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SEC's Investor Advocate Decries Deregulatory Agenda Under Clayton

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The Securities and Exchange Commission’s deregulatory agenda under former Chairman Jay Clayton, characterized as efforts to “modernize” or “streamline” rules, diminished investor protections, according to SEC Investor Advocate Rick Fleming.

In its year-end report to Congress, the SEC’s Office of the Investor Advocate also told lawmakers that the commission also failed to “prioritize repairs to the antiquated infrastructure of the proxy voting system, bypassed opportunities to make disclosures machine-readable, and failed to establish a coherent framework for the disclosure of environmental, social, and governance (ESG) matters that could influence a company’s long-term performance.”

Fleming’s office suggested reversal of what the Investor Advocate Office considered “the most troubling recent actions” of the commission: the shareholder proposal rule, the proxy advisory firm rules, a rulemaking to “harmonize” various Securities Act registration exemptions, and a rulemaking related to inverse and leveraged exchange-traded funds.

The launch of the first nontransparent ETFs during 2020 represented “a significant milestone for the ETF industry while triggering potential new investor protection concerns,” the 96-page report states.

As the report explains, unlike traditional ETFs, nontransparent ETFs are not required to disclose their portfolio holdings on a daily basis. This feature enables asset managers to utilize the ETF structure for active portfolio management strategies without exposing their proprietary strategies to the marketplace. The feature also necessitates, however, that a nontransparent ETF find a satisfactory replacement or substitute for the transparency-based arbitrage mechanism that has been at the conceptual core of ETFs for decades.

“Given the very recent launch of these products, it is too early for us to conclude whether the various arbitrage mechanisms utilized by nontransparent ETFs are as safe and effective as the traditional, transparency-based ETF arbitrage mechanism,” the report notes.

Fleming also noted that his office will encourage the commission to consider in the coming months the Financial Industry Regulatory Authority’s proposed new Rule 4111 (Restricted Firm Obligations), which, among other variables, would require deposits of cash or qualified securities that could not be withdrawn without FINRA’s prior written consent, if a firm exceeds a certain threshold calculation of broker or other misconduct.

“We reviewed the comments received, analyzed the data behind the rule, and met with FINRA staff to express our support for the concept and the analysis,” Fleming wrote.

The Office of the Investor Advocate was created by the Dodd-Frank Act. Fleming was the first person named to the post, by then-SEC Chair Mary Jo White in 2014. Though he reports to the SEC chair, he submits two reports a year directly to Congress.

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