Dodd-Frank rollbacks (see HERE on the Financial Choice Act 2.0); finders’ fees (see HERE for more), eligibility for Regulation A+ (see HERE for more), and small business-venture capital marketplace.
#7: The costs of a rule now often include the cost of demonstrating compliance
Clayton states, “[R]ules are meant to be followed, and the public depends on regulators to make sure that happens. It is incumbent on the Commission to write rules so that those subject to them can ascertain how to comply and — now more than ever — how to demonstrate that compliance.” Vaguely worded rules end up with subpar compliance and enforcement. Clayton refers to the officer and director certifications required by the Sarbanes-Oxley Act and the need to create a system of internal controls to support the ultimate words on the paper – which system can be hugely expensive.
I note that understanding rules and their application is one of the biggest hurdles in the small-cap industry, including where responsibility lies vis-à-vis different participants in the marketplace. For example, the responsibility of a company, transfer agent, introducing broker, and clearing broker in the chain of the issuance and ultimate trading of a security, continues to provide challenges for all participants. Often participants are left with an education and interpretation by enforcement process, rather than what would be a much more efficient system providing participants with the knowledge and tools to create compliance systems that prevent fraud and related issues and reduce the need for retrospective enforcement.
#8: Coordination is key
Clayton notes that “the SEC shares the financial services space with many other regulatory players charged with overseeing related or overlapping industries and market participants.” There are more than 15 U.S. federal regulatory bodies and over 50 state and territory regulators, plus the Department of Justice, state attorneys general, self-regulatory organizations (SRO – such as FINRA) and non-SRO standard-setting entities (for example, DTC) in the financial services sector. In addition, the SEC works with international regulators and markets cooperating with over 115 foreign jurisdictions.
Clayton specifically points to the regulations of over-the-counter derivatives – including security-based swaps for which the SEC shares regulatory functions with the CFTC (for more on this, see HERE). Clayton is committed to working with the CFTC to improve this particular area of financial regulation and reduce unnecessary complexity and costs.
In addition, cybersecurity is an important area requiring regulatory coordination. Information sharing is essential to address potential and respond to actual cyber threats.
Putting Principles into Practice
After laying out his eight principles for the SEC, Chair Clayton addressed some specific areas of SEC policy.
Enforcement and Examinations
Clayton is committed to deploying significant resources to enforcement against fraud and shady practices in areas where Main Street investors are most exposed, including affinity and micro-cap fraud. He indicates that the SEC is taking further steps to find and eliminate pump-and-dump scammers, those that victimize retirees, and cyber criminals. As a practitioner in the small- and micro-cap market space, I welcome and look forward to initiatives that work to reduce fraud, while still supporting the honest participants and the necessary small-business ecosystem.
Clayton also recognizes that the markets also have more sophisticated issues requiring enforcement attention related to market participants. The SEC is “committed to making our markets s fair, orderly, and efficient – and as liquid – as possible.” Although prior Commissioners and Chairs have made similar statements, the addition of “and as liquid” by this regime continues to illustrate a commitment to supporting business growth and not just enforcement.
Finally on this topic, Clayton stresses the importance of cybersecurity in today’s marketplace. Public companies have an obligation to disclose material information about cyber risks and cyber events (see HERE for more on this topic). However, cyber criminals, including entire nations, can have resources far beyond a single company, and companies should not be punished for being a victim where they are being responsible in face of cyber threats. To bring proportionality to the topic, Clayton points out that cyber threats go beyond capital markets but affect national security as well.
Consistent with his pro-business attitude, Jay Clayton advocates enhancing the ability of “every American to participate in investment opportunities, including through public markets.” Of course, the flip side is the ability for businesses to raise money to grow and create jobs. Clayton is also consistent with the message that he and other Commissioners have been relaying that the U.S. public markets need to grow and become more attractive to businesses (without damaging the private marketplace).
As a first step, the SEC recently expanded the ability to file confidential registration statements for all Section 12(b) Exchange Act registration statements, initial public offerings (IPO’s) and for secondary or follow-on offerings made in the first year after a company becomes publicly reporting, to all companies. Previously only emerging growth companies (EGC’s) were allowed to file registration statements confidentially. For more on this, see my blog HERE. Clayton believes that allowing companies to submit sensitive information on a non-public basis for initial staff review, will make the going public process more attractive to earlier-stage entities.
As a last point on capital formation, Chair Clayton encourages companies to request waivers or modifications to the financial reporting requirements under Regulation S-X, where the particular disclosure or reporting is overly burdensome and not material to the total mix of information presented to investors.
Clayton suggests shifting the focus of the conversation on market structure to actions. He recommends proceeding with a pilot program to test how adjustments to the access fee cap under Rule 610 of the Securities Exchange Act of 1934 would affect equities trading. The pilot would provide the SEC with more data to assess the effects of access fees and rebates on market makers, pricing and liquidity. Clayton is open to that and further suggestions from the SEC’s Equity Market Structure Advisory Committee.
Clayton believes the SEC should broaden its review of market structure to also include the fixed-income markets, to provide stable investment options for retirees. In that regard the SEC is creating a Fixed Income Market Structure Advisory Committee.
Investment Advice and Disclosure to Investors
Chair Clayton addresses both the fiduciary rule and improving disclosures to investors. Related to the fiduciary rule, Clayton states that it is important for the SEC to bring clarity and consistency to the area. In that regard, in June the SEC issued a statement seeking public input and comment on standards of conduct for investment advisers and broker-dealers.
Related to disclosures, as with all other areas of disclosure, investment advisors must provide potential investors with easily accessible and meaningful information. Clayton refers to the SEC’s ongoing Disclosure Effectiveness initiative, the progress in which is summarized at the end of this blog.
Resources to Educate Investors
A priority for the SEC is to provide more information to investors through technology and other means.
Further Reading on Disclosure Effectiveness Initiative
I have been keeping an ongoing summary of the SEC’s ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes. I note that we have not seen any regulatory changes since the election and new regime at the SEC, but certainly significant changes are expected in light of Chair Clayton’s, and the Commissioners’, publicly disclosed priorities.
On August 31, 2016, the SEC issued proposed amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The proposed amendments would require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the proposed amendment would also require that all exhibits be filed in HTML format. See my blog HERE on the Item 601 proposed changes.
On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE.
On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE.
That proposed rule change and request for comments followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept Release HERE and HERE.
As part of the same initiative, on June 27, 2016, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The SEC also previously issued a release related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates. See my blog HERE.
As part of the ongoing Disclosure Effectiveness Initiative, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the reporting requirements in general, see my blog HERE.
In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.
In early December 2015 the FAST Act was passed into law. The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging-growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K. The current Regulation S-K and S-X Amendments are part of this initiative. In addition, the SEC is required to conduct a study within one year on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information. See my blog HERE.
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