Talking With SEC's Uyeda; Judges Weigh Constitutionality of Finra; Companies Worry About AI Regulation
Capitol Account: Free Weekly Edition
Financial regulation hit all three branches of government this week. The U.S. Court of Appeals for the Fifth Circuit in New Orleans heard an important challenge to an SEC hedge fund regulation. But that didn’t deter the agency from moving ahead with another rule that the industry vehemently opposes — setting new oversight for firms that trade a lot of government debt. On the Hill, Treasury Secretary Janet Yellen testified in both the House and Senate. She got an earful on bank capital. Also on the legal front, we covered the oral arguments in Washington’s federal appeals court over whether Finra’s in-house judges and board members should be appointed by the president. And we took a look at companies’ growing angst over the SEC chair’s interest in AI. For our Friday interview, we spoke with a Republican commissioner at the securities regulator.
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Friday Q and A: As a Republican member of the SEC, Mark Uyeda is used to being on the losing side of major policy votes. That was certainly the case this week, when the agency approved new oversight for the big trading firms that dominate the Treasury market. But his methodical – and fiery – dissent got a lot of attention, especially for the assertion that the rule was “another salvo in the commission’s war” on hedge funds and private equity.
We sat down with Uyeda in his office to hear some more. And he didn’t disappoint. Our wide-ranging conversation touched on everything from SEC Chair Gary Gensler’s busy agenda to cryptocurrency regulation to artificial intelligence.
Uyeda knows the SEC from the bottom up – he’s been at the agency since 2006 and held a wide range of roles, including as a staffer in the investment management division and a senior adviser to two commissioners and a chairman. Uyeda also has Capitol Hill experience; he was on detail to the Senate Banking Committee when he was nominated in 2022. Before joining the SEC, he worked as a private lawyer and as a top aide to California’s securities regulator.
What follows is our (lightly edited and condensed) conversation.
Capitol Account: Plenty of people took notice this week when you discussed the war on private funds in you comments on the Treasury dealer rule. What did you mean by that?
Mark Uyeda: We have had a steady set of regulations, which just seem to be designed to impose very significant crushing regulation – and to smaller private fund managers in particular. That includes Form PF, the private fund adviser rule amendments, others that we've done on short selling disclosures, securities lending activity and even say on pay.
CA: What’s driving this?
MU: It is unclear to me. I've heard a lot of different theories out there. We’ve had this ongoing discussion between the public and the private markets and whether or not we've made it too easy to raise money privately. Is the thought that if we make it more difficult to do private funds…then you somehow take away that as an option to raise money? So it will be forced to go into the public company reporting ecosystem? But you know, on the public company side, we've imposed a lot of new disclosure requirements. We've got another one that would potentially be very, very difficult – climate change.
CA: In August you voted against the rule that sets new disclosure requirements for private funds, partly due to concerns about the impact on smaller firms. One issue you raised is that the economic analysis stressed that managers `have the option of reducing their assets’ so they aren’t captured by the regulation.
MU: That was one of the more outrageous things I've seen. We did get a couple of letters, especially from women-owned or minority-owned firms, that said, 'This is going to be really tough’…The response was, `Well, you just should stay below $100 million.’ That's a terrible response.
CA: Is there a broader problem with that?
MU: In our regulatory system, there are very important investor protection aspects that need to be effective. But we need to do it in a way that does not create what I view as a barbell industry – where you're really large because you could absorb all these costs or you're really small…and nothing in between. What we're seeing is a lot of firms that are merging together to basically go big, or they end up breaking apart…Is that the type of industry we want?
CA: Gensler often describes these rules as promoting competition.
MU: There are goals, and there are effects.
CA: Many think the next few months at the SEC are going to be jam-packed with final rule votes. Are you seeing that?
MU: It will be a busy year. But I think that’s to be expected. It is a bit of how every chairmanship goes. They throw proposals out, and then we have the adoptions. What made the past several years difficult was there were a lot of things that came out really, really fast.
CA: What are the implications of that?
MU: I have concerns as to whether or not we properly identified the actual harm we were trying to address, and whether or not we had the sufficient data and evidence. In the ideal world, it's a bit like construction: measure twice, cut once. You want to get everything lined up. Have those discussions with all the various persons that have a view – the investor advocates, the asset managers, the traders, the retail investors, the institutional investors. And, I should say, the other government agencies. That's also very important because some of our [rulemakings] interact with, or have implications for, other areas.
CA: What’s your assessment of how the commission has been handling crypto?
MU: I think we made a lot of mistakes…We’ve been going on for a number of years, with still no real answer in sight…We have a lack of clarity and ambiguity of what makes crypto a security and what makes Bitcoin, for instance, not…We could have addressed it head on. I'm sure some people might've been unhappy, but it would've been reviewed by the judicial system. We probably would've, by now, had answers on this – and a path forward. Instead, we have extensive ongoing litigations in various forums….And what is this uncertainty doing to potential innovation? It's driving it offshore.
CA: We expect some of the most controversial rules on the chair’s agenda, including climate disclosure and the market structure overhaul, to soon come up. Are you likely to vote against them?
MU: I'll say this, there are a lot of concerns that have been raised in the comment file on those. We'll have to see, working with our staff, what the recommendation is and where the various members of the commission are. And that's how Congress designed it. That's why there are five of us….(Friday)
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Self Regulation on Trial: The federal appeals judges hearing oral arguments on the constitutionality of Finra peppered lawyers on both sides with questions, an indication that it may not be so easy to draw the line between what constitutes a self-regulator or an unaccountable private corporation exercising government power. The session in the D.C. Circuit Thursday stretched into a two-hour marathon – far beyond the 30 minutes that the court had allotted.
Still, Finra seemed to have an easier time than Alpine Securities, the recidivist brokerage that filed the case in an effort to get an emergency order blocking its expulsion from the industry. The firm’s main argument is that the SRO’s board and hearing officers are “unaccountable enforcers of federal law” and should be subject to the Appointments Clause of the Constitution. That would mean they could be removed at will by the president (or a subordinate like the SEC chair).
Finra stressed that it is solely a membership organization – and all its actions are ultimately overseen by the SEC. The group has described the suit as an “existential” challenge, and its attorney noted that the entire model of self regulation could be on the line. Toward that end, a number of conservative organizations that seek to limit the power of the administrative state weighed in with supportive briefs on behalf of Alpine. But Finra also has a powerful backer – the Justice Department, which defended it in court.
Judge Patricia Millett, in particular, had issues with some of Alpine’s arguments. “What I’m troubled by here is that I think it would be the first time, and maybe I’m wrong, that the court would be declaring someone an officer of the United States when they are hired by and employed by and paid by a private entity — without any congressional provision for their income,” she said.
Millett, an Obama appointee, underscored that Finra was different from the PCAOB where the Supreme Court found that the board members weren’t properly appointed and should be removable at will by the SEC. “You’ve got to admit this is a privately chartered corporation without government appointed boards or government funding,” she told Alpine’s attorney. “It’s a lot more complicated.”
Chief Judge Sri Srinivasan, another Obama appointee, also questioned some of the implications of Alpine’s contention. He pointed out that Finra’s board members and hearing officers could face impeachment if they are appointed under Article II of the Constitution. “That’s quite a dynamic,” he said, for “somebody who’s with what they assumed was a private company.”
The third judge on the panel, Justin Walker, had written an unusual concurrence when the court accepted the case last July, contending that Finra may have “a constitutional problem.” The Trump appointee was more sympathetic to Alpine. One issue that Walker raised was the unfettered grip that Finra has over the industry. He noted that Congress in 1983 required all brokers to be members of an SRO – but Finra is the only one. Suddenly, there was no way to escape its dictates or check its powers.
Walker described the problem with that by using a sports analogy. “Major League Baseball can decide who gets to play Major League Baseball,” he said. “But in 1983, Congress comes in and says, `you can’t play baseball at all.’”
Srinivasan also acknowledged to Alpine’s attorney “that your argument gains force because there happens to be one” SRO. But Millett noted that there was nothing stopping anybody from trying to create a competitor to Finra. “It seems like a market choice that has been made,” she said…(Thursday)
AI Angst: Business groups often complain that Gensler doesn’t engage enough with the industry before jamming out rules that could have all sorts of unintended consequences. In recent months, companies have become increasingly concerned he’s heading in that direction on artificial intelligence – a topic the SEC chair clearly has great interest in.
In a sign of the growing angst, the U.S. Chamber of Commerce sent Gensler a letter last week urging him to tread carefully before setting new guardrails for AI. The note also offers some unsolicited advice: As a first step, the agency should convene “roundtables” to gather thoughts from executives and other experts. That’s something that Gensler has generally declined to do for big rule proposals. (One major example is the market structure overhaul; the lack of get-togethers frustrated Wall Street firms so much that they’ve held their own.)
The chamber is also encouraging the commission to hire more employees with backgrounds in technology, and it says the agency should issue “concept releases” to gather lots of public feedback on areas where tighter oversight might be warranted.
The main point, it seems, is that any AI regulations shouldn’t be so onerous that they impede innovation. Here’s the broad take from the letter, written by Tom Quaadman, executive vice president of the chamber’s Center for Capital Markets Competitiveness:
“When used responsibly with other tools and human oversight, AI has the potential to revolutionize capital markets by improving efficiency, enhancing decision-making and strengthening risk management. AI can help analyze large data sets to reveal insights that traditional methods may overlook; for example: identify investment opportunities, optimize order execution across different venues and optimize portfolio allocation. When other technological advances have been embraced, such as decimalization, costs have plummeted, price discovery was improved and the vistas of investor opportunity expanded.”
Quaadman underscores that the chamber isn’t necessarily opposed to new rules, saying that with any emerging technologies, it’s “important to recognize the benefits, identify any potential adverse consequences and for regulators to put in place appropriate safeguards when needed.” But he also points out that a group of academics, business leaders and former policy makers that the chamber convened in 2022 to study AI concluded that many “activities are covered by existing laws or regulations.”
Gensler has discussed AI regularly in speeches and interviews since last summer, often postulating that it’s likely to be just as transformative as the Internet and the mass production of automobiles. While the SEC chief concedes that the technology could foster financial inclusion and improve customer service, he also warns that it might also trigger the next financial crisis. One of his top worries is that a handful of big firms will end up using just a few sets of algorithms, a situation that could prompt them to crowd into the same trades. That, he stresses, could be disastrous if there’s a sharp and fast market reversal. The chair is set to talk about AI again next week on Feb. 13, at an event hosted by Yale’s law school…(Wednesday)