In 118th Congress, House Financial Services Committee, Public Policies, Securities and Exchange Commission

On Tuesday, April 18th, SEC Chair Gary Gensler made his eagerly anticipated return to Room 2128 of the Rayburn House Office Building to represent his agency at a House Financial Services Committee (HFSC) hearing on oversight of the SEC.  The hearing marked Gensler’s first appearance before the HFSC since October 5, 2021.  While the hearing was not expected to be easy, it proved even more challenging than Gensler apparently anticipated, with the Chair taking significant criticism. While nearly all of the hostile questioning came from Republicans, the way that Gensler mishandled some of the more important questions could exacerbate concerns about him and his agency among moderate Democrats on and off the HFSC, and in the Senate, whose votes will prove pivotal for upcoming policy battles, from crypto to climate.

Here are eight important takeaways from Tuesday’s hearing.

(1)  Republicans have quietly positioned the HFSC for aggressive oversight and the SEC is a priority target.  Despite months of publicly emphasizing legislation and policy, McHenry’s recent actions dispel any doubt that he intends to use all of the investigatory tools at his disposal to gain leverage and political advantages over the Biden Administration and its financial regulatory agencies.

In many respects, Tuesday’s hearing recalled the sort of oversight theater usually reserved for Democratic CFPB Directors, complete with a blistering harangue from the Chair that doubled as an opening statement.  In his opening remarks yesterday, McHenry portrayed the agency as inept and unresponsive.  He described the Commission’s major rule proposals under Gensler as “disastrous,” blamed the SEC for “driving innovation overseas and endangering American competitiveness,” and warned Gensler that his “responses to Congressional inquiries have been unacceptable.”  McHenry then yielded subcommittee chairs Ann Wagner (R-MO) and French Hill (R-Ark) to hammer Gensler with additional criticisms.  The hearing also was clearly choreographed to gain the maximum leverage from various recent, overlapping, and disparate inquiries lobbed at the SEC by the new HFSC majority, including requests related to China, climate disclosure rulemaking, recordkeeping, capital formation, the decision to charge FTX founder Sam Bankman-Fried, and all manner of other political landmines.  It was apparent that large numbers of GOP staff at all levels had labored to make this a prime-time affair.  Therefore, at the dawn of a new GOP House majority – a House majority marked by a new HFSC chair who is much more interested in capital markets policy than any chair in recent memory – the SEC under Chair Gensler seems poised to vie with the Bureau for the distinction of being the GOP’s favorite boogeyman and political target.

(2) A growing number of Democrats are finding their voices and honing their messages in the debate over the size and scope of private securities markets – and this may be just in the nick of time.  In the face of a looming markup on April 26 expected to feature roughly thirty GOP authored legislative proposals that collectively would enact the most dramatic expansion in the size and scope of the marketplace for exempt offerings since the JOBS Act of 2012, Democrats on Tuesday spoke persuasively and cogently in support of policies that that would shift the regulatory framework decisively against such offerings, effectively articulating a competing vision that contrast with the Republican agenda by emphasizing policies geared toward pushing future capital raises into the public markets.  In what was perhaps the most notable example of this sharpening in rhetoric, Rep. Brad Sherman (D-CA), the top Democrat on the Capital Markets Subcommittee, used both his opening statement and his questions to highlight issues related to the outsized role of “private” or “exempted” offerings in capital raising framework.

During his opening statement, Sherman thanked Gensler “for standing up to the crypto bro billionaires who were an area where the multi-billion-dollar frauds are just the beginning of the societal harm, noting that “investor protection is not the antithesis to capital formation, it is the necessary antecedent.” Sherman also used his statement to address his view that “private placements cannot swallow the whole idea of companies being public…the idea that 2,000 shareholders should become 2,000 shareholders of record through a phony math that allows companies to have perhaps 10,000 beneficial shareholders and not consider themselves public is something that needs to change.”

During the Q&A portion of the hearing, Sherman returned to the question of the private securities marketplace, including the “accredited investor” definition and the “shareholder of record” definition under Section 12(g) of the Securities Exchange Act of 1934.

“The definition of ‘accredited investor’ that we have now relates to the wealth of the investor or their income, which may have nothing to do with their sophistication and knowledge. And I look forward to working with others on this committee to have a definition of accredited that discards the idea of wealth and looks instead at knowledge.…  The definition of an accredited investor we have now is based on wealth levels set in the 1980s, which means they’re completely out of date and probably shouldn’t be used at all.…  Congress expanded from 500, all the way up to 2,000, the number of entities that can be beneficial owners, and still have the company thought of as a private company. I mean, that’s a lot 2,000 owners.  But we’ve got a huge loophole here where you could have dozens or hundreds of beneficial ownership entities counted as only one if they list the stock in street name.”

Sherman was not the only Democrat to focus significant time on issues related to private markets.  Other Committee Democrats raising the issue included Rep. Jim Himes (D-CT), who noted “I’ve long been concerned by the fact that an awful lot of our capital markets are migrating to private markets…I worry that profitability and good deals will migrate to those private offerings.”

(3) The GOP is livid that Gensler cannot speak for the SEC. In a number of interactions, it became clear that Republicans are frustrated that Chair Gensler is one of five commissioners and, therefore, cannot make pronouncements on behalf of the agency. In what was perhaps the oddest example, Rep. Pete Sessions (R-TX) used nearly all of his time to question Chair Gensler on the semantics of the SEC’s “standard disclaimer,” which requires that SEC officials speaking publicly disclaim that their remarks reflect their personal views and “do not necessarily reflect the views of the Commission or any of my colleagues on the staff of the Commission.”

SESSIONS:  Mr. Gensler, you started your conversation with this committee with my views on my own. Why did you say that?

GENSLER:  Because it’s part of our law that I always say that my views are my own. They don’t represent the staff or my fellow Commissioners.

SESSIONS:  Do they represent the agency?

GENSLER:  I’m here as the chair of the agency, but because I’m a member of a five-member commission, the Commission speaks, as that commission. And so that standard language that we include in each of our speeches and our testimonies.

SESSIONS:  Standard language? So, you don’t represent the — you cannot speak on behalf of the agency? Why are you here?

GENSLER:  As chair of the agency, they express the views as the Chair of the agency.

SESSIONS:  Then why didn’t you say express the views as Chairman as opposed to my own? I don’t understand that. Those are personal. When you say my own, that’s personal. Now, you’re contradicting that insane as chairman.

GENSLER:  Again, because it’s written into our —

SESSIONS:  I think you ought to reevaluate that because I think that’s a complete cop out. I think that’s a cop out that I think we hear and that’s why this committee is going to express its opinion to you today.

But this was not the only exchange typifying the GOP’s frustration with Gensler’s legal inability to speak authoritatively on behalf of the four other commissioners…

(4)  Chair Gensler’s awkward mishandling of Rep. Patrick McHenry’s questions on Ether set the tone for a rough day for Gensler.  In what we view as the most important and consequential exchange of the day, Gary Gensler badly mishandled opening questions from the HFSC Chair about whether the cryptocurrency Ether is a security. In his defense, Gensler appears to have not wanted to speak on behalf of the agency on this important question that the five commissioners have yet to vote on, but he walked into McHenry’s trap aimed at exposing the lack of clarity around the SEC’s continued position on crypto.  Indeed, given the fact that he and his talented staff have been working on crypto for 18 months—and have been thinking about how to respond when Congressman Patrick McHenry asks him to explain the agency’s regulatory framework for crypto—and that McHenry has been pressing and pressing and pressing the SEC Chair to provide “clarity” with respect to his thinking on digital assets generally and Ether specifically, we were frankly baffled.

The exchange should also have been a key opportunity for Gensler and the SEC seize the initiative in the debate over where authority to regulate crypto should reside.  Gensler surely saw the question coming miles away, and he should have seized on the opportunity – or at the very least responded to it in a way that might provide moderate Democrats with a reasonable basis to trust the SEC on crypto and defend its chairman’s handling of crypto.  We bet Gensler wishes he had this one back.

We have included the exchange in its entirety below.  While it takes a few minutes to read, it felt even longer to witness in real-time.

MCHENRY:  Ether is one of the most popular digital assets empowers Ethereum blockchain. Back in 2018, then SEC Corporation Finance Director Bill Hinman said that the [SEC] believe[d] Ether was not a security. Last month, CFTC Chair Behnam expressed his view that Ether is a commodity. The State Attorney General of New York asserted in a court filing last month that Ether is a security.  Clearly, an asset cannot be both a commodity and a security. Do you agree?

GENSLER:  Actually, all securities are commodities under the Commodity and Exchange Act. It’s that we are excluded commodities. But I would agree that a security cannot be also an excluded commodity and an included commodity. I’m sorry, Chair, just to talk about the Commodity Exchange Act more precisely.

MCHENRY:  OK. So, do you recognize — how would you categorize these then?

GENSLER:  I think that the general sweep of what Congress did not just in the 30s, but as a mandate –

MCHENRY:  I’m asking you [to] make an assessment under the laws as exist: Is Ether a commodity or a security?

GENSLER:  Without speaking to any one token, it’s a matter of fact…

MCHENRY:  I know you’ve repeatedly said you’re not going to speak to one.  Except you’ve spoken to one, Bitcoin. So, I’m asking you to speak to a second one, the second largest market cap here.

GENSLER:  And speaking to the tokens, there’s 10,000 to 12,000. If there’s a group of entrepreneurs –

MCHENRY:  I’m asking about one.

GENSLER:  — that the public is anticipating a profit based on the (INAUDIBLE).

MCHENRY:  I’m asking a specific question, Chair Gensler. I said this in private, this should be no shock to you I’m asking this question. Is it an – is Ether a commodity or security?

GENSLER:  And again, it depends on the facts and the law. And if there’s a group of individuals…

MCHENRY:  I’m asking about the facts and the law sitting in your seat, and the judgment you are making.

GENSLER:  And so, Mr. Chair, I think you would not want me to prejudge because I’m also…

MCHENRY:  But you have prejudged on this. You’ve taken 50 enforcement actions. We’re finding out as we go, as you file suit, as people get Wells Notices on what is a security in your view and your agency’s view. I’m asking you a very simple question about the second largest digital asset. What is your view?

GENSLER:  And my view is, is if there’s a group of individuals in the middle that the public isn’t anticipating….

MCHENRY:  All right. So let me just ask a second then.  Do you think it serves the more market for an object to be viewed by the commodities regulators a commodity and the securities regulator to be viewed as a security? Do you think that provides safety and soundness for the product? Do you think it provides consumer protection? Do you see — do you think it serves the value of innovation? I think no, should be a very simple answer for you here. That uncertainty is bad, is it not?

GENSLER:  And I think that Congress has said that there’s one agency, the Securities and Exchange Commission under this committee –

MCHENRY:  And you won’t answer my question and you’re the head of that agency. So, give me a break. Come on.

GENSLER:  I’m answering it in the generic because you would not want me to speak about any one set of facts and circumstance.

MCHENRY:  OK. But you’ve already spoken. Have you said anything about Bitcoin?

GENSLER:  My predecessors and the agency itself has spoken to them.

MCHENRY:  OK. So, you’re not willing to do the same about Ether? OK. So let me just step back. There’s a lack of clarity here in the marketplace. Can you at least agree to that?

GENSLER:  I think that the clarity is there, the law is clear that there’s a group of individuals…

MCHENRY:  So – let me be explicit about this. The market doesn’t see it.  Your regulatory actions and the CFTC’s regulatory actions say that there’s a great deal of uncertainty here. It is the intention of this committee to fix that uncertainty and actually provide a sound legal basis for this.

As we have previously addressed, there is a reasonable case that Ether is a security.  Gensler and his team at the SEC clearly appreciate this; it is the logical basis for the Chair’s intentional decision not to reiterate the agency’s pre-2021 policy position that “current sales of Ether are not securities transactions.”  Gensler could have instilled confidence by answering the question in a more convincing manner than he did.  Instead, he treated it like a hypothetical.  He repeated ad nauseum his insistence that he simply could not answer the question, and in so doing, whether wittingly or unwittingly, Gensler allowed himself to become “Exhibit A” in the Republican effort to persuade moderate Democrats that the SEC just doesn’t get it on crypto, and will never get it, and that a legislative fix is the only viable path forward.

(5)  The SEC is actively working on rules to implement the executive compensation rules that regulators left dangling in 2012 and 2016.  As we noted in our summary of last month’s House Appropriations Financial Services and General Government Subcommittee hearing, Section 956 of the Dodd-Frank Act, which directs financial regulators to prohibit compensation practices that encourage excessive risk taking by executives, is having a moment.  Tuesday’s hearing revealed additional momentum for the effort to resuscitate this moribund provision, which was the basis for two aborted rulemaking efforts in the 2010s, when Chair Gensler disclosed to Rep. Nydia Velasquez that the SEC “has initiated discussions with the [bank] regulators and the FHFA to do this…I am committed to getting this [rule] done.”

(6)  At least one Democrat is prepared to vote to mandate electronic delivery of SEC mandated disclosures, and that number could grow.  The issue of mandating the came up only a single time in a question line by Rep. Wiley Nickel (D-NC), a co-sponsor of the Improving Disclosure for Investors Act of 2023. However, the sponsor of the, Rep. Huizenga, passed up the opportunity to mention it.  The contest pits consumer advocates, such as AARP and Consumer Federation of American, against large broker dealers and their influential and bipartisan trade association, the Securities Industry and Financial Markets Association (SIFMA).

(7)  Reg. BI Has Virtually Disappeared as a Political Issue.  Four years ago, when the SEC voted along party lines to adopt Regulation Best Interest on June 5, 2019, the victory for then Chair Jay Clayton seemed likely to be fleeting and transitory.  Instead, roughly four years since the rule was adopted and two years after taking effect in earnest, Reg. BI seems barely to register with Democrats, Republicans, or the SEC Chair.  The only time the once infamous regulation was even discussed at Tuesday’s hearing was when it was brought up (naturally) by Rep. Wagner.  Any opportunity created by this lone and brief cameo was rendered moot when Chair Gensler expressed confusion about what rule he was being asked to discuss.

WAGNER: Do you remain committed to supporting the continued implementation of Reg BI?

GENSLER: We look to vigorously enforce it.

WAGNER: Do you intend to rewrite regulation best interest Reg BI? You’ve said no in the past.

GENSLER: Oh, I’m sorry. I misunderstood your question. It’s not on our unified agenda.

WAGNER: Great.

(8) One final thing: Gensler is developing an image problem. We took note in a private conversation earlier this month when a House Democrat characterized their impression of Gensler as “arrogant.” This has long been his M.O., but he was never before the chairman of such a high-profile agency at a time when it is engaged in pursuing a divisive agenda that allies can make or break.  Indeed, this reputation for arrogance is one reason why Gensler is unlikely to be considered for Treasury Secretary if the position were to open up any time soon. We think it necessary that Gensler be more sincere and less obsequious.  Although the Chair’s image will not matter to the committee hardliners, it will play a role in whether Democratic moderates are willing to go to bat for the agency on issues that receive little play outside of the Beltway.

Political disagreements are a dime a dozen in DC, but political disagreements without mutual respect can limit policy and career opportunities.

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