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WashingtonWise Investor: Episode 41


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What Does a Busy SEC Agenda Mean for Investors?

The SEC’s agenda is packed with issues that directly impact individual investors. What steps are underway to address them while keeping the markets moving?

The new SEC Chair, Gary Gensler, is known for getting things done. But he is faced with an ambitious agenda, including protecting small investors who are increasingly trading through apps on their phones, regulating the exploding cryptocurrency world, encouraging corporate transparency as socially responsible investing grows in popularity, and overseeing the proliferation of SPACs. Host Mike Townsend explores whether Gensler can strike the proper balance to ensure a safe environment for individual investors while keeping the markets running efficiently and promoting transparency from corporations. Also in this episode, Mike covers the latest on the negotiations on Capitol Hill over infrastructure spending and tax increases and the growing support for retirement savings legislation in Congress.

WashingtonWise Investor is an original podcast from Charles Schwab.

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MIKE TOWNSEND: Unless it’s Bernie Madoff being investigated for a mega Ponzi scheme, or a celebrity like Martha Stewart getting charged with insider trading, most people just don’t pay much attention to the Securities and Exchange Commission.

Even though the SEC is responsible for protecting investors and overseeing our capital markets, it stays out of the spotlight—and out of people’s minds.

So unless you are a devotee of the financial news stations, you won’t hear reports of the many times the SEC fines public companies for accounting violations or investigates companies for possible fraud.

But for investors, there is no more important regulatory body in the nation’s capital. Its 2021 agenda is packed with issues that directly impact ordinary investors—and that makes it something we ought to keep our eye on.

Welcome to WashingtonWise Investor, an original podcast from Charles Schwab. I’m your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation’s capital and help investors figure out what’s really worth paying attention to.

Today’s episode will primarily focus on the SEC, its new leadership, and the numerous high-profile issues before it that are in the headlines. We’ll explore what the agency does and the impact the SEC may have on investors in the coming months.

But first, let’s take a look at some of the other issues making headlines right now.

As expected, the last couple of weeks in Washington have been dominated by jockeying between the two parties over the two spending bills proposed by the Biden White House—one on infrastructure and climate change priorities and one to expand social programs. The president has proposed both corporate and individual tax increases to pay for his plans. The negotiations on Capitol Hill are just beginning, but there have been a couple of notable developments.

A group of Republican senators, led by Senator Shelly Moore Capito of West Virginia, has been working on a proposal that focuses on the area of most common ground between the two parties: a so-called “hard infrastructure” plan that would spend between $600 billion and $800 billion on roads, bridges, public transit, and airports. The group met with President Biden at the White House last week; and a follow-up meeting took place this week. A key issue is how to pay for the proposal—Republicans have flatly rejected the president’s proposed increase in the corporate tax rate and are instead seeking to pay for their infrastructure plan with user fees.

The plan is much smaller and much more targeted than the president’s $2.25 trillion American Jobs Plan. While the talks have been cordial, the two sides are still far apart. The question is whether the White House is serious about breaking off one piece of the plan in order to attract bipartisan support.

The other big development over the last couple of weeks is that President Biden signaled that he was open to compromise on his proposal to increase the corporate tax rate from 21% to 28%. Some Democrats have pushed back on the plan and have advocated a smaller increase, to perhaps 25%. The president did not specifically endorse that number, but he indicated that he was open to it.

If you listen to this podcast regularly, you’ve heard me say this before. But it is really important for investors to keep in mind that these proposals are just starting points for negotiations. The American Jobs Plan and the American Families Plan are still just ideas the White House has put forward. Congress has not even started drafting actual legislation, and when it does, there are likely to be a lot of changes.

There is real uncertainty on Capitol Hill as to how many of the White House’s proposals to increase taxes on wealthy filers can be passed by Congress—even some Democrats are skeptical. And there is equal uncertainty about the size and scope of the two proposals—and how the economy will react to another $4 billion in spending by the government.

Congress moved very quickly in February and March to pass the president’s economic stimulus plan. But that’s not what is happening this time. Right now we remain stuck at the very beginning of a process that is likely to take months. So, as an investor, making any plans about how these proposals will shake out in the end is very premature.

On my Deeper Dive today, I want to run through just what the Securities and Exchange Commission is, how it operates, who the commissioners are, and what their role is in overseeing the capital markets and protecting investors. And then I want to explore the high-profile issues the SEC is tackling, how they directly affect individual investors, and how they may play out in the coming months and years.

Let’s start with a quick history lesson. Launched in 1934, the SEC was created in the wake of the Great Depression, when it became clear that financial institutions had misled investors, engaged in insider trading, and ultimately brought the market crashing to its knees.

Over time, the SEC helped to rebuild confidence in the capital markets, and it has been an important—if not always visible—part of maintaining that confidence ever since.

The SEC is an independent agency, which is different from a Cabinet agency, like the Department of the Treasury or the Department of the Interior, because it is not part of the executive branch.

It’s run by a bipartisan board of five commissioners, who serve staggered terms. These commissioners are nominated by the president and confirmed by the Senate. Typically, three of the members, including the chair, are members of the president’s party, while the other two are from the party that does not control the White House.

The new chair, Gary Gensler, was confirmed just a month ago, but Gensler has already testified before Congress and done a major interview with CNBC, where he began laying out his agenda. Currently he is filling out the unexpired term of his predecessor, which expires in early June, but the Senate has already confirmed him for his own five-year term, which runs until 2026.

Gensler was a partner at Goldman Sachs before becoming an undersecretary of the Treasury during the Clinton administration and later the chair of the Commodity Futures Trading Commission during the Obama administration. Most recently, he’s been teaching at MIT’s Sloan School of Management.

That’s an impressive résumé, but there are four other commissioners who have strong credentials of their own:

  • Hester Peirce, a Republican, is the SEC’s longest-serving commissioner at just over three years. Peirce has been a staffer at both the SEC and at the Senate Banking Committee in her career.
  • Elad Roisman, also a Republican, became a commissioner in September 2018. He, too, served as a staffer at both the SEC and on the Senate Banking Committee.
  • Allison Herren Lee, a Democrat, was confirmed as a commissioner in summer of 2019. She served as acting chair of the agency from January of this year until Gensler took office last month. Her background includes a stint as a staffer at the SEC—apparently an ideal path for becoming a commissioner.
  • And Caroline Crenshaw, also a Democrat, is the fifth commissioner. Prior to becoming a commissioner, she—you guessed it—spent more than seven years in various senior roles on the SEC staff.

As chair, Gensler is the most visible member of the commission—he is typically the one called on to testify before both House and Senate committees on behalf of the agency, for example. The chair sets the priorities for the agency, controls the agenda and is generally the public face of the agency. Perhaps no single individual nominated by President Joe Biden will have more of an impact on investors and on the markets over the next four years than Gary Gensler.

But the other four commissioners are also important. They give speeches, do media interviews and make other public appearances in which they opine on a wide variety of topics. The chair often taps other commissioners to take the lead on certain issues.

Beyond the five commissioners, the SEC is a sprawling agency, with more than 4,500 employees spread across the Washington headquarters and 11 regional offices across the country. It has a budget of nearly $2 billion, appropriated by Congress. And it has six divisions committed to three basic missions: protecting investors; ensuring fair, orderly, and efficient markets; and facilitating capital formation.

The SEC does that by setting the rules that govern the operation of our markets. Now, rulemaking is a complex and time-consuming process—by design, in order to ensure that new rules are carefully thought out and fairly crafted.

Typically, the staff investigates an issue, usually spurred by some incident in the markets. Then they draft a report and make recommendations for potential rule changes. Next the commission meets in a public session to hear the staff’s recommendations and takes a public vote on whether to propose a rule—each commissioner’s vote counts equally, and a majority is needed to put forward a rule.

Proposing a rule kicks off a long process of soliciting public input on the proposal. After the rule is published in the Federal Register, the public has a period of time, usually 60 days, to submit comments on the proposal. More technical proposals, like a minor change in how exchanges operate, may generate just a couple of dozen comments. But major rule changes can generate thousands of comments. Back in 2012, the original proposal of what became known as the Volcker Rule, which prohibited banks from trading for themselves instead of their clients, generated tens of thousands of comments. After the comment period closes, the staff and the commissioners review the comments and consider whether any changes need to be made to the proposed rule. With no timetable for this stage, it can take a few months or a few years. Sometimes, rule proposals get bogged down in controversy at this stage and may never be voted on.

But generally, after a few months, the commissioners gather in another public meeting to hear from the staff about any revisions to the proposed rule. They debate the rule and eventually vote to finalize it. Most rules have a lengthy transition period built into them—often a year, sometimes more—to allow the industry to prepare by making systems and procedural changes and educating investors about the implications of the new rules.

Once a rule is approved by the SEC, it’s on the books forever. A future SEC could modify or overturn it but doing so would have to go through the same lengthy rulemaking process I just described. In addition, the SEC is a relatively apolitical organization—there is a three-to-two party split among the commissioners, and the staggered five-year terms mean that the commissioners usually remain in their jobs regardless of who is in the White House. Four of the five commissioners today, for example, were confirmed during the previous administration. That means that what the SEC does tends to stay in place for a long time. Indeed, the three pillars of our entire capital markets structure today are the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940. The SEC has made countless updates to the rules under those laws to keep up with evolving technologies, of course, but the basic foundations have been in place for more than eight decades.

With that background, let’s turn to some of the key issues on Gensler’s plate as he settles into his new role. I want to focus on four issues that I think have the potential to have the most direct impact on investors.

Topping the list is the ongoing fallout from what is now known as “the GameStop situation,” a reference to the retail trading frenzy in the stock of GameStop Corporation earlier this year, which was fueled by discussions on Reddit and other social media platforms that sent the company’s stock on a wild rollercoaster ride. The frenzy spread to other so-called “meme stocks,” and more recently, to a cryptocurrency called Dogecoin that was originally launched as a joke.

During his testimony earlier this month on Capitol Hill, Gensler called the GameStop episode “part of a larger story about the intersection of finance and technology.” He went on to say that SEC staff is in the process of preparing a report on the events that he expects will be completed and released publicly this summer. And he said that the agency is looking at the episode to determine whether any violations occurred, as well as to consider whether additional regulation is needed.

Gensler cited seven specific areas the agency is looking at: the “gamification” of stock trading, payment for order flow, equity market structure, short selling and market transparency, social media, the clearing and settlement process, and system-wide risks. Gensler made a couple of interesting points on these topics.

The gamification of stock trading has become a big discussion point in the debate over the GameStop situation. Gensler specifically pointed to behavioral prompts and predictive data analytics that can be used to push investors into increasing their activity—in other words, trading more. He noted that this kind of technology is being used in all sorts of ways in our lives today—it’s how Netflix recommends movies for you to watch, or how health apps provide incentives for you to exercise more.

But, Gensler said, following the wrong prompt on a trading app can lead to financial losses. And, he said, some studies have shown that more active trading can lead to lower returns.

On social media, Gensler said that he is “not concerned about regular investors exercising their free speech online.” In other words, there’s nothing wrong with investors going online and talking about stocks they like. But he said he is concerned that this could be a venue for “bad actors” to take advantage of less sophisticated investors.

Finally, Gensler said that he was concerned about the practice of payment for order flow, where brokers get a fee for routing customer orders to a particular trading venue. He questioned whether this was an “inherent conflict of interest” and whether investors were getting the best price on their trade or whether the trade was being executed at the venue that gave the best deal to the broker.

The SEC’s staff report on these and the other issues he raised in his testimony will be eagerly anticipated. But Gensler’s tone was clear—changes are coming to make sure that investors are protected in this increasingly fast-changing online trading world.

The second issue on Gensler’s to-do list is socially responsible investing—known as ESG investing for “environment, social, and governance.” During his confirmation hearing before the Senate Banking Committee, Gensler said that he thought investors wanted to see more disclosure about the impact of climate change on public companies, as well as more information about the risks that climate change poses to companies. Earlier this year, when she was acting chair, Commissioner Allison Herren Lee launched a project to solicit public comment on dozens of questions related to the SEC’s climate risk disclosure regime—a first step in what is expected to be an updating of the SEC’s current disclosure rules, which date back to 2010.

Gensler has also spoken about how public companies need to be more forthcoming about their diversity and inclusion policies and their political spending. And he has mentioned that there needs to be more clarity on what exactly constitutes an ESG fund so that investors are not misled.

Now, this will be a politically sensitive topic for Gensler to negotiate. Republicans on Capitol Hill have accused Gensler of using the ESG investing issue to push a progressive policy agenda. It is perhaps the main reason that just three Republicans voted to confirm him in last month’s Senate vote. 

Third on the agenda is SPACs. That’s an acronym for a special-purpose acquisition company. A SPAC is essentially a shell company launched by investors with the sole purpose of acquiring a company and taking it public—it’s another way to go public without a traditional IPO.

SPACs were not really a thing many people noticed until recently. In 2019, just 59 SPACs were launched. Then in 2020, that number rose to 248. And in the first quarter of 2021, there were a record 318. Most experts attribute the sudden growth to the pandemic. Companies were worried about the market volatility, and IPOs declined as a result. By merging with a SPAC, a company that wants to go public can do so more quickly than in a traditional IPO.

But the SEC has started to grow worried about the rise in SPACs. In March, the agency issued an investor alert that warned investors that celebrity involvement with a SPAC is not a good reason to invest in a SPAC. Later that month, the SEC issued a “staff statement” that raised issues with the accounting, financial reporting and governance of SPACs.

If chilling the boom in SPACs was the goal of those two statements, well, it worked. After 109 SPACs were launched in March alone, just 10 were launched in April.

So what to make of all this.? Well, I think it’s clear that more guidance and potentially new rules are coming from the SEC.

And finally, cryptocurrency. The cryptocurrency world has been excited ever since Gary Gensler’s name first appeared as a potential contender for the SEC chairmanship. Why? Because Gensler spent time at MIT studying this issue and taught courses in digital currencies and blockchain technology. Cryptocurrency enthusiasts believe that he brings a depth of experience and knowledge about the growing industry that could lead to a stamp of legitimacy from the regulator.

But in his recent testimony and in his CNBC interview the next day, Gensler made two points that indicated it may be a while before the cryptocurrency world gets that stamp of approval. He repeatedly said that the cryptocurrency markets could benefit from greater investor protection. And he called on Congress to clarify the SEC’s regulatory oversight of cryptocurrency trading venues.

Speaking on CNBC, Gensler said, “Whether it’s stock exchanges or futures exchanges, there are regimes that were put in place in the 1930s to help protect against fraud and manipulation on the exchanges and protect the integrity of that. And I think that’s really something that we’ll be working on with Congress … to bring some protection for people that want to invest in this speculative asset class.”

Not exactly a ringing endorsement. And the process of getting Congress to grant the SEC authority to regulate cryptocurrency trading venues—well, that would require legislation to pass both the House and the Senate and be signed into law by the president—legislation that, at the moment, has not even been drafted.

Gensler’s comments also seem likely to push the pause button on one of the most eagerly anticipated aspects of the cryptocurrency space—SEC approval of the first Bitcoin exchange traded fund. Nearly a dozen asset management companies are in various stages of submitting applications to the SEC to launch the first Bitcoin ETF, something the agency has declined to do ever since the first application was filed in 2013. Momentum seemed to be on the asset managers’ side—earlier this year, Canada approved its first-ever Bitcoin ETFs, and Gensler’s arrival at the agency had applicants believing that such a product could be approved in the United States in a matter of months.

Now, that seems less likely. There’s a key date looming in mid-June, when the SEC has said it will decide on the first of those applications. But given Gensler’s comments, the likelihood of an approval now seems dim.

That’s a lot of issues for investors to keep track of. So I’ll be keeping you posted on all of these issues on this podcast in the months ahead.

In the Why It Matters segment, a quick update on a story I discussed on the last episode: the bipartisan retirement savings bill. Turns out it truly is bipartisan—it was approved unanimously by the House Ways & Means Committee.

The legislation would slowly increase the age at which individuals have to begin taking required minimum distributions from their retirement account from 72 to 75 over the next decade. It would allow individuals on the cusp of retirement—those aged 62 to 64—to increase the amount they can contribute to a retirement account, known as a “catch-up contribution.” It would increase the Saver’s Credit that gives lower-income individuals an incentive to save for retirement. And it would make a number of changes to help companies of all sizes start a retirement plan for their employees and help those employees maximize their savings.

Two things that matter here. One is that unanimous vote in the House Ways & Means Committee—that’s as strong a signal as could be sent about the support for this bill. At a time in which very few things on Capitol Hill are agreed to by both political parties, that vote bodes well for the bill’s chances of passing the House.

The other thing that matters is that there are signs that the Senate is also moving forward on this issue. A Senate retirement savings bill is set to be introduced. And it, too, has bipartisan support. It’s not exactly the same as the House bill, but it’s close enough that reaching a compromise between the two bills should not be difficult.

Now, to be clear, this is not the highest priority for Congress right now. So I expect that it may take a while for the House and Senate to pass retirement savings legislation. But my confidence that Congress will pass retirement savings legislation in 2021 continues to grow.

Well that’s all for this week’s episode of WashingtonWise Investor. I’ll be back in two weeks, so please take a moment now to follow the show in your listening app so you don’t miss an episode. And if you like what you’ve heard, leave us a rating or a review—that really helps new listeners discover the show.

For important disclosures, see the show notes or, where you can also find a transcript.

I’m Mike Townsend, and this has been WashingtonWise Investor. Wherever you are, stay safe, stay healthy, and keep investing wisely.

Important Disclosures

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Investing involves risk, including loss of principal.

Digital currencies, such as bitcoin, are highly volatile and not backed by any central bank or government. Digital currencies lack many of the regulations and consumer protections that legal-tender currencies and regulated securities have. Due to the high level of risk, investors should view Bitcoin as a purely speculative instrument.

Whether you are investing in a SPAC by participating in its IPO or by purchasing its securities on the open market following an IPO, you should carefully read the SPAC’s IPO prospectus as well as its periodic and current reports filed with the SEC pursuant to its ongoing reporting obligations.

All corporate names are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.

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