SBC Gensler Hearing

Senate Committee on Banking, Housing, and Urban Affairs

Oversight of the U.S. Securities and Exchange Commission

Thursday, September 15, 2022

 

Topline

• Senators from both sides of the aisle raised a variety of SIFMA priorities with Chair Gensler throughout the hearing.
• Hagerty criticized SEC staff’s application of 15c2-11 to fixed income securities, including in the 144a market, emphasizing the distinction between institutional and mom-and-pop investors.
• Warner and Rounds highlighted the Commission’s overlapping, interconnected proposals and short comment periods.
• Warner also raised the Commission’s cyber incident disclosure proposal in light of authority given to CISA by Congress earlier this year.
• Much of the hearing focused on criticism of the Commission’s climate risk proposal and digital assets. Other notable topics included Treasury markets, human capital, and country-by-country reporting.

 

Witnesses

• The Honorable Gary Gensler, Chair, U.S. Securities and Exchange Commission

 

Opening Statements
Chairman Sherrod Brown (D-Ohio)

In his opening statement, Brown said Committee Republicans have bellyached about the Commission’s agenda and that if Wall Street and its allies are complaining, it probably means the Commission is doing something right, adding the SEC must continue to make enforcement a priority. He then praised Gensler and Menendez’s work on insider trading, Van Hollen and Kennedy’s work on Public Company Accounting Oversight Board (PCAOB) auditing of Chinese companies, SEC enforcement efforts, and the Banking Committee and Senate Agriculture Committee’s work to address digital asset issues, emphasizing the need for the SEC and Commodity Futures Trading Commission (CFTC) to collaborate on cryptocurrency (crypto) regulation. He concluded by praising the Commission’s work on climate risk disclosure and stock buybacks.

 

Ranking Member Patrick J. Toomey (R-PA.)

In his opening remarks, Toomey criticized Gensler for failing to provide regulatory clarify on digital assets, prompting Congress to step in, and expressed his concerns with the Commission’s climate disclosure rule in light of the Supreme Court’s ruling in West Virginia v. EPA, including materiality, compliance costs, and the activist agenda driving the proposal. He then highlighted the SEC’s inadequate response to Senate Republicans on their concerns regarding the climate risk proposal and concluding by saying the SEC should consider itself to be on notice by the Supreme Court that the separation of powers still exists and will be upheld.

 

Testimony

The Honorable Gary Gensler, Chair, U.S. Securities and Exchange Commission (SEC)

In his testimony, Gensler provided updates on market structure, predictive data analytics, issuers and issuer disclosure, funds and investment management, enforcement and examinations, and resources.

 

He outlined several proposals concerning the bond market that SEC staff have worked on in consultation with the Department of Treasury and the Federal Reserve and expressed support for the Financial Industry Regulatory Authority’s (FINRA) work to improve efficiency and transparency in non-Treasury fixed income markets. He next discussed concerns with wholesalers, dark pools, and lit exchanges and the work of SEC staff to take a cross-market view of how to update rules in equity markets and consider recommendations related to best execution, disclosure of order execution quality, the National Best Bid and Offer (NBBO), tick size, exchange access fees and rebates, payment for order flow (PFOF), and order-by-order competition. He asserted that the offer and sale of nearly 10,000 crypto tokens in the market are covered by securities laws, which require registration absent an exception, but that it may be appropriate to be flexible in applying existing disclosure requirements. He added that stablecoins may be shares of a money market fund or other type of security, prompting the registration requirement. Gensler then said that since most crypto tokens are securities, their intermediaries are subject to registration as well and suggested that it may be appropriate for them to dual register with both the SEC and Commodity Futures Trading Commission (CFTC).

 

After receiving feedback from the Commission’s request for comment on digital engagement practices (DEP), Gensler said he asked staff to make recommendation on how to address conflicts of interest and sales practices in light of increased used of predictive analytics.

 

Next, he highlighted the Commission’s climate disclosure rule, on which it received 14,000 comments, and a recent agreement between the PCAOB and Chinese regulators to provide a framework for PCAOB inspections of firms in China and Hong Kong. He then briefly touched on proposals concerning special purpose acquisition companies (SPAC), share repurchase disclosure, beneficial ownership, and 10b5-1 plans.

 

Gensler highlighted the Commission’s proposals on private funds and environment, social, and governance (ESG), money market funds, Form PF, cybersecurity, and possible improvements he asked staff to consider in order to enhance open-end fund liquidity, pricing, and resiliency during periods of stress. He then asked for more resources to support enforcement, examinations, and additional personnel.

 

Question and Answer

SEC Rulemaking Process and Comment Periods

Sen. Mike Rounds (R-S.D.) highlighted the SEC’s extensive agenda, including proposals on complex issues that impact financial markets and that are being implemented on overlapping timelines, impacting different market sectors and leading to unintended consequences. He then asked why the SEC has not considered the cumulative and cross sector effects of these proposals. Gensler said the SEC does consider cross sector issues and re-opens proposals for that very reason and summarized SEC staff’s process for public comment consideration.

 

Sen. Bill Hagerty (R-Tenn.) disagreed with Gensler’s characterization of U.S. securities laws and regulations as the gold standard and noted the decline of publicly listed companies and initial public offerings (IPO) in the U.S., stating that regulations encourage companies to stay private or go abroad for their IPOs. He then criticized the SEC’s environment, social, and governance (ESG) disclosure rule and said America’s lead in capital markets has been in spite of, not because of, increasingly crushing red tape, adding that if we continue down this path, there will be no more investors left to protect. He also criticized the SEC’s private funds proposal, to which Gensler responded by suggesting the rule might decrease costs for investors and promote competition and transparency.

 

Sen. Mark Warner (D-Va.) characterized Gensler’s agenda as aggressive, even though he agrees with many of his proposals, and asked, in light of the Commission quick pace of rulemaking, for Gensler to discuss appropriate comment period lengths and how he looks holistically at the interoperability of the Commission’s proposals. Gensler said he looks at them proposal by proposal, considers public comment, and that regardless of comment period length, the Commission will consider comments after the deadline, adding that the Commission occasionally publicly re-opens comment periods, citing the SEC’s efforts on securities lending and stock buybacks, due to the interrelatedness of proposals.

 

15c2-11 and 144a

Hagerty criticized SEC staff’s announcement of the application of Rule 15c2-11 to the fixed income market, including under Rule 144a, asserting that qualified investors in private placement securities do not need handholding and that the Commission new rules will act as an impediment to innovators who need capital to grow. Hagerty then asked if the distinction between institutional investors and mom-and-pop investors is unimportant, or if there is some other motivation driving the SEC to dedicate so many resources to go after larger investors to whom Gensler’s predecessors had given a degree of autonomy. Gensler said there is a distinction between accredited and non-accredited investors and then directed his attention to addressing Hagerty’s comment on the private funds rule as part of the same line of questioning.

 

Climate Risk Disclosure and ESG

Sen. Thom Tillis (R-N.C.) asked when the SEC will provide a specific, longer than one page response to a letter by Senate Republicans concerning a lack of transparency and disregard for a significant congressional oversight request concerning the SEC’s proposed climate disclosure rule. Gensler said his staff is ready to meet with Tillis’ staff to talk about the process and has already put out 500 pages of information on the topic, which he characterized as backed by decades of law.

 

Brown asked Gensler to explain why the Commission’s climate risk disclosure proposal is not regulating climate policy. Gensler said the SEC is not a merit regulator but a disclosure regulator and that investors care about climate risk. Sen. Tina Smith (D-Minn.) asked why climate risk disclosure information is material for investors. Gensler tied the definition of materiality to climate risk and discussed how investors take these issues into consideration when considering risk in companies in which they invest. He also referred to public comments from the investor community supporting the proposal.

 

Sens. Jon Tester (D-Mont.) and Rounds asked what responsibilities the production agriculture sector would have to disclose emissions under the Commission’s climate risk disclosure rule. Gensler said the SEC has heard from various farm bureaus and that public companies would have responsibilities to disclose estimates of emissions if they are material and that the Commission is taking a close look at the issue. Tester asked what recourse a private farmer has when a public company they sell to asks for emissions information. Gensler said the public company does not have an obligation to ask the farmer for specific information and that these kinds of issues are what the public comment process is about.

 

Sen. John Kennedy (R-La.) asked what the cost of compliance would be for the SEC’s climate risk disclosure proposal. Gensler said the cost would be in the single digit billions of dollars across the economy. Kennedy countered that it would cost scarce resources in the billions of dollars to comply and implied that the purpose of the rule was to push investors to pay attention to climate change and influence portfolio companies. Gensler responded that the rule was not a merit rule on the climate change issue and that the purpose is to help investors get more consistent climate change risk disclosure information.

 

Sen. Steve Daines (R-Mont.) recommended that the Commission withdraw its climate disclosure rule, citing the massive burdens it would place on both large and small companies and the issue of Scope 3 emissions, and asked if Scope 3 emissions disclosures were a reasonable request of public companies. Gensler cited the hundreds of companies already disclosing Scope 3 emissions and said the SEC is trying to bring standardization to those disclosures. Toomey highlighted the West Virginia v. EPA case and asked if Gensler has given any consideration to rescinding that rulemaking in light of how the major questions doctrine was used in the case. Gensler said he takes the Supreme Court’s decisions seriously and is considering the climate risk proposal in light of the SEC’s authorities, securities laws, and the SEC’s history of disclosure authority.

 

Sen. Elizabeth Warren (D-Mass.) discussed emissions disclosures under the SEC’s climate risk proposal and asked whether investors have adequate information on climate risk information. Gensler said the comments received by the Commission demonstrate that stakeholders prefer information on all three scopes of emissions. Sen. Catherine Cortez Masto (D-Nev.) asked about green washing risk. Gensler referred to the Commission’s proposals on truth-in-advertising and the need to provide integrity in the ESG investing space.

 

Digital Assets

Brown asked why it is important for financial regulators to coordinate oversight of cryptocurrency to make sure gaps and loopholes do not exist. Gensler explained the close coordination the Commission has with other financial regulators. Cortez Masto asked why crypto intermediaries should be regulated under the Exchange Act. Gensler said most crypto tokens are securities under the Howey test and that intermediaries will have securities on their platforms, which would prompt their subjection to securities laws. He added that the SEC will continue to protect the public as best it can. Sen. Cynthia Lummis (R-Wyo.) highlighted her digital assets bill, the Responsible Financial Innovation Act, and asked Gensler his thoughts on the need for disclosures in digital asset markets. Gensler said disclosure is key, that the Commission has set up a new office to handle this field, and that entrepreneurs should bear a disclosure obligation. Lummis added that she does not expect her bill to pass this Congress but intends to reintroduce the bill in January.

 

Toomey asked if central or decentral control is a factor in whether a digital asset is a security. Gensler responded by explaining the common enterprise part of the Howey test. Toomey and Gensler then engaged in a colloquy on digital asset control and classification.

 

Toomey asked if the SEC should provide guidance to digital asset intermediaries instead of inviting those parties to approach the SEC. Gensler said he has asked staff to use the SEC’s toolkit to help facilitate this space. Rounds asked if any crypto firms have approached the SEC for guidance. Gensler responded that not liking the answer from the SEC does not mean there is not guidance and that many intermediaries are likely to be noncompliant with securities laws through their current use of crypto tokens.

 

Cyber Incident Disclosure

Warner highlighted the successful passage of cyber incident reporting legislation earlier this year and the SEC’s similar proposal. He then asked how the Commission considers proposals outside its purview, like cyber incident reporting, in light of similar cyber incident reporting rulemaking efforts by both the Cybersecurity and Infrastructure Security Agency (CISA) and the SEC. Gensler said securities laws are about investors understanding material risk and events and explained the SEC’s cyber incident disclosure proposal, emphasizing its materiality requirement, and conversations with the Department of Homeland Security and Department of Justice on this topic.

 

Treasury Markets

Tillis asked about Treasury markets and if the Commission intended a recent proposal to require customers, like pension funds, to register as dealers. Gensler said the proposal would not cover pension funds. Sen. Jon Ossoff (D-Ga.) asked about liquidity in Treasury markets. Gensler said there have been jitters in that market every few years and emphasized the need to ensure that high frequency traders and platforms in that market are registered and regulated.

 

Human Capital

Warner asked about the importance of human capital investment, to which Gensler responded by rhetorically asking why public shareholders should not also get the same human capital information as those buying and selling companies.

 

Country-By-Country Reporting

Van Hollen asked about country-by-country reporting disclosures and whether new disclosures are needed in this area. Gensler said he supports the Financial Accounting Stability Board’s (FASB) project around disaggregating reporting for public companies and that he expects FASB to provide further information on this over the next couple of months.

 

Diversity, Equity, and Inclusion

Sen. Robert Menendez (D-N.J.) asked for an update on the status of recommendations from the Asset Management Advisory Committee on diversity, equity, and inclusion, the benefits of corporate diversity disclosures, and if fiduciaries should exclude minority asset managers as part of their fiduciary duty. Gensler agreed with and sympathized with Menendez’s encouragement of diversity but did not commit to any strict timeline for implementation of recommendations.

 

Fraud and Abuse

Sen. Chris Van Hollen (D-Md.) asked about the Empowering States to Protect Seniors from Bad Actors Act, a bill to help states crack down on elderly investor financial abuse. Gensler sympathized with the purpose of the bill.

 

Audits and Accounting

Sen. Jack Reed (D-R.I.) asked what steps the SEC is taking to make sure that auditors are prioritizing independence over seeking non-audit revenue. Gensler said he has asked the Office of the Chief Accountant (OCA) and the PCAOB Board to put updating the separation and independence standard on its agenda. Kennedy asked for an update on implementation of the Holding Foreign Companies Accountable Act. Gensler said the law gave the SEC leverage in negotiations with the Chinese and that the PCAOB is sending inspectors to China for a process that will likely take eight to ten weeks.

 

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