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Not for the first time, Gary Gensler is under fire. Six groups representing private equity, venture capital and hedge fund businesses have sued the Securities and Exchange Commission, alleging that the agency Gensler chairs has overstepped its authority with a package of new rules for regulating the $27tn private funds industry.
By a 3-2 majority, the SEC voted in August to demand that the previously lightly regulated firms disclose more to clients about their performance and expenses, and to ban the practice of secretly giving favourable terms to some investors but not others.
Several of the SEC’s attempts to address concerns about opacity and conflicts of interest are reasonable. The growing significance of an industry that now has three times the number of funds as it did a decade ago means that more disclosure about how it operates is warranted, not least as it looks to draw in smaller investors. Despite the industry’s complaints about increased costs, its members should be able to comply and still make handsome returns. The final rules were sufficiently watered-down versions of Gensler’s original proposals to leave many reform advocates frustrated that he had not gone further.
Even so, the SEC’s interventions are stretching the definition of its role in private markets, which are, after all, designed to be less transparent than public markets. The sheer breadth of its reform agenda is also playing into a broader concern in the US business and financial community about regulatory over-reach in Joe Biden’s administration, visible from the Department of Justice to the Federal Trade Commission.
There is little question that Gensler has unleashed the most interventionist regulatory agenda the US financial sector has seen since right after the global financial crisis, stretching from cryptocurrencies to carbon emissions and from asset custody to the Treasuries market. Even before this salvo against private funds, this SEC had surpassed its recent predecessors in the number of substantive new rules it adopted.
Groups targeted by Gensler’s actions are now pushing back hard in the courts, where the SEC is battling plaintiffs including the US Chamber of Commerce and Ripple Labs, the cryptocurrency pioneer behind the XRP digital token. A federal appeals court recently ruled that the SEC had been “arbitrary and capricious” when it turned down Grayscale Investments’ proposed spot bitcoin ETF. Gensler appears to have anticipated such challenges and is willing to continue pushing out new proposals and enforcement actions regardless. Reform advocates argue that the SEC’s actions are necessary responses to rapid upheavals in capital markets that earlier regulators did not anticipate.
They clearly also chime with a more populist political philosophy that has emboldened Democrats to target perceived concentrations of power in finance and business. And the urge to set new rules through enforcement and regulations stems in part from elected officials’ failure to do so. Compared with previous eras, strikingly few of the SEC’s recent rules have been mandated by Congress, which can still not agree on some basic regulatory standards.
This legislative vacuum leaves America’s judicial system likely to end up deciding how much of Gensler’s agenda will survive. The question of whether the SEC is overreaching its statutory mandate may ultimately be decided by a Supreme Court that has made clear that it is highly sensitive to administrative over-reach. The court’s conservative majority may relish the opportunity to rein in the SEC. Gensler’s desire to regulate more of America’s rapidly changing financial markets must be balanced with pragmatism if he is not to risk his ambitions backfiring, with consequences that could last for years to come.