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SEC Investor Advisory Committee Meeting

Securities and Exchange Commission

Investor Advisory Committee Meeting

Thursday, September 9, 2021

 

Panel Discussion: Reimagining Investor Protection in a Digital World: The Behavioral Design of Online Trading Platforms
Moderators: Elissa Germaine, Executive Director, John Jay Legal Services; and Paul Sommerstad, Partner, Cerity Partners

Panelists

  • Stephen Hall, Legal Director and Securities Specialist, Better Markets
  • Daniel P. Egan, Director of Behavioral Finance and Investing, Betterment
  • Punam Anand Keller, PhD, Charles Henry Jones Third Century Professor of Management
  • Steve Shu, PhD, Managing Principal, Digital Nudging Tech

Hall focused on the investor advocates perspective and explained how modern platforms are driven by profit, not the interests of investors, and maximizing trading volume, not democratizing finance. He added that some of these platforms are making recommendations within the meaning of the Regulation Best Interest rule (Reg BI). He stated that while Reg BI was a disappointment to investor advocates, it should be used to make sure platforms act in investors’ best interest. He said that platforms use features designed to bombard investors with signals to trade without regard to financial health, criticized payment for order flow, and provided an example from Massachusetts about the consequences of gamification.

Egan discussed how advisors benefit when their clients succeed financially and want to advise in a way that makes investors comfortable with recommending them to friends and family. He added that designers of trading platform applications underestimate how much they influence investor clients. He said that designers make decisions like color, numbers, and different signals to communicate market changes for investors. He also discussed the tax implications of capital gains and lack of client knowledge about those tax implications and how designers can provide that information to investors. He said that while we should be wary of how trading platform apps are designed, we should avoid regulating specific design and should encourage pro-consumer innovation and added that designers should keep investor interests in mind when they design and make sure advisor success tracks with client success.

Keller discussed behavior change and marketing perspective and addressed why certain marketing tactics result in less than prudent investing and how to overcome those challenges. She also highlighted what communications tactics we can use to preserve the benefits of access to investment while ensuring responsible investing. She also discussed ways that online trading platform marketing is misleading and why online platforms may be deceptive. Keller concluded that opportunities exist to help investors participate in the market and make more responsible decisions.

Shu discussed capabilities and confidence, heterogeneity, behavioral context regarding different levels of confidence and confirmation bias, and behavioral research showing that people “go off path” and how online platforms might benefit from incorporating ideas from “lane keeping” technology and the like (e.g., behavioral blind spot detectors). He also addressed how to reimagine investor protections through a strategy and planning phase, hypothesis development and solution ideation, and research and testing.

Question and Answer
Reg BI
Rick Fleming asked Hall for a recommendation on how to brighten the line between solicited and unsolicited recommendation in the context of Reg BI. Hall conceded this is a challenging area but that a facts-and-circumstances analysis is required, and Reg BI takes this into account. He added that the distinction is not impossible to navigate.

Pros and Cons of Online Trading Platforms
Marietta-Westberg asked what research has been done on the benefits of online trading platforms and whether current research is being posted online for replication. No panelist addressed posting of research online, but Keller said there is not a lot of data on the cost and benefits of online trading platforms, other than anecdotal data. Egan said existing studies show that it takes time for investors to recognize loss or risk in investing because of the noise in that environment. Paul Mahoney asked how many of the issues identified by the panel are specific to online platforms and if we should only be talking about gamification. Hall said he would not limit the analysis to gamification but would expand it to any online features that amount to recommendations or advice even if not labeled as such. Jamila Abston asked about inclusion and access in the trading industry. Hall responded that online platform technology can be used to improve access without using predatory tactics. He added that investor education is a wonderful tool, and that technology can make trading more accessible.

Recommendations
Heidi Stam asked what the framework should be for investor protection. Shu suggested education, leaning toward regulatory guidance, and possibly additional disclosure. Shu said regulation to address predatory practices should be considered, and he observed that the SEC is doing what they need to do in this space and is facing unique challenges with innovations in technology. Hall stated that it is virtually impossible to do effective cost benefit analysis, so the regulatory approach should not necessitate that kind of analysis. Ted Daniels asked if there should be educational protocols on online platforms before trades are executed. Shu responded that education makes sense in the onboarding process and as good practice, but not necessarily as regulation or guidance. Egan said trading education should be outcome oriented.

Panel Discussion Regarding Competition and Regulatory Reform at the PCAOB
Moderator: JW Verret, Associate Professor, Antonin Scalia Law School

Panelists

  • Wes Bricker, Vice Chairman, PWC Americas, and former Chief Accountant at the SEC
  • Colleen Honigsberg, PhD, Professor of Accounting, Stanford Law School
  • Sara Lord, Chief Auditor, RSM
  • Alistair Thompson, Director of Remedies, Business and Financial Analysis, United Kingdom Competition and Markets Authority
  • Lynn Turner, Senior Advisor, Hemming | Morse, and former Chief Accountant at the SEC

Thompson discussed findings from their report and explained their main concerns, which were 1) low quality, as it is difficult to measure audit quality, and the persistent failure to meet regulator benchmarks for audits, and 2) persistent high concentration and cost in the market. Issues they found were 1) that firms have a perceived lack in choice of auditors, 2) the criteria used to select auditors were not driven by quality and challenge, and 3) certain incentives resulting from audit-firm structure. His main two recommendations were 1) required joint audits and peer review and 2) creation of an operational split between audit and non-audit services to give a greater focus on audit quality.

Honigsberg began with explaining that restatements have declined over the past fifteen years (despite the recent uptick due to SPACs), and they found many characteristics of audits that make people nervous, such as PCAOB inspections deficiency rates, litigation risks, and competition. They found that audit firms are not being punished for poor inspections due to competition in the marketplace. Most of the solutions she discussed are to address the fact that audits are a credence good (difficult to determine the quality of the audit). Recommendations included 1) changing the format of the audit report to be more customized to the company like a credit report, 2) increased disclosures by the PCAOB and have regulators that grade audit firms along a curve, 3) disclosure of audit quality indicators to equip audit committees with metrics, 4) allow for limited access to audit work papers to the public, 5) provide shareholders the ability to select or remove the auditor, 6) change the objective of the audit away from strictly compliance with GAAP, and 7) make external audits optional.

Turner began discussing findings from a competition perspective and said they found that the Big Four were making a significant amount of compensation, which creates an oligopoly for audit firms. He said not much can be done on competition unless fundamental changes are made by the government. He then turned to the audit quality issue and said this discussion of quality indicators has gained no movement in the past decade. Turner said the main takeaway from his whitepaper is to change the culture in the firms so that they view investors as the ultimate client, not the management team. He also touched on the idea to give investors more power by getting rid of the government mandate for an auditor, leaving it up to investors to decide if they want an independent audit or not.

Bricker highlighted a few key points that PWC is grounded by: trust in quality of information is necessary; trust is earned by delivering on promises; it is crucial to be selected, overseen, by independent audit committees and address their audit reports to both the board and stockholders; and as the world continues to evolve, they must continue to challenge how trust is earned and how employees and investors are valued. He supported the discussion of how to indicate and measure data about audit quality but said disclosures are only useful when the investors have expertise to understand the material. He suggested having a user guide as a solution for investors to better understand the information and increase transparency around audit quality.

Question & Answer
Audit Quality Indicators
Verret asked about audit quality indicators (AQI) and the initiatives firms have undertaken, if they are on an issuer specific basis and getting to audit committees, and then what level of that information needs to go to the investing public. Bricker first touched on the audit committee question and said the commission staff did a concept release that works towards those issues and focuses on how audit committees provide information to investors about their selection, oversight, and compensation responsibilities. He said the committees routinely ask for AQIs that are relevant to the engagement. Lord also said the audit committees ask for different information, arguing it is not homogeneous across every engagement. To the metrics question, Bricker said a starting point requires a common view or regulator baseline of operational measures (i.e. the definition of “staff”).

Restatements as Revisions
Jennifer Westberg asked about declining restatements, the idea that some of them may be masquerading as revisions, and if there needs to be a focus on this issue. Honigsberg said the SEC should be looking into the issue of restatements being masked as revisions.

Audit Fees and Incentives
Brian Hellmer asked about audit fees being a small percentage of the firms’ overall revenue stream and said there are worries about the incentive structure. Bricker discussed how the SEC’s rules deal with incentives differently than other jurisdictions. Turner said investors tend to look at the percentage of revenues a firm gets from consulting (but that it is not a test of is the firm’s independence) and that the audit fee itself is never big enough to matter.

Non-Competes
Verret mentioned that the PCAOB has authority to look at competition issues and asked about the role of non-compete agreements for large accounting firms, stating there is general bipartisan interest for non-competes. Thompson said they view this as a barrier for growing challenges and that a non-compete would making a “switching cost” very large.

Draft Recommendation of the Investor-as-Purchaser and Investor-as-Owner Subcommittees on SPACs
Christopher Mirabile explained the Subcommittees’ offer for “preliminary” recommendations to focus on the challenges SPAC investors face in assessing risks and opportunities, as well as looking at the role of sponsors, inherent conflicts of interest, guardrails around target companies, and preparedness of target companies. The subcommittee suggests that the SEC consider requiring “a standardized disclosure of the sponsor’s total investment in the transaction; the value of the sponsor’s interest if the proposed merger closes including all management and promoter fees; and the break-even post-merger price for the sponsor.” They also said it should be clear to investors that the sponsor has an interest in completing a transaction even if this might not benefit the remaining investors after the de-SPAC. They said the Recommendation was circulated this Summer for comment, and the final draft was circulated to the Committee in preparation for this meeting.

Sandra Peters said it is important for the Commission to look at the details of this draft and said a lot of people are redeeming at the de-SPAC in recent months and doing an IPO through an S-4 (merger process) with no underwriter due diligence. She agreed with Commissioner Lee’s comments for further recommendations. Leslie Van Buskirk said she supports the Recommendation and hopes the SEC will treat this as a floor, not a ceiling, in crafting the regulatory framework for SPACs. Rick Fleming underscored that the Commission has taken important steps already to protect investors and said he hopes this Recommendation is not seen as a criticism of what efforts have been made thus far.

The Committee voted unanimously in support of the Recommendation.

Draft Recommendation of the Investor-as-Owner Subcommittee on 10b5-1 Plans
Cambria Allen-Ratzlaff summarized the SEC Investor Advisory Committee’s June meeting about 10b5-1 plans and solicited questions about the plan. Paul Mahoney asked for clarification on whether the SEC will view changes to rule 10b5-1 as a vehicle to put additional restrictions on issuer stock purchases beyond what is in existing law. Mirabile said that a footnote will be in the final draft, explaining that the proposal does not cover corporate transactions, just 10b5-1 individual, personal plans. Allen-Ratzlaff stated that the Recommendation does cover all 10b5-1 plans but does not address buybacks in particular. Mahoney said that the final draft would not apply to issuer purchase transactions. Allen-Ratzlaff said the committee could add a footnote saying that the Recommendation does not impact anything related to share buybacks.

The Committee voted unanimously, with two committee members not present, in favor of the final Recommendation subject to having a chance to review the final footnote.

Subcommittee Reports
The Investor-as-Owner Subcommittee said they have been mostly focused on the two Recommendations for this meeting on SPACs and 10b5-1, but moving forward, they will be looking at ethical artificial intelligence and looking more into framing additional recommendations around the needs of institutional investors.

The Investor-as-Purchaser Subcommittee said moving forward they are looking at the issue of investment apps and trading platforms.

The Market Structure Subcommittee said they will be working on conflicts of interest and payment for order flow, and they are interested in urging the SEC to link this issue with gamification rather than treating them separately.

For more information on this hearing, please click here.