Bates Research  |  11-20-17

Seeking Sunlight for Investors,  SEC Chair Addresses Five Areas of Focus

With the latest cyber crises momentarily at bay (see Bates report on the cyber breaches involving the SEC EDGAR system and the Equifax credit reporting agency database), SEC Chair Jay Clayton is taking the opportunity to address both short- and long-term agency priorities. In a speech before the Practising Law Institute’s 49th Annual Conference on Securities Regulation, Mr. Clayton continued to set forth the agency’s near-term, narrowly focused retail and institutional regulatory priorities and articulated longer-term elements of a five-year strategic plan. As required by statute, this plan is to be submitted and published as part of the federal government's Unified Agenda and further articulated in early 2018.

At the core of the Chairman’s message is a commitment to increasing transparency within the securities markets and in particular, addressing “how we can reduce opacity and, thereby, enhance our efforts to deter, mitigate, and eliminate fraud.”

Greater Transparency is the Answer

In part, Mr. Clayton sees greater transparency as the key to ridding the securities market of most fraud. Coupled with the recently announced SEC enforcement reorganization (see Bates report on the Cyber Unit and Retail Strategy Task Force) and a commitment to continued aggressive enforcement action, Mr. Clayton made the case for closely examining policy and rulemaking “to fight the type of opacity that can create an environment conducive to misconduct.” Mr. Clayton identified five areas where SEC efforts can be improved:

Fee Disclosure

Mr. Clayton stated his expectation that the “Enforcement Division will continue to be active in pursing cases where hidden or inappropriate fees are at it issue,” but that “more can be done to clarify fee disclosures made to retail investors” in order to “reduce the opportunities for misbehavior.” He expressed concern with “complex, obscure, or hidden fees and expenses that can harm investors,” citing several recent cases. These included cases (i) where a firm invested clients’ money in certain fund classes that charged fees when lower-cost share classes of the same fund were available, (ii) where advisers improperly chose to use fund assets to pay expenses that should be paid by the firm, and (iii) where customers “were deceived when brokers charged fees that are designed to cover the costs of services provided, while also marking up the prices of securities” to earn profits which went undisclosed.

Penny Stocks

The Commission will “continue to vigorously pursue bad actors in the penny stock market” and examine ways to increase transparency in these markets, where reliable information on financial condition is often unavailable, stale or inaccurate. He noted the continuing problems of “piggybacking” of inadequate information, as well as problems of insufficient custody arrangements which can “open the door to fraud and exploitation.”

Transaction Processing

With respect to broad concerns of fraud committed in the distribution of unregistered securities, Mr. Clayton committed the SEC to better monitoring of transfers and transfer agents, noting the SEC’s conclusion that the problem is particularly “acute in the microcap market, where OTC issuers may not be subject to certain of the Commission’s disclosure requirements and [where] there is an increased potential for fraud and abuse.”

Initial Coin Offerings (ICOs)

The SEC will seek greater transparency and clarity for investors facing risks associated with initial coin offerings. He highlighted the “lack of information about many online platforms that list and trade virtual coins or tokens offered and sold in ICOs.” Investors may be “vulnerable to price manipulation and other fraudulent actions,” he warned, because they may “not appreciate that ICO insiders and management have access to immediate liquidity, as do larger investors, who may purchase tokens at favorable prices.” Mr. Clayton stated that the SEC plans to offer guidance as to (i) how tokens are listed on exchanges, (ii) the standards for listing, (iii) how tokens are valued, and (iv) what protections exist for investors. He also noted that “the Commission recently warned that instruments, such as ‘tokens,’ offered and sold in ICOs may be securities, and those who offer and sell securities in the United States must comply with the federal securities laws.”

New SEC Website to Search Individual Violators

Mr. Clayton plans to find ways to provide more information to investors. He asserted that as bad actors shift from a registered space for investment advisers and broker-dealers to an unregistered space, “investors should be armed with information that makes it more difficult for them to be defrauded.” He said the SEC is creating a website that will contain a searchable database of individuals who have been barred or suspended as a result of federal securities law violations. More resources, more background checks and more accessibility to information are his prescriptions to combat this problem.

The Long Game

Consistent with his previous testimony, Chair Clayton highlighted shareholder engagement as a long-term focus for the SEC. He expressed concern that shareholder participation in corporate governance, particularly by long-term retail investors, is inadequate, and that voting power often sits with investment advisors. In response, the SEC will conduct a close examination of whether the current rules are effectively meeting both shareholder and company needs. Such an examination, he said, may include a review of ownership level thresholds for the submission and resubmissions of shareholder proposals. Mr. Clayton said the SEC may demand a review and corresponding updates to ensure that long-term retail investors are fairly represented.

Mr. Clayton’s remarks provide a framework for understanding the direction the SEC will take to address challenges and trends facing the securities markets. He was clear that he will work with fellow commissioners to reconsider mandatory Dodd-Frank rulemakings and chart a way forward based on these considerations. Bates will continue to keep you apprised of any developments in SEC priorities or areas of focus.


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