HFSC SEC Oversight Hearing

House Financial Services Committee

“Oversight of the U.S. Securities and Exchange Commission: Wall Street’s Cop Is Finally Back on the Beat”

Tuesday, October 5, 2021

Witnesses

• The Honorable Gary Gensler, Chair, Securities and Exchange Commission

Opening Statements
Chairwoman Maxine Waters (D-Calif.)
In her opening statement, Waters decried what she characterized as President Trump’s legacy of deregulation and investor harm and listed actions she disapproved of from the past administration and how they favored multibillion dollar companies, did nothing to promote ESG disclosure, saw SEC staff cuts, and reduced enforcement. She added that current rules are stacked against new entrants to securities markets and expressed concern for the lack of regulation in the cryptocurrency market. She concluded by explaining the Committee’s continued investigation into the GameStop issue and risk to the market posed by reaching the debt limit.

Ranking Member Patrick McHenry (R-N.C.)
In his opening statement, McHenry highlighted what he characterized as troubling social media posts by Gensler on digital assets and expressed concern about how Gensler will regulate the digital asset space and if the law is on Gensler’s side on that issue, adding that Congress should intervene. He concluded by discussing his Clarity for Digital Tokens Act of 2021 to help bring legal certainty to digital asset projects that regulatory clarity is needed to launch.

Rep. Brad Sherman (D-Calif.)
In his opening statement, Sherman discussed the Facebook whistleblower and expressed hope that Gensler would give her disclosures full consideration.

Rep. Bill Huizenga (R-Mich.)
In his opening statement, Huizenga discussed Gensler’s tweets on disclosure requirements and expressed disagreement with his remarks, adding that the SEC should not be involved in ESG disclosure.

Testimony
The Honorable Gary Gensler, Chair, Securities and Exchange Commission
In his testimony, Gensler touched on three main areas of focus for the SEC. First, regarding market structure and capital formation, he has asked staff to look at five projects across capital markets: the Treasury market, non-Treasury fixed income markets, equity markets, and security-based swaps. The second issue he flagged is rapid changes in technology, focusing mostly on data analytics and crypto assets. Gensler said there is currently not enough investor protection in crypto finance, issuance, trading, or lending, and called it the “Wild West” or “buyer beware” that existed before the securities laws were enacted. He said this asset class is rife with fraud, scams, and abuse in certain applications and asked SEC staff to work with fellow regulators along two tracks: how to work with other financial regulators under current authorities to best bring investor protection to these markets, and what gaps exist that Congress can help the SEC fill. The final area of focus Gensler flagged was issuer disclosure, and he said today’s investors are looking for consistent, comparable, and decision-useful disclosures around climate risk, human capital, and cybersecurity. He has asked staff to develop proposals for the Commission’s consideration on these potential disclosures, and they will be put out to public comment for what information matters most to investors. Finally, Gensler said the Public Company Accounting Oversight Board (PCAOB) adopted a rule to fulfill its obligations under the Holding Foreign Companies Accountable (HFCA) Act, and he expects the Commission to promptly consider this rule with the hope of finalizing its required rulemaking before the end of the year.

Question & Answer
Regulating Crypto
Reps. McHenry and Carolyn Maloney (D-N.Y.) asked if crypto should be treated and regulated like a security and if the SEC has all the authority they need to do so. Gensler said although SEC authorities in this space are clear, Congress could help facilitate coordination across agencies and fill gaps around stablecoins in the banking regulatory regime. McHenry said there needs to be clarity on what counts as a digital asset and asked specifically about Bitcoin and Ethereum. Gensler said he will not get into the specifics of any one token. Rep. Ted Budd (R-N.C.) asked if Gensler supports what China has done in implementing crypto bans. Gensler said the U.S. approach is different and involves bringing more consumer protection.

Rep. Jim Himes (D-Conn.) asked for guidance on how to prioritize the legislation between exchanges and defining who should regulate what type of cryptocurrency. Gensler said there are a number of innovations, and he is focused on the trading and lending platforms because investors are giving up ownership rights. Himes asked if they need to craft a whole new structure or use current existing regulations of exchanges as a basis. Gensler said that will be for Congress to decide, but they already have two great market regulators and do not need another. Rep. Warren Davidson (R-Ohio) mentioned more legislative proposals and said he is drafting a bill to clarify yield products and how they should be protected.

Risks with Crypto
Reps. Jesús “Chuy” Garcia (D-Ill.) and Ritchie Torres (D-N.Y.) asked if stablecoins are a systemic risk. Gensler said stablecoins can present systemic risk but stopped short of saying that they absolutely do. He added that the Commission is currently looking into stablecoins, including in the categories of financial stability, money laundering, and investor protection. Garcia asked if speculation and regulatory arbitrage are important drivers in the price of Bitcoin, and Gensler said that Bitcoin is used to try to arbitrage between regulatory regimes.

Rep. Al Lawson (D-Fl.) asked about crypto being traded on the same platform as securities. Gensler said the exchanges need to be inside the public policy framework and that the idea a token (1) may not have any ownership and (2) is trading in the marketplace on the potential that it might be worth more in the future because others will pay for it is highly speculative. Gensler said the SEC will get more of these projects and companies to register and fall within the investor protection framework. Rep. Anthony Gonzalez (R-Ohio) stated his support for crypto, and argued it is not similar to gambling in a casino. Gensler said he wants to make sure the public is not being defrauded by claims of returns from these crypto trading platforms.

Rep. Josh Gottheimer (D-N.J.) asked how stablecoins will be integrated into the U.S. financial system and what the SEC’s role might be in this process. Gensler said if a stablecoin would be directly tied to deposits and cash in a bank, then a banking remit can be put around it. He said instability occurs when they take on characteristics of money market funds and added that cryptocurrencies are often being used inside platforms for illicit activity and to avert laws around tax compliance. Rep. Juan Vargas (D-Calif.) asked how crypto impacts the dollar. Gensler said the USD is the leading currency of the globe, and it is unlikely for hundreds of currencies to persist, noting that most of them are just investment vehicles.

Payment for Order Flow (PFOF)
Rep. Ann Wagner (R-Mo.) asked for more specificity of why best execution would have been violated by retail brokers. Gensler said there is the potential for conflict of interest when orders are routed to a wholesaler or broker purchasing that order flow. Wagner said one leading brokerage firm created billions in price improvement by executing through wholesalers. Gensler said price improvement is a good thing, but the measuring rod of that price improvement is based off of the National Best Bid and Offer (NBBO), which has constraints, and he has asked staff to update it because the NBBO does not include what is in the dark markets or everything in the NYSE and Nasdaq. Wagner asked if a PFOF ban is on the table, to which Gensler said he just wants to foster efficient, competitive markets. Rep. Roger Williams (R-Texas) asked what would happen if PFOF or rebates were eliminated. Gensler said they are looking at whether PFOF and rebates truly promote competition, efficiency, and best execution.

Rep. John Rose (R-Tenn.) asked how far the staff has gotten in examining PFOF. Gensler said in terms of the January events, the report has been shared with the Commissioners, and it will be out shortly. For broader public policy issues, Gensler said it will be based on the economics and whatever promotes market competition.

Lawson asked how to ensure changes made around PFOF do not create additional barriers for market participation. Gensler said PFOF has been used by some brokerage firms but not all, and their projects are focusing on the overall market structure, as well as working towards lower cost and greater access to capital markets.

Rep. Bill Foster (D-Ill.) asked about requiring that retail customers receive a summary of fees or commissions plus summary of how the price they received compares to some estimate of the market price. Gensler said he would like for SEC staff to review it.

Debt Limit
Foster asked if the SEC is making contingency plans to deal with the chaos that would occur if the U.S. defaults. Gensler said approaching October 18^th, lawmakers need to understand that markets can do things that no one expects. He added that as capital market participants start to anticipate what Congress will or will not do, we will be in uncertain times in those last few days. Waters asked what would happen to retirement investments and businesses in the case of a default. Gensler said if we end with a default, we will have a lot of uncertainty in major market participants, and also discussed breakages in the system. Foster asked if Gensler would be willing to provide a confidential briefing to interested members on that scenario planning as the deadline approaches. Gensler said he would want to work with Yellen on that. Foster asked if there is any downside to the debt limit being outright repealed. Gensler said, however Congress goes about addressing it, it would lower uncertainty in the market and lower the cost of capital. Rep. Madeleine Dean (D-Penn.)  asked if Gensler would recommend elimination of the debt ceiling. Gensler did not respond directly but said that, leading up to default, we will see fraying of the marketplace.

Consolidated Audit Trail (CAT)
Barry Loudermilk asked when the SEC will finish the rulemaking to remove most personally identifiable information (PII) from the CAT. Gensler said removing that data from the CAT is important, and it is on their docket and will follow up with an update as to what month it will be ready.

ESG Disclosures
Rep. Frank Lucas (R-Okla.) asked Gensler if he is concerned the upcoming climate risk framework could have a larger burden on small and medium sized companies. Gensler said they are putting something out for public comment and has asked staff to look at qualitative and quantitative disclosures and how to phase the implementation amongst large and small issuers, as well as for different types of disclosures.

Rep. David Scott (D-Ga.) mentioned the SEC’s newly proposed ESG regulation and asked how exposed our financial and securities systems are to these weather patterns. Gensler said climate risk can affect a company’s physical risk and also transition risk as some move towards lower emissions goals.

Rep. Blaine Luetkemeyer (R-Mo.) asked if the SEC will set standards so companies saying they are “green” are actually doing things to qualify for that characterization. Gensler said for investment funds they are looking into what should stand behind calling a fund “green” or “sustainable”, and on the company side, they are looking at more disclosures.

Rep. Sean Casten (D-Ill.) asked if climate disclosures would be looking for details of a company’s capital structures in addition to their contribution or exposure to climate change. Gensler said their focus is on what investors demand, but he would like to better understand the capital structure, and if Casten believes it is falling short in some way, Gensler would like to follow up.

Rep. Andy Barr (R-Ky.) asked how Gensler plans to ensure the SEC climate disclosure rule maintains the threshold of materiality and not burden investors and issuers with an avalanche of extraneous information. Gensler said it is about investor demand. Barr said retail investors only care about the returns and that ESG funds have fees higher than non-ESG funds and cut into these returns for investors. Gensler said he has asked staff to look into promoting greater competition to bring down those fees in the fund management space and that being clear in the naming and what stands behind those “green” names can help.

Reps. French Hill (R-Ark.) and Barr asked if there are plans to provide liability protections for issuers and what is needed to ensure that these disclosures are preserved for investors and not hijacked by lawyers for frivolous lawsuits. Gensler said the disclosures and liability protections will be based on what investors want.

Vargas and Rep. Nydia Velazquez (D-N.Y.) asked about updated findings from the SEC’s Climate and ESG Taskforce. Gensler said investors have increasingly asked for climate risk and work force disclosures and that they will put it out for notice and comment.

Treasury Markets
Lucas asked about the review of the Treasury markets structure. Gensler said there have been a number of challenges in our treasury markets, and they are working closely with the Fed, Treasury, and Commodity and Futures Trading Commission (CFTC) in trying to think through how to build greater resiliency into the market.

China
Rep. David Kustoff (R-Tenn.) asked Gensler about Chinese companies needing to open their books or become barred from U.S. exchanges in 2024. Gensler said China and Hong Kong currently do not open up their records to the Public Company Accounting Oversight Board (PCAOB), while nearly 50 other jurisdictions do. Kustoff asked who the 207 companies are, and Gensler said that is the current number of China-related companies and that for each year in this three-year clock (so the early part of 2022), if China and Hong Kong are not yet compliant, the SEC will identify the names of specific companies. Kustoff asked if this number could grow. Gensler said it could grow, but the SEC put a pause on it to enhance disclosures around Variable Interest Entity (VIE) structures. Rep. Brad Sherman (D-Calif.) asked if Gensler believes the two-year timeframe in the Accelerating Holding Foreign Companies Accountable Act will help ensure accurate audits. Gensler said that that he does not mind if Congress shortens the timeline from three to two years.

SPACs
Kustoff asked if Gensler has gotten recommendations for new Special Purpose Acquisition Company (SPAC) disclosure requirements. Gensler said they have preliminary recommendations but nothing for a full rule. He added that SPACs are very costly vehicles for companies to raise money and to the retail public.

Financial Transaction Tax (FTT)
Gottheimer asked if Gensler has any follow up thoughts to an FTT. Gensler said he has not studied it further.

Reg BI
Wagner and Maloney asked if Gensler still commits fully to supporting the implementation of Reg BI. Gensler said yes and that he is asking staff to consider how to ensure brokers and investment managers understand their duties under that role.

Capital Markets Regulations
Posey asked if there are regulations on capital markets that could be relaxed. Gensler said in the Treasury markets and equity markets structure reviews, they are looking at how to ensure resiliency and efficiency. Relating to crypto, Gensler said if people come in to say the transfer agent rule or custody rule does not quite fit, he will engage in conversations to adjust these more technical rules.

Financial Accounting Standards Board (FASB)
Luetkemeyer said he is working on legislation to enhance transparency of FASB’s standard setting process and asked Gensler if he thinks that FASB is the appropriate entity to determine how assets related to crypto and ESG are treated. Gensler said the SEC will put things out to notice and comment on crypto and ESG but said he is not familiar with what FASB is doing specifically in those areas.

Exempt Offering Framework
Lawson asked about the SEC’s changes to exempt offerings. Gensler said they have facilitated, through exempt offerings, capital raising in both the capital and private markets. He said it is important investors get full and fair disclosures in the public markets.

Gamification and GameStop Events
Casten asked about conflicts between investors best interest and the ways companies earn money. Gensler said it is central to the issue and that digital analytics are being used to optimize company and platform revenues. Scott asked what the SEC is doing to protect investors. Gensler said they are doing many projects, including shortening the clearing cycles and putting out for comment use of digital engagement practices. Scott said he wants to introduce a bill to make it impossible for social media platforms to abuse the financial system.

Private Equity Regulatory Scrutiny
Rep. Ayanna Pressley (D-Mass.) asked what tools the SEC is using to better monitor activities of nonbanks. Gensler said in terms of private equity, he has asked staff to ensure the arrangements between the general partners and limited partners have the appropriate transparency and that investment managers are living up to their duties. He also asked staff about updating and expanding information and reporting requirements that the SEC collects on foreign private funds.

SEC Budget Request
Waters asked how Gensler’s budget request would help the SEC do its job. Gensler said it would help the SEC help companies go public and enhance economic activity. Dean asked if the SEC’s budget request will address the Commission’s staffing issues. Gensler said the budget request will not fully restore staff to 2016 levels, adding that the SEC spends considerable funds on technology.

Short Sales
Velazquez asked where a short selling rule proposal is on the SEC’s list of priorities and when the SEC will propose one. Gensler confirmed his efforts to provide a proposal for a vote by the Commission.

Executive Compensation
Velazquez asked about her Greater Accountability in Pay Act and how the bill would increase the accuracy of equity prices and allow better oversight of markets. Gensler went broader, discussing how investors benefit from transparency on executive compensation and the SEC’s efforts to address claw backs and say-on-pay.

Margin and Swaps
Sherman asked how to regulate and legislate around margin and return swaps. Gensler said there are rules going into effects in November regarding swap dealer registration and reporting and said he has discussed with staff a possible rulemaking around aggregate positions and total return swaps.

Diversity
Rep. Gregory Meeks (D-N.Y.) asked Gensler to elaborate on how the SEC plans to promote diversity. Gensler said he asked staff to come up with rulemakings relating to diversity disclosure for the workforce in public companies and board diversity. Dean asked about diversity among SEC staff, and Gensler said diversity is a priority throughout all ranks of the SEC.

Insider Trading
Meeks asked about 10b5-1 plan abuse, if there is an obvious need to change the 10b5-1 framework, and what Congress can do to address any loopholes. Gensler confirmed that there are gaps and explained some of the abuses, adding that he has asked staff to come up with recommendations. Rep. Rashida Tlaib (D-Mich.) asked if the SEC is looking into Fed presidents’ insider trading. Gensler did not directly answer the question but said that, generally speaking, it is against the law to trade on non-public information.

Stock Buybacks
Rep. Alexandria Ocasio-Cortez (D-N.Y.) asked if stock buybacks make a productive contribution to firms. Gensler said buybacks are a tradeoff between investing in a company and paying back shareholders but would not comment on whether it was a productive contribution. Ocasio-Cortez asked if the SEC monitors whether buyback activity fits within Rule 10b-18’s safe harbor. Gensler said the Commission does what it can but that there are a large number of companies to oversee in the U.S. She then asked if the SEC would rescind Rule 10b-18, and Gensler said he has asked the staff to look more broadly in this area.

Whistleblower Protection Reform Act of 2021
Rep. Al Green (D-Texas) asked how this legislation will be helpful. Gensler said giving support to whistleblowers is an important part of their oversight of markets. Green said knowing that whistleblowers are protected should also act as a deterrent in the corporations.

Machine Learning Technology
Rep. Van Taylor (R-Texas) asked if the SEC is using machine learning technology and how the SEC could improve its use of technology, and Gensler said the Commission’s use of machine learning is limited and behind securities market participants, adding, however, that technology could help with enforcement.

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