Crown image Columbia Law School

SEC Chair Clayton Offers “MD&A” for the Agency

Disclosure and the concepts of materiality, comparability, flexibility, efficiency and responsibility have been, and continue to be, the bedrock principles that make our public capital markets the most fair and efficient markets in the world. Today, I will take a page from our disclosure rulebook and give you a look at the Securities and Exchange Commission (“SEC”) through the “eyes of management,” similar to what public companies do in the “Management’s Discussion and Analysis,” or “MD&A” section of their SEC filings. In other words, I am going to be eating some of our own cooking.

First, some “cautionary” language:

  • the following discussion and analysis is intended to help you better understand the SEC, but you should also consider this discussion in conjunction with our four year strategic plan and our annual report for fiscal year 2018;[1]
  • some of the statements in this discussion are forward-looking statements and, as such, are subject to risks and uncertainties—actual results will almost certainly vary, and could vary materially; and
  • my words are my own and do not necessarily reflect the views of my fellow Commissioners or the SEC staff.

Overview

At the SEC we have a three-part mission: (1) to protect investors, (2) to maintain fair, orderly, and efficient markets, and (3) to facilitate capital formation. Each tenet of our mission is critical and drives the actions we take. Among other things, we oversee: (1) over $97 trillion in securities trading annually on U.S. equity markets; (2) the disclosures of approximately 4,400 exchange-listed public companies with an approximate aggregate market capitalization of $34 trillion; and (3) the activities of over 27,000 registered entities and self-regulatory organizations. These registered entities and registrants include, among others, investment advisers, broker-dealers, transfer agents, securities exchanges, clearing agencies, mutual funds and exchange-traded funds (“ETFs”), and employ almost one million people in the United States.

We could not do this without our most important resource—our human capital. Our workforce of about 4,500 people is located in Washington and across our 11 regional offices. We have no employees stationed permanently outside the United States. This is a remarkable and talented group. Continuing the tradition of this event, I ask that every current member of the SEC staff please stand. Now, would alumni of the SEC please join them in standing. Thank you for everything you do, or have done, for the agency.

Factors and Trends Affecting Our Results of Operations

As it is the case with companies, our work has been, and we expect it to continue to be, affected by a number of factors that may cause actual “results” to differ from what we set forth to do, including our anticipated rulemaking agenda.[2] In our case, these factors include:

  • Our ability to retain and recruit talented staff.
  • Our ability to invest in technology, and staff with expertise to employ that technology, in order to oversee the increasingly complex markets we regulate and the companies we review. Unfortunately, we live in a world where bad actors are constantly attempting to finds ways to enter or disrupt systems that contain valuable information or that are critical to market function, including our own systems.
  • The need to divert resources to respond to major or unexpected events, changes in the regulatory landscape or congressional mandates.
  • The potential effects of the United Kingdom’s exit from the European Union, or “Brexit,” and other events beyond our control on our capital markets.[3]
  • Our ability to assess and improve how we deal with risks—both internal risks to the SEC, in an effort coordinated by our new Chief Risk Officer Gabe Benincasa,[4] and external risks affecting the U.S. capital markets, in an effort coordinated by Jeff Dinwoodie, our new Senior Counsel and Policy Advisor for Market and Activities-Based Risk.[5] Note the use of the word “coordinated.” These risk identification, assessment and management activities are large group projects involving the energy and talents of dozens, and in some cases hundreds, of people across the SEC.

Results of Operations, Liquidity and Capital Resources

Let’s turn to the factors that drive our results. Here is where public companies generally include a table with their consolidated statements of operations as of the end of their three most recent fiscal years, or two most recent fiscal years in the case of emerging growth companies or smaller reporting companies. Like public companies, the SEC prepares annual financial statements and notes to the financial statements that are independently audited by an outside audit organization. In our case, the auditor is not an audit firm registered with the Public Company Accounting Oversight Board, or PCAOB. The law instead prescribes that our audit be performed by an expert government auditing agency independent from us, the Government Accountability Office, which conducts its audits in accordance with generally accepted government auditing standards. Also, like public companies, the effectiveness of our internal controls over financial reporting undergoes an annual self-assessment by SEC management and an annual audit by our independent auditor. In November, 45 days after the end of our fiscal year, the SEC publishes an Annual Financial Report that includes our annual financial statements, our auditor’s opinion, and the results of these internal control assessments.[6] Our Annual Financial Report once again received the Certificate of Excellence in Accountability Reporting from the Association of Government Accountants—the 13th year in a row the SEC has received this award.

Since the SEC’s financial statements are already reported in detail annually, I thought it might be more illuminating to take a step back and give you a sense of how our budget has changed over the last five years.

Fiscal Year 2018 Compared With Fiscal Year 2013

Employee pay and benefits was our largest expenditure in fiscal years 2018 and 2013. This is not surprising given that our human capital is by far our most important asset. Technology expenditures have increased in total dollars and as a percentage of the total budget over the last five years. This is a direct result of our commitment to maintaining and upgrading our information technology systems and enhancing the agency’s cybersecurity and risk management. Leasing expenditures have remained constant over the last five years, while travel and all other expenses have decreased in total dollars and as a percentage of the total budget over the same period.

Fiscal 2019 Expenditures

For fiscal year 2019, our current fiscal year, employee pay and benefits is expected to continue to account for a significant portion of our appropriation. As a result of a hiring freeze, Commission staffing is down more than 400 authorized positions compared to fiscal year 2016. To ensure we can continue to meet our mission objectives, the resources Congress provided the agency for fiscal year 2019 will allow us to lift the hiring freeze and add 100 much-needed positions. This would put our staffing level on par with where we were five years ago.

Accomplishments

Now I will take a few minutes to highlight some of our accomplishments in fiscal year 2018.

I would be remiss if I did not note that a vast majority of the work of the SEC staff goes unheralded by our public agenda, but is critical to the efficient functioning of our capital markets. The staff reviews tens of thousands of issuer filings and disclosures. They provide informal guidance and respond daily to questions from investors, issuers and other market participants. They collaborate with domestic and international counterparts to address issues related to events such as Brexit and the implementation of the European Union’s General Data Protection Regulation, or GDPR. Our investigative, litigation and examination teams work tenaciously to enforce compliance with our securities laws. These efforts are a key component of the success of America’s capital markets.

Take the recent victory in Lorenzo v. SEC[7] in the Supreme Court—a decision that will have a significant impact on our continued ability to bring charges against those involved in the dissemination of misstatements, including in our private markets. Although the final result of the staff’s work is very public—just look at the countless law firm memos and articles about the decision—what you do not see is the intellectual capital contributed by the talented attorneys in our Office of the General Counsel and Division of Enforcement who worked to achieve this success.

Our Rulemaking Agenda

Shifting to our rulemaking agenda, previously I noted that the near-term Regulatory Flexibility Act agenda would be streamlined to increase transparency and accountability to the public and Congress, as well as to provide greater clarity to our staff, by including only initiatives the agency could reasonably expect to complete over the next 12 months. During fiscal year 2018, the Commission advanced 23 of the 26 rules on the near-term agenda, a good result on both a percentage basis (88 percent) and an absolute basis.[8] In addition, the Commission responded to major events and changes in the broader regulatory landscape by advancing several other initiatives not in the original agenda.[9]

To be sure, statistics—such as an 88 percent completion rate—often fail to tell more than a narrow story. Main Street investors—the market participants we have at the forefront of our minds—will not assess our work by the number or percentage of rules and initiatives we complete, but rather will be looking at what our efforts substantively do for them. In MD&A speak, they are our owners and we want to use our resources to drive long term outcomes for them.

So, let me give you a few examples. The Division of Corporation Finance is leading a number of regulatory actions to encourage capital formation. This is important because encouraging capital formation in our public markets provides a broader and more attractive set of investment opportunities to Main Street investors. In fiscal year 2018, the Commission adopted amendments to the “smaller reporting company” definition that expanded the number of companies that can qualify for certain existing scaled disclosure requirements,[10] and proposed amendments to financial disclosures to encourage guaranteed debt offerings to be conducted on a registered rather than a private basis.[11]

The Division of Investment Management is leading a long-term project to explore modernization of the design, delivery and content of fund disclosures and other information for the benefit of investors. In 2018, over 100 million individuals representing over 57 million households, or almost 45 percent of U.S. households, owned funds (generally ETFs or open ended mutual funds).[12] In June 2018, the Commission issued a request for comment on enhancing disclosures by mutual funds, ETFs and other types of investment companies to improve the investor experience and to help investors make more informed investment decisions.[13] Initiatives like this are an important part of how the Commission can serve investors in the 21st century.

The Division of Trading and Markets led several initiatives in fiscal year 2018 to increase transparency about market activities. For example, in July 2018, the Commission adopted amendments that enhance the transparency requirements governing alternative trading systems, commonly known as “ATSs.”[14] This initiative is a key part of our efforts to ensure fair and efficient markets, particularly those with significant Main Street investor participation.

One final effort from our fiscal year 2018 that I want to highlight is the joint work by the Divisions of Investment Management and Trading and Markets to enhance and clarify the standards of conduct and mandated disclosures for our two principal types of financial professionals—broker-dealers and investment advisers.[15] My view is these standards should reflect what retail investors would reasonably expect of these financial professionals, while preserving investor choice in: (1) the type of professional with whom they want to work; (2) the nature and scope of services they receive; and (3) how they want to pay for them. Completing our standards of conduct rulemaking is a top priority for me.

Enforcing the Federal Securities Laws

Apart from rulemaking, the interests of long-term Main Street investors also require capital markets that are vigorously policed for fraud and other misconduct. The ongoing efforts by our Division of Enforcement to deter misconduct and punish securities law violators are critical to safeguarding millions of investors and instilling confidence in the integrity of our markets. The nature and quality of the SEC’s enforcement actions during the last year speak volumes to the hard work of the women and men of the agency.[16]

Co-Directors, Stephanie Avakian and Steven Peikin noted in the Enforcement Annual Report that our success is best judged both quantitatively and qualitatively and over various periods of time.[17] In my opinion, by any measure, Enforcement has been successful during fiscal year 2018.

In the digital assets space, for example, the Division of Enforcement has brought cases that demonstrate that there is a path to compliance with the federal securities laws going forward, even where issuers have conducted an illegal unregistered offering of digital asset securities. This path includes appropriate disclosures to investors so they can make a more informed decision as to whether to seek reimbursement or continue to hold their tokens.

Additionally, in my view, protecting retail investors means, whenever possible, putting money back in their pockets when they are harmed by violations of the federal securities laws. In fiscal year 2018, the Commission returned $794 million to harmed investors. Here, I will call out for commendation the Division’s approach to the too widespread practice of investment advisers placing retail investors in higher cost share classes of mutual funds—when the same funds were available to those investors at lower cost—without adequately disclosing the practice or with disclosure that was inconsistent with the advisers’ actual practices. In a little over a year, the Division’s approach will result in the return of over $125 million to retail investors.[18] Importantly, the resulting savings to retail investors from moving to the lower cost share classes will continue for years to come. We remain committed to this important Main Street investor-focused part of our work, and we expect to continue our efforts to return funds to harmed investors as promptly as practicable.

Examining SEC-Registered Entities

Our examination program, executed by the Office of Compliance Inspections and Examinations (“OCIE”), is another key area where our work directly protects the interests of Main Street investors. In December 2018, OCIE published its 2019 Examination Priorities, which reflected a continued focus on the SEC’s commitment to protecting retail investors, including seniors and those saving for retirement.[19] In particular, OCIE has looked closely at products and services offered to retail investors, the disclosures they receive about those investments and the financial services professionals who serve them. OCIE has also focused its attention on several other areas that present heightened risks, including: (1) compliance and risks in critical market infrastructure, such as exchanges and clearing agencies; (2) digital assets, including cryptocurrencies, coins and tokens; and (3) cybersecurity.

Outreach and Education

Turning to outreach, the SEC promotes informed investment decision-making through education initiatives aimed at providing Main Street investors with a better understanding of our capital markets and the opportunities and risks associated with the array of investment choices presented to them. The Office of Investor Education and Advocacy (“OIEA”) spearheads these efforts, and participation extends throughout our divisions and offices.[20] This morning we launched a campaign designed to empower investors to take control of their financial future by encouraging them to go to Investor.gov to get answers to their saving and investing questions. In connection with those efforts, I released the first of several videos in a new series, “Notes from the Chairman.” These videos are based on my experiences traveling the country and meeting with Main Street investors, who often ask me for my top tips on investing.

Over the past year, SEC staff, my fellow Commissioners and I have engaged directly with Main Street investors from around the country through town halls, outreach tours, new digital tools, and other methods. In a first-of-its-kind event, on June 13, 2018, the full Commission and SEC leadership met with more than 400 members of the public during an investor town hall at the Georgia State University College of Law in Atlanta, Georgia. This event, organized by the SEC’s Office of the Investor Advocate and the Atlanta Regional Office, marked the first time the full Commission met with Main Street investors outside of Washington, D.C. Since then, there were additional roundtable meetings with retail investors in Houston, Miami, Washington, D.C., Philadelphia, Denver, and Baltimore.

In addition, the Commission recently acquired a powerful voice for small businesses and their investors—our first Advocate for Small Business Capital Formation, Martha Miller.[21] Martha brings a wealth of experience and passion to the role and will be a proponent for American businesses and their investors. Martha has hit the ground running in building the office and already hosted her first public event in Kansas City, Missouri a couple of weeks ago. She will be speaking later today and providing insight into her office’s roadmap for serving small businesses, including traveling to areas that traditionally have received less attention from investors.

Economic Analysis and Retrospective Review of Commission Rules

None of the efforts by our policymaking divisions and offices discussed above would be possible without the work of the economists in the Division of Economic and Risk Analysis (“DERA”).[22] I have noted that the SEC is committed to performing rigorous economic analysis of our rules and has done so in each of the rulemaking initiatives I have described above. However, effective rulemaking does not end with rule adoption. Our Strategic Plan calls for reviewing Commission rules retrospectively to identify outdated rules that might not be functioning as intended in modern markets.

Conclusion

To conclude, and as you can surely tell from my narrative, every single significant accomplishment was driven by our people—the 4,500 women and men that everyday demonstrate their commitment to Main Street investors. I thank you for everything you do.

ENDNOTES

[1] U.S. Securities and Exchange Commission, Strategic Plan Fiscal Years 2018-2022 (Oct. 11, 2018), available at https://www.sec.gov/files/SEC_Strategic_Plan_FY18-FY22_FINAL_0.pdf; U.S. Securities and Exchange Commission, Agency Financial Report Fiscal Year 2018 (Nov. 15, 2018), available at https://www.sec.gov/files/sec-2018-agency-financial-report.pdf.

[2] The most recent unified agenda for the federal government, which includes rulemakings the SEC plans to issue in the near- and long-term, was published in the Federal Register on August 7, 2018, available at https://www.reginfo.gov/public/do/eAgendaMain?operation=OPERATION_GET_AGENCY_RULE_LIST&currentPub=true&agencyCode=&showStage=active&agencyCd=3235. See also Chairman Jay Clayton, SEC Rulemaking Over the Past Year, the Road Ahead and Challenges Posed by Brexit, LIBOR Transition and Cybersecurity Risks (Dec. 6, 2018), available at https://www.sec.gov/news/speech/speech-clayton-120618.

[3] See, e.g., William Hinman, Director, Division of Corporation Finance, Applying a Principles-Based Approach to Disclosing Complex, Uncertain and Evolving Risks, Remarks at the 18th Annual Institute on Securities Regulation in Europe (Mar. 15, 2019), available at https://www.sec.gov/news/speech/hinman-applying-principles-based-approach-disclosure-031519.

[4] Press Release 2019-24, SEC Names Gabriel Benincasa As Its First Chief Risk Officer (Feb. 28, 2019), available athttps://www.sec.gov/news/press-release/2019-24.

[5] Press Release 2019-41, SEC Names Jeffrey Dinwoodie Senior Counsel and Policy Advisor for Market and Activities-Based Risk (Mar. 25, 2019), available athttps://www.sec.gov/news/press-release/2019-41.

[6] The SEC’s Annual Financial Reports are published on our website. See www.sec.gov/reports. To easily find the Annual Financial Report for a particular fiscal year, please select “Annual Reports” in the drop-down “Category” menu.

[7] 587 U.S. ___ (2019).

[8] Over the past 10 years, the Commission completed, on average, approximately one-third of the rules listed on the near-term agenda.

[9] For example, during fiscal year 2018, we issued guidance to public companies about disclosures of cybersecurity risks and incidents. See Press Release 2018-22, SEC Adopts Statement and Interpretive Guidance on Public Company Cybersecurity Disclosures (Feb. 21, 2018), available at https://www.sec.gov/news/press-release/2018-22. The Commission also responded to a new congressional mandate from the Economic Growth, Regulatory Relief, and Consumer Protection Act by expanding a key registration exemption used by non-reporting companies to issue securities pursuant to compensatory arrangements. Rule 701 — Exempt Offerings Pursuant to Compensatory Arrangements, 83 Fed. Reg. 34,940 (July 24, 2018); see also Concept Release on Compensatory Securities Offerings and Sales, 83 Fed. Reg. 34,958 (July 24, 2018). The Commission also provided proactive relief for those investors and companies affected by Hurricane Florence. See Press Release 2018-202, SEC Provides Regulatory Relief and Assistance for Hurricane Victims (Sept. 19, 2018), available at https://www.sec.gov/news/press-release/2018-202.

[10] See Press Release 2018-116, SEC Expands the Scope of Smaller Public Companies that Qualify for Scaled Disclosures (June 28, 2018), available at https://www.sec.gov/news/press-release/2018-116.

[11] See Press Release 2018-143, SEC Proposes Rules to Simplify and Streamline Disclosures in Certain Registered Debt Offerings (July 24, 2018), available at https://www.sec.gov/news/press-release/2018-143.

[12] See ICI Research Perspective (Nov. 2018), available at https://www.ici.org/pdf/per24-08.pdf.

[13] See Press Release 2018-103, SEC Modernizes the Delivery of Fund Reports and Seeks Public Feedback on Improving Fund Disclosure (June 5, 2018), available at https://www.sec.gov/news/press-release/2018-103. The request for comment seeks input from retail investors and others on how they use fund disclosures and how they believe funds can improve disclosures to aid investment decision-making. In order to facilitate retail investor engagement and comment on improving fund disclosure, the Commission created a short Feedback Flier on Improving Fund Disclosure, which can be viewed and submitted at www.sec.gov/tell-us.

[14] See Press Release 2018-136, SEC Adopts Rules to Enhance Transparency and Oversight of Alternative Trading Systems (July 18, 2018), available at https://www.sec.gov/news/press-release/2018-136.

[15] See Press Release 2018-68, SEC Proposes to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships with Investment Professionals(Apr. 18, 2018), available at https://www.sec.gov/news/press-release/2018-68.

[16] See U.S. Securities and Exchange Commission, Division of Enforcement, Annual Report: A Look Back at Fiscal Year 2018 (Nov. 2, 2018), available at https://www.sec.gov/files/enforcement-annual-report-2018.pdf.

[17] Relevant qualitative factors include, among other things, asking whether we are: bringing meaningful actions that target the most serious violations, pursuing individual sanctions in appropriate cases, obtaining punishments that deter unlawful conduct and returning money to harmed investors.

[18] See Press Release 2019-28, SEC Share Class Initiative Returning More Than $125 Million to Investors (Mar. 11, 2019), available at https://www.sec.gov/news/press-release/2019-28.

[19] U.S. Securities and Exchange Commission, Office of Compliance Inspections and Examinations, 2019 National Exam Program Examination Priorities (Dec. 20, 2018), available at https://www.sec.gov/files/OCIE%202019%20Priorities.pdf.

[20] In fiscal year 2018, the SEC conducted over 150 in-person investor education events focused on various segments of the investing population, including senior citizens, military personnel, younger investors and affinity groups.

[21] See Press Release 2018-304, Martha Miller Named Advocate for Small Business Capital Formation (Dec.21, 2018), available at https://www.sec.gov/news/press-release/2018-304.

[22] DERA economists also provide important analysis that supports our examinations and enforcement efforts, and identify emerging trends in our markets. They also work hard to manage data and make it available to the public.

These remarks were delivered by Jay Clayton, chairman of the U.S. Securities and Exchange Commission, on April 8, 2019, at the “SEC Speaks” conference.