SEC Chairman Gary Gensler and his staff have been very busy lately, and they are about to get busier.
The Securities and Exchange Commission has roughly 50 proposed rule changes it is considering, and a handful that are in a final regulatory stage and could be adopted soon.
“This is one of the largest regulatory agendas we have seen from the SEC in many years,” Amy Lynch, president of Frontline Compliance and a former SEC compliance official, told me.
“There are a lot of items on the list. They are going to have to pick and choose” which one to prioritize, she told me.
What’s the priority?
While the list of proposed rules changes is large, they can be loosely grouped into several “buckets”: ESG-type proposals, buybacks, insider trading and executive compensation, as well as trading activities and investor protection.
Those “hot button” issues include proposed rules around what has become known as Environmental, Social and Governance (ESG), an investing sub-group that has become a popular investment theme.
Proposed ESG-type rules include:
Climate change: enhanced disclosures on climate-related risks and opportunities.
Board diversity: disclosure about the diversity of board members and nominees.
Human capital management: additional disclosure on how companies manage their workforce.
These proposed ESG rules are being closely watched by Wall Street. Dozens of mutual funds and Exchange Traded Funds (ETFs) now offer what they claim are ESG-focused investments.
David Franasiak, an attorney at Williams & Jensen who tracks Washington legal developments, noted that the ESG community would be delighted to get their hands on additional information on what corporate America is doing to address ESG issues.
“They want usable metrics to update their models and provide new products,” Franasiak told me. “These ESG funds are wildly popular.”
Still, it’s not clear how popular the ESG funds are at the SEC. Gensler has also said he would like companies and investment advisers to disclose what criteria they are using to define what constitutes an ESG-type investment.
Buybacks, insider trading and executive compensation
Gensler and his staff have also made it clear they want to know more about how corporate America is spending its profits, how executives are compensated, and how those executives buy and sell their shares. There are proposed rules on:
Buybacks: more disclosure on share repurchases.
Insider trading: Gensler seems concerned that corporate executives are skirting around rules that require disclosure about their stock sales and trades. He wants more disclosure around Rule 10b5-1, which provides a “safe harbor” defense to insider trading for executives that have access to material nonpublic information.
Executive compensation: Gensler is re-proposing implementing guidelines that were first proposed after passage of the Dodd-Frank Act in 2010 that would prohibit incentive-based payment arrangement and require disclosure of any such arrangements. Those rules were never implemented.
Trading activities and investor protection
The SEC also wants to know much more about trading activity, including who is shorting stock, and the loaning or borrowing of stock.
Short Sale Disclosure: would consider mandating monthly disclosure of short sales. The Dodd Frank Act of 2010 mandated that the SEC create rules for the monthly disclosure of short sales, which was never implemented.
Loan or Borrowing of Securities: would require lenders of securities to disclose details of the lending transactions and make them available to the public, another mandate from Dodd Frank that was never implemented.
SPACs: the SEC wants to know a lot more about Special Purpose Acquisition Companies (SPACs), likely including fees and the potential conflict of interest between sponsors and investors.
Market structure and payment for order flow (PFOF)
Gensler has taken a particular interest in the Gamestop/Reddit saga. The SEC is proposing new rules on market structure relating to order routing, conflicts of interest, best execution, market concentration, and the disclosure of best execution statistics.
Gensler has expressed concerns about several aspects of the U.S. trading system, specifically gamification of trading (trading with game-like features such as points, rewards, leaderboards, bonuses, and competitions to increase engagement).
He also has spoken out about payment for order flow (PFOF), in which brokers send their orders to market makers in exchange for payments. This enables some brokers to charge zero commissions. Gensler has said there may be a conflict of interest for brokers.
Industry participants have been urging Gensler to be careful.
“You need to be very deliberate on that approach,” Ken Bentsen, president and CEO of The Securities Industry and Financial Markets Association (SIFMA), told me.
“We have been calling for a review of market structure for some time, but let’s be careful not to try to fix things that may not be broken. The retail investor is getting a better deal than they ever have.”
While there are no explicit proposals on cryptocurrency, Gensler and his staff will be very active deciding what comes under their jurisdiction. Gensler has refused to approve a pure-play bitcoin ETF on the grounds bitcoin is subject to fraud and manipulation, and has also made it clear he believes Congress should clarify the regulatory regime around the crypto space. But Congress is unlikely to pass any legislation.
“In the absence of new regulation, Gensler can continue to define what is a registered security, which will determine whether the SEC has jurisdiction over coins, crypto exchanges, or other parts of the crypto universe.” Thomas Gorman, an attorney with Dorsey Whitney who held key positions at the SEC for many years, told me.
He noted the SEC will likely claim that certain crypto investments and platforms meet the definition of a security under existing law and will seek to force them to register with the SEC.
How rules get adopted
How does the SEC get to change the rules?
Under the Administrative Procedure Act, the SEC and all federal agencies must follow a series of procedures in order to implement or change an existing rule. A majority of the SEC Commissioners (there are 5 members when fully staffed) must propose a rule, then asks for comments from the public (minimum of 30 days response time). The SEC can then respond to comments, ask for additional comments, or propose a final rule. The final rule can then be voted on and adopted.
The majority of the rule changes being considered are still in the “Proposed Rule Stage.”
Getting to that final vote is not always easy, Lynch explains.
“There has to be agreement in the division responsible for that rule with the SEC commissioners, which can be a very political process,” she told me. “The key is, whether the proposal is on the minds of the majority.”
And if it is not on the minds of the majority? “The commissioners may decide not to vote on it, in which case it dies on someone’s desk.”
Disclosure is a main theme
At the heart of many of Gensler’s proposed rules is disclosure, lots of it.
Few argue against disclosure, but the issue revolves around how much is necessary and how it is used.
“The point of disclosure is, do people have enough information to make an informed decision?,” one SEC watcher, who asked to remain anonymous, told me.
Referring to the PFOF controversy, this source told me, “The point is not to regulate the pricing of the products. If there are hidden fees, they should be disclosed, but the point should not be, ‘You guys are making too much money, and we should do disclosure so you can make less money,”
What can get done?
With an agenda this big, SEC watchers are openly wondering how much Gensler can realistically accomplish.
“The real theme from Gensler so far is, ‘I will look at this, I’ll tell the staff to study it, and I’ll think about it,” Gorman told me.
“The bottom line is, he’s not promising you he’s going to do this. At the end of the day, he’s going to take a small number of topics, and likely we will see more disclosures, but it’s unlikely he’s going to implement dramatic changes.”
Gorman particularly expressed doubt that the SEC would get rules passed on the ESG-type proposals.
“I’d be surprised to see them move on the ESG-type proposals,” he told me. ”Rules on the environment will be very controversial. For the SEC to wade into that, they would get a firestorm of opposition from the corporate world.”
The hostility Gensler has shown toward PFOF is also controversial.
Many observers believe that despite the rhetoric, Gensler is unlikely to attempt an all-out ban on PFOF, since it would not only affect market makers who execute orders on behalf of brokers, it would also threaten the business models of both the NYSE and Nasdaq, which also rely on similar payment for order flow arrangements, known as rebates.
Once again, more disclosure is the likely outcome.
“At the end of the day, we are going to have enhanced disclosure, and even more information for retail investors to make better informed decisions,” Andrew Smith, head of investor relations at market maker Virtu, told me.
Gensler himself has been cagey on the subject of his priorities. In a speech to the Exchequer Club last month, he was vague on the process of deciding what and when the SEC will vote on in 2022, saying the process was “intentionally flexible; it’s about getting proposals right, based upon the economic analysis and our legal authorities, and learning from public feedback.”
“This is a multiyear project,” he told Bloomberg in a recent interview. “We don’t want to rush things, we want to get it right.”
Wait: there’s even more coming
The SEC will hold a meeting next Wednesday, where it is expected there will be new proposals on cybersecurity disclosure and risk management, shortening the settlement time for stock trading (currently investors must settle transactions in 2 days, known as “T+2”), and more disclosure for private funds.
Considering that under the Trump administration there was a general hostility toward expanding regulations, SEC watchers are marveling at the turnaround.
“I think he [Gensler] wants to make the biggest dent he can,” Amy Lynch told me.