New SEC Chairman

This week, Jay Clayton gave his first public speech as the new SEC Chairman. It was…interesting. Most of his comments seem fairly benign but I’d like to “read the tea leaves” a little.

“The SEC has a three-part mission: (1) to protect investors, (2) to maintain fair, orderly, and efficient markets, and (3) to facilitate capital formation. Each tenet of that mission is critical. If we stray from our mission, or emphasize one of the canons without being mindful of the others, investors, companies (large and small), the U.S. capital markets, and ultimately the economy will suffer.”

This is on par with the commission’s goals in the past. Really, number one and number three more than anything else. Number two only really happens when something hits the fan and the markets are decidedly unorderly but I’m not going to split hairs with this guy.

“How does the SEC assess whether we are being true to our three-part mission? The answer: the long-term interests of the Main Street investor. Or, as I say when I walk the halls of the agency, how does what we propose to do affect the long-term interests of Mr. and Ms. 401(k)? Are these investors benefitting from our efforts? Do they have appropriate investment opportunities? Are they well informed? Speaking more granularly: what can the Commission do to cultivate markets where Mr. and Ms. 401(k) are able to invest in a better future?”

This is a little interesting for me. Most of these comments seem supportive of that first goal: to protect investors, but the last line takes the whole paragraph in a different direction. There is a spiritual difference between “protecting investors” and “cultivating markets.” Protecting investors implies that there are unscrupulous companies looking to defraud investors and the SEC is keeping them at bay. “Cultivating markets” implies that there are fantastic investment opportunities that “Mr. and Ms. 401(k)” can’t access. I would say that both statements are probably true but if they are, then the hidden fourth objective of the SEC is to not only do a better job of knowing when a company is bad, but to also make it easier for good companies to access public markets. So far that sounds like a dubious prospect at best. How do you make it easier to enter public markets while simultaneously restricting public markets? Either, the SEC has been creating a tough regulatory environment and the cost is that a few good companies get excluded, or it has been creating a tough regulatory environment and a ton of good companies get excluded. Either way, the SEC wants more companies to regulate.

“I believe in the regulatory architecture that has governed the securities markets since 1933. It is abundantly clear that wholesale changes to the Commission’s fundamental regulatory approach would not make sense.”

Ok, that’s one approach. So as a reminder, here’s what we know: 1) The SEC wants to protect the public, 2) The SEC wants to incentivize companies to be traded on a public exchange, and 3) The SEC is totally happy with current regulatory measures. Hmmm….

“Incremental regulatory changes may not seem individually significant, but, in the aggregate, they can dramatically affect the markets. For example, our public company disclosure and trading system is an incredibly powerful, efficient, and reliable means of making investment opportunities available to the general public. In fact, this disclosure-based regime has worked so well that we — not just the SEC, but lawmakers and other regulators — have slowly but significantly expanded the scope of required disclosures beyond the core concept of materiality. Those actions have been justified by regulators and lawmakers alike, often based on discrete, direct and indirect benefits to specific shareholders or other constituencies. And it has often been concluded that these benefits outweigh the marginal costs that are spread over a broad shareholder base.”

Just to recap: He is saying that small regulatory changes are good but then promptly lays out that small regulatory changes “have slowly but significantly expanded the scope of required disclosures beyond the core concept of materiality.” He’s implying that they are bad but also admits that “these benefits outweigh the marginal costs that are spread over a broad shareholder base.” Ok, good, I’m feeling a little conflicted still, do I like tough regulatory environments, or don’t I? I think I’m still supposed to like them.

“While there are many factors that drive the decision of whether to be a public company, increased disclosure and other burdens may render alternatives for raising capital, such as the private markets, increasingly attractive to companies that only a decade ago would have been all but certain candidates for the public markets. And, fewer small and medium-sized public companies may mean less liquid trading markets for those that remain public.”

Ahhhhh! See what he did?!? In the first sentence, he lumps the phrase “increased disclosure” in with “other burdens.” Now I know I am not supposed to like tough regulatory environments.

“As I mentioned earlier, evidence shows that a large number of companies, including many of our country’s most innovative businesses, are opting to remain privately held.”

And:

“One message was loud and clear: private markets operate well in many sectors and, in these areas, they offer a very attractive alternative to the public markets. I believe we need to increase the attractiveness of our public capital markets without adversely affecting the availability of capital from our private markets.”

From a traditional SEC perspective, the current structure works. The average retail investor is protected from fraud with strict and occasionally burdensome regulations. Companies that don’t want to meet traditional SEC disclosure requirements can circumvent public markets and raise capital privately from individuals that know what they are getting into. From Clayton’s perspective, traditional retail investors need an opportunity to invest in companies that don’t want to disclose things because these companies can be a great investment. But how do you do it Clayton? Lowering disclosure standards would give investors the opportunity to buy more innovative companies but it would also give them an opportunity to buy more fraudulent companies. There is also an unseen, or at least unmentioned, issue here. Some really great companies may not have an issue with disclosure, but rather don’t care for the way publicly-traded companies are beholden to shareholders on a quarterly basis. Wall Street “short-termism” will not be solved by the SEC.

Unicorns

There is something to be said for private companies not wanting to go public. Snap and Blue Apron, two of this year’s most closely followed IPOS have struggled to maintain their high valuations in the face of investor scrutiny. In case you are wondering, these are great examples of why traditional retail investors (Mr. and Ms. 401(k)!) don’t need access to private markets. Since its initial public price of $17, Snap has dropped to $15.44 at the time of writing this blog and Blue Apron has dropped from $10 (already a discount) to $7.37. How do companies get valuated so high in private markets? Essentially, it’s supply and demand. There is also a little bit of disclosure (or lack of). There aren’t a lot of (attractive) private companies to invest in, but a tremendous amount of private dollars with which to fund them. Also, the actual prices are not disclosed daily, or revalued. And this is OK! When a billionaire makes an investment in a private company and quickly loses 10% (or more!) it’s hard to feel sympathy. When Mr. and Ms. 401(k) (I hate that name but I can’t help myself) invest in an IPO and lose money you may start to feel like the company’s valuation should have been reported more accurately.

Traders

Bloomberg posted a great article on bored traders.

“One bond trader says he’s been slipping out early to watch his kids play sports. A fund manager says his office just staged a golf retreat. A trading supervisor at another bank confides he’s swiping through a lot of profiles on Tinder, the dating app.”

Yes, that’s right! Boring markets have recently driven Wall Street bond traders to spend time with their family! I guess that’s news…

“After four straight quarters of rising income from trading, the biggest U.S. investment banks spent the past few months in a renewed slump. Shareholders will soon see how dull it’s been. Analysts estimate the five largest firms will say their combined revenue from trading dropped 11 percent from a year earlier to $18.4 billion— the smallest haul for a second quarter since 2012. The banks start posting results July 14.”

Sure, slowing markets are probably worth reporting on but also, like, of course investment managers date, play golf, and occasionally spend time with their kids. But then,

“One portfolio manager said he left work for a few hours in late June to play his recently delivered Nintendo — the NES Classic Edition — a new miniature version of the iconic video game console originally released in 1985.”

And also, “the executives asked not to be identified discussing their activities.” Well sure, I wouldn’t either but probably for different reasons. If my job was so slow that I was forced to play miniature versions of video games from my childhood I would just be embarrassed. Mostly because this would mean that all the new, cool video games had been played and I was starting back at the beginning. This reminds me of when Netflix tries to encourage me to “Watch It Again.” I’ve seen all Netflix has to offer and now it’s time to replay the old favorites.

Also, there’s this:

“‘Something always blows up over summer,’ he said. ‘We’ve seen it for many years.’ But even an escalation — or resolution — of tensions with North Korea, or a terrorist attack, would probably only spur ‘a very short and temporary impact,’ Compass Point Research & Trading bank analyst Charles Peabody said.”

Put differently, “I hope something terrible happens so I don’t have to watch my kids play soccer.”

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