Speech by Commissioner Crenshaw on Investor Protection and Market Transparency

Good morning and thank you Aaron [Klein].  It is a pleasure to be here this morning.  While this isn’t a “farewell address,” I hope you will indulge me if I take the opportunity to reflect a little bit on what I’ve learned, what we accomplished prior to this year, and provide commentary on where I think the markets are today and where I think they should be headed. [1]

***

The securities laws, as drafted, were designed to provide legal structure around an intricate system of market participants with different interests and different incentives.  It has evolved over time, including through the passage of new statutes and rules, into a unique ecosystem of checks and balances.[2]

This structure, which has accommodated growth in volume, speed, and complexity over the last 90 years, is far from perfect.[3] But, more or less, it has worked.  If those who can afford to invest buy and hold plain vanilla diversified products based on investment advice that is provided in their best interest, those investors should get, and generally have gotten, more money out than they put in. And American businesses have successfully raised capital year-in and year-out.

Our job, at the SEC, is to ensure fairness and order, improve efficiency and effectiveness, and require appropriate transparency in the markets.  We must do that carefully and with adherence to certain foundational principles, including, ideally, the belief that this is a system for everyone, and not for any special interest or market participant.  The job of the SEC is a critical one.  The agency must understand the interactions between all of the participants, while recognizing the interests and incentives of each of them, and ensure that the overall structure remains balanced and works for everyone.

Nearly five and half years ago, I had the privilege of testifying before the Senate for a hearing on my nomination.  At that hearing, I explained who I wanted to be as a Commissioner.  I said:

“I [] carry with me [today] the Stories of Soldiers, family, and friends who give the SEC’s mission real meaning.  As a Captain in the United State Army Reserve, Judge Advocate General Corps, that mission means making sure my fellow Soldiers have a fighting chance to secure the financial futures they deserve.  As a sister of an entrepreneur, it means making sure our markets unite job-creating capital with individuals like my brother who recently started a small business developing 3D printing technology for military uses.  [A]s a new mother, it means promoting the level playing field that will allow my family and millions of other American families, to fund the rising costs of education by safely and confidently investing in our markets.  [As a Commissioner, I promise to] provide tools that allow individuals…to fund their retirements in safe and sustainable ways.”

Those were some lofty goals!  Whether I have been successful in pursuit of those goals, history will judge.  But I can say proudly, today, that I never lost sight of why I took this job.

Over my tenure, the Commission has brought meaningful enforcement actions to recompense victims of fraud and wrongdoing, including soldiers and their families;[4] simplified disclosures;[5] made it harder for corporate insiders to rig the system to their benefit;[6] required disclosure of material information on executive compensation,[7] climate risk,[8] and cybersecurity risk;[9] and put in place restrictions designed to enhance the protection of customer information.[10]

Unfortunately, recently, my voice has become one of ubiquitous dissent.  It has been unsettling to see how precipitously one Commission is willing to undo the work of the Commission that came before it—all without a single notice-and-comment rulemaking to date.  I’m concerned that the fundamental precepts upon which our markets have been built—tenets that have, by and large, kept our markets safe for both issuers and investors alike—are being eroded.  I fear that the very core of our intricate market structure is under attack.  And instead of safeguarding our markets for investors to fund their retirements in safe and sustainable ways, we are moving in a direction where markets start to look like casinos.  The problem with casinos, of course, is that in the long run the house always wins.  This approach flies in the face of the work I set out to do.  Here’s how.

I.

The Rubble

Trend 1: Devaluing the Investor

First and foremost, we see a trend towards devaluing investor rights.  It’s pervasive and already worn deep.

For example, the Commission has made it harder for investors to communicate their preferences to issuer management;[11] it has shown outright hostility to investor proxy proposals;[12] and, we are dismantling private rights of action by allowing public issuers to force their shareholders into arbitration.[13]

These actions seem fueled by the fictitious notion that we need to punish investors in order to revitalize public markets – or purportedly to “make IPOs great again.”  But IPOs can only be revitalized with investor money.  Treating investors as a nuisance is shortsighted at best.

Trend 2: Moving Into the Shadows

While part and parcel of the devaluation of investors, a separate and pervasive trend of this Commission is moving markets out of the light and into darkness.  Intent on reducing industry’s perceived burdens, this Commission is reducing transparency.  For example, it has stated plans to reduce the cadence of public-issuer filings.[14]  This means investors will have less access to timely financial information, including audited financial statements, less analysis from management, fewer disclosures about evolving risks, less analyst coverage, and it will be easier to smooth earnings shortfalls, among many other potential effects.  Investment decisions will inevitably be based on either: (i) stale data, (ii) data voluntarily released by companies that lack uniformity (at best) or are cherry-picked (at worst); or (iii) on information other than company metrics, such as social media posts, promotions, hype, or even just “vibes.”  The Commission has also made clear that it intends to roll back the universe of people who must register and what information must be disclosed.[15]

Transparency is also important for ensuring our equity markets work fairly and efficiently. One of the great strengths of U.S. equity markets is the use of displayed bid and offer prices by exchanges, which we call “lit trading.”  Lit trading matters because it provides an important and central public source of price transparency that can directly benefit investors.  Displayed quotes are used for many purposes such as informing trading decisions, establishing security valuations, and performing index calculations.  In addition, exchange trading is important for maintaining high investor protection standards since exchanges are subject to comprehensive regulation.

However, in recent years, there has been a shift in market activity away from “lit trading” on exchanges to dark markets.  There is increasing evidence that this shift is “obscuring the true prices of stocks, raising the cost of trading, and, by extension, damaging investor confidence.”[16]  For this reason, it is fundamentally important to support displayed liquidity and carefully consider any interventions that might impact transparency in our equity market structure—such as limiting or rescinding the Order Protection Rule, which the Commission seems poised to do.[17]

The Commission has also been shrouding its policymaking in darkness, shunning public comments and, instead, relying on hidden voices to drive its agenda.  In a mad dash to implement its policy preferences, the Commission, again and again, has implemented a new vision through staff statements[18] and extensions of the compliance dates of Commission rules[19] without deigning to ask investors what they think and what they want. This approach flouts notice-and-comment rulemaking requirements under the Administrative Procedure Act.[20]  Moreover, it is a different approach than my colleagues advocated for when policies they did not favor were on the table.[21]

What is lost when the Commission does not solicit public comment?  Well, obviously, the Commission loses out on the benefit of the public flagging blind spots the Commission did not see.  The public also loses the opportunity to identify the industry voices driving the policy decisions and to evaluate their motives.  The public deserves to know who is really behind the policy choices that will impact their financial futures.  Perhaps most perniciously, this retreat from public comment denigrates investors, sending the clear message that the Commission does not value their perspectives and that it knows better than investors do what is best for them.  The Commission’s approach to nontransparent policymaking has treated investors like silly children to be ignored rather than fully formed persons with ideas and concerns worth hearing and considering. Investors deserve better.

Trend 3:  Pushing Main Street Investors into Private Markets Without Protections.

This brings me to another trend.  The Commission is opening the private markets to Main Street investors’ pockets, including their retirement assets.[22] This is a harmful policy choice—and not just because it undermines the safer, more transparent, and more efficient public markets.  The private markets expose retail investors to more risky investments—ones that were specifically crafted for non-retail investors.  To justify this irresponsible departure from foundational pillars of the securities laws, my colleagues use lots of buzz words—freedom, diversification,[23] democratization.[24]  Call it what you will, at bottom it’s risky and it’s reckless.

Private markets do not offer the same guardrails that make our public markets a level playing field for retail investors.[25]  There’s limited transparency.  Investors don’t get the same standardized disclosures as in the public markets; the Commission does not have the same tools to detect fraud or other wrongdoing before it happens; investors are kept in the dark about certain fees and expenses; and valuations are opaque and inconsistent.[26]  In the private markets, smaller investors almost certainly will be subject to higher fees (and, therefore, lower returns) than large investors with the power to negotiate.

Unleashing the private markets’ insatiable hunger for capital on retail investors’ wallets will come back to bite regulators—but not before Main Street Americans’ savings have been looted.

Trend 4: Deterrence? What is That?

As the Commission dismisses investors, reduces transparency, and sends retail into the private markets wilderness, it cedes important tools: Its enforcement tools.  We see this in multiple ways:

• The Commission has dismissed SEC enforcement actions left and right, undermining the credibility of our lawyers and the agency overall;[27]
• It has brought fewer enforcement actions;[28]
• Civil penalties, when assessed, are purposefully lower;[29]
• The purveyors of massive white-collar fraud are being pardoned or having their sentences commuted by the President,[30] leading the Commission in many cases to drop its parallel litigations as an “exercise of its discretion”;[31]
• Whistleblower awards have all but grounded to a halt;[32]
• As I mentioned earlier, the Commission has given permission to issuers to enforce mandatory arbitration provisions against their shareholders, meaning (i) less private enforcement of the law, and (ii) confidentiality provisions that will keep corporate wrongdoing out of the public eye.[33]

Deterring misconduct is a public good.  Without deterrence, there is no accountability. Corporate actors comply with the rules because failing to do so, under normal circumstances, is costly.  When we remove the tools that detect fraud and we make it less costly to commit fraud, people will commit more fraud.  It’s that simple.

***

Taken together, these trends embody a sort of chaos that I think has characterized the past year.  The appetite to deregulate has been rapacious; the analysis of the costs and benefits of our policies has been non-existent; and, the repercussions, I would argue, could be dire.  We live in an echo chamber where politicians and policymakers make their own truth through repetition.[34]  But, the markets have a way of correcting themselves—not always immediately, but over time.  So, I think the true advisability of these policies will reveal themselves eventually. I certainly wouldn’t be alone in analogizing the trend toward deregulation in the current environment to the period prior to the stock market crash in 1929.[35]

And our ability to understand and respond to market events of all kinds is only as good as our best resource: the staff.  Staff numbers across the board are down by between 15-20 percent.  I cannot overemphasize how harmful the overnight loss of decades of institutional knowledge and securities expertise has been to our agency generally, and how significantly it will impair our ability to respond nimbly in times of tumult.  We have lost experts of all stripes who have weathered past market events; brought reform from calamity; guided recovery efforts; and have instituted protections that decrease the risk that similar disasters might happen again.

Of late, we have frequently been told that today is a “new day” at the Commission.  But anyone aware of our place in the calendar knows that with each successive day the nights grow longer.  I fear that the darkest depths of winter still lie ahead for America’s capital markets.

II.

The Rebuild

That’s the doom and gloom part of the speech.  But out of the rubble I believe we can find opportunity.  Clarity. Purpose.  I believe we will have the chance to rebuild and we will rebuild it better than before.  And, of course, I’m here at Brookings, so I need to bring some big ideas.  I challenge each of you to envision, debate, and, importantly, build consensus around those ideas so the best of them can be implemented when the time comes.

I think the big question we will likely have to answer is: how do we make our markets work for the American people?  The government is responding to big industry’s wish list at the moment,[36] but our focus should be on everyday Americans.

First, let’s return to market fundamentals.  We need to promote policies that encourage trading based on actual fundamentals: issuer operations, cash flows and real financial metrics of companies, not on tweets.  Policies should favor long-term buy-and-hold investing.  People invest in crypto because they see (some) others get rich overnight.  Less visible are the more common stories of people losing their shirts.

One thing that has consistently puzzled me about crypto is – what are cryptocurrency prices based on?  Many (but not all) crypto purchasers are not trading based on economic fundamentals.  I think it’s safe to say they’re speculating, reacting to hysteria from promoters, feeding a desire to gamble, wash trading to push up prices, or as one Nobel laureate has posited – betting on the popularity of the politicians who support, or stand to benefit personally from, the success of crypto.[37]  Regardless of asset class, our legal framework – including our tax framework (I’m looking at you, Congress) – must promote long-term investing based on sound economic principles.

Second, government should be more nimble and interdisciplinary.  The world looks very different than it did when our financial agencies were created.  We may have to reimagine financial regulatory agency structure or at least come up with a framework for real collaboration that looks different than today.  Does it make sense that some lending is overseen by banking regulators and some lending is overseen by the SEC?  And all the while neither regulator has real insight into how exposed our banks are to private credit?[38]  Does it make sense that commodity-based swaps are regulated by the CFTC and security-based swaps to be regulated by the SEC?  Do these products look sufficiently different to require different regulatory regimes?

And, Congress may have to ask normative questions about the way the economy is structured.  Private equity is buying up single family homes, healthcare, and even the very accounting firms that may be signing off on the financial health of their portfolio companies.  We need to look carefully at whether more robust guardrails are needed around these practices.

Third, we must confront the changing face of the American economy. Artificial Intelligence is here.  It might well upend the labor force.[39]  We need to revisit our rulebook with AI in mind.  For example, many of our securities laws require evidence of bad intent to prove a violation.  But how will we prove intent if no human is involved?  And, what are the real risks involving the use of AI by issuers and intermediaries that investors should know about?  Is shifting compliance obligations to AI tools resulting in appropriate internal reviews?  We will need to build a more rigorous scaffolding around the markets to address AI.

Fourth, let’s pursue policies that actually promote our small businesses.  We should be a resource to them as they seek to raise capital, by helping them understand our disclosure regimes and helping them get information to investors about their businesses.  And let us reimagine our exemptions from public company registration, including Regulation D, which has effectively become an economic subsidy for large private issuers, to the disadvantage of our small businesses.  We should revisit this. Let’s take a look at what small really means, not just reflexively provide loopholes and exemptions and rollbacks for larger and larger businesses.

And finally, let us govern with ethics and meaning.  Let us respect and support our public servants, not punish them.  Let us give regulators the tools they need to oversee markets in a meaningful way and to help prevent the all-to-predictable mistakes of the past from repeating themselves.

Let us rebuild with the purpose of ensuring that the American economy works for everybody, not just those able to buy political influence—so my fellow Soldiers have a fighting chance to secure the financial futures they deserve; so our markets unite job-creating capital with small business owners like my brother; so families can fund the rising costs of education; and, so Americans can fund their retirements in safe and sustainable ways.

Thank you.