Securities regulators give updates at SIFMA panel

By Lene Powell, J.D.

Senior regulators from the SEC, FINRA, and OCC shared insights at a panel of the SIFMA C&L Annual Seminar 2019 about current priorities and challenges at their agencies, including Regulation Best Interest, digital assets and assets, fixed income initiatives, and market structure issues.

The panel was moderated by Merri Jo Gillette, deputy general counsel at Edward D. Jones & Co., L.P., and included Brett Redfearn, director of the SEC Division of Trading and Markets; Bob Colby, chief legal officer at FINRA; Morris Morgan, senior deputy comptroller and chief operating officer at the Office of the Comptroller of the Currency; and Dick Walker, partner at King & Spalding.

Regulation Best Interest. According to Redfearn, Reg BI is a “very high priority” for the SEC, with the agency having received 6,000 comment letters so far and more still coming in. The SEC has two goals for the rule: 

1. Enhance the quality of a broker-dealer’s recommendations by reducing the potential harm that could come from conflict of interest;
2. Preserve the broker pay-as-you-go model. Redfearn sees this as “extremely important.” 

“Ultimately, we’re walking into a world where it becomes very clear that a broker-dealer cannot put his or her interests ahead of a customer when making a recommendation,” said Redfearn.

The challenge, said Redfearn, is tailoring common fiduciary principles to the broker-dealer regulatory regime, and dealing with conflicts of interest. Conflicts will need to be disclosed, mitigated where possible, and in some cases eliminated. For example, Redfearn noted that Chairman Clayton has pointed to high-pressure sales contests as creating a conflict that should be eliminated.

Redfearn said the SEC is in close communication with the states to avoid inconsistencies with their rulemakings. He did not have any information on when the rule will be finalized, but said hopefully the comment period is “wrapping up.”

Colby said that FINRA is “a very strong supporter of Reg BI.” He noted that the proposal refers to FINRA 472 times, and that there’s a lot of overlap between the existing suitability rule and the direction that Reg BI is going in order to mitigate conflicts. When FINRA gets the final rule, they will look to see if anything is different from FINRA’s rule, and will fix any differences. FINRA is also looking to see if there’s any reason to continue to have a separate suitability rule, because they will be enforcing Reg BI and do not want to be inconsistent in any way.

FINRA priorities. In addition to Reg BI, Colby said that another FINRA priority is dealing with brokers or firms that have a history of misconduct, so that good firms and brokers can stand up and say, “You can trust us.” FINRA has been working on an approach to firms with persistent misconduct issues that will provide better tools to speed their exit from the business.

Another FINRA priority is the Consolidate Audit Trail (CAT), for which it has been given the responsibility of developing. Getting it done right and quickly is a very high priority for FINRA, said Colby, but progress is delayed because the agency is picking up the responsibility at a late stage.

Digital assets and FinTech. Regarding the emerging area of digital assets and cryptocurrencies, Walker observed that last November, a small group called ADAM (Association for Digital Asset Markets) issued a press release about forming an SRO. Duncan Niederauer is head of its advisory board. The Winklevoss twins and other people are looking at something similar. According to Walker, this would have great value to the industry, and he hopes that regulators will support it.

Redfearn said the SEC is open to such an SRO, but he pointed out that there’s a securities law framework already in place that’s probably valid for any type of security. It’s unclear to the SEC that a whole new regime for digital securities is needed.

Colby said that one recurring issue is the question of custody – how do you get it and maintain it? Another issue is that a lot of the assets underlying initial coin offerings (ICOs) are currently of low quality. As someone told him, “A lot of these ICOs are a techno wrapper around a penny stock.” Colby noted that FINRA’s first enforcement action in the space was against something called “HempCoin”, and there are a lot of plain old bad asset issues and sales in the space. It complicates thinking through the technical issues, he said that a lot of the underlying assets are “not great.”

Colby quickly qualified this assessment, however, and agreed with Walker that the technology is valuable, and after the bad actors have left the space, there will still be permanent value there. Redfearn concurred, saying that the SEC believes completely in the promise, but at the same time, when you have an unregulated space, bad actors tend to flock there. So, the number of enforcement cases and the amount of manipulation and fraud, bad sales practices is astronomical. Colby agreed, and noted that this is compounded by the fact that a lot of products are being thought up by 20-year-olds who are focused on the technology and don’t necessarily see the need for regulation. Walker brought it back around to the idea of a digital asset SRO, saying that given the conduct issues, having responsible people getting together and defining conduct standards would be a good thing.

Fixed Income. Regarding the activities of the Fixed Income Market Structure Advisory Committee (FIMSAC), Redfearn reported the group has come up with give recommendations: 

1. Block pilot for corporate bonds. The group is looking at how current reporting regime impacts the liquidity of block trades. There is a proposal to raise block size for reporting for investment grade instruments to $10M and for high-yield to $5M. Above that, there would be a delay period of 48 hours before they would have to be reported.
2. Review of the regulatory framework for electronic trading platforms. Different platforms have different protocols and so differing regulatory regimes. The committee is looking at how ATS rules should possibly be modified.
3. Creation of a centralized and widely accessible new issue reference database. The database would contain specific data elements for newly issued corporate bonds, so that data gets to everyone that needs it. FINRA has filed a rule proposal related to this.
4. Creation of a labeling scheme for exchange-traded products (ETPs). The idea is just to have more clarity on what are ETPs. This would include exchange-traded funds, exchange-traded notes, exchange-traded commodities, and exchange-traded instruments.
5. Promotion of investor education concerning fixed-income ETFs. This would be to increase investor awareness around these instruments. 

Market structure. Redfearn noted that he and Chairman Clayton gave a speech in early March that touched on market structure issues. He identified three main issues that came out of roundtables in 2018:

• Thinly traded securities. Currently there is largely a one-size-fits-all market. Securities that trade once a day have the same market structure as securities that trade 10 million shares a day. The question is, is that market structure appropriate for thinly traded securities? A lot of market participants in the roundtables said that it is not. The SEC is looking at a policy statement articulating the possibility of “no UTP,” which would mean that an SRO would have exclusive listings of a thinly-traded security.
• Retail investor fraud and penny stocks. Here, the SEC is looking at Rule 15c2-11, at the piggy-back exception that comes with quoting some of these smaller securities. Some securities are being quoted where there hasn’t been any financial information reported for sometimes months or years. The SEC is asking, if somebody isn’t putting out any financial information and this is a zone that is ripe for fraud, and investors don’t have what they need, should they be still be quoted or be able to avail themselves of the piggy-back exception?
• Market data and market access. Technological progress has made the U.S. equity markets extremely efficient and competitive, but Reg NMS is now 12 years old. The SEC approved a transaction fee pilot, which is planned to launch, and is asking questions about data being slower and having less content on the SIPs than on the proprietary data feeds. Should the core data be upgraded to be faster and have more content? The SEC is also looking at transparency for market data businesses. There are governance issues because SROs are not only running the core data but also selling the other products that in some respects might compete. Finally, the SEC is asking questions about odd lots. For securities trading over $500, 60 percent of quoting and trading activity inside a 100-share round lot is not being seen by the marketplace. These are significant notional values that are not being seen, said Redfearn.