Peirce Out: Remarks at the U.S. Chamber of Commerce Capital Markets Summit

Thank you, Jim [Febeo]. I am delighted to be part of the Summit. My views are my own as a Commissioner and not necessarily those of the Commission or my fellow Commissioners. My days of giving that disclaimer are rushing to an end. After nearly thirty years in DC, I am leaving the city and moving to the beach. When I think back on my time here, many memories were born within several blocks of where I am standing now. I spent one summer during college as a research assistant for scholars at the Smithsonian's Castle, a wonderful building on the mall. Some years later, I sat nervously on a bench in Lafayette Park as I prepared for an interview with Judge Roger Andewelt on the Court of Federal Claims. Early in my clerkship, Judge Andewelt took me and my fellow clerk to the top of the Hotel Washington at 15th and Pennsylvania for a breathtaking view of the city and my first (and I hope last) raw oysters. Following the Judge's wise counsel and ceaseless cheerleading, I found my way into a law firm several blocks west of where we are today. I also have many memories from this building in which I have enjoyed hours of conferences on fascinating financial regulatory issues. I mean that sincerely. I love this stuff.

I love it because it matters. Financial markets underpin our vibrant economy. And capital markets are particularly important because they are so good at directing money to its highest and best use. Capital markets facilitate the sharing of risks and rewards. They organically match enterprise and capital to achieve socially useful ends. Someone who has a good idea but does not have rich family or friends can get funding to commercialize her idea. A company that wants to build a new factory can get money from strangers to build it. The capital markets embrace and support the risk-taking innovations that propel human progress. Failure happens routinely in these capital markets; innovation is a risky business. But capital markets absorb these failures and redirect capital to new endeavors. Contrary to some misrepresentations of these markets, they are not bastions of isolated individualism; they bring people together to build things. The more people who participate in these markets, the better they work. Each person brings a necessary input to the market: ideas, capital, speculative appetite. Together, market participants build companies, which, in turn, make products and provide services that people need. The capital markets invite people to cooperate for the improvement of society.

The United States has the best capital markets in the world. People come here from all over the world to raise money and to invest. Our markets have helped build the globe's companies and economies. Other countries look longingly to the U.S. capital markets and hope to emulate them. Representatives of foreign governments, whose economies are in thrall to bank finance, routinely ask us what they can do to replicate our dynamic capital markets. Banks serve an important role here in the United States too, but bank finance inherently lacks the dynamism of capital markets and the flexibility necessary to fund innovation.[1]

Why is the United States blessed with such powerful capital markets? As a regulator, perhaps I should credit government as the reason our markets are so strong. But one of the reasons our capital markets work so well is that government generally does not meddle with them. It does not attempt to override the decisions of market participants to direct capital to politically favored places. It is a referee, not a player, on the capital markets field. Certainly, the government has an important role: having sensible rules and enforcing them judiciously gives people the confidence to participate in the markets. Investors, companies that use their capital, and intermediaries feel comfortable in U.S. markets because they can trust both that our laws will be enforced as written and that the enforcement will be fair and impartial. The reliable consistency of the governing law and the confidence in fair and impartial enforcement form the foundation of mutual trust essential to transacting. However, as important as the regulatory framework is in cultivating trust, the nature of this country and its people deserve the primary credit for the success of our capital markets.

Less than a month from now we will celebrate the 250^th anniversary of the signing of the Declaration of Independence, which so powerfully proclaimed the "self-evident" truths "that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness."[2] We do not always abide by these truths, but we hold one another accountable when we fail and eventually correct course. Indeed, next week on Juneteenth we will commemorate the hard-fought end to the most pernicious infidelity to the Declaration's truths. In declaring independence, the nation repudiated the bonds of consanguinity in favor of bonds forged through a common commitment to principles of freedom. These principles continue to be the unifying thread of this nation, which is composed wonderfully of people with roots reaching every corner of the world. We are, as the Declaration reflected, a nation of risk-taking liberty lovers who are well-suited for the rough-and-tumble of the capital markets.

The Declaration of Independence not only celebrated every person's right to life, liberty, and the pursuit of happiness, but recognized government's appropriate, but limited, role in "secur[ing] these rights."[3] To perform this role effectively, governments must "deriv[e] their just powers from the consent of the governed."[4] A government committed to securing the life, liberty, and pursuit of happiness of its people cannot usurp its people's freedom to achieve these objectives. A successful government is made up of people who recognize that the exercise of government power, by its very nature, constrains human freedom. Consequently, these governing officials exercise power only when the people to whom they are accountable direct them to do so out of a belief that the exercise of government power will help on balance to secure that freedom. A government mandate that you cannot do something or must do something overrides personal choice, so a government committed to protecting personal liberty should use such mandates sparingly. These foundational precepts may seem lofty, but they are essential strictures on the government's daily work.

The SEC, as part of the government, must limit itself to the exercise of powers given to it by the people. The SEC celebrated its 92^nd birthday on Saturday; on June 6, 1934, the Securities Exchange Act, which created the SEC, became law. This law and other statutes give the agency its powers. We do not have the consent of the American people to exercise powers not conferred upon us by those statutes. I may have written the law differently if I were holding the pen, but my job is to follow statutory directives as given by Congress. We cannot freelance outside of these directives, and, of course, the ultimate constraint on SEC action is the Constitution; even if the statutes tell us to do something, we cannot do it if it contravenes the Constitution.

Applying these principles day-to-day can be challenging. Complicating the task is that the markets are vast and complex, many of the statutes are old and drafted during times when the markets operated with fewer participants and less complicated technology. The endless creativity of market participants raises continuing interpretive challenges when dealing with the SEC's numerous and often technical regulations, especially when other regulators' jurisdictions overlap with ours. Moreover, our statutes wisely require eschewing merit-based regulation, which means that capital markets will include products, services, and practices that some members of the Commission and the staff personally disfavor.

Several recent actions reflect the Commission's efforts to regulate the capital markets within the boundaries that the Constitution and Congress drew for it. Last month, the Commission ended its policy of requiring people who settle with the Commission not to deny-or allow anyone else to deny-the allegations against them.[5] A regulatory policy that prevents people from speaking against government action and requires them to actively dissuade others from speaking necessarily raises First Amendment concerns. The Commission also recently proposed to rescind its climate disclosure rules.[6] In my view, those rules required disclosures not authorized under our statutes. More generally, the Commission is reviewing its disclosure requirements under Regulation S-K to ensure that they are tied to materiality and the purposes underlying our statutory disclosure mandate. In April, the SEC and the CFTC proposed to revise Form PF, a form that has morphed over the years into a much lengthier, more burdensome, and more wide-ranging reporting requirement for private funds than envisioned by the underlying Dodd-Frank mandate.[7] Also in April, the Commission issued a concept release about the troubled Consolidated Audit Trail ("CAT"), which is a massive market surveillance monitoring operation.[8] The release asks questions related to the CAT's implications for civil liberties and privacy.[9] A more general effort to return to its statutorily mandated regulatory territory is the Commission's work on crypto during the past year-and-a-half; the Commission has sought to tie our crypto regulatory and enforcement activities to the statutes we administer.[10]

The Commission has more work to do. I am concerned, for example, about the constitutionality of the pay-to-play rule for investment advisers.[11] Our pay-to-play rule is not a direct restriction of political speech inasmuch as it does not outright prohibit political donations, but it nonetheless functions as a restriction. Prohibiting advisers who make political donations from providing advisory services to governmental customers creates significant financial disincentives from making those donations and from running for office.[12] Given that the rule effectively regulates political speech-speech at the core of the First Amendment-we ought to ask ourselves whether the rule is really the least restrictive means to achieving the desired objective: preventing public corruption. Moreover, we ought to ask whether that objective is one Congress charged the SEC with achieving.

I also am concerned that the Commission through aggressive statutory interpretations is pushing hard against the limits of its authority. Reasonable restraint in reading our statutes and rules is the best course. If we rush up to the edge of every law and regulation, we might tumble over into unauthorized territory. We tried that with an aggressive interpretation of the term "dealer" and met with judicial disagreement.[13] We similarly aggressively read our own Rule 15c2-11, which was written with equity securities in mind, to include fixed-income securities, much to the dismay of just about everyone including me.[14] In March, the Commission proposed amendments to rectify that overreading.[15]

The Commission likewise should bridle its overly expansive reading of the Foreign Corrupt Practices Act's requirements that companies devise and maintain a system of "internal accounting controls."[16]The Commission has misapplied this provision in its enforcement program by failing to limit it to the accounting context and instead using it as a lever to discipline companies that lack what the Commission perceives to be adequate internal controls unrelated to accounting.[17] his aggressive reading already has drawn judicial criticism,[18] and I hope the Commission turns about in response.

Also of note is the Commission's use of its authority under Section 206(4) of the Advisers Act. Enacted in 1960, Section 206(4) added two sentences to the Act.[19] The first sentence prohibits investment advisers from "engag[ing] in any act, practice, or course of business" of a certain character-those that are "fraudulent, deceptive, or manipulative."[20] The second sentence directs the Commission to "define, and prescribe means reasonably designed to prevent" the conduct prohibited by the first sentence.[21] This seemingly simple text raises a difficult interpretative question. Because fraud, deceit, and manipulation all are state-of-mind terms that require knowing or intentional misconduct,[22] the best reading of the first sentence is that it prohibits knowing or intentional misconduct, not merely negligent misconduct. But does the second sentence's authorization for the Commission to define what constitutes "fraudulent, deceptive, or manipulative" empower it to adopt a rule that defines merely negligent conduct as fraudulent, deceptive, or manipulative? This question percolated when the Commission adopted Rule 206(4)-8 and took the position that negligent conduct was sufficient to violate the rule's prohibition on fraudulent, deceptive, or manipulative acts, practices, or courses of business. During my tenure, I have supported enforcement actions that relied on negligent violations of Rule 206(4)-8, but after careful consideration, I have come to agree with the concurrence Chairman Atkins published at the time of adoption.[23] It seems unlikely that when Congress authorized the Commission to define types of acts, practices, and courses of businesses that are fraudulent, it authorized the Commission to write out of existence an essential attribute of fraud-knowing or intentional conduct. For this reason, while the Commission may adopt negligence-based, or even strict liability, rules designed to prevent fraudulent conduct-meaning knowing and intentional conduct-the Commission should not read the statute as granting it the power to redefine fraud itself.

I cannot leave the topic of reading-and reading into-statutes without discussing disgorgement, an issue that has landed the Commission in the Supreme Court several times in the past decade. Disgorgement is perhaps the most consequential expansion of the ancillary equitable relief sought by Commission. The remedy began to take shape in the 1960s when, in SEC v. Texas Gulf Sulphur, the Commission asked the court to order certain defendants who had purchased securities while in possession of material, non-public information to make restitution to some sellers and to return profits from certain transactions to the company.[24] By 1972, the Commission labelled the remedy "disgorgement" and explained that: "The S.E.C.'s primary function is to protect the public from fraudulent and other unlawful practices and not to obtain damages for injured individuals. Thus, a request that disgorgement be required is predicated on the need to deprive defendants of profits derived from their unlawful conduct and to protect the public by deterring such conduct by others."[25] Court opinions reflected this emphasis on deterrence.[26]

The Commission's disgorgement-as-deterrence rationale arguably reached its nadir-or perhaps apex, depending on one's view-in SEC v. Contorinis.[27] In that case, the district court, responding to a Commission request, ordered the defendant to disgorge all the profits from insider trading, including profits that the defendant himself never received or retained because they accrued to a fund that he managed, not to him personally.[28] The appellate court, while acknowledging that disgorgement "may not exceed the total amount of gain from the illegal action," rejected the contention that a "wrongdoer need disgorge only the financial benefit that accrues to him personally."[29] As the dissenting judge noted, this holding was peculiar given that in the parallel criminal action, the same court held that the defendant could not be ordered to forfeit those same profits because "a defendant can be ordered to forfeit only the proceeds that he actually received or controlled."[30] Not surprisingly, given the expansive use of the remedy, three years later, the Supreme Court observed that "deterrence is not simply an incidental effect of disgorgement" and concluded that the remedy as sought by the Commission "bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate."[31] Three years later, in Liu, the Supreme Court, clarified that the Commission could seek equitable disgorgement, but cautioned that the remedy must be limited to "a defendant's net profits from wrongdoing."[32] Congress entered the fray shortly thereafter by enacting provisions that specifically authorized the Commission to seek and the district courts to order disgorgement.[33] The combination of the Court's rulings and new legislation did not-to put it mildly-set out a clear path forward.

Indeed, just last Thursday the Court issued its third disgorgement opinion in the last ten years. [34] The Court, without deciding whether the new statutory provision was legal or equitable, reminded the Commission of certain "key limitations" on equitable disgorgement: (1) it "must be limited to the defendant's net profits (not total revenues) derived from his securities-law violations"[35] and (2) because "equity aims to deliver wrongful gains to wronged victims . . . the SEC must return a defendant's gains to wronged investors, contrary to its practice of depositing a defendant's gains with the Treasury."[36] The Court went on to hold that the SEC does not have to show a pecuniary loss to justify a disgorgement award. [37] The Court's narrow ruling leaves many questions unresolved; stay tuned for the next installment of the scintillating series SEC Disgorgement at the High Court, which both the majority and concurring opinions foreshadowed. In the meantime, the Commission must accept that equitable disgorgement is a remedy circumscribed by a long history of limiting principles. These principles apply to the Commission, with perhaps even greater force because the Commission is acting to enforce the securities laws rather than to remediate its own harm. Moreover, as reflected in Justice Thomas' concurrence, if the Commission reads its new statutory authority as freeing disgorgement from its equitable limitations, jury trials may await.[38]

Well-intentioned people can disagree about how to regulate capital markets. We must remember, however, our shared interest in ensuring that our capital markets continue to flourish and grow to serve more investors and companies. Healthy capital markets are essential to generate the economic growth we need to increase the standard of living and decrease the national debt. Properly functioning capital markets are key to increasing the employment and investment prospects of the next generation of Americans. Factions across the political spectrum might have fundamental disagreements about regulating capital markets, but maybe we can find common ground in the boring basics. Updating transfer agent rules, empowering firms to use new technologies to enhance investor disclosures, rethinking recordkeeping rules, reforming investment company proxy processes, and tending to other similar matters may be some unifying projects. We will not agree on every detail, but the joint work of getting to a good place might build good will that can be applied to areas of deeper disagreement.

Thank you for indulging the meandering reminiscences of a soon-to-be former regulator. I am sad to be leaving a place that has allowed me to engage in the important work of regulating the finest capital markets in the world alongside fellow Commissioners and a wonderful staff who are committed to doing that task well. Yet I am delighted to be leaving a seat that should not be occupied by the same person for too many years. Ours is a government grounded in timeless principles, not fleeting personalities. The SEC will benefit from energetic new voices with fresh ideas about how to protect our precious and powerful capital markets. Happy 250^th anniversary to the nation I have been so honored to serve.