In his first public speech as chairman, Jay Clayton outlined his agenda and operating philosophy for the Securities and Exchange Commission.
He addressed the Economic Club of New York on July 12. Nearly six months ago, his predecessor, Mary Jo White, gave her last public address as SEC Chair at the same forum.
Clayton outlined “eight principles” that will guide his SEC chairmanship.
Principle #1: “The SEC’s mission is our touchstone.”
The SEC has a three-part mission: to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate capital formation. “Each tenet of that mission is critical,” Clayton said. “If we stray from our mission, or emphasize one of the canons without being mindful of the others, investors, companies (large and small), the U.S. capital markets, and ultimately the economy will suffer.”
Principle #2: “Our analysis starts and ends with the long-term interests of the Main Street investor.”
“How does the SEC assess whether we are being true to our three-part mission? The answer: the long-term interests of the Main Street investor,” Clayton said. “How does what we propose to do affect the long-term interests of Mr. and Ms. 401(k)? Are these investors benefitting from our efforts? Do they have appropriate investment opportunities? Are they well informed?”
Principle #3: “The SEC’s historic approach to regulation is sound.”
“Disclosure and materiality have been at the heart of the SEC’s regulatory approach for over 80 years,” Clayton said.
“I believe in the regulatory architecture that has governed the securities markets since 1933,” he added. “It is abundantly clear that wholesale changes to the Commission’s fundamental regulatory approach would not make sense.”
Principle #4: “Regulatory actions drive change, and change can have lasting effects.”
“Incremental regulatory changes may not seem individually significant, but, in the aggregate, they can dramatically affect the markets,” Clayton said.
The SEC’s disclosure-based regime “has worked so well that we—not just the SEC, but lawmakers and other regulators—have slowly but significantly expanded the scope of required disclosures beyond the core concept of materiality,” he added. “Those actions have been justified by regulators and lawmakers alike, often based on discrete, direct and indirect benefits to specific shareholders or other constituencies. And it has often been concluded that these benefits outweigh the marginal costs that are spread over a broad shareholder base.”
Clayton said that the roughly 50 percent decline in the total number of U.S.-listed public companies over the last two decades “forces us to question whether our analysis should be cumulative as well as incremental.”
“I believe it should be,” he answered, lamenting the fact that “studies show the median word-count for SEC filings has more than doubled, yet readability of those documents is at an all-time low.”
While there are many factors that drive the decision of whether to be a public company, increased disclosure and other burdens may render alternatives for raising capital, such as the private markets, increasingly attractive to companies that only a decade ago would have been all but certain candidates for the public markets, he suggested.
Principle #5: “As markets evolve, so must the SEC.”
Technology and innovation “are constantly disrupting,” and the SEC must recognize this and strive to ensure that its rules and operations reflect the realities of our capital markets, Clayton said.
“Technology is not just the province of those we regulate,” he added. “The SEC has the capability to develop and utilize it, too.”
As the SEC evolves alongside the markets, however, it must remember that implementing regulatory change has costs,” Clayton said.
“Companies spend significant resources building systems of compliance, hiring personnel to operate those systems, seeking legal advice concerning the design and effectiveness of those systems, and adapting the systems as regulations change,” he said. “Shareholders and customers bear these costs, which is something that should not be taken lightly, lest we lose our credibility as regulators.”
Principle #6: “Effective rulemaking does not end with rule adoption.”
“The Commission should review its rules retrospectively,” Clayton said. “We should listen to investors and others about where rules are, or are not, functioning as intended. We cannot be shy about being introspective and self-critical.”
Principle #7: The costs of a rule now often include the cost of demonstrating compliance.”
“Rules are meant to be followed, and the public depends on regulators to make sure that happens,” Clayton said. “It is incumbent on the Commission to write rules so that those subject to them can ascertain how to comply and—now more than ever—how to demonstrate that compliance. Vaguely worded rules can too easily lead to subpar compliance solutions or an overinvestment in control systems. We must recognize practical costs that are sure to arise.”
For example, when the SEC requires a Chief Executive Officer to make a certification that a specific requirement has been met, while he or she retains ultimate responsibility, realistically, it should be expected that the responsibility will be supported through the chain of command in a demonstrable manner.
“This can be an expensive practice that goes well beyond a prudent management and control architecture; when third parties, such as auditors, outside counsel, and consultants, are involved, the costs—financial costs and, in many ways more important, the cost in terms of time—can skyrocket,” Clayton said. “This may be the appropriate regulatory approach, and to be clear, in some areas I think it is. However, the Commission needs to make sure at the time of adoption that we have a realistic vision for how rules will be implemented as well as how we and others intend to examine for compliance.”
Principle #8: Coordination is key.
The Commission works alongside more than 15 U.S. federal regulatory bodies, over 50 state and territory securities regulators, the Department of Justice, state attorneys general, self-regulatory organizations, and non-SRO standard setting entities. It also works with regulators in over 115 foreign jurisdictions. “Coordination with, between, and among all these organizations is essential to a well-functioning regulatory environment,” Clayton said.
Cyber-security is an area where coordination is critical. “Information sharing and coordination are essential for regulators to address potential cyber threats and respond to a major cyber-attack, should one arise,” he said. “The SEC is therefore working closely with fellow financial regulators to improve our ability to receive critical information and alerts and react to cyber threats.”
Speaking of cyber-security, “public companies have a clear obligation to disclose material information about cyber risks and cyber events,” Clayton said, adding that he expects “them to take this requirement seriously.”
He recognized that the cyber space has many bad actors, including nation states that have resources far beyond anything a single company can muster. “Being a victim of a cyber-penetration is not, in itself, an excuse,” he said. “But, I think we need to be cautious about punishing responsible companies who nevertheless are victims of sophisticated cyber-penetrations.”
“I fully intend to continue deploying significant resources to root out fraud and shady practices in the markets, particularly in areas where Main Street investors are most exposed,” Clayton said. He specifically targeted affinity fraud, microcap fraud” sound unremarkable and remote on paper, pump-and-dump scammers, those who prey on retirees, and “increasingly, those who use new technologies to lie, cheat, and steal.”
“Turning to the more sophisticated participants in our markets, the Commission will continue to use its enforcement and examination authority to support market integrity,” he added. “Market professionals have a special place in our economy, do not take unfair advantage of it.”
“There are circumstances in which the Commission’s reporting rules may require publicly traded companies to make disclosures that are burdensome to generate, but may not be material to the total mix of information available to investors,” Clayton said. “Under Rule 3-13 of Regulation S-X, issuers can request modifications to their financial reporting requirements in these situations. I want to encourage companies to consider whether such modifications may be helpful in connection with their capital raising activities and assure you that SEC staff is placing a high priority on responding with timely guidance.”
Clayton added, regarding market structure, that the time is right for the SEC to broaden its review of market structure to include specifically the efficiency, transparency, and effectiveness of fixed income markets. “The Commission must explore whether these markets are as efficient and resilient as we expect them to be, scrutinize our regulatory approach, and identify opportunities for improvement,” he said. To that end, he has asked staff to develop a plan for creating a Fixed Income Market Structure Advisory Committee.
Clayton dove into the uncertain waters of the Department of Labor’s so-called fiduciary rule.
“With the Department of Labor’s Fiduciary Rule now partially in effect, it is important that the Commission make all reasonable efforts to bring clarity and consistency to this area,” he said. “It is my hope that we can act in concert with our colleagues at the Department of Labor in a way that best serves the long-term interests of Mr. and Ms. 401(k).”
In June, Clayton issued a statement seeking public input on standards of conduct for investment advisers and broker-dealers.