March 23, 2023 - As we’ve noted before, the SEC has been promulgating an endless stream of complex and transformative rule proposals affecting the securities markets generally and private funds (including loan funds) in particular.  The LSTA itself has submitted comment letters on proposed rules for security-based swaps, corporate and advisor-related ESG disclosure, Private Funds Disclosure, Oversight of outsourcing by registered advisers, and Liquidity Risk Management for open end loan funds.  We are currently responding to the recently reproposed Conflicts in Securitizations and Custody proposals.  Notwithstanding the deluge of complicated proposals, the SEC has been offering stakeholders historically short comment periods.  In a remarkable letter to the SEC’s interim Inspector General, Senator John Boozman, calls out both the unprecedented magnitude of the SEC’s aggressive regulatory agenda and crystallizes how the way the SEC is proceeding is seriously upending industry norms, resulting in a very flawed commenting process. The letter hits home since the LSTA and its members have struggled to respond to rulemakings and has repeatedly pushed back against the unreasonably short comment periods.  And, it’s not just the LSTA weighing in.  We have joined with many other trade associations to complain as have many members of Congress.  Following, we summarize the Boozman letter.

Senator Boozman begins by noting that under Chair Gensler’s leadership, the SEC has pursued an aggressive regulatory agenda, publishing in the first six months of 2022 twenty notices of proposed rulemaking (“NPRMs”) taking up 1,627 pages and posing thousands of questions for comment. Many of those NPRMs propose regulations with far reaching consequences, and, if finalized, would cover activity the SEC has not previously regulated. Importantly, many of the NPRMs are interrelated and affect the same entities, meaning the SEC has forced commenters to analyze multiple, complex proposals simultaneously and their ability to assess and meaningfully comment on how one proposal will affect the policy implications of other proposals is limited.  The letter then focuses on several specific concerns, including (i) short comment periods; (ii) the failure of the Commission to consider whether its actions “promote efficiency, capital formation and capital formation”, and (iii) the underutilization of SEC career staff.

Inadequate Comment Periods.  Boozman noted that the SEC is required to “give interested persons an opportunity to participate in the rule making [process] through submission of written data, views, or arguments”, that soliciting public comment is an integral part of the rulemaking process, and failing to give the public adequate time to comment on a proposal risks introducing “arbitrariness and irrationality in[to] the formulation of [its] rules.”  Through many administrations, it was understood that proposed regulations should have comment periods of at least 60 days and for larger, more complex proposals, 90 days or more.  It was commonly understood that where an agency “engages in a slew of interrelated rulemaking activity, 30 days is likely insufficient to provide a meaningful opportunity to comment on a highly technical and complex regulation.”  Boozman pointed out that the average length of the comment periods for the 20 NPRMs the SEC published in the first half of 2022 was 43 days. In comparison, from 2013-2020, the SEC proposed 61 rules, 55 of which had comment periods of 60 days or longer. By contrast, all but three of the 20 NPRMs the SEC published in the first half of 2022 had comment periods less than 60 days.

Efficiency, Competition and Capital Formation.  Senator Boozman then pivots to what he considers the inadequate economic analyses in the SEC’s recent NPRMs that “in many instances only pay lip service to the SEC’s regulatory obligations”.  Under the APA, the SEC is required to consider whether its “action will promote efficiency, competition, and capital formation and, if it fails to consider the economic consequences of a proposed regulation, the “promulgation of the rule [is] arbitrary and capricious and not in accordance with law.”  The SEC violates its statutory mandate by failing to “make any finding on the existing level[s] of competition, [efficiency, or capital formation] in the marketplace.” The SEC must also “adequately . . . quantify the certain costs [of its rules] or . . . explain why those costs could not be quantified.” Many of the SEC’s recent NPRMs contain economic analyses that fall short of these standards. For example, the Private Fund Disclosure Rule for Advisers NPRM “fails to assess existing levels of capital formation, competition, and efficiency, and fails to quantify costs and benefits, instead saying that it is ‘difficult to quantify how costly it would be to comply with the [proposed] prohibitions,’ and that it is “difficult to quantify the benefits of these prohibitions.’” Boozman ends the discussion of this topic by suggesting that the SEC “failing to provide robust assessments of how proposed rules would impact capital formation, competition, and efficiency further undermines the validity of these rulemakings, and will ultimately diminish the quality and legality of final rules eventually adopted.”

Underutilization of SEC Career Staff.  Consistent with his second point, Boozman’s third point is a suggestion that the SEC should “draw upon the expertise of career economists to ensure that proposed rules contain the robust economic analysis required” under the law.   He notes that the SEC’s own Inspector General has also recommended that the SEC’s rule writing divisions should look for ways for its agency’s “economists to provide additional input into cost-benefit analyses of SEC rulemakings to assist in including both quantitative and qualitative information to the extent possible.” He raises the concern that “the SEC’s political leadership may be sidelining the agency’s career staff as they pursue an expedited rulemaking agenda.”

Request for an Audit.  Because of these perceived shortcomings, Senator Boozman requests that the SEC Office of Inspector General (OIG) audit the SEC’s compliance with its rulemaking obligations. Specifically, he asks OIG (1) What is the basis for materially shorter comment windows under Chair Gensler than under all previous modern Chairs and to what extent have these shortened comment windows potentially limited meaningful public comment? (2) How has the lack of rulemaking experience among the employees involved in current rulemaking (identified by a previous audit report) affected the SEC’s and regulated entities’ ability to assess the impact the proposed rules will have on competition, efficiency, and capital formation? and (3) To what extent is the SEC’s political leadership underutilizing the expertise of its career staff in formulating the proposed rules?

Commenting Takes Time.  To paraphrase the late, great George Harrison, commenting on complex, transformative rulemakings takes time, a whole lotta precious time to do it right.  (It also takes a whole lotta money but that’s another issue).  Apparently Chair Gensler has not heard that song and, as Senator Boozman, the LSTA and others have pointed out, in order to “get it right” it is essential that the SEC ensure a full and fair opportunity for its major proposals to be put through the crucible of adequate notice and comment.

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