Timothy M. Simons, CFA, CFP, CIPM, CSCP
Senior Managing Member
Focus 1 Associates LLC
June 27, 2017
On June 27, 2017, SEC Chairman Jay Clayton testified before the Senate Appropriations Subcommittee on the SEC’s Fiscal Year 2018 Budget Request. It was interesting to note that the FY2018 request was the same as the FY2017 appropriation, $1.602 billion. “With a workforce of about 4,600 staff, the SEC oversees (1) approximately $75 trillion in securities trading annually on U.S. equity markets; (2) the disclosures of 8,800 public companies including 77 of the world’s 100 largest companies; and (3) the activities of over 26,000 registered market participants …. We also engage and interact with the investing public on a daily basis, from our investor education programs and alerts to our SEC.gov portal where, on a typical day, investors and other market participants view or download more than 50 million disclosure documents filed on EDGAR.” This is certainly one of the reasons that the SEC is asking for $240 million for information technology in FY2018, more than 50 million documents viewed or downloaded in a single day.
“Additionally…the SEC’s funding is deficit-neutral. Whatever amount Congress appropriates to the agency will, by law, be fully offset by transaction fees, and will not impact the deficit or the funding available for other agencies. The current transaction fee rate is just over two cents for every $1,000 in covered securities sales.
The SEC also has been a net contributor to the U.S. Treasury in other ways that are not directly related to our appropriations. By law, companies pay a fee to the SEC at the time they register securities for sale. For FY2018, the fee rate will be set at a level sufficient to collect $620 million. A small portion of these collections – $50 million – will be put into the Reserve Fund, which the agency devotes to information technology improvements, while the remaining $570 million will be deposited in the general fund of the U.S. Treasury.”
Investment Adviser Examinations
“The request will also enable the SEC’s national examination program, led by the Office of Compliance Inspections and Examinations (OCIE), to focus on conducting risk-based examinations of registered entities, including broker-dealers, investment advisers, investment companies, municipal advisors, national securities exchanges, SROs, transfer agents, and clearing agencies to evaluate their compliance with applicable regulatory requirements. This is an example of an area where flexibility is necessary. Registered investment advisers now manage more than $70 trillion in assets, which is more than three times 2001 levels. In 2016, the SEC reassigned approximately 100 staff to the national examination program’s investment adviser examination unit. As a result of this shift and the introduction of efficiencies, the SEC is on track to deliver a 20% increase in the number of investment adviser examinations in the current fiscal year. For FY2018, OCIE anticipates being able to deliver a further 5% increase in the number of investment adviser exams. I expect that for at least the next several years we will need to do more each year to increase the agency’s examination coverage of investment advisers in light of continuing changes in the markets.
In the coming fiscal year, OCIE plans to increase the number of inspections to assess compliance with Commission rules designed to ensure that the cybersecurity infrastructure that is critical to the U.S. securities markets is secure and resilient. OCIE also will continue to bolster its risk-based approach to exam selection through the continued development of data analytics tools. These tools help us identify activities that may warrant further examination and efficiently focus our examination efforts.”
I respect Chairman Clayton’s remarks, especially about the examination program, but I think the SEC is going to be challenged to reach the previously identified goal of examining every registered adviser on a five year cycle. Looking at the last two fiscal years, since Dodd-Frank decreased the number of SEC registered advisers, the SEC registered adviser population has increased at roughly 5% per year, while the number of examinations of SEC registered advisers has increased at about 10% per year. For FY2016, the SEC examined 11% (an 8.8 year cycle) of the registered advisers, roughly 1,365 exams for 12,000 advisers. In FY2017, if we see another 5% increase in registered advisers (to about 12,600) and a 20% increase in the number of exams (to about 1650), only 13% (a 7.6 year cycle) of registered advisers will be examined. In order to eventually catch up, we need to minimally continue to increase exams at the 10% level (after a 20% increase this year) with registered adviser growth at the 5% level which would eventually catch up in FY2027, or in 10 years. Of course, that is assuming that the SEC can keep up the increase in the number of examinations with either an increase in staffing or an increase in the effectiveness of the use of risk analytics and technology, without an increase in the growth of the registered adviser universe.
Facilitating Capital Formation
“The Commission’s rules seek to facilitate offerings by large and small companies engaged in all manner of commerce, while also protecting investors and maintaining confidence in the U.S. capital markets.
In recent years, the SEC has carried out this responsibility through a number of key initiatives, including most recently in response to the JOBS Act and FAST Act, with a particular emphasis on expanded capital-raising opportunities for smaller businesses. While much progress has been made, I believe the SEC can and should strive to do more to enhance capital formation particularly (1) for small and emerging companies and (2) in our public capital markets. U.S. capital markets remain the envy of the world, but fewer companies are choosing to enter the public capital markets than in the past, and, as a result, investment opportunities for Main Street investors are more limited. Your support for our FY2018 budget request will enable the staff to develop and present to the Commission rulemaking initiatives aimed at promoting firms’ access to capital markets to generate economic growth while fostering important investor protections. I recently named a new Director of the Division of Corporation Finance, Bill Hinman, who is leading these efforts and working with the staff to develop proposals for consideration. Bill is a recognized leader with more than three decades of experience advising companies of all sizes in capital-raising and acquisitions. We share the view that there is no better architecture for fostering capital formation, providing investment opportunities, and protecting investors than our public company disclosure-based system.”
Key Technology Initiatives
- “Expanding data analytics tools to integrate and analyze the large and ever-increasing volume of financial data we receive, enabling us to detect potential fraud or suspicious behavior earlier and allocate resources more effectively;
- Improving our examination program through risk assessment and surveillance tools that help identify high-risk areas for further examination;
- Increasing investments in cybersecurity, including strengthening our capabilities for monitoring and avoiding advanced persistent threats;
- Enhancing additional systems that support our enforcement program, including applying sophisticated algorithms that foster the detection of potential insider trading and manipulation;
- Improving access and usefulness of information available to the public through our EDGAR electronic filing system; and
- Investing further in business processes automation and enhancements including the retirement of legacy systems.”
As we know from watching the rapid increases in technology in the past ten years, most of us cannot imagine what technology will look like ten years from today, otherwise, we would be buying the firms that will produce that technology. Perhaps all of the companies leading the indices in ten years will be start-ups in those intervening ten years. It could happen.