For Wall Street, there's a new, more hospitable sheriff in town
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In the opening months of the new Trump administration, congressional leaders and administration officials have advocated for less regulation of our nation’s financial and investment markets. Already, the administration has delayed the Department of Labor Fiduciary Rule, and Rep. Jeb Hensarling (R-Texas) has proposed a complete rescission of the Dodd-Frank Act. 

Lost in the headlines has been the relatively bipartisan confirmation of the new SEC chairman, Jay Clayton, the nation’s chief securities and markets regulator. Few pundits have a handle on how Clayton, a public service newcomer with a Wall Street pedigree (and by some accounts, a political independent), will proceed with policy and enforcement.

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As Clayton sets his priorities, he has a unique opportunity to reshape securities regulation with a new “tone at the top.” While nobody yet knows the outcomes, we do know the topics that will likely take his attention (absent a major financial event). 

 

Broad Principles            

Clayton’s opening statement before the Senate Banking Committee provides some indication of his overarching principles:

  • Well-functioning capital markets are important to every American.
  • All Americans should have the opportunity to participate in, and benefit from, our capital markets on a fair basis, including being provided accurate information about what they are buying when they invest. 
  • There is zero room for bad actors in our capital markets.

It may be difficult to determine how (or if) these general principles may be put into practice. However, if we take Clayton at his word, there are several areas specific to the investment management industry that should be on his list of priorities.

Broken Windows Enforcement

Clayton’s predecessor, Mary Jo White, announced and implemented a policy of “broken windows” enforcement, designed to punish even the smallest infractions in an effort to encourage strict compliance. As a veteran securities attorney and counsel to Wall Street firms, Clayton will likely place more emphasis on capital formation and market functioning and less on small-case enforcement.

Also, we suspect that this corporate deal lawyer, as compared to the securities litigator who preceded him, will focus on broad policy goals and industry-vetted rules rather than using enforcement as a tool to set policy. This does not mean a return to unregulated securities markets. In fact, Clayton’s private sector role models, such as Arthur Levitt and William Donaldson, were consummate investment community insiders, yet were not known for lax treatment of the industry. 

However, within the SEC, we may see more emphasis on the Division of Investment Management and the Division of Trading and Markets, with less influence from the Enforcement Division, the SEC’s favored group under White. We certainly believe that Clayton can follow the footsteps of industry predecessors to ensure vibrant capital markets while also protecting investors. 

Fiduciary Rule/Best Interest Standard

The delay in implementing the DOL’s Fiduciary Rule provides an opening for the SEC to adopt a more comprehensive fiduciary standard, a policy supported by current SEC Commissioner Michael Piwowar. Absent the Fiduciary Rule, brokers have been held to a so-called “suitability standard,” which obliges them to recommend investments that are “suitable” for their clients, but falls short of requiring that they put clients’ best interests first. 

Proponents of the Fiduciary Rule, as well as its foes, have called upon the SEC to devise a harmonized best interest standard for brokers and advisers (albeit for different reasons). Both investors and the asset management industry would be well-served if the SEC were to adopt a consistent, universally-applicable best interest standard that would apply the same legal standard to any financial professional that serves the retail investor.  

Supervision of Private Equity Firms

Among the elements of the Financial CHOICE Act, proposed by House Financial Services Committee Chairman Hensarling, is the exemption of private equity (PE) fund managers from registration and reporting obligations of the Investment Advisors Act. We don’t think Congress will repeal PE registration, but we do believe Clayton’s SEC may change the way it regulates PE firms. 

This could mean raising the registration threshold (a concept supported by former Massachusetts Democratic Congressman Barney Frank), promulgating tailored compliance rules for PE firms, or changing the enforcement focus. While PE firms don’t fit the traditional advisor model, they play a vital role in our capital markets as sources of financing for their portfolio companies and as drivers of considerable initial public offering (IPO) and merger and acquisition (M&A) activity. Moreover, with or without registration, institutional investors have come to rely on the more robust compliance infrastructure required of registered advisers.  

Third-Party Advisor Exams 

Chairman Clayton’s SEC will also likely revisit a proposal (first championed by former SEC Commissioner Daniel Gallagher) that would require third-party compliance reviews of investment advisors. The SEC’s Office of Compliance Inspections and Examinations (OCIE) is only able to review about 10 percent of investment advisors (representing some 30 percent of assets under management by registered advisors) annually. 

Before the current administration took office, the SEC staff presented a recommendation for third-party compliance reviews, which should be considered as a practical approach to strengthening protections for U.S. investors without expanding government. 

Cybersecurity

One of the major issues facing the investment management industry, and, thus, the SEC, is cybersecurity. The commission last addressed this topic over two years ago, providing guidance on the need to assess exposure and adopt strategies for cybersecurity threats.  Given the rapid changes in technology, the SEC will very likely take another look at cybersecurity, including the adequacy of advisors’ practices and disclosures relating to data breaches. We expect some formal guidance.  

While markets can change direction quickly and without warning and the balance of political power can shift in an instant, regulatory change in Washington happens slowly. No law or rule impacting the investment advisory industry has yet changed. Consequently, the investment management industry must continue on its current compliance-focused path. Clayton has a big job balancing capital markets and investor protection, but his agenda appears to be taking shape. We wish him success.

Todd Cipperman is the founding principal of Cipperman Compliance Services (CCS). CCS helps advisers, broker-dealers and funds build a culture of compliance through the development, implementation and operation of customized compliance programs.


The views expressed by contributors are their own and not the views of The Hill.