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House Committee on Financial Services Subcommittee on Capital Markets: SEC Overreach: Examining the Need for Reform

House Committee on Financial Services
Subcommittee on Capital Markets
SEC Overreach: Examining the Need for Reform
Wednesday, March 20, 2024

Topline

  • Republicans discussed potential legislative reforms to improve accountability and transparency at the SEC and warned of the cumulative impact of the agency’s aggressive rulemaking pace.
  • Most Democrats defended the SEC, including the agency’s recent Climate Disclosure Rule. Rep. Wiley Nickel (D-N.C.) raised concerns over the SEC’s Staff Accounting Bulletin (SAB) 121, and Reps. Nickel and David Scott (D-Ga.) warned about the impacts of exhibiting hostility towards technology and innovation.

Witnesses

  • Jennifer Schulp, Director of Financial Regulation Studies, Center for Monetary and Financial Alternatives, Cato Institute
  • David Burton, Senior Fellow in Economic Policy, Thomas A. Roe Institute for Economic Policy Studies, The Heritage Foundation
  • John Gulliver, Executive Director, Committee on Capital Markets Regulation 
  • Alexandra Thornton, Senior Director, Financial Regulation for Inclusive Economy, Center for American Progress

Opening Statements

Capital Markets Subcommittee Chair Ann Wagner (R-Mo.)

In her opening statement, Wagner discussed how the SEC’s aggressive and burdensome regulatory approach reveals the urgent need for sensible reforms. She described how Chair Gensler’s frenetic, partisan rulemaking agenda has threatened the health of U.S. capital markets and highlighted the need for targeted institutional reform. Wagner said the Committee’s proposed reforms are targeted and practical, and criticized Chair Gensler’s SEC for pursuing partisan policy objectives instead of adhering to its statutory mission.

Wagner noted that since taking office, Chair Gensler has flooded the marketplace with roughly 60 new proposals and more than 30 final rules. She explained that many of these proposals included sweeping new changes and were advanced without the requisite statutory authority or a cost-benefit analysis. Wagner warned that many of the SEC’s proposed and finalized rules don’t satisfy the Administrative Procedure Act (APA), citing the climate disclosure rule as a prime example. She concluded that the SEC is not an environmental regulator, nor was it given authority to finalize climate-related regulations that will burden businesses with excess costs. Wagner noted the full Financial Services Committee would explore the climate rule on April 10. She concluded that the hearing’s topic should not be a partisan issue, noting that Members on both sides of the aisle should support commonsense reforms.

Capital Markets Subcommittee Ranking Member Brad Sherman (D-Calif.)

In his opening statement, Sherman noted the facts and policy are not on the side of the SEC’s detractors, which is why they are focusing on procedure. He discussed the need for guidance to be published from the SEC, and lauded the SEC for finally doing what Congress told them to do in the Dodd-Frank Act. Sherman discussed how the recent near government shutdown created uncertainty which led firms to delay IPOs and made it more difficult for the U.S. to compete for capital. Sherman said that the SEC is giving 67 days to comment on average when calculated starting from the date which the proposed rule was posted on the SEC’s website, not the federal register. He concluded by highlighting the need for climate disclosures, which he said are material to a material percentage of investors investing in American markets.

Full Committee Ranking Member Maxine Waters (D-Calif.)

In her opening statement, Waters discussed how the SEC has played a critical role in protecting investors from fraud and abuse. She noted that while the agency has done a solid job under the Biden Administration, there is more work to be done. Waters called for transparency in the unregulated private securities markets and for new rules to stop corporate executives from engaging in anti-work stock buybacks. She said the U.S. needs more comprehensive climate risk disclosures and concluded by calling for the SEC to be fully funded so it can remain a relevant and effective regulator.

Testimony

Jennifer Schulp, Director of Financial Regulation Studies, Center for Monetary and Financial Alternatives, Cato Institute 

In her testimony, Schulp explained how the SEC would benefit from reforms aimed at increasing the Commission’s accountability and transparency, ensuring adequate input and analysis for rulemaking, and holding the agency to high standards in the exercise of its functions. She discussed how the SEC’s use of administrative law judges denies the public the accountability provided by judicial courts. Schulp noted that the Commission has a mixed record, at best, of complying with the APA. She said the SEC inappropriately relies on agency guidance and enforcement actions to create new regulations, which decreases regulation quality by preventing public input. Schulp encouraged Congress to consider setting a baseline for SEC comment periods and have the SEC be required to repropose rules that are substantially revised from the proposal. She noted that the SEC’s economic analyses often fail to account for costs and rely on speculative benefits and concluded that the agency would benefit from reforms to improve its accountability, responsiveness, and competence, regardless of the Commission’s policy agenda.

David Burton, Senior Fellow in Economic Policy, Thomas A. Roe Institute for Economic Policy Studies, The Heritage Foundation 

In his testimony, Burton said the Commission does an increasingly bad job of discharging its core functions, partially because the Commission’s resources have flowed into unnecessary management support and ancillary functions. He noted the SEC is managed exceedingly poorly and described it as one of the most management heavy and bureaucratic agencies in government. Burton said the SEC provides inadequate oversight of so-called self-regulatory organizations (SROs) and does an inadequate job providing information to policymakers to make informed judgments. He explained that the Commission has failed to address current regulatory issues, opting instead to pursue regulation by enforcement. Burton criticized the SEC for pursuing political and ideological objectives that are unrelated to its core mission and said that Chair Gensler’s ideological pursuit is doing real damage. He called on the SEC to discharge the mission Congress has given it. Burton said legislation of that would roll the PCAOB back into the SEC is welcome and noted that creating the PCAOB was a mistake and putting it back in the government will restore due process, transparency, and rulemaking protections associated with government. He concluded by complimenting legislation including the SEC Regulatory Accountability Act, the legislation that requires a GAO study of the IT programs at the SEC, the legislation that requires a GAO study of the SEC’s cost benefit analysis in up to 10 rule makings, and the legislation that requires at least 60-day comment periods for rulemakings.

John Gulliver, Executive Director, Committee on Capital Markets Regulation  

In his testimony, Gulliver noted that under Chair Gensler, the SEC has embarked on an unprecedented rulemaking agenda. He said that the SEC has not conducted a comprehensive analysis of how its rulemakings will collectively impact public companies and investors. Gulliver agreed that now is precisely the time to consider whether reforms to the SEC’s regulatory process are needed. He warned that short public comment periods for SEC rulemakings have failed to reflect a proposal’s significance and complexity, citing an estimate from SIFMA which found that the average period of time for comment for recent SEC proposals has been just 47 days.

Gulliver criticized the SEC for issuing proposals on overlapping issues, such as securities lending and short selling disclosure rules, without considering their aggregate impact and resulting in conflicting regulations. He noted that the SEC’s rules including the private funds rule are being challenged in court due to fundamental issues with their economic analysis and discussed his support for legislative reforms to clarify and enhance the SEC’s regulatory process. Gulliver said the SEC should be required to clearly identify and substantiate that a market failure exists and how the rule would address that failure. He noted that his recommendations are consistent with the SEC Regulatory Accountability Act and added that the SEC should be required to periodically review its past rulemakings. Gulliver concluded that Congress should require a minimum comment period of 60 days for SEC rulemakings and 180 days for complex rules. 

Alexandra Thornton, Senior Director, Financial Regulation for Inclusive Economy, Center for American Progress 

In her testimony, Thornton noted that opponents of SEC rulemakings are misusing reasonable administrative process protections and turning them into years long gauntlets for agency actions. She said the Commission is bending over backwards in response to these attacks to allow for lengthy periods of comment, which in turn results in the SEC’s economic analyses becoming longer and much more complex. Thornton said this has led to paralysis and explained that the agency does not have enough staff to engage in strained analysis for thousands of comments on every single proposed rulemaking.

Thornton discussed how private funds have grown in size, complexity, and numbers since the Dodd-Frank Act required private fund advisers to begin registering with the SEC. She explained that the SEC’s private fund adviser rule addresses common risks and harms in an adviser’s relationship with private funds. Thornton described the rule as essential, noting that it takes on heightened importance due to the rapid growth of private markets. She warned that allowing extremely large companies that have thousands of employees and sell to millions of Americans to avoid basic disclosure rules invites waste, fraud, and abuses.

Thornton said the wholesale exemption of securities offerings from the public disclosure framework has undermined Congress’ intent. She explained that the solution is either to give the SEC a stronger hand in making regulations to protect all investors from making investments they can’t possibly understand well enough to make sound investment decision no matter how sophisticated they are, or to shrink or close the loophole so that larger companies comply with the public disclosure framework and prevent large private companies from raising capital from retail investors without providing the same type of disclosures that public companies make.

Question & Answer

Proposed Legislative Reforms

Wagner asked how her draft bill, the SEC Regulatory Accountability Act, would improve the quality of the SEC’s analyses. Gulliver explained that her bill would require the SEC to identify an actual problem before issuing a proposal. Wagner asked how higher quality analyses would promote better policymaking outcomes and prevent overreach. Gulliver said the benefits of a rule should exceed its costs and requiring that explicitly through legislation would serve an important policy purpose.

Wagner asked about the impact of requiring the full Commission, not just the Chair, to testify before Congress. Schulp noted the Commission is a five-member body that was designed to be bipartisan and emphasized the importance for the SEC to have a live back-and-forth with the entity that regulates it and the public to hear all five viewpoints. Sherman said he agreed with Wagner and said the entire Commission should testify before Congress.

Sherman said he would be supportive of the bill bringing the PCAOB inside the SEC if it did the same for FASB because he believes that FASB is broken in one major aspect; it mandated writing off R&D expenses when they should be capitalized. He said that we do need regulation in the crypto area and that the crypto industry is often asking what the rules are. He also said he would support legislation requiring a 60-day comment period but said that the 60 days need to start when the SEC publishes a rule on their website. Sherman criticized the SEC’s swing pricing proposal as doing more harm than good.

Rep. Bill Huizenga (R-Mich.) said the PCAOB was intended to operate independently and criticized Chair Gensler for removing an independent PCAOB chair and board members and appointing a hand-picked board. Huizenga said that by folding the PCAOB into the SEC, Congress would have the ability to hold them accountable.

Rep. Dan Meuser (R-Pa.) said the regulatory processes at the SEC do not foster trust. He noted that his bill, HR 6825, the Amendment for Crowdfunding Capital Enhancement and Small-business Support Act of 2023 (ACCESS Act of 2023), would address some of these issues. Meuser asked if his legislation would impact small businesses that are considering raising money in a crowdfunding offering. Schulp said yes. 

Meuser highlighted one of the discussion drafts related to the hearing, which would make certain actions by SEC staff, including Rule 14a-8 no action letters and denials, require a report to Congress. He explained the goal of the draft legislation is to increase accountability around SEC actions that take place outside the formal rulemaking process and asked Gulliver to comment. Gulliver noted the SEC’s no action letters don’t have a lot of transparency, and said he supported the draft.

Rep. Vicente Gonzalez (D-Texas) noted that the SEC reopened the comment period on some of their more contentious rulemakings to allow for additional input. He asked Burton to pinpoint a magic number of days for a comment period. Burton said the number of days depends on the regulation. He explained that something like inflation adjustment can be 30 days, a simple rule that is easy to grasp should require 60 days, and some of the extraordinarily complex rules should require 120 days. 

Rep. Young Kim (R-Calif.) explained that her legislation, HR 7030, the Review the Expansion of Government Act of 2024 or the REG Act of 2024, directs the SEC to review all of its rules every five years. She added that if the agency determines the rule is no longer necessary or appropriate to uphold their mission, the SEC can revise or eliminate the rule. Kim noted that her legislation would also require the SEC to consider the cumulative effects of every rulemaking. She asked why the SEC’s decision to review rules in isolation, without considering their aggregate impact and interconnectedness, makes our capital markets less efficient. Gulliver cited the existence of conflicts between rules. He noted the SEC’s short selling rule and the SEC’s securities lending rule are directly in conflict and has led to a lawsuit against the SEC.

Kim asked if the REG Act of 2024 would help with capital formation. Gulliver said it would.

Criticism of the SEC

Rep. Pete Sessions (R-Texas) discussed the SEC’s adoption of a rule that would have required public companies to disclose information about stock repurchases. Gulliver noted that rule contained a particularly flawed cost-benefit analysis. He added that the SEC did not provide any evidence to support their claims, which led the Fifth Circuit to invalidate the rule he said that the takeaways are that when the SEC claims there is a market failure, they need to substantiate it and that the SEC’s claims of insufficient data did not hold up because commenters provided the SEC with data. 

Sessions said the SEC does whatever they want, and accused the Commission of attempting to harm the growth of the U.S. He then asked Gulliver to discuss other examples of the SEC’s overreach and overregulation. Gulliver noted that it’s concerning that the SEC is reaching into private markets. He warned that bringing public regulations into private markets would be a big problem. Sessions replied that the SEC is against the free enterprise system.

Rep. French Hill (R-Ark.) noted that the SEC has not only lost in the court of public opinion but is now getting trampled by the federal court system. He discussed a court’s August 2023 rejection of the SEC’s reasoning for blocking Grayscale’s Bitcoin Trust from converting to an exchange-traded fund. Hill also recounted how just this week, a Utah judge-imposed sanctions on the SEC for bad faith conduct and gross abuse of power in a case against Dropbox. He noted that the Commission is required to pay these legal fees, which means that American tax dollars are paying for the Commission’s overreach. Hill concluded that under Chair Gensler, the SEC blatantly and repeatedly oversteps its authority.

Hill talked about the Consolidated Audit Trail (CAT) and how the SEC proposes to collect every investor brokerage account statement every day and the risks associated with this collection of data. He asked what the biggest vulnerabilities are with CAT from a cyber point of view. Gulliver said that it is unnecessary for the CAT to collect social security numbers for all US investors because there is a risk of breach.

Meuser asked Burton to answer how disruptive the SEC’s speed of new regulations has been to capital markets and capital formation on a scale of 1-10. Burton said the answer has two parts: on one side it is 9 out of ten, on the other it is close to 0 because the SEC has failed to address entrepreneurial capital formation issues. 

Gonzalez cited criticisms comparing the SEC’s recent rulemaking to throwing spaghetti at the wall and seeing what sticks. He emphasized the need to strike a balance to avoid overregulating and stifling the ability of our markets. Gonzalez asked at what point legislation should be the answer rather than rulemaking. Gulliver said the economic analysis process should be taken more seriously and should drive policy decisions.

Rep. Bryan Steil (R-Wisc.) noted that one of the first things Chair Gensler did was gut the Proxy Adviser Rule. Steil asked if this was an unusual step, and whether it raised concerns about legality. Schulp said yes to both of his questions. Steil asked if Chair Gensler prejudged the outcome of the rule. Gulliver said Gensler’s decision seemed to be rushed.

Steil explained that there is a new understanding of materiality on the left. He asked about the importance of materiality as a threshold. Burton said the left is trying to redefine materiality for political purposes. He warned that fiduciaries are trying to throw their investors under the bus to achieve political returns.

Rep. Andrew Garbarino (R-N.Y.) asked Burton to explain some of the problems with Chair Gensler’s rulemaking approach. Burton said most of the objectives in Chair Gensler’s rulemakings are not related to the statutory mission of the SEC. He cited the SEC’s corporate board diversity rule and described it as a form of racism. 

Garbarino said that Chair Gensler is treating everything like it’s a security. Burton agreed and said the SEC has adopted the position that anything you buy for the purpose of making money is a security.

Rep. Wiley Nickel discussed his concerns with the policy and the process surrounding the SEC’s Staff Accounting Bulletin (SAB) 121. Nickel said that SAB 121 makes the digital asset industry less safe for consumers. He asked if SABs are supposed to guide market participants in understanding and interpreting existing rules, rather than making new policies like SAB 121. Gulliver said yes, adding that SAB 121 was extremely harmful for investors and that consumers benefit from custody by well-regulated financial institutions. Nickel asked what the SEC should have done differently. Gulliver said the SEC should rescind SAB 121 and promulgate rules that would allow for the regulation of crypto exchanges to better protect investors.

Rep. Mike Lawler (R-N.Y.) said he is extremely alarmed by the pace and aggression of the SEC’s rulemaking, noting that Chair Gensler’s frenetic agenda has highlighted the need for reform. Lawler said Chair Gensler’s SEC has completely neglected the capital formation aspect of its mission and asked about the consequences of the SEC neglecting this important duty. Schulp said the consequences are terrible, explaining that when small businesses are unable to raise capital, it creates a drag on the economy. 

Rep. Zach Nunn (R-Iowa) said he’s concerned about the SEC’s attempt to overhaul the custody rule, which would take authority away from state insurance regulators. He asked why it is a concerning trend that the SEC is pushing beyond its authority and infringing on states’ abilities. Gulliver said the custody rule is another example of a rule too extreme to be finalized and trying to fix a problem that does not exist.

Rep. Erin Houchin (R-Ind.) said the SEC has shown time and again that it is committed to pursuing ideological goals at the expense of ordinary Americans. She noted that one of her foremost concerns is that the cumulative effect of new rulemakings will change how our capital markets work. Houchin asked Gulliver about the potential consequences of financial regulators, beyond just the SEC, implementing many policies, like Basel III, concurrently and without input from our market participants and stakeholders. Gulliver said there’s a real possibility these policies are not in our best interest.

Regulation of Private Markets

Waters said many Americans would be surprised to learn that private markets now dwarf public markets. She asked Thornton to discuss what gets lost when large companies that access American capital markets stay opaque and unaccountable. She asked if Congress needs to set new rules for these types of large companies that have a significant impact on society, or if the SEC has sufficient authority to promulgate rules in this space. Thornton explained there’s a lot the SEC can do in this space, but there are some things that Congress might need to do. She said that although there is some debate as to whether they can do it on their own, that the holder of record needs to be defined as beneficial owners so institutional investors that hold shares for thousands of clients are counted as one holder of record. She said that changing this rule would have a lot of large companies automatically having to register and do public reporting.  

Climate Disclosure Rule

Sherman said the SEC did a good job with climate disclosures. He asked whether it makes sense in a capitalist society to tell people with capital that they can’t make a decision based on climate. Thornton said no, explaining that capitalism is about information and there are many climate related factors that impact investing decisions.

Rep. Juan Vargas (D-Calif.) discussed the Republican Chairman of the Texas State Board of Education recent decision to pull $8.5 billion in investment from BlackRock. Vargas noted that BlackRock has outperformed the market for years, and explained that in this situation, culture war politics were politicized over the well-being of constituents. Vargas said Republican anti-ESG laws have cost Texas taxpayers an average of $270 million each year in debt related costs.

Vargas lauded the SEC for putting people over politics, listening to investors, and adopting rules to require enhanced climate related disclosures. He emphasized that climate risk is financial risk. He said climate disclosures are material information, and investors want it. Thornton agreed and emphasized that climate information has a profound impact on companies. She explained that companies with operations in certain areas are at risk, and investors need to know they have a plan. 

Rep. Sean Casten (D-Ill.) started his time by saying that you should never trust someone who claims to be free market when they are trying to protect the interests of the powerful. He then discussed the SEC’s Climate Disclosure Rule, and asked Burton if the SEC received significant public feedback. Burton agreed and said they got a lot of comments. Casten said they made a lot of responses to the comments. 

Casten then asked Schulp about her statement made on a podcast that companies already provide a ton of voluntarily disclosed climate specific financial information, he asked if there is a standard format for this disclosure. Schulp said that yes, they are making them in SEC mandated filings. Casten said that those filings don’t actually exist yet so there are no consistent filings.

Casten then asked Thornton to “educate our economically moderately literate members in the room on why basic economics, why competitive markets, why investor protection, demands that we provide consistent accurate information?” Thornton explained that if the information is not standardized, investors may not be able to find it. She added that the required information needs to be in a format where an investor can compare it from one year to the next. Casten asked if that is not true for all GAAP accounting, and it would probably be cheaper for all companies if they did not need to do any accounting. Thornton said probably.

Casten then mentioned that in 2020 the Trump CFTC issued a report on climate risk that said “climate change presents a major risk to the stability of the US Financial System, regulators and financial institutions need reliable, consistent, and comparable data and projection for climate risk exposure sensitivity.” He then cited a 2021 report from FSOC that climate change is an emerging threat to the US financial system. He then asked the witnesses to raise their hands if they thought that climate change could pose a significant risk to the US financial system. Thornton raised her hand and none of the other witnesses did. Casten said this is insane and that insurers are pulling out of Florida, Texas, Louisiana, and California posing the question of who will be left holding the bag. He said that this is billions of dollars and accused the three witnesses of denying that climate change is real and protecting the interest of the powerful. He said that Congress needs to represent.

Artificial Intelligence & Innovation

Rep. David Scott (D-Ga.) noted that the SEC recently charged two investment advisers for making false and misleading statements about their use of artificial intelligence (AI). He asked what more Congress can do to ensure the SEC continues to hold bad actors accountable. Thornton said the SEC’s efforts to enforce the marketing rules are very important. She said that when it comes to AI, Chair Gensler has been very clear about the unique risks and speculated that Gensler is interested in considering other rules.

Scott asked how Congress can ensure that the SEC does not exhibit hostility towards technology and innovation that could have a positive increase on access to markets for underserved investors.

Thornton said Chair Gensler has acknowledged the many benefits of AI but warned that it’s important to ensure guardrails protect the very investors Scott referenced. Scott touted AI as having the unique potential to improve inclusion and efficiency within our financial system.

Scott said AI is here to stay, and said Congress needs to make sure it serves us properly. He explained that AI has the potential to improve inclusion and efficiency in our financial system. Scott warned that absent a robust regulatory regime addressing the rise in false and misleading statements regarding the use of this technology, we risk hurting more investors.

Nickel said he is worried about the SEC’s Predictive Data Analytics Rule’s impact on innovation and retail investors seeking inclusion in the financial system. He noted the proposal’s scope is extremely broad and said the only recourse to address such an overly broad and inherently flawed rule is to repropose it. Nickel asked if changes could be made to the rule without the SEC running afoul of the APA. Gulliver said finalizing the rule in any form would violate the APA. 

Nunn said he is concerned about the use of the SEC’s blunt and one-size-fits-all approach to regulating new technologies. He asked how the SEC’s approach to rulemaking is having a chilling effect on innovation. Schulp said the SEC is taking the wrong approach, explaining that fear mongering statements about AI and crypto are making business environments in the U.S. uncertain and hostile. 

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