SEC Chair White Calls for Vigilance of the “Unicorns”

SEC Chair Mary Jo White outlined the opportunities, challenges and risks of “Silicon Valley” technology in the financial markets and urged entrepreneurs and issuers of private companies – particularly of “unicorns” (private start-up firms with valuations that exceed $1 billion) – to focus on investor interests.

Chair White examined the following challenges for new and evolving markets:

  • Pre-IPO Financing: Chair White asserted that despite broad sophisticated investor awareness that the majority of pre-IPO companies fail, venture capital firms, private equity funds, smaller retail investors and the “next . . . student whose great idea needs funding” all equally lose when “participants choose – with eyes wide open – to invest in private companies at valuations that may be ethereal or over-inflated.” She called for vigilance of so called unicorns, by establishing robust internal controls and governance procedures to provide accurate disclosures of financial results.
  • New Models of Capital Formation: Chair White declared that the SEC will hold brokers and funding portals responsible to be “bulwarks of investor protection” in securities-based crowdfunding that was recently introduced by Regulation Crowdfunding. She also emphasized that the SEC is counting on advisers as “gatekeepers” presenting information on the significant risks involved to make secondary market trading work fairly for investors. Although Chair White recognized that many secondary market participants may be “buy and hold” investors seeking exposure to late round pre-IPOs to profit from an eventual IPO or acquisition, she asked for regulators to scrutinize these emerging platforms to ensure they provide a functioning market that operates within the disclosed parameters.
  • Financial Controls and Corporate Governance: Chair White noted a “current slow-down” in IPOs and that unicorns are staying private longer. She called on entrepreneurs and their advisers, venture capital and private equity investors as well as general industry leaders to request that private startups develop enhanced governance structures and internal control environments to match their respective size and impact.
  • Fintech: Chair White highlighted that the SEC is exploring whether: (i) blockchain technology applications require registration under existing SEC regulatory regimes, such as those for transfer agents or clearing agencies; (ii) “robo-advisors” meet Investment Advisers Act obligations and their fiduciary duties when they solely provide automated advice; and (iii) online marketplace lending platforms provide adequate information to investors on offered securities and whether these offerings are registered or made using an exemption.

Chair White concluded by encouraging cooperation between the SEC and Silicon Valley.

Chair White delivered her remarks at the SEC-Rock Center for Corporate Governance speaker series, “The Silicon Valley Initiative: Protecting Investments in Pre-IPO Issuers.”

Lofchie Comment: While it is certainly appropriate for the SEC to concern itself with investment in private issuers, the SEC should also be concerned that the costs of the regulation that it imposes might discourage companies from going public. Put differently, the SEC should consider whether it is selling a “product” (access to the public capital markets and exchange liquidity) that is unattractive in light of its subsequent costs.

Congress should also be concerned about the deterrent costs of needless regulation. When issuers and investors see that the costs of going public include regulatory requirements such as those relating to “conflict minerals” or “compensation ratios” that have no reasonable benefit to either party, they may forsake liquidity for the sake of rationality.


Federal Reserve Bank President Evaluates Federal Reserve Board Actions Post-Crisis

President of the Federal Reserve Bank of New York William Dudley praised the Federal Reserve Board for providing support to firms during the financial crisis and criticized efforts either to make the Board’s monetary policy more formulaic or to subject the Board to greater political control. At the Annual Meeting of the Virginia Association of Economists, President Dudley emphasized historical lessons and that the United States should maintain a strong central bank “insulated from short-term political pressures in [its] conduct of monetary policy.”

Drawing conclusions from the 2008 crisis, President Dudley asserted that:

  • The regulatory community did not fully grasp the vulnerability of the financial system. Accordingly, the Federal Reserve took actions to: (i) raise capital and liquidity requirements, (ii) put banks through annual stress tests, (iii) establish the Large Institution Supervision Coordination Committee to evaluate large firms, and (iv) set up the Office of Financial Stability.
  • The financial system needs to explain its actions with greater transparency. To increase transparency, Mr. Dudley stated, the Federal Reserve now (i) issues statements after each Federal Open Market Committee meeting, and (ii) holds a press conference four times per year to explain the Committee’s releases and its economic projections.
  • Some large financial institutions had become too-big-to-fail. Title II of the Dodd-Frank Act presently establishes a process to ensure that any financial firm can be resolved without threatening the viability of the financial system and without putting taxpayer funds at risk.

Lofchie Comment: President Dudley asserts that when the Board extended credit in the financial crisis, “it intervened to prevent the failure of several systemically important institutions, including firms it did not supervise – namely Bear Stearns and AIG.” The gist of Mr. Dudley’s remarks seems to be: if the Board made any mistakes leading to the crisis, it was not realizing that others would screw up. Wouldn’t it have been fairer to say that if the Board had not existed as a lender of last resort, the entire financial system might have collapsed, including institutions that were supervised by the Board? Isn’t it the case that a large number of banks would have failed without access to the Fed’s Discount Window?

There is no disagreement with the fact that the Board did step in as a lender of last resort. But there is an inconsistency between simultaneously claiming the need to learn from mistakes and the claim to have succeeded brilliantly. According to Mr. Dudley, whatever mistakes the Board might have made leading up to the financial crisis, without the Board’s wise conduct since that event, “the recovery would have been slower, the unemployment rate would have been higher, and there would have been a greater risk of deflation.” To those who worry that the Board’s policies have unduly distorted market forces, Mr. Dudley “simply responds” that “monetary policy always affects financial markets.” Shouldn’t a response be a little less simple? Like by how much and for how long

OCC Summarizes Latest Developments of Its Innovation Initiative

The Office of the Comptroller of the Currency (“OCC”) published the latest summary of its “Innovation Initiative.” The initiative has undertaken the development of a framework to improve the agency’s “ability to identify and understand trends and innovations in the financial services industry, as well as the evolving needs of consumers of financial services.”

In the white paper titled “Supporting Responsible Innovation in the Federal Banking System,” the OCC defined responsible innovation to mean “[t]he use of new or improved financial products, services and processes . . . consistent with sound risk management and . . . aligned with the bank’s overall business strategy.” Having surveyed the regulators it deemed most “resilient” during the financial crisis, the OCC listed the negative risks associated with certain kinds of innovation, and noted the importance of emphasizing effective risk management and corporate governance in defining responsible innovation.

The OCC stated that it would support innovation that is “consistent with safety and soundness, compliant with applicable laws and regulations, and protective of consumers’ rights,” and highlighted eight principles that were designed to reflect that goal and guide the development of its framework for evaluating products, services and processes. Those principles emphasized the need to “[s]upport responsible innovation” and “[f]oster an internal culture receptive to responsible innovation.”

In a speech delivered at Harvard Kennedy School’s New Directions in Regulation Seminar, Comptroller of the Currency Thomas Curry conceded that “the banks we supervise – as well as [financial technology companies] – might view us as inhospitable to innovation.” He also acknowledged that the competitiveness of traditional banks is challenged increasingly by financial technology companies. Comptroller Curry summarized his own views as follows:

Not every innovation is appropriate for a regulated financial institution, and not every innovation that is appropriate for a regulated institution is appropriate for all regulated institutions. But avoiding new approaches completely is equally dangerous. Banks have to continuously adapt to prosper, and we, as regulators, have to be knowledgeable enough to understand new technology and nimble enough to render timely decisions on matters requiring regulatory approval, as well as guidance about our supervisory expectations [emphasis in original].

The OCC is soliciting comments, which are due by May 31, 2016, on all aspects of the paper.

Lofchie Comment: A regulatory mindset that regards the failure to innovate as an indicator of a legal violation ultimately will discourage the very innovations that Comptroller Curry praises, since restrictions and punishment tend not to engender creativity. It is inevitable that bank regulators are cautious. Even so, a regulator’s inclination to say “no” to innovation by punishing failed innovation is likely to give the less regulated a strong competitive advantage.


Today’s WSJ: ‘Focusing on Bank Size, Missing the Real Problem’…

Today, The Wall Street Journal published an op-ed titled “Focusing on Bank Size, Missing the Real Problem.”

CFS Board Member and former Treasury Under Secretary Randal Quarles and I note how:

The new president of the Minneapolis Federal Reserve Bank, Neel Kashkari, along with Bernie Sanders, Elizabeth Warren, and Sherrod Brown believe that breaking up “too big to fail” institutions or turning them into regulated utilities is the only way the country can be confident that the 2008 bailouts won’t be repeated.

This proposal is misguided.

We offer three solutions:

– Facilitate orderly liquidation of failing or failed banks.
– Adopt a monetary policy rule to reduce the incentive for banks to take dangerous risks.
– Fully measure and evaluate the impact of Dodd-Frank before arbitrarily taking an ax to big banks and irreparably damaging the economy.

View the full article.