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Bates Research  |  05-26-22

SEC Chair Gensler Speaks: The Latest on the SEC’s Agenda

In a conversation with FINRA President Robert Cook at FINRA’s annual conference last week, SEC Chair Gary Gensler discussed his agency’s rulemaking agenda by explaining that the market is in the midst of a transformation that requires adjustments, modernizations and updates to existing regulations. President Cook covered a broad range of topics, probing where the SEC may be focusing its attention next. Chair Gensler responded by giving historical context, reciting congressional authorizations and legal reasoning, and providing examples of current events requiring urgent action concerning products and services across the market. He saved his comments on the implication of digital engagement practices on broker-dealer and adviser obligations until the next day, when he addressed an audience of State securities regulators (NASAA). Here are some of the highlights from both events.

FINRA President Robert Cook’s Discussion with Chair Gensler

FINRA President Cook peppered the SEC Chair with a number of questions covering the gamut of financial services industry concerns.

Digital Engagement Practices

Foreshadowing his address on digital engagement practices and the related compliance implications for brokers and advisers, Chair Gensler framed the agency’s efforts around digital engagement in light of “the transformative time in which we are living—[when] data analytics can predict so much of our choices as individuals.” While noting that the SEC has learned from many comments it received in response to an agency request on the subject earlier this year, and from “GameStop” and other market events, Mr. Gensler questioned whether retail investors were getting “the best advice, the best recommendations—where best interest is supposed to be best interest and best execution is supposed to be best execution.” He questioned whether the duty of care and the duty of loyalty to real standards can “stand the test in this new data analytics period.”

Complex Products

Referring to concerns about risks from complex exchange-traded products and derivatives that may be embedded in such products (e.g., leveraged or inverse ETFs), Mr. Gensler linked the question to whether the product is risk-appropriate for the retail investor. “Just think about it on a brokerage app,” he said, “It doesn’t just have to be one of those complex inverse products or a double-two-times leveraged product, but it’s also about options, or margin accounts—is that really appropriate for that investor?” In the institutional space, Mr. Gensler cited enforcement efforts against companies using derivatives inside of structured vehicles. As a result, Mr. Gensler said he directed staff to offer recommendations on sales practice appropriateness, valuations, and “making sure folks aren’t gaming the system and basically trying to mislead the public and its investors.”  

When challenged on the broad scope of these staff directives, Mr. Gensler asserted the necessity of updating the capital markets. “We can’t take anything for granted; technologies are changing so rapidly…we are living in a truly transformative age. I think every bit as transformative as the internet.” He argued that current marketing is now based on predictive data analytics. “All of that [data] is being souped up, which raises the question of how the platform is marketing to you—are they doing it in your best interest with your best execution of a trade, or is it about their revenues? And therein lies the challenge of our times.” Briefly referring to Reg BI, Mr. Gensler focused on the importance of the role of broker-dealers and investment advisers in instilling trust in the markets.

Fixed Income Market Transparency

Mr. Gensler framed questions on fixed income market transparency as part of the SEC’s goal to “driv[e] efficiency in the core product” within the “hundred-trillion-dollar capital market.” He directed staff to consider “the authorities Congress has given us and good economic analysis to help promote greater efficiency in the middle…better return for investors, better for issuers, [but] maybe a little less return for the market makers and the service providers in the middle.” He described how FINRA’s trade reporting system (TRACE) has led to greater economic efficiency in the market and how the transparency it provides promotes competition. He emphasized the importance of (i) greater transparency in post-trading; (ii) shortening the time frame to get the information out (“fifteen minutes [is] a lifetime now in markets”); (iii) greater transparency in terms of spread products “or what can be called corporate bonds that are priced as a spread to an underlying treasury curve;” and (iv) making available currently collected data to market participants “not just the official sector.”

In terms of pre-trade information, Mr. Gensler advocated for greater transparency and resiliency as to electronic platforms and alternative trading systems. He directed staff to “look for ways to promote greater pre-trade transparency for the corporate and municipal market.” He emphasized that the key to boosting competition and resiliency is “getting those platforms registered.” He also said that the SEC is working with the Treasury and Federal Reserve Board on clearing issues on both sides of the trade. He warned of the risk residing inside these platforms and explained: “What we know about clearing is, it’s not a silver bullet, it’s not without risk, but it significantly lowers risk in a system through netting—the math of netting—and through the collection of the margin both initial and variation, importantly the robust risk protocols one can put on the clearinghouse.”

Further, Mr. Gensler said he was working with his colleagues on “over a dozen resiliency projects,” citing myriad risks, including “uncertainties from the geopolitical side—the unprovoked war in Eastern Europe, the COVID surge—and the uncertainties in the financial markets moving from a more accommodating toward a tightening stage.”  He said, “There’s a lot of uncertainty in our capital markets; these macroeconomic times are a reminder how important these resiliency projects are.”

Market Structure

Beyond promoting pre- and post-trade transparency and resilience, Mr. Gensler cited a list of other agency steps in the works to strengthen competition and efficiency across all parts of the market. He said that staff is taking a “holistic” approach to every element: payment for order flow, exchange rebates, access fees, and the minimum increment (tick size). “There’re a lot of pieces—the last time this was updated was 2005. Congress gave us broad authority in the seventies, during the early days of new technologies at NASDAQ. That led Congress to tell the SEC to promote competition. After 17 years, we think its time to put out a proposal.”

Cybersecurity and Risk Management Requirements on Broker-Dealers

Chair Gensler stated that cyber risk is a part of the reality of the economy today, calling it “an arms race [between] those who are operating the systems [and] those who want to disrupt the systems.” The list of those disrupters includes those who want to take commercial or proprietary information for economic gain, and those who want to steal intellectual property, whether they are State or private actors. Mr. Gensler cited a long list of SEC actions taken to enhance cybersecurity. He said that the SEC (i) is not the lead, but is active on “team CYBER;” (ii) has put out a proposal on cyber-hygiene for advisers and investment funds; (iii) is working on a similar proposal for broker dealers; (iv) extended a rule called Systems Compliance and Integrity (“Rule SCI”) concerning the biggest platforms, including stock exchanges and clearinghouses; (v) proposed similar rules for fixed income and alternative trading systems, and for issuers; and (vi) proposed disclosure requirements when there is a material incident. Mr. Gensler also noted his intention to update Regulation SP, a privacy notice requirement for customers in both the broker dealer and investment adviser space.

Crypto Assets

Mr. Gensler reminded the investing public that crypto markets are “a highly speculative asset class.” He warned that, with crypto, investors are not getting the disclosure they get with other asset purchases. He argued that such disclosure reflects a basic bargain: “You, the investing public, can make your choices as to the risk you take, but there’s supposed to be full and fair disclosure and people aren’t supposed to lie to you. That’s the basic bargain, and then you get to choose.”

He explained that many of crypto tokens fall within the securities laws but are not registered, and, therefore, are not living up to the basic bargain—to the detriment of the investor. Further, he warned investors: “don’t think you actually own your tokens when you go into your digital wallet or your crypto wallet and you transfer ownership to the platform. If the platform goes down, guess what, you just have a counterparty relationship with the platform, and get in line at bankruptcy court.” He also warned them that, unlike the equity markets, “when [these platforms] take your custody, when they take your tokens, they can use them, they can trade them…these platforms are often trading against you. They’re actually making markets against you.”

Mr. Gensler said that contrary to popular belief, there are really only a handful of platforms, and that “this crypto-asset space is not that decentralized.” He said that the focus of the SEC’s attention is on these platforms, and how to protect the public with “basic market integrity” activities to prevent front running, manipulation and fraud.

SEC Spotlight: New Cybersecurity Rules Heading Your Way

SEC Chair on Regulation Best Interest

A day after his conversation at the FINRA conference, Mr. Gensler addressed state securities regulators to talk about the dangers inherent in broker-dealers or investment advisers providing advice digitally through investment platforms (e.g., robo-advising, brokerage apps, and wealth management apps). He questioned whether these advisers could provide these services and still act in the best interests of their clients (and not place their own interests in front of their clients'). He questioned how, in the digital age, regulators can ensure that broker-dealers (through Reg BI) and advisers (through their fiduciary duty) “live up to their obligations and the trust that’s been placed in them.”

Mr. Gensler highlighted financial innovations that raise these questions, referring to the use of predictive data analytics, built upon artificial intelligence and machine learning. He “coupled” those innovations with the advent of “differential marketing, differential pricing, and individually tailored behavioral prompts…called digital engagement practices…which are increasingly shaping many parts of our economy.”

Mr. Gensler asserted that these digital engagement practices raise issues of (i) bias (through the use of data that is itself biased) and (ii) systemic risk (concerning known predictive data analytics vulnerabilities like “herding,” “interconnectedness,” and “concentration”). The Chair stated that the SEC must safeguard against these biases and vulnerabilities.

As to the impact on brokers and adviser obligations, Mr. Gensler is concerned that the use of these applications—“behavioral nudges” that narrowly target each consumer with specific marketing and pricing—raise questions about whether digital engagement practices optimize for the investor’s benefit or for the platform’s revenue or performance. “When do behavioral nudges take on attributes similar enough to advice or recommendations such that related investor protections are needed?” he asked.  

As a result of these concerns, Mr. Gensler directed staff to develop new guidance on conflicts of interest inherent in these questions. Specifically, Mr. Gensler wants additional guidance to ensure that (i) brokers comply with their best interest obligations and “eliminate the conflict, don’t give the advice, or find some other way to ensure that they don’t put their interests ahead of the retail investor’s interests;” (ii) brokers and advisers demonstrate meaningful consideration of reasonably available alternatives; and (iii) brokers and advisers really consider costs and risks in the investor’s best interests.


Chair Gensler’s ability to make the case for expansive rule revision in the capital markets is predicated on addressing the needs of this transformative time. His eye on the big picture, his fluency with historical detail and legislative history merge with his professorial ability to convey the gravity of the moment. His admonitions on the need to keep up with market and technological innovation is compelling. His answer to this need is a waterfall of rulemaking. His efforts to address, simultaneously, all compliance risks concerning many “incredibly complex issues” (Mr. Cook’s words), however, sparks concern over how much market participants can absorb. As the SEC continues to release new requirements for broker-dealers, Bates will keep you apprised.

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Contact Bates Group

Bates Group is with you every step of the way. Contact us today for more information on how our End-to-End Solutions can help your firm.