Yesterday, in the most recent installment of the Competitive Enterprise Institute’s “Repeal for Resilience” event series, CEI President Kent Lassman welcomed Securities and Exchange Commission (SEC) member Hester Peirce and former SEC Commissioner Paul Atkins for a discussion on the future of finance regulation.
Commissioner Peirce led off with a description of some of the SEC’s helpful policy responses to the coronavirus pandemic, which have resulted in reformed, rather than newly imposed, requirements. These are consistent with regulations in other areas across federal, state, and local governments, such as telehealth and food and beverage service, that have been scrapped in the fight against COVID-19. Many have been determined to have been #NeverNeeded in the first place.
Our guests also reviewed the recent reform of the Commission’s “accredited investor” rule, which limits who can invest in the private equity world. In August, CEI’s John Berlau issued a statement in reaction to the rule change:
Liberalizing the accredited investor regulation is a step toward equality and against systemic privilege. The SEC voted 3-2 to allow ordinary investors who have demonstrated their financial knowledge to have the same opportunities to build wealth as the rich do.
Previously, the SEC would only allow wealthy investors—those with income in excess of $200,000 a year or net worth (excluding personal residence) of more than $1 million—the opportunity to invest in private stock offerings not weighed down by the red tape from laws like Sarbanes-Oxley and Dodd-Frank. Now, ordinary investors who hold credentials like Series 7 certifications may join the “accredited” club and have the same opportunity to build their wealth by buying shares in early-stage growth companies.
Keeping strict limits on accredited investor status is a classic example of governmental paternalism that “protects” Americans from investment gains as much as investment losses. In a nation in which many people believe that opportunities for wealth accumulation are unequal, this “modernization,” as the Commission termed it, is a step toward making opportunities for both risk and reward equally available to all.
Peirce and Atkins also considered the regulatory prospects for cryptocurrencies. Since the SEC’s portfolio includes regulating both traditional securities and various kinds of “investment contracts,” they may have a role in the crypto world, though to what an extent will be governed, in part, by the Supreme Court decision in SEC v. W. J. Howey Co. (1946). Manhattan Street Capital, for example, has a short explainer on how crypto tokens could be considered an investment contract under Howey, and therefore be subject to regulation by the SEC. My CEI colleague John Berlau, however, maintains that most cryptocurrencies fall outside even Howey’s broad definition of securities, and the SEC is clearly exceeding its jurisdiction.
But Commissioner Peirce also looked at the question as a matter of a token issuer’s timeline, or lifecycle. In its early phase, raising capital for the launch of a new cryptocurrency may look like an investment contract, but in its mature phase, the token may trade in a way that is very different. So the Commission should be aware of this and structure rules that protect investors while not choking off useful financial innovation, including offering “safe harbor” protections for novel investing structures, so that the legal uncertainty of potential enforcement action doesn’t care off investors. Peirce emphasized that this wouldn’t constitute a special favor to a particular business structure or an attempt to favor an “infant industry” while it gets off the ground, but simply allow new investment types to come to market without undue burdens.
Our guests also took a look at environmental, social, and governance (ESG) investing, and what position regulators should take regarding it. Atkins acknowledged that similar concepts, like “impact investing,” have been around for a long time, and that it’s perfectly appropriate for investors to choose to prioritize non-monetary returns from their investments.
Commissioner Peirce expressed concerns that binary ESG ratings, by which firms are assigned a categorical good or bad status, are a reductive and unhelpful way of assessing progress toward ESG-type goals. This echoed remarks she delivered in 2019 in which she compared some current ESG ratings to the adultery-shaming in Nathaniel Hawthorne’s Scarlet Letter:
[In the current method of ESG assessment] we see labeling based on incomplete information, public shaming, and shunning wrapped in moral rhetoric preached with cold-hearted, self-righteous oblivion to the consequences, which ultimately fall on real people. In our purportedly enlightened era, we pin scarlet letters on allegedly offending corporations without bothering much about facts and circumstances and seemingly without caring about the unwarranted harm such labeling can engender. After all, naming and shaming corporate villains is fun, trendy, and profitable.
Peirce also expressed concerns that choking off capital flows to companies that run afoul of arbitrary standards could create serious problems down the road—even for ESG advocates themselves. Consider environmentally motivated investors who shun big energy companies that currently sell a lot of oil and gas. Those same companies are the ones with the expertise, infrastructure, and resources to innovate in renewable technologies as well. Therefore, throttling access to investor capital to Chevron and Exxon today might actually slow the adoption of new, cleaner energy sources tomorrow. ESG activists should be careful what they ask for.
There’s a lot more in the full video, so please watch and share with anyone interested in the future of the SEC.
This post was updated on October 1, 2020 to include a reference to John Berlau's CEI paper "Cryptocurrency and the SEC’s Limitless Power Grab: Why Speculative Consumer Goods Are Not 'Securities.'"