We previously underscored the regulatory focus areas the Biden administration would likely bring to bear. At the time, we flagged Gary Gensler as the most likely successor to Jay Clayton’s chair at the Securities and Exchange Commission (SEC). Last week by a vote of 53 to 45, Gensler was approved by the U.S. Senate to be the new SEC chairman. Much has been written about Gensler’s elevation to the position since his initial nomination. This is due in no small part to the fact that Gensler is a known quantity to the U.S. asset management industry. He was previously head of the Commodity Futures Trading Commission (CFTC) under the Obama administration. In this CFTC role, he built a reputation as a hardnosed policymaker, implementing comprehensive reforms to the U.S. derivatives markets as part of the Dodd-Frank reforms and being a driving force behind significant enforcement actions around the LIBOR manipulation cases at the time.
Here we take a whistle-stop tour of the top issues likely to ensure Mr. Gensler doesn’t get a whole lot of a “honeymoon period” when he takes his seat at the head of the SEC table. One thing is for certain, he starts his tenure with a full plate. Beyond the “business as usual” examination priorities recently published, here are seven specific areas likely to come up for consideration early in his tenure:
1. GameStop Fallout
The GameStop trading frenzy and other so called “meme” stocks continue to be high profile and much discussed. The event highlights the challenges of increased direct retail participation in the investment markets and the impact of relatively new methods of communicating on markets, such as social media and use of sales devices, like gamification of trading. The event was multi-faceted with regulatory considerations ranging from short selling transparency to appropriate trade settlement cycles from payment for order flows, to market manipulation and how to properly account for securities information channeled through unregulated forums such as online and social media accounts. The event merited a congressional hearing with all the main characters of the story being asked about it, but it seems certain the GameStop fallout and associated issues remain unfinished and we will likely see Gensler and the SEC return to the case study to pick through its bones in the near future.
2. SPAC Boom
The past year has seen a surge in the popularity of Special Purpose Acquisition Companies (SPACs) in the United States. To the uninitiated, SPACs are formed to raise money through an initial public offering (IPO) to buy another target company. At the time of the SPAC IPOs, the SPAC has no existing business operations or may not even have a specific target company in mind for acquisition. SPACs usually have two years to complete an acquisition or they must return their funds to investors. According to SPACinsider.com 564 SPACs have launched in the U.S. already in 2021, already double the number in 2020. This rapid and exponential growth has not gone unnoticed at the SEC. In fact, the agency has released several regulatory releases on different aspects of SPACs:
Rapid growth of new innovative product involving retail investors tends to pique the interest of regulators. It is very likely that on Gensler’s watch we will see both exam and investigatory activity along with a more comprehensive and joined up approach on how to address investor protection aspects comprehensively within SPAC issuances in the coming months.
3. ESG and Climate Change
While the SEC awaits it new Chair to be approved and take his new position, they have continued to carry out their mission. One of the very obvious areas that the SEC are looking to pro-actively address is the issue of ESG. Under acting Chair Alison Herron Lee who has been very vocal in advocating for SEC action in addressing the apparent regulatory vacuum in the U.S. on the issue of climate change and ESG regulation, the SEC has started to mobilize around the topic of ESG flagging aspects such as investor disclosures and proxy voting responsibilities with regards to ESG as key areas in several recent speeches. The SEC launched a task force within the regulator’s Division of Enforcement. The SEC also recently issued a risk alert to highlight to investors the potential misleading statements found during recent examinations of investment companies that offer environmental, social, and governance (ESG) products and services.
Indeed, ESG was a topic covered extensively within Gensler’s congressional confirmation hearing before the Senate Banking Committee where he said “Increasingly, investors really want to see – tens of trillion of dollars in assets behind it – climate risk disclosure. Issuers would benefit from such guidance. So, I think through good economic analysis, working with the staff, putting out to the public to get public feedback that is something the commission, if I’m confirmed, would work on.”
While Europe has to date been the epicenter of the ESG regulatory debate with SFDR and other regulations, the SEC appears to want to ensure an adequate and well understood policy baseline on ESG is established also in the U.S. markets, and it seems that ESG is unavoidable and we will continue to see it as a central focus of the SEC on Gensler’s watch.
4. Achegos Consequences
There is nothing like a large high profile blow up to spur regulatory action, and the Archegos case will be of particular interest to Gensler primarily because it involves swaps trading transparency, one of the major elements of his role when he was head of the CFTC. The complication of the Archegos event is that since they registered as a family office, they were exempt from certain registration or Form PF requirements with the SEC because they had less than 15 clients. Family offices can self-elect to report to the SEC through its EDGAR system, but in the case of Archegos they did not report and as such built up large leveraged positions through total return swaps which allowed them to circumvent regulatory reporting requirements on these big stakes.
These family office registration and reporting exemptions are likely to be revisited and tightened under Gensler’s watch. The role of the prime brokers will also come into focus as the event is further reviewed.
5. Regulation Best Interest
- The SEC’s Regulation Best Interest (Reg BI) has bobbed around for a long time now and interacts with the Department of Labor’s standards as well. Reg BI requires that financial advisors and broker-dealers must place the best interests of their customers ahead of their own. It also includes a requirement for the filing of additional paperwork. The client relationship summary, better known as Form CRS, is the primary additional obligation. Under Reg BI, financial advisors and broker-dealers must share versions of the Form CRS with their retail investors. The SEC has already conducted certain market inspections of Reg BI. Through its December 2020 Statement on Recent and Upcoming Regulation BI Examinations once again the SEC highlighted that retail investor protection and ensuring that product costs, suitability, and general duty of care to investors by advisors and broker dealers remain a high priority.
There has been much talk about revisiting Reg BI as it falls short of adopting the so-called Fiduciary standard. In view of competing priorities, it is more likely that the effectiveness of the current rule will be more intensely scrutinized: examinations and subsequent enforcement actions a likely to be ramped up.
6. Bitcoin ETFs
SEC approval of bitcoin ETFs has been an issue which has ebbed and flowed for several years now. In 2018, the SEC rejected nine bitcoin ETF applications and for a while applications like these went into hibernation. The SEC has previously denied requests to create a bitcoin ETF, citing concerns over fraud, adequate custody provisions and excessive price volatility. Proponents suggest that the market has matured to a level where these concerns are not as prevalent. Since the initial applications, a well-functioning bitcoin future market and regulated crypto custodians with insurance have emerged. The first quarter of this year has seen a number of bitcoin applications filed with the SEC and many in the industry see positive signals in the market which might lead to the SEC finally approving the structures. The focus has intensified in the U.S. market with the recent approval of a Canadian bitcoin ETF too.
Much of the recent positive sentiment around Gensler’s elevation as Chair of the SEC has come from the bitcoin and cryptocurrency sector of the market. The excitement lies in the fact that he is generally seen as a crypto advocate, and has recently been lecturing at MIT on cryptocurrency, blockchain technology, distributed ledgers, and smart contracts. He is seen as one of the best and brightest minds on the concepts and how they fit into existing regulatory infrastructure. Along with so called “Crypto Mom” Hester Peirce, the SEC seems to have knowledgeable commissioners who will take such rule changes at their merits. The issue gets a lot of press attention, but there are many competing priorities for the SEC to address, so it is not guaranteed that this issue will be fully resolved once and for all in the short term.
7. Payment for Order Flow
This issue was a central element to the GameStop event and the interaction between Robinhood and retail investors in particular was predicated on the commercial arrangements in place. Robinhood remains very popular with retail investors because of the low-cost commission free trading that it extends to its customers. Many other similar firms charge clients nothing for trading because instead they receive direct payment from broker-dealers to route these retail orders to them, a process known as "payment for order flow." All parties must still work to ensure that the investor receives “best execution” for their trades and also that there is transparency around the arrangements and all conflicts of interest are adequately disclosed.
What is interesting too is that ESMA, the primary European securities regulator, felt compelled to talk about the GameStop event and that it was a cautionary tale which should prompt the E.U. to also look at a plethora of aspects such as zero commission trading, payment for order flow, conflicts of interest, best execution, and inducements within its own MIFID and Market Abuse Directive rules.
There are continued questions stemming from the GameStop event including payment for order flow models and their interaction with best execution standards. It is an area that the SEC and Robinhood have already engaged upon, and an area which undoubtedly will be high on Gensler’s short-term agenda. Appropriate disclosure at a minimum will be an area which will comes under greater scrutiny.
It is unquestionable that regardless of the lack of new rules and regulations, 2021 will remain a vibrant year at the SEC and the other U.S. regulatory agencies.
