Securities Regulation Daily Clayton addresses proxy advisers, fiduciary standard, buy-backs, Brexit with Senate
Tuesday, December 11, 2018

Clayton addresses proxy advisers, fiduciary standard, buy-backs, Brexit with Senate

By Jay Fishman, J.D.

SEC Chairman Jay Clayton, on December 11, 2018, testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs about the Commission’s new strategic plan for 2018 to 2022, which: (1) prioritizes long-term main street investors’ needs; (2) allocates Commission resources to handle U.S. capital market trends and developments; and (3) invests in SEC staff by enhancing the Commission’s technology, data analytics and human capital. Clayton additionally remarked upon the below subjects that, in many cases, fostered SEC initiatives:

  • Brexit;
  • Capital formation;
  • Consolidated Audit Trail (CAT);
  • Cybersecurity and enterprise risk;
  • Distributed ledger technology, digital assets and Initial Coin Offerings (ICOs);
  • Dodd-Frank Act issues;
  • Enforcement protecting main street investor interests;
  • Engagement with main street investors and other market participants;
  • Fiduciary standard for broker-dealers;
  • Improving the investor experience;
  • IPOs;
  • Modernizing asset management regulations;
  • Modernizing trading and market structure;
  • Proxy process including proxy advisory firms;
  • Security based swaps; and
  • Transition away from LIBOR.

In the one-hour designated for his testimony, Clayton provided the Senate Committee with the SEC’s current "take" on all of the above issues, but answered the most "heated questions" on the following four subjects:

Proxy voting process. Senator Mike Crapo asked what the SEC is doing about the proxy voting process made up of three distinct areas: (1) proxy plumbing; (2) shareholder voting; and (3) proxy advisory firms. The proxy adviser subject has particularly become a "hot topic" because Congress currently has two bills on the table that if passed could require previously exempt proxy advisory firms to register with the Commission. Clayton stated that a proxy roundtable held in December 2018 reached a consensus among its investor, company and other market participants that proxy plumbing needed an overhaul.

Regarding proxy advisory firms, he acknowledged a growing agreement that the current dynamics among proxy advisory firms, investment advisers who employ those firms (and have a fiduciary duty to their investors), issuers, and investors at large, including main street investors, could be improved. Additionally, Clayton said that greater clarity was needed about the division of labor between proxy advisors and the investment advisers they serve, as well as the analytical and decision-making processes they employ. Clayton concluded that he is awaiting staff recommendations on these and other issues, including proxy advisory firm conflicts of interest.

Fiduciary standard for broker-dealers. Clayton testified about proposed Regulation Best Interest, which would mandate a broker-dealer to put a client’s interest above the broker-dealer’s own interest when providing an investment recommendation. But Senator Elizabeth Warren emphasized that numerous studies, including the SEC’s own research, have shown that such disclosure-based regulations do not work because retail clients remain in the dark about the differences between a broker-dealer and an investment adviser, and the tasks they each perform. She grilled Clayton about why the SEC does not simply adopt the same fiduciary standard for broker-dealers that it has for investment advisers; having identically worded standards, she said, would clarify the confusion for all retail clients.

Senator Catherine Cortez-Masto suggested that allowing broker-dealers to have any financial incentive for making a recommendation, other than regular pay, would lead the broker-dealers to put their own interests above the clients’ when making a recommendation. But Clayton disagreed by suggesting that certain incentives, as long as they are not hidden, might actually ensure a win-win for the broker-dealer and client.

Stock buy-backs. Senator Jack Reed asked Clayton whether he considered it wrong for companies to buy back investors’ stock and layoff workers rather than investing in the long term future of the company. Clayton’s response clarified that the Commission has no authority over how a company allocates its shares, and could only get involved if a prohibited manipulation occurred in connection with the buy-back. Clayton did admit, however, that the SEC could do a better job around disclosure, specifically "driving disclosure toward human capital."

Brexit. In light of the increasing risk to U.S. companies from Theresa May’s decision to delay the vote on the Brexit deal, Senators were insistent upon Clayton providing his "take" on the current situation and what the Commission planned to do. Clayton acknowledged Brexit’s complexity, said that both he and his CFTC counterpart Christopher Giancarlo have spoken with European Union (EU) representatives about the U.S. impact, and received responses that the U.S. effect would be considered in EU decision-making. Clayton additionally made the following personal observations: (1) the actual effects of Brexit will depend on many factors, some of which may prove beyond United Kingdom (U.K.) and EU control, but will simultaneously depend on the U.K.’s and EU’s ability to provide a path forward that allows for adjustment without undue uncertainty, disruption or cost; and (2) our markets are international so that the effects of Brexit on U.S. markets and main street investors will be international.

Furthermore, he mentioned having directed the SEC staff to focus on the disclosures that companies make about Brexit, and that he has already seen a wide range of disclosures, even within the same industry. He said that some companies have fairly detailed disclosures about Brexit’s impact on them while other companies simply state that Brexit presents a risk. He declared that he would like to see companies providing more robust disclosure about how management is considering Brexit and the impact it may have on the company and its operations. Lastly, Clayton remarked that the staff has begun ongoing discussions with other U.S. financial authorities, its U.K. and EU counterparts, and with market participants, to identify and plan for potential Brexit-related impacts on U.S. investors and markets.

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