SEC and White House seek greater oversight on private investment in China

Topline

• SEC Investor Advisory Committee discusses outbound investment review and IA oversight

• SEC directors grilled by Congress while appropriations moves to block SEC reforms

• Schumer unveils AI legislative framework

• State privacy patchwork expands in absence of federal action

SEC Investor Advisory Committee discusses outbound investment review and IA oversight

Outbound investment review

The SEC’s Investor Advisory Committee (IAC) met on Thursday to discuss federal efforts to monitor private investment in China and the SEC’s potential role in the process through private fund disclosures. The Biden administration has been working to finalize an outbound investment review EO, which would implement regulations that would require investors to provide notifications on investments in China in targeted sectors, including semiconductors, artificial intelligence, and quantum computing, and allow the government to review and potentially restrict them. While supporters claim this new authority is needed to further national security interests, lawmakers and industry leaders have pushed back, citing the negative impacts on private fund investment into companies with supply chains or technology linked to targeted regions. While these efforts have been in the works for a while, the “reverse CFIUS” EO seems imminent.

Why it matters: New outbound investment screens will introduce a compliance burden and potential divestment risk for private funds. Establishing guardrails around emerging technologies like AI will be difficult for the regulators to structure and difficult for fund managers and investors to navigate when evaluating potential investments. A key focus of the SEC under Chair Gary Gensler has been increasing transparency in the private markets. The impending outbound investment EO could bolster SEC efforts to increase disclosures for venture capital and private equity funds making these investments. 

Enhanced RIA oversight

The IAC also discussed a recommendation designed to enhance SEC oversight over registered  investment advisers (RIAs), including SEC-registered private fund advisers. The number of RIAs and private funds managed by RIAs has outpaced SEC staff responsible for examining these advisers. To assist the SEC’s oversight, the IAC considered a number of alternatives to bolster examination efforts, including by imposing user fees and facilitating third-party examinations. Any user fee would have to be set by Congress, but the SEC could adopt rules to require third-party compliance exams. 

Why it matters: While IAC recommendations are not binding, they can influence Congress and Commission actions, particularly when transparency and oversight of private funds are top of mind. Third-party efforts to bolster SEC exams will likely impose costs on the industry, which could increase barriers for smaller advisers. But even without additional exam resources, private fund advisers should expect more scrutiny. As noted by the SEC’s most recent exam priorities, private fund advisers are a key focus area, particularly around fees, conflicts of interest, and marketing rule compliance. And we have seen an increasing number of enforcement actions in the private fund space, including one this week. 

SEC directors grilled by Congress while appropriations moves to block SEC reforms

The SEC captured the spotlight on the Hill this week as the House Financial Services Committee held a series of SEC oversight hearings with the SEC’s General Counsel, Trading and Markets Director, and Chief Economist in the hot seat. As expected, questioning largely fell along partisan lines: Republicans used the hearings to critique Chair Gensler’s market structure reform proposals and highlight the SEC’s lack of responsiveness to congressional requests, while the Democrats applauded his work. The hearings represent a shift from the policy discussion phase to the oversight phase. Meanwhile, the House Appropriations Financial Services Subcommittee approved a draft version of the fiscal 2024 spending bill, which includes riders that would block the SEC from implementing some of the most contentious parts of their agenda, including climate risk disclosures, custody rules, equity market structure reforms, and changes to section 12(g) that would prematurely push more companies into the private markets. The bill would also cut $150 million in SEC funding from fiscal year 2023 levels, delivering nearly $500 million less than the amount requested by the SEC.

Why it matters: House Republicans are leveraging the tools at their disposal—congressional oversight and funding constraints—to slay and potentially stop the SEC’s aggressive rulemaking agenda, including on private markets. While such actions may slow the efforts, create further arguments for litigation around proposals, and—ideally—soften final rules, they are unlikely to stop them. Expect Chair Gensler to continue to push forward on the agenda, which could include policies that restrict investor access to private markets, increase burdens on private companies, and push private companies public faster.  

Schumer unveils AI legislative framework

At a speech this week, Senate Majority Leader Chuck Schumer announced his SAFE Innovation Framework for the development of artificial intelligence policy. The policy looks to further Schumer’s overall goal of promoting American dominance in the AI landscape by focusing on five key objectives: (Security, Accountability, Foundations, Explain, and Innovation). Schumer worked with academics and industry groups to inform the framework, but he’s now turned to a bipartisan group of senators to build out the policy response as committees develop legislation. Schumer also intends on convening AI insight forums with thought leaders and industry experts with a wide range of viewpoints to further inform the efforts. 

Notably, Schumer grounded his call to action in the importance of giving the United States a strategic advantage over China and ensuring emerging technology like AI aligns with democratic values, though the U.S. is lagging behind the EU on AI regulation. Enacting a broad stand-alone AI framework is unlikely, but China-tethered pieces from various campaigns could be combined into another bipartisan competitiveness package at the end of the year. 

Why it matters: Washington knows the U.S. is behind in understanding and regulating AI technology—and policymakers are desperately trying to catch up. However, enacting any sort of comprehensive framework is a slow-moving process—particularly when it concerns an extremely complex emerging technology. While the EU moves forward, the pressure on the U.S. will only grow. Expect the drumbeat of hearings and legislation to continue to ramp up over the coming months. 

State privacy patchwork expands in absence of federal action

As efforts to enact a comprehensive federal data privacy framework have stalled, Texas became the 11th state to enact a stand-alone privacy statute, with Montana, Florida, and Tennessee also approving state privacy frameworks in recent weeks. These statutes largely apply to companies that do business in or sell products to residents of the respective states, and businesses are generally required to limit the personal data they collect. Many state laws also require consumers to be given the option to opt-out of the sale of their personal data and from targeted advertising.

Why it matters: State privacy frameworks share some similarities, but each enactment exacerbates the patchwork of different regulations companies must comply with when operating in multiple states. This fuels, but also complicates, discussions around a federal privacy framework. The appropriate degree of federal preemption of state data privacy regimes has long been a sticking point in negotiations, including in the most successful campaign to date: the once-bipartisan American Data Privacy and Protection Act. Navigating multiple state-specific privacy frameworks can be burdensome for businesses and consumers, but states will remain the arbiter of privacy standards for the foreseeable future, as federal efforts to craft a framework continue to stall.

Carta QSBS event: Everything you need to know about QSBS and small business taxes

Most companies miss out on the benefit of QSBS because they don’t know it exists or don’t know how to check if they are eligible. The QSBS tax break can save stakeholders—including founders and employees—up to $10M in capital gains. Join Carta on June 27, 2023 at 10:00am PT / 1:00pm ET to hear our panel of experts discuss how the QSBS landscape may be quickly changing.

News to know

• SEC charges audit firm for widespread quality control deficiencies. Marcum was fined $13 million from the SEC and PCAOB and will implement supervisory structural changes for deficiencies related to SPAC work. The SEC has been increasing its scrutiny of “gatekeepers”—auditors, accountants, and lawyers—and we expect this trend to continue.

• Assistant Attorney General speaks out on bank mergers. In a speech this week, AAG Jonathan Kanter noted that the Department of Justice will expand the number of considerations in its bank merger review process.

• Crypto and stablecoin laws get approval by the UK Parliament. Parliament’s upper chamber approved the laws, which would recognize crypto as a regulated activity in the country and would regulate stablecoins under the country’s payments rules. The bill will now return to the lower chamber, where a final version will be agreed upon.

• Binance and the SEC reach a deal to keep U.S. customer assets in the country. The deal ensures that the assets of U.S. customers will remain in the United States until the lawsuit between Binance and the SEC is resolved. Earlier this month, the SEC filed a sweeping lawsuit against Binance and its CEO for a series of securities violations.

• Senate Banking Committee passes executive compensation clawback bill. The bipartisan bill would increase regulatory enforcement over big bank executives’ compensation, the most recent effort to hold executives accountable for bank failures. 

• FDIC chief says that Basel proposal might apply to SVB-sized banks. FDIC Chair Martin Gruenberg noted that an upcoming proposal that will raise capital requirements on the largest banks might also be applied to lenders with between $100 billion and $250 billion in assets.

• CFTC seeks whistleblower tips relating to carbon markets misconduct. In a rare action, the CFTC has put out a call for whistleblowers to come forward with information around fraud and misconduct in the carbon credit markets, which could foreshadow upcoming enforcement activity in the sector. 

• BlackRock files for spot Bitcoin ETF. The firm submitted an application with the SEC with Coinbase as the crypto custodian. The SEC has yet to approve a spot Bitcoin ETF, and is currently embroiled in a lawsuit with Grayscale over their spot Bitcoin ETF proposal.

Upcoming events

• Commodity Futures Trading Commission Open Meeting – June 26 at 9:00 a.m. PT / 12:00 p.m. ET

• Carta QSBS Virtual Event: How To Save Up to $10M in Capital Gains: Qualified Small Business Tax Exemption – June 27 at 10:00 a.m. PT / 1:00 p.m. ET

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