We’re Raising the Standard of Conduct for Broker-Dealers

Chairman Jay Clayton began his career as a clerk for the Honorable Marvin Katz of the U.S. District Court for the Eastern District of Pennsylvania. He then joined the Wall Street law firm of Sullivan & Cromwell where he advised market participants on capital raising and regulatory enforcement, until 2017, when he was nominated to chair the U.S. Securities and Exchange Commission. 

Host: Arthur Levitt

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Episode Transcript

Speaker 1 (00:00):
This is a closer look with Arthur Levitt. Arthur Levitt
is a former chairman of the u S Securities and
Exchange Commission, a Bloomberg LP Board member, a senior advisor
to the Promontory Financial Group, and a policy adviser to
Goldman Sachs. J. Clayton began his career as a clerk

(00:21):
for the Honorable Marvin Tatz of the United States District
Court for the Eastern District of Pennsylvania. He then joined
the Wall Street law firm of Sullivan and Cromwell, where
he advised on capital raising and regulatory enforcement until two
thousand and seventeen, when he was nominated to chair the

(00:45):
U S Securities and Exchange Commission. As chairman, he created
the Fixed Income Market Structure Advisory Committee to examine an
address equity and fixed income market structure issue, and the
Commission just finalized it's regulation Best Interest to replace the

(01:07):
Department of Labor's Fiduciary Standard. He joins me now for
a closer look a replacement for the fiduciary standard, Regulation
best Interest was just finalized. You said that we're raising
the standard of conduct for broker dealers. You're going to

(01:27):
have to be very candid with your investor. That's a
wonderful question because the complaints that we get, the cases
that we see, they often involve a lack of candor
from the financial professional. Two the customer, and what customers
want to know. What people want to know is how

(01:49):
are you, my financial professional, making your money and how
much of my money is going to work for me.
What our standard are new regulation best interest for brokers,
and what our interpretation for investment advisors make clear is
that you've got to tell your client, your customer, how
you're making your money and how much of their money

(02:12):
is going to work for them. It's been way too
long in our marketplace that that has not been clear.
SEC doesn't actually define best interest, instead assessment of the
facts and circumstances of how the broker dealer has satisfied
the four component obligations of regulation. Best interest is the

(02:32):
basis for judgment. What are the four components, Well, let
me just say that there are actually five. There's an
overriding component, which is as a broker dealer, you cannot
put your interests ahead of your customers. So, in addition
to that overriding requirement that did not exist before, we

(02:54):
have four other requirements. There's a duty of care, a
clear duty of care. You have to know your customer.
You have to think about what products are right for
your customer given their circumstances. We also have a duty
of disclosure. You have to tell your customer, as we
just spoke about how you're making your money and how
much of their money is going to work for them.

(03:16):
Then you have a conflict mitigation requirement. You have to
look at your conflicts and either mitigate them eliminate them.
And then finally we have a policy and procedure requirement.
That policy and procedure requirement, it's part of a package.
You can have standards, but unless you have policies and
procedures to judge them against, it makes very difficult for

(03:39):
people like the SEC to inspect for those standards and
to extend people breach them to enforce them. So those
policies and procedures have a twofold purpose. One is to
ensure that the broker is actually following the rules, and
then it gives us a way to check whether they're
following the rules. Regulation best interest was proved of the

(04:00):
long party lines with a three one vote. Now, states
like New Jersey and Massachusetts and Nevada have taken up
their own rulemaking to address what they have said, our
serious shortcomings in the new SEC rule. What are you
going to do about those states to see if there

(04:21):
isn't a way for the federal government and states to
work closer together on this issue. So, throughout the process
of coming up with regulation best interest, which let me
just say this, this was an organic process at the SEC.
It was driven by our long term career staff, including
our inspection staff, at our enforcement staff, we've engaged with

(04:45):
representatives of the states. None of what we were doing
came as a surprise to the states, and I believe
in continuing that kind of engagement. So you know, I
expect that at my level and at the staff level,
we will continue to engage with the states as we
implement regulation best interest. Let me address your your your

(05:06):
question in a broader sense, this was ten twenty years
overdue a reassessment of how financial professionals deal with their
retail customers. It should not shock anybody that in that
ten twenty years political views have developed. Now that's the
way things work if something has been unaddressed for a

(05:28):
long time. Of course, politics is going to enter some
particularly something this big, depending on you how you measure it.
This is either a forty trillion or eighty trillion dollar market.
It's gigantic. So you know, I expect that we will
have to go through questions about whether we've done the
right thing or haven't done the right thing. I can
tell you that our staff who inspect for these things

(05:52):
every day, enforce these things every day, and have the experience,
they know that we've done the right thing. Here, you're
comfortable with yes. In fact, I was just in San
Francisco meeting with our San Francisco office and Sue Sponte.
You know, without without prompting, our inspection staff told me
that the fiduciary interpretation and regulation best interest is going

(06:14):
to make it much easier for them to get the
bad guys. Another part of regulation best interest is form
cr S, the Customer Relationship Summary, which provides a way
to compare brokers with advisors, the different types of services
advisors provide, the duties they owe and the compensation they receive.

(06:38):
The Commission has chosen to give advisors flexibility and how
they present that critical information. Do you believe that most
retail investors who will be able to adequately understand those
particular disclosures. Let me frame what we've done here. For
some time, both brokers and investment advisor have had disclosure obligations. However,

(07:02):
there's been no page limit or framework around those disclosure obligations.
Other than some lengthy forms they've worked adequately for the
first time. We're saying, if it's important to a retail customer,
you've got to fit it on two or four pages. Now,
I expect that many retail customers will be able to

(07:25):
digest this information in the format that we've presented it.
But more importantly, it will allow i would say, other
market participants to compare brokers form crs, investment advisors form
crs and assess which ones have certain business models and

(07:46):
which ones have i would say more complicated business models.
That information will become much more apparent in the future
than it is today. Turning to the world of crypto currency,
initial coin offerings or i c o s, it's been
a problem. You found that many were fraudulent, and now

(08:09):
you have to deal with a spinoff. I e o s.
Initial exchange offerings another way to generate capital. How are
they different and are I e O s proving to
be somewhat safer for investors. Well, let's just let's just
take a step back at level set here. I think

(08:29):
you and I and I want to say I always
enjoy being here with you and having these conversations. A
year and a half ago we talked about I c
O S and I and I raised a great deal
of concern as this was just another way to conduct
the securities offering. UM, but people were not following the rules.
It turns out if you look at that cohort of

(08:51):
I c O S from a year and a half ago, UM,
I don't know if you can find one. We're an
investor made money, and I know you can find hundreds
of not thousands, where investors lost substantially all of their money.
I am highly skeptical of new ways of conducting securities
offering that don't follow our rules. Now, if you want

(09:14):
to use digital assets in a way that is compliant
with our long standing rules for making securities offerings, I
am all for it. We'll sit down, we'll help you.
We have a finn hub, we have people they're willing
to help in how to how to mechanically conduct these offerings.
But you still have to give people disclosure that's adequate

(09:36):
for them to make an investment decision. Just calling it
an I e O or an I c O when
it's a securities offering and then saying I don't need
to disclose the financial performance of my venture. In a word,
it's crazy town. All your commissioners agree with that. Yes,
you've been assessing and planning for the potential adverse effects

(09:59):
on you as capital markets from Brexit, including a possible
no deal Brexit. What's your greatest concern? Like anything, your
concerns evolve over time. Before the delay of Brexit, my
concern was a broader economic concern, uh that investors did

(10:21):
not have a full picture for what breggs it meant
for the companies they were invested in, and what broad
economic effect it could have and therefore effect those companies.
The disclosure that has been coming out from companies has
improved in that regard. Then we'll turn to the mechanics
of Brexit. Are there things that from a regulatory perspective,

(10:43):
as a result of Brexit will create frictions that we
and our fellow financial regulators will have to deal with.
Some of those still exist. Blomberg reported that officials and
the SECS Enforcement Division are investigating Boeing over the faith
crash of the seven seven max. Is that what the

(11:05):
SEC is looking for in terms of what brought about
that accident. So I'm not going to comment on any
specific investigation, whether it's happening or not happening. I'm very uh,
let me put it this way. I don't think it's
appropriate for somebody in my position, But what I will

(11:26):
say about our enforcement is that we are a disclosure
oriented regulator. And the question, the fundamental question is, yeah,
have you adequately informed investors of the information they need
to make an investment decision. So when we look at
you know, when we look at anything, that's that's the question.

(11:48):
Now there's a tendency to ask the SEC to go
beyond its mandate to regulate environmental issues to regulate other issues.
And you know, we should. We should understand those issues.
We are part of that's part of the economy. We
need to understand them, but we need to be careful

(12:08):
that we're not overstepping our bounds. Um I I have
great respect for staying in your lane. I think government
works most effectively when people stay in their lane. Training
to politics, is the present Commission party oriented or do
the Democrats and Republicans tend to vote together as a group.

(12:36):
Let me take the second part of that first. And
I don't look at the statistics to any great extent,
but I think if you'll look at the statistics, you'll
find that the Commissioners largely vote together on matters um.
But there are matters on which there's disagreements. UM. I
think some people categorize those disagreements as generated by politics.

(12:58):
I can tell you that in my time as chairman,
what I've fundamentally asked is what's the right thing for
investors over the long term. That's what's driven my agenda.
It's driven what I bring for a vote of the Commissioners.
And I think that's been the right way to approach
being chairman of what is an administrative agency. From a

(13:20):
personality point of view, I cannot think of any possible
human being that could do a better job of getting
commissioners of any party strike to go along with what
he thought was best for the Commission in the country.
Thank you. Has Donald Trump spoken to you about what

(13:43):
he expects from the Commission? So? Um? When I was
offered this job, the President elect asked me to do
a good job. And let me say this, He asked
me to do a good um, and he said he
would leave me to do a good job. And he's

(14:04):
kept to his work. I Dodd Frank rule was just
finalized with a compromise that would place most uncleared swaps
trading by CFTC registered firms under the CFTCS Capital Rules,
avoiding the additional SEC charge. It's been said that the

(14:26):
SEC and c FTC are going to work more closely
together on policy and enforcement. Has that worked that way?
It has? I I look at the Dodd Frank Title
seven as an opportunity. It has required the Commission to
write an entire body of new rules to deal with

(14:49):
securities based swaps and related matters. For most people this
will will be esoteric. But but this created an opportunity
for us to engage with the cft SEE. And I
believe Chairman John Carlo, who's who's about to leave after
a after a nice tenure there, took the same view,
which is, okay, we get to write on a bit

(15:09):
of a blank slate here to create a new UH
I would say, regulatory framework for security space swaps. Let's
try to do it in a way where there's a
great deal of cooperation. Now we're not completely harmonized. We
have a different mandate from the CFTC. The CFTC is
largely an institutional regulator, largely a risk transfer regulator. We

(15:34):
have a much broader investor protection mandate and so I
have to respect that. But by and large we've coordinated
very well. Does the SEC have the manpower and budget
to take on the task of managing the best interest rule?

(15:56):
So when I got to the Commission, I made an
assessment where we stood in terms of of manpower, and
our greatest assets are people. It's our budget. It's the
most important thing we have other than people. We have
some some technology which is pretty good, and we have
space office space. I am looking to grow our staff

(16:20):
in several areas, and one of the areas is what
i'll call financial professional surveillance. The ability to make good
risks assessment of where we should inspect, the ability to
take the data that they provide to us and use
that data to identify risks areas. I'm particularly excited about

(16:41):
some of the tools we have to identify churning. So
the short answer to your question is, I want to
put more resources into that area, and I feel like
we have a good way to do it. Have you
made any progress in terms of better defining what insider
trading is? Insider trading is, well, it's been defined by

(17:07):
the courts over the years. Let me say this, Have
they gotten it perfect? No? Have they done a really
good job in terms of addressing the need to get
at what we all know is nefarious and improper activity,
but at the same time not discouraging people from trying
to ferret out information. We want people looking at whether

(17:31):
trucks actually have the equipment in them. We want people
trying to find out whether companies are telling us the
truth or not. We want people searching for information. It
helps all investors. We want them to do it in
the right way, and I think the courts have done
a pretty good job on dividing that line between the
the proper search for information and the improper search for information.

(17:54):
What's the status of our relationship with foreign regulator? Are
we in tune? Are there any significant differences between regulatory
bodies that we deal with. I'll take your your question
reverse and then I'll end with something positive. I think
to always be searching for being in tune too. Let's

(18:18):
say ignoring other issues is a mistake. Of course, we're
going to be out of step with foreign regulators on
certain issues. They have different agendas, they have different politics,
they have different economies. We are in tune on a
number of important issues. But what I will say, and
I'm and I feel really pretty good about, is we

(18:39):
have a candid relationship with our foreign regulators. There's no
doubt in their minds where we stand, and I think
I have a pretty good understanding of where they stand it.
And if you have that kind of relationship, you can
you can get more done. Three major high speed trading
firms are bank an appeals court filing by the New

(19:02):
York's Trock Exchange NASDAC and the CBOE Global Markets to
have the transaction fee pilot program ruled unlawful and beyond
your authority. What's the purpose of the fee pilot program?
And why is there so much pushed back? So let

(19:23):
me again try to level set where we are. It's
been about a decade since we established the rules for
what i'll call our market ecosystem, our equity markets trading ecosystem.
A lot has changed. Uh, People ask me what percentage
of our market is electronic trading. The answer is just

(19:45):
about virtually every order goes through some kind of algorithm
before it is executed, whether it's executed um, whatever venue
it's executed on, whether it's executed on exchange, off exchange,
and internalized or or all those words show you how
complicated it's become. The question is, with all the changes,

(20:05):
do we still have it right? The purpose of the
transaction fee pilot is to get the data for us
to be able to assess whether we still have it right,
whether we still have our trading ecosystem operating for the
long term interests of our market, And that's that's one
component of it. Do you have any feeling about it?

(20:26):
Up to now? Do I have any feeling about I
think it's overdue for assessment. This was a recommendation from
our Equity Market Structure Advisory Committee on a way to
get data to assess the market. And I think it's
entirely appropriate for us to be assessing whether the marketplace
of today is as efficient and effective as it should be.

(20:48):
You've said that we currently have what can be described
as a two tiered system of market data and market
access in US Equity Market says technology g has shifted
the regulatory landscape since the adoption of regulation n MS
over a decade ago. What do you think needs to

(21:10):
be changed or updated to keep up with best execution?
So I have going back to my my prior answer,
I have no set change in mind. Don't che change
in mind to make the markets work better. But the
characteristic you cited that there are people who access data

(21:34):
much more quickly and in much greater detail than many
other participants in the marketplace, I think it's my job
to look at that and assess whether that is the
most effective way for the market to operate. CFTC Commissioner
Rustin Brriman is warning that risks from climate change are

(21:57):
as serious as those proposed by the mortgage meltdown. Risk
to financial markets, mortgage holders, insurance companies, pensions all could
be affected by extreme weather. Is the SEC thinking about
this issue, Yes, and we've thought about it for a
long time. We've put out disclosure guidance on how companies

(22:19):
should think about discussing the risks of climate change and
regulation related to climate change and other effects to their investors,
and that guidance has been out for some time. We've
been reviewing that guidance. We've been reviewing the disclosures that
public companies make. I think if you look at the
disclosures that public companies make around this, particularly those where

(22:43):
climate change may have an impact on their operations, you'll
see that the disclosure is fairly robust. What is the
turnover rate at the Commission now? In terms of numbers
of people that are we have a very low turnover rate.
They have very low tone of a rate. And and
what I really like about it is, I don't think

(23:04):
all people love their job, but a lot of them
really love their job. People that you speak of is
about the same as the number of people that I
dealt with when I was at the Commission. Everything else
has gone up. Why hasn't that number been nine thousand people. Well,

(23:26):
I deal with the reality that I have and as
and as we discussed, I think there are areas, particularly
in the area of we talked about market structure, market surveillance,
understanding markets, inspecting investment advisors, using using technology to make
us better. Those areas and our areas where we need
to grow our human capital, both in both in expertise

(23:50):
and a number of people. He was a partner at
the international law firm of Sullivan and Cromwell for over
twenty years, where he was a member of the firms
management committee and co head of the firm's corporate practice,
while also a lecturer in law and adjunct professor at
the University of Pennsylvania Law School. In two thousand and seventeen,

(24:15):
he began his term as the Chairman of the US
Securities and Exchange Commission. Chairman, Jay Clayton, thanks for joining us.
By the way, if you have comments about the program
or suggestions for topics, please email me at a Closer
Look at Bloomberg dot net. That's a closer Look one

(24:38):
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at Arthur Levitt one word. This is a Closer Look
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