Reimagining the role of the next SEC chair

President-elect Joe Biden will soon nominate a new chair of the U.S. Securities and Exchange Commission (SEC). Democrats will hold a slim majority in the upper chamber, and some will be tempted to appoint an SEC chair bent on unwinding regulations ushered in during the Trump administration.

There’s plenty to unwind: Former Chairman Jay Clayton, who left the Commission in December, drove a prolific rulemaking agenda. During his tenure, the SEC adopted more than 90 new rules, many of which are “principles-based” – think guideposts, not roadmaps – and beg interpretation.

The incoming chair will find opportunities in those rules and, rather than scrapping them, she or he should focus on interpreting and enforcing them — reimagining rather than reinventing. 

Take, for example, the principles-based advertising rule now applicable to investment advisers. Despite calls from industry compliance professionals for “specific guidance” on the scope and application of the rule, the Commission adopted flexible standards that give financial advisers leeway in deciding how to market their services. The reconstituted Commission will decide what the new standards mean and how to apply them; that is, the Commission will give meaning to the principles on which the rule rests and enforce it appropriately. 

Another example lies in the Clayton Commission’s Regulation Best Interest (Reg B1), a principles-based rule that prohibits brokers from placing their own interests ahead of their customers’. The rule is unpopular with investor advocates and state securities regulators, because it doesn’t require brokers to meet the rigorous “fiduciary standard” imposed on investment advisers. Critics’ (mostly Democrats’) fears may be tempered by simply giving Reg BI teeth. Sen. Sherrod Brown (D-Ohio) put it nicely in a June 2020 letter to then-Chairman Clayton: “[T]he Commission [must] fulfill its investor protection mandate through tough compliance examinations and enforcement of Reg BI.” Thus, the new chair can lean on the examinations and enforcement teams to shape the “best interest” standard without reinventing it through rulemaking. 

The amended definition of the term “accredited investor” is yet another lever the new chair can pull rather than replace. The amended definition expands the universe of investors who may access private securities offerings. Many Democrats object to the broader definition, because they fear it removes an important safety valve for “Main Street investors.” 

However, rather than re-tightening investors’ access to private funds, the Commission might assume a more aggressive enforcement posture with respect to private issuers who solicit retail investors. Again, channeling Sen. Brown, tough compliance examinations and enforcement of private funds may be the most effective way to fulfill the SEC’s investor protection mandate.

Some will say that this is just “regulation by enforcement” — a means of drawing regulatory boundaries through reprisals rather than rulemaking. It’s not. 

The Commission adopted imprecise rules. The new chair has license to elucidate and enforce the rules she or he inherits.

Separately, there are areas where the SEC chair must stake out new ground. Developing environmental, social and governance (ESG) disclosure rules will undoubtedly be on the agenda. So, too, will the regulation of cryptocurrencies and initial coin offerings (ICOs). The chair will also contend with fallout from the COVID-19 pandemic, including disclosure issues and investment schemes. 

In addition, the chair must consider investment product and fintech innovations that are rapidly changing our capital markets. New complex and thematic investment products (like leveraged exchange-traded products and “disruption” ETFs) enter the market each year. Simultaneously, automated investment tools (“robo-advisors”) and online brokerage services (so-called “self-directed” trading platforms) are experiencing explosive growth. Former SEC Commissioner Robert Jackson acknowledged last year that regulators have struggled to keep pace with these innovative new products, services and platforms. They require greater scrutiny.

Beyond product and platform innovation, there remain traditional areas that demand renewed focus. Insider trading is, perhaps, the best example. Insider trading cases remained stagnant in the Clayton Commission. While there are calls for clear insider trading legislation, there is a great deal the SEC could do now: increase the enforcement focus on insider trading, close the “8-K trading gap,” investigate executives and entities that improperly rely on 10b5-1 plans to shield illicit trading and enforce the STOCK Act.

Thus, there is ample room for the new chair to forge a path ahead, rather than retread old ground.

There is no clear favorite to become the new chair, though Robert Jackson, former CFTC Chairman Gary Gensler, former U.S. Attorney Preet Bharara and current SEC Commissioner Allison Herren Lee are often listed among the top contenders.   

Opinions about potential nominees fall along predictable lines: Republicans fear an (overly) aggressive new chair who will stretch the bounds of regulations or resort to regulation by enforcement; Democrats need a nominee who can survive the confirmation process – a slim majority in the Senate provides no guarantee that Democrats’ top pick will be confirmed – while promising to pursue progressive policy imperatives. 

In keeping with the Biden transition team’s ethos, Senate Democrats should nominate a chair who will be a consensus builder — not a compromise candidate, but a “tough but fair” chair focused on restoring faith and fairness in our capital markets. 

Such a chair would be able to make meaningful progress within the regulatory framework she or he inherits. They might even be able, as the saying goes, to “build back better.” 

Kurt Wolfe is a member of Troutman Pepper’s Government Investigations, Compliance and Enforcement practice. He is also a co-host of PLI’s inSecurities podcast. Follow him on Twitter @Enforce_Update.