Join us as Hester Peirce, Commissioner on the Securities and Exchange Commission, discusses the intersection of individual liberty and securities regulation.
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Dean Reuter: Welcome to Teleforum, a podcast of The Federalist Society's Practice Groups. I’m Dean Reuter, Vice President, General Counsel, and Director of Practice Groups at The Federalist Society. For exclusive access to live recordings of practice group teleforum calls, become a Federalist Society member today at www.fedsoc.org.
Dean Reuter: Welcome to a special Capital Conversations edition of The Federalist Society’s practice group teleforum conference call as today, December 10, 2020, we welcome a special guest to Capital Conversations. We’re very pleased to have with us SEC Commissioner Hester Peirce, who’s going to be discussion the intersection of individual liberty and securities regulation. I’m Dean Reuter, Vice President, General Counsel, and Director of Practice Groups here at The Federalist Society.
As always, all expressions of opinion are those of the expert on today’s call. And today’s call is being recorded for use as a podcast and will very likely be transcribed.
As I mentioned, we’re very pleased to welcome a single guest today. She’s going to give us opening remarks of some 15 or 20 minutes, but as always, we’ll be looking to you for your questions, so please have those ready for when we get to that portion of the program. And without further, SEC Commissioner Peirce, the floor is yours.
Hester Peirce: Thank you, Dean. And I appreciate you giving the disclaimer, but I’m going to give it again, which is that the views that I represent are my own views and not necessarily those of the Securities and Exchange Commission or my fellow commissioners or anyone else.
Last week, the nation lost economist Walter Williams. Dr. Williams, in addition to his academic research, spent his career explaining economics to both graduate and undergraduate students in the classroom, and then to ordinary people in his syndicated column. Williams persistently pointed out the inherent conflict between government power and personal liberty. That principle is too often forgotten by regulators, mired as we are in the details of particular rules, and may not be front of mind for regulated entities, either. Sometimes, they’re seeking to use regulation to gain or retain advantages over potential competitors.
Our instincts as regulators are to protect people, but protection that comes in the form of overruling personal choices is what parents do for children, not what governments ought to be doing for citizens. Financial regulation, therefore, often undercuts personal liberty. Let me give some examples to illustrate the point, but I’ll be happy to talk about other issues during the Q&A portion of this.
One example that has gotten quite a bit of attention over the last several years is the accredited investors standard. The accredited investors have access to private markets that are largely inaccessible to other investors. Historically, to be accredited, a person had to be wealthy or have a high income. For purposes of our rules, that means having a net worth exceeding $1 million, excluding the value of your home, or an income in excess of $200,000 in each of the two most recent years, or joint with a spouse in excess of $300,000 in each of those years. The goal of this provision was to prevent unsophisticated people from making investment decisions that could hurt them.
In a change that took effect just this week, we expanded the accredited investor category slightly to include certain financial professionals who hold a Series 7, 65, or 82 license. In terms of the number of new accredited investors created by our amended rule, this is actually a pretty small change, but the incremental step reflected an acknowledged need to look beyond wealth and income because they are imperfect measures of sophistication.
A willingness to measure sophistication more creatively eventually may open additional channels to get into the accredited investor pool such as getting a degree, taking relevant classes, or passing a test. Indeed, the Commission has invited members of the public to propose additional professional certifications designations or other credentials that should qualify an individual as an accredited investor.
Although I’m pleased with the progress and welcome the call for further public engagement, the presumption that people need to entreat a regulator for permission to invest still offends principles of personal liberty which allow people both to earn and spend money as they see fit. Why should government be authorized to assess the sophistication of the American people so as to constrain their decision-making in this particular area? If we as a society permit government to do so in this area, is that a license for government to make other even more consequential life decisions for us?
In addition to constraining the choices of investors, regulation restricts the liberty of people trying to raise capital for their businesses. Recently, after hearing small business advocates ask for relief for two decades, we’ve proposed exemptive relief for a category of people called finders who match investors with businesses in need of capital. Finders are the people in your community who know lots of other people, including potential investors. Under the law as it is and as we presently interpret it, finders, if they want to get paid for making introductions of small businesses to investors, likely would have to register as broker-dealers, which would then cost a lot more than any compensation that they could earn from acting as finders.
One commentor on the proposal that we put out explained, quote, “A business owner should be able to compensate people for helping him or her to find and raise capital.” Our rules can hinder the kind of community support for business that, particularly at a time like the present, could keep an otherwise doomed business afloat.
Hereto, well-intentioned regulation is very much intention with personal liberty. One area in which questions about the intersection between personal liberty and regulation loom large is crypto regulation. In the middle of the 2007 to 2009 financial crisis, Satoshi Nakamoto, whoever he or they may be, laid out the mechanics of, quote, “an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”
That vision, which has since gained passionate adherence the world over, is rooted in a key principle that Walter Williams emphasized as well, the powerful and fundamental right of people voluntarily to engage in mutually beneficial transactions with one another. Crypto, a way to hold easily and seamlessly transfer value, has made that principle even more powerful than ever before in history. People are able to enter into transactions with others across the world without an intermediary.
Regulators, however, are used to dealing with intermediaries because they’re easy to grab hold of and easy to regulate. So crypto poses new challenges for us. Those challenges are only growing as crypto evolves. The SEC is wrestling with such issues as whether digital assets are securities, how registered entities can custody digital assets in compliance with our rules, and whether regulated investment products holding bitcoin can meet our standards.
The explosion of decentralized finance, also known as DeFi, which is designed to displace regulated entities such as exchanges and broker-dealers will pose thorny questions and decisions for us in the coming years. As this technology gains adoption outside and now inside the legacy financial system, we should figure out a way to embrace the personal liberty principles undergirding it. If we were instead to steamroll the technology’s liberty enhancing features under the weight of regulation, we would lose a lot of the power of the new technology to afford opportunities to people whose autonomy has previously been curbed by, for example, limited access to the traditional financial system, geographic location, social standing, or subjection to a repressive government.
The decentralization of crypto is the opposite of central planning, which is making something of a comeback with financial regulation as one of its primary tools. After an unsuccessful history, people would reject central planning out of hand unless it came in a disguise. And the disguise of the day is climate policy.
At first blush, central planning measures undertaken to protect the climate do not raise the same kind of fears that other types of central planning might. Indeed, governments have come to believe that by directing capital flows away from what they determine to be anti-climate uses and toward what they decree to be pro-climate uses, they may be able to reach their desired climate goals. Thus, for example, the network for greening the financial system, a who’s who of global central bankers and prudential and securities regulators, seeks to, quote, “help strengthen the global response required to meet the goals of the Paris Agreement and to enhance the role of the financial system to manage risks and to mobilize capital for green and low carbon investments in the broader context of environmentally sustainable development.”
Familiar regulatory levers, capital requirements, stress tests, asset management regulation, and corporate disclosures are being repurposed to divert asset flows to, quote, “environmentally sustainable investments as defined by government taxonomies.” By employing these regulatory tools, governments effectively decide where capital should flow based on their expectations of what will be good for the environment. Such an approach, of course, assumes that financial regulators have the knowledge and wisdom to assess where those positive technologies are going to be and the relative environmental benefits and costs of different industries, and they assume that they can identify what future innovations are likely to address a whole range of climate phenomena.
This assumption is wildly optimistic and almost charmingly naïve. Regulatory fiat is no substitute for the valuable role that financial markets play in directing capital to productive uses, including companies developing solutions for mitigating climate change. When not constrained by government taxonomies, capital can shift quickly to new sustainable solutions as soon as they emerge. Pre-planning by regulators is not nimble, and I can guarantee that regulatory taxonomies, even if initially well-crafted, will not keep up with technological innovation. The Commission, after all, still requires some regulated entities to submit reports via telegram.
Government rulebooks may not be the right place for us to look for the authoritative word on state-of-the-art technology, whether in communications or in sustainability. Regulatory usurpation of decision-making by individuals voluntarily engaging with one another to fund and build transformative technologies will be harmful to liberty and to our shared goals for a greener, safer, healthier, and more prosperous world.
There’s no doubt that the financial markets are essential to developing effective responses to climate issues, such as they have been doing in solving so many of our other problems. Attempting to direct the whole effort through financial regulation, including through so-called ESG, or environmental social governance disclosure requirements, that are detached from our traditional materiality standard will make the capital markets more brittle and less effective at serving all sectors of the economy. Every choice a regulator makes displaces a choice that a freethinking individual who faces real-world consequences for the decision otherwise would make.
I’ll close with another issue of deep concern for me from a personal liberty standpoint, and that’s the Consolidated Audit Trail, or CAT. I’ve spoken so often about my concerns about the CAT that I dread seeing my moniker change from Crypto Mom to CAT Lady. But I do think that the liberty implications of this proposal warrant continued discussion.
The Commission, in concert with numerous self-regulatory organizations, has been building the CAT so that it can track all equities and options orders as they wend their way through our markets. As with many other ideas that give me concern from a liberty standpoint, the objective is unobjectionable, affording regulators easy and holistic insight into what’s happening in the market.
Nevertheless, the price for that insight is simply too high. Regulators, without having any grounds for suspicion, will be able to watch every move of every person who trades in our markets. We wouldn’t find it pleasant or appropriate for a government minder to monitor our purchases at a farmers market or a flea market, and it’s no more pleasant or appropriate for government regulators to do that in an equity market. The CAT is an example of a regulatory project that got unmoored from liberty concerns as everyone was focused on very real technical concerns.
Walter Williams, quote, “wanted students to share his values that personal liberty, along with free markets, is morally superior to other forms of human organization.” But he also wanted them to think for themselves. “The most effective means to accomplish that goal is to give them tools to be tough, rigorous, hard-minded thinkers, and they will probably reach the same conclusions as I have,” he said.
I’m grateful to The Federalist Society for similarly promoting rigorous freethinking, and I suspect that we will have many case studies in the coming years about how government policy and personal liberty interact. So there will be many opportunities for us to sharpen our thinking and to reembrace our national passion for personal liberty.
Dean, I’ll turn it back to you and am happy to take questions.
Dean Reuter: Well, thank you very much, Commissioner. We certainly appreciate it, and thanks again for being with us. I have questions of my own, but let me open the floor. I mentioned I have a few questions -- I’ve got six or seven questions here, but let me ask one and then I’ll turn to the audience. I’m curious if you could say a little bit more about challenges you might face in regulating what I consider to be the fast-paced technology sector. Are there challenges with the regulators keeping abreast of the developing technology and staying relevant and not inhibiting those developments that are beneficial?
Hester Peirce: Yeah, there certainly are. And I think when I came to the SEC a couple years ago, I had been here before as a member of the staff and I was coming back as the Commissioner. And one of the things that I really was hoping to work on was thinking about better ways for us to deal with innovation, and so that involved technology but also just innovation in products that we regulate. Products that we regulate generally have to go through -- although we’re not a merit regulator, they have to go through some sort of approval process with us before they can be listed and traded. And so I wanted us to think more creatively about how to do that better and how to do it faster.
And so soon after I arrived, I realized that one of the big topics in which these kinds of issues were coming up was crypto, and that was something that I had had some exposure to before coming to the SEC. But I’d started in early 2018, and that was when a lot of the ICO initial coin offering issues were being talked about at the SEC. And so I realized that that was an area we needed to be nimble to try to get out there with some regulatory clarity for people who were trying to innovate in the crypto space and unsure what the intersections with SEC regulation would be.
Now, here we are a couple years later, and we’ve done some -- we’ve issued some guidance, but a lot of what we’ve done has been to bring enforcement actions after the fact and really not to provide a ton of concrete guidance about what people should do. We’ve put out some guidance about how to think about whether something is a security, whether a digital asset is a security or not. And we’ve gotten a lot of pushback because it’s really hard for people to parse through. And even people who are seasoned securities lawyers really are having difficulty in this area. So I think one thing we do need to do is provide guidance where we can provide it and also think about how we can write our rules so that they are technologically neutral.
That said, one of the interesting things about the securities laws is that the definition of securities is actually quite open-ended for the purpose of being evergreen so that you don’t have to change it all the time. It really includes a provision that says if you’re doing something that’s -- you’re selling an investment contract that essentially is a way for people to buy into your enterprise, then we’re going to treat it like a security, and that makes a lot of sense.
But we’ve actually been quite -- we’ve interpreted that definition quite broadly over the years, and so as a result, digital assets come along, and there’s a lot of uncertainty about what counts as a security or not. So I think clarity where we can provide it is good, and I think some honest interaction with the industry to figure out where guidance is needed and whether we do need to change any of our rules. And that’s something that’s just been really slow in coming.
So that, I think, ties back to my main remarks which are the cost of regulating is high in terms of personal liberty. It’s also high in terms of preventing innovation from happening that might otherwise happen, and so we have to be very careful when we put regulations in place to think of some of those costs which maybe are a little bit less easy to measure but are very real.
Dean Reuter: Very good. Let’s open it up to the audience.
Caller 1: Good afternoon. I appreciate the Commissioner speaking. I’m going to ask about an old stock, and old security, GE. And the SEC just slapped them on the wrist with a $200 million penalty. And I think regulation is critical, especially when a stock implodes 76 percent. And if the Commissioner could comment?
Hester Peirce: Sure. The caller is referring to an action that we just announced yesterday, I believe. And that action was against GE for certain disclosure violations, essentially not disclosing some trends that they were aware of. There were a couple of different issues.
And so that is one of the areas where the SEC does bring enforcement actions when we have a disclosure regime in the U.S. that’s materiality based. So the idea is that you want investors to be able to see the company through the eyes of management, and so management should be disclosing to investors what they need to know to assess the long-term financial value of a company. And when companies, as happened in this instance, do not do that, then we bring enforcement actions against them.
One thing I would underscore is that when we think about public companies and when we think about bringing enforcement actions against them, a lot of focus tends to go on, well, how much did the SEC fine the company? And I think it’s important to remember that a company is nothing more than a group of people working together to achieve something, and it’s owned by shareholders. And so shareholders are the ones who are hurt when management doesn’t tell them what’s going on at the company. But they’re also the ones who end up, at the end of the day, paying the penalty when there’s a penalty.
And so I think we really need to be careful not to measure the value of what the SEC can accomplish by just looking to the numbers that it’s imposing. Ultimately, actions against individuals are much more effective at deterring bad conduct at companies than actions against the company where the shareholders are the ones who are bearing the brunt of that action.
Caller 1: Are you going to go after the CEO who collapsed GE stocks?
Hester Peirce: I would prefer not to talk about particular instances. Again, people are welcome to read the press release that came out on yesterday’s action, but I can’t talk about any potential or actual enforcement actions that we have not brought and may not bring or might bring.
Dean Reuter: That seems fair enough. We've got two questions pending. With that -- three questions pending now.
Caller 2: Hi there. Thank you, and thanks so much to the Commissioner for speaking today. I had a question about stablecoin and the new proposed legislation, the STABLE Act. And I’d love to get your thoughts on what kind of approach you think would be best to regulate stablecoin. Just by way of background, the STABLE Act would require stablecoin issuers to become chartered banks, and so they’d be subject to bank regulation as well as additional stablecoin requirements, including having a one-to-one reserve which the OCC has provided guidance on in interpretive letters already and disclosure requirements.
I’d like your thoughts on the best approach to regulate stablecoin, whether the bank approach is the right approach, or is there a better approach like money services business registration? And I’d like your thoughts on consumer protection concerns that these legislators, Chuy Garcia and some others, have raised when proposing this legislation, and if you see those consumer protection issues present in the stablecoin area.
Hester Peirce: Let me first give a little bit of a disclaimer, which is that I am a securities regulator, and so some of that discussion really falls outside of my area. That said, I think you raise an important issue. Stablecoins are gaining a lot of attention, both in the crypto community but also in the regulatory community. And there are conversations going on at the domestic and international level among regulators to try to think about stablecoin. I think the issue was really put on the front of everyone’s agenda or at the top of everyone’s agenda when we heard about Libra -- the plans by Facebook to announce -- to start Libra.
I think one aspect of the conversation that’s really important is to remember that not all stablecoins are created equal. And so, as with other things, when we look at something and we try to assess whether or not it’s a security, we’re thinking about the different facts and circumstances, and that will affect whether or not we look at it as a security. But I do urge people who are designing stablecoins and thinking about how to interact with them to consider whether or not the particular stablecoin they’re looking at is a security or not.
And more broadly, I will say that it’s important for -- and I think I was trying to touch on this a bit during my remarks. It’s important for all of us as we look at stablecoins or any other kind of new innovation in the financial arena to remember that the financial system -- it’s a wonderful system. Our capital markets in the U.S. are wonderful and they’re the best in the world. And our financial system is a very effective one. But there is room for improvement, and that’s why it’s always good to have new people with new ideas coming in with new ways of doing things.
And so we need to look at new technologies. Sure, we need to ask questions, but we also need to look at the promise that they offer and the chance that they might afford someone who hasn’t had access to the traditional financial system to gain access to the financial system, or they might allow someone in a country with a repressive government to do things that she might not otherwise have been able to do. And so let’s not, out of fear, lose sight of the promise that the new technologies offer.
So I hope that as we and our colleagues across the regulatory landscape, both at the federal level and at the state level think about these things, we are thinking about it with that lens. And so Brian Brooks over at the OCC -- you mentioned the Office of Comptroller of the Currency, the work that they’ve done to allow banks to participate in this space. I think we have a lot to learn from them in the approach that they’ve taken, and I hope that that conversation between the OCC and folks on the Hill and other regulators here in D.C. will continue.
Dean Reuter: We’ve got just two questions pending, then our lines are open.
Caller 3: Hi there, Commissioner, and thanks for taking the question. It’s been a big year this year for enforcement under the Foreign Corrupt Practices Act, and I was wondering your thoughts about the current direction of FCPA enforcement and what we might expect in the next year.
Hester Peirce: Well, again, I can’t really speak to what we might expect because I can’t prognosticate on what enforcement actions are out there or might be out there. FCPA cases tend to get a lot of attention because they often have very large dollar amounts tied to them.
So for people who aren’t familiar with the FCPA, the Foreign Corrupt Practices Act allows us essentially to bring enforcement actions against companies that are paying bribes to foreign governments or foreign government officials. Sometimes, those cases are actually just internal accounting controls cases, and they don’t have an actual established bribery component. And sometimes, because they’re difficult to investigate, sometimes they can be -- it can take a very long time to bring them. Other countries have similar regimes, but we’re more serious about enforcing our FCPA, and so that can pose some competitive challenges to companies that are listed in the U.S. So it’s one area of what we do.
As with any other case, I look at the facts and circumstances and try to assess in light of those whether it makes sense for us to spend our enforcement resources on those particular things. We have more than enough that we could be doing, and so it’s always a challenge to try to figure out how to allocate resources. And so that’s something I’m always thinking about, too.
I do think that we as an agency need to be careful not to too broadly interpret what the FCPA is. It can be very complicated in thinking about how this applies in some countries because in some other countries, almost everyone is a government official. And so normal business practices then become potentially violative of the FCPA, and that can be problematic. But it certainly has been an area where we’ve been fairly active.
Dean Reuter: We've got just one question pending, and then our lines are wide open.
Caller 4: Thank you. And thank you, Commissioner Peirce, for speaking today. I appreciate your comments on the individual liberties and the point on terms of regulation.
I just wanted to follow up on the comments of the first person who asked some questions about the GE settlement, and I have two comments. First off is you responded to his question saying that, in essence, perhaps it’s not all that appropriate for shareholders to bear the cost of SEC settlements where they’re not the ones who engaged in the wrongdoing. And I would just like to note that ultimately the shareholders are responsible for selecting the board, and the board is responsible for selecting management. And so perhaps it is appropriate for the shareholders to bear some of those costs, albeit that management and the board should obviously be on the -- first in line to cover some of those costs. So to the extent that the company and shareholders are bearing costs without management and the board also bearing costs, that seems to be a little bit asymmetric in my view.
Second comment, also along the same lines on the GE settlement, it seems that the SEC has a long history of entering into settlements with companies where the companies do not admit any wrongdoing. And I think that these settlements, even in fairly egregious circumstances like this GE case, these settlements are sending a message to the market that you can go ahead and violate SEC regulations and there’s no real cost of doing so other than a cost of doing business. GE is a large, multinational company, and $200 million is not a lot of money to their bottom line in any quarter, much less overall.
So I would encourage the commissioners to really give some thought about whether it’s appropriate to continue to enter into settlements with these companies where the companies don’t even admit that what they did was wrong. I think that sends a very bad message to the market, and I think it leads me to believe that there’s really no consequence to violating SEC regs. Thanks.
Hester Peirce: Yeah, thanks for the comments. The SEC does enter into a lot of settlements that have this “no admit, no deny” language in them, which doesn’t require the -- effectively, it doesn’t require the companies to agree to every bit of what’s in the settlement document. And I think there has been some interest in trying to get -- along the lines of what the caller has been saying, to get companies and others to admit to wrongdoing. And so that’s certainly something that we think about here.
It’s something that we sometimes do not have in our -- “no admit, no deny” settlements are standard, but they’re not universal. If we were to move to a world where we said we’re not going to do that kind of settlement, I can assure you it would take a longer time to reach settlement and hammer out the details. And it might not be worth it from the perspective of our resources as we’re negotiating those settlements because there often are follow-on collateral consequences of entering into a settlement with the SEC.
I would disagree with you when you say that there’s no cost to companies of violating our rules. I think that’s certainly not true. It’s never a good moment for a company to have to announce or have announced that it’s been part of a settlement with a regulator for violating the rules. The whole process of investigating and going through the investigation is a cost we want for companies.
Fair point about shareholders are responsible for what goes on at their companies, but I still contend that individual liability is a better way to actually change behavior. And I think then, also, we need to be very careful about the cases that we bring and thinking about how we’re using our resources. We have a lot of rules on the books, and we have to think about where it makes sense to spend our limited enforcement resources.
Dean Reuter: While we’re waiting to see if somebody else rings in, let me ask you a question I don’t know the answer to, Commissioner Peirce, and that’s on the topic of settlements, does SEC have a history of engaging in third-party settlements, or third-party payments, rather, on settlements? That is that some organization A is under investigation, and as part of the settlement, they agree to make payments to related third parties, whether it’s some sort of housing association or something like that. Do you know if that --
Hester Peirce: -- I know what you’re referring to, and I know that some other agencies do enter into those kinds of settlements. That has not been -- I was going to say that has not been the standard practice here.
I will say, though, that when there are -- for example, take a financial professional who steals money from her client. We might, as a condition of the settlement, say, “Okay, and you’re going to pay the money back to your client.” Or in the case of a big corporate penalty, we might say, “Okay, you’re going to pay the money back to the shareholders. We’re going to take the money from the corporation, and then we’re going to dole it out to shareholders who might have been affected.” So we do that, but it tends to have quite a close tie to what the reason is that we’re bringing the enforcement action in the first place or not. We’re not sending the money to third parties, aside from the Treasury. A lot of our money ends up going to the Treasury.
And then one other feature I should mention is that now we have a very active whistleblower program at the SEC, so this is -- we had a whistleblower program before, but Dodd-Frank, which was opposed to financial crisis legislation, that really increased the activity of our whistleblower program. And so we’re also paying out money to whistleblowers, so that is another place where we direct payments, albeit the funding for that is separate. But it’s important for people to be aware of that program.
Dean Reuter: Right, very good. We do have another audience question.
Caller 5: Thanks very much. Since we are in a Federalist Society forum, just curious about the Commissioner’s thoughts with respect to the federal-state balance. I’m no securities specialist, limited knowledge of the ‘33 and ‘34 Acts and the ‘40 Act and so forth, but this may be one of those areas where at the time of the Framing -- I think commercial realities have changed drastically, and the degree to which securities law is regulated by state blue sky and similar statutes as opposed to being addressed at a national level.
I wonder at times to what extent some of the remedies that came in the middle of the last century were directed at problems that don’t exist anymore. A lot of the information disclosure provisions there at the root, as I understand, of the ‘33 and ‘34 Acts and the ‘40 Act were about forcing the disclosure information.
Well, now we are awash in a sea of information, and I’m wondering to what extent it might be appropriate, prudential, maybe even more in the spirit of the Framers, to recommit some of those principles back to the states and take more of a laissez-faire attitude federally with respect to it. It seems like the growth of quasi-federal common law actions — I’m thinking of 10b5 litigation and so forth — seems to have taken on a life of its own that may not really do a whole lot of good for a whole lot of people other than plaintiff’s letters. So I would be fascinated at the Commissioner’s perspectives on any of that.
Hester Peirce: Well, it’s an interesting perspective to think about whether more should be devolved to the states. The states are a very important partner for us in regulating the securities markets. Each state plays an important role in protecting the investors in that state. And so I would say that we work with them, but one feature of the current landscape is that a lot of people are coming to us and saying, “Look, we operate nationally, and so having different state rules, different rules in each state, is very difficult.” And so there is some pressure in many areas to try to come up with a common federal standard.
And that’s a tension for me too because I share your belief that the states have a really important role to play in regulation. And to the extent that we can leave things to states to handle, that can be a good approach. But it does effectively make -- if we have a situation where you’ve got many different standards, it makes it impossible for some companies to provide -- really, to operate. We see this in lots of different areas where if you’ve got to get permission in every state, it just doesn’t happen.
And a lot the states tend to have a merit regulation approach. So you mentioned the disclosure, which you’re right. The essence of what the SEC is about is to try to address this information asymmetry problem. Someone who’s trying to raise money has a lot of information about what she’s planning to do with the money, and we want to make sure that the person who’s investing gets that information from the person who’s trying to raise the money, gets material information. And so that’s what a lot of our rules are, at core, about.
Now, you point out there’s a lot of information out there, and so maybe that role that we play is less important, although I would argue I think our securities disclosure rule framework has done quite a good job at getting information to investors that they need. And I think it still plays a valuable role in that job.
State regulators, many of them are merit regulators. So instead of saying, “Well, you’ve got to tell people what it is you’re doing with the money,” the state regulators say, “Well, we want to take a look and see whether we think what you’re doing with the money merits people investing in it.” And so it’s almost like a quality check. Instead of leaving the decision up to the investor, a lot of states are much more engaged in trying to assess whether or not it’s a good investment or not.
And from my perspective, that really isn’t the role for a regulator. I think that one can argue it makes sense for the regulators to be involved in getting the information out there, but I think it’s much harder for one to argue that the regulator needs to stand in the place of the investor in actually making the decision about whether or not an investor should invest.
So I know I’ve given you not really a very clear answer, but I think there are a lot of different things you have to think about in that federal-state balance. And I will say that state regulators continue to be a really excellent partner in helping us think about where there are problems, where we need to -- how we need to think about investor protection because they’re closer to the ground in that sense. They have a lot of experience and they relay that to us, and that’s very helpful.
Dean Reuter: Commissioner, this is Dean. I’m wondering if there’s any relevance here in something I’ve heard about regulatory sandboxes, if this pertains to SEC activity and state level activity. I know these happen in the state level, Arizona, but does that intersect with the SEC’s work?
Hester Peirce: Yes, it does. We don’t have a formal sandbox. We have a no action letter and exemptive process where someone can come in and say, “Hey, here’s what I’m trying to do. Here are the conditions that I promise to adhere to. It doesn’t exactly work under your existing rules, but can you give me a pass and let me do this if I adhere to the conditions that I’ve laid out?” And that can serve as something of a sandbox, but there have been calls for a more formal sandbox type approach where you would have innovators come in and talk to us and work with us and develop a prototype that they can test under the close scrutiny of the regulator, of us.
And I think there’s some attraction to that approach. I have expressed concerns in the past about that approach because when you stick a regulator in the sandbox with the innovator, it certainly does change the innovative process. So I think it has, again, positives and negatives. If we are going to do something like that, I think we should do it in a cross-agency way.
The last caller mentioned the state securities regulators. One unique aspect of the U.S. financial regulatory system is that we have so many financial regulators, not only all of the states, but then we also have a real division of labor at the federal level. And that has its benefits. It can help us to hold each other accountable in terms of how we approach regulation. We can learn good habits from one another. We can also sometimes learn bad habits from one another.
But it also has a real cost to people who are trying to figure out, “Wait, who do I need to go to to try to figure out whether I can do X, Y, or Z?” And it may not really be clear. And so especially for someone who’s trying to do this on a shoestring budget without lots of lawyers and lots of lobbyists, that can be a very daunting prospect. And so I’ve been thinking that perhaps setting up some kind of cross-agency sandbox would be helpful, not only with respect to crypto but with respect to other kinds of fintech innovation.
Dean Reuter: Interesting. We’ve got about 10 minutes left. I’ll ask a question. Again, I don’t know the answer to this and I’m a novice in this area, but my understanding of disclosure requirements, a requirement to disclose material information to potential investors and lenders, I suppose, I’m wondering about the intersection of that requirement and new ESG type investments or moves that corporations might make.
It strikes me, again as a novice, that some of these things corporations are doing are not bottom line movements. In other words, they wouldn’t necessarily increase the bottom line. They might harm the bottom line of a corporation in the sense that they’re perceived as good citizen or good corporate citizen type moves. They might, I guess, increase the reputation of a corporation.
But is there a duty to disclose those types of things, or is there an inclination on corporations to have to disclose those and brag about them? Is there overlap there?
Hester Peirce: Yeah, so that’s a good question. There has been a lot of attention on those kinds of questions lately. I point to the fact that materiality is the touchstone of our securities disclosure framework. What we’re trying to get at is information that investors need to know to make an assessment of the long-term financial value of a corporation.
Now, a lot of companies decide that they want to disclose other kinds of information, and the flavor of the day is ESG. Some of those kinds of things have been disclosed for many years, but now a lot of companies put out a separate sustainability report or corporate social responsibility report that discloses that kind of information. They typically do that outside of our securities disclosure framework, which is really designed, as I said, for material information that investors need to know.
A lot of the demands for ESG type information are coming from non-investors and others who just might be curious to know what the company is doing, and so I think it is appropriate for a lot of that disclosure to happen outside of our framework. Once it’s inside our framework, there are also different liability consequences and other consequences. And I think it can lead to a situation where you bury the material information in a sea of information, again, that’s interesting to non-investors but may not be as interesting to investors. Certainly, that’s how I think about it.
If there are particular ESG type metrics that people think should be discloses across every company, I would say I welcome people to come in and talk to me about it and explain to me why it would be material across every company. We tend to try to keep the disclosure requirements fairly open-ended so that they work for all different kinds of companies and all different kinds of industries.
Just harkening back to the last question about state regulation, one area where states have been very successful for a very long time is that they are where corporate governance issues are appropriately housed. And over time, the SEC has stuck its fingers in that area more and more. And I think a lot of people now are hoping that the SEC will become more active in that area so that we can move off of focus on shareholders and start thinking about other constituencies in connection with our disclosure framework.
And so there’s the big debate now between shareholder capitalism and stakeholder capitalism. And again, I caution us that we shouldn’t throw out everything that has worked so well in the past. A shareholder-centric approach does not preclude companies from thinking about other constituencies. Of course they have to think about their customers. Otherwise, they’re going to go out of business. Of course they have to think about their communities and about their employees.
But the notion of having boards and management serve multiple constituencies essentially means -- and I think there was a good Wall Street Journal piece about this earlier this week. It essentially allows them to be accountable to no one. So I really would encourage people to think carefully before they push us down that path. I think it will not be good for particular companies, but also for the ability of companies to serve society in the way that they have and to make things that people need and want.
Dean Reuter: Very good. We've got one question pending, and I think we’ve got time for this.
Caller 6: Thank you for sharing your thoughts, Commissioner. And this may be somewhat tangential to the last point you made, but I’m wondering what you think about the liberty interest in the context of perhaps powerful intermediaries that are private sector actors like large asset managers, exchanges, proxy advisors, and so on, when they’re not acting at the behest of regulators.
I guess on one hand, you could view them as fairly private actors subject to the same liberty interests as any other company, but on the other, you could argue that they serve some kind of quasi-regulatory role. And I think they’re increasingly taking on issues that are less than straightforwardly economic, so I’m wondering how you think about that.
Hester Peirce: Well, that’s a good question, and I think there are a lot of different entities that fall into different buckets in the category of really active intermediaries. So you have exchanges, which are actually self-regulatory organizations. We regulate them, and they do play a regulatory role. Or you have something like an asset manager, which is not a self-regulatory organization but is regulated by us.
The one area in which I think large asset managers have been getting bigger and bigger over time, and they manage a lot of people’s money, and they typically do that through mutual funds and exchange traded funds. And as fiduciaries, they have to remember that their obligation is to manage the fund’s money in accordance with the fund’s objectives. And so you might have an asset manager run by people who have very strong opinions about many things and really would like to have those funds managed according to whatever their own personal objectives are. But we’ve taken steps recently to remind them that their fiduciary duty is to the funds they manage, and that means they have to abide by those objectives. And they should be clear with the investors who are investing in those funds what those objectives are and how they’ll fulfil them.
So definitely, the rise of intermediaries has posed challenges for us as we think about those things. We, just earlier this year, adopted a rule related to proxy advisors and other intermediaries that you mentioned. And so we’re constantly thinking about these new players in the landscape and how they interact with our regulatory framework, whether they fall within our regulatory reach or not.
But again, I do -- as I started out, I like to really allow as much flexibility for people to enter into transactions with one another that they want to enter into and only step in as a regulator where it’s important that we do so under the statutory mandate that we’ve been given.
Dean Reuter: Very good. Looks like we’ve had our final question, which is good timing. We’ve got a minute left, so I’m going to give you a chance to express any final thought you might have, Commissioner Peirce.
Hester Peirce: Well, I always like to just let people know that I appreciate the questions but am happy to have conversations with people who have ideas or suggestions or concerns about what the SEC is doing. You can reach me at CommissionerPeirce@sec.gov. Make sure you spell my last name right; otherwise, it won’t get to me. But I welcome interaction. And I think a lot of great ideas come from outside of the agency, so don’t hesitate to reach out.
Dean Reuter: Well, we certainly appreciate the interaction today, Commissioner. My personal thanks, and thanks on behalf of The Federalist Society for joining us. We really appreciate it. I want to thank the audience as well for dialing in and for your thoughtful questions. A reminder to the audience to check our website and monitor your emails for notices of upcoming teleforum conference calls. But until the next call, we are adjourned. Thank you very much, everyone.
Hester Peirce: Thank you.
Dean Reuter: Thank you for listening to this episode of Teleforum, a podcast of The Federalist Society’s Practice Groups. For more information about The Federalist Society, the practice groups, and to become a Federalist Society member, please visit our website at www.fedsoc.org.