Republicans expressed their appreciation for Clayton’s efforts to bring simplicity to the SEC’s regulatory framework, while Democrats were less enthusiastic about the chairman’s legacy, especially regarding climate risk.
SEC Chairman Jay Clayton, who announced he will leave the Commission at the end of the year, made his final appearance as chairman before the Senate Banking Committee, where he was peppered with questions about his legacy, accolades for the SEC’s modernization and deregulation efforts, and admonishments for being too easy on corporations. Clayton’s prepared testimony outlined the Commission’s efforts in 2020, including its response to the coronavirus pandemic, its regulatory and policy agenda over the past 12 months, diversity and inclusion, and enforcement, compliance, and investor education initiatives.
Praise. Several members of the committee lauded the Commission’s actions with Clayton at the helm, in particular the modernization of outdated rules and the staff’s resilience in dealing with the challenges presented by COVID-19. Chairman Mike Crapo (R-Idaho) praised SEC rulemaking on the definitions of "accredited investor" and revamping the SEC’s framework for exempt offerings, which he said would help smaller companies get back on track after COVID. Other improvements made under Clayton that were "long overdue" included updating the submission thresholds for shareholder proposals and resubmissions, streamlining disclosure under Regulation S-K, and adopting Regulation Best Interest and Form CRS, according to Crapo.
Senator Mark Warner (D-Va) also mentioned the SEC’s efforts to modernize Regulation S-K, in particular the inclusion of human capital metrics disclosure. Warner said that Clayton had taken an important first step in requiring some level of disclosure in this area, which is important due to companies investing less in tangible goods and more in intangible goods such as human capital. While he hopes the work of the Commission will proceed further on this issue, Warner called it a good start towards establishing a baseline for comparison of human capital metrics between industries.
Criticism. While Sen. John Kennedy (R-La) heralded Clayton as "one of the best SEC Chairman this country has ever had," not all committee members were as complimentary in their comments. Ranking Member Sherrod Brown (D-Ohio) asserted that Clayton had tried to reduce transparency and undermine investor protections even in the face of strong opposition from large and small investors, advocates, and experts. The amended SEC rules on shareholder proposals and proxy advisory firms show that the Commission favors corporate interests over those of small investors and would stifle boardroom conversations on diversity, governance, and climate risk, Brown remarked. He also criticized the Commission’s perceived inaction on climate risk disclosure, stating that Clayton advanced "one bad rule after another" while watering down corporate financial disclosures.
Senator Elizabeth Warren (D-Mass) also called out Clayton on climate risk, proclaiming that as the climate crisis has worsened, Clayton’s SEC has done nothing. The SEC currently lacks uniform standards for climate risk reporting so investors can compare companies head-to-head, and there are huge gaps in the SEC’s disclosure rules that allow companies to conceal or downplay climate risks, she stated.
Clayton, echoing a sentiment he has expressed in the past, reiterated that if a risk is material, it must be disclosed, including risks related to climate change. He maintained that investors want good, decision-useful information. Unconvinced, Warren declared that the climate crisis is an existential threat and expressed her hope that the new SEC chair would place the issue at the top of his or her priorities.
Taking a somewhat gentler approach to his questioning, Sen. Brian Schatz (D-Hawaii) asked Clayton where the SEC is now in terms of enforcement efforts related to climate risk disclosure and what he wants to see in the future. Clayton replied that everyone believes that for certain industry sectors and companies, climate disclosure is material and is required. He said he gravitates to the view that disclosure should be sector-specific but warned that it is difficult to make forward-looking disclosures that will be accurate over time. As such, Clayton would advocate a safe harbor for good faith disclosures, adding that issuers shouldn’t necessarily be held to precision when it comes to forecasting the future.
SEC initiatives under Clayton. Senator Tom Cotton (R-Ark) decried "regulation by enforcement," which he said was "infamous" under President Obama, and asked Clayton how he felt about using enforcement actions to set regulatory policy instead of going through a notice and comment period under the Administrative Procedure Act. While Clayton remarked that some rules do require the staff to rely on a facts-and-circumstances application, he agreed with Cotton that in general, the SEC should not expand its enforcement authority without promulgating rules through notice and comment.
A fundamental principle of the rule of law, Cotton continued, is that it is hard to have an ordered society without clear and established rules known in advance that all citizens can obey. He cited in particular the SEC’s Share Class Selection Disclosure Initiative, which provided investment advisers a mechanism to self-report disclosure violations related to conflicts of interests regarding mutual fund fees. The SCSD Initiative ultimately returned $139 million to investors. According to Cotton, several firms were fined because they did not list certain items in their disclosures. While these types of disclosures might be considered "best practices," the SEC did not provide clarity in advance on how they would be enforced, Cotton said.
Clayton defended the SCSD Initiative, stating that investment advisers have the duty not to put their own interests before those of their clients. The SEC tried to deal efficiently with a widespread practice that was inconsistent with the law, Clayton advised. While some firms who were fined may have felt that they were within the bounds of the law, the SEC disagreed. He added that he hoped the Initiative had brought clarity to the issue and assured that the Enforcement Division staff pursued these actions based on rigorous analysis supporting the Division’s position.
Noting that fewer companies have gone public in recent years, Sen. Pat Toomey (R-Pa) asked how the SEC can create an environment that makes it more attractive for companies to go public at an earlier stage. Clayton said that the SEC’s rules promulgated under the JOBS Act helped facilitate the move for private companies to become public companies by providing an on-ramp to the public market. He also remarked that the SEC has expanded access to the JOBS Act, which he believes has made a difference over time to the decision between staying private or going public. While he said he wouldn’t take a "victory lap" just yet, he noted that IPOs have increased, acknowledging that the increase could be due to many factors.
Future actions. Some senators asked Clayton what the Commission should focus on following his departure. Clayton touted the idea of improving "corporate hygiene" to remove uncertainty that corporations are operating with transparency and rigorous governance. Areas to examine in this space include 10b5-1 plans, option pricing, and the 8-K information gap, he explained.
The SEC can also learn from its mandatory telework environment imposed at the beginning of the COVID crisis, Clayton said, especially as it relates to the efficiency and importance of electronic communication. The SEC should move its regulatory framework forward to an electronic framework. Transitioning to telework showed the importance of being able to conduct business electronically and remotely, he said. While the SEC will still provide information on paper to investors who prefer it, everyone will be better off on a level electronic communication playing field, Clayton advised.
Senator Mike Rounds (R-SD) noted that some state legislatures are considering implementing a financial transaction tax and asked Clayton how this might affect the market. Clayton responded that such a tax largely falls on the end user—here, the investor—so legislators should approach the issue with that in mind. He also warned that a state-by-state, piecemeal approach might result in critical infrastructure moving from one jurisdiction to another for more favorable treatment, which could cause problematic operational issues.
Senator Catherine Cortez-Masto (D-Nev) raised the issue of the SEC’s proposal to raise the threshold for investment manager reporting on Form 13F from $100 million in holdings to $3.5 billion, observing that the comment letters received have been overwhelmingly opposed to the proposed amendment. She asked Clayton if the SEC plans to take action on the proposal before he leaves the Commission. Clayton responded no, but added that the SEC has learned from the comments that other changes need to be made. For instance, the staff learned that Form 13F was being used for companies to find their own shareholders, an issue that can potentially be fixed by reforming the OBO/NOBO system. The staff also learned that Form 13F is being used for tracking a fund’s trading strategies, he added, noting that this method is an inefficient way of tracking.
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