Jay Clayton On The SPAC Explosion, 13Fs, Reg BI and More
CNBC Transcript: CNBC’s Bob Pisani interviews United States Securities And Exchange Commission Chairman Jay Clayton from the CNBC Financial Advisor Summit today, discussing the SPAC explosion, Reg BI, how to use Form CRS and more.
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BOB PISANI: Thank you very much. Jay, welcome to the CNBC Financial Advisor’s Summit. It’s great to have you here.
JAY CLAYTON: Thank you, Bob. Great to be here.
On Regulations And Fiduciary Obligations
BOB PISANI: So, of course this is the Financial Advisor’s Summit. We want to hear what you have to say about things like regulations, maybe fiduciary obligations. But I know you wanted to make some introductory remarks. Why don’t you do that right now and we’ll come back and talk on the other side?
JAY CLAYTON: Great. And I’ll be fairly brief, Bob, because we always get more out when you ask me questions. So three things: First is the people here at the Commission. Second is modernization, which is a theme that goes through what we’ve been working on over the past several years. And then third, a few words about Regulation Best Interest and Form CRS, our work in the area of improving the experience between financial professionals and their customers. So, our people — I just can’t say enough about how our people have switched to a mandatory telework environment without missing a beat. And I want to say that they’ve just done a terrific job in not only keeping the water flowing through the pipes of the financial system, but engaging with market participants, whether they be our Main Street investors or financial professionals and the like. I think that, thanks in large part to that work, and again the work of the Federal Reserve and the Treasury, our markets have been relatively stable through this very challenging time. Second, modernization. One of the reasons why our markets have been performing I would think better than you may have expected going into a pandemic-driven situation is the efforts over the last decade and, in particular, the efforts we’ve made in the last several years to modernize our marketplace, use technology in a smart way. Thank goodness we are able to touch people through the internet, through technology, and that we’re not waiting on paper and the like to keep constant with customers of financial institutions. I think there’s a relative level of confidence that is driven by that realtime communication. So, you know, hats off to the people at the SEC, but also hats off to the industry for being constantly modernizing and putting us in a position where we were more resilient in this difficult time. And then third, you know, a seminal rulemaking here at the SEC, which is Regulation Best Interest and Form CRS, we’ve raised the standard of conduct required of broker-dealers when dealing with their customers to not only drive customer protection, but also to drive customer engagement. And the same thing with Form CRS, that is now what I would say is a focal point of the client relationship, be it investment advisor or broker-dealer, communicates a great deal of information in a short amount of space, and most importantly, it is a conversation starter, so that people understand the scope of the relationship that they have with their financial professional, the obligations of that financial professional, and important things like, does the financial professional have any disciplinary history. So Bob, those are three things that what I can say I’m very proud of, and in particular proud of our people here at the SEC. But back to you.
On The Recent Surge In Retail Investment
BOB PISANI: Thanks very much, Jay. As someone who stays in regular contact with the SEC, I really appreciate the fact that your people are there, been working through the pandemic, so my hats off to you and your whole team. I want to start by talking about retail investors. As you know, there’s been a surge in investor interest in the markets. I think this is wonderful, of course, more people investing. Broader participation in the markets is a wonderful thing and, yet, at the same time there’s been a lot of concerns about how they invest and whether the investments are always sound. I know you’re very big on disclosure, warning people. But I’m wondering if, in certain circumstances, the SEC might not be able to do a little bit more than just warn people and write something in big crayon on the form saying, “This is a risky investment.” How do you feel about the recent surge in retail investment? And is there anything that worries you or that you think the SEC might require to be a little more aggressive in monitoring?
JAY CLAYTON: So, two things. Speaking broadly, I like that you use the word “investing.” To the extent we have an increase in retail investing, investing for the long-term, people saving for retirement, saving for college, saving for a better life, that’s great. To the extent it’s short-term flavor of the day, favor of the month type things, those types of things make me nervous, Bob. So look, more exposure of the American public to our capital markets for the long-term is terrific. We have 50 million American households that are invested in our capital markets. I think we’ll have a better country if we increase that. One of the focuses here at the SEC is to make sure that it’s not just the wealthy who are invested in our capital markets for the long-term. We can talk more about that, if you want. In terms of big red writing and warnings, one of the things about our enhanced standard of conduct for broker-dealers and investment advisors is there are a number of products that just aren’t appropriate for most retail investors, and we’re doing a lot more to make it clear what those types of products are. Products with high leverage, you know, products with what looks like indebted options, things that only sophisticated investors, people who are really educated, should be trading in. We don’t want our long-term retail investors being exposed to those without a great deal of dialogue with the financial professional.
On Reg BI
BOB PISANI: So high leverage, that’s a very interesting word. I know there’s a limit to what you can do, other than talking about disclosure. So, going back to Reg BI, you talked about suitability standards for brokers before. We had a prior suitability standard, now we have a somewhat higher standard, the best interest, although, best interest is not explicitly defined – to Reg BI. So I’m wondering what you’re just saying. I think it’s very important about there are some investments that may not be appropriate. We had some situations a few months ago, you were watching this, where we had a company that was floating a secondary that was bankrupt. And there was a tremendous amount of retail interest, and all of us here were saying: Oh boy, this is a real red flag here, this is a real warning sign. That ultimately didn’t happen. But I’m wondering if there are situations where the SEC could just jump in and say — clearly define what is suitable, what is not suitable, without getting into the nanny state where you’re telling people what to invest in?
JAY CLAYTON: You got it right, Bob. And, look, thank you for having me on your program during that particular offering so I could say that the SEC was concerned about that. Now that’s an idiosyncratic circumstance that we hope doesn’t happen very often. We have a lot of gatekeepers in our marketplace, underwriters and the like should prevent those types of situations from happening. But getting back to, you know, the individual customer. Different products are right for different types of customers. But let’s talk about something like a leveraged exposure to the treasury market through some type of product. That is something that a sophisticated trader might use to hedge a position or the like, but it’s certainly not something that you would put a long-term investor in for the long-term, because in all likelihood, the cost of rolling those types of investments are going to erode the benefits. And you know, we’re making it clear that financial professionals need to think about those types of things and only recommend those products in those idiosyncratic circumstances where they’re appropriate.
On How To Use Form CRS
BOB PISANI: Just to move on from this, last question on this subject, are you implying that you’re going to be more aggressive in helping advisors figure out what is appropriate and what is not appropriate? Because the line is a little blurry right now, we know that. I can name several ETF products where it’s very questionable about whether it is or it isn’t. Are you going to help advisors figure out what is appropriate and not appropriate in certain circumstances?
JAY CLAYTON: Short answer, yes. Longer answer is yes, through — in fact, we have a round table on Monday on Form CRS to help advisors on how to use Form CRS, more guidance on these types of products.
BOB PISANI: Okay. Let me move on.
JAY CLAYTON: Yeah.
On The SPAC Explosion
BOB PISANI: Okay. Let me move on. I want to talk about the SPAC explosion. I think we all feel the same way about SPACs as we do about retail investors. Everybody is happy that more companies are going public. Too many companies have sat private for too long and missed out. The public has missed out on the growth opportunities of the young phase of these companies, so I think it’s wonderful that more companies are going public. I think the concern about SPACs is you have a fairly innovative product and I think the concern out there is, how do you monitor this without it getting too out of hand? We have now several hundred SPACs — hundred — several hundred that are out there looking for investments to buy. How do you sort of monitor this new way of going public, making sure that it does work without blowing up and having a lot of investors invest in stuff that’s just a complete loser two years from now?
JAY CLAYTON: Well, Bob, you’re right. It is an alternative way to distribute stock to the public, as compared to a traditional IPO. But I think what investors need to understand and what the professionals who are involved need to help them understand, is that it’s not the same as an IPO. The motivations of the SPAC sponsors, the motivations of the company that they’re purchasing and the de-SPACing transaction are different from the motivations of your traditional owners and management teams in an IPO. Not saying that’s right or wrong, but they’re different; investors should understand that. Also, there’s something that happens in the IPO process that doesn’t happen as much in the de-SPACing process, and that is institutional investors on your traditional road show kick the tires on the company. That doesn’t happen to the same extent in the de-SPACing transaction. So do I like the idea that there’s competition in the distribution of stock, that there’s not only one method in IPO; that there’s direct listings in SPACs? Sure, we like competition. But investors really need to understand that this is a different means of distributing stock and that price discovery and principle motivations are different.
On 13F Filings
BOB PISANI: Yeah, good point. I want to move on and talk about 13F filings here. Of course, these are the forms that institutional investors are required to file four times a year, and they usually indicate or disclose what kind of holdings they have. We monitor these kinds of things very carefully. You proposed changing those threshold levels. It’s been $100 million for many, many years. You proposed changing it to $3.5 billion. Are you still planning to move forward with that proposal?
JAY CLAYTON: Yeah, Bob. We learned a lot. Look, this is one of those things that if you haven’t updated something in 40 years, which is what happened here, $100 million for 40 years, we proposed a threshold that would have captured 90 percent of what’s currently captured. And we got comment letters saying, “Hey, please don’t do that.” But they weren’t saying please don’t do it for the reasons that Form 13F exists, which is sort of the monitor market integrity and the like, and the principle reasons — and they are interesting reasons and good reasons are, one, I want to see what strategies other fund managers or fund managers were using, what are the professionals doing in their strategies? I’ll come back to that. And the second was from companies, which was, this is the only way we have to effectively identify who our shareholders are? That’s a problem. If we’re using 45-day trailing filings of a select group of people to help companies figure out who their shareholders are in the day of electronic communication, that’s something we’ve got to address. And I will throw these terms out there: OBO/NOBO, it’s how we interact through the brokerage system with ultimate beneficial owners. But we need to look at that. Going back to the people who want to look at how professional managers manage their portfolios, I just want them to understand, fine, but these are imperfect means to do that. It’s 45 days late, it includes only long holdings, not all long holdings. So, to the extent you’re using these to follow, as some people might call it the “smart money,” understand that that’s a very imperfect way to look at that. It’s not what the form was designed for, but it’s — I will say this, it is very interesting to me how many people seem to use it for that purpose.
BOB PISANI: Yeah, well, certainly we do. We’re financial reporters, and we file that. The Wall Street Journal, we all follow as a means of indicating who holds what. But back to your 45-day point. We’ve had complaints about this for years. I guess the question is, why don’t you take it to the logical conclusion and change it from 45 days to 15 days and make it shorter and make it more useful to people? This is under the assumption that there’s nothing wrong with seeing other people’s strategies. If you feel there is, go ahead and say that. I personally don’t feel there is anything. Is there any reason why there’s something wrong with wanting to know what other people’s strategies are a few days or a few weeks after a reporting period?
JAY CLAYTON: Yeah, Bob, I think you raised exactly the question that has been debated in this for years, is at what point, how many days, 15 days, 45 days or more, would knowing somebody else’s strategy allow you to take advantage of that strategy and, you know, take unfair advantage, throw out a loaded term there, unfair advantage of knowing how someone else is operating in the marketplace. I mean, there are a lot of people — and, you know, we have long held that your investment strategy is proprietary information to yourself. I think that’s a pretty fundamental principle. So how long of a delay do you have before that kind of trading information is no longer proprietary information or should no longer be protected as proprietary information? Good question.
BOB PISANI: It’s a very good question. So what is the answer? Are you planning to move forward with the proposal?
JAY CLAYTON: Look, I think where we are, Bob, is we need to examine this, and we need to examine all those issues. So, you know, why are people following us from a trading strategy point of view? Why is it necessary for people to use this form for its unintended purpose of finding out who their holders are? Is there a more efficient way to do that? And if you address those problems, what is the right threshold for a 13F filing?
On ESG Practices
BOB PISANI: All right. I take it that’s a definite “maybe.” Let me move on and talk about ESG, environmental, social and governance. We’ve seen massive inflows this year. The numbers are all over the place. But it’s huge. This has caught a wave, and my suspension is this is a little more than just a fad by now. This is not, you know, pot ETFs or something like that, that it’s a lot more serious. But it has been getting some pushback recently. I’m wondering what, if any, position the SEC has on this. It was pushed back from the fossil fuel industry for years because they feel it disadvantages them. But there’s been pushback from some other groups that view this as pushing a social agenda; that climate change, boardroom practices, clean energy are really social agendas and is it sort of an appropriate thing for financial advisors to be pushing or asset managers. Other than disclosure, does the SEC have any interest in this at all, and if so, what is that?
JAY CLAYTON: Well, Bob, let me try and put this into two buckets. First is the question of whether something like an ESG score, it is information that is valuable to an investment decision. And Burton Malkiel and others, and I have commented on this. This is a very subjective thing. So you say, you know, I have a higher or lower ESG score. What does that really mean? How have you weighted G? How have you weighted S? How have you weighted E? What goes into those? Trying to boil down these myriad forward-looking factors into a single score and having that convey valuable investment decision information, that’s difficult. And one of our questions at the SEC is if people are marketing to investors based on that, are investors really understanding what that means from a return perspective and investment philosophy perspective? So there’s that issue. And then on the social debate about this, is, is this something where — is it really a capital allocation decision? It is terrific if somebody says, “Look, I think that our economy is going to go through a transition. I want to be in front of that transition, and I want to know how to do it.” That’s a fundamentally, you know, valid way to invest, absolutely. But if somebody is sitting there saying, “I want to drive the transition of our economy using SEC rules,” that’s a different story. And trying to, you know, handle the difference between those two and convey investment decision information to people as effectively as practical, that’s our job.
BOB PISANI: So you’re making a very fine distinction here. Is it possible someone could run afoul of SEC rules by advocating ESG practices? You just tried to make a very fine distinction there.
JAY CLAYTON: Well, Bob, anybody who is advocating a practice, that’s fine. You can advocate a practice. But anybody who is saying, “I’m giving you an investment that does something,” when the investment doesn’t clearly do that, that’s an issue. If I’m out marketing a fund as doing something, you know, it can be environmentally friendly or something else, and there’s no rigor behind whether it actually does that, that’s a problem. And to the extent there is rigor and investors want it, that’s terrific. But we’ve got to make sure that the marketing and the substance line up.
On China IPOs In The United States
BOB PISANI: Yeah, there’s a subtle distinction, so I expect to hear more about that in the future. I want to move on, a couple more topics. China IPOs in the United States. Of course, there’s been proposals out there for Chinese companies with shares traded on U.S. exchanges to give up their listings if they don’t comply with U.S. audit requirements. This was a plan floated earlier in the year by the Trump Administration. I know, speaking with you in the past, that the unwillingness of Chinese regulators to allow increase by U.S. auditors into Chinese firms that list in the United States has been a tremendous source of frustration for you and your fellow regulators. Can you update us on where that stands? Is there any movement at all from Chinese regulatory authorities to allow U.S. auditors, U.S. regulators, more access to Chinese companies that list in the United States? Are we any closer to resolving this, or is this getting worse? Just give us an update.
JAY CLAYTON: So, of course, we have continuing dialogue with our regulatory counterparts in China and would love to progress this on a bilateral basis. But, Bob, when I came in in early 2017 to this job, this issue had been around for a while. Just to frame it for the viewers, Sarbanes-Oxley gave us some things that really have great investor protection bang for the buck. Two of those are the Independent Audit Committee and the PCAOB inspection of audits. For over a decade we haven’t been able to effectively conduct PCAOB inspections in China. That is a problem, because this is a fundamental part of our investor protection. And what we’re working on is whether we’re going to continue to allow companies that do not allow PCAOB inspections to list their securities in the U.S. It’s a recommendation from the President’s Working Group, and the staff here at the SEC is moving forward on proposals that would implement that, that would go out for public notice and comment. I will note, Bob, that there is legislation moving through Congress that would do a similar thing, so we’re watching that, as well.
BOB PISANI: Jay, we’ve hit on a lot of topics. We’re running towards the end of our time here. Retail traders, SPAC, 13F, ESG, China, IPOs. Just, in conclusion, is there anything out there that’s on your plate right now that is sort of front and foremost that we haven’t covered that you think we should be knowing about and that the financial advisors should be knowing about right now?
JAY CLAYTON: Cyber security, resilience. Your customers now, more than ever, are depending on electronic communication to work with you. Make sure your systems are protected, that you’re sharing information with each other. And it’s not a matter of if, it is a matter of when. We will have cyber incidents. It’s how we deal with them. But keeping the confidence in the system is crucial. Part of keeping that confidence is maintaining good cyber hygiene and what I would say is being able to react quickly in the event of an issue.
BOB PISANI: Cyber security. Okay. Very important topic. We would like to have you back to talk about that with us in the future. Jay Clayton, Chairman of the SEC, thank you so much for joining us. We really appreciate it and appreciate your advice and guidance.
JAY CLAYTON: Thank you, Bob.