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Securities and Exchange Commission (SEC)

The Securities and Exchange Commission oversees securities exchanges, securities brokers and dealers, investment advisors, and mutual funds in an effort to promote fair dealing, the disclosure of important market information, and to prevent fraud.

Source: https://www.usa.gov/agencies/securities-and-exchange-commission

SECURITIES AND EXCHANGE COMMISSION

Supplemental Standards of Ethical Conduct for Members and Employees of the Securities and Exchange Commission

II. Description of Final Rule Amendments

A. Prohibited Ownership of Financial Industry Sector Funds

The Commission proposed amending § 4401.102(c)(1) to explicitly prohibit employee ownership of certain Financial Industry Sector Funds by expanding the scope of “entities directly regulated by the Commission” to include registered investment companies, common investment trusts of a bank, companies exempt in part or in total from registration under the Investment Company Act of 1940, or other pooled investment vehicles that have a stated policy of concentrating their investments in entities directly regulated by the Commission. As discussed in the Proposing Release, the existing rule prohibits employees from purchasing or owning any “security or other financial interest in an entity directly regulated by the Commission,” such as registered broker-dealers and investment advisers. In order to avoid conflicts and appearance concerns with employee ownership of sector funds that invest in entities the SEC directly regulates, the Commission proposed to amend § 4401.102(c)(1) to explicitly prohibit employee ownership of certain Financial Industry Sector Funds by expanding the scope of “entities directly regulated by the Commission” to include investment funds that have a stated policy of concentrating their investments in entities directly regulated by the Commission.

1. Comments Received

The Commission received numerous comments in favor of the proposal to prohibit ownership of Financial Industry Sector Funds.  In general, comments in support of this amendment focused on the fact that the prohibition would mitigate any actual or perceived conflicts and appearance concerns and would ensure employees of the SEC maintain the utmost trust and transparency with the public.

For example, one commenter noted that because the SEC regulates the industry in which Financial Industry Sector Funds predominately invest, an SEC employee who invests in these funds could be seen as having a financial interest in the success of the very companies they are tasked with regulating, which could potentially lead to bias in regulatory decision-making or the perception of such bias. The commenter expressed the view that “there is the same threat to independence” if an SEC employee owns “sector funds that specifically deal in entities that are regulated by the agency,” as that “has the same financial attachment as owning securities in a SEC regulated entity.”

 Another commenter called the amendment “an essential step in ensuring that employees of the SEC can maintain the utmost trust and transparency with the public,” agreeing that the amendment would “help avoid conflicts and appearance concerns with employee ownership of sector funds that invest in entities the SEC directly regulates,” and “mitigate any actual or perceived conflicts and appearance concerns.” (…) The commenter stated that the Commission’s regulatory and enforcement actions frequently move financial markets, so employee trading restrictions “should be effectively tailored to limit the opportunity for abusing non-public information or the risk that Commission staff will face an incentive to tilt the Commission’s activities in any particular way because they hold a financial industry sector fund.”

 The Commission received several comments opposing the Financial Industry Sector Fund prohibition. In general, commenters argued that the risk of conflict is not so substantial as to impact the mission of the agency, that the proposal does not mitigate any known risk, that the requirement to divest should depend on the employee’s role at the Commission, and that absent actual conflict, “optics” is not an appropriate rationale to prohibit employee ownership of such funds. Commenters also expressed doubt that such a prohibition is legally authorized and concern over the tax implications of required divestiture.

For example, one commenter stated that the proposal does not mitigate any known risks and called the 90-day divesture requirement outlined in the Code of Federal Regulations “an unreasonably short time frame” that is likely to result in significant tax consequences and disrupt the diversity of investment portfolios.” The commenter stated that the amendment would set an alarming precedent. The commenter claimed that the proposal does not explain why employees would be required to sell their holdings in such a short time frame despite the fact that employees have long been permitted to hold financial ETFs. The commenter further claimed that the risk identified in the proposal “is already somewhat mitigated as staff are currently prohibited from holding an excessive amount of sector ETF holdings….”

Another commenter echoed similar concerns, arguing that (…) the proposed ban is unnecessary because there has been no publicly reported issue linked to SEC employees including a small portion of Financial Industry Sector funds in their portfolios. The commenter described the amendments as “about so-called ‘optics’” and stated that optics are not an appropriate rationale for an ethics rule.

 Another commenter suggested that the prohibition on owning Financial Industry Sector Funds be more narrowly tailored and questioned why the Commission applies uniform personal trading regulations to employees in different divisions and roles. The commenter also asked why the trading restrictions are applied to spouses. The commenter disagreed with being “forced to sell a sector ETF that numerous other Chairs and Ethics Offices didn’t find problematic,” and found it puzzling that they would have to divest and be faced with the choice of either hiring an accountant to manage a potential taxable gain or pay such a tax immediately.

2. Final Rule

The Commission has carefully considered the comments received and is adopting §4401.102(c)(1) as proposed. The President, through Executive Order 12,674, as modified, and OGE through 5 CFR 2635.105, have authorized agencies to prohibit employees, their spouses and minor children from holding certain investments based on the agency’s determination that the acquisition or holding of such financial interests would cause a reasonable person to question the impartiality and objectivity with which agency programs are administered. Regulatory prohibited holdings restrictions must be established through an agency’s supplemental ethics regulation, issued jointly by the agency and OGE. To date, over twenty other agencies, with the concurrence of OGE, have established prohibited holdings regulations for their employees. (…) As described in the Proposing Release, the Commission is responsible for regulating the trading of securities, investigating securities fraud and manipulations, requiring registration of brokers, dealers, and investment advisers, and supervising the activities of entities it regulates for compliance with the securities laws. To ensure that the public can have the utmost trust in these activities, the Commission has long prevented employees from purchasing or owning any “security or other financial interest in an entity directly regulated by the Commission.” In this regard, the Supplemental Standards help promote public confidence that staff are not benefiting personally from their positions as SEC employees with respect to non-public information about securities and securities markets. The Supplemental Standards also mitigate the risk of real or perceived conflicts of interest.

(…) The final amendment is appropriately tailored to this risk by focusing on only investments in the financial services industry that are regulated by the Commission. Moreover, the Commission finds it appropriate to extend the current prohibited holdings regulation to prevent the incongruous result under the current rules that an SEC employee is prohibited from owning a single share of a directly regulated entity but could theoretically hold an unlimited value in a Financial Industry Sector Fund that concentrates holdings in directly regulated entities. Both cases present similar conflict of interest concerns. (…) Finally, as noted in the Proposing Release, Congress authorized OGE and the Internal Revenue Service to defer capital gains taxes that arise because of the divestiture of property when it is reasonably necessary to comply with Federal conflict of interest statutes, regulations, rules, or Executive orders, including the Supplemental Standards. As a result, members and employees, including spouses and minor children, required to divest Financial Industry Sector Funds may be eligible for a Certificate of Divestiture (“CD”) from OGE to defer taxable gain consequences, as is the case for employees required to divest prohibited holdings under the current rule. Affected employees may contact the SEC’s Office of the Ethics Counsel (“OEC”) staff for advice and counsel on the CD process.

Source: https://www.sec.gov/files/rules/final/2024/34-99582.pdf

After reading the above texts and, in light of them, write a 30-line summary of the discussed rule, comments received, and final decision of what was discussed.