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SEC Is Stretched Thin, Gensler Testifies

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What You Need to Know

  • Exam staff has remained relatively flat despite growth of more than 20% in number of RIAs.
  • House support of a $2 billion fiscal year 2022 budget for the SEC won't be enough.
  • Meanwhile, the agency faces emerging challenges in regulating crypto, private funds and firms' digital engagement practices.

Securities and Exchange Commission Chairman Gary Gensler told House lawmakers Tuesday that while the agency completed more than 3,000 exams of firms it oversees in 2020, exceeding the previous year’s numbers, the agency staff has shrunk “about 4% to 5%” over the past five years.

“As our capital markets have grown and technology continues to shape the face of finance, though, the SEC has not grown to meet the needs of the 2020s,” Gensler told members of the House Financial Services Committee during an oversight hearing.

At the end of fiscal year 2016, the SEC had 4,650 people on board, Gensler testified. Nearly five years later, that number had decreased by about 4%.

Since 2016, Gensler continued, “the Division of Examinations’ total staff has remained relatively flat despite growth of more than 20% in the population of registered investment advisors and a 65% increase in the assets managed by these firms. Other divisions are similarly stretched thin.”

The House’s support of a fiscal year 2022 budget of about $2 billion for the SEC, Gensler said, would get the securities regulator back to “only a headcount of 4,859.”

As of September, the agency is working under a voluntary return to the office, Gensler stated.

New Crypto Bill

Rep. Patrick McHenry, R-N.C., ranking member on the committee, introduced the same day the Clarity for Digital Tokens Act, which he said ensures that the regulatory framework for digital assets embraces new technology and innovation by providing a “safe harbor” for startup digital asset projects, while maintaining investor protections.

McHenry told Gensler that he has “strong concerns” about how Gensler’s SEC will regulate in the digital assets space, and “whether the law is on your side.”

“It’s time for Congress to step up and provide clear guidelines that will not allow an SEC chair to change the law by interview or statement or a statement posted on the Commission’s website,” McHenry said. “We need to nurture innovation and technology in this country, not send it overseas.”

McHenry said his bill, which borrows from work done by Republican SEC Commissioner Hester Peirce, “helps bring legal certainty to digital asset projects that we badly need regulatory clarity to launch.”

Gensler told the committee: “We just don’t have enough investor protection in crypto finance, issuance, trading or lending. Frankly, at this time, it’s more like the Wild West or the old world of ‘buyer beware’ that existed before the securities laws were enacted. This asset class is rife with fraud, scams and abuse in certain applications. We can do better.”

He said SEC staffers are working with other financial regulators to protect investors under current authorities and to identify gaps that, with Congress’ assistance, can be filled.

In both of these areas, Gensler stated, the SEC has initiated “projects” on:

  • The offer and sale of crypto tokens;
  • Crypto trading and lending platforms;
  • Stable-value coins;
  • Investment vehicles providing exposure to crypto assets or crypto derivatives; and
  • Custody of crypto assets.

This year has brought the launch of a number of open-end mutual funds investing in Bitcoin futures traded on the Chicago Mercantile Exchange.

“Subsequently, we’ve started to see filings under the Investment Company Act with regard to exchange-traded funds (ETFs) seeking to invest in CME-traded bitcoin futures,” Gensler said in a recent speech. “When combined with the other federal securities laws, the ’40 Act provides significant investor protections for mutual funds and ETFs. I look forward to staff’s review of such filings.”

Confusing Crypto Statements

McHenry and Rep. Bill Huizenga, R-Mich., Republican Leader of the Investor Protection, Entrepreneurship, and Capital Markets Subcommittee, told House Financial Services Committee Chairwoman Maxine Waters, D-Calif., Wednesday in a letter that Gensler failed to provide sufficient information “to fully understand the Commission’s ongoing deliberations.”

A hearing with all five Commissioners no later than spring 2022, the two lawmakers wrote, “will allow for a balanced and thoughtful look at future rulemakings expected over the next several months.”

Republican members of the committee, McHenry and Huizenga wrote, “appreciated the opportunity to question Chair Gensler on his various confusing statements about cryptocurrency and his unilateral effort to politicize the Public Company Accounting Oversight Board, among other things.”

Private Fund Disclosures

Gensler also told the Financial Services Committee that the securities regulator is working to enhance disclosures offered by private funds — “in particular the conflicts of interest their managers may have and the information they are providing investors about the fees they charge.”

Enhanced disclosures in this area, Gensler told the committee, would better enable “pensions and others investing in these private funds to get the information they need to make investment decisions. Ultimately, every pension fund investing in these private funds would benefit if there were greater transparency and competition in this space.”

Gensler said he’s asked staff for recommendations on enhanced reporting and disclosure through Form PF, which private fund advisors must file with the agency, or other reforms.

In separate comments during a recent conference, Gensler noted that the SEC oversees about 14,000 RIAs with more than 48 million clients and almost $112 trillion in regulatory assets under management.

“Within this field, there has been significant growth in the size and number of private funds, in particular private equity and venture capital funds,” he said. “The number of private equity funds has increased by 58% over the last five years; the number of VC funds, 110%.”

The asset management field, he continued, is growing and evolving.

“SEC staff are seeing new strategies, structures, and business practices,” Gensler reported. “Technology is rapidly changing. This trend not only creates new opportunities, but also risks for markets and investors.”

Regarding digital engagement practices, or DEPs, “asset managers — both incumbents and fintech startups — can tailor marketing and products to individual investors, using predictive data analytics and other DEPs,” Gensler stated.

In the case of robo-advisors or investment advisors, Gensler continued, “I wonder what they are doing within the predictive data analytics algorithms — if, statistically speaking, they are maximizing for our returns as investors, or, say, the revenues of the platforms. Further, to the extent that they’re maximizing revenues or doing a bit of both, how do we address the potential conflicts of interests that arise?”

Predictive Data Analytics

During the Oct. 5 oversight hearing held by the House Financial Services Committee, Gensler also reiterated his concerns about predictive data analytics and machine learning, which he said “are shaping and will continue to reshape many parts of our economy.”

Policymakers, he said, “must consider what rules of the road we need for modern capital markets and for the use of predictive data analytics. Today, trading platforms have new capabilities to tailor marketing and products to individual investors.

“While this can increase access and choice, such differential marketing and behavioral prompts raise new questions about potential conflicts within the brokerage, wealth management, and robo-advising spaces, particularly if and when brokerage or investment advisor models are optimized for the platform’s revenue and data collection.”

Gensler issued a request for comment Aug. 27 seeking information on broker-dealers and advisors’ digital engagement practices, including their use of apps with gaming features. The comment period expired last week.

Robinhood’s president, David Dusseault, told Gensler in his comment letter that an SEC attempt to regulate DEP would face legal hurdles.

“To be justified and lawful, any DEP rulemaking will need to address significant issues,” Dusseault wrote. Under the Administrative Procedures Act, “the SEC has a foundational duty of reasoned decisionmaking when it comes to rulemakings, particularly rulemakings addressing issues so consequential to retail investors.

“In order to conduct a proper rulemaking, the SEC will need to ‘examine the relevant data’ — including quantitative and qualitative evidence submitted — ‘and articulate a satisfactory explanation for its action including a ‘rational connection between the facts found and the choices made,’” he explained.

Sen. Pat Toomey, R-Pa., ranking minority member on the Senate Banking Committee, told Gensler in his comment letter to “proceed cautiously” and avoid imposing new regulations on digital trading apps that could restrict investor freedom.

“The federal securities laws do not authorize the SEC to act as a merit regulator and limit the choices of investors in the absence of fraudulent or manipulative conduct,” Toomey wrote.

“Investors understand that there are consequences — whether they gain or lose — from their investment decisions. It is not the government’s role to tell retail investors what they can and cannot buy, including through indirect measures that restrict how brokers can interact with their customers on digital platforms,” he added.