By Amanda Maine, J.D.
The declining number of IPOs in the U.S. and the SEC’s recently proposed Regulation Best Interest for broker-dealers were hot topics of discussion during a hearing of the House Financial Services Committee with SEC Chairman Jay Clayton as its star witness. However, the chairman answered questions on a number of topics during the two-and-a-half hour meeting, including revisiting the proxy process, the rise and challenge of addressing issues related to cryptocurrencies and initial coin offerings, and the modernization of the market.
Concerns about capital formation. In his opening statement, committee Chairman Jeb Hensarling (R-Tex) said that one aspect of the SEC’s mission—promoting capital formation—has received short shrift. Even though the economy is doing well now, initial public offerings have been on a gradual slide downward and, in 2016, entrepreneurship had reached a 30-year low. He also voiced concern about the ability of the U.S. to successfully compete with China, which currently produces one-third of the world’s IPOs. Main Street investors need more opportunities to invest in their futures, he said, noting that these investors are not allowed the same private investment opportunities of the very wealthy.
Clayton agreed that the quality of opportunities available in the public market space is not as good as those in the private market space. Hensarling inquired about Sarbanes-Oxley Section 404(b), which requires the auditor of larger publicly held companies to attest to management’s assessment of its internal controls. Non-accelerated filers are exempt from this requirement, and under the JOBS Act, emerging growth companies (EGCs) are generally exempt for their first five years as a public company. Clayton said that at the SEC’s upcoming open meeting on June 28, the Commission will be considering amendments to the definition of “smaller reporting company.”
Representative Bill Huizenga (R-Mich), who chairs the Subcommittee on Capital Markets, urged Clayton and the SEC to make the Commission’s outdated rules more relevant for today’s capital markets. We are currently in digital, fast-paced markets, Huizenga said, but companies are still dealing with rules from an analog, paper-based era. Representative Brad Sherman (D-Cal) echoed Huizenga’s concerns and applauded the Commission for adopting Rule 30e-3, which will allow mutual funds to send certain documents electronically. Clayton said that Rule 30e-3 was just a start, and modernizing rules is one of the SEC’s priorities. He again drew attention to the SEC’s upcoming meeting, noting that the Commission will be voting on whether adopt amendments to requiring the use of the XBRL in operating company financial statement information and fund risk/return summary information.
Regulation Best Interest. A number of members brought up the Commission’s recently proposed Regulation Best Interest (Reg BI). Representative Carolyn Maloney (D-NY), Ranking Member of the Subcommittee on Capital Markets, said a standard for broker-dealers is long overdue, but expressed disappointment that the SEC did not propose a universal best interest standard for investment advisers and broker-dealers. She is concerned that it is not as strong as it could have been or as strong as the Department of Labor’s fiduciary rule, which was vacated by the Fifth Circuit in March. Representative David Scott (D-Ga) noted that the Dodd-Frank Act required both raising the standard for broker-dealers and harmonizing the standard for investment professionals. He urged Chairman Clayton and the SEC to be leaders in the promulgation of a new standard and asked him if he would be “captain of the ship.” Clayton responded at first that no one person can do this, but then reluctantly agreed to his new position of “captain of the ship.” He also agreed with Scott that the SEC is the agency best-suited to lead the others in the harmonization of a standard.
Proxies. Some committee members expressed displeasure at the current threshold for shareholders to submit a shareholder proposal under Exchange Act Rule 14a-8, which currently requires holding $2,000 (or 1 percent, which can be less than $2,000) held continuously for one year. Representative Ted Budd (R-NC) noted that legislation has been introduced that would raise that threshold and inquired if the SEC intended to do anything in the meantime. Clayton said the shareholder proposal threshold would be examined as part as an overall examination of the proxy process.
On proxy advisory firms, Rep. Edward R. Royce (R-Cal), head of the House Foreign Affairs Committee, observed that two firms have a “stranglehold” on the market and asked Clayton about the causes of this lack of competition and if the SEC plans on taking any action. Drawing on his own background in economics, Clayton explained that the dominance of two firms could be explained by economies of scale. The core function of those firms is aggregating data, crunching it, and producing data reports. He acknowledged that proxy advisory firms do have an important role in the regulatory “ecosystem” and that they should be looked at.
Cryptocurrency and ICOs. Speaking on a popular recurring topic, several members inquired about the SEC’s approach to cryptocurrency and ICOs. Responding to a question from Rep. Claudia Tenney (R-NY), he reaffirmed comments made by CorpFin Director Bill Hinman that, in the cryptocurrency space, Bitcoin and Ethereum do not fall under the SEC’s jurisdiction. He tempered that, however, with a warning that in bringing those assets into an SEC-regulated entity, that entity still needs to go through the regular “Know Your Customer” and anti-money laundering procedures.
Representative Warren Davidson (R-Ohio) asked Clayton about enacting a regulatory framework for ICOs to ensure “regulatory certainty,” stating that he is concerned that disparate court opinions might not be as coherent as Congress, regulators, innovators, and investors would like. He singled out in particular Ripple, which has been the subject of numerous court cases. Clayton, ostensibly referring to the investment-contract Howey test, said that all of the SEC’s enforcement actions and guidance are rooted in a consistent approach to raising capital in the U.S. He does not want to change those rules simply because of the existence of a new technology.