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PRINCIPLE FOUR:
Congress should vigorously exercise its oversight authority on behalf of the investing public – including, and especially, retail investors.

Congress has a responsibility to shine a spotlight on risks to investors and examine potential solutions to address these risks. When there is insufficient objective data to inform policymaking, Congress should exercise its authority to collect the requisite data or require the SEC to do so. Similarly, Congress should insist that the SEC prioritize issues impacting retail investors.


Oversight of Self-Directed Individual Retirement Accounts (SDIRAs).

SDIRAs allow individuals to use tax-deferred retirement funds from their IRAs to purchase “alternative” investments, such as real estate, private company stock, “over-the-counter” securities, promissory notes, and oil and gas offerings that cannot be purchased through traditional IRAs. Certain SDIRAs allow investments in  “digital assets,” which include crypto-currencies and coins and tokens, such as those offered in so-called initial coin offerings (ICOs).[i] Because SDIRAs are designed to appeal to self-directed investors, often with particular expertise or interest in certain non-traditional investments, SDIRA custodians generally do not perform the same services as a traditional IRA custodian.[ii] Specifically, SDIRA custodians generally do not have the fiduciary duties associated with investment advisers. This lack of services, and protections, is fertile soil for scammers.

A significant number of enforcement actions taken by state securities regulators each year involve scammers accessing retirement funds in SDIRAs.[iii] These schemes allow the scammers to access an investor’s 401(k) and IRA savings after they have been rolled over into the SDIRA, and they can be devastating to an investor’s retirement. The problem is amplified by the fact that custodians generally do not evaluate the quality of any investment in the SDIRA or its promoters. The 117th Congress should examine the relationship between SDIRAs and fraud, including what, if any, steps the industry is taking to address these problems or whether legislation may be in order.

Oversight of SEC Regulation Best Interest. 

To ensure that Regulation Best Interest (Reg BI) meaningfully improves broker conduct to the benefit of the investing public, Congress must conduct rigorous and robust oversight of Reg BI’s implementation. Further, such oversight should include direct scrutiny of the SEC and FINRA’s implementation activities, including examination findings and enforcement actions, and make improvements to the Regulation as needed to ensure that brokers are putting their clients’ interests first. Congress should hold hearings to examine the industry’s implementation of the new standard and encourage the GAO and other independent entities to evaluate whether investors are adequately protected. Finally, Congress should require the SEC and FINRA to periodically report on Reg BI’s impact on complex and high-risk products, such as private securities, variable annuities, non-traded real estate investment trusts (REITs), and leverage- or inverse exchange traded funds (ETFs), and account for any investor confusion and harm emanating from these products including how they are sold.

Oversight and Reform of Exchange Act Rule 10b5-1 Trading Plans.

[iv]The securities laws prohibit insider trading because, among other things, it undermines investor confidence in the fairness and integrity of our securities markets. Rule 10b5-1 under the Exchange Act provides an affirmative defense to insider trading liability for insiders who, in good faith, enter prearranged plans to buy or sell securities in the future and who are not at the time in possession of material nonpublic information. Although simple in concept, the rule has proven extremely difficult to enforce.[v] Today, it is comparatively easy for corporate insiders to manipulate the rule in order to engage in conduct that might otherwise appear to be insider trading by, for example, belittling the potential materiality of nonpublic information or instituting trading plans that can be modified or canceled prior to execution.[vi] Congress should examine the benefits of possible new restrictions, including restrictions on when issuers and issuer insiders can establish trading plans within an issuer-adopted trading window, how many trading plans they can adopt, and the number of permissible modifications to those trading plans.

Oversight of Special Purpose Acquisition Companies (SPACs).

Special Purpose Acquisition Companies, or SPACs, are companies without assets or operations that are incorporated with the sole purpose of raising capital in an IPO to acquire or merge with a private operating company and thereafter take it public. The number of SPAC offerings grew dramatically in 2020, with the number of US-listed SPACs nearly tripling this past year.[vii] SPACs can be attractive because they allow sponsors to access capital through a process that is faster than a traditional IPO and retain a potentially lucrative stake in the equity of the acquired company.[viii]

The proliferation of SPACs warrants close attention from Congress. At a minimum, SPACs deprive investors of protections afforded by traditional public company registration under the Securities Act and the Exchange Act. Further, because they bring to market companies that have bypassed the traditional IPO protocols and the associated scrutiny, SPACs present risks to retail investors, who are unaware of what company a SPAC will acquire when making their investment[ix] or whether that acquisition will close at a realistic valuation.[x] In addition, as the number and size of SPACs increase, SPACs will, out of necessity, compete for a finite number of profitable deals,[xi] which, in turn, will create pressure on SPACs to accept less favorable terms or inflated valuations.

Oversight of Direct Listings.

Like SPACs, direct listings are another way to bypass the traditional IPO process. Direct listings have become increasingly popular because they do not require the participation of underwriters, thereby making it easier, faster, and less costly to become a publicly-traded company. Further, unlike the SEC comment review found in the traditional IPO process, direct listing companies are required only to meet the listing requirements of an exchange. The price of securities offering through a direct listing is entirely market-driven, and with no underwriter-imposed lockup periods, insiders can “cash out” as soon as the company’s shares begin trading.[xii] Because direct listings have the potential to expose retail investors to significant new risks, the 117th Congress should conduct rigorous oversight of the policies and protocols that the SEC and relevant self-regulatory organizations are developing in regard to these types of offerings to ensure that investor protection is adequately considered.

Oversight of Multi-Class Share Structures.

Today, Facebook, Google, Snap, and a whole host of other companies, have dual,[xiii] and in some cases, multi-class stock structures.[xiv] The recent proliferation of multi-class share structures, designed to empower founders and executives by allowing them to take companies public while preserving control over their boards, has changed corporate incentives and behavior in worrisome ways. Congress should evaluate measures that could mitigate these problems, including a requirement that public companies with dual or multi-class share structures utilize “sunset clauses” that could require shareholders of all share classes to periodically vote on whether to extend the multi-class structure.


NOTES:

[i] See SEC Investor Alert: Self-Directed IRAs and the Risk of Fraud. (Aug. 8, 2018), available at https://www.sec.gov/investor/alerts/sdira.html.

[ii] For example, investors often wrongly assume the custodian has vetted the promoter and has approved the investment.  In fact, SDIRA custodians typically do not investigate the assets or the background of any promoter.

[iii] Most recently, in 2020, 30 states and the CFTC obtained an asset freeze and a receivership in a $185-million precious metals scam targeting senior citizens nationwide that made use of SDIRAs to execute the scheme.

[iv] In the 116th Congress, NASAA expressed support for legislation that would reform 10b5-1. See NASAA’s Letter to HFSC Chairwoman Maxine Waters and Ranking Member Patrick McHenry Regarding H.R.624 (Jan. 23, 2019), available at https://www.nasaa.org/wp-content/uploads/2019/05/NASAA-Letter-to-Chair-Waters-and-Ranking-Member-McHenry-Re-H.R.624-January-23-2019.pdf.

[v] As a practical matter, because all information related to Rule 10b5-1 trading plans is maintained by a corporation, insiders – i.e., the corporate officers or directors – are in effect policing themselves.

[vi] The Wall Street Journal published a series of articles in 2012 that highlighted suspiciously fortuitous trading patterns under Rule 10b5-1 plans adopted by corporate insiders. The investigation found that more than 1,400 executives, including some with 10b5-1 plans, had made profitable and well-timed trades in the days before their companies released “material, potentially market moving” announcements. See https://www.cooley.com/news/insight/2012/is-the-level-of-profitable-trading-by-insiders-under-10b51-plans-just-serendipity.

[vii] As of December 2, 2020, more than 200 SPACs had listed in 2020, raising a record $66.3 billion. The Financial Times. See https://www.ft.com/content/faedd2a1-2008-4f1e-9198-7694fba791b0.

[viii] Unlike traditional IPOs, SPACs do not have commercial operations at the time of the IPO. As a result, SPAC IPOs are faster and face less regulatory scrutiny, and their financial and business disclosures are substantially shorter than traditional IPOs. See SPAC IPO: Background and Policy Issues, CRS Report (Sept. 29, 2020) available at  https://crsreports.congress.gov/product/pdf/IF/IF11655.

[ix] SPAC investors place trust in the sponsors to identify acquisition targets. They do not know the details of a SPAC’s future investment at the time of its IPO. In contrast, investors in a traditional IPO purchase shares in a specific operating company.

[x] Over 65% of SPACs issued since 2015 have positive returns. During the same period, the median SPAC lost approximately 36% of its value while traditional IPOs gained 37%.  

[xi] See https://dealbook.nytimes.com/2007/06/11/its-hard-out-there-for-a-spac/

[xii] The SEC recently approved a new NYSE rule that has the potential to drastically expand the appeal of direct listings and reduce the incentive for companies to use the traditional IPO process.

[xiii] See https://www.mondaq.com/unitedstates/Finance-and-Banking/739314/Super-Voting-Stock-What-Is-It-And-How-Can-I-Get-It.

[xiv] See https://www.sec.gov/news/speech/fleming-dual-class-shares-recipe-disaster.