Has Gary Gensler turned the SEC into a regulatory ‘Hotel California’?

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Securities and Exchange Commission (SEC) Chair Gary Gensler hadn’t testified before the U.S. House of Representatives for 18 months. Republican members made up for lost time when he sat down last week. They questioned the SEC’s rigorous regulation of crypto currency companies, the federal overhaul of equity markets, the agency’s controversial proposed climate disclosure rule, and why capital is shifting from the public to private markets.

Lawmakers grilled Gensler over what many critics consider an aggressively political agenda. The SEC’s conversion into an unsanctioned climate change regulator has fueled much concern on Capitol Hill. Republicans also suggested that pursuing a pro-environmental, social, and governance (ESG), anti-crypto agenda has diverted the agency’s focus away from fulfilling its core bureaucratic mission.

Many Republican members of the Committee, including Rep. Bill Huizenga (R-MI) attributed Gensler’s long congressional absence to two-years of stonewalling.

Gensler was said to have ignored a series of scathing letters sent by Huizenga, alongside Chairman Patrick McHenry (R-NC), and Sen. Tim Scott (R-SC), outlining serious concerns over SEC rulemaking. The most recent letter was sent February 22, 2023, requesting that essential documents and information be provided about the Commission’s proposed climate disclosure rule.

While the controversial rule was expected to be finalized in April, it is now likely to be further delayed until September or October. The letter outlines how the climate rule, in its current form, lacks proper transparency and administrative justification for seeking to compel public companies to disclose their greenhouse gas emissions.

In a strange series of responses to congressional requests, Gensler’s office has provided a copy of the publicly available disclosure rule (twice), a copy of the SEC’s public calendar, transcripts of previous speeches Gensler gave, and even a copy of the 2021 congratulatory letter that McHenry and Huizenga sent for his confirmation.

“Frankly it is insufficient and unacceptable what has been going on,” Huizenga said. “I think it is an embarrassment to you and to your team that you sent me a copy of the letter that I sent you and then try to call that responsive? That doesn’t make a whole lot of sense.”

At the hearing, Gensler refused to provide a clear “yes” or “no” response to Huizenga’s request for a climate disclosure cost-benefit assessment.

“I am a firm believer in Congressional oversight,” Gensler pleaded, “the SEC looked at, I think over 6,000 public registration statements, yes, there’s a lot of [cost-benefit] analysis and that is summarized and put out to public comment.”

Yet he was ultimately unwilling to confirm if the Committee will receive an internal cost-benefit analysis of the proposed rule.

Most federal agencies are required by Executive Order 12866 to show that the expected costs of an “economically significant” rule have been weighed against its expected benefits. While this rule technically excludes certain independent regulatory agencies like the SEC, it does apply to executive branch agencies like the Environmental Protection Agency (EPA). Unlike the SEC’s unilateral attempt to compel corporate disclosures of greenhouse gas (GHG) emissions in the absence of statutory authorization, the EPA is permitted to solicit GHG disclosures from registered companies.

Critics say that if the SEC is attempting to enforce the same GHG disclosures as the EPA, lawmakers should either subject the SEC to the same cost-benefit standards or prohibit the agency from acting in a manner inconsistent with its statutory limitations.

Given the lack of statutory justification for SEC non-financial climate disclosures, many GOP representatives were highly skeptical. Rep. Blaine Luetkemeyer (R-MO) quipped that he mistook Gensler for the EPA director, given that the SEC has taken on a “different mission” by expanding the scope of its rulemaking authority to incorporate ESG factors.

Gensler responded to criticisms by claiming that the SEC is “not a climate regulator” and that only public companies will be required to disclose their GHG emissions to the Commission. In responding to Rep. Joyce Beatty (D-OH), Gensler downplayed the severity of the rule’s Scope 3 requirements on small businesses.

According to his testimony, such entities listed on the registrant’s value chain would only need to provide “estimates” of GHG emissions produced by upstream and downstream activities.

However, providing such complex estimates will, in fact, prove to be very costly and burdensome to a host of small suppliers. The requirement for an unregistered company to issue these estimates is a form of compelled disclosure, since this emissions data will be incorporated in the registrant’s disclosure. The SEC may exceed its disclosure authority in compelling such information from unregistered entities.

Gensler admits that two motivating factors for the climate disclosure rule are, first, a perceived need for every public company to be more consistent with reporting GHG emissions, and, second, a need for the U.S. markets to mimic and become justified by European markets that are more ESG-friendly.

“I think that what we can do is help bring some consistency,” Gensler argued. “Also, ensure for those companies that are public that consistently helps them against some that might be making bold claims. One might call it greenwashing and the like and help them tell their stories in a consistent way.”

He added, “As the Representative said earlier, Europe also is requiring things. So, it will help us be recognized by Europe hopefully that our rules would be recognized by them rather than their more restrictive rules.”

Gensler was also criticized for the SEC’s approach to regulating cryptocurrency intermediaries. He claimed that the SEC is the “cop on the beat watching out for your constituents,” yet failed to acknowledge why the agency was caught unaware of the $9 billion collapse of FTX. Rep. Andy Barr (R-KY) pointed to how the agency overlooked Sam Bankman-Fried’s co-mingling of investor funds, refusal to assess risks, and lack of any consistent recordkeeping for transactions.

“I find it very interesting that nobody at the SEC, under your supervision, noticed that FTX, a one-time $32 billion company, was run on QuickBooks,” Barr said.

Chairman McHenry expressed concern over the SEC and Commodity Futures Trading Commission’s (CFTC) lack of agreement on classifying crypto assets. He cited three conflicting views from SEC, CFTC, and New York state officials over whether digital currencies should be labeled a security or commodity.

In the hearing, Gensler was unable to define whether the digital currency Ether constitutes a commodity or a security. In February, he argued “everything other than Bitcoin” qualified as a security.

“Basically, if the public is putting their hard-earned funds with entrepreneurs, promoters, and anticipating a profit, there’s a four-part [Howey] test and it’s a broad sweep”, Gensler said in response to McHenry’s question. “Thurgood Marshall said that Congress painted with a broad brush to protect the public.”

This lack of clarity has not prevented the SEC from pursuing 130 enforcement actions against crypto currency companies. How can the SEC justify its punishment of crypto actors when it is incapable of defining what crypto is in the first place? Here again the SEC is likely exceeding its bounds by regulating an area where Congress has not provided clear legislative guidance.

The SEC’s internal rulemaking process also raised many red flags. Under Gensler, the agency has permitted 21% less time for public comments on proposed rules, despite proposing roughly twice as many rules as previous Chairs Jay Clayton and Mary Jo White at the same point in their tenures.

Amid the proliferation of new rules, Rep. Bill Posey (R-FL) cites an Inspector General report on how the agency grapples with a 10-year high workforce attrition rate. Despite less personnel, the agency averages more than two rules a month. Rules are released at a rapid pace and often without considering existing studies or conducting proper cost-benefit analyses.

Gensler’s participation in the 5-hour congressional hearing underscores how unpopular his tenure as SEC chair has been. There was little disagreement among Republicans and Democrats over the progressive, fast-pace approach to rulemaking that Gensler has pursued.

Under him, the SEC has regulated without congressional permission, denied the typical amount of time for the public to respond, rushed new rules without weighing consequences, and unilaterally expanded its jurisdictional reach to control crypto and unregistered entities.

In summarizing Gensler’s track record at the SEC, Rep. Warren Davidson (R-OH) said:

You [Gensler] average more than two rules proposals a month, you inappropriately provide inappropriately short comment periods. You have unworkable and unlawful ESG disclosure mandates on the market. You have essentially a Hotel California rule for crypto where you can check in anytime you like, but you can never leave. You have endless discovery with no resolution and no clarity for the captives in the market. You have unworkable proposals for overhauling equity market structure, a de-facto ban on crypto through proposed custody rule. You have high staff turnover, unhappy people leaving your office, and unhappy companies and capital leaving our country.

In light of the questions and Gensler’s answers at the hearing, look for the House to conduct more oversight of the SEC. Many in Congress want the agency to pursue its historical and statutory mission, not the chair’s political agenda.