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From Securities Regulation Daily, April 26, 2018

Clayton touts SEC priorities in budget request hearing

By Amanda Maine, J.D.

Information technology and cybersecurity continue to be a priority for the SEC as evidenced by the agency’s fiscal year 2019 budget request and the questions posed to SEC Chairman Jay Clayton by members of a House Appropriations subcommittee. Members also peppered Clayton with questions about cryptocurrencies, virtual tokens, and the Commission’s priorities in general.

Budget request. The Commission is requesting $1.658 billion for SEC operations in FY 2019, a "modest" increase over the previous fiscal year’s $1.652 billion. In his testimony before the Financial Services and General Government Subcommittee, Clayton said that the budget request reflects the Commission’s focus on five components: (1) leveraging technology and enhancing cybersecurity and risk management; (2) facilitating capital formation; (3) protecting Main Street investors; (4) maintain effective oversight of changing markets; and (5) supporting the Commission’s leasing efforts.

As a threshold matter, Clayton testified that the SEC’s FY 2019 request would enable it to start lifting the hiring freeze that has been in place since FY 2016. The request also relies on the SEC having continued access to the Commission’s Reserve Fund to fund information technology improvements, including those related to cybersecurity. He also noted that the SEC’s funding is deficit-neutral and that any amount appropriated to the agency will beoffset by transaction fees.

Proxy advisory firms. Subcommittee Chairman Tom Graves (R-Ga) queried Clayton about whether the Commission plans to take any action regarding the oversight of proxy advisory firms, citing Clayton’s own words in a speech in which he said Commission should be "lifting the hood" and taking a hard look at how shareholders are getting their information. Clayton said the issue of proxy advisory firm oversight is not on the SEC’s short-term agenda, but it does intend to examine it in the future. Referring to the Commission’s 2010 guidance on theme chanics of voting under the U.S. proxy system, which had been dubbed "proxy plumbing," Clayton remarked, "the plumbing is out of date." He also referenced some recent proxy contests and amount of time it took to resolve them as a reason for reexamining the issue. "Stay tuned," Clayton said.

Proposed rules on Best Interest. Graves also asked Clayton to speak about the rules for investment advice professionals that were recently proposed by the SEC. Clayton explained that the Commission is calling the proposed standard a"best interest" standard, but added that, for broker-dealers, the core fiduciary principals embodied in that standard are the same as the core fiduciary principals embodied in the investment advisers standard, in his opinion. The SEC has recognized that an investment adviser’s relationship with a client is different from a broker-dealer’s client relationship, but the Commission is seeking to harmonize the actual duties that are owed while recognizing those differences, Clayton said.

Enforcement priorities. Ranking Member Mike Quigley (D-Ill) sought answers from Clayton about why the number of enforcement actions and the amount of penalties imposed have declined under his tenure. Even more troubling, according to Quigley, is that there seems to be a change in enforcement strategy where the SEC is charging fewer entities and more individuals, or "going after the small fish."

Clayton pointed out that the gestation period for the SEC’s enforcement cases is typically around 23-24 months, so the study cited by Quigley regarding the drop in enforcement cases reflects decisions made by the Division before Clayton joined the SEC. He also noted that the SEC has many experienced enforcement personnel at the SEC working on pursuing bad actors.

Clayton defended the pursuit of individuals in enforcement actions. According to Clayton, pursuing individuals has a greater deterrent effect. "When I talk to people in the private sector and caution them to be careful, I don’t point to particular company, I point to an individual," he said. "Twenty years later, people still remember." He stressed, however, that the SEC will still go after companies, pointing to the recent $35 million civil penalty imposed on the company formerly known as Yahoo! for disclosures failure following a data breach.

Cybersecurity and cryptocurrency. A number of members mentioned the Commission’s focus on cybersecurity and the area of cryptocurrencies and tokens. Representative David Young (R-Iowa) noted that in the FY 2019 budget there is a strong emphasis on cybersecurity and asked it was done from a reactionary standpoint or a proactive standpoint. Clayton replied that internally, it has been both reactionary and proactive. He noted that he initiated a review from a cybersecurity standpoint when he arrived. He also referenced the breach of the SEC’s EDGAR system, which the SEC is addressing specifically, but noted that the staff is also looking more broadly across the SEC to find its vulnerabilities to address and reduce them. He pointed to a recent rule adopted by the Commission that eliminates personally identifiable information from forms where it is not necessary.

Regarding cryptocurrency, Rep. Chris Stewart (R-Utah) inquired about the regulations of cryptocurrencies. Clayton noted that it is a complicated area as there are different kinds of crypto assets. A pure medium of exchange, such as bitcoin, would not be a security; however, when it comes to virtual "tokens" that are used to finance projects, "there are none that I’ve seen that aren’t securities," Clayton said, echoing statements he has made in the past. To the extent something is a security, it should be regulated as a security, Clayton advised.

Disclosure. Representative Matt Cartwright (D-Pa) was critical of the SEC for its lack of enforcement regarding its own climate change disclosure guidance from 2010. The climate disclosure put out by companies these days is usually generic, he said. He asked Clayton if the Commission is taking climate change risk disclosure seriously. Clayton responded that the SEC takes all disclosure mandates seriously because investors need to have all the information required to make an investment decision. He stressed, however, that a company’s climate risk disclosure should be to its investors about what may affect that company; it is not a uniform issue, and there are many industries where it is not a material risk. A lack of enforcement action should not be perceived as a lack of action, he added.

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