Commissioners speak to SEC’s past, and future

The annual gathering of officials and staff at the Securities and Exchange Commission is sponsored by the Practising Law Institute. Among those in attendance was Chairman Jay Clayton.

His speech was an effort to “give you a look at the SEC through the eyes of management, similar to what public companies do in the Management’s Discussion and Analysis, or MD&A section of their SEC filings,” he said. “In other words, I am going to be eating some of our own cooking.”

Fiscal 2019 expenditures

For fiscal year 2019, the current fiscal year, employee pay and benefits are expected to continue to account for a significant portion of the Commission’s appropriation. As a result of a hiring freeze, staffing is down more than 400 authorized positions compared to fiscal year 2016, Clayton added.

“To ensure we can continue to meet our mission objectives, the resources Congress provided the agency for fiscal year 2019 will allow us to lift the hiring freeze and add 100 much-needed positions. This would put our staffing level on par with where we were five years ago,” he said.

Rulemaking agenda

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,” Clayton said.

“To be sure, statistics—such as an 88 percent completion rate—often fail to tell more than a narrow story,” he said. “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. In MD&A speak, they are our owners and we want to use our resources to drive long-term outcomes for them.”

The Division of Investment Management, he said, 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.

“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,” Clayton said.

The Division of Trading and Markets led several initiatives in fiscal year 2018 to increase transparency about market activities. For example, Clayton noted, in July 2018, the Commission adopted amendments that enhance the transparency requirements governing alternative trading systems, commonly known as “ATSs.”

“This initiative is a key part of our efforts to ensure fair and efficient markets, particularly those with significant Main Street investor participation,” he said.

“One final effort from our fiscal year 2018 that I want to highlight is the joint work by the Divisions of Investment Management and Trading and Markets to enhance and clarify the standards of conduct and mandated disclosures for our two principal types of financial professionals—broker-dealers and investment advisers,” Clayton told the audience. “My view is these standards should reflect what retail investors would reasonably expect of these financial professionals while preserving investor choice in the type of professional with whom they want to work, the nature and scope of services they receive, and how they want to pay for them. Completing our standards of conduct rulemaking is a top priority for me.”

“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 2018, the Commission returned $794 million to harmed investors,” he added. 

Commissioner Elad Roisman addressed the topic of “Encouraging Smaller Entrants to Our Capital Markets.”

“While our equities market receives the lion’s share of the SEC’s focus and resources, assets in the fixed income market are significantly greater. Chairman Clayton and the SEC staff have taken our responsibilities over these markets very seriously and have taken steps to promote a dialogue with market participants, including through the creation of the Fixed Income Market Structure Advisory Committee. I look forward to considering further improvements to these markets,” he said.

Roisman shared his thoughts on road blocks for small public companies.

”I think often of the story of Apple’s initial public offering in 1980. Massachusetts and several other states declared the IPO ‘too risky’ for state residents and barred the sale of shares to individual investors,” he said. “I will note that the SEC is purposefully not a merit regulator and, of course, an investor always assumes the risk that the stock he or she purchased will not return a profit. That said, we all know where Apple is today.”

Unfortunately, “there are fewer opportunities for retail investors to invest in a company like Apple at such an early stage of growth and more generally in smaller IPOs,” he added. “While it is not common for state regulators to ban their citizens from participating in early-stage IPOs, there are other barriers to small business capital formation that I think the Commission should understand and address.”

It is “no secret that the owners of private companies struggle with the decision of whether to enter our public markets” given the costs and challenges that come with it, Roisman explained. “In explaining his decision to sell a majority stake in Blue Bottle Coffee to Nestlé rather than taking the company public, the founder stated of the option to become a public company, ‘Everything that I’ve seen and read, it seems like a way of living in hell without dying.’”

“I take that statement to heart,” he said. “If business owners feel that way and are motivated to keep their companies private, retail investors have fewer options and opportunities to grow their wealth. I believe it is critical for the SEC to scrutinize whether its rules and regulations have contributed to this decreasing public company environment.”

In addition to regulatory burdens, Roisman cited costs related to litigation as another deterrent from raising capital in the public markets. 

What can the SEC do to help?

“As a general principle, it is the SEC’s responsibility to constantly engage with those who participate in, or want to participate in, our markets and to help facilitate capital formation. I think of the entrepreneurs wondering how to raise money to grow their businesses. I want those people to know that we are doing our best to ensure that the capital markets are accessible to them,” Roisman said. 

In December, the Commission issued a request for comment on quarterly reports and earnings releases. “The request for comment asks a lot of questions about how the Commission can reduce burdens associated with quarterly reporting while maintaining investor protections. It also asks for comments on how the existing periodic reporting system, earnings releases, and earnings guidance may foster an overly short-term focus by managers and other market participants,” Roisman said. 

Also, earlier this year, the Commission proposed extending the availability of test-the-waters communications to all issuers, regardless of size. Currently, the accommodation is only available to emerging-growth companies.

“Our hope is that extending the test-the-waters reform to a broader range of issuers will encourage issuers to conduct registered public offerings and lower their cost of capital, which will provide investors with more opportunities,” he said.

In addition to rulemaking efforts, he commended the SEC staff for working closely with issuers who express a wish to enter the public markets “through paths less traveled.”

For instance, he has seen companies pursue direct listings instead of initial public offerings, where they have amassed enough private capital to allow them to do that. 

“We have also seen recent examples of IPOs from companies with dual-class share structures. In these instances, investors are provided with robust disclosures of their rights and choose to buy shares with differing or no voting rights attached,” Roisman said. “This is certainly an appropriate investment for those who want to own a piece of a company and trust management to continue making the types of decisions that have made the company a success so far. If investors decide at a point in the future that they no longer agree with management, there is a market where they can sell their shares and part ways with the company. I think it is important for the SEC to allow for flexibility in corporate governance structures.”