In recent remarks, Securities and Exchange Commission Commissioner Lizarraga called on the SEC to move forward to implement the rulemaking mandate in Section 956 of the Dodd-Frank Act.  The Commissioner was speaking at an Americans for Financial Reform event.  Section 956 required six regulators (the banking agencies, the Federal Housing Finance Agency and the SEC) to propose regulations that would prohibit incentive-based compensation arrangements that encourage inappropriate risks by a covered financial institution that has assets of $1 billion or more by providing an executive officer, employee, director, or principal stockholder of the institution with excessive compensation, fees or benefits, or that could lead to a material financial loss to the institution.  The agencies jointly proposed rules in 2011 and 2016.  In April this year, three of the banking agencies proposed a new rulemaking essentially reproposing the 2016 rules with some modifications (to account for the passage of time and other changes).  In part, the reproposal was prompted by the failures of Silicon Valley Bank and a few others.  The Commissioner contends in his remarks that in connection with the global financial crisis “pay structures often encouraged big bets that maximized short-term profits but ignored bigger longer-term risks that threatened to take down our entire financial system.”  He points out that this particular Dodd-Frank Act rulemaking is mandatory and had a deadline.  He argues that “Section 956 is about ensuring sound compensation practices that ensure there is sensitivity to downside risks. It will benefit investors and contribute to the financial stability of our very interconnected system.”

Action on this is included on the SEC’s rulemaking agenda, though it remains to be seen whether this will be taken up in the near future.  See the full text of the Commissioner’s comments here, https://www.sec.gov/news/speech/lizarraga-remarks-section-956-webinar-061724.

During his remarks at a meeting of the International Bar Association’s Asset Management Industry Conference on Global Challenges and Opportunities in Boston, Commissioner Uyeda commented on investment research and the research rules.

Commissioner Uyeda commented favorably on the United Kingdom’s Financial Conduct Authority’s consultation on modifying certain research unbundling rules required by the UK Markets in Financial Instruments Directive (“UK MiFID”), which were derived from the European Union’s MiFID II.  He noted the importance of research to well-functioning capital markets.  The Commissioner made two interesting observations.  First, that the decline of third-party investment research may increase the risk that market participants might place undue reliance on social media and influencers as these will tend to fill the information vacuum.  In turn, this would have the effect of resulting in a less informed investing population and in less efficient markets, both of which would lead to an increase in the cost of capital.  He also observed that regulators are demanding additional disclosures from public companies, including, for example, climate-related disclosures and disclosures relating to cyber security incidents.  The additional disclosure may be difficult to process by investors without the assistance of expert views, like those of research analysts.

The Commissioner reviewed the regulatory framework relating to research, including Section 28(e) of the Securities Exchange Act, the Global Research Settlement and Regulation AC.  He contrasted the U.S. approach to the approach in the EU and the UK, where the bundling of execution and research have been viewed as an inducement to asset managers and, as a result, an investor protection issue.  Therefore, MiFID II requires managers to pay for research separately from execution services, charge clients a separate fee, or pay for research.  MiFID II’s research rules may have intended for independent research and lower commissions to offset the reduction in sell-side research; however, it appears that it may have not accomplished these goals.  Instead, it has had unintended results, such as a decline in research relating to small and medium-sized companies.  In addition, MiFID II’s inducements regime has given rise to conflicts of law issues for U.S. broker-dealers.  The SEC’s Division of Investment Management issued temporary no-action letter relief to permit U.S. broker-dealers to comply with MiFID II’s research requirements and continue their business models.  Despite significant efforts to seek an extension, as well as proposed legislation that would have provided a fix, the relief expired in July 2023.

The Commissioner recommends that the SEC undertake a retrospective review of Regulation AC, follow through with the 2017 recommendation from the U.S. Department of the Treasury and conduct a holistic review of the Global Research Settlement and the research analyst rules, and determine which provisions should be retained, amended, or removed, with the objective of harmonizing a single set of rules for all financial institutions. 

Significant concerns also have been expressed about the role of equity research for smaller and mediumsized public companies.  In 2023, the SEC’s Small Business Capital Formation Advisory Committee considered the role of equity research in anticipation of the sunset of MiFID relief and adopted a recommendation for the SEC relating to research. The Office of the Advocate for Small Business Capital Formation has considered the role of research for smaller public companies.  In its 2023 annual report, for example, the OASB noted that small public companies place greater importance on increasing research coverage than large or mega-cap public companies.  The average number of analysts covering a mega-cap public company is more than four times higher than at small public companies.  Legislation introduced in the House, in the Financial Services Committee, would mandate a study of the SEC’s research rules. 

See the full text of the Commissioner’s remarks here.

Chair Gensler recently testified before the Subcommittee on Financial Services and General Government in connection with the Securities and Exchange Commission budget request.  In his testimony, the Chair included a number of important statistics.  For example, he pointed to the size of the U.S. capital markets, now at approximately $110 trillion, or 40% of the world’s capital markets, while the United States represents 24% of the world’s economy.  He noted that now, approximately 58% of U.S. households own stocks, up from 52% in 2016, and more than half own registered funds.  The U.S. debt capital markets facilitate 75% of debt financing of non-financial corporations, whereas in Europe, the UK, and Asia, only between 12% to 29% is raised in the capital markets.  The entire U.S. banking system is $23 trillion.  The U.S. capital markets are nearly five times the size of the U.S. banking sector.  There are more than 7,400 active reporting companies, up from about 6,800 in 2020.  Of the 7,400 reporting issuers, 4,000 companies are listed on U.S. securities exchanges.  Transaction volume in listed equities doubled in the last five years and tripled in the last 17.  Today, more than 15,400 registered investment advisers advise 57 million clients.  At the end of 2016, by comparison, 12,000 registered investment advisers advised 43 million clients.  Commenting on the SEC’s enforcement activity, the Chair noted that in fiscal year 2023, the SEC received more than 40,000 separate tips, complaints, and referrals from whistleblowers and others, a 13% increase over fiscal year 2022.  The Enforcement Division brought 784 enforcement actions in fiscal year 2023, a 3% increase over fiscal year 2022.  These resulted in orders for $4.9 billion in penalties and disgorgement.  Of course, the Chair requested an increase in budget allocation for the SEC; the full testimony is available here, and his oral remarks are available here.

Commissioner Uyeda spoke at the Securities and Exchange Commission’s 30th Annual Institute for Securities Market Growth and Development. Commissioner Uyeda focused on the need to root out bad actors and promote transparent disclosures to promote market integrity and confidence. The Commissioner noted that removing bad actors from the market should lower the cost of capital. He pointed out that regulation should be cost-efficient. Commissioner Uyeda noted that reducing the costs might be achieved by eliminating duplicative regulations and cooperating with international regulators in their efforts to oversee markets. He also touched on the role of new technologies in achieving efficiencies, like tokenization. He noted that, “[t]okenization may provide transactions with a higher level of security, transparency, and immutability. It also may remove the need for most intermediaries, streamlining the process and reducing transaction costs.” He pointed to the November 2023 UK Financial Conduct Authority’s blueprint on implementing tokenization for FCA-authorized funds, followed by a March 2024 interim report on use cases and next stages for fund tokenization. These, he noted, are good models for other regulators to consider as they evaluate tokenization and the role it might play in reducing transaction costs. See the full text of his remarks here.

The PIPE market has proven to be resilient during times of stress.  In 2023, issuers raised over $33.8 billion in 809 PIPE transactions according to PrivateRaise.  This is considerably less than in 2021 during which issuers raised over $108.8 billion.  However, PIPE transaction activity has accelerated during the first five months of 2024.  Between January 1 and May 31, 2024, issuers have raised $14.5 billion, or an increase of 34% in the amount raised over the same period in 2023. 

Life sciences companies have always been particularly dependent on PIPE transactions.  Life sciences issuers accounted for 44% of all PIPE transactions in 2023 and for 55% of PIPE transactions through May 31, 2024.  Life sciences companies raised over $8.5 billion across 187 PIPE transactions during the first five months of 2024, with deals raising an average of $45.6 million.  Of all life sciences equity follow-on offerings undertaken in 2024, PIPE transactions accounted for 32% in 2024 through mid-March. 

There are various reasons why issuers choose PIPE transactions—often issuers are motivated by the quick execution and in other instances PIPE transactions may the best financing alternative to raise capital for an acquisition, for example.  See our At A Glance: PIPE Transactions infographic for additional data.

On May 22, 2024, the US House of Representatives passed H.R. 4763 – the Financial Innovation and Technology for the 21st Century Act (FIT21) – the first time a chamber of Congress has passed major digital asset legislation.  While the prospects of FIT21 becoming law remain very uncertain, FIT21 is an important milestone in the evolution of digital assets regulatory proposals in the United States.

In this Legal Update, we provide a summary of FIT21 and its key provisions.  We also provide a roadmap for how FIT21 may be considered in the Senate in the coming months.

Continue reading this Legal Update.

On May 13, 2024, the US Securities and Exchange Commission (“SEC”) and the US Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) issued a joint notice of proposed rulemaking (the “CIP Proposal”) that would apply customer identification program obligations to SEC registered investment advisers and exempt reporting advisers. In this Legal Update, we provide background on recent efforts by the US government to expand the scope of AML compliance obligations to new markets and market participants, a summary of the CIP Proposal, and a discussion of key takeaways from the CIP Proposal and FinCEN and the SEC’s invitation for public comment on its contents. 

Continue reading this Legal Update.

Several days ago, FINRA released guidance updating its Frequently Asked Questions relating to Rule 2210 on Advertising and Public Communications to address Artificial Intelligence.  This follows after FINRA has consistently been noting that the use of AI and AI tools should be addressed by member firms in their policies and procedures and may implicate their regulatory obligations.  The two new FAQs are accessible from the FINRA page on FAQs About Advertising Regulation.

The first addresses supervising chatbot communications and asks, “If a firm uses AI technology to create chatbot communications that are used with investors, how should the firm supervise that activity?”  FINRA notes in response that these communications may be subject to FINRA communications rules as correspondence, retail communications, or institutional communications.  The communications, like other communications, would be subject to FINRA Rules 2210 and 3110.  Rule 3110(b)(4) requires firms to establish, maintain, and enforce written procedures for the review of incoming and outgoing written (including electronic) correspondence relating to the firm’s investment banking or securities business that must be appropriate for the member’s business, size, structure, and customers.

The second addresses AI-created communications and asks, “Is a firm responsible for the content of communications created using artificial intelligence (AI) technology?”  Of course, as one would expect, firms are responsible for all communications, including AI-generated communications.  FINRA in the response reminds firms that they must ensure that AI-generated communications comply with applicable securities laws and regulations and FINRA rules, including compliance with supervision requirements, recordkeeping requirements and content standards, among others.

The Securities and Exchange Commission announced an upcoming meeting of its Investor Advisory Committee, which will be held on June 6, 2024.  The agenda includes a number of interesting topics.

The Committee will consider and address the impact of “finfluencers.”  The agenda notes that recent studies have found that these social media influencers who focus on financial services seem to have a particular impact on younger investors and on investors of color.  According to studies, investors of color are more apt to rely on social media, trading apps and similar sources of information, rather than investment advisers, for financial information.  Among the materials that will be considered and presented at the meeting is a January 2024 study titled, “The Finfluencer Appeal:  Investing in the Age of Social Media,” which was published by the CFA Research & Policy Center.  The study considered the role of social media in the financial services sector, focusing specifically on finfluencers who provide general investment information, promote investment products, offer investment guidance and sometimes make investment recommendations.  The report analyzes the finfluencer model and the adequacy of regulatory and policy frameworks in several jurisdictions, including the United States, the United Kingdom, Germany, France and the Netherlands.  It notes that generally the content published by these influencers is not tailored or customized by region.  Most of the content discusses individual stocks, index funds, and ETFs.  The study makes a number of suggestions for regulators—among these, the study suggests that regulators should develop a more universal definition of an “investment recommendation;” that national regulators should engage with finfluencers; that national regulators should record and publicly report data on complaints and whistleblower activity relating to finfluencer posts and commentary; regulators should enhance social media controls; and finally that firms using finfluencers should provide compliance training, review their posts, and maintain records of their posts and materials.  FINRA is already focused on the activities of member firms with respect to finfluencers.  We commented on this in an earlier post.  The Committee will consider recommendations in light of the issues raised by the study, as well as those already known to FINRA and observed by others.

The Committee also will consider the development of various AI technologies and address issues related to disclosures, data controls, bias, and education, with the objective of understanding how the SEC might promote the advancement of AI while addressing these concerns. 

Following the financial sector disruptions in 2023, financial institutions turned first to covered bonds for funding and the covered bond market demonstrated its resilience.  Just as the covered bond market remained available through the financial crisis in 2008 through 2010, it remained a safe harbor in recent times.  Now, four continents (in addition to Europe) have a covered bond framework.  The United States remains the only significant market that does not have an efficient legal framework to facilitate issuance.  At the end of 2023, there were more than EUR 2.3 trillion in covered bonds outstanding globally. In 2023, issuance of USD-denominated covered bonds increased by almost 9% year-over-year, reaching over $35 billion in covered bonds issued.  Canadian issuers lead the issuance of USD-denominated covered bonds, with over $78 billion in covered bonds issued since 2018.  In our latest At A Glance infographic, we provide key facts and stats about the covered bonds market.

For the latest on covered bonds, visit www.us-covered-bonds.com/.