In April, the former investment banker and former government official Gary Gensler was sworn in as the head of the Securities and Exchange Commission, and the direction of the agency under his leadership is beginning to take shape. This was especially clear in his testimony at a hearing before the House Financial Services Committee to discuss the surge in meme stock trading fueled by social media.
While Gensler’s tenure as chair of the SEC is in its early stages, here is what we see as focus areas for the agency based on what he told lawmakers:
Environmental, social and governance
The surge in popularity of ESG issues has prompted increased scrutiny from the SEC in two regards:
- Investment funds—in April, the SEC’s examination unit indicated that some money managers are promoting their funds as sustainable or socially conscious, when the reality is quite different. With the demand for ESG-focused investment funds expected to grow rapidly, the SEC will continue to focus more resources on examining such investments to ensure they are accurately representing the funds’ strategy to investors. If failures continue to be identified by the agency, one can anticipate the SEC will be left with no choice but to start sanctioning funds found in violation.
- Public company reporting—increasing demand by investors for climate change disclosures in public company reporting is leading more organizations to add these disclosures to their SEC filings. Yet there is no uniform requirement mandating such disclosures or even consistency among disclosures. Upon the close of the comment period on the matter in June, the SEC will likely develop a requirement and a framework for such disclosures to provide investors with consistency and comparability to what is being reported.
Rise of the retail trader
While retail trading is not new, the increase in trading options for retail investors—coupled with the power of social media—led to an explosion of retail trading activity in January focused on widely popularized meme stocks such as GameStop. This unprecedented retail activity has led the SEC to review what transpired.
The focus of the review, which Gensler is pushing to publish by summer, will likely touch on the rise of retail trading platforms, including the gamification of trading on select platforms and the use of social media platforms in trading. While awaiting the results of the review, it is too early to speculate on what, if any, regulatory changes will come.
That leaves one to focus then on Gensler’s testimony on Capitol Hill, where he indicated that the SEC will pursue enforcement actions on those determined to be manipulating the market through the use of social media platforms, and that fresh rules may be needed to protect investors who may be prompted to make unnecessary trades due to the gamification used by select retail trading platforms.
Gensler indicated that the SEC will pursue enforcement actions on those determined to be manipulating the market through use of social media platforms.
Pay for order flow
Given Gensler’s comments that a limited number of market makers dominate the trade execution landscape, which in turn can lead to negative outcomes for traders, the practice of payment for order flow will become a significant area of focus. Gensler has indicated that while this practice has led to the advent of commission-free trading, certain inherent conflicts of interest for the market maker may require a review of existing regulation with changes that may be warranted to protect investors.
Cryptocurrencies
The explosion in popularity of cryptocurrencies has not gone unnoticed by the SEC. Gensler, a professor at the MIT Sloan School of Management who has taught classes on digital assets, has long been speculated to lead the charge at the SEC on increasing cryptocurrency acceptance. Many expect regulation to be a key factor in that effort.
While more had hoped for stronger commentary from Gensler related to the SEC’s plans regarding cryptocurrencies and related exchanges, his acknowledgment before Congress that cryptocurrencies such as Bitcoin leave U.S. investors exposed or unprotected gave cryptocurrency enthusiasts some indication of what may come.
If the SEC is granted authority to move forward with regulation surrounding the crypto space, many will applaud the move; such regulations would likely lead to broader acceptance of cryptocurrencies by institutions and retail investors alike. Still we also anticipate there would be some criticism.
Market plumbing
The trading surge in January led to rapidly changing prices, swings in volatility and trading volumes that created problems for some broker-dealers as they worked to manage liquidity and overall risk when clearing these trades. These problems then resulted in some broker-dealers restricting trading of certain stocks, which then hurt many retail traders.
While Gensler has indicated that there may not be sufficient disclosures for such items as margin requirements and trading restrictions for retail investors, his consideration of the overall timing it takes a trade to settle is drawing more attention. The SEC is reviewing the customary T+2 (trade day plus two days) settlement cycle to determine the feasibility of moving to T-0 or T-evening (same-day settlement). Given advances in technology, such a settlement cycle isn’t impossible to envision. Yet the effort by capital markets firms to make such a move is likely to be a very burdensome undertaking.
Gensler’s consideration of the overall timing it takes a trade to settle is drawing more attention.
The takeaway
The common thread among these five areas is that market participants are being put on notice by the SEC as the agency moves to modernize.
For participants, it will be critical to monitor the latest developments from the SEC for any rule changes, disclosure requirements or other agency commentaries that may require action. When the SEC is involved, simply doing nothing is an unacceptable answer.
