In his first address as Chairman of the Securities and Exchange Commission, Jay Clayton reaffirmed his dedication to the Commission’s guiding principles and historic approach to regulation. At the same time, however, Chairman Clayton said he sees areas where the SEC’s regulations need to evolve to "reflect the realities of our capital markets.” One of these realities is that implementing regulatory change has costs, and over time cumulative regulation and the associated costs can drive behavior that has dramatic effects on the market.
One example of such a driver of behavior, according to Chairman Clayton, is public company disclosure. This ever-expanding body of regulation brings a robust transparency to the markets. Clayton fears, though, that some of these disclosure requirements have strayed from their core purpose.
"[O]ur public company disclosure and trading system is an incredibly powerful, efficient, and reliable means of making investment opportunities available to the general public. In fact, this disclosure-based regime has worked so well that we — not just the SEC, but lawmakers and other regulators — have slowly but significantly expanded the scope of required disclosures beyond the core concept of materiality. Those actions have been justified by regulators and lawmakers alike, often based on discrete, direct and indirect benefits to specific shareholders or other constituencies. And it has often been concluded that these benefits outweigh the marginal costs that are spread over a broad shareholder base."
Increasing regulatory requirements force public companies to dedicate greater and greater resources toward meeting their disclosure compliance responsibilities. Clayton warns that regulators forget this fact at their own peril.
"Companies spend significant resources building systems of compliance, hiring personnel to operate those systems, seeking legal advice concerning the design and effectiveness of those systems, and adapting the systems as regulations change. Shareholders and customers bear these costs, which is something that should not be taken lightly, lest we lose our credibility as regulators."
While many factors affect whether a firm goes public or stays private, disclosure burdens may be driving firms that in the past would have chosen to go public to look to private sources of capital. In this way, cumulative regulation may be changing behavior, reducing liquidity in trading markets by taking small and medium-sized firms to avoid public markets.
"While there are many factors that drive the decision of whether to be a public company, increased disclosure and other burdens may render alternatives for raising capital, such as the private markets, increasingly attractive to companies that only a decade ago would have been all but certain candidates for the public markets. And, fewer small and medium-sized public companies may mean less liquid trading markets for those that remain public. Regardless of the cause, the reduction in the number of U.S.-listed public companies is a serious issue for our markets and the country more generally. To the extent companies are eschewing our public markets, the vast majority of Main Street investors will be unable to participate in their growth. The potential lasting effects of such an outcome to the economy and society are, in two words, not good.”
Disclosure is merely a single example of where cumulative regulation could be driving behavioral change in the markets. Regulation needs to evolve, says Chairman Clayton, to reduce or eliminate market-distorting effects. Evolution includes creating more dynamic regulation that identifies or anticipates new tensions, risks, uncertainties, and conflicts. It also includes applying technology to regulation, not just regulation to technology. Clayton touts innovative uses of artificial intelligence to analyze company filings and detect suspicious or disruptive market activities. He also advocates retrospective and self-critical reviews of regulations to assess the effectiveness and understand the costs of compliance in real rather than theoretical terms.
"With respect to rulemaking, the SEC has developed robust processes for obtaining public input and is committed to performing rigorous economic analyses of our rules, at both the proposing and adopting stages. These efforts are critical to identifying the benefits and costs of regulatory actions, including situations where a rule’s effects may not be consistent with expectations. But we should not stop there.
The Commission should review its rules retrospectively. We should listen to investors and others about where rules are, or are not, functioning as intended. We cannot be shy about being introspective and self-critical.”
Another way to reduce regulatory burden, Clayton said, is for the SEC to coordinate better with other regulators like the CFTC and state securities regulators. By harmonizing overlapping rules. the various agencies can reduce the burden of duplicative or redundant regulation.
The full text of Chairman Clayton’s July 12, 2017 address is available via https://www.sec.gov/news/speech/remarks-economic-club-new-york