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Monday, February 17, 2020

ANALYSIS/OPINION:

In recent speeches, President Trump hailed deregulation as key to fueling big economic gains for all types of workers. Mr. Trump reminded Americans in his 2020 State of the Union address that his administration has been “slashing a record number of job-killing regulations” and has been moving forward with a “bold regulatory reduction campaign.” 

But a recent proposal from the Securities and Exchange Commission (SEC) is making some wonder if SEC Chairman Jay Clayton hears the president’s deregulatory message. Over the objections of the SEC’s two other Republican commissioners appointed by President Trump, Mr. Clayton has proposed a regulation that could effectively ban many middle-class investors from buying mutual funds and exchange-traded funds that have been sold on the U.S. stock market for decades. As noted by a recent coalition letter signed by several conservative and free-market groups — including the Competitive Enterprise Institute, Heritage Action for America, and Americans for Tax Reform — “Not only do these rules clash with the Trump administration’s goal of freeing the economy with less red tape, they would foster further inequality in financial markets by potentially making certain mutual funds and exchange traded funds unavailable to the average American investor.”


If it goes into effect, the regulation would cripple investors’ ability to buy dozens of funds they can now purchase on American stock exchanges for zero-dollar commissions from discount brokerages and investing apps such as Robinhood. Under the regulation, investors could not purchase these funds unless they can answer an extensive questionnaire of highly personal questions about their investing knowledge and household assets to the SEC’s satisfaction. SEC Republican Commissioners Hester Peirce and Elad Roisman have blasted the regulation as a “blunt overly paternalistic approach to investor protection.”

Despite these objections, the regulation could still move forward because the SEC, like some other Beltway entities such as the Federal Trade Commission, is designed as an “independent” multimember agency, structured with three members of the president’s party and two members of the opposition party. Once appointed, members of the SEC generally can’t be removed by the president during their fixed terms and can vote with whomever and for whatever they wish.

Mr. Clayton alarmed many by putting forward this proposed regulation despite the concerns of his fellow Republicans. It is now open for public comments that are due March 24. If Mr. Clayton votes to finalize the rule along with Democrats on the SEC, who have praised the regulation as it’s currently proposed, it would go into effect. But if Mr. Clayton is as concerned about financial inclusion and access to wealth-building as he professes (and, as I have written, he did put forth a good proposal to lessen the burden of Sarbanes-Oxley red tape), he would send this proposal back to the drawing board.

The funds at issue contain financial instruments that allow investors to hedge market conditions so that they will face less volatility from economic events such as recessions, natural disasters, and rough patches in certain industry sectors. The instruments — such as options, futures, and swap contracts — present some risks, but these risks are fully disclosed to investors under existing SEC rules. And as Ms. Peirce and Mr. Roisman point out, if the SEC feels current risk disclosure rules are inadequate or in need of modernization, it could always improve them. 

Instead, the regulation would require brokers to make a determination that investors “may reasonably be expected to be capable of evaluating the risks of buying and selling” these funds. To make this determination, the broker — whether it is Robinhood or a fancy Wall Street firm — would need to obtain from the investor sensitive information such as annual income, net worth, liquid net worth, and information about the customer’s investment experience. 

Even if some middle-class investors could pass this test to the SEC’s satisfaction, the commissions and fees for trading these funds would likely skyrocket. The SEC’s own Division of Economic and Risk Analysis (DERA) estimates that the total industry cost of just one part the regulation for the first year would be $2.4 billion (figure on page 292 of proposed regulation) and the cost of its various mandates would exceed $400 million a year after that. Like the costs of all regulations, these costs would be passed on to the customer, so investors may have to wave goodbye entirely to zero-dollar commissions.

The regulation also would set a terrible precedent in subjecting investment vehicles already listed on American stock exchanges to new arbitrary rules for middle-class investors to purchase them. Like these funds, individual stocks also carry risks. Every year, dozens of publicly traded companies go bankrupt. If this regulation goes through, what’s to keep the SEC from putting stocks currently trading on the New York Stock Exchange and NASDAQ off-limit to middle-class investors unless they can jump through a similar series of hoops? Then wealthy “accredited investors” — whom the SEC already exempts from many of its rules — would be the only ones who could take investing risk that could lead to building wealth. 

Mr. Clayton, who often speaks of “our Main Street investors,” must protect the rights of middle-class investors to choose the risks they take in order to grow their wealth.

• John Berlau, a senior fellow at the Competitive Enterprise Institute, is author of the forthcoming “George Washington, Entrepreneur: How Our Founding Father’s Private Business Pursuits Changed America and the World.” CEI research associate Gibson Kirsch contributed to this article. 


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