It has been more than a year since Donald Trump’s surprise election. His nominee to lead the U.S. Securities and Exchange Commission, Jay Clayton, was confirmed by a vote of 61-37 in the full Senate, with several moderate Democrats joining Republicans in favor of his chairmanship. Clayton was sworn in as the 32nd chairman of the SEC on May 4, 2017, and has now been on the job for the better part of a year. Following are 10 issues to watch during the coming year at the SEC.
1. Full House
For the first time since 2015 — when Commissioners Daniel Gallagher and Luis Aguilar resigned their seats — the SEC will be operating with a full slate of five commissioners. Last month, the Senate confirmed two pending nominees. Hester Peirce, a Republican who worked for SEC Commissioner Paul Atkins and served on the Senate Banking Committee staff when Dodd-Frank was enacted, brings a wealth of experience and expertise to the commission. Similarly, Robert Jackson, a Democrat and Columbia law professor, has been a corporate policy expert who assisted the Treasury Department’s Troubled Asset Relief Program, or TARP, during the financial crisis. Peirce and Jackson will join sitting commissioners Michael Piwowar, a Republican and economist, and Kara Stein, a Democrat who worked on Capitol Hill before her appointment to the SEC in 2013. The full slate of five commissioners will bring a wider variety of views and perspectives to the agency, as Congress intended when it created the SEC in 1934. It also will make it easier for Clayton to meet the agency’s quorum requirements. While Clayton will seek consensus among all commissioners, partisan differences will divide them on certain issues.
2. Staff is Policy
Clayton has moved with deliberate speed to appoint a cast of competent and talented senior staff. With some exceptions, Clayton has hired experienced people from outside the SEC, rather than promoting from within, though a number of his senior staff previously served at the SEC. The role of division directors and other senior staff in how SEC regulations, policies, and programs are developed and implemented should not be underestimated.
3. New and Improved Reg Flex Agenda
The SEC’s semiannual agenda was published in December and is a dramatic departure from past practices. Frankly, the SEC’s so-called Reg Flex agenda (required by the Regulatory Flexibility Act of 1980) historically has been a long list that reveals little about what rules may or may not actually be considered. Clayton promised a much shorter — and accurate — near-term agenda that he expects will be completed during 2018. Items of interest to asset management firms on the new and improved short-term list include: (1) SEC rulemaking, in coordination with the U.S. Department of Labor, regarding standards of conduct for investment professionals; (2) reproposing rules for “plain vanilla” exchange-traded funds; (3) proposed rules to harmonize SEC and U.S. Commodity Futures Trading Commission derivatives rules; and (4) amendments to the Volcker Rule. There are two significant potential rulemakings that have fallen off the SEC’s rulemaking agenda: (1) the proposed business continuity and transition planning rule (withdrawn in September); and (2) potential rules requiring investment advisers to have third-party compliance reviews.
4. Treasury Reports
Trump issued an executive order on Feb. 3, 2017, directing the Treasury secretary to issue a report on laws and regulations that are inconsistent with seven “core principles.” The Treasury Department has issued three reports thus far: Banks and Credit Unions (June 12, 2017), Capital Markets (Oct. 2, 2017), and Asset Management and Insurance (Oct. 26, 2017). A final report will be forthcoming covering nonbank financial institutions, fintech and financial innovation. The Treasury Department also released a report on the Financial Stability Oversight Council on Nov. 17, 2017, as directed by a separate April 21 Trump memorandum, that sets the stage for favorable FSOC reforms. The Treasury’s asset management report is of particular interest to investment management firms. The recommendations include sensible regulatory actions that can and should be considered by the SEC, such as delaying and revising the liquidity rule, considering the adoption of an appropriate derivatives rule, adopting a plain-vanilla ETF process, withdrawing the proposed business continuity and transition planning rule, modernizing the delivery of mutual fund shareholder reports, and encouraging the SEC to take a leading role with the Financial Stability Board and the International Organisation of Securities Commissions in international issues. The report recommends the CFTC to exempt firms that are already registered with the SEC and encourages harmonization of reporting requirements by the SEC, CFTC and self-regulatory organizations. Finally, it recommends that the DOL should continue its examination of the fiduciary rule and that the SEC and DOL should work together to adopt consistent rules relating to standards of conduct for investment professionals to benefit all investors. These recommendations will find wide support among asset management firms and trade organizations. The Treasury Department should be applauded for its thoughtful and meaningful report. Indeed, the SEC’s Reg Flex agenda reflects consistency with many of the Treasury recommendations, and further regulatory actions may result down the line as a result of the Treasury reports.
Clayton has made it very clear that he considers cybersecurity to be one of the commission’s top priorities. The SEC’s 2016 EDGAR breach and the massive Equifax hack have heightened congressional and public attention on cyber issues. Clayton has promised thorough investigations by the agency’s inspector general, Enforcement Division and general counsel’s office regarding the EDGAR breach. Cybersecurity will continue to be one of the most important, resource-intensive and time-consuming issues that asset managers and others must deal with during the coming year and beyond. On the one hand, asset management firms must be cognizant of the SEC’s stated intent to ensure that all registrants take their cybersecurity obligations seriously. Given Clayton’s establishment of the SEC’s new Cyber Unit within the Enforcement Division, one question is whether the SEC will bring enforcement actions against firms for failing to take reasonable steps to mitigate potential cyberattacks, to protect sensitive client data and to notify clients when a breach occurs. Clayton has stated the SEC is focused on determining whether firms take appropriate action to inform investors after a breach has occurred and that the SEC will investigate firms that mislead investors about material cybersecurity risks or data breaches, emphasizing the need for more and better disclosure. This is an area where the SEC should be very cautious in pursuing any rulemaking that could impose inflexible requirements that may be outdated before they go into effect. And cybersecurity is not simply a matter of worrying about the SEC. It is a business imperative. Why would anyone want to deal with a firm if they have reason to believe that the firm is not taking proactive steps to avoid cyberattacks and to protect client information? This is an area where the technology and potential threats are escalating and changing rapidly and will require substantial, continuing, cooperative and dedicated efforts by both government agencies and the private sector.
6. Fiduciary Rulemaking
Clayton has stated that a standard of conduct rulemaking is one of his top regulatory priorities. Clayton and Labor Secretary Alexander Acosta have both pledged to work together on fiduciary rulemakings. There’s no reason to believe that the two agencies are not cooperating with each other. But the basic dilemma is that that the agencies operate under different statutory provisions. The DOL must follow the strict mandates of the Employee Retirement Income Security Act, while the SEC must follow the federal securities laws, including the complicated provisions of Section 913 of the Dodd-Frank Act. It’s ironic that members of Congress have chided the SEC for not taking the lead in harmonizing SEC and DOL conduct standards but fail to acknowledge the different statutory requirements of the two agencies. The next shoe to drop at the DOL will be the report ordered by Trump’s Feb. 3 executive order. Expect the report during the first quarter of 2018. It will outline changes DOL would like to see in its rule. An Administrative Procedure Act rulemaking will follow later in the year. Anticipate the SEC to also consider a proposed rulemaking during 2018. But the fact of the matter remains that, if this was easy, it would have been accomplished many years ago.
7. Enforcement/Inspection Priorities
Clayton’s predecessor, Mary Jo White, had a stated enforcement philosophy of “broken windows.” Clayton has a very different background from White, who came to the SEC as a former prosecutor. But he has clearly voiced his steadfast support to continue a strong and active enforcement program. His proposed 2018 budget will continue to devote 50 percent of the SEC’s resources toward enforcement. He has made two appointments — Steven Peikin and Stephanie Avakian — as co-directors of the Enforcement Division. He supports a continuation of a robust enforcement program, with an enhanced focus on cybersecurity and retail investor issues and all should be forewarned that enforcement actions in the retail and cyber areas should be expected going forward. Similarly, Clayton has expressed strong support for an effective inspection program. With respect to investment adviser examinations, Clayton has noted his intent to increase the examination rate for investment advisers in 2018 and beyond.
8. Industry Groups
The wide variety of trade groups representing asset management firms are also trying to influence the SEC’s agenda. Groups representing mutual funds, mutual fund directors, investment advisers, hedge funds and private equity firms have met with Clayton and submitted numerous regulatory proposals. The Investment Company Institute, for example, has suggested a delay and revisions to the 2016 liquidity rule, as well as supporting a properly tailored derivatives rule. The Investment Adviser Association has expressed support for a retrospective review of investment adviser rules. The Managed Funds Association has asked the SEC to ensure data security and treatment of confidential information. The American Investment Council has asked the SEC to abandon the business continuity/transition planning rule proposed last year and to revise the current pay-to-play rule. These examples are just the tip of the iceberg. These and other interest groups will continue to push for changes and it is certainly possible that some of those ideas could end up on the SEC’s agenda.
9. Potential Legislation
On Capitol Hill, it’s a tale of two houses. In June 2017, the House passed the sweeping Financial Choice Act on a strict party-line vote. Essentially, this is the anti-Dodd-Frank Act. Among many other things, it would repeal the Volcker rule, repeal private equity SEC registration requirements, repeal the authority of the FSOC to designate nonbank systemically important financial institutions, and repeal the Labor Department’s controversial fiduciary rule. There’s virtually no chance that the Senate is going to do anything similar. It is possible at some point that incremental legislation could gain bipartisan momentum in the Senate where 60 votes are required to get to a vote. But the bottom line is that, absent some external, unexpected event, it’s highly unlikely that Congress will enact significant asset management legislation anytime soon.
The SEC undoubtedly will be under some pressure to re-examine cryptocurrency issues during 2018. Last month, Clayton released a statement on cryptocurrencies and initial coin offerings, noting that the SEC has not yet approved any ICO application and emphasizing the risks that such offerings bear. But the recent launch of bitcoin futures under CFTC self-certification rules, along with hyper-intense interest in cryptocurrencies, has raised some expectations that the SEC may act in the future.*
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Clayton’s agenda is beginning to take shape, including regulations to enhance initial public offerings and other corporate governance issues, a focus on cybersecurity and retail investors, working with the Department of Labor on fiduciary regulations, considering numerous issues raised by reports from the Treasury Department, as well as considering proposals from numerous trade groups. In the interim, asset managers and other regulated entities need to continue to observe their legal, regulatory and compliance obligations while paying close attention as developments occur in the coming year.
*This article was updated to reflect the launch of bitcoin futures, following listing approval from the CFTC at the time of writing.
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