Advice to the New SEC Chair: Balance Investor Protection and Choice

Editor's note: In April 2021, the Senate voted to confirm the nomination of Gary Gensler to lead the Securities and Exchange Commission. This article originally ran in January 2021 and has been updated.

Now that President Biden’s SEC chair nominee, Gary Gensler, has been confirmed by the Senate he will have many considerations to balance as he assesses the direction of future SEC regulation and enforcement.

In 2020, the SEC took steps to advance both investor choice and investor protection. Now, the new SEC chair will have to determine if the former has gone too far in hindering the latter.

Here are some of the top SEC regulations he will have to consider.

Regulations Driving Investor Protection We see two main SEC regulations that have the potential to dramatically expand the protections and disclosures available to the retail investor.

• Regulation Best Interest. Though Regulation Best Interest was adopted in July 2019 and came into compliance last summer, it will be up to this SEC to put its teeth into Regulation Best Interest with strong enforcement. The new chair will want to focus on SEC and FINRA exams, as well as disclosures in the client relationship summary, to determine whether the rule is sufficiently strong in its current state. The SEC should also pay particular attention to rollover recommendations and whether they tend to end up triggering the Department of Labor Fiduciary rule under the five-prong test (which defines what advice constitutes investment advice). If they do, the agencies should collaborate to give both regulations more teeth. If not, the SEC is on its own in policing rollovers unless and until the new DOL or Congress changes the Fiduciary Rule.
• Fund Disclosure. The SEC has a tremendous opportunity to improve disclosures for investors as it moves forward with its bipartisan fund disclosure proposal. As it stands, the proposal would greatly enhance disclosures to make them more standardized, streamlined, and comparable, thus making them more helpful to individual investors. We believe the new chair should make the most of this opportunity.

Has the Pendulum Swung Too Far Toward Investor Choice? In the past year, the SEC also advanced a number of investor freedoms, raising the possibility that the reins will have to be pulled back in the coming year. Here's what to watch.

• Crowdfunding. In the area of crowdfunding, the SEC greatly expanded who could access crowdfunding, allowing lower-income individuals to put more of their savings in a single crowdfunding opportunity. In addition to monitoring potential crowdfunding scams, the SEC should keep an eye on the number of individuals that are investing in undiversified crowdfunding opportunities. They should ask: Are more companies using crowdfunding to raise money? And how do these companies and investors fare over time? The SEC should keep tabs on the companies raising money from lower-income investors to determine whether the loosening of this regulation is leading to investor harm.
• Access to Private Investment Opportunities. The Accredited Investor Definition (which defines the entities that are allowed to trade securities that may not be registered with the SEC) was liberalized to some extent, though not as much as initially anticipated by the proposal. This SEC regulation now allows individuals with certain licenses (Series 7, 65, and 82) to gain access to private opportunities. In addition, the definition has been expanded to include knowledgeable employees, limited liability companies, registered investment advisors, family offices and family clients, and entities owning investments over $5 million. The SEC should keep track of how this liberalized definition affects which investors gain access to opportunities previously unavailable to them. If sophisticated investors seek out private equity or private offerings, then there is not a concern with respect to investor protections. If private opportunities are marketed more broadly through retirement and other vehicles, then questions regarding the suitability of these investments arise, given their liquidity profiles and lack of public information. These questions must be addressed if such opportunities are to be made more accessible.
• Leveraged Exchange-Traded Funds. The SEC also liberalized the process for launching leveraged ETFs. These products have been criticized by many, even those in the ETF industry. They are high-risk products, and as Morningstar has mentioned, not understood well by investors. We believe the SEC should watch carefully to see whether it has an impact on the number of new fund launches and flows into these products. The SEC should use information about fund flows to determine whether the appropriate balance exists for this product: one that allows those who understand the risks to invest while not making leveraged ETFs too accessible to those who do not adequately recognize their risks.

A Fine Line Between Investor Protection and Choice While the balance between investor protection and choice is not a new one for the SEC, it is particularly challenging to pull back freedom once it is granted.

If the SEC finds that certain loosening of restrictions leads to investor harm, we think it should be rigorous in its analysis before making changes that could upset those who are in favor of more investor freedom.