So you might have missed this, but last week the Securities and Exchange Commission proposed exempting a large swath of hedge funds and other institutional investors from quarterly disclosure of their stock holdings.
For most compliance professionals, this news might seem obscure — but actually, it’s a fascinating glimpse into the crabbed state of SEC rulemaking these days.
Let’s start with what the agency wants to do. It proposed raising the threshold for compliance with Rule 13F-1, which requires institutional investors to file what’s known as a Form 13F with the SEC every quarter. That form lists a fund’s equity holdings, so financial regulators and other Wall Street players can have a better sense of what’s going on in the market.
The SEC wants to raise the reporting threshold for Form 13F from $100 million in assets under management, where it’s been since Form 13F was established by statute in 1975, to $3.5 billion.
The agency argues that since U.S. capital markets today are roughly 30 times larger than what they were in 1975, the compliance threshold should be raised by a similar degree. Managing $100 million isn’t nearly as significant as it used to be, the SEC says, so lots of smaller hedge funds are forced to comply with an antiquated rule.
How many funds would therefore be exempt from compliance under the higher threshold? The SEC estimates that roughly 90 percent of all firms filing Form 13F today would no longer need to comply at the $3.5 billion level.
At the same time, however, most money managed by institutional investors today is at large firms that will keep reporting Form 13F. Their holdings, all still disclosed as usual, would account for roughly 90 percent of the total dollar value reported today. See nifty chart below, lifted from the SEC press release.
The SEC estimates that since Form 13F went into effect 45 years ago, the number of firms forced to comply with the rule has risen from less than 1,000 back then to more than 5,000 today. Raising the compliance threshold to $3.5 billion would exempt roughly 4,500 of them and save somewhere from $68 million to $136 million in compliance costs per year.
That’s the dry SEC presentation. Now let’s hear the other side.
Opposition From Commissioner Lee
Commissioner Allison Herren Lee, currently the lone Democratic on the commission, published a statement Friday evening that lit into the SEC’s proposal “because it lacks a sufficient analysis of the costs and benefits.” More specifically:
The costs of losing transparency are glossed over in brief narrative form and largely discounted… I am concerned that the projected cost savings in today’s proposal are greatly overstated and wholly inconsistent with the Commission’s past analysis — and, importantly, that the actual cost savings do not justify the loss of visibility into portfolios controlling $2.3 trillion in assets.
Lee cited several other problems with the proposal. First, the text of the law sets the reporting threshold at $100 million or lower — meaning, therefore, that the SEC has no authority to raise the limit higher. Yes, the SEC does have some authority to adjust reporting limits that reflect good business and economic sense; but not where doing so would contradict what Congress specifically says in statute.
Second, she faulted how the SEC analyzed the potential cost savings. As recently as 2018, SEC staff estimated the cost of compliance with Form 13F at roughly $31.2 million — for the entire investment fund industry as a whole. Now the staff have produced a new analysis that pegs the cost of compliance at roughly $113.6 million.
How did the costs of compliance increase fourfold in two years? The SEC proposal says the new number is based on outreach to hedge fund managers. Lee wasn’t buying it. “More detail regarding this outreach is needed in order to ascertain whether the analysis is sufficiently rigorous and methodologically sound,” she said, “especially in light of the heavy reliance on the analysis in justifying the proposal.”
Third, Lee questioned the fundamental wisdom of this retreat from disclosure. Yes, hedge funds are relieved of the burden of compliance — but everyone else loses the benefits of that transparency. For example, smaller companies can use Form 13F data to see which funds are buying their stocks. If that visibility goes away, the small company must either hire a stock surveillance firm, or live without insight into who owns its shares or the behavior of its share price.
That’s the other side. Now let’s get to the crabbed rulemaking part.
What’s Wrong With This Picture
First, the optics of how the SEC presented this proposal look terrible. The agency floated its proposal late on Friday afternoon, when people were much less likely to see it. (This is a move SEC chairman Jay Clayton has used numerous times during his tenure.) While the agency did disclose the proposal via a press release, complete with a rah-rah quote from Clayoton, Lee was the only SEC commissioner to publish a detailed statement expressing her views about it. The three Republican commissioners are keeping quiet.
Stealthy moves like this feed the narrative that Clayton isn’t interested in thoughtful discussion of financial regulation, but rather in ramming through deregulation while nobody is looking — either because his tenure as SEC chairman is likely to end by January 2021 or because he’s bucking for that federal prosecutor job in New York.
Second, the cost-benefit analysis of the proposal is sloppy, and the Commission’s statutory authority to act is questionable. Lee brings up both points in her critique of the proposal for a reason: because that can be the groundwork for a legal challenge to whatever rule Clayton and fellow Republicans ultimately adopt. That was a standard line of attack for SEC regulation during the Obama Administration, too: challenge new rules on the basis of flawed cost-benefit analysis. Litigation would then tie up SEC rulemaking for years.
I’m not sure who might have standing to bring such a challenge here — small filers themselves, perhaps, since they would start suffering harm immediately from the lack of transparency — but Lee’s statement reads like 1,500 words of “someone please sue us if the agency actually does this.”
Third, the SEC views “cost of compliance” in simple terms. Yes, Form 13F compliance does cost firms money — but rather than exploring how to reduce those costs to make compliance easier, the agency starts with the assumption that it should reduce compliance obligations to save the firms money. That is, this SEC proposal talks about reducing compliance burdens. Instead, it could consider how to make compliance less burdensome. There’s a difference.
For example, could better use of technology allow for simpler, speedier reporting of Form 13F data? The Federal Deposit Insurance Corp. is exploring that idea for banks’ regulatory reports right now. Could the SEC do something similar here?
My point is that technology solutions exist that could make compliance less expensive for investment funds, which would preserve the benefits of Form 13F disclosure for everyone who uses that data. On the other hand, if the SEC reduces the cost of compliance simply by cutting the number of compliance obligations — that creates benefit for some (the hedge funds), but imposes a loss on others (the parties that use Form 13F data).
So we have the SEC advancing a proposal when few people are looking; with dubious cost-benefit analysis and legal authority to act, which might bring court challenge; and questions about the idea’s fundamental premise.
By the way, this is the dictionary definition of “crabbed.”
See what I mean?