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Securities and Exchange Commission Investor Advisory Committee Meeting

Securities and Exchange Commission

Investor Advisory Committee Meeting

Thursday, September 19, 2019

Discussion Panels

Opening Statements

Commissioner Hester M. Peirce

In her opening statement, Peirce expressed her appreciation for the development of better disclosures. She stated that with the progression of new technology, the Securities and Exchange Commission (SEC) could adjust rules. Peirce added that she would appreciate advice for areas the SEC can adapt or make flexible to achieve the goal for investors to be able to obtain necessary information.

Commissioner Allison Herren Lee

In her opening statement, Lee echoed her appreciation regarding the discussion of disclosures, adding the importance of correctly making rules on disclosures. She noted the importance of the effects of content for effective disclosure. Lee also applauded the discussion regarding related SEC regulatory implications and the timeliness of the discussion.

Panel I: Discussion Regarding Methods to Develop Better Disclosures for Investors

Panel Presentation

Brenda J. Cude, Professor, Department of Financial Planning, Housing and Consumer Economics, University of Georgia, highlighted six significant areas to address: 1) to structure disclosures with consumer empowerment in mind; 2) the effectiveness of disclosures; 3) disclosure designs require expertise guidance to be more effective; 4) disclosures should be easy to evaluate based on reading levels; 5) the timing of providing disclosures is important; and 6) the effectiveness increases with increased knowledge. She added that disclosures are less likely to be accepted when transactions are more complex.

Billy Kingsland, Group Director, Brand Communication, Siegel + Gale, suggested that disclosures are made more effective through information design, simplicity, and consumer interactions. He stated that disclosures should be “clear, useful and beautiful.” Kingsland added that disclosures should fit an intended purpose and be built to be interactive. He added that complexities waste time and money, while simplicity helps increase trust and brand loyalty as well as save operational costs, specifically for financial institutions. Kingsland expressed that disclosures have become more intimate and personal for consumers. Kingsland suggested that the SEC consider tailoring compliance and cross-market pollination in their approach. He added the need to ask if the disclosure is accomplishing the intended goal and consider how it makes the user feel.

Dan Silverman, Rondthaler Professor of Economics, Arizona State University, Research Associate, NBER, stated that regulators need to consider whether the basic model for how disclosures are designed is still optimal. He said that the most optimal design for disclosures balances the costs and the amount of information disclosed. Silverman noted that with technology advancements, disclosures have become cheaper and the “free disposal” of information has become a regular occurrence, which has led to consumers ignoring the provided information. Silverman referenced disclosure designs implemented for new products such as target-date funds or age-based 529 accounts and recommended that the SEC consider the aim of these disclosures for specific groups.

Yuhgo Yamaguchi, VP, Design Strategy, Fidelity Labs, Fidelity Investments, said that Fidelity aims to increase their customer satisfaction by providing information with a focus on making effective technological, social and cultural changes. He expressed that expectations should be rising to meet the needs of customers, to account for what people understand, need and value and how to best articulate disclosure designs.

Question & Answer

Barbara Roper, Investor Advisory Committee, asked if technology enables the SEC to rethink their approach of using paper-based disclosures and potential advantages and challenges. Yamaguchi responded that electronic disclosures provide better delivery timeliness, the ability for visually impaired individuals to adjust readability settings and make searchability easier. Kingsland recommended that the SEC create a design based on the needs of customers combined with the expertise and distillation of companies, as disclosures should not overload information. Silverman responded that the natural conclusion would be to offer a variety of forms, but added that tailoring could lead to complexity.

Roper also asked about the possibility of using layering in disclosures. Cude stated that readily available information is useful. Yamaguchi added that it is essential to have “bite-sized” pieces of information for customers to process. He also said that the layered journey does not have to be binary, and there are ways to organize documents in a helpful layered approach.

Susan F. Wyderko, Investor Advisory Committee, asked what the best approaches are for regulators mandating disclosures. Cude recommended asking consumers for their feedback to pare down the length of information included in disclosures. Yamaguchi recommended designing disclosures that are tailored to different audience levels.

Jennifer Marietta-Westberg, Investor Advisory Committee, asked about key takeaways to consider in finalizing a decision. Yamaguchi stated that Fidelity continuously measures impacts on consumers’ decision making, which helps prevent the company from guessing consumer needs. Kingsland responded that setting key performance indicators (KPIs), benchmarks to test against, and determining what is being measured are important factors. He also stated that testing disclosures while they are in the market is helpful.

Heidi Stam, Investor Advisory Committee, asked about the dangers of mandating specific disclosures and creating a one size fits all system. Cude responded that companies need a template and specific language to follow that they can fill in and modify. Silverman stated that reinventing the wheel would be wasteful and costly. He recommended refining and standardizing existing forms.

J.W. Verret, Investor Advisory Committee, recommended that the panel “give up” on 10K and 10Q disclosures and focus their efforts on simplifying merger and acquisition (M&A) disclosures.

Jerome Solomon, Investor Advisory Committee asked about ways to ensure people reading disclosures are getting the right information. Silverman answered that getting people to read necessary information is difficult. Yamaguchi said that layered disclosures are a powerful tool that can drive information comprehension. Cude noted that the timing of providing disclosures is critical.

Lydia Mashburn, Investor Advisory Committee, recommended that the SEC implement research, design and testing tools in the process. Roper responded that she would love to see this be systematically incorporated. Rick Fleming, Investor Advisory Committee and Kingsland encouraged making this a baseline process at the SEC.

Panel II: Discussion Regarding Increased Leverage and Related SEC Regulatory Implications

Panel Presentation

Elisabeth de Fontenay, Professor of Law, Duke University, stated that the U.S. loan market has evolved into a large and liquid market, with potential areas of risk that could lead to significant losses in a downturn. She said that traditional bank loans, built on long term relationships and extensive monitoring until maturity, have evolved to mirror corporate bonds. De Fontenay noted the repeal of the Glass Steagall Act and the Basel II framework led to the erosion of traditional banking and credited the demand for loan syndication secondary trading. De Fontenay believes that leveraged loans and collateralized loan obligations (CLOs) low default rates and high recovery rates, with low levels of risk, are misleading. She recommended that the SEC consider investigating the decline in underwriting standards and other misleading averages for CLOs.  De Fontenay added that covenant-lite loans are a growing loan, with no proper mechanisms in place to measure their default risks. She expressed her belief that the low interest rates and possibly overheating economy have to be corrected by the Federal Reserve (Fed), not the SEC. De Fontenay said she is skeptical of how much authority the SEC has in this area, and does not believe additional disclosure requirements would have much of an effect.

Erik F. Gerding, Professor of Law & Wolf-Nichol Fellow, University of Colorado Law School, suggested disruptions to the market can occur at either side of the pipeline. He said that often underlying assets of leveraged loans are monitored, and recommended the SEC consider monitoring underwriting standards and the rise of convent lite loans. Gerding also expressed concern about demand for CLOs and said that if demand were to dry up, or if selling stopped, warehouse risk could materialize and the market could freeze. Gerding said this would lead to the materialization of liquidity risks. He expressed skepticism of CLO tranches liquidity, due to the lack of reporting of the depth of liquidity in leveraged loan markets. Gerding said the dealer-focused market is primitive because of their opaqueness and impaired price discovery. He said the lack of price and liquidity could make exiting the leveraged loan market easy and freeze the market. Gerding recommended the SEC consider who is purchasing CLOs and what are the risks of CLOs. He stated that regulatory capital arbitrage is an area to be concerned about, due to the ability for risk to be stuffed in asset-backed securities. He recommended the SEC study regulatory capital arbitrage, the behavior of fire sales, utilize disclosure tools, not expand CLO exemptions, and collaborate with other regulators.

Andrew O’Brien, Head of Global Loan Capital Strategy, Managing Director, JPMorgan, stated that leveraged loans are based on floating rates, typically on the London Interbank Offered Rate (LIBOR), and used to entirely be held by banks. He noted that CLOs are the largest component of the leveraged loan market, and managers perform due diligence in the creation and crediting the loans. He stated that leveraged loans are something that should be monitored in the current market, although the average transaction levels have not hit pre-crisis numbers. O’Brien said the markets are more disciplined now, and there are better average liquidity checks in place as well as primary commitment calendars. He said the committed calendar has not been exacerbated over $100 billion since the crisis, and the at-risk calendar is at $150 billion. O’Brien said the current loan market is functioning, and mark to market CLO’s do not exist anymore.

George S. Oldfield, Principal Emeritus, The Brattle Group, said the structured securitized yields have revolutionized in capital markets. He stated that corporate credits have helped the market expand and made borrowing and spending more manageable. Oldfield added that the markets moving into such a regime resembles the markets of the early 2000s. He recommended monitoring CLOs for due diligence and quality. Oldfield also recommended the SEC consider looking into the processes of credit rating agencies and their tranches, and whether competition is playing the right role in the market.

Question & Answer

Solomon asked the panel about areas of concerns regarding CLOs, how the SEC should regulate them, and the default rates of covenant-lite loans. O’Brien said that the CLO market is not as deep as it once was and that rating agencies use a variety of tests to measure CLO risk. Gerding stated that it depends on whether leveraged loans are considered securities. He added that the health information of covenant-lite loans is a critical issue that should be investigated by the SEC. Oldfield said that he does not believe the SEC has the resources to regulate loans.

Solomon also asked about risk implications and stress testing. De Fontenay said testing the market as a whole makes sense to understand how each market impacts the others. Oldfield recommended that regulators consider whether their job is to remove risk from the markets and that a lot of time would be spent to accomplish this goal. Gerding added that certain risks are unacceptable and that regulators should consider the whole picture and big shocks to the economy.

Mina Nguyen asked about disparities in arbitrage, standardizing disclosure, and driving factors for competition. Gerding answered that there still is not a solution for addressing rating agencies and that enhanced competition does not necessarily work as intended. He also said he would not advocate for too much disclosure, but rather for banks to consider utilizing multiple rating agencies and spreading credit default. De Fontenay said the AAA ratings are important, and she believes there was collusion pre-crisis for AAA ratings to tranches. She recommended the need for independent mechanisms to monitor for risk.

Mashburn asked if the banking regulatory structure is causing the development of new instruments, and if revisiting the structure should occur. Gerding said that banking capital regulations and the Basel accords have led to these new instruments, such as regulatory capital arbitrage.

Marietta-Westberg asked about the potential of regulatory coordination. Gerding said that he is a proponent for data collection and research before any regulation. He stated that regulatory coordination would help to address authority and regulation gaps and help map out a plan for regulators to determine and address the gaps.

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