Triumphs and unfinished business: SEC Chair Gary Gensler's first three years

October 10, 2024 3:45 PM

SEC Chair Gary Gensler came to the agency three years ago with plans to overhaul public markets' plumbing, make the industry uninhabitable for bad actors and fence in the "Wild West" of cryptocurrency.

Much of his ambition came directly in response to events of recent years. The "meme stock" craze of 2020 — which saw online commenters carry out an unlikely plan to drive shares of GameStop, AMC and other disfavored companies sky high — gave rise to questions about whether ordinary investors were being manipulated.

Similar concerns accompanied the advent of commission-free online trading, pioneered by Robinhood Markets in 2013 and eventually embraced by nearly all of its competitors. Skeptical regulators were quick to note brokerages had simply replaced commissions with a "payments for order flow" system giving them rebates for routing trades to certain wholesale market makers.

Along with his concerns about markets, Gensler arrived at the SEC full of suspicion about the multi-trillion dollar market for cryptocurrencies and other digital assets. His doubts were shown to be well-grounded with the spectacular collapse of the offshore crypto exchange FTX in November 2022.

Meanwhile, Gensler has also been one among many regulators trying to come to grips with the latest technological craze to capture the world's attention. The release of the large language model ChatGPT in late 2022 was followed quickly by anxieties about how artificial intelligence, machine learning and similar innovations might change markets in irrevocable and unpredictable ways.

Gensler has responded to all this with perhaps the most extensive regulatory agenda put forward by an SEC chair in recent memory. By the SEC's own count, he had more than 50 items on his original to-do list.

The majority of those — 43, says the SEC — have gone on to be implemented. Among them have been some big triumphs from Gensler's perspective: A requirement that public companies report cybersecurity breaches within four days; a mandate that stock trades be settled in a day (and other sweeping market reforms); and changes to a "naming" rule requiring investment funds to pursue the investing priorities that their names suggest.

The SEC's enforcement arm has also responded to Gensler's zeal for weeding out bad actors. The agency collected a record $6.4 billion-plus in penalties in its 2022 fiscal year and followed that with a $5 billion haul in 2023. Much of the fining has been driven by a crackdown on firms' failure to track employees' use of WhatsApp and other encrypted messaging services for business-related communications.

Amy Lynch, the founder and president of the regulatory consultant FrontLine Compliance, also gives Gensler credit for enforcing the SEC's new marketing rule allowing only accurate and substantiable statements in firms' advertising material. The requirements were approved before Gensler took office, but he has overseen a steady increase in enforcement cases.

"That was the first time that the Investment Advisers Act [of 1940] was ever truly significantly changed," Lynch said. "So he can take ownership of that one. That's probably his biggest win, purely from an asset management space perspective."

Of course, not all has gone as planned. Some rules, such as one calling on advisors to eliminate conflicts of interest in their use of AI and similar technologies, have been sent back to the drawing board following intense pushback from industry groups. Others were adopted only to be stalled in court. Such was the fate this June for a rule requiring private equity and hedge funds to provide their investors with detailed quarterly reports on fees and expenses.

Throughout all of this, industry groups have expressed discomfort with different parts of individual proposals and sought changes. Their bigger complaint, though, has simply been that the SEC is trying to do too much, too fast.

Carlo di Florio, the global advisory leader at the compliance firm ACA Group, said Gensler has certainly left a mark on market regulation with his ambitious rule-making agenda and accomplishments. A more unfortunate part of his legacy, though, may be industry groups' now freshly stoked willingness to fight every new regulation in court.

"So we're now in an environment where any chair of the SEC is going to have to be really thoughtful and really careful about what kind of rule they want to bring forward, and then to define that rule proposal in a way that will position it for success if it is finalized and it becomes challenged," di Florio said. "That's a big change."

Gensler himself has given little indication in recent interviews of any second-guessing. "Knowing everything we know now, we would probably have laid out a similar agenda," Gensler told Bloomberg in an interview in February.

With the U.S. presidential election less than a month away, time may be running short for Gensler to finish everything he set initially out to do. Scroll down for a list of his biggest bits of unfinished business related to wealth management.

Eliminating conflicts from AI

The SEC put forward a rule in July 2023 seeking to make advisors responsible for eliminating or neutralizing any conflicts of interest that may be inherent in any sort of AI, machine learning or sophisticated algorithm they may be using to provide investment advice or other client services. The proposal was greeted almost immediately with pushback from many corners of the industry. Critics contended the rule's wording was so far-reaching and ambiguous, it could conceivably apply to spreadsheets and other sorts of applications long in use.

The proposal has since been sent back for redrafting. Di Florio said he thinks AI regulation remains a priority. But he also believes chances are growing slim that Gensler will be the one pushing a new rule across the finish line.

"I think the new administration will want to take a fresh look at the process and all feedback that came in from the industry and carefully think about the next steps before bringing anything forward in these areas," he said.

Ben Marzouk, a partner in the Washington, D.C., offices of Eversheds Sutherland, said the SEC might even try an entirely different tack. With the U.S. Supreme Court having handed down decisions rolling back administrative agencies' rule-making authority, regulators' next move might be to try to do something within existing conduct standards.

Marzouk noted that the SEC's Regulation Best Interest already requires advisors to make sure any investment recommendation they're giving is in clients' best interest. The agency, he said, could simply try to extend its definition of "recommendation" to include advice dispensed by AI.

"That could be a sort of safe space for people at the SEC who want to broaden the rules to cover these AI-types technologies, but also want to do it in a manner that doesn't really upset the industry," Marzouk said.

Custody rule

A rule proposed in February 2023 would extend the SEC's custody requirements to cryptocurrencies, private securities, real estate, derivatives and other so-called alternatives. Wealth managers are now under an obligation to custody — or hold for safekeeping — assets such as stocks and bonds in clients' advisory and brokerage accounts.

The proposed extension of custody requirements came in response to the increasing popularity of nontraditional investments in private markets, digital assets and other vehicles. Custodial firms like Charles Schwab and BNY Mellon's Pershing provide an outside set of eyes to help make sure nothing untoward is happening with clients' assets.

But like so many proposals put forward by Gensler, his new custody rule quickly met with industry resistance. One of the biggest complaints was that small RIAs struggle to get large custodians to enter into the sorts of agreements required by the proposal.

The deadline for commenting on the custody rule was extended in August 2023, and there has been nary a peep since. At this point, Lynch said, it would be a very close-run thing to try get something adopted before a new president takes office next year.

"It's going to have at least a 60-day comment period, right?" she said. "So if you take into account the 60-day comment period, and then they have to get the comments back, and then they have to review it, it would be extremely tight."

Cybersecurity

Gensler has notched two large victories regarding cybersecurity. First there was the adoption in July 2023 of the rule giving publicly traded companies four days to report data breaches to regulators.

Then in May this year, it adopted revisions to its 20-year-old Regulation S-P dealing with advisors' and broker-dealers' storage of confidential client information. Among other things, the changes allot firms no more than 30 days to alert clients of hacks.

But two pieces of unfinished business related to cybersecurity remain. One, directed specifically at RIAs and similar firms, would allow advisory firms 48 hours to provide confidential reports of data breaches to the SEC and to disclose to clients current cybersecurity risks and past attacks.

The other, aimed at the broker-dealer side of the industry, would require brokers to immediately tell regulators of hacks and follow up in 48 hours with more detailed reports.

Di Florio and Lynch both thought these proposals may still have enough momentum to be adopted. Di Florio noted that the requirements for advisors are on the SEC's agenda for this fall.

"I think cybersecurity should be passed," Lynch said. "It's the no-brainer for the asset management space as far as what the expectations are."

Third-party outsourcing

Another proposed rule, this one put forward in October 2022, would make firms responsible for making sure that third-party companies they contract to provide cybersecurity, investing software and other "core advisory services" are staying compliant. This proposal also quickly ran into industry resistance.

Opponents argued that advisors are already under a fiduciary duty to make sure any service or product they recommend to a client is in the client's best interest. That, they said, extends to services and products from third parties. Many of them complained that the SEC's proposal would merely increase advisors' paperwork burden while doing little to provide additional protection to investors.

With the rule apparently stalled, firms won't have to worry about filling out all those extra documents just yet. But di Florio predicted regulatory compliance for third parties will remain a priority.

"Who could argue with strengthening oversight of third parties?" he said. "There's a risk of having concentration in a handful of vendors, with cybersecurity and so forth. So the principles I could see being picked up and carried forward."

Cryptocurrency

Gensler has never tried to hide his concerns about the digital asset industry. But his regulatory priorities suffered a serious setback in August 2023 when a federal appeals court overturned the SEC's attempt to block a bitcoin exchange-traded fund offered by Grayscale Investments.

Rather than push back against that rebuke, the SEC went on in January of this year to give its stamp of approval to 11 proposed bitcoin ETFs. Regulators have since suffered further pushback from courts in their attempts to rein in the industry.

One of the biggest questions still unanswered in Gensler's time in office is whether most digital assets are in fact securities falling directly under the regulation of the SEC. Until that matter is resolved, any regulator's bid to oversee digital assets is likely to remain firmly in the category of unfinished business.