On September 12, the U.S. Securities and Exchange Commission (SEC) Chair Gary Gensler testified before the U.S. Senate Committee on Banking, Housing, and Urban Affairs. His testimony emphasized that market growth combined with technological change has led to high rates of securities fraud. He briefed Congress on the newly implemented and newly proposed SEC regulations with respect to Climate Disclosures, Private Funds, Cryptocurrency, and Artificial Intelligence – areas in which investors seek clarity and require further protection, according to Gensler, and which have therefore become priorities of the commission.
Climate Risk Disclosure
The Climate Risk Disclosure Rule proposed by the Commission in March 2023 would require public companies to disclose climate risks, giving investors information necessary to make investment decisions. Already, Gensler explained, “a majority of the top thousand issuers by market cap already make such disclosures, including what’s known as Scope 1 and Scope 2 greenhouse gas emissions… investors representing tens of trillions of dollars in assets are making decisions relying on those disclosures.”
The aspect of the rule which raised the most questions among Committee members is the rule’s requirement to disclose Scope 3 emissions, meaning the emissions from the entire supply chain. Senator Tester of Montana, for instance, expressed concern that this could raise burdens on family farms, which are not public companies. Chair Gensler emphasized that the rule would not increase the reporting burdens for private companies unless they are material in the Scope 3 emissions of public companies.
The National Whistleblower Center commented on this rule back in April, saying, “If the Climate Disclosure Rules are enacted, whistleblowers will play a vital role in bringing violations to light, as they possess inside information about whether a registrant’s disclosures of climate-related risks accurately reflect the registrant’s conduct.”
Private Fund Rule
Chair Gensler also discussed the Commission’s new private fund rule, which requires private fund advisers registered with the Commission to provide detailed disclosures to investors regarding fees, expenses, and performance.
“Private funds nearly have tripled in size in the last decade to approximately $26 trillion in gross assets. This compares to the U.S. commercial banking industry of approximately $23 trillion. This makes visibility into these funds critical,” said Gensler.
He explained that this rule is vital because it protects the every-day people who invest their retirement funds or pensions in private funds.
“The vast majority of crypto tokens likely meet the investment contract test,” said Gensler, affirming his the Commission’s previous assertion of jurisdiction over most cryptocurrencies. However, despite the fact that most crypto tokens and their intermediaries are subject to securities laws, Gensler noted that the industry’s “wide-ranging noncompliance… [is] reminiscent of what we had in the 1920s before the federal securities laws were put in place.”
In addition to increased enforcement actions against crypto fraud, the SEC is regulating crypto security markets through new rulemaking. The commission has also proposed a new exchange definition, and an updated investment adviser custody rule which would cover all crypto assets and enhance protections.
Senator Brown, Chair of the Senate Committee on Banking, Housing, and Urban Affairs, noted that we are already seeing bad actors flocking to crypto. Gensler agreed, saying he’s never seen a field “so ripe with misconduct… it’s daunting.”
Whistleblowers who report these bad actors have already been a vital trigger for SEC enforcement actions with respect to crypto security fraud. The new rules will only further empower whistleblowers and clarify the SEC’s jurisdiction over those crypto fraud.
Artificial Intelligence and Predictive Data Analytics
The SEC also proposed a rule to analyze conflicts of interest that can emerge when using predictive data analytics to interact with investors. Firms would need to identify whether such models would place the firm’s interest ahead of investors’ interests in such conflicts, and eliminate or neutralize the effects where they arise. Gensler underscored that this rule is not an effort to take any stance on technology – he referred to the Commission as a “technology neutral” body – but he explained that this rule is vital to the Commission’s mission of protecting investors.
In the Q&A segment, Senator Menendez and Senator Cortez-Masto inquired about the extent to which the Commission is embracing the opportunities brought by AI, such as financial service providers using AI to enforce Anti-Money Laundering or the SEC using AI for market surveillance. Gensler responded that the Commission is indeed expanding its use of AI, particularly given that markets have grown 50-70% in the last 7 years, while the agency has only grown 3% larger, and AI can help compensate for the lack of adequate resources in the agency.
That being said, Gensler noted that developing AI systems requires funding as well as caution, as poorly built AI tools can entrench systemic racism and other biases capital markets.
Gensler made clear to the Senate that rule-making to keep up with changing times has long been part of the commission’s job. He cited a seminal 1963 Commission report, which said, “no regulation can be static in a dynamic society.”
Gensler's remarks reflect the enforcement priorities of the Commission under Gensler’s leadership. The SEC has increasingly taken enforcement action with respect to these four issues. This should signal to anybody who might be aware of fraud schemes related to these enforcement priorities that they may have strong cases and that the SEC will likely act on a high-quality disclosure.
Through the SEC Whistleblower Program, whistleblowers may report anonymously and qualified whistleblowers are entitled to monetary awards of 10-30% of the funds collected by the SEC in connection with their whistleblowing.
Gensler has previously highlighted the importance of the whistleblower program, noting in 2022 that the program has “greatly aided the Commission’s work to protect investors. In the years since the program was established, the SEC has used whistleblower information to obtain sanctions of over $5 billion from securities law violators, return over $1.3 billion to harmed investors, and award over $1.3 billion to whistleblowers for their service.”