[Senate Hearing 116-]
[From the U.S. Government Publishing Office]
FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL
YEAR 2020
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WEDNESDAY, MAY 8, 2019
U.S. Senate,
Subcommittee of the Committee on Appropriations,
Washington, DC.
The subcommittee met at 11:30 a.m., in room SD-124, Dirksen
Senate Office Building, Hon. John Kennedy (Chairman) presiding.
Present: Senators Kennedy, Coons, and Van Hollen.
SECURITIES AND EXCHANGE COMMISSION AND
COMMODITY FUTURES TRADING COMMISSION
OPENING STATEMENT OF SENATOR JOHN KENNEDY
Senator Kennedy. I am going to call the subcommittee
meeting to order. I want to apologize to everyone for our
tardiness but as you know, we had votes on the Senate floor.
Today, we have the Chairman of the Securities and Exchange
Commission, the Honorable Jay Clayton. We also have the
Chairman of the Commodity Futures Trading Commission, the
Honorable Christopher Giancarlo. Thank you both for being here
today. I am going to skip my opening statement in the interest
of time, our objective today being to try and get through this
by 1:00 p.m. given that we all have other commitments,
including and especially our two Chairmen.
Before turning to Senator Coons though, I do want to thank
Chairman Giancarlo for being here today, this will be your last
hearing. I want to thank you for your service. I want to thank
you for your hard work. I want to thank you for giving so much
to the American people. And I know all of my colleagues join
with me in that sentiment. Five years is a long time to give up
your life, and I know it is not a job, it is sort of a
lifestyle that you take on as Chairman, both of you. You know
what I am talking about, and we are just very, very grateful,
Mr. Chairman.
Senator Coons.
STATEMENT OF SENATOR CHRISTOPHER A. COONS
Senator Coons. Thank you, Chairman Kennedy. I too will be
brief. Thank you to our key witnesses today, Chairman Jay
Clayton and Chairman Chris Giancarlo. And to your wife Regina,
if I might just would like to express our gratitude for your
support for his service. And I will join with the Chairman in
our thanks to you both for the time you have dedicated to our
Nation in your role as chairmen of the SEC and CFTC.
I will be interested in hearing about how cryptocurrencies
are challenging your oversight and your regulatory role. How
cybersecurity is and remains a challenge both for the agencies
you are responsible for and for financial markets more broadly.
How you have invested the modest, but I think very responsible
increased investments we have made, and then where you are in
terms of the request you are making this year and how we could
improve our service to the general public. By that, I will
follow the Chairman's lead and conclude my opening remarks and
say, let's get going with this hearing. Thank you, Mr.
Chairman.
Senator Kennedy. Thank you, Senator Coons. Let us start
with opening statements. Chairman Clayton, who has been our
chairman since May of 2017. He was previously a partner at the
very prestigious law firm of Sullivan & Cromwell LLP. I will
recognize him for his testimony.
STATEMENT OF HON. JAY CLAYTON, CHAIRMAN, SECURITIES AND
EXCHANGE COMMISSION
Chairman Clayton. Thank you, Chairman Kennedy and Ranking
Member Coons. It is nice to have the opportunity to testify
before you today. I am pleased to be joined by Chairman
Giancarlo. We have worked very closely together over the past 2
years and I echo your comments. He is a great public servant.
I am going to focus on a few high-level matters as my
written testimony provides a detailed review of the
Commission's work over the past year, as well as a discussion
of how we will leverage the resources that you provide us to
further the interests of our Main Street investors.
First, on behalf of my fellow Commissioners and the 4,500
women and men of the SEC, I want to thank you for your past
support. Your funding has enabled us to make targeted hires in
much-needed areas, including cybersecurity, enforcement, our
examination program, market oversight, and small business
capital formation. It has allowed us to lift our hiring freeze,
make significant investments to modernize our information
technology infrastructure, improve our cybersecurity, and more
generally, continue to execute on our 2018-2022 Strategic Plan.
Turning to our fiscal year 2020 budget request, we are
requesting $1.746 billion dollars, an approximately 4 percent
increase over current levels. I will start with two points on
that:
First the SEC budget request relies on the SEC having
continued access to the Reserve Fund to invest in information
technology improvements, including those related to
cybersecurity. Second, and I want to emphasize this, the
funding is deficit-neutral, and any amount appropriated to the
agency will be offset by transaction fees.
Our operational funding has three principal components. The
first is our people--our human capital. This funding, including
compensation and benefits, is the largest portion of our
budget, approximately 68 percent, and also our most important.
My written testimony lays out a number of initiatives we have
undertaken on behalf of our Main Street investors, and each of
these was attained only through the hard work and
professionalism of the SEC staff. Continued investment in our
human capital is critical to our ability to recruit, retain,
and develop top talent that is needed to effectively pursue our
mission.
The second component, information technology, including
again cybersecurity, makes up a significant and in recent past,
increasing portion of our overall budget, approximately 14
percent. We have made meaningful progress in the past 2 years
in upgrading our technical and staff capabilities in these
areas with the resources provided by Congress. As we become
more data dependent and cyber threats to the industry,
investors, and governments continue to evolve, I expect
investments in our information technology and cybersecurity
capabilities to stay front of mind for the agency.
Finally, the third component is leasing. The SEC is engaged
with the GSA currently for procurement process for both our
Headquarters and our New York Regional Office. We expect GSA to
announce contract awards for these leases in fiscal year 2019
and 2020 respectively.
In closing, I would like to again thank the subcommittee
for its continued support of the SEC, its mission, and its
people.
I look forward to working with each of you on our fiscal
year 2020 request, and I am prepared to answer any questions
you may have. Thank you very much.
[The statement follows:]
Prepared Statement of Hon. Jay Clayton
Chairman Kennedy, Ranking Member Coons and Senators of the
subcommittee, thank you for the opportunity to testify today on the
President's fiscal year 2020 budget request for the U.S. Securities and
Exchange Commission (SEC).\1\
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\1\ The views expressed in this testimony are those of the Chairman
of the Securities and Exchange Commission and do not necessarily
represent the views of the President, the full Commission or any other
Commissioner.
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It is an honor to appear before this subcommittee again with my
colleague, U.S. Commodity Futures Trading Commission (CFTC) Chairman
Christopher Giancarlo. This is the fourth time we have testified
together before Congress, and since he is planning on leaving the
agency soon, I want to express my deep appreciation for his work on
behalf of our markets, our investors and, importantly, our country.
Over the past year, we and the staff of our respective agencies have
collaborated on a number of issues to strengthen our markets, including
developing and improving regulations for our swaps and security-based
swap markets, preparing for the effects of Brexit and addressing issues
raised by cryptocurrencies, initial coin offerings (ICOs) and similar
products and technologies. In these and other matters on which we have
worked together, Chairman Giancarlo has always had the interests of our
country front of mind.
As a threshold matter, I would like to thank the members of this
Committee for your support of the Commission's mission and its people.
The funding Congress provided for the agency for fiscal year 2019
positions the SEC to maintain effective oversight of our changing
securities markets and to continue to pursue policies to benefit long-
term Main Street investors, American businesses and our markets. The
fiscal year 2019 funding is allowing us to lift our hiring freeze, and
we are in the process of improving our human capital, including through
the targeted hiring discussed in our fiscal year 2019 budget request.
Additionally, the fiscal year 2019 funding provides necessary resources
to maintain and upgrade our information technology systems and enhance
the agency's cybersecurity and risk management. I am committed to being
a responsible and prudent steward of these resources and look forward
to working with each of you on the agency's fiscal year 2020 request
during the congressional appropriations process.
fiscal year 2020 budget request
To begin, I want to make it clear that our people--our human
capital--are our most important resource. Over the past several years,
they have moved the Commission forward in the face of ever-changing
markets as well as well-known and emerging risks. A key principle of
mine is to continue to invest in and upgrade our human capital. Staff
compensation is the largest portion of our budget, and the most
critical in order for the SEC to stay competitive in retaining and
recruiting top talent whose skills and expertise provide them with many
employment choices.
The SEC's workforce of about 4,500 staff, located in Washington and
across our 11 regional offices, permits the SEC to oversee, among other
things: (1) over $97 trillion in securities trading annually on U.S.
equity markets; (2) the disclosures of approximately 4,400 exchange-
listed public companies with an approximate aggregate market
capitalization of $34 trillion; and (3) the activities of over 27,000
registered entities and self-regulatory organizations. These registered
entities and registrants include, among others, investment advisers,
broker-dealers, transfer agents, securities exchanges, clearing
agencies, mutual funds and exchange-traded funds (ETFs), and employ
almost one million people in the United States.
For fiscal year 2020, our request of $1.746 billion, a 4.2 percent
increase over the fiscal year 2019 enacted levels, will allow the
agency to carry out our mission to protect investors, maintain fair,
orderly and efficient markets and facilitate capital formation. This
funding level would support 4,694 positions, including 34 new
positions. Along with the funding provided for 100 additional positions
in fiscal year 2019, the fiscal year 2020 request will enable the SEC
to fill approximately one-third of the approximately 400 positions lost
due to the hiring freeze. The fiscal year 2020 request also includes
additional funding for information technology and cybersecurity
upgrades to build on the agency's recent work to improve our systems
and expertise. Finally, the fiscal year 2020 budget request relies on
the SEC having continued access to the Commission's Reserve Fund to
fund multi-year information technology improvements, including those
related to cybersecurity.
It is important to note that the SEC's funding is deficit-neutral.
Any amount appropriated to the agency will be offset by private sector
transaction fees. The current transaction fee rate is just over two
cents for every $1,000 in covered securities sales. In addition, the
SEC has been a net contributor to the U.S. Treasury in ways that are
not directly related to our appropriations. By law, companies pay a fee
to the SEC at the time they register securities for sale. For fiscal
year 2019, the fee rate will be set at a level sufficient to collect
$660 million. A portion of these collections will be put into the
Reserve Fund, while the remaining funds will be deposited in the
general fund of the U.S. Treasury.
For fiscal year 2020, the requested funding will enable the SEC to
execute initiatives in our new 2018-2022 Strategic Plan, including
continuing to invest in our human capital, modernizing key information
technology systems and further strengthening our cybersecurity and
enterprise risk management consistent with our multi-year information
technology strategic roadmap. Our Strategic Plan for 2018-2022 outlines
three goals that will guide the work of the SEC moving forward.\2\ We
have already made meaningful progress on each of these goals, and
importantly, our fiscal year 2020 request is calibrated to further
these initiatives in the coming year.
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\2\ See U.S. Sec. and Exch. Comm'n Strategic Plan: fiscal years
2018-2022 (Oct. 2018), available at https://www.sec.gov/strategic-plan.
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Our first goal, which has been a priority of mine since I became
Chairman, is focusing on the interests of our long-term Main Street
investors. The past year has presented many opportunities for me, my
fellow Commissioners and SEC staff to interact directly with investors
from across the country. Those discussions allowed us to better answer
the question we ask ourselves every day: how does our work benefit the
Main Street investor? Each proposal or action we take is guided by that
principle.
Our second goal--to be innovative and responsive--reflects the
changing nature of our markets. As technological advancements and
commercial developments have changed how our securities markets
operate, the SEC's ability to remain an effective regulator requires
that we continually monitor the market environment and adapt our rules,
regulations and oversight. This maxim applies to nearly every facet of
what we do at the SEC. For example, since I arrived at the SEC, these
principles have driven the establishment of a Cyber Unit in the
Division of Enforcement (Enforcement or Division), a Fixed Income
Market Structure Advisory Committee (FIMSAC), and more recently, our
new Strategic Hub for Innovation and Financial Technology (FinHub).
Our third goal--elevating the agency's performance through
technology, data analytics and human capital--embodies our commitment
to maintaining an effective and efficient operation. Maintaining a high
level of staff engagement, performance and morale is critical to our
ability to execute the SEC's mission on behalf of Main Street
investors. Our staff represents top talent in our field, and when we
recruit, we look for candidates who can match this high standard for
professional qualification and experience. We also are using
technology, analyzing data and promoting information-sharing and
collaboration across the agency to strengthen our cybersecurity and
enterprise risk profiles, while also maintaining the work environment
that has resulted in consistent high levels of employee satisfaction.
With the support of the Committee, we are committed to continued
investment in both new technology and human capital.
fiscal year 2018 review
Before I discuss our fiscal year 2020 budget request in more
detail, I would like to briefly provide an overview of our
accomplishments over the prior fiscal year (fiscal year 2018). Last
year, I noted that the near-term Regulatory Flexibility Act agenda
would be streamlined to increase transparency and accountability to the
public and Congress, as well as to provide greater clarity to our
staff, by including initiatives the agency could reasonably expect to
complete over the next 12 months. During fiscal year 2018, the
Commission advanced 23 of the 26 rules on the near-term agenda, a good
result on both a percentage basis (88 percent) and an absolute
basis.\3\
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\3\ Over the past 10 years, the Commission completed, on average,
approximately one-third of the rules listed on the near-term agenda.
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In addition, the Commission responded to major events and changes
in the broader regulatory landscape by advancing several other
initiatives not in the original agenda. For example, we issued guidance
to public companies about disclosures of cybersecurity risks and
incidents.\4\ During fiscal year 2018, the Commission also responded to
a new congressional mandate from the Economic Growth, Regulatory
Relief, and Consumer Protection Act by expanding a key registration
exemption used by non-reporting companies to issue securities pursuant
to compensatory arrangements \5\ and provided proactive relief for
those investors and companies affected by Hurricane Florence.\6\ In
addition, to facilitate more accurate, clear and timely communications
between issuers and shareholders, the staff released guidance on how to
approach near-term financial reporting questions resulting from tax law
changes on the same day the bill was signed by the President.\7\
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\4\ See Press Release 2018-22, SEC Adopts Statement and
Interpretive Guidance on Public Company Cybersecurity Disclosures (Feb.
21, 2018), available at https://www.sec.gov/news/press-
release/2018-22.
\5\ See Press Release 2018-135, SEC Adopts Final Rules and Solicits
Public Comment on Ways to Modernize Offerings Pursuant to Compensatory
Arrangements (Jul. 18, 2018), available at https://www.sec.gov/news/
press-release/2018-135.
\6\ See Press Release 2018-202, SEC Provides Regulatory Relief and
Assistance for Hurricane Victims (Sept. 19, 2018), available at https:/
/www.sec.gov/news/press-release/2018-202.
\7\ See Press Release 2017-237, Commission Staff Provides
Regulatory Guidance for Accounting Impacts of the Tax Cuts and Jobs Act
(Dec. 22, 2017), available at https://www.sec.gov/news/press-release/
2017-237.
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To be sure, statistics--such as an 88 percent completion rate--
often fail to tell more than a narrow story. Main Street investors--the
market participants we have at the forefront of our minds--will not
assess our work by the number or percentage of rules and initiatives we
complete, but rather will be looking at what our efforts substantively
do for them.
While each of these regulatory initiatives is a key component of
our agenda, I would be remiss if I did not note that a vast majority of
the work of the SEC staff goes unheralded but is critical to the
efficient functioning of our capital markets. From (1) reviewing tens
of thousands of issuer filings and disclosures to (2) providing
assistance, informal guidance and responding to daily questions from
investors, issuers and other market participants to (3) collaborating
with domestic and international counterparts to address issues related
to events such as Brexit \8\ and the pending phase out of LIBOR to (4)
the daily, dogged efforts of our investigative, litigation and
examination teams, much of the SEC's staff work is unseen by many but
nonetheless a principal component to the success of America's capital
markets.
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\8\ In addition to collaborating with domestic and international
counterparts on Brexit-related issues, I directed the SEC staff to
focus on the disclosures companies make about Brexit. We have seen a
wide range of disclosures, even within the same industry. Some
companies have fairly detailed disclosures about how Brexit may impact
them, while others simply state that Brexit presents a risk. While many
companies' disclosures improved in their most recent annual filing, I
would like to see more companies providing robust disclosure about how
management is considering Brexit, and the impact it may have on the
company and its operations, particularly the impact of a so-called
``hard Brexit.'' See also William Hinman, Applying a Principles-Based
Approach to Disclosing Complex, Uncertain and Evolving Risks (Mar. 15,
2019),
available at https://www.sec.gov/news/speech/hinman-applying-
principles-based-approach-
disclosure-031519
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With that in mind, and using the goals in our Strategic Plan as
guideposts, I would like to provide additional detail on a few of our
recent initiatives and how our fiscal year 2020 budget request will
enable the SEC and its people to further the interests of our long-term
Main Street investors.
Focusing on the Interests of Long-term Main Street Investors
I have noted that my touchstone when considering issues before the
Commission is the interests of long-term Main Street investors. The
importance of well-functioning capital markets to Main Street
investors' financial goals--whether saving for retirement, a home,
college or other endeavors--cannot be overstated. And perhaps more
importantly, Main Street investors' continued participation provides
the lifeblood for our capital markets, as at least 52 percent of U.S.
households are invested directly or indirectly in the capital
markets.\9\ This represents tens of millions of Americans who are
invested in our capital markets and make personal investment
decisions--both direct investment decisions such as which stocks,
bonds, mutual funds, ETFs and other securities to purchase or sell and
indirect investment decisions such as whether to hire a broker-dealer
or investment adviser. Many other Americans are also invested in or
exposed to our markets through pension funds, insurance products and
other intermediaries.
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\9\ Data Source: 2016 Survey of Consumer Finances (SCF). The SCF is
a triennial interview survey of U.S. families sponsored by the Board of
Governors of the Federal Reserve System with the cooperation of the
U.S. Department of the Treasury. See https://www.Federalreserve.gov/
econres/scfindex.htm.
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This level of retail investor participation stands out against
other large industrialized countries. Other countries want to replicate
it because such broad investor participation in our capital markets is
a significant competitive advantage for our economy, and participation
in our capital markets has made many Americans' lives better and their
retirements more secure. But this level of investor participation--
which has been a decades-long endeavor among investors, issuers, the
SEC and other market participants--should not be taken for granted.
Standards of Conduct for Broker-Dealers and Investment
Advisers
One of the more important ways in which we can further the
interests of our long-term Main Street investors is by enhancing and
clarifying the standards of conduct and mandated disclosures for our
two principal types of financial professionals--broker-dealers and
investment advisers. My view is these standards should reflect what
retail investors would reasonably expect of these financial
professionals, while preserving access and choice for investors who
prefer the ``pay as you go'' model for advice from a broker-dealer or a
fee-based model from an investment adviser (or a combination of both
types of arrangements), as well as preserving retail customer choice of
the level and types of advice provided and the products available. Our
standards of conduct rulemaking is years--perhaps decades--overdue, and
of significant importance to a vast number of retail investors.
In April 2018, the Commission proposed for public comment a
significant set of rulemakings and interpretations designed to serve
Main Street investors that would: (1) require broker-dealers to act in
the best interest of their retail customers; (2) reaffirm, and in some
cases clarify, the fiduciary duty owed by investment advisers to their
clients; and (3) require both broker-dealers and investment advisers to
state clearly key facts about their relationship, including their
financial incentives.\10\ This set of initiatives is intended to
enhance investor protection by bringing the legal requirements and
mandated disclosures of financial professionals in line with reasonable
investor expectations.
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\10\ See Press Release 2018-68, SEC Proposes to Enhance Protections
and Preserve Choice for Retail Investors in Their Relationships with
Investment Professionals (Apr. 18, 2018), available at https://
www.sec.gov/news/press-release/2018-68.
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Specifically, proposed Regulation Best Interest would enhance
broker-dealer standards of conduct by establishing an overarching
obligation requiring broker-dealers to act in the best interest of the
retail customer when making recommendations of any securities
transaction or investment strategy involving securities. Simply put,
under proposed Regulation Best Interest, a broker-dealer cannot put her
or his interests ahead of the retail customer's interests when making a
recommendation. The proposal incorporates that key fiduciary principle
and goes beyond and enhances the current suitability obligations
applicable to broker-dealers under the Federal securities laws. To meet
this new requirement, the broker-dealer would have to satisfy specific
disclosure, care and conflict of interest obligations, including a
requirement to adopt policies and procedures reasonably designed to
identify and disclose and mitigate, or eliminate, certain conflicts of
interest arising from financial incentives.
Proposed Regulation Best Interest and its ``best interest''
standard draw upon fiduciary principles applicable in other well-known
contexts, including those underlying an investment adviser's fiduciary
duty, recognizing that, while their client relationship models differ,
both broker-dealers and investment advisers provide recommendations and
advice in similar contexts and in the face of conflicts of interest. In
another part of our reform efforts, we proposed an interpretation
reaffirming--and, in some cases, clarifying--the fiduciary duty that
investment advisers owe to their clients. This proposed interpretation
is designed to provide advisers and their clients with a reference
point for understanding the obligations of investment advisers to their
clients and, specifically, reaffirms that an investment adviser also
must act in the best interest of her or his client.
While proposed Regulation Best Interest draws on fiduciary
principles, the obligations of a broker-dealer under Regulation Best
Interest and the obligations of an investment adviser pursuant to its
fiduciary duty under the Advisers Act would differ in certain respects,
reflecting the differing scope of the services, payment forms and other
relationship terms offered by broker-dealers and investment advisers,
respectively. For instance, aspects of the obligations applicable to
broker-dealers under proposed Regulation Best Interest are more
specific than those applicable to investment advisers and reflect the
characteristics of the generally applicable broker-dealer model--
transaction-specific recommendations and compensation.\11\
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\11\ In these specific areas, the obligations of broker-dealers
under proposed Regulation Best Interest are more prescriptive,
consistent with the generally rules-based regulatory regime that
applies to broker-dealers.
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While the generally applicable investment adviser model--ongoing,
regular advice and services provided in the context of broad investment
management with compensation based on the value of assets under
management, a fixed fee or other arrangement--differs from the
generally applicable broker-dealer model, in my view the key elements
of the standard of conduct that would apply to broker-dealers under
proposed Regulation Best Interest at the time that a recommendation is
made would be substantially similar to key elements of the standard of
conduct that applies to investment advisers pursuant to their fiduciary
duty under the Advisers Act. It is my intention that, regardless of
whether the retail customer chooses a broker-dealer or an investment
adviser, the retail customer will receive recommendations (from a
broker-dealer) or advice (from an investment adviser) that are in the
best interest of the retail customer, and that do not place the
financial professional's interests ahead of the interests of the retail
customer.
Finally, under our proposed rulemaking package, firms would be
required to provide retail investors with a new, succinct disclosure
form referred to as the ``relationship summary'' or ``Form CRS.'' As
proposed, the relationship summary would highlight key aspects of
broker-dealers and investment adviser relationships, including: (1) the
principal types of services offered; (2) the legal standards of conduct
that apply to each; (3) the fees the customer would pay; and (4)
certain conflicts of interest that may exist. It also would include key
questions for retail investors to ask their financial professional. I
believe that the relationship summary will result not only in more
informed retail investors, but also will drive competition by
facilitating transparency and comparability of these key features of a
relationship with a financial professional.
In order to hear first-hand from retail investors who will be
directly impacted by our various rulemaking efforts, the SEC staff
organized seven roundtables across the country to provide Main Street
investors the opportunity to speak directly with me, my fellow
Commissioners and senior SEC staff to tell us about their experiences
and views on what they expect from their financial professionals. I had
the opportunity to lead five of these discussions--in Houston, Atlanta,
Miami, Denver and Baltimore--and attend another in Washington, D.C.
These candid, experience-based conversations were incredibly valuable
and are informing our work moving forward. The transcripts from these
roundtables are included in our public comment file. We also invited
investors to view samples of the proposed relationship summary to share
their insights and feedback with the Commission by going to https://
www.sec.gov/tell-us. In addition, our Office of the Investor Advocate
engaged RAND Corporation to perform investor testing of the proposed
relationship summary. The results of the investor testing were made
available on the SEC's website in order to allow the public to consider
and comment on this supplemental information.\12\
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\12\ See Press Release 2018-257, Investor Testing of the Proposed
Relationship Summary for Investment Advisers and Broker-Dealers (Nov.
7, 2018), available at https://www.sec.gov/news/press-release/2018-257.
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The staff of the Division of Trading and Markets (Trading and
Markets) and the Division of Investment Management (Investment
Management) are reviewing all of this information, and the more than
6,000 comment letters,\13\ as they work diligently together to develop
final rule recommendations.
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\13\ See Comments on Proposed Rule: Regulation Best Interest,
available at https://www.sec.gov/comments/s7-07-18/s70718.htm. Of the
more than 6,000 comment letters, approximately 3,000 were unique
letters.
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Facilitating Capital Formation
Focusing on the interests of long-term Main Street investors also
requires encouraging capital formation for emerging companies seeking
to enter our public capital markets while maintaining, and in many
cases enhancing, investor protections. Doing so provides greater
investment opportunities for Main Street investors, as it is generally
difficult and expensive for them to invest in private companies. As a
result, Main Street investors may not have the opportunity to
participate in the growth phase of these companies if the companies
choose not to enter our public markets or do so only later in their
life cycle. Additionally, it is my experience that companies that go
through the SEC public registration and offering process often come out
as better companies, providing net benefits to the company, investors
and our capital markets.
Since 2017, the Division of Corporation Finance (Corporation
Finance) has led a number of regulatory actions to benefit public
company capital formation.\14\ For example, Corporation Finance now
accepts voluntary draft registration statement submissions for many
securities offerings, including for initial public offerings (IPOs) and
offerings within 1 year of an IPO, for review by the staff on a non-
public basis, building on the successful confidential submission
process established by the Jumpstart Our Business Startups (JOBS)
Act.\15\ Additionally, earlier this year the Commission issued a
proposal to expand the ability of companies that are contemplating
raising capital to ``test-the-waters'' by engaging in communications
with certain potential investors prior to or following the filing of a
registration statement for an IPO.\16\ I have seen firsthand how this
has benefitted emerging growth companies considering an IPO, as they
are able to engage investors earlier to explain their business and
obtain feedback in advance of a public offering. This also benefits
investors and shareholders as companies are better able to determine
the appropriate time for an offering and to more effectively size and
price the offering.
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\14\ See Remarks on Capital Formation at the Nashville 36|86
Entrepreneurship Festival (Aug. 29, 2018), available at https://
www.sec.gov/news/speech/speech-clayton-082918; see also Press Release
2019-38, SEC Adopts Rules to Implement FAST Act Mandate to Modernize
and Simplify Disclosure (Mar. 20, 2019), available at https://
www.sec.gov/news/press-release/2019-38.
\15\ See Press Release 2017-121, SEC's Division of Corporation
Finance Expands Popular JOBS Act Benefit to All Companies (June 29,
2017), available at https://www.sec.gov/news/press-
release/2017-121.
\16\ See Press Release 2019-14, SEC Proposes to Expand ``Test-the-
Waters'' Modernization Reform to All Issuers (Feb. 19, 2019), available
at https://www.sec.gov/news/press-release/2019-14.
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Corporation Finance has several proposals on the horizon designed
to encourage capital formation for emerging companies seeking to enter
our public capital markets. These include amending the definition of
``accelerated filer'' that triggers Section 404(b) of the Sarbanes-
Oxley Act of 2002, which requires registrants to provide an auditor
attestation report on internal control over financial reporting. This
proposal, which also builds on the success of the JOBS Act, should
reduce the number of smaller companies that are required to provide the
auditor attestation report while maintaining appropriate incentives and
safeguards to ensure that such companies have appropriate controls over
financial reporting.
Beyond our public markets, I expect the Commission to take a fresh
look at the exempt offering framework to consider whether changes
should be made to harmonize and streamline what can be fairly described
as a patchwork approach. While Congress and the SEC have taken a number
of steps to expand the options that small businesses have to raise
capital, most notably in the bipartisan JOBS Act, there has not been a
comprehensive review of our exemptive framework to ensure that the
system, as a whole, is rational, accessible and effective. The staff is
working on a concept release that I expect will bring to the forefront
these and other topics on how we can better harmonize exempt
offerings.\17\ Receiving input from investors, startups, entrepreneurs
and other market participants who have firsthand experience with
investing, raising capital and our regulatory framework is extremely
important to make sure we get it right.
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\17\ As we embark on this project, I believe there are several
things we should consider. We should evaluate the level of complexity
of our current exemptive framework for issuers and investors alike and
consider whether changes should be made to rationalize and streamline
the framework. For example, do we have overlapping exemptions that
create confusion for companies trying to navigate the most efficient
path to raise capital? Are there gaps in our framework that impact the
ability of small businesses to raise capital at key stages of their
business cycle? We also should consider whether current rules that
limit who can invest in certain offerings should be expanded to focus
on the sophistication of the investor, the amount of the investment, or
other criteria rather than just the wealth of the investor. And we
should take a look at whether more can be done to allow issuers to
transition from one exemption to another and, ultimately, to a
registered IPO, without undue friction.
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Another significant initiative for Corporation Finance and
Investment Management is improving the proxy process. In November 2018,
the SEC staff held a proxy roundtable to discuss: (1) the proxy
solicitation and voting process; (2) shareholder engagement through the
shareholder proposal process; and (3) the role of proxy advisory
firms.\18\ I was pleased with this largely solutions-oriented event,
which included a diverse group of panelists representing the views of
investors, companies and other market participants. While we heard a
wide range of views, we saw more agreement than disagreement, and I
believe that we should act to improve each of these areas with an
initial focus on the matters where there was broad agreement action is
appropriate. The staff is looking at a number of issues that were
discussed at the roundtable and submitted for public comment, and I
have asked them to formulate recommendations for the Commission's
consideration. On timing, it is clear to me that these issues will not
improve on their own with time, and I intend to move forward with the
staff recommendations, prioritizing those initiatives that are most
likely to improve the proxy process and our markets for our long-term
Main Street investors.
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\18\ See November 15, 2018: Roundtable on the Proxy Process,
available at https://www.sec.gov/proxy-roundtable-2018.
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Each of these initiatives is designed to ensure that American
businesses continue to have the ability to effectively raise capital,
while maintaining, and in some ways enhancing, investor protections.
Our fiscal year 2020 request would provide resources to Corporation
Finance to continue their efforts, including by adding a new position
to Corporation Finance to assist with new capital formation policy and
rulemaking initiatives. This would include the continuation of efforts
to consider a scaled disclosure framework for smaller companies,
disclosure modernization and simplification and anticipated
recommendations arising out of our upcoming concept release on the
exempt offering regulatory framework.
Beyond our policymaking divisions, the Commission recently acquired
a powerful voice for small businesses and their investors--our first
Advocate for Small Business Capital Formation, Martha Miller.\19\
Martha brings a wealth of experience and passion to the role and will
be a proponent for American businesses and their investors. Martha has
hit the ground running in building the office and engaging with many
small businesses and their investors, including participating in
several panels on entrepreneurship and hosting her first public town
hall in Kansas City, Missouri in April. She also released a business
plan providing insight into her office's roadmap for serving small
businesses, including traveling to areas that traditionally have
received less attention from investors.\20\
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\19\ See Press Release 2018-304, Martha Miller Named Advocate for
Small Business Capital Formation (Dec. 21, 2018), available at https://
www.sec.gov/news/press-release/2018-304.
\20\ See Office of the Advocate for Small Business Capital
Formation Foundational Business Plan (Apr. 2019), available at https://
www.sec.gov/files/2019%20OASB%20Business%20Plan.pdf
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Our fiscal year 2020 request will allow the SEC to expand the
Office of the Advocate for Small Business Capital Formation (OASB),
bringing its total staffing to nine positions so that it can pursue its
mission and provide outreach, offer assistance, identify problems and
unique challenges to raising capital for small businesses, including
minority- and women-owned small businesses and small businesses
affected by natural disasters, and give a stronger voice at the
Commission to small businesses and small business investors. The
request would also assist OASB in supporting the Advisory Committee on
Small Business Capital Formation, which is designed to solicit ideas
from a diverse group of professionals about ways to better facilitate
small business capital formation. In this regard, I am very pleased to
say that my fellow Commissioners and I recently announced the formation
of that Committee, including its inaugural members, all highly
accomplished individuals who are committed to entrepreneurship and
growth and who, collectively, provide a wide range of expertise,
experience and perspective.\21\
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\21\ See Press Release 2019-61, SEC Announces Members of Small
Business Capital Formation Advisory Committee (Apr. 25, 2019),
available at https://www.sec.gov/news/press-release/2019-61.
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Enforcing the Federal Securities Laws
The interests of long-term Main Street investors require capital
markets that are vigorously policed for fraud and other misconduct. The
ongoing efforts by Enforcement to deter misconduct and punish
securities law violators are critical to safeguarding millions of
investors and instilling confidence in the integrity of our markets.
The nature and quality of the SEC's enforcement actions during the last
year speak volumes to the hard work of the women and men of the agency
as they have made our capital markets a safer place for investors to
put their hard-earned money to work.
As noted by Enforcement's Co-Directors, Stephanie Avakian and
Steven Peikin, in the Division's Annual Report, our success is best
judged both quantitatively and qualitatively and over various periods
of time.\22\ Based on such an evaluation--and in my opinion by any
measure--Enforcement has been successful over the past year. I can
assure you that the Division will continue its vigorous enforcement of
the Federal securities laws and hold bad actors accountable, whether on
Main Street or Wall Street.
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\22\ Relevant qualitative factors include, among other things,
asking whether we are: bringing meaningful actions that target the most
serious violations, pursuing individual sanctions in appropriate cases,
obtaining punishments that deter unlawful conduct and returning money
to harmed investors. See U.S. Sec. & Exch. Comm'n, Div. of Enforcement,
Annual Report: A Look Back at fiscal year 2018 (Nov. 2, 2018),
available at https://www.sec.gov/files/enforcement-
annual-report-2018.pdf.
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To further our enforcement efforts on behalf of Main Street
investors, in September 2017, the SEC announced the formation of a
Retail Strategy Task Force (Task Force), which has two primary
objectives: (1) to develop data-driven, analytical strategies for
identifying practices in the securities markets that harm retail
investors and generating enforcement matters in these areas; and (2) to
collaborate within and beyond the SEC on retail investor advocacy and
outreach.\23\ Each of these objectives directly impacts the lives of
Main Street investors and involves collaboration among many divisions
and offices. We anticipate that new data-driven approaches will yield
significant efficiencies in case generation and resource allocation by
targeting enforcement efforts where the risks to Main Street investors
are the most significant. Although it has been operative for less than
2 years, the Task Force has already undertaken a number of lead-
generation initiatives built on the use of data analytics.
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\23\ See Press Release 2017-176, SEC Announces Enforcement
Initiatives to Combat Cyber-Based Threats and Protect Retail Investors
(Sept. 25, 2017), available at https://www.sec.gov/news/press-release/
2017-176.
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Additionally, in my view, protecting retail investors means,
whenever possible, putting money back in their pockets when they are
harmed by violations of the Federal securities laws. In fiscal year
2017 and fiscal year 2018, the Commission returned $1.07 billion and
$794 million to harmed investors, respectively. Here, I will call out
for commendation the Division's approach to the too-widespread practice
of investment advisers placing retail investors in higher cost share
classes of mutual funds when the same funds were available to those
investors at lower or no cost, without adequately disclosing the
practice or with disclosure that was inconsistent with the advisers'
actual practices. In a little over a year, the Division's approach--
which centered on self-reporting and cooperation--will result in the
return of over $125 million to retail investors.\24\ Importantly, the
resulting savings to retail investors from moving to the lower cost
share classes will continue for years to come. We remain committed to
this important Main Street investor-focused part of our work, and we
will continue our efforts to return funds to harmed investors as
promptly as practicable.
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\24\ See Press Release 2019-28, SEC Share Class Initiative
Returning More Than $125 Million to Investors (Mar. 11, 2019),
available at https://www.sec.gov/news/press-release/2019-28.
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The fiscal year 2020 request will provide critical resources to
Enforcement, allowing the Division to add six positions to expand our
capability to investigate and prosecute alleged misconduct involving
actions that affect Main Street investors. These positions will bolster
our Task Force and also provide further support to Enforcement
investigators and litigators.
Examining SEC-Registered Entities
Our examination program, executed by the Office of Compliance
Inspections and Examinations (OCIE), is another key area where our work
directly protects the interests of Main Street investors. In December
2018, OCIE published its 2019 Examination Priorities, which reflect a
continued focus on the SEC's commitment to protecting retail investors,
including seniors and those saving for retirement.\25\ In particular,
OCIE has looked closely at products and services offered to retail
investors, the disclosures they receive about those products and
services and the financial services professionals who serve them. OCIE
has also focused its attention on several other areas that present
heightened risks, including: (1) compliance and risks in critical
market infrastructure, such as exchanges and clearing agencies; (2)
digital assets, including cryptocurrencies, coins and tokens; (3)
cybersecurity; and (4) anti-money laundering programs.
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\25\ U.S. Sec. & Exch. Comm'n, Off. of Compliance Inspections and
Examinations, 2019 Nat'l Exam Program Examination Priorities (Dec. 20,
2018), available at https://www.sec.gov/files/
OCIE%202019%20Priorities.pdf.
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OCIE conducts risk-based examinations of SEC-registered entities,
including broker-dealers, investment advisers, investment companies,
municipal advisors, national securities exchanges, clearing agencies,
transfer agents and the Financial Industry Regulatory Authority
(FINRA), among others.\26\ During fiscal year 2018, OCIE conducted over
3,150 examinations, an overall increase of 11 percent from fiscal year
2017. This includes a 17 percent coverage ratio for SEC-registered
investment advisers--which increased 13 percent from fiscal year 2017,
even as the number of registered investment advisers increased by
approximately 5 percent.\27\ While OCIE will face challenges in
sustaining this trajectory in fiscal year 2019, OCIE will continue to
leverage data analysis to identify potentially problematic activities
and firms as well as to determine how best to scope the examinations of
those activities and firms.
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\26\ In conjunction with OCIE's examination activities, OCIE
published a number of risk alerts to inform SEC-registered firms and
investors of common compliance issues OCIE observed. Over the last
year, OCIE risk alerts addressed topics ranging from transfer agent
safeguarding of funds and securities to fee and expense compliance
issues for investment advisers. These alerts provide OCIE's views on
ways to sharpen the identification and correction of potentially
deficient practices, maximize the impact of our examination program and
better protect the interests of Main Street investors.
\27\ The number of investment advisers has increased from
approximately 9,000 in 2005 to over 13,000 in 2018. In addition, in
response to the Department of Labor Fiduciary Rule adopted on April 8,
2016 (vacated by the Fifth Circuit Court of Appeals in March 2018) it
was reported that the broker-dealer industry, among other things,
reduced service and advice to small retirement accounts and encouraged
retail customers to move towards self-directed accounts and advisory
accounts, including robo-advisors. The SEC will continue to monitor the
effects of this trend on investor protection and market integrity more
generally.
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The fiscal year 2020 request would allow us to restore five
positions to OCIE, enabling it to bring on additional expertise of SEC-
registered entities and continue its risk-based efforts to protect Main
Street investors.
Investor Outreach and Education
The SEC promotes informed investment decisionmaking through
education initiatives aimed at providing Main Street investors with a
better understanding of our capital markets and the opportunities and
risks associated with the array of investment choices presented to
them. The Office of Investor Education and Advocacy (OIEA) spearheads
these efforts and participation extends throughout our divisions and
offices. In fiscal year 2018, the SEC conducted over 150 in-person
investor education events focused on various segments of the investing
population, including senior citizens, military personnel, younger
investors and affinity groups. In addition to in-person education
events, OIEA developed informative, innovative and accessible
educational initiatives.
We use a variety of channels to deliver information to investors.
For example, we created a website to educate the public about frauds
involving ICOs and just how easy it is for bad actors to engineer this
type of fraud--our HoweyCoins.com mock website promoted a fictional
ICO.\28\ The website was created in-house, very quickly and with few
resources. It attracted over 100,000 people within its first week. We
also published a variety of investor alerts and bulletins to warn Main
Street investors about other possible schemes and risks for fraud,
including certain investment schemes that use celebrity endorsements,
self-directed individual retirement accounts, the risks in using credit
cards to purchase an investment and the potential harm resulting from
sharing their personal contact information with online investment
promoters.
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\28\ See Press Release 2018-88, The SEC Has an Opportunity You
Won't Want to Miss: Act Now! (May 16, 2018), available at https://
www.sec.gov/news/press-release/2018-88.
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We also continued to promote our national public service campaign,
``Before You Invest, Investor.gov,'' which encourages investors to
research the background of their financial professional. Our experience
demonstrates that working with unlicensed promoters who have a history
of misconduct greatly increases the risk of fraud and losses. In May
2018, we supplemented this information service with a new online search
tool, the SEC Action Lookup for Individuals, or SALI.\29\ This tool
enables investors to find out if the individual he or she is dealing
with has been sanctioned as a result of SEC action, for both registered
and unregistered individuals. SALI continues to be updated on an
ongoing basis, making it an ever better resource for Main Street
investors. We are encouraged by the fact that unique page views on
Investor.gov increased by 45 percent compared to fiscal year 2017.
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\29\ See Press Release 2018-78, SEC Launches Additional Investor
Protection Search Tool (May 2, 2018), available at https://www.sec.gov/
news/press-release/2018-78.
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Additionally, SEC regional offices engage in investor initiatives
in their local communities. For example, the San Francisco Regional
Office has conducted extensive outreach to California teachers through
its Teacher Investment Outreach Initiative. This project seeks to help
teachers make informed decisions on investment portfolio options, fees
and risk. Regional staff, many of whom have personal connections to the
teaching community, created this initiative in response to learning
about the limitations of the investment options (and related high fees
and costs) offered to public school teachers under the defined
contribution portion of their retirement plans.
More recently, as part of National Financial Capability Month, I
released several videos in a new series, ``Notes from the Chairman.''
\30\ These videos are based on my experiences traveling the country and
meeting with Main Street investors. In these meetings, two common and
related themes emerged, regardless of demographics and geography.
Investors wished they (1) started investing in our markets earlier and
(2) had known more about investing and financial affairs more generally
earlier. These views were universal and deeply held and, while not
entirely within the purview of the Commission to address, will continue
to resonate with me--and I will continue to work to address them--
during my tenure at the Commission.\31\
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\30\ See Tips for Main Street Investors from Chairman Jay Clayton
(Apr. 2019), available at https://www.sec.gov/page/investment-tips-
chairman-jay-clayton.
\31\ See CNBC, SEC chair Jay Clayton weighs in on America's
retirement crisis (Apr. 26, 2019), available at https://www.cnbc.com/
video/2019/04/26/sec-chair-jay-clayton-weighs-in-on-the-
americas-retirement-crisis.html (last visited Apr. 29, 2019).
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The fiscal year 2020 request would permit expanded outreach to Main
Street investors through the work of OIEA and the Office of the
Investor Advocate, and to small business owners and investors through
OASB. Further, SEC staff plans to conduct additional research to gain
deeper insight into how different types of investors participate in our
capital markets to benefit both our policymaking and investor education
efforts.
Recognize Significant Developments and Trends in Our Evolving Capital
Markets and Adjust Our Efforts to Ensure We Are Effectively
Allocating Our Resources
Overseeing the Capital Markets
As our markets continue to evolve through technological
advancements and other developments, the SEC staff must stay abreast of
these changes to ensure that all investors, including our Main Street
investors, have access to fair and efficient capital markets. Many of
our trading markets have become data and algorithm driven and are
populated by firms with extensive resources and expertise. Transparency
is a bedrock of healthy and vibrant markets. It enhances monitoring and
can energize competitive forces to benefit investors. Transparency is a
key part of our efforts to ensure fair and efficient markets,
particularly those with significant Main Street investor participation.
We have taken significant steps over the past year to make our markets
more transparent.
For example, in July 2018, the Commission adopted amendments to
Regulation ATS that enhance the transparency requirements governing
alternative trading systems, commonly known as ``ATSs.'' \32\ These
amendments provide investors, brokers and other market participants--as
well as the Commission--with increased visibility into the operations
of these important markets for equity trading. Additionally, in
November 2018, the Commission adopted amendments to Regulation NMS to
provide investors with greater transparency concerning how brokers
handle and execute customer orders.\33\ Both of these sets of
amendments will provide investors with significantly enhanced
disclosures that will impact their ability to ensure best execution for
their orders to buy and sell securities.
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\32\ See Press Release 2018-136, SEC Adopts Rules to Enhance
Transparency and Oversight of Alternative Trading Systems (July 18,
2018), available at https://www.sec.gov/news/press-release/2018-136.
\33\ See Press Release 2018-253, SEC Adopts Rules That Increase
Information Brokers Must Provide to Investors on Order Handling (Nov.
2, 2018), available at https://www.sec.gov/news/press-release/2018-253.
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Further, in December 2018, the Commission adopted a transaction fee
pilot for NMS stocks, which will provide the Commission with data to
help us analyze the effects of exchange fees and rebates on order
routing behavior, execution quality and our market structure
generally.\34\ In my view, this pilot will lead to a more thorough
understanding of these issues, which will help the Commission make more
informed and effective policy decisions in the future.
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\34\ See Press Release 2018-298, SEC Adopts Transaction Fee Pilot
for NMS Stocks (Dec. 19, 2018), available at https://www.sec.gov/news/
press-release/2018-298.
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Our fixed income markets are also critical to our economy and Main
Street investors, though, historically, less attention has been focused
on these relative to the equity markets. With large numbers of
Americans retiring every month and needing investment options, fixed
income products attract more and more Main Street investors. Yet, many
of those investors may not appreciate that fixed income products are
part of markets that differ significantly from the equity markets. In
November 2017, the Commission established the FIMSAC to provide diverse
perspectives on the structure and operations of the U.S. fixed income
markets, as well as advice and recommendations on fixed income market
structure. The Committee has held five public meetings and dozens of
subcommittee meetings and has provided the Commission with six
thoughtful recommendations on ways to improve our fixed income
markets.\35\
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\35\ See Fixed Income Market Structure Advisory Committee,
available at https://www.sec.gov/spotlight/fixed-income-advisory-
committee. FIMSAC's recommendations include the following: (1) the
development of a pilot program to delay public dissemination for 48
hours of trades in any investment grade corporate bond above $10
million and any high-yield corporate bond above $5 million (requires
FINRA rulemaking); (2) the formation of a joint SEC, FINRA and MSRB
working group to review the regulatory framework for electronic trading
platforms in corporate and municipal bonds; (3) the adoption of a
comprehensive classification scheme for exchange traded products; (4)
for the SEC to encourage the formation of an industry group to promote
investor education and work towards the establishment of a centralized
and widely accessible database of key ETF data; (5) that the SEC, in
conjunction with FINRA, establish a new issue reference data service
for corporate bonds that would be widely accessible on commercially
reasonable terms; and (6) to permit principal trading with advisory
clients in negotiated municipal securities offerings.
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Turning back to the principle of transparency, in May 2018, new
FINRA and Municipal Securities Rulemaking Board (MSRB) requirements
regarding the disclosure of mark-ups and mark-downs on certain
corporate and municipal bond trades with retail investors went into
effect, and I am pleased that investors now have substantially greater
transparency into the costs of participating in those markets. I
believe this transparency will increase competition and reduce trading
costs, all to the benefit of investors, including our Main Street
investors who directly or indirectly hold approximately two-thirds of
this market.
With respect to our security-based swap regime, the Commission has
finalized many, but not all, of the security-based swap rules mandated
by Title VII of the Dodd-Frank Act. The Commission has continued our
efforts to lay out a coherent package of rules to finalize our
statutory security-based swap rulemaking obligations, and I anticipate
making significant progress in completing this work in 2019. As part of
this effort, our staff has been actively engaged with our counterparts
at the CFTC to explore ways to further harmonize our respective
security-based swap rules with the swap rules developed by the CFTC to
increase effectiveness and reduce complexity and costs. An important
milestone of this work occurred in June 2018 when CFTC Chairman
Giancarlo and I executed a memorandum of understanding (MOU) between
our two agencies.\36\ The MOU explicitly acknowledges where we have
shared regulatory interests, including but not limited to Title VII,
and reconfirms our commitment to work together to facilitate efficient
markets for the benefit of all market participants.
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\36\ See Press Release 2018-114, SEC and CFTC Announce Approval of
New MOU (June 28, 2018), available at https://www.sec.gov/news/press-
release/2018-114.
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Staying current with market trends and developments is essential to
the SEC's ability to remain an effective regulator of our capital
markets. The fiscal year 2020 request would add four additional
positions to Trading and Markets, which regulates the major securities
market participants such as broker-dealers, transfer agents, securities
information processors, securities exchanges and clearing agencies and
oversees self-regulatory organizations such as FINRA. In particular,
these positions would enable Trading and Markets to expand its
expertise relating to fixed-income markets, Treasury markets, digital
asset markets and other asset classes, as well as provide additional
insight into trading firm operations. The request also includes one
position for the Office of Municipal Securities to address municipal
market transparency, including recommendations provided by the FIMSAC.
Finally, one of my most significant responsibilities is to
participate in the Financial Stability Oversight Council (FSOC), which
is tasked with identifying risks to the U.S. financial system. The
Commission and its leadership also participate in the Financial
Stability Board (FSB) and other international bodies. We rely
significantly on SEC staff in these efforts, and in fiscal years 2019
and 2020 I intend to add additional structure to our efforts in these
areas so that the expertise of the Commission, across our various
divisions and offices, is more effectively brought to bear in these
fora, particularly in the areas of market risk, market fragmentation,
disclosure effectiveness, audit quality and enforcement.
Improving the Investor Experience and Modernizing Our
Framework
Main Street investors have significant holdings in mutual funds and
other investment companies. In 2018, over 100 million individuals
representing over 57 million households, or almost 45 percent of U.S.
households, owned funds (generally ETFs or open ended mutual
funds).\37\ Fund disclosures are especially important to these millions
of Americans who invest in funds to help them reach personal financial
goals, such as saving for retirement and their children's educations.
Investment Management is leading a long-term project to explore
modernization of the design, delivery and content of fund disclosures
and other information for the benefit of investors. These initiatives
are an important part of how the Commission can serve investors in the
21st century.
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\37\ See ICI Research Perspective (Nov. 2018), available at https:/
/www.ici.org/pdf/per24-08.pdf.
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In June 2018, the Commission issued a request for comment on
enhancing disclosures by mutual funds, ETFs and other types of
investment companies to improve the investor experience and to help
investors make more informed investment decisions (Fund Disclosure
RFC).\38\ The Fund Disclosure RFC seeks input from retail investors and
others on how they use fund disclosures and how they believe funds can
improve disclosures to aid investment decision-making. In order to
facilitate retail investor engagement and comment on improving fund
disclosure, the Commission has provided a short Feedback Flier on
Improving Fund Disclosure, which can be viewed and submitted at
www.sec.gov/tell-us.
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\38\ See Press Release 2018-103, SEC Modernizes the Delivery of
Fund Reports and Seeks Public Feedback on Improving Fund Disclosure
(June 5, 2018), available at https://www.sec.gov/news/press-release/
2018-103.
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Investment Management also led work on the Commission's recent
proposal on offering reforms for business development companies and
registered closed-end funds.\39\ The proposed rule amendments would
implement certain provisions of the Small Business Credit Availability
Act and the Economic Growth, Regulatory Relief, and Consumer Protection
Act. By making available to these funds the communications and
prospectus delivery rules currently available to operating companies,
the proposal would improve access to capital and facilitate investor
communications by these funds.
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\39\ See Press Release 2019-39, SEC Proposes Offering Reforms for
Business Development Companies and Registered Closed-End Funds (Mar.
20, 2019), available at https://www.sec.gov/news/press-release/2019-39.
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The fiscal year 2020 request would allow Investment Management to
build on these initiatives, including by providing four additional
positions to bolster their expertise and oversight of products that
receive significant investments from Main Street investors such as
mutual funds, variable insurance products and ETFs, among other
products.
Economic Analysis and Retrospective Review of Commission
Rules
None of the efforts by our policymaking divisions and offices
discussed above, including our work with the FSOC and the FSB, would be
possible without the efforts of the economists in the Division of
Economic and Risk Analysis (DERA). I have noted that the SEC is
committed to performing rigorous economic analysis of our rules and has
done so in each of the rulemaking initiatives I have described in this
testimony and for each other major rule enacted in fiscal year 2018.
However, effective rulemaking does not end with rule adoption. Our
Strategic Plan calls for reviewing Commission rules retrospectively to
identify outdated rules that might not be functioning as intended in
modern markets.
Our fiscal year 2020 request would provide resources to hire two
additional positions in DERA to enable further robust economic analysis
and retrospective review of Commission rulemaking and allow DERA to
fully support other divisions and offices in their regulatory and
oversight responsibilities.
Evaluate the SEC's Performance by Enhancing Our Analytical Capabilities
and Human Capital Development
Cybersecurity and Information Technology
Cybersecurity and minimizing cyber risks at the SEC continue to be
top priorities, and the additional resources Congress provided in
fiscal year 2018 enabled us to upgrade our information technology
infrastructure and strengthen our cybersecurity risk profile. The SEC
and other agencies are frequent targets of attempts by threat actors
who seek to penetrate our systems, and some of those actors may be
backed by substantial resources. Recognizing the twin realities that
electronic data systems are essential to our mission and that no system
can ever be entirely safe from a cyber intrusion, it is incumbent upon
us to continue to devote substantial resources and attention to
cybersecurity, including the protection of personally identifiable
information (PII). Over the past year, we have been focused on a number
of areas for improvement, including with respect to information
technology governance and oversight, security controls, risk awareness
related to sensitive data, incident response and reliance on legacy
systems--and much work remains to be done.
A key principle as a part of our review of our cybersecurity and
enterprise risk profiles is to evaluate the data we take in, assess our
regulatory and enforcement responsibilities, and limit the scope of
that information to what is necessary to achieve those
responsibilities. In particular, we are closely scrutinizing how we can
reduce any potential exposure of PII contained in SEC systems,
including EDGAR. In this regard, in April 2018, the Commission acted to
eliminate the collection of social security numbers and dates of birth
on a number of EDGAR forms where we concluded that the information was
not necessary to our mission.\40\ Moreover, return copies of test
filings are no longer stored within the EDGAR system. Additionally, the
Commission recently implemented modified submission deadlines for
filing non-public reports for registered investment companies that will
allow the agency to receive and analyze the data while meaningfully
reducing the sensitivity of that data at the time it is
transmitted.\41\
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\40\ Amendments to Forms and Schedules To Remove Provision of
Certain Personally Identifiable Information, Rel. Nos. 33-10486, 34-
83097, IC-33077 (Apr. 24, 2018), available at https://www.sec.gov/
rules/final/2018/33-10486.pdf.
\41\ See Press Release 2019-23, SEC Modifies Timing for Filing Non-
Public Form N-PORT Data to Align with Its Approach to Data Management
and Cybersecurity (Feb. 27, 2019), available at https://www.sec.gov/
news/press-release/2019-23.
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The agency has also focused closely on its cybersecurity risk
governance structure. We recently hired a Chief Risk Officer, Gabriel
Benincasa, who will help coordinate our enterprise risk management
efforts across the agency.\42\ We have worked to promote a culture that
emphasizes the importance of data security and operational resilience
throughout our divisions and offices. The staff has also been engaging
with outside experts to assess and improve our security controls. For
example, on a technical level, these efforts include the deployment of
enhanced security capabilities, additional penetration testing and code
reviews, investment in new technologies and experienced cybersecurity
personnel and acceleration of the transition of certain legacy
information technology systems to modern platforms. We will be taking
additional actions in fiscal year 2020 to further strengthen our
cybersecurity posture. We will also continue to coordinate and partner
with other Federal agencies to identify and mitigate risks to our
information technology environment and assets.
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\42\ See Press Release 2019-24, SEC Names Gabriel Benincasa as Its
First Chief Risk Officer (Feb. 28, 2019), available at https://
www.sec.gov/news/press-release/2019-24.
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To date, the additional information technology and cybersecurity
resources Congress has provided have allowed the SEC to make
significant strides in our cybersecurity expertise and defenses. But
these challenges are continuing to evolve, as the threat actors find
new, innovative ways to carry out their attacks. As such, fiscal year
2020 will be a critical year for the agency to follow through on
strategic technology priorities, including a number of multi-year
initiatives. The fiscal year 2020 request seeks funding for information
technology and cybersecurity, including funding to hire three
additional staff positions to the Office of Information Technology to
strengthen its expertise in new technologies and expand our security
efforts against attacks by threat actors. The funding, including use of
the Reserve Fund, will also enable the SEC to continue investments to
strengthen the security of our systems and data, retire outdated legacy
systems and develop new information technology systems and analytic
tools to increase our effectiveness.
Human Capital
Returning to where I started, a critical part of our Strategic
Plan, and inherent in our fiscal year 2020 request, is investing in our
current workforce and ensuring that the SEC can continue to build
expertise in the areas most important to Main Street investors. The
quality and character of the women and men who serve American investors
in our headquarters and our 11 regional offices are the reason I am
confident that the resources Congress has provided to the SEC are well
spent. They have faced new challenges head-on with professionalism and
commitment to our shared cause. I often say that our people are our
greatest assets--this is not simply a cliche but a recognition that
without our skilled, dedicated staff, the SEC could not advance our
tripartite mission to the benefit of our Main Street investors. I
believe our fiscal year 2020 request will ensure that the SEC continues
to have a workforce known for its expertise and motivation to work for
the benefit of Main Street investors and our markets.
Leasing
One final, important component of our fiscal year 2020 budget
request is support for the leasing of office space. The SEC is
currently participating in the General Services Administration's (GSA)
competitive procurement process for a successor lease for the SEC's New
York Regional Office (NYRO) and our Washington, DC headquarters.
Currently, the GSA expects to announce a contract award for the
headquarters lease by the end of fiscal year 2019, and an announcement
for the NYRO lease award is expected in fiscal year 2020. Working
through GSA, the SEC extended the terms of the current headquarters
leases to align with the anticipated fiscal year 2024 start of the new
headquarters lease. Additionally, as the outcome of GSA's competitive
acquisition for NYRO may require moving to a new space, the fiscal year
2020 request includes funding for the planning and execution of the
movement of files, equipment and personnel from NYRO. None of these
funds would be used for the operations of the SEC, and we have proposed
appropriations language that provides a mechanism whereby any unused
portion of these funds would be refunded to fee payers, or the Treasury
general fund, depending on the source.
conclusion
Thank you again for the opportunity to testify today on our fiscal
year 2020 budget request. I greatly appreciate this Committee's support
of the SEC and stand ready to work with each of you this year to ensure
that the SEC has the resources necessary to fulfill our mission to
protect investors, maintain fair, orderly and efficient markets and
facilitate capital formation. I look forward to answering any of your
questions.
Senator Kenney. Thank you, Mr. Chairman. Chairman
Giancarlo.
STATEMENT OF J. CHRISTOPHER GIANCARLO, CHAIRMAN,
COMMODITY FUTURES TRADING COMMISSION
Mr. Giancarlo. Thank you, Chairman Kennedy, and Ranking
Member Coons, and Members of this subcommittee. Thank you for
your kind words as well.
There is indeed a strong partnership today between the SEC
and the CFTC. Early on, Chairman Clayton and I committed our
agencies to work more closely together, and it set a tone from
the top. And you can see that cooperation today in matters of
regulatory enforcement, crypto asset regulation, Dodd-Frank
rule harmonization, Clearing House oversight, disaster recovery
testing and planning, and so much more.
In fact, it is a privilege, a pleasure, and honor for the
CFTC to work alongside the dedicated professionals of the SEC.
And thank you my friend for our close cooperation and our work
on behalf of American markets. And I want to thank this
committee, the subcommittee, for its fiscal year 2019 budget
increase that you provided and for your constant support for
our agency. You know, when people think of the SEC, they think
of American markets for capital formation and investment
trends, they think of markets where investors with capital find
investors with new ideas and new products that together produce
prosperity and create jobs.
Well when people think of the CFTC, they think of futures,
options, and swaps markets known as derivatives. These are the
markets not for capital formation and capital transfer, but for
risk mitigation. They enable the transfer of business risks of
variable prices such as commodities, energy, foreign currency,
and interest rates, from those who cannot bear that risk to
those who can. And they serve the social good of moderating
price, supply, and other commercial risks that then free up
capital for job creation and economic growth. Now most
Americans do not trade in these markets, yet these markets are
the reason why consumers enjoy stable prices, not only in the
supermarkets, but in all manner of consumer finance from auto
loans to household purchases. Derivative markets are where the
price of heating in American homes is found, energy used in
factories, interest rates that borrowers pay on home mortgages,
and the returns that workers earn on their retirement savings.
American derivative markets are the world's largest, most
developed, and most influential, and they are relatively
unmatched in their depth and breadth, providing deep pools of
trading liquidity, low transaction costs, and participation by
a diverse array of global counter-parties. And while American
markets are some of the world's oldest, they are also some of
the world's fastest growing and most technologically
innovative. American markets are known to be the world's best
regulated, and the United States is the only major country in
the Organization for Economic Cooperation and Development to
have a regulatory agency specifically dedicated to derivatives
market regulation. And I believe there is a connection between
having the world's largest and most competitive derivative
markets and independent Federal regulation.
For over 40 years, the CFTC has been recognized for its
principles-based regulatory framework, and econometric-driven
analysis, and it is recognized around the world for its depth
of expertise and depth of capabilities. And I truly believe
that America's well regulated, independently regulated
derivative markets are a national advantage in global economic
competition. But to remain the best regulated U.S. derivatives
markets must have an adequately funded regulator. The CFTC must
have adequate resources to continue to serve its mission to
foster open, transparent, competitive, and financially sound
U.S. derivatives markets that are the envy of the world.
Turning to our budget, the Commission requests a total of
$315 million for fiscal year 2020. This consists of two
separate requests, the annual Commission operational funding of
$284 million, and a new request to support the relocation of
three regional offices of $31 million. The annual operational
request of $284 million will provide 707 FTEs in fiscal year
2020. And it is a $2.5 million amount above the fiscal year
2019 President's budget request and reflects an inflation rate
adjustment of less than 1 percent. This request seeks an annual
increase of $35 million above the fiscal year 2019 continuing
resolution funding level and is in line with fiscal year 2019
President's budget. The budget request of $284 million is the
level of funding necessary, I am certain, to fulfill our
statutory mission.
In closing, I am grateful for your consideration of this
budget request that we will discuss today. As it is likely my
last appearance before you, I want to say that it really has
been a pleasure and privilege to have served under this
subcommittee, and it is an honor to have been of service to the
American people and to have led the extraordinary men and women
of the U.S. Commodity Futures Trading Commission. Thank you.
[The statement follows:]
Prepared Statement of Hon. J. Christopher Giancarlo
introduction
Thank you, Chairman Kennedy, Ranking Member Coons, and Members of
the subcommittee. I appreciate the opportunity to appear before you
today, along with my fellow colleague from the Securities Exchange
Commission (SEC), Chairman Jay Clayton.
I want to start by saying thank you to all the members of this
subcommittee for supporting the work of the Commodity Futures Trading
Commission (CFTC), and for the budget increase you provided with the
enactment of the fiscal year 2019 budget.\1\
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\1\ Consolidated Appropriations Act, 2019, PL 116-6 at https://
www.congress.gov/bill/116th-
congress/house-joint-resolution/31
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I would also like to acknowledge the strong working relationship
that exists today between the SEC and CFTC. From the outset Chairman
Clayton and I recognized the need for our agencies to work more closely
together. We are doing that today in the areas of regulatory
enforcement, cyrptoasset regulation, Dodd-Frank rule harmonization,
clearinghouse oversight, disaster recovery testing and resolution
planning and so much more. It has been a privilege, a pleasure and an
honor to work alongside him and the fine men and women of the SEC. I
thank Chairman Clayton for being a good partner and trusted colleague
in the challenging roles that we serve.
As you know, the CFTC oversees the futures, options and swaps
markets. While most Americans do not actively participate in these
markets, businesses of all sizes use the derivatives markets to manage
commercial and market risk. These markets are one reason why American
consumers enjoy stable prices, not only in the supermarket, but in all
manner of consumer finance from auto loans to household purchases.
Derivatives markets influence the price and availability of heating in
American homes, the energy used in factories, the interest rates
borrowers pay on home mortgages, and the returns workers earn on their
retirement savings.
Today, American derivatives markets are the world's largest, most
developed, and most influential. They are relatively unmatched in their
depth and breadth, providing deep pools of trading liquidity, low
transaction costs and friction and participation by a diverse array of
global counterparties. They are also some of the world's fastest
growing and technologically innovative.
American derivatives markets are also the world's best regulated.
The United States is the only major country in the Organization for
Economic Co-operation and Development to have a regulatory agency
specifically dedicated to derivatives market regulation: the CFTC.
There is a connection between having the world's most competitive
derivatives markets and independent Federal regulation. For over 40
years, the CFTC has been recognized for its principles-based regulatory
framework and econometrically-driven analysis. The CFTC is respected
around the world for its depth of expertise and breadth of capability.
The combination of regulatory expertise and competency is one of
the reasons why derivatives markets continue to serve the global need
to hedge price and supply risk safely and efficiently. It is why well-
regulated U.S. derivatives markets, by allowing low-cost and effective
hedging, are of great benefit to American producers and consumers and
to the rest of the world.
In short, America's well-regulated derivatives markets are a
national advantage in global economic competition. However, we must not
take this advantage for granted. In order for U.S. derivatives markets
to remain the world's best, U.S. markets must remain the world's best
regulated. To be the best regulated, U.S. derivatives markets must have
an adequately funded regulator. The CFTC must have adequate resources
to continue to serve its mission to foster open, transparent,
competitive, and financially sound U.S. derivatives markets that remain
the envy of the world.
It was 5 years ago this month that I first testified before the
Senate Agriculture Committee concerning my nomination to serve on the
Commission. I knew that if confirmed, I would bridge the last years of
the Obama administration and the early years of the new administration.
In 2017, as Chairman of the Commission, I set out my agenda for moving
the Agency forward. I pledged to make sure that our derivatives markets
performed their essential role moderating price, supply and other
commercial risks--shifting risk to those who can best bear it from
those who cannot. I said that our markets should be neither the least
nor the most prescriptively regulated--but the BEST regulated--
balancing market oversight, health and vitality. To do that, we would
follow a three-part agenda: completing unfinished business of the past,
improving current operations, and preparing for the future, what I call
becoming a 21st Century digital regulator.
I believe the budget request for fiscal year 2020 supports this
agenda.
budget request
The Commission is requesting a total of $315.0 million for fiscal
year 2020. This budget request consists of two separate requests, the
annual Commission operational funding of $284.0 million and a new
request to support the relocation of three regional offices of $31.0
million. The annual operational request of $284.0 million will provide
707 FTE in fiscal year 2020; this request is $2.5 million above the
fiscal year 2019 President's Budget Request \2\ and represents an
inflationary adjustment of less than 1 percent. This request seeks an
annual increase of $35.0 million above the fiscal year 2019 Continuing
Resolution funding level and is in line with the fiscal year 2019
President's Budget.
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\2\ Commodity Futures Trading Commission, fiscal year 2019
President's Budget, February 2018, at: https://www.cftc.gov/About/
CFTCReports/cftcreports_historical.html
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The budget request of $284 million is the level of funding
necessary to fulfill the CFTC's statutory mission.
21st century regulator
I have frequently talked about transforming the CFTC into a 21st
Century regulator amidst today's increasingly digital and algorithmic
markets. I recently identified several factors that are challenging the
work of regulators: the extraordinary pace of exponential technological
change, the disintermediation of traditional actors and business
models, and the need for technological literacy and big data
capability.
I said that the CFTC's response to rapidly changing markets and
technological developments, including blockchain technology and
cryptocurrencies, is built upon the following four cornerstones:
--Adopting an ``exponential growth mindset'' that anticipates the
rapid pace of technological innovation and the need for
appropriate regulatory response;
--Becoming a ``quantitative regulator'' able to conduct independent
market data analysis across different data sources, including
decentralized blockchains and networks, without being reliant
on self-regulatory organizations and market intermediaries;
--Embracing ``market-based solutions'' to determine the value of
technological innovations, as we witnessed with the launch of
crypto-asset-based futures products; and
--Establishing an internal FinTech Stakeholder to address the
opportunities and challenges that FinTech presents and manage
the ever-present tension between innovation and regulation.
For us, that stakeholder is LabCFTC, which was launched almost 2
years ago. In that time, it has had over 250 separate interactions with
innovators big and small. It has offices in New York City. It conducts
``lab hours'' in places where innovators work: from Silicon Valley,
California to Silicon Hills, Texas and from the South Bank of London to
Singapore Center. LabCFTC is not a ``sandbox.'' It does not try to pick
winners from losers, nor does it exempt firms from CFTC rules.
Instead, LabCFTC provides us both an internal and external
technological focus. Internally, it means explaining technology
innovation to agency staff and other regulators and advocating for
technology adoption. Externally, that means reaching out and learning
about technological change and market evolution, while providing a
dedicated liaison to innovators. It has entered into FinTech
cooperation agreements with regulators in London, Singapore and
Australia. It has published well-regarded technology primers and
requests for comments. I am proud to say that LabCFTC has become a
category leader. Every U.S. Federal financial regulator has either
created or is creating a program similar to LabCFTC.
economic modeling and econometric capabilities
The fiscal year 2020 budget request will continue to allow the
agency to expand its core economic expertise in order to conduct in-
depth analytical and empirical studies of issues affecting all areas of
Commission and regulatory interest. It will allow the Commission to
address the large volumes of data collected as a result of the Dodd-
Frank Act. The resulting work will further enhance the Commission's
understanding of market risk or systemic risk and derivatives market
structure and participants, including end users, intermediaries, and
traders, and connections between futures, cleared swaps, and uncleared
swaps.
Improved economic and econometric analysis will improve the
analytical and empirical foundations of the Commission's policies and
rules and better inform its cost-benefit considerations. Furthermore,
this request will enable the Commission to provide more of its analysis
to the public in the form of white papers on topics of current
interest, as well as recurring reports on aggregate market trends,
trading activity, and positions, and high-quality research papers on
fundamental properties of relevant markets and sectors of market
participants.
cyber security
As market leaders and regulators, we must continue to take every
step possible to thwart cyber-attacks that have become a continuous
threat to U.S. financial markets. With the fiscal year 2020 budget
request, the Commission plans to strength cybersecurity and network
defenses, support the LabCFTC 2.0 initiative, and invest in the
agency's multi-year cloud strategy.
The Commission seeks new IT security resources to continue progress
towards achieving compliance with Federal Information Security
Management Act (FISMA) and related Office of Management and Budget
(OMB) security mandates and ensuring the protection of sensitive market
participant data.
The same vulnerabilities hold true in the case of futures
commission merchants where customer accounts hold records and
information that requires protection. We as an agency will work hard to
ensure that regulated entities live up to their responsibility to
ensure their IT systems are adequately protected from attacks and
customers are protected.
agency reform and the kiss project
Two years ago, I announced the launch of Project KISS. It stands
for ``Keep It Simple Stupid.'' It is an agency-wide review of CFTC
rules, regulations and practices to make them simpler, less burdensome
and less costly. It has resulted in a range of rule and process
improvements that are reducing regulatory costs and burdens.\3\ Many
KISS initiatives were recommended by market participants, but many were
also initiated by our own agency staff that saw ways to reduce undue
obligations on registrants and market participants. There are still
more Project KISS initiatives in the pipeline. It is my belief that
this effort should continue upon my departure and be a regular part of
the agency's mission.
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\3\ Michael Gill, Chief of Staff, U.S. Comm. Fut. Trading Comm'n,
Remarks at the National Press Club, CFTC KISS Policy Forum, Washington,
D.C. (Feb. 12, 2018), available at https://www.cftc.gov/PressRoom/
SpeechesTestimony/opagill2.
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dodd frank rulemaking
The Commission has made progress on completion of its critical
Dodd-Frank Act rule making. On November 5, 2018 a five-Member
Commission voted unanimously on the threshold for swap dealer de
minimis to provide the market with certainty that the threshold will
not fall from $8 billion to $3 billion.\4\
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\4\ ``Commission Approves a Final Rule on Swap Dealer De Minimis
Exception'', November 5, 2018, at: https://www.cftc.gov/PressRoom/
Events/opaeventstaffmeeting110518.
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In addition, all five Commissioners have committed to Congress to
move forward with a final position limits rule. I believe the final
rule must be responsive to the public comments and ensure that
regulatory barriers do not stand in the way of long standing hedging
practices of American farmers, ranchers, producers and manufacturers,
who depend on our markets. I intend to put forth such a position limits
rule proposal before I leave the Commission.
sef reforms
The CFTC's implementation of its swaps trading rules has long been
a concern of mine. I believe the current framework is inconsistent with
the Dodd-Frank Act by being too prescriptive, too burdensome and too
modeled on futures markets. The framework is also highly subjective and
overly reliant on a series of no-action letters, staff interpretations
and temporary regulatory forbearance that may change at any time.
That is why, last November, the Commission issued a proposed rule
to amend the SEF regulations and the trade execution requirement and a
request for comment on the practice of ``post-trade name give-up.'' \5\
I believe there are two crucial reasons to improve the SEF rules: risk
and opportunity. The impermanence of the current SEF rule framework
poses risk for market participants. At any time staff may well change
or withdraw the numerous interpretations, guidance and compliance
expectations that underpin the current framework. Moreover, the current
restrictions on methods of execution may turn out to be, by themselves,
a source of trading risk during a liquidity crisis--when swaps
counterparties need to be found through less prescriptive and more
flexible means of execution.
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\5\ Federal Register, November 30, 2018, at: https://
www.Federalregister.gov/documents/2018/11/30/2018-24643/posttrade-name-
give-up-on-swap-execution-facilities.
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On the other hand, improving the SEF rules presents opportunity--
opportunity for service innovation by existing and new market entrants
that has waned under the current framework. It is the opportunity to
boldly create a regulatory framework that actually fosters innovation,
entrepreneurship, competition and increased market vibrancy rather than
stifle it. Improving the SEF rules also increases the chance that the
SEC will draw on the new framework in whole or in part for their
security-based SEF regime. It would create a common U.S. regulatory
approach for all swaps products, reducing operational and compliance
costs and risks.
I do not support merely tinkering with the current SEF rules to fix
their most glaring shortcomings or perpetuating the many no action
letters and staff guidance on which they rely. Such a step would be
unworthy of the regulator of the world's most vital derivatives
markets. Instead, the agency must not be afraid to build a better and
more durable regulatory framework for swaps execution that encourages
the return of innovation and new service offerings and supports vibrant
markets and broad-based prosperity for a generation or more.
increased examinations of clearinghouses
Fully funding the CFTC at the fiscal year 2020 levels will support
the agency's oversight of clearinghouses. The agency's work to conduct
regular examinations, in concert with the Commission's surveillance and
other functions, is a highly effective method to maintain market
integrity so that American businesses can rely on these markets. The
Commission leverages resources by conducting joint examinations across
Commission divisions, and through coordinated examinations with the
Federal Reserve and the Securities and Exchange Commission, where
possible. This effort allows the Commission to be more efficient with
its limited resources and at the same time, reduce burdens for dual
registrants.
In addition, examinations of DCOs help the Commission identify
issues that may affect a clearinghouse's ability to control and monitor
its risks. These are among the most important examinations that the
Commission conducts, as clearinghouses have become critical single
points of risk in the global financial system. Furthermore, the number
of clearinghouses, the scope and complexity of the examination issues
and the importance of these examinations to overall financial stability
are all increasing.
In addition to U.S. clearinghouses, the Commission regulates six
registered non-U.S. clearinghouses, and has limited oversight of four
non-U.S. clearinghouses exempt from registration. The Commission
anticipates new applications for DCO registration resulting from the
explosion of interest in crypto currencies; an area in which protection
of the crypto currencies will be one of the highest risks.
The Commission has an active, data-driven daily risk surveillance
function, and expects to continue investing additional resources on
human capital, data, and technology to improve our current analytical
capabilities to keep up with growth in both the scale and complexity of
risk transmission in the derivatives markets.
Given the emphasis of G-20 and Dodd Frank reform efforts on central
clearing as a critical tool to help mitigate systemic risk in the
global financial markets, the Commission expects to grow our stress
testing program to help ensure that the clearing eco-system continues
to be resilient to absorb both market and systemic shocks.
effective international engagement
Recently, the CFTC along with the Bank of England and the Financial
Conduct Authority (FCA), with support from Her Majesty's Treasury,
issued a joint statement providing assurances to market participants on
the continuity of derivatives trading and clearing activities between
the UK and U.S. regardless of the outcome of the UK's withdrawal from
the EU.\6\ Together, the four authorities are taking measures to avoid
regulatory uncertainty about the continuation of derivatives market
activity between the UK and U.S. These measures should give confidence
to market participants about their ability to trade and manage risk
across the Atlantic. It is a great credit to the decades-long
cooperation between the CFTC and the Bank of England, FCA, and HM
Treasury, that we are able to work together to take these steps.
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\6\ ``Joint Statement by UK and US Authorities on Continuity of
Derivatives Trading and Clearing Post-Brexit'', February 25, 2019, at
https://www.cftc.gov/PressRoom/PressReleases/7876-19.
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It is critical that the CFTC continues to work positively with its
overseas regulatory counterparts, not just in the UK, but in all
financial centers. I am a firm believer that by working together with
my regulatory counterparts across the globe, in a cooperative spirit,
we can strengthen our economies while keeping our financial system
resilient and stable. That is why the afternoon after the CFTC-UK
announcement; I traveled to Brussels to meet with European Commission
Vice President Valdis Dombrovskis and Director-General Olivier Guersent
to discuss how to broaden cooperation between the CFTC and the EC.
In addition, I am proud to report that we achieved a significant
milestone on March 13, 2019 as the CFTC and the Monetary Authority of
Singapore announced the mutual recognition of swaps trading venues in
our respective jurisdictions.\7\ In this regard, the CFTC exempted
certain Singapore trading venues from the SEF registration
requirements. This exemption reduces the burdens associated with
duplicative and overlapping regulations, mitigates market
fragmentation, enables U.S. market participants to access Singaporean
markets to manage risks effectively, and enhances cross-border business
opportunities for both U.S. and Singaporean firms.
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\7\ ``Joint Statement of the CFTC and the Monetary Authority of
Singapore Regarding the Mutual Recognition of Certain Derivatives
Trading Venues in the United States and Singapore, March 13, 2019, at:
https://www.cftc.gov/PressRoom/PressReleases/7887-19.
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Recently, EU co-legislators reached a political agreement on the
new amendments to the European Market Infrastructure Regulation (EMIR
2.2) pertaining to the regulation and supervision of central
counterparties (CCPs). To mark this occasion, I issued two statements:
a joint statement with Valdis Dombrovskis (Dombrovskis), the Vice-
President of the European Commission (EC), and a separate statement as
Chair of the CFTC. The statements publically affirm that the CFTC's
concerns regarding the potential adverse impact EMIR 2.2 on U.S. CCPs
and the broader U.S. financial markets remain a significant issue for
the U.S. and it is our expectation, that EU authorities will address
our concerns during the EMIR 2.2 legislative process.
The joint statement with Dombrovskis asserts that the CFTC will
continue to engage with EU authorities on EMIR 2.2 through the next
phase of the legislative process, the drafting of the implementation
regulations (the Level 2 process), and that the EC will consider the
CFTC's concerns during this Level 2 process. It also states that it is
the expectation of the EC and the CFTC that the implementation of EMIR
2.2, along with the CFTC's on-going review of its cross-border regime,
will result in a future transatlantic relationship between the EU and
the CFTC, which will be based on greater deference than there is now.
In my separate statement, I reaffirm my understanding that although
the application of EMIR 2.2 to U.S. CCPs is not likely to occur until
2020 or beyond, EU authorities, including the EC and the European
Securities and Markets Authority (ESMA), will work with the CFTC to
address U.S. concerns during the legislative process. Further, I state
that the starting point for any future recognition assessment of U.S.
CCPs must be the current 2016 Equivalence Decision.
These statements taken together are meant to provide market
participants who transact in both U.S. and EU markets assures that the
CFTC and the EC will continue to work through our differences to
mitigate the impact of unnecessary regulatory and supervisory burdens,
and to foster economic growth and stability for our global CCPs.
Six months ago, I released a White Paper on cross-border swaps
regulation that proposed updating the agency's current cross-border
application of its swaps regime with a rule-based framework based on
regulatory deference to third-country regulatory jurisdictions that
have adopted the G-20 swaps reforms.\8\ As our regulatory counterparts
continue to implement swaps reforms in their markets, it is critical
that we make sure our rules do not conflict and fragment the global
marketplace. That is why I believe the CFTC should move to a flexible,
outcomes-based approach for cross-border equivalence and substituted
compliance and operate on the basis of comity, not uniformity, with
overseas regulators.
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\8\ ``Chairman Giancarlo Releases Cross-Border White Paper'',
October 1, 2018 at: https://www.cftc.gov/PressRoom/PressReleases/7817-
18.
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Before I leave the Commission, I intend to put forward a rule
proposal to address the registration of non-U.S. CCPs clearing swaps
for U.S. persons. I also intend to put forth a rule proposal addressing
the registration and regulation of non-U.S. swap dealers and major swap
participants. In particular, the proposal will address the risk that
non-U.S. swap dealing activity poses to the United States, but do so in
a way that does not apply the swap dealer rules extraterritorially
without sufficient consideration of whether the activity truly poses a
``direct and significant'' risk to the U.S. financial system, as
Congress intended.
enforcement
The fiscal year 2020 budget request will allow the Commission to
continue its strong record on enforcement and oversight of the
derivatives markets to ensure they operate free of fraud, manipulation,
and other trading abuses.
Two years ago, I issued a warning to those who may seek to cheat or
manipulate our markets that they would face aggressive and assertive
enforcement action by the CFTC. I pledged there would be no pause, let
up or reduction in our enforcement of the law and punishment of
wrongdoing.
During my watch, the CFTC has been resolute in holding market
participants to the highest standards of behavior. In fact, by any
measure, enforcement has been among the most vigorous in the history of
the CFTC, including more enforcement actions, more penalties, more
large-scale matters, more accountability, more partnering with criminal
law enforcement and more whistleblower awards than in prior
years.highest standards of behavior. In fact, by any measure,
enforcement has been among the most vigorous in the history of the
CFTC, including more enforcement actions, more penalties, more large-
scale matters, more accountability, more partnering with criminal law
enforcement and more whistleblower awards than in prior years.highest
standards of behavior. In fact, by any measure, enforcement has been
among the most vigorous in the history of the CFTC, including more
enforcement actions, more penalties, more large-scale matters, more
accountability, more partnering with criminal law enforcement and more
whistleblower awards than in prior years.\9\
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\9\ See, generally, ``Regulatory Enforcement & Healthy Markets:
Perfect Together!'', Remarks of Chairman J. Christopher Giancarlo at
Economic Club of Minnesota, October 2, 2018, Minneapolis, Minnesota,
at: https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo56.
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The Commission has strengthened its rules and procedures to better
protect whistleblowers, brought new impactful enforcement cases, and
successfully resolved other important enforcement cases. In addition,
enforcement resources have been enhanced through the internal
realignment of the Market Surveillance Branch in 2017 to report
directly to the Director of Enforcement. This is one of several actions
the Commission has taken to better utilize resources across the
Commission.
At the same time, I have strived to make sure CFTC enforcement
staff is committed to providing incentives for companies and
individuals to engage in ethical corporate behavior--to develop a true
culture of compliance, to do the right thing. The cooperation and self-
reporting policies issued by the Division make clear that companies and
individuals could receive a recommendation for a Commission reduction
in penalty if they fully cooperate with enforcement investigations,
timely remediate, and, most importantly, self-report misconduct before
the Commission learns about it.
To better encourage compliance, the Division recently issued an
advisory on cooperation and self-reporting concerning foreign corrupt
practices. As noted in remarks accompanying the advisory, James
McDonald, the Commission's enforcement director, made clear that if a
company or individual not registered (or required to be registered)
with the CFTC timely self-reports a violation of the CEA involving
foreign corrupt practices, fully cooperates, and appropriately
remediates, the Division will apply a presumption, absent aggravating
circumstances, that it will not recommend a civil monetary penalty.\10\
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\10\ ``Speech of James McDonald, Director of the Division of
Enforcement Commodity Futures Trading Commission Regarding Perspectives
on Enforcement: Self-Reporting and Cooperation at the CFTC'', September
25, 2017 at: https://www.cftc.gov/PressRoom/SpeechesTestimony/
opamcdonald092517
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Before I entered government service, I spent a decade and a half
working on Wall Street. My commitment to transparent examination
practices and robust regulatory enforcement derives from that
experience. It is the duty of government generally and the particular
mission of the CFTC to fairly enforce market regulation and prosecute
bad actors. We fulfill that mission so that America's financial markets
are places for good people to fulfill their dreams, grow the economy
and increase prosperity.
agricultural commodity futures
Under my leadership at the Commission, we have refocused our
attention on agricultural commodity futures, the agency's traditional
foundation.
During almost 5 years on the Commission, I have travelled the
country and visited agriculture producers in over two dozen States from
Montana, Texas, Arkansas, Louisiana and Iowa to Minnesota, Missouri,
New York, Georgia, Mississippi and Oklahoma. I have walked in wheat
fields and harvested soybeans, tramped through rice farms and beneath
pecan groves, milked dairy cows and toured feedlots, visited grain
elevators and viewed cotton gins. I have also met with our energy
producers, going 900 feet underground in a Kentucky coal mine and 90
feet in the air on a North Dakota oil rig. Throughout, I have been
moved by the diverse beauty of this country. I have come to love its
hard-working families producing food and energy from this abundant
land. These visits have been a great privilege for me.
This year in Kansas, we held the CFTC's second annual agricultural
futures conference along with Kansas State University.\11\ Panelists
discussed current macro-economic trends and issues affecting our
markets, such as market speculation, algorithmic trading, trade data
transparency, novel hedging practices and market manipulation. Our
common purpose was to hear from end users who use our markets to hedge
risk and consider and address issues of emerging market structure and
trading practices.
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\11\ 2nd Annual Agriculture Commodity Futures Conference, April 11-
12, 2019, at: https://www.k-state.edu/riskmanagement/conference1.html.
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We also hosted a CFTC Agricultural Advisory Committee meeting in
Kansas where panelists discussed the future of Futures Commission
Merchants (FCM) and cash market innovations, as well as the evolution
of electronic trading in agricultural markets, both very timely and
important topics. I believe this was the first ever CFTC advisory
committee meeting held outside of Washington with all five
Commissioners in attendance.
conclusion
Looking to the past, I will be pleased that I have furthered and
confirmed much of the Dodd-Frank mandate for swaps. Where I have
identified flaws in implementation, I have proposed comprehensive
solutions. In my view, now is the time to create better frameworks that
are more flexible, more durable and more supportive of deep and liquid
markets, in good times and in bad.
As for the present, I have tried to do what my parents taught me--
to leave any place I visit in a better condition than I found it:
better run, better funded, more transparent, more accountable and more
efficient in its vital mission overseeing American markets.
As for the future, I will be satisfied that I have raised the
profile and reputation of the CFTC and set it on a course for the
digital Twenty-First Century. So much is changing, and changing rapidly
in our commodity derivatives markets. As market regulators, we are
ready to listen, and we are working to understand. And, we will be
dogged. The greater the pace of change, the greater must be our
capacity to keep pace, understand and harness it.
The CFTC is well along the course of that new direction set 2 years
ago--a course that is sustainable and true.
Thank you for a privilege to speak to you today. It has been my
honor to serve you, our dynamic markets and the American people.
Senator Kennedy. Thank you, Mr. Chairman. Let me begin with
a request to each of you. I think you have to talk to your
colleagues about this and put together the information, but I
am interested in knowing, and I am going to ask this of all of
the agencies and departments that we fund, if you have any
vendors with which or with whom you do business who have an
unpaid final judgement against them for taxes. Could you check
that for me? I am not saying we have a problem at your
agencies, but we seem to have a problem across the Federal
Government in that regard and I would like to look into it.
[The information follows:]
All of our payments to vendors are checked against a list
maintained by Treasury of any company or vendor that owes the
government funds, and if there is one, the amount paid to the vendor
from CFTC funds is reduced by their liability to the Federal
Government.
Let me start with Jay, Chairman Clayton. As you know, Mr.
Chairman, Senator Warner and I have a bill that would allow the
SEC to seek disgorgement as a remedy and create a new authority
for restitution for violations of Securities laws. Tell me
about the issue with respect to disgorgement and your ability
to enforce the law.
Chairman Clayton. So, there was a recent Supreme Court case
where the Supreme Court said that our current authority with
regard to disgorgement was subject to a 5-year statute of
limitations. Now, in a number of instances, that is probably
correct. You know, statutes of limitations have value but there
are some instances, in particular Ponzi schemes, well-concealed
frauds where that type of statute of limitations, and we have
the numbers that show this, impact our ability to get people
their money back.
A cut-off of 5 years, you could say in some way, rewards a
well-concealed fraud. I do not like that, and I very much would
like us to have the power to get people their money back. In
many cases, like one that we have talked about, the Stanford
Ponzi scheme--these are ordinary people who need our help to
get their money back.
Senator Kennedy. Okay. So, you would be supportive of the
legislation by Senator Warner and me?
Chairman Clayton. Let me be direct, yes.
Senator Kennedy. Okay. Alright. Thank you for that. Let us
talk about Stanford for a second. Last month we marked the 10th
year anniversary of the Stanford Ponzi scheme, the second
largest, unfortunately, that we have sustained. Most of the
investors, as you know Mr. Chairman, were Mom-and-Pop investors
that could not afford to lose the money. I know you have
emphasized main street investors and protection of them in your
work at the SEC. What role, if any, does the SEC have in
overseeing the fees charged by the receiver? The fees are up to
$224 million, and I do not want to begrudge anybody of a living
wage, but they haven't recovered as much as I had hoped.
Chairman Clayton. Let me say this. We have a role here that
I think is pretty broad. There are a lot of other cooks in the
kitchen and responsible people including the court that is
overseeing the receivership and how this takes place, but
again, in the interest of being clear and perhaps too blunt,
the outcome here is unacceptable. And you know, you have
situations where people clearly take risks. I mentioned and
maybe we will talk about ICOs. You use your credit card to buy
some offshore ICO outside the United States on the back an
Internet empty promise. Hopefully you know you are taking the
risk.
The Stanford victims were not at all in that situation.
There were all the indications of a well-thought-out,
legitimate, secure investment, including lots of large
institutions and government agencies in the mix, yet their
recovery is anemic. We should learn from that at the very
least.
Senator Kennedy. Well, I know the SEC has been very
supportive. We had hoped that the SPSC would cover these
losses. I know the SEC filed a suit to try to get a judgment to
that effect. You lost, we lost. I don't want to imply that the
SEC has not been very cooperative. You have, but I will be
having some conversations with you about what we can do to
review some of the fees being charged and to help us recover as
much of this money as we can. I did not mean to imply by my
question that the SEC had not been with us all the way because
I know we have talked about it and you have been very
supportive.
Senator Coons.
Senator Coons. Thank you, Chairman Kennedy. Let me ask a
couple of questions about some broader issues, if I might.
Chairman Clayton, FASB, the Financial Accounting Standards
Board, has issued a new accounting standard for calculating
expected losses, commonly referred to as the CECL (Current
Expected Credit Loss) standard. Has the SEC analyzed the
potential impact of the standard more broadly on the financial
sector and then more specifically for small businesses and
consumers? And if not, do you think you have the relevant
expertise and jurisdiction to conduct an informative study
about the potential impact of the CECL standard?
Chairman Clayton. So the CECL standard has been
particularly a recent subject of a fair amount of debate and I
have met with a number of people who have concerns. I think the
principal concerns of the standard are the potential economic
and other impacts of it and the cost of implementing it. To our
larger banks, I think that cost is not material given the way
they already run their systems and the like. For our less
large, and mid-sized, and smaller banks that is an issue.
The second issue is whether implementing CECL, an
accounting standard, is going to increase capital requirements
which is often a bank's regulatory standard and whether that
will have an impact on the ability of banks to lend and
otherwise affect their balance. And the third is a dynamic
effect, and that, is given that this is an adjustment you do
about expected losses, as economic conditions worsen you
generally want people to continue to lend. And will this type
of accounting treatment cause people to actually pull back from
lending at the very time when we might want them to lend?
So, we have analyzed that, but I should say that, unlike
some of the other self-regulatory organizations, our oversight
of FASB does not include reviewing and approving their rules.
But what I will say is I have encouraged the FASB and I have
encouraged the participants to continue to engage in those type
of topics that I just outlined, and to think about ways that we
can make sure that larger banks, mid-sized banks, smaller
banks, we are taking into account those size considerations as
we implement and analyze the rule. And continued engagement
around this is important.
Senator Coons. Thank you, Mr. Chairman. I think sharing
that analysis, the points, some of the SEC's significant
analytical capabilities around the implementation of this will
be important because I think there is a lot of concern about
exactly the impacts you discussed. Let me turn if I could to
Chairman Giancarlo about cryptocurrencies, and you may both
want to speak to this. But your budget request includes $4.2
million for the Division of Clearing and Risk to expand
examination, specifically into virtual currencies. Could you
talk about the unique challenges of regulating an emerging
market like virtual currencies, and the potential risks CFTC
will be working to mitigate?
VIRTUAL CURRENCY REGULATION
Mr. Giancarlo. Let me clarify that amount. Our Division of
Clearing and Risk goes beyond just--they monitor all clearing
houses. So, clearing house supervision is an important part of
putting the swaps market into a cleared infrastructure under
the Dodd-Frank Act. The demands on us as a derivatives clearing
house regulator have grown, and so we are looking for resources
to make sure that our capabilities, what I call our preventive
approach, which is to make sure that if there is a problem in a
clearing house, we see it before it becomes a market-based
problem, is an important component there and in all areas.
The challenge of cryptos is that for the cash-end of that
market--it is the wrong word to use cash, right--the spot-end
of that market, we do not have jurisdiction over that except
for fraud and manipulation. So, our standards by which
derivatives clearing houses must operate, the reporting
requirements, the oversight, and the very thing you mentioned,
the examinations, we do not get to do in these spot crypto
exchanges, only if there is fraud and manipulation that results
an impact to the derivatives market, of which as you know there
is now a Bitcoin future. And so, for those exchanges, their
price point determines the future's price point. We watch that
very closely for fraud and manipulation, but neither the CFTC
nor the SEC for non ICOs have actual exchange authority.
And so, as Chairman Clayton noted, it is very much a buyer
beware situation, and we work very hard individually and
collectively. In fact, our two agencies 10 days ago issued a
joint warning to investors to beware of the siren song of spot
exchanges for cryptos and promises so that we make market
participants aware because we are not there managing them and
setting our regulations around how those exchange, those spot
exchanges operate.
Senator Coons. Chairman Clayton, do you want to add
anything to the question of cryptocurrency regulation?
Chairman Clayton. If you don't mind because I never miss an
opportunity to say this, if you are looking at the quotes of
stocks on one of our major exchanges and then you are looking
at the quotes of a cryptocurrency on an offshore exchange, if
you think those two are anything similar, you are wrong. We
have all sorts of protections on trading. We have all sorts of
abilities to audit and look into forensic analysis about
whether somebody was manipulating or not and they have to have
capital, they have to have--over there, nothing. Those trades
could be fictitious. We would not know, and we can't do
anything about it.
Senator Coons. Thank you. Mr. Chairman.
Senator Kennedy. Chairman Giancarlo, you are going to be
you are asking for $31 million for relocation costs. You are
moving some of your regional offices. Tell me about that.
LEASING ISSUE
Mr. Giancarlo. Yes. So, we have to relocate our offices in
Kansas City, Chicago, and New York. Those offices, their term
lease, is coming to an end, but they were also opened, several
chairmen ago by the CFTC acting unilaterally and not through
the GSA. And subsequent to that was a determination that that
was a violation and that we must work through the GSA. I have
decided to embrace that new relationship, which we have with
the GSA and work very closely with them.
In fact, I have instructed my team, we are not only going
to work well with the GSA, we are going to be their number one
client. And we have been, and it is working very well. We have
now identified space in New York and in Chicago, which are in
the GSA buildings, within a short distance of our existing
offices. First-class, A level space. And the $31 million is to
do interior design work, fittings, relocation costs, all of the
prep work we need to have in place so that in 2021 and 2022,
when we make those office moves, we will be well positioned to
do it.
Senator Kennedy. You are reducing your square footage?
Mr. Giancarlo. Right now, we have excess capacity on a
blended basis where we are four offices. We have about 82
percent occupancy, 18 percent unused space, and with the budget
we put forward, our headcount is not going to be raised
significantly in any way to make-up that lost space. We have
worked hard to try to return some of that. We were able to
sublet some of our space in Kansas City and we have been
working with a landlord in New York to try to do that. But with
our leases coming to an end, it is very hard and unlikely that
we will be successful, at least in the next 2 years.
But in our new space, we will be much closer to full
occupancy with a little bit of swing space. But I think our
leasing costs, or at least our square footage will go down.
Rents go up, but I think net, we are going to save some money
all the way around for the U.S. taxpayer.
Senator Kennedy. Well good for you. Good for you. We
appreciate that. I want to ask you about your fee proposal. You
are the only Federal financial regulator that relies
exclusively on appropriated funding. Do you think that ought to
change?
FEES
Mr. Giancarlo. Well it has been the position of, I think,
four of the five last Presidents that the CFTC should have some
sort of market participation in fees. Ultimately that is a
decision for Congress to make, not a decision for us to make.
Senator Kennedy. Right. Okay. Fair enough. Chairman
Clayton, let me ask you a couple of other questions here. I
want to talk to you about the Consolidated Audit Trail, I think
you call CAT. CAT is going to compile information on every
Securities trade known to humankind. So, a lot of data.
Obviously, you are looking for fraud and securities violation.
The concern is I am not suggesting that you should not, but
with algorithms and artificial intelligence, there is a lot of
potential there to help you and your people do an even better
job. But, tell me about the data security issues and what you
have done. I know you are not going to collect social security
numbers but how are you going to make sure that data stays
secure?
Chairman Clayton. Yes. So, let me say this, I think we,
broadly speaking, we need the CAT for what I would say is those
kind of enforcement, surveillance issues but also to understand
our market structure and understand the, you mentioned,
electronic trading, speed of trading, to understand the
vulnerabilities that may exist as a result of the changing
market structure. We had a flash crash a number of years ago
and it took us a long time to unpack and find out what
happened. So, we need----
Senator Kennedy. With EDGAR (Electronic Data Gathering,
Analysis, and Retrieval system)?
Chairman Clayton. No, this is when stocks dropped----
Senator Kennedy. Oh, okay. No, I know what you are talking
about now.
Chairman Clayton [continuing]. Why did that happen?
Senator Kennedy. Yes.
Chairman Clayton. Why all of a sudden did liquidity dry up.
We need to understand that. But your concerns are concerns of
mine. Are we collecting two types of data. One is proprietary
data of people who participate in our market that they have a
right to keep secure and then the personally identifiable
information of what I call our Main Street investors. Both of
those need to be addressed in any final CAT plan.
I would like to say that the discussions around that when I
first got to the SEC, I was unsatisfied with. They had a lot of
things that were, we cannot do that, we cannot do this, but not
really constructive. I feel better about where we are now. We
are actually talking about not taking social security numbers,
only using CAT specific IDs. Thus, limiting the fields that
would have any kind of personal information, so it is difficult
to use the information for any kind of nefarious purpose, and
then of course, protecting that data by segregating trading
data and trader data in different databases and those types of
things.
All that said, my message is we are not taking information
unless we need it, and particular, in the area of personally
identifiable information, unless we reasonably believe we can
protect it. And that is how we are proceeding. This is a multi-
staged--it is not like you flip the switch and the CAT goes on.
It has got about, you know, almost enumerate milestones, but as
we work through those, that is going to be in my mind.
Senator Kennedy. Okay. Senator Van Hollen.
Senator Van Hollen. Thank you, Mr. Chairman. Thanks both of
you for being here and for your service. Chairman Clayton, I
always have an opportunity also to talk about issues with you
on the Banking Committee and I want to follow up on a couple of
those issues, but first though relates to the mandatory
arbitration question, because as I think you know, 21 Senators
sent a letter to you urging you to continue to allow investors
to have their day in court and that is supported by a Supreme
Court decision way back in the day. There has been some talk
that the SEC would try to eliminate those provisions and
require mandatory arbitrations.
So, can you just talk a little bit about where you see the
SEC heading on this question.
Chairman Clayton. So, I think I was first asked this
question in the Banking Committee maybe as many as 2 years ago,
and I am in the same position today that I was then. I have
given some lengthy feedback on this and that is, if this issue
were to be presented to the Commission, I would do everything I
reasonably could to ensure that it was analyzed, discussed, and
decided in an open way where the public and people who have
different views, have an ability to weigh in. All that said,
you know, there is the law and we are not the only, as recent
developments have shown, we are not the only cook in this
kitchen.
Senator Van Hollen. Right. Do you have--are you personally
in the position where you are still listening to arguments or
have you reached any conclusions of your own on this issue?
Chairman Clayton. I am in the same place I was 2 years ago
which is I am not anxious to see--you know, this is not an
issue that I want to use up the commission's bandwidth dealing
with----
Senator Van Hollen. Got it.
Chairman Clayton [continuing]. But if I have to, I will.
Senator Van Hollen. Got it. On the stock buyback issue and
we have had a number of conversations there as well. We have
Commissioner Jackson's findings. There are also questions about
whether or not stock buybacks are being used for compensation
purposes for, you know, executives of different companies. What
is your sense of whether or not we should move ahead? As you
know, I think this is something that warrants a deeper dive and
a more formal study. What is your latest thinking on this?
Chairman Clayton. So, to be clear, we do not regulate stock
buybacks. Companies don't come to us and say, ``can I buy back
a hundred shares or thousand shares?'' What we do regulate is
if a company decides to buy back stocks as a means of returning
capital, whether they are doing so in compliance with our anti-
manipulation and our insider trading laws. And we also require
them to report, on a quarterly basis, how much stock they do
buy back, and we require executives to report within a very
brief time, two days, if they are making any sales for
purchases generally, including during a buyback.
You and I have had discussions on this, and there is an
issue here that has been--I could say that this issue has been
on my mind for many years, and that is, when a company decides
to do a stock buyback, they are not just deciding in the
abstract. There are other things going on including equity-
based compensations and the holdings of their executives. We do
require disclosure of their sales, but it has always concerned
me that the Compensation Committee of the Board of Directors,
the Board of Directors generally, is looking at that
compensation structure and analyzing whether the buyback is
consistent with being appropriate stewards and setting
appropriate compensation levels. But we have discussed that.
Senator Van Hollen. Right, and I look forward to continuing
that conversation. I mean, I know you do not, you know, tell
companies can and cannot do buybacks, but as you know, we put
in place, not you personally, but many years ago the Safe
Harbor rule which is what has allowed companies to engage in
stock buyback activity.
So, it seems to me we should be very vigilant about whether
or not they are doing it in the interests of their stockholders
as opposed to just fattening the wallets of returns for the
executives. So, we will continue that conversation, but you
know it goes to what is prioritized as the SEC, right. You know
as the Chairman, I mean you have got a lot of discretion and so
I think you know, you send signals based on what you decide to
focus on. Yes. Do I have a----
Senator Kennedy. Sure.
Senator Van Hollen. Thank you, Mr. Chairman. So, Mr.
Giancarlo, good to see you. As part of your budget request the
administration requested that $65 million of the $284 million
be raised through an enacted user fee, which is not unlike what
the SEC does for at least part of its budget. So, I am assuming
that is something that you and the administration are
advocating for. This is actually one of the things in the
President's budget I will say, one of the few things, not that
I think maybe it is a good idea because I think it is important
that we generate additional resources for your work. Have you
made an effort to encourage, you know, members of the
Appropriations Committee to support the provision in the
budget?
Mr. Giancarlo. So, this President's budget, like many other
President's budgets before, has a proposal for some sort of fee
arrangement, whether it is transaction-based, which I have been
frankly as a markets person not supportive of but some sort of
fee structure. As I said to the chairman a few moments ago, I
really believe that at the end of the day it for Congress to
determine how this agency is funded, what its level of funding
is. And, I have always felt as a public servant it is not for
me to tell Congress what to do but for Congress to determine
how we should be funded and then set the priorities as to how
we do it. So, I would say that if it is Congress' determination
that some part of our budget should come from the marketplace
in some form, then obviously the agency would act on that.
Senator Van Hollen. Well, I appreciate the deference to
Congress. We appreciate the fact that, you know, you recognize
the power of the purse here. I will say that this is a hearing
of course to get the Administration's budget request and I
think it is worth noting Mr. Chairman that part of that request
is to apply this fee, which is a similar idea to what we have
in place with the SEC. The FDA has a fee as well, a user fee.
So, I know you have been interested in looking for ways to, you
know, find additional resources without putting the obligations
on the taxpayer. I hope we can have a conversation about moving
ahead in this direction. Thank you.
Senator Kennedy. Senator Coons.
Senator Coons. Thank you, Chairman Kennedy. Chairman
Clayton, I have got a couple of questions for you if I might.
First, your headcount I think in your written testimony you
note this budget supplement, this budget request would allow
you to back fill. You would complete backfilling 134 positions
of the 400 that you lost through the hiring freeze. Is that
sufficient? Is it realistic? You would still be operating with
nearly 300, 276 fewer positions than you had at the SEC before
the hiring freeze. I think that is about a 5 percent total
decrease. What are you not doing that you could be doing if
more fully staffed? Do you feel these 134 position add is
enough and will remain level? Talk to me about your staffing
request and requirements.
Chairman Clayton. So, I think we have been able to fulfill
our mission. A lot of it really comes down to the dedication of
the people we have in place. The 100 new positions that we are
now in the process of hiring, I think that is money very well
spent. These hires are mostly in the area of enforcement,
inspections, and then market, some of the issues that I have
just spoken to Senator Kennedy about, getting our market
knowledge up-to-speed, and then cybersecurity, and support of
course. The 34 are largely in some of those same places.
We are also now able to, in addition to the 134 hires, when
someone leaves or retires, we are able to back fill their
position. I feel good about that. You know, if you ask me 8 to
18 months or 2 years ago, you know, if you said, hey, here is
another 50 FTEs, I might not have known where I could use
those. At this point in the job and the relationship I have
with my direct reports, I am sure I could put additional people
to work on that kind of marginal basis. I think you should be
able--you should have that in your mind if you are running an
agency.
Senator Coons. I just think across both agencies, you know,
the increasing complexities of the markets, new areas of
regulatory responsibility, the Dodd-Frank, gave you new
mandates and responsibilities. So, the opening statements you
both made, it is critical that we have the best regulated
financial markets in the world, and I want to make sure we are
not being penny-wise and pound-foolish. Let me move to
cybersecurity.
Last year we talked about the EDGAR system breach. Do you
believe your budget request will give you all the resources you
need to protect that database and other information held by the
SEC, and can you talk at all whether that breach resulted in
the perpetrators using the information to their market
advantage? Is that something that--it would be relevant to help
update us on.
Chairman Clayton. Yes. We believe that the breach did give
them an advantage in the marketplace and we brought cases
accordingly. And the money that you have appropriated in the
past, and the money that we are requesting now, has enabled us
to lift the security of EDGAR.
We have also reduced the amount of sensitive information
coming into EDGAR. It is a very important system that is a
legacy system. You know, it is somewhat of a kind of, maybe
this is too negative, but imagine a cell phone that you
purchased in the mid-90s, continuing to use it today, enhancing
it and enhancing it. You know, if we were building the system
from scratch, it would not look like this--but that is not
where we are. So, I feel good about what our team has been able
to do to lift it. We have had outside consultants come in and
review our work, both Government consultants and private sector
consultants, have done penetration testing. So, I feel a lot
better, but we are going to continue to need to invest,
investigate, and test as we go forward.
Senator Coons. Yes, I think for both of you, IT and
cybersecurity are going to be ongoing, critical questions. Let
me ask you one last question about it. A proposal that
generates a fair amount of controversy, and I am just interest
in your view on where we are going. You are currently in the
rule-making process to require a new standard of care for
financial professionals. Broker dealers would act in the best
interest of their client but would not require the same
fiduciary standard that applies to investment advisors.
As I am sure you are all well aware, the previous
Administration moved forward a different approach. Your written
testimony says the obligations of an investment advisor differ
from that of a broker dealer. The DOL, regulation under the
previous Administration, made them the same. Talk about the
justification for the different standards in these two roles,
its impact, and where you see this process going forward.
Chairman Clayton. Sure. So, one of the important things in
our marketplace for retail investor services is competition and
choice. It is important to me and my colleagues at the SEC--the
career people at the SEC believe this as well--that you have a
choice between a fee-for-service model like a broker model, I
come to and kind of pay as I go, or a, fee per account model
and that is an advisor model where I pay a fee either an annual
fixed fee or based on assets under management.
There are many types of relationships for which the fee for
the service model is cheaper than the fee for the account
model, like the investment advisor model. That is important for
competition. Now, there are many people for whom an investment
advisor ongoing service monitoring discretionary investment is
the better way to go but we need to keep that competition and
choice. Then, you know what, the complaints that on the
brokerage side there was too much activity that people said was
``lawful'' but made you sick, we need to fix that. We also need
to fix, do I know who I am dealing with, how are they getting
paid, and what their incentives are, right.
So, preserve that choice, preserve the competition, and
raise the level of conduct required on the broker side. I can
talk in detail about that, about what we are going to do, but
that is what we are doing.
Senator Coons. I appreciate that broad overview. I see I am
well past my time, Mr. Chairman.
Senator Kennedy. That is okay. Thank you, Senator. I have
got two more questions, and just let me say to both of you,
what I admire about both of you is you thought deeply about
issues at the macro level. And I really appreciate that.
Chairman tell me about your swaps reform.
SWAPS REFORMS
Mr. Giancarlo. So, I was a supporter of the court reforms
that became Title VII of the Dodd-Frank Act, and somewhat
uniquely, perhaps coming from my side of the aisle but I
believe that actually Congress got Title VII right because it
adopted actual emerging practices in the marketplace
themselves. Moving swaps to clearing was already starting to
increase in the marketplace, and while clearing is not a
panacea for risk, it provides superior risk management,
mutualization, and diversification.
I was a supporter of the swaps reporting requirements and
have been a supporter of continuing that at the Commission. In
terms of the swaps execution position, I think Dodd-Frank got
that right, but I think in a number of areas, the CFTC erred in
how it implemented that. Now, I think the errors were natural
because what the CFTC did is it took what it knew, which was
the futures market, and used that model for the unlisted, over-
the-counter swaps market. And I think the result of that was to
make our market much less competitive on a global basis than it
should be. In 5 years, under the current approach, we have had
no new innovation in the market. We have had no new entrants
into the market offering services. We have not had new platform
development, and so what I have proposed, and we put this
forward on a four to one vote on the Commission in the fall,
was a more flexible approach, which does two things.
I think it is actually more true to what Congress said
because Congress did not dictate the mode of execution for
transactions, but also I think it is truly more American. It is
much more flexible. It is much more innovative, and I think it
will lead to an explosion of innovation in our markets. In
fact, one analyst said that it will lead to dozens of new
market participants coming into the marketplace, and what could
be more American than competition in the marketplace. It brings
down fees. It brings down costs. Allows new entrance and
participation in the market.
I am very proud of the proposal we have forwarded to the
Commission. I am sorry that I probably will not have the time
to see it through during my term, but I encourage the future
Chairman and the Commissioners there to take it up. I think it
will be good for American competitiveness and for American
market robustness and market activity.
Senator Kennedy. Chairman Clayton, I want to talk to you
for a second, this will be my last question, about the
Municipal Securities Rulemaking Board (MSRB), and I have got a
bill, I am not going to ask if you are supporting it. That
would not be fair. Let me just say that municipal securities,
rule-making board, there is some really good men and women on
it, have some good leadership, their past members really fine
past members, but as you know, we have talked about, I have
some concerns about it.
I think the structure of it in terms of who gets to be on
it is incestuous, as I have explained to you. My bill would
reduce the board from 21 to 15, 15 people. I think that will be
more manageable. As you know, the board has private
representatives, folks who represent the private-sector, and
people who represent the public sector. The problem in my mind
is that many of the public members used to be in the private
sector. That is okay. They garnered a great deal of experience,
but my bill would provide that there needs to be 5 years
between their work say as a broker-dealer, and then putting on
the hat of representing the consumer, if you will. It would
require members of the MSRB to be confirmed by the SEC. You
know, you are kind of responsible for them. You know, you did
not father the child, but you have got to raise it, so I
figured give you some parental control.
The other thing has to do with salary-cap. Now, I know this
is not public money, but it also didn't fall from heaven. There
is not a money tree. I am not saying that they are not good
people over there, but we have got folks over there making $1.4
million, you know, that is just a lot of money from somebody
who is running a Government organization and I think we need to
take a look at it. It is not personal. Give me your thoughts in
general about the MSRB.
Chairman Clayton. Okay. So, let me say, I will go to the
governance, structional issues in a second. On a substantive
issue, I have enjoyed my engagement with the MSRB.
Senator Kennedy. As have I.
Chairman Clayton. Yes. And I think we are doing better. I
have made a few issues----
Senator Kennedy. We are since you have been there.
Chairman Clayton. But there are few things that I really
care about including that investors know how old the financial
disclosure is that they are getting about municipalities. The
way municipal securities transactions are executed and reported
so that buyers know what the all-in cost of getting in and out
a muni bond is. Those things are important, and they have
worked well with us in, I would say, elevating those standards
and can continue that.
In terms of governance of the Self-Regulatory Organizations
(SROs), people who perform a function--look, I think we should
always be examining whether our governance gets the job. I
mean, governance is not an end in itself, it is a means to an
end, but accountability does drive pretty good ends. And as a
general matter I favor accountability, like, you know, I did
not wake up this morning, I can't wait to go answer your
questions, but I think it is a good idea.
Senator Kennedy. Well you operate off of fees in the
private sector. Do you make a million bucks?
Chairman Clayton. No.
Senator Kennedy. Okay. Just checking. Chris, do you have
anything else?
Senator Coons. Two quick questions if I could. Just this is
more satisfying my own curiosity than anything else. Impact of
Brexit potentially, Chairman Giancarlo, and then the Fed just
came out with a report historically high corporate debt. I
would be interested in your thoughts on whether the increase in
debt owned by U.S. businesses poses unacceptably high risks to
our economic stability.
BREXIT, CYBER, DEBT
Mr. Giancarlo. If I could also add, after I discuss Brexit,
if I could just add a word about cyber from the CFTC's point of
view. I know Chairman Clayton addressed it and I agree with
what he said, but I do want to talk about it for just a moment.
On Brexit, we have two particular concerns at the CFTC. One is
simply the impact on not just the European economy with a
British exit, the entire European economy, but the global
economy of what a sudden and unexpected Brexit exit could have
brought. I think it now seems to be on a much slower burn. I
think a lot of that is priced somewhat into the market and so
if there is no sudden moves, I think we are a little less
concerned about a short term market disruption.
We still remain concerned long-term about more impact, but
there is something that is very particular to derivatives that
is unique about London. London has emerged over the last
several decades, in fact the last decade in particular, as the
global servicing center for the global derivative market
because of a combination of special utilities like the London
Clearing House where most of the interest rates swaps are now
cleared, as well as the use of English law in contracts and
accounting, and other settlement services. London is really the
epicenter of that marketplace.
There is really no continental European locale that has the
readiness to take that on and some of the proposals out of
Europe were to break up that set of clearing that takes place
in London. If London were to be displaced and disrupted as the
global center for swaps and markets, that could have a real
strong impact on the markets that we at the CFTC are in a
unique role to oversee. So, we have taken the lead on alerting
market participants, speaking to our friends in Brussels and
London, as well as with our own Financial Stability Oversight
Council, of these concerns and have been very active in the
area.
We continue to monitor it closely. We view the U.S. dollar
as a global reserve currency so we do not have a territorial
view as to where the dollar denominated assets must clear
provided it is stable, provided it is done properly. If London
were to be displaced, then we would have some concerns as to
the future of the market.
A quick word on cyber. Chairman Clayton and I have spent a
lot of time talking on this. I think we share the view that
cyber is the number one risk to our markets and in some ways,
number one risk to our own agency operations because the amount
of data. The amount of data that we take in every day at the
CFTC has gone from 10 million per day to over a 100 million in
just the last several years. We are increasingly becoming a
database regulator, but we are very concerned about cyber
activities. We see close to 200,000 separate cyber-attacks on
our agency per month and that amount is going up all the time.
Senator Kennedy. How many?
Mr. Giancarlo. 200,000 per month. And they are coming from
all over the world. Now just to give you an idea, before I took
over as Chairman our budget for cyber-defense was about $5
million a year and even though our budget has not gone up until
recently, we have been able to increase our cyber spending to
close to $7 million. We will devote close to $7 million this
year. But in our budget is a request for close to $10 million.
Of all the things we need, we really, really need that. You
know, it is not a question of if an agency or institution or
enterprise will be cyber hacked, it is only a question of when.
We have been fortunate the last few years of not having
suffered that to the extent we know, because sometimes you do
not know till long afterwards, but we do need to, and I am not
saying we have weaknesses now. I think our position is very
strong, but we do have--there are some facilities we would like
to move to, and it is just simply a matter of resources. And
so, if I can ask amongst all our requests, if that one you
could give special attention to because we really do that.
Thank you.
Senator Coons. Chairman Clayton, anything on risky levels
of corporate debt?
Chairman Clayton. Yes. Corporate debt has increased in
absolute and relative terms. We should not be surprised by
this. We have a credit financed economy. Dodd-Frank, other
measures, we have relatively shrunk the size of the bank
lending sector, so someone has got to fill in the credit. The
corporate credit side has done that. Other factors, low
interest rates. Low interest rates make actually increasing the
amount of debt you are willing to take on more attractive if
you are a person looking to structure your balance sheet in the
appropriate way.
Okay, change. We ought to recognize that and ask ourselves
has this created new risks and how are we monitoring them? And
I am pleased to say that Chairman Giancarlo, Chairman Powell,
Vice-Chair Quarles, Chair McWilliams, Comptroller Otting, we
have all met on this. Not only said, okay, it has changed,
let's get more granular, what sectors has it changed in.
Importantly, are people who are buying this debt are they
buying it for liquidity or trading, which in any kind of
exogenous thing would lead to greater shocks, or are they
buying it for a long term investment? Are they buying it as
asset-liability management say an insurance company versus
liquidity in a mutual fund? Those are two very different
buyers. Where is this corporate debt coming to rest and what
kind of risk does that present?
So, I commend my people because they have been looking at
this now for a while. I feel smarter about it today than I did
before. Sharing that with our colleagues both inside and
outside the United States, and the answer to your question is,
the short answer is, yes, this is where we should be looking.
We should be understanding it. And, is there anything that
keeps me up at night about that market at the moment? No, but
if we had a--let me give you an example of what would keep me
up, a very large mutual fund having significant holdings in
leveraged loans where people expected immediate liquidity.
Would that create maybe a systemic risk? Probably not, but is
that a risk to those investors that maybe they do not know what
they are facing? Yes. This is a subject on which I can talk for
way longer than the time you have but, the short answer is we
are looking at it.
Mr. Giancarlo. If I could just say, a real quick note to
that, we started project in our Office of Chief Economist to
look at how banks that are in the leverage loan marketplace are
then using different techniques to mitigate their exposure to
the market by trading in and out of some of those. A lot of
those loans the banks will then trade out of or will use other
techniques to reduce either their exposure to the interest rate
exposure or even the credit exposure. And so, we have got a
study going on this and we will make that public once we have
it, but we think there is a fair amount of risk mitigation
going on.
So, when you see figures from let us say, there is $1
trillion of these loans and $300 billion are on the balance
sheets of banks, in fact that $300 billion is an absolute
number. It may be a lot less in terms of risk to the market
because of hedging practices that are used by those banking
institutions. But it is an area that we are looking into and we
will have a report for that when it is done.
Senator Coons. Could you ask your helpers to send me a
copy? I would like to see it.
Mr. Giancarlo. Yes.
[The information follows:]
A draft of the paper on the interest-rate risk of banks, including
their use of derivatives, will be ready in a couple of months to the
end of summer. We will share when it is completed. A different paper on
bank credit risk management and the use of CDS, is in a much more
preliminary stage.
ADDITIONAL COMMITTEE QUESTIONS
Senator Kennedy. Alright, gentlemen. Thanks. The hearing
record is going to remain open until next Wednesday for any
statements or questions.
[The following questions were not asked at the hearing, but
were submitted to the Commissions for response subsequent to
the hearing:]
Questions Submitted to Hon. Christopher Giancarlo
Questions Submitted by Senator Jerry Moran
First off, I want to express my great appreciation for your work to
return the CFTC to its Ag roots. I hope the valuable partnership
between the CFTC and the Kansas State University for the Agricultural
Commodity Futures Conference continues under your eventual successor.
In February, you and your fellow Commissioners--Republican and
Democratic Commissioners alike--submitted a unified comment letter to
the prudential regulators raising concerns about a proposed rulemaking
related to bank capital rules.
These concerns surround the calculation of the supplementary
leverage ratio (SLR) related to derivatives transactions. As you know,
the SLR currently fails to recognize the risk-reducing nature of
segregated client margin in these transactions. This has led to rising
costs and less competition in the derivatives markets for commodity
producers seeking to hedge risks in the markets.
a. How will the change you and your fellow commissioners propose
contribute to the health of the cleared derivatives market--in
particular for the farmers and ranchers back in Kansas?
Answer. On June 20, 2019, the Basel Committee on Banking
Supervision announced an agreement on a targeted and limited revision
of the leverage ratio to allow margin received from a client to offset
the exposure amounts of client-cleared derivatives. I was pleased to
see that the Basel Committee recommended the exclusion of initial
margin from the leverage ratio. I have consistently raised the concern
of whether the amount of capital that bank regulators have caused
financial institutions to take out of trading markets is at all
calibrated to the amount of capital needed to be kept in global markets
to support their overall health and durability. Studies have shown that
end users and others, risk losing access to cleared derivatives markets
as the leverage ratio disincentivizes the provision of clearing serves.
The suggested revision will significantly reduce capital costs for
clearing members. As I have said in the past, if these savings are
fully passed on to their customers, these reductions could translate
into an increase in trading activity, especially hedge positions that
are carried overnight. A reduction in cost to a service that is
important to managing systemic risk in swaps supports the critical FCM
link in the mandatory clearing model. I believe that the financial
system will be safer and more stable for it.
b. Are you and your staff at the CFTC continuing to engage with the
prudential regulators on this topic as they move forward with the
rulemaking process?
Answer. Once the Basel Committee publishes its standards, I would
urge the relevant bank regulatory agencies in the US and elsewhere to
move quickly to implement these amended standards in their respective
rules. This will help mitigate a key systemic risk present in our
derivatives markets.
c. Do you think they will make this change to the SLR calculation?
Answer. Yes, I believe they will.
d. If not, does Congress need to step in with a legislative fix?
Answer. It is my hope that this change will be done through
rulemaking by the relevant agencies.
I urge you to continue engaging with your fellow regulators. The ag
community in my State needs access to affordable risk management tools.
I'd hate to miss an opportunity that could help them in this key area,
particularly when there is bipartisan support from your fellow
Commissioners on this topic.
Thank you for your continued service to our country until your
eventual successor's confirmation and it has truly been a pleasure
working with you.
______
Questions Submitted to Hon. Jay Clayton
Questions Submitted by Senator Jerry Moran
1. In light of the effective collaboration under Chairman Giancarlo's
and your leadership, what can the SEC do to alleviate the ills of
calculating the exposure amount of derivatives contracts and ensure
bank capital rules are adequately risk-sensitive?
Answer. We understand that market participants have expressed
concerns to the U.S. Federal banking agencies and to the Basel
Committee on Banking Supervision (BCBS) regarding the impact of the
Basel III leverage ratio (referred to in the United States as the
supplementary leverage ratio) on central clearing. More specifically,
they have raised concerns about the treatment of cash collateral posted
to a clearing agency as initial margin (cash that is received by a
clearing member from its client and that is generally passed to the
clearing house).
We understand that BCBS met on June 19 and 20 of this year in Basel
and, at its meeting, agreed on a targeted and limited revision of the
leverage ratio to allow margin received from a client to offset the
exposure amounts of client-cleared derivatives. While we are not a
member of the BCBS and do not oversee the prudential regulation of
banks, we are committed to continuing our productive collaboration with
the CFTC and prudential regulators to examine areas of common concern
in regulating derivatives markets, including issues that may impact
central clearing.
2. I know the Consolidated Audit Trail (CAT) project was dropped in
your lap and you are making the best of a tough situation to get this
surveillance mechanism to improve investor confidence in our markets up
and running.
While I appreciate that and support your efforts, I am deeply
concerned about one thing: that the CAT still plans to collect the
personally identifiable information (PII) of America's retail
investors.
The CAT can work without PII and the cost of subjecting the
personal information of Americans across the country to cyber risk and
identity theft outweighs any benefit of collecting this information.
2a. We both care deeply about investor protection. Can you give me
a public assurance today that the CAT will not collect and retain
retail investors' PII in a single centralized database?
I strongly urge you to continue exploring an expedited request
mechanism that more closely reflects the current blue sheet process
instead of creating such a high-value target at significant
cybersecurity risk.
Answer. I know there are concerns about the protection of
investors' PII that would be stored in the CAT. I share many of these
same concerns and continue to make the security and confidentiality of
CAT data, particularly any form of PII, a threshold issue.
The CAT is intended to enable regulators to oversee our securities
markets on a consolidated basis--and in so doing, better protect these
markets and investors. The CAT Plan developed by the national
securities exchanges and national securities associations
(collectively, the SROs) includes specific security requirements
designed to mitigate the risk of a breach of the CAT and the
possibility of misuse of data reported to the CAT. The security
features required by the Plan include, among other things: (1) the
encryption of PII and all other CAT data, as well as a comprehensive
System Security Plan that must cover all components of the CAT System
such as physical assets and personnel; (2) adherence to the NIST 800-53
security standards, which are a set of security and privacy controls
for Federal information systems and organizations; (3) incorporation of
tools that will enable logging, auditing and access controls for all
components of the CAT system; (4) secure methods of connectivity; and
(5) development of a Cyber Incident Response Plan.
While these and other features are designed to ensure that the CAT
provides appropriate protection for proprietary data and reflect a
current assessment of the key measures necessary to achieve an
effective data security environment, it is also important that we
continually assess whether the CAT's approach to PII is appropriate and
effective or can be improved. I am aware that the SROs are moving
forward with a plan to eliminate the need to maintain social security
numbers in the CAT database. I support this effort and will continue to
monitor the SROs' progress in this area. More specifically, as the SROs
continue to make progress in the development, implementation and
operation of the CAT, I believe that the Commission, the SROs and the
plan processor must continuously evaluate their approach to the
collection, retention and protection of PII and other sensitive data.
In addition, as I have stated on several occasions, the SEC will not
retrieve sensitive PII information from the CAT unless there is a
regulatory need for the information, and we are confident that there
are appropriate protections in place to safeguard the information.
I look forward to working with you and other members of Congress as
the implementation of the CAT moves forward.
3. You have undoubtedly heard the unrest surrounding the January, 2020
implementation of the current expected credit loss (CECL, ``see-sull'')
accounting standard developed by an unaccountable standard-setting
body.
3a. What are you and your staff at the SEC doing to address the
meaningful concerns regarding the negative impact CECL will have on the
U.S. economy, banks, and access to credit nationwide?
At a House subcommittee hearing in December, Joe Stieven--an
investor who was co-chair of FASB's investor advisory committee--was
very clearly opposed to CECL and said he knew of no bank investors who
supported it. We've also heard of other large bank investors who do not
support CECL.
3b. What kind of outreach has the SEC done to understand these
concerns and what will the SEC be doing in response?
We are hearing that banks are being bombarded by software vendors
and auditors to help them comply with CECL. In fact, a cottage industry
for CECL implementation has developed and banks are on the wrong end of
it.
3c. In the end, who is benefitting? The investors or the auditing
firms? Given the potential disruptions and costs involved, don't you
think we should put on the brakes, study, and figure out how to move
forward in a more responsible manner?
Answer. I am and continue to be supportive of all parties engaging
in productive dialogue regarding the new accounting standard to further
our shared goal of maintaining high-quality financial reporting for the
benefit of investors in the U.S. capital market and addressing
unintended negative consequences of a change in accounting standards.
The SEC's role is not to endorse standards adopted by the FASB. The
Sarbanes-Oxley Act grants the SEC authority to designate an independent
private sector standard setter, but it does not create a mechanism for
the SEC to approve or endorse the FASB's standards. But this does not
mean that accounting standards are, or should be, developed in
isolation.
The SEC staff monitors the FASB's standard-setting activities and
process as a part of the SEC's oversight, and the SEC staff has
participated as an official observer in the FASB's public meetings of
its Transition Resource Group for Credit Losses. Transition Resource
Group members include companies, investors, auditors, regulators, and
FASB members and staff. In addition, the SEC Chief Accountant has
participated as an official observer to the FASB's transition resource
group.
The SEC staff also regularly engages with market participants to
listen to stakeholder concerns, understand emerging issues and risks,
answer questions and share staff views on current financial reporting
matters, including CECL. In these discussions, stakeholders have shared
their views with SEC staff, and some stakeholders have offered public
studies and data, the results of which are mixed and incorporate
broader public policy objectives than the topic of accounting
standards. Implementation of CECL involves complexities and potential
unintended consequences, including because the affected institutions
vary significantly in size as well as type and scope of operations.
Many of the concerns expressed also appear to me to be the result of
the interaction of the new accounting standard with existing regulatory
capital requirements. I understand the Federal banking regulators are
currently reviewing whether CECL should have a direct impact on bank
capital requirements and stress-testing rules. I support the work of
these agencies and encourage them to understand the anticipated effects
of CECL on regulatory capital requirements and the effect of those
regulatory capital requirements (after an institution's adoption of
CECL) on the U.S. economy. SEC staff will continue to engage with the
prudential regulators on this issue and provide any assistance they
require as they undertake their process for reviewing their standards.
This week, at the July 17, 2019 meeting, the FASB voted to propose
a delay to the effective date of the standard for certain entities,
including SEC filers that are smaller reporting companies and private
companies. We are monitoring this development.
The SEC expects the FASB to continue to engage with relevant
stakeholders throughout the implementation process, and I support all
parties engaging in productive dialogue regarding the new accounting
standard to further our shared goal of maintaining high-quality
financial reporting for the benefit of investors in the U.S. capital
markets and addressing unintended negative consequences.
______
Questions Submitted by Senator Joe Manchin, III
1. foreign purchase of securities
--I'm concerned with the many illegal actions that foreign companies
take to undercut our economic successes--stealing trade
secrets, personal identifying information, or patents.
--Especially attempts from foreign companies to make investments and
gain control of certain American technologies and industries.
We know than many of these foreign companies, especially in the
case of China, are ultimately controlled by their government.
--As such, I'm extremely supportive of the Committee on Foreign
Investment's (CFIUS) efforts.
--While I recognize CFIUS falls under the Treasury Department I know
it engages many other departments and agencies as needed.
Question 1a. Can the SEC effectively identify and punish public
companies that do not accurately disclose violations of CFIUS or other
export laws?
Answer. The Division of Corporation Finance (Corporation Finance)
conducts reviews of filings made under the Federal securities laws with
respect to public reporting companies. Staff in Corporation Finance
issues comments to companies where it appears that they could enhance
their compliance with applicable disclosure requirements, which may
include providing additional disclosure about material government
regulations, including those relating to CFIUS or other export laws,
and about material risks relating to conducting business in certain
countries in light of ownership restrictions and the foreign legal and
regulatory environment. When warranted, Corporation Finance refers
potential violations to the Division of Enforcement.
A significant portion of the SEC's enforcement program involves
identifying (including through internal referrals, such as those from
Corporation Finance) and charging public companies that make material
misstatements or omit to state material facts necessary to make the
statements not misleading. A fact is material if there is a substantial
likelihood that a reasonable investor would consider it important in
making an investment decision. If public companies do not accurately
disclose required material information to investors, which may include
information relating to violations of CFIUS or other export laws, then
the SEC has jurisdiction to investigate and, where appropriate, bring
civil actions for violations of the Federal securities laws.
Question 1b. Are there other resources or authorities that can help
the agency identify these violations?
Answer. The SEC staff frequently coordinates with other agencies at
the Federal, State, and local level to, among other things, assist in
the identification of potential violations of the Federal securities
laws. These agencies include those more directly implicated by CFIUS
and other export laws, such as the Treasury Department. While the SEC
currently does not expect to need additional authorities or resources,
beyond those identified by our fiscal year 2020 budget request, we will
keep Congress informed should we identify statutory or resource
impediments.
Question 1c. From the SEC's perspective, what is the greatest
threat, either domestically or internationally, to our financial
markets?
Answer. Your question addresses a topic--threats and risks to our
markets and investors--that is front of mind for me and my colleagues
at the SEC. The U.S. and international financial markets of today are
substantially different from those of the past, including the markets
of the early 2000s. As markets evolve, market risks change, and new
risks emerge.
In my view, there is not one single threat that stands apart from
other threats as presenting the greatest risks to our financial
markets. Our markets are subject to a constantly evolving framework of
threats and risks, and therefore, we must continuously keep abreast of
developments in the capital markets, as well as other areas that affect
these markets. This includes, for example, monitoring relevant
macroeconomic factors, as well as events and trends in other markets
that affect the securities markets, directly or indirectly. It also
includes ensuring we have the resources in terms of human capital
expertise and technology to keep pace with these market changes.
There are, however, a number of significant risks to the securities
markets we are currently monitoring closely, including: (1)
cybersecurity--from the perspectives of market oversight and integrity,
issuer disclosure, and our own agency's cybersecurity risk profile; (2)
the transition away from LIBOR as a reference rate for financial
contracts; (3) Brexit--and its potential effects on U.S. investors and
securities markets and on our global financial markets more broadly;
and (4) issues related to market structure, including market
fragmentation and participant concentration.\1\
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\1\ See SEC Rulemaking Over the Past Year, the Road Ahead and
Challenges Posed by Brexit, LIBOR Transition and Cybersecurity Risks
(Dec. 6, 2018), available at https://www.sec.gov/news/speech/speech-
clayton-120618.
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Regarding the first risk, cybersecurity, the SEC is looking at this
risk from a number of perspectives. From the issuer disclosure
perspective, it is important that investors are sufficiently informed
about the material cybersecurity risks and incidents affecting the
companies in which they invest. From a market oversight and integrity
perspective, we continue to prioritize cybersecurity in our
examinations of market participants. The SEC is also focused on
assessing and improving our own cybersecurity risk profile. We now have
a Chief Risk Officer to help coordinate our risk management efforts
across the agency. We have worked to promote a culture that emphasizes
the importance of data security throughout our divisions and offices
and have been engaging with outside experts to assess and improve our
security controls.
The second risk that I identified relates to the transition away
from LIBOR as a benchmark reference for short-term interest rates.
LIBOR is used extensively in the United States and globally as a
benchmark for various commercial and financial contracts, including
interest rate swaps and other derivatives, as well as floating rate
mortgages and corporate debt. It is likely, though, that the banks
currently reporting information used to set LIBOR will stop doing so
after 2021, when their commitment to reporting information ends. The
expected discontinuation of LIBOR could have a significant impact on
the financial markets and may present a material risk for certain
market participants, including public companies, investment advisers,
investment companies, and broker-dealers. It is important that market
participants plan and act appropriately. The SEC staff is actively
monitoring the extent to which market participants are identifying and
addressing these risks and recently issued a statement that contains
guidance to help participants respond to risks associated with the
discontinuation of LIBOR.\2\
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\2\ See Press Release 2019-129, SEC Staff Publishes Statement
Highlighting Risks for Market Participants to Consider as They
Transition Away from LIBOR (July 12, 2019), available at https://
www.sec.gov/news/press-release/2019-129.
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The third identified risk is Brexit. Even though exit has been
delayed, Brexit and its potential effects on U.S. investors and
securities markets, and on our global financial markets more broadly,
remains a risk. I have directed the staff to focus on the disclosures
companies make about Brexit and the functioning of our market utilities
and other infrastructure. With regard to market utilities and
infrastructure, following the 2016 Brexit vote, SEC staff commenced
discussions with other U.S. financial authorities, with our U.K. and
E.U. counterparts, and with market participants, all with an eye toward
identifying and planning for potential Brexit-related impacts on U.S.
investors and markets. These discussions are ongoing, and I expect
their pace to increase.
Finally, we and many of our regulatory colleagues are examining
market structure issues from various perspectives to identify potential
systemic and other material risks. Issues we are focused on include
risks related to market fragmentation and participant concentration.
These are just a few of the risks to the domestic and international
financial markets. My approach to identifying, monitoring and
responding to risks takes into account the ever-changing risk
environment and the related need to draw on information and resources
from across the SEC and other bodies, including through the President's
Working Group on Financial Markets, the Financial Stability Oversight
Council (FSOC), the Financial Stability Board (FSB) and other
organizations.
In recognition of the SEC's critical role in this area, earlier
this year I created a new position focused on market and activities-
based risk. This senior officer position is responsible for managing
and coordinating the agency's efforts in this area. The bulk of our
agency's work identifying, monitoring and responding to market risks is
performed on a daily basis by the SEC's various operating divisions and
offices, particularly the Division of Trading and Markets, the Division
of Economic and Risk Analysis, the Division of Investment Management,
and the Office of Compliance Inspections and Examinations.
In addition, the SEC plays an active role and contributes to and
benefits from our participation in various domestic and international
organizations that focus on market and systemic risks. As for
engagement with FSOC, I serve as one of the 10 voting members on the
Council. In addition to voting on proposed FSOC actions, I, along with
the SEC staff, also actively contribute to FSOC deliberations and the
development of FSOC's priorities, agenda and annual report. The SEC
staff also actively participates in FSOC's staff-led committees,
including: (1) Systemic Risk Committee, which serves as a forum for
FSOC member agency staff to identify and analyze potential market
risks; (2) Regulation and Resolution Committee, which supports FSOC in
its duties to identify potential gaps in regulation that could pose
risks to U.S. financial stability; and (3) FMU Committee, which
supports FSOC's work in monitoring and evaluating risks relating to
FMUs and their activities. In addition to engagement with FSOC and
other formal organizations, we also directly coordinate with and share
information and observations on almost a daily basis with our
regulatory counterparts at the Treasury Department, the Commodity
Futures Trading Commission (CFTC), and the Federal Reserve, among
others.
2. cryptocurrencies and online sales of opioids
For Chairman Clayton and Chairman Giancarlo
--I have long had concerns related to the implications of financial
technology, such as cryptocurrencies especially the lack of
clear regulating authority and ability to protect the safety
and security of our citizens.
--During this ambiguous time, I'm concerned with how cryptocurrencies
are being used. Specifically, in connection to the sale of
opioids.
--West Virginia has had to deal with the devastating consequences of
the opioid epidemic longer and more directly than nearly any
other State.
--I'm eager to understand if and how opioids are being sold using
cryptocurrencies.
Question 2a. Can you elaborate on what the SEC and CFTC are doing
or plans to do in regards to the regulation of cryptocurrencies?
Answer. The SEC works closely with other financial regulatory and
law enforcement partners, including the CFTC, to make sure we are
coordinated appropriately in our approach to digital assets. An
individual determination by one agency that certain conduct involving a
particular digital asset falls under its regulatory jurisdiction does
not negate the possibility that conduct involving the same digital
asset may also be regulated by another agency. A number of agencies may
have concurrent jurisdiction over different aspects of conduct
involving a digital asset. We work closely with other regulators,
including through interagency working groups, to coordinate our
activities to the extent possible and appropriate under the
circumstances.
To determine whether an activity involving a digital asset falls
under the SEC's statutory and regulatory authority and mission, we look
at the facts and circumstances, including the economic substance and
structure of an activity to determine whether the digital asset itself,
manner of offer or sale, parties to a transaction or documentation and
disclosures concerning an activity, among other things, are subject to
the SEC's jurisdiction.
If a particular digital asset is considered a security for purposes
of the Federal securities laws, that status triggers a number of
important obligations under the Federal securities laws, many of which
focus on investor protection, including SEC registration and reporting
obligations for the offering and sale of securities. To determine
whether a digital asset is a security, generally speaking we look at
whether the digital asset fits the definition of a security set forth
in the Federal securities statutes and regulations. We also apply tests
developed through decades of case law--including the U.S. Supreme
Court's ruling in SEC v. W.J. Howey Co., 328 U.S. 293 (1946)--to
determine whether, for example, a particular digital asset is an
``investment contract.'' The crux of that test ``is the presence of an
investment in a common venture premised on a reasonable expectation of
profits to be derived from the entrepreneurial or managerial efforts of
others.''
The definition of security is broad, but one thing to emphasize is
that the approach we take when evaluating a digital asset is really no
different than what the SEC has been doing for years when evaluating
all kinds of novel instruments.
In an effort to further coordinate the SEC's work on digital
assets, in October 2018, the SEC announced the Strategic Hub for
Innovation and Financial Technology (FinHub) staffed by representatives
across the agency to serve as a public resource for fintech-related
issues and serve as a portal for public engagement. On April 3, 2019,
though staff-level guidance, FinHub published a framework to aid market
participants in analyzing whether a digital asset is an investment
contract, and therefore a security. On that same day, the Division of
Corporation Finance issued a staff no-action letter to a market
participant in connection with a proposed offer and sale of a digital
asset. Additionally, SEC staff, along with FINRA, recently issued
guidance related to broker-dealer custody of digital assets. To the
extent market participants continue to have questions regarding whether
a particular digital asset is a security, SEC staff is encouraging
market participants to reach out through the FinHub webpage.
Unfortunately, while some market participants have engaged with the
SEC constructively and in good faith, others have sought to prey on
investors' excitement about cryptocurrencies and Initial Coin Offerings
(ICOs) to commit fraud or other violations of the Federal securities
laws. The SEC, through the Division of Enforcement, has brought
numerous enforcement actions for violations involving digital assets
that meet the Supreme Court's definition of ``investment contracts.''
These matters have included actions for fraud violations, failures to
register offerings with the SEC and violations by gatekeepers.\3\ For
example, the SEC obtained an emergency court order against a company
and its founder, halting pre-ICO sales and an upcoming ICO, alleging
that the company falsely claimed, among other things, that it would be
the first U.S. licensed and regulated tokenized cryptocurrency exchange
and index fund and that the ICO was registered with and approved by the
SEC.\4\ Similarly, the SEC charged three individuals with fraud in
connection with an ICO that raised $32 million, alleging that the
defendants targeted retail investors, falsely stated that they had a
partnership with Visa and MasterCard, and created fictitious executives
with impressive backgrounds.\5\
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\3\ See U.S. Sec. and Exch. Comm'n, Cyber Enforcement Actions,
available at https://www.sec.gov/spotlight/cybersecurity-enforcement-
actions.
\4\ SEC v. Blockvest LLC, et al., Litig. Rel. No. 24400 (Feb. 14
2019).
\5\ SEC v. Sharma, et al., Litig. Rel. No. 24117 (Apr. 20, 2018).
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The SEC has acted swiftly to crack down on allegedly fraudulent
activity in this space, particularly where the misconduct has targeted
Main Street investors. Regardless of the promise of this technology,
those who invest their hard-earned money in opportunities that fall
within the scope of the Federal securities laws deserve the full
protections afforded under those laws.
Question. 2b Are either of your agencies tracking if
cryptocurrencies have been used in the sale of opioids? What resources
would you need to be able to do this?
Answer. The SEC's jurisdiction includes the enforcement of the
Federal securities laws and regulations, including with respect to
digital assets that meet the definition of a security. The SEC's
jurisdiction does not, however, extend to the criminal enforcement of
laws and regulations, including those related to the illegal drug
trade. To the extent the SEC identifies digital assets within our
jurisdiction that involve potential violations of the Federal
securities laws, we investigate such matters and bring appropriate
charges if warranted. To the extent the SEC, during the course of those
investigations, uncovers evidence or information about potential
violations of other laws, including those related to the illegal drug
trade, it is our practice to refer those to the appropriate agencies,
including the Department of Justice, as appropriate.
We understand that, with regard to cryptocurrencies, money
transmission businesses that operate in the United States generally
must register with FinCEN and applicable state regulators. Many of the
cryptocurrency trading platforms have registered as payment services
that are not subject to direct oversight by the SEC or the CFTC. To the
extent these platforms are complying with applicable Bank Secrecy Act
(BSA) obligations, it is possible that the filing of reports under the
BSA could provide some evidence of such conduct.
3. volcker rule
For Chairman Clayton and Chairman Giancarlo
--With 5 regulators--including the SEC and CFTC--involved in the
implementation and enforcement of Section 619 of the Dodd-Frank
Act, commonly known as the Volcker Rule, it has made the
implementation complex for both banks and the agencies. This
view has been confirmed by a number of current and former
regulators including past Fed Chair Janet Yellen.
--In December of last year, I signed onto a letter expressing support
for your efforts to clarify and improve various aspects of the
Volcker Rule, and I appreciate both of your written responses
acknowledging my letter.
--I want to be clear, I believe the Volcker Rule is a critical
component of the post-crisis regulatory framework and I
strongly support its purpose.
Question 3a. Can you provide an update on your efforts to revise
the Volcker Rule?
Answer. The SEC, together with the other four agencies responsible
for implementing the Volcker Rule, proposed amendments last year that
were intended to make the rule work in a more efficient manner, while
maintaining and enhancing inspection and enforcement capabilities
consistent with the objectives and requirements of the statute. Those
underlying objectives include placing limits on proprietary risk-taking
by banking entities and promoting the safety and soundness of the U.S.
financial system.
In preparing the proposal, the SEC and its staff worked closely
with the staffs of the four other agencies, and each agency brought its
own perspective and expertise to the proposal. Adoption of amendments
to the Volcker Rule is on the SEC's near-term Regulatory Flexibility
agenda, and I believe they are important to complete. Although I cannot
say definitively when we will complete our work, I can state that both
the staffs and the principals of each of the five agencies responsible
for implementing the Volcker Rule remain engaged in regular and ongoing
dialogue with each other. We also continue to review and analyze
carefully the comments received on the proposal, both with respect to
the specific requests for comment in the release and additional
suggestions from commenters. Any final rules adopted by the five
agencies will take into account all relevant comments.
Question 3b. What are some of the other reforms that can be made
that prohibit the dangerous trading that led to the 2008-2009 financial
crisis?
Answer. I believe that improving the operation of the Volcker Rule
should go a long way towards furthering the goal set forth in your
question. As you know, the Volcker Rule generally prohibits U.S.
banking entities from engaging in proprietary trading because of the
perceived risks of those activities to U.S. banking entities and the
U.S. economy. To that end, in the course of preparing the 2018
proposal, the five agencies responsible for implementing the Volcker
Rule asked a number of questions aimed at soliciting information about
potential changes that could improve the rule. We continue to review
and analyze carefully the comments received on the proposal.
It also is important to note that the SEC and its staff endeavor to
ensure that firms can comply with all of the rules the SEC adopts,
including the Volcker Rule, in as streamlined and efficient a manner as
possible, while at the same time furthering the objectives of the
underlying statute. In that respect, the proposed amendments to the
Volcker Rule were designed to provide banking entities with greater
clarity and certainty about what activities are prohibited, to reduce
compliance obligations for small and mid-size banking entities relative
to their trading activity, and to improve the effective allocation of
compliance resources where possible.
4. sec best interest standard
--As you are well aware, the Dodd-Frank Act required that the SEC
conduct a study on various aspects of standards of client care
for retail investors. Released in 2011, the SEC recommended a
uniform fiduciary standard for the retail advice given by all
types of financial professionals, including broker-dealers.
--The fiduciary standard for financial professionals was originally
under the purview of the Department of Labor, but the DOL
Fiduciary Rule was vacated.
--In April of 2018, you (the SEC) proposed a package of proposals
including the Regulation Best Interest (Reg BI) which would
require a broker-dealer ``to act in the best interest of a
retail customer when making a recommendation of any securities
transaction or investment strategy involving securities''.
--This standard has been praised by industry and criticized by
consumer groups.
Question 4a. Why do you feel the Reg BI will effectively allow for
financial professionals to act in the best interest of the customers?
Answer. Regulation Best Interest, or Reg. BI, substantially
enhances the standard of conduct for broker-dealers. Importantly, it
does so in a manner that establishes a standard of care for
transaction-based advice that draws upon principles underlying the
investment adviser fiduciary duty, and is workable for broker-dealers.
As a result, (1) whether a retail investor chooses a broker-dealer or
an investment adviser (or both), the recommendation or advice is
required to be in the best interest of the retail investor and cannot
place the interests of the firm or the financial professional ahead of
the interests of the retail investor, and (2) the ability to choose
between a broker-dealer transaction-based model and an investment
adviser portfolio-based model--and choose among the various iterations
and combinations of each--will be preserved.
Below are a few (of the many) key features of Reg. BI that enhance
the standard of conduct:
1. Reg. BI applies to account recommendations, including
recommendations to roll over or transfer assets in a workplace
retirement plan account to an IRA, as well as recommendations to take a
plan distribution. These recommendations are often provided at critical
moments (such as at retirement), may be irrevocable (or very costly to
reverse), can involve a substantial portion of a retail investors net
worth, and can have significant long-term impacts on the retail
investor. Accordingly, this is a critical enhancement over both
existing broker-dealer obligations and our proposal.
2. Reg. BI affirmatively requires broker-dealers to act in the
best interest of their retail customers and not place their own
interests ahead of the customer's interests. The broker-dealer must
comply with the four component obligations. The specific component
obligations of Regulation Best Interest are mandatory, and failure to
comply with any of the components will violate Regulation Best
Interest.
-- The Disclosure Obligation, which requires full and fair
disclosure of all material facts about the scope and terms of
its relationship with the customer, including material facts
relating to conflicts of interest associated with its
recommendations.
-- The Care Obligation, which requires brokers to exercise
reasonable diligence, care, and skill, to understand the
potential risks, rewards, and costs associated with the
recommendation, and to consider those risks, rewards, and costs
in light of the customer's investment profile in order to make
a recommendation that is in the best interest of the retail
customer and does not place the broker-dealer's interest ahead
of the retail customer's interest.
-- The Conflict of Interest Obligation, which requires firms to
implement policies and procedures to mitigate (and in some
cases, eliminate) certain identified conflicts of interest that
create incentives to make recommendations that are not in the
retail customer's best interest.
-- The Compliance Obligation, which requires firms to implement
policies and procedures reasonably designed to achieve
compliance with Reg. BI as a whole.
3. The Care Obligation will apply to a series of recommended
transactions (currently referred to as ``quantitative suitability'')
irrespective of whether a broker-dealer exercises actual or de facto
control over a customer's account. This enhancement will allow us to
bring enforcement actions against broker-dealers engaging in misconduct
over the course of a relationship more efficiently and thereby return
money to harmed retail investors more quickly.
Whether a broker-dealer has acted in the retail customer's best
interest will turn on an objective assessment of the facts and
circumstances of how the specific components of the rule are satisfied.
This principles-based approach is a common and effective approach to
addressing issues of duty under law, particularly where the facts and
circumstances of individual relationships can vary widely and change
over time, including as a result of innovation. This approach to
determining what is in the ``best interest'' of a retail customer is
similar to an investment adviser's fiduciary duty, which has worked
well for advisers' retail clients and our markets.
5. sec budget
--The mission of the SEC is to protect investors, maintain fair,
orderly, and efficient markets, and facilitate capital
formation.
--Your (the SEC) budget request seeks $1.746 billion, a $71 million
increase from fiscal year 2019 enacted amount, including 34 new
positions.
--Last year we provided the SEC with the funding for 100 additional
positions in fiscal year 2019.
Question 5a. Given that roughly 130 positions have been or will be
added over fiscal year 19 and fiscal year 20, is this sufficient to
address priorities of the agency?
Question 5b. Can you explain how these new 34 positions would help
the SEC achieve its mission?
Answer. Yes, I believe the additional positions will be sufficient
to address the key priorities of the agency. With the enactment of the
fiscal year 2019 appropriation, the SEC is adding new positions in
critical areas to enhance our expertise in areas with emerging issues
and challenges. These include additional staff in the cybersecurity and
risk management functions, staffing the newly-created Office of the
Advocate for Small Business Capital Formation, expanding our
enforcement and examination programs with a focus on Main Street
investors and enhancing our oversight of the changing markets--
especially in areas experiencing rapid technological advancements.
Our fiscal year 2020 request builds on our fiscal year 2019 request
by adding new positions in areas where they will contribute
significantly to achieving the objectives of the SEC's Strategic Plan
for fiscal years 2018-2022 and addressing staff shortages in mission-
critical areas. The request would enable us to invest in staff with the
skills and expertise in vital areas such as cybersecurity and market
oversight, shift or expand our focus in certain key areas for the
benefit of our Main Street investors and companies, and to adapt our
regulatory oversight to keep pace with changes in the markets we
oversee.
SUBCOMMITTEE RECESS
Senator Kennedy. If you are here from CFTC or SEC raise
your hand, please ma'am and sir. Thank you for your good work,
and I mean that. And thank you for the leadership. Chairman
Giancarlo, we are going to miss you. I mean that. You have done
an extraordinary job.
Mr. Giancarlo. I think I thought I would never say this,
but I am going to miss you too.
[Laughter.]
Senator Kennedy. Well, your sentence is up, okay. Five
years is a long time.
[Laughter.]
Mr. Giancarlo. Thank you.
Senator Kennedy. Godspeed. Thank you all. Meeting is
adjourned.
[Whereupon, at 12:30 p.m., Wednesday, May 8, the
subcommittee was recessed, to reconvene subject to the call of
the Chair.]