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Lawsuit Challenges Interpretation on 144A Bond Disclosures

September 18, 2023

On September 12, the National Association of Manufacturers (NAM) filed a federal lawsuit against the SEC for its new interpretation that would require 15c2-11 public disclosures to private-issue 144A bonds. At issue is the SEC’s application of the rule to fixed income bonds without a new rulemaking.

“The SEC’s attempt to force private companies to disclose confidential financial information publicly is a clear violation of the Administrative Procedure Act,” said NAM Chief Legal Officer Linda Kelly.

Why it matters: Starting in January 2025, broker-dealers would be required to verify that certain issuer (or asset-backed) information is publicly available on 144A securities to freely quote the bonds. For CREFC members, this change would impact Single Asset Single Borrower CMBS and CRE CLOs, among others.

The interpretation was originally supposed to go into effect in January 2023, but CREFC and other organizations worked with Congress and the SEC to get an extension. While CREFC continues to work on a legislative fix, the interpretation would go into effect in 2025 absent action from Congress, the courts or the SEC.

What they’re saying: NAM’s suit alleges procedural deficiencies in the SEC’s rulemaking process.

• Since Rule 15c2-11 was introduced in 1971, it has always been treated as applying exclusively to the equity markets. NAM says that expanding the rule would have to follow the Administrative Procedures Act.
• But the SEC now claims the rule has always applied to fixed income and the rulemaking is unnecessary.

What’s next: The lawsuit was filed in the Eastern District of Kentucky, which is in the Sixth Circuit Court of Appeals.

• While finally resolving the litigation could take years, observers expect the district court could issue a “nationwide injunction” to temporarily pause application of the rule during the challenge.
• The injunction could quickly be appealed up through the levels, including to the Supreme Court, before the case is even heard on the merits. Thus, the change could be paused while the litigation proceeds.

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SEC Gensler at Senate Hearing

September 18, 2023

SEC Chair Gary Gensler testified before the Senate Banking Committee, where he fielded questions on a variety of issues, including private equity and hedge funds, climate disclosures, crypto, and artificial intelligence. Gensler will appear next on the House side on September 27.

Why it matters: Gensler’s aggressive and expansive agenda continues to draw bipartisan criticism, but he also has his defenders. Banking Committee Chairman Sherrod Brown (D-OH) praised Gensler’s actions, including the SEC moving to implement the Conflicts of Interest in Securitization rule.

What they’re saying: The SEC’s broad jurisdiction over the economy leaves room for many topics, the recently final Private Funds Rule, the soon-expected Climate Disclosures, cryptocurrency, and AI were repeated topics.

Private funds rule

• Republicans heavily criticized the agency’s private funds rule, which Ranking Member Scott (R-SC) characterized as a “tax” on private markets that will hurt small businesses and push small and diverse fund managers out of the market. Sen. Hagerty (R-TN) insinuated that the actual purpose of the proposal is to change the negotiated dynamics between two sophisticated players in favor one over the other.
• In contrast, Sen. Brown welcomed efforts to fix this power imbalance, highlighting that private equity firms managed trillions in assets for pension funds and endowments last year, controlled between 15% and 20% of the whole economy, and they were able to do so without offering much information on how they’re using people’s money, including around fees, comparable performance data, independent audits, and conflicts of interest disclosures.
• Brown asked how providing this information will help protect pension funds, charitable endowments, and other investors. Gensler responded that the rules bring greater transparency about fees, performance, and side letters, which will help promote competition and efficiency in the market. “If the cost comes down, that means the returns for retirees goes up,” he added.

Climate disclosures

• Gensler stated that the SEC isn’t a “climate regulator” three separate times, while also noting that 80% of the top 1,000 companies by market cap already make climate risk disclosures: “We’re just trying to bring some comparability to that,” he said.
• Sen. Brown agreed that the majority of the largest companies already disclose GHG emissions on a voluntary basis because investors demand it; however, without a clear standard, the information is not easily digestible nor comparable across companies, he said. Gensler reiterated that the proposal is about bringing comparability and consistency to climate disclosures, adding that they “try not to do things against the clock.” It depends when the staff and Commission are ready, he concluded.
• Across the aisle, Ranking Member Scott emphasized that the compliance burdens associated with the new rules will quadruple the cost of running a public company. On a related note, Sen. Tester (D-MT) sought assurances that the climate rule won’t lead to additional “pain in the neck” for agricultural producers, saying that the “bleed down of regulation” happens often and he wants the agency to make crystal clear that farmers and ranchers won’t have to report on goods they sold at public companies.
• In response to Sen. Tester’s question on what SEC envisions Scope 3 reporting to look like, Gensler admitted that Scope 3 requirements are not as well developed as Scope 1 and 2, given that public companies currently report some GHG emissions, though the SEC is assessing an appropriate path forward.

Artificial Intelligence

• Democrats focused on specific AI applications and emerging risks, with Chair Brown previewing a hearing in the coming weeks on the impact of AI on financial markets and consumers.
• Chair Gensler answered that predictive data analytics and AI are used today in robo advising, in brokerage apps, for market sentiment analysis, on account opening documentation, to submit insurance claims, to assist with AML compliance, etc.
• Sen. Warner (D-VA) expressed that AI could undermine public trust in our capital markets and in our free and fair elections, mentioning deepfakes and how AI tools can generate false complaints about products or false regulatory filings.
• Ranking Member Scott slammed the SEC’s new rules around conflicts of interests associated with the use of AI by broker-dealers—despite being labeled as an “AI” rule, this “power grab” will stifle innovation, he said.
• Sen. Cortez Masto (D-NV) asked if trading firms and money managers, in addition to broker-dealers and investment advisers, should be required to disclose their use of the technology. Chair Gensler responded that, given the new challenges posed by AI, the lack of explainability, and the chance for biases in AI models, Congress may want to take up such disclosures.

The bottom line: The SEC will continue to be in the spotlight with several hearings over in the House next week. Contact David McCarthy (dmccarthy@crefc.org) with questions about Congress’s oversight of the SEC.

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SEC Chairman Gary Gensler appeared before the Senate Banking Committee last week.

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Partisan Stopgap Bill Emerges as Shutdown Looms

September 18, 2023

House GOP leadership had hope to use their first week back to advance several appropriation bills, but pushback from the House Freedom Caucus once again held up action on the floor. But late Sunday night, House Republicans among themselves on a 30 day continuing resolution to fund the government.

Why it matters: The stopgap bill will kick off negotiations, but McCarthy will likely have to buck hardliners to fund the government.

• The CR includes spending cuts, hardline immigration restrictions, no disaster relief funding, and no Ukraine funding. Those provisions won’t fly with Democrats in the House, Senate, or White House.
• While McCarthy has been able to power through tough fights before (e.g., debt ceiling), it took Democratic votes and remains a sore spot for the Freedom Caucus.
• McCarthy’s announcement of an impeachment inquiry sought to placate some of his conference, but it does not appear to have been enough to cool tempers on spending. The inquiry also strains McCarthy’s relationship with Democratic leadership.

What they’re saying: Puchbowl News broke the news on the CR and included bill summaries from the various House GOP factions. Here’s a summary of the proposal from the Main Street Caucus, and here’s one from the House Freedom Caucus. Announcing an agreement among the fractious conference is an achievement.

Yes, but: It is unclear if the CR will even pass the House.

• Last week, House Republicans were unable to advance a party-line defense appropriations bill after a conservative wing delayed the bill to try to push more government spending cuts.
• McCarthy could not count on Democratic support for the defense bill since it included many partisan provisions targeting diversity, equity, and inclusion initiatives at DOD. The same is true for this CR.

The Senate, however, made progress by advancing one of three spending “minibus” packages for a final vote expected this week.

• Senate Appropriations Chair Patty Murry (D-WA) and Ranking Member Susan Collins (R-ME) have taken a diligent approach to clearing bills out of committee in a bipartisan fashion in order to clear the 60 vote hurdle over a filibuster.
• To avert a shutdown, the Senate can modify the one House-passed appropriations bill to fashion an omnibus or continuing resolution. That would require the House to vote on the bill again, however.

What’s next: No one knows.

• Absent some negotiating breakthrough, McCarthy’s options have been to put a bill on the House floor that either 1) cannot pass the Senate or 2) attract Democratic votes and anger critics in his own party.
• The CR is Option 1. If the House passes the CR, McCarthy can claim an initial victory.
• Some are looking to the Senate progress as the way forward.

Contact David McCarthy (dmccarthy@crefc.org) with questions. 

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Without Congressional action federal government funding authority expires after September 30.

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