Announcer:
From the library of the New York Stock Exchange at the corner of Wall and Broad Streets in New York City, you're Inside the ICE House, our podcast from Intercontinental Exchange on Markets leadership and vision and global business, the dream drivers that have made the NYSE an indispensable institution of global growth for over 225 years. Each week we feature stories of those who hatch plans, create jobs, and harness the engine of capitalism right here, right now at the NYSE and at ICE's exchanges and clearing houses around the world. And now welcome Inside the ICE House. Here's your host, Josh King of Intercontinental Exchange.
Josh King:
Anytime business leaders, economists, regulators, and exchange pundits kibbutz around the current market, invariably someone's going to crank up the Wayback Machine and invoke October 29th, 1929, Black Tuesday. That's the day when stock prices collapsed and over 16 million shares were traded on the New York Stock Exchange, marking the beginning of the Great Depression. The moment serves as a reliable specter for what happens when markets become overturned and underregulated. But it's not the first nor the last time the markets saw a double digit percentage drop in one day.
The early history of the NYSE featured a regular cycle of booms and busts, where traders like Jay Gould, the subject of our show back on episode 316, made outrageous fortunes appear and disappear dozens of times over his career by hook and by crook. To glean what was different about the '29 crash requires us to jump forward a couple years to 1934. That's when FDR signed the Securities Exchange Act, creating the US Securities and Exchange Commission as one of President Roosevelt's new deal programs to combat the economic fallout of the Depression.
The '34 Act anointed the SEC with power to regulate the securities industry, including us here at the NYSE, as well as individuals and companies flaunting securities laws. Now, a lot's changed in the 90 years since, but unquestionably, the SEC and NYSE have worked together to create the most regulated, most transparent markets in the world. In 2022, those seeking the unregulated Gould styled rollercoaster have turned instead to another market, crypto. In just the last two years, those markets have made more than $2 trillion appear and disappear.
Over the last month or so since the collapse of FTX, there's been a bull market on doomsaying, but could 2023 finally usher in the type of regulation for those markets to finally flourish? Which brings us to our guest today, Jay Clayton, who spent his career wearing different hats, working on behalf of large corporations and Main Street investors alike, helping to ensure the public markets grow and operate accordingly, while leveling the investment playing field for individuals.
A poignant proponent of financial literacy and crypto regulation, Jay's voiced his opinions in multiple op-ed pieces in The Wall Street Journal, piquing my interest and many of us here at ICE, to guide us through his journey toward the intersection of law, policy, and finance, his work at Sullivan & Cromwell and his service as SEC chair, and importantly, his thoughts on regulation as it relates to crypto and digital assets. Our conversation with Jay Clayton is coming up right after this.
Audio:
When you hear the word sustainability, you think, too big. When you feel you have to do something, you think, too complicated. Hold on. Think about your decisions. Get closer. Those that are big or small for you, your decisions and other people's decisions, those that have to be made every day. Step back a little. Think of the decisions that add up to many more. There are millions of decisions that change everything little by little for the better. Now, think about who can help you make better decisions, and there we are.
So that what you save, the planet saves too. To keep moving forward without leaving anyone behind. And now when you hear the word sustainability, you think opportunities. At BBVA, we're putting new solutions at your fingertips in order to build a greener and more inclusive future. BBVA, creating opportunities.
Josh King:
Our guest today, Jay Clayton, Sullivan & Cromwell Senior Policy Advisor and Of Counsel and the Non-Executive Chairman of Apollo Global Management, was nominated by President Donald Trump to serve as the 32nd chairman of the US Securities and Exchange Commission back in May 2017. Prior to his appointment, Jay was a partner at the law firm Sullivan & Cromwell, where he specialized in advising clients on M&A and their capital raising efforts, including back in the late 1990s as a young lawyer the acquisition of a defunct energy trading exchange called Continental Power Exchange by one Jeffrey Sprecher. Welcome, Jay, Inside the ICE House.
Jay Clayton:
A big smile on my face. I remember the first time I met Jeff.
Josh King:
Talk about that deal.
Jay Clayton:
Remarkable vision, right? Bringing electronic trading from the commodities markets to what we have today. Jeff, look, to his credit, saw where the puck was going long before others did.
Josh King:
Did you ever think it would amount to a company called ICE with a market cap of 60 billion on the back of Jeff's investment of a dollar?
Jay Clayton:
No, did not. You meet a lot of wonderful entrepreneurs along the way, and this is one that I thought was good, I thought there was a lot of good backing, but I didn't see this coming.
Josh King:
Where were you as a lawyer at the time you're pulled into this deal, and what job do you provide at that point?
Jay Clayton:
What do a lot of M&A lawyers do? The principles. They understand the type of transaction that they want and how the risk is going to get split. Is it going to work out? If I'm not buying what I thought I did, how much recourse do I have? Those types of things. How's the regulatory process going to work? As a younger transactional lawyer, your real job is to make sure that whatever that meeting of the minds around the allocation of risk, the allocation of time, the allocation of responsibilities is actually reflected in the documents and then you hope like hell, no one has to look at them again.
Josh King:
Not many people look at them again after that deal is done. It's now probably 22 years since ICE was formed in 2000, 23 years. You've visited this place many times certainly as a lawyer and then SEC chair. What's it feel like to be back at the exchange again?
Jay Clayton:
Every time I walk in here, you get that sense of history. Your lobby is well laid out with the iconic American companies that have listed on the exchange. You mentioned it in the beginning, the American capital markets are a marriage between great ideas for companies and the investors that support them. Look, it sounds like mom and apple pie and America, but that faith, the willingness to take your after tax dollars and put them into companies with the hope that they're going to be something better tomorrow, that's part of American culture that really doesn't get duplicated other places.
You walk through that lobby. I saw CVS started as Consumer Value Stores. You see many companies that were there before the airlines, and then right next to them you see the airlines. It's a nice walkthrough the history of American commerce and the participation of the public in that endeavor.
Josh King:
We hosted you many times here during your service as chair, but it's good to have you back in your nonofficial capacity so that you don't have to caveat your remarks as you always do at the beginning by saying your views don't represent those of your fellow commissioners. How has it been for you over the last couple years? A feeling of liberation?
Jay Clayton:
Well, in some ways, there's a feeling of liberation. We all think we're better than we were or whatever. You have a nostalgic view of your own self. But I did try to be very candid when I was chair about what I thought. Maybe it wasn't what would happen at the commission, but I tried to share my views about what I did think. And look, what's nice now is you can have some interactions with people that in government service you really can't have. I mean, from a faith of the public point of view, most of your interactions really have to be on a formal basis, and it's nice to reconnect with some people that I was friendly with before I went into government.
Josh King:
Jay, let's start by addressing a couple elephants that are in the room, in this case, maybe a donkey in the room. I want your view of how Chair Gensler is doing. I mean, are you going to be more like George W. Bush staying mum on the sidelines on Barack Obama, or Donald Trump talking to Truth Social to critique Joe Biden?
Jay Clayton:
It's a provocative question because, of course, Chair Gensler and I disagree on some policy matters. That's been clear because he has changed course on some areas where I obviously thought the policy was right. But in terms of the overall job, look, you are a steward of an administrative agency. That's very important. It's important that all of us who've had these jobs support those who've come after us and came before us. Because that agency, leadership changes, commissioners change, but the staff, which have an average time there, well into the double digits and are very dedicated, they're constant.
What I would say is people's day-to-day interaction with the commission doesn't really change. You want it that way. You can't have an administrative agency where the day-to-day interaction changes dramatically every three, four, or five years, or in the case of changing of chairs, many times, much sooner than that. There has to be a consistency of approach.
Josh King:
One thing that you and Gary have very much in common is you're sort of passing the baton during the height of COVID, and I remember very much as your agency, that gorgeous building right near the Union Station, had to clear out, people working remotely. That is certainly a world in which Gary inhabited. What was it like for you with the assignment to run the SEC and the culture that was very much a bunch of lawyers in that building all collaborating and working together to suddenly have to do it remotely? How did that tie Gary's hands when he took over?
Jay Clayton:
Remarkable job in two areas. The first was the IT area. We sent everybody home a bit earlier than everyone else. Not because we had great foresight, but because we thought we had a COVID case. We thought, okay, we're just going to send everybody home. And you know what? Maybe we'd be back in a week. Maybe we'd be back in two weeks, three weeks. But we did get a head start on the technology. And lo and behold, we found out that 3,500 people could all be logged on remotely working in our systems we're operating. I can't say enough good things about our IT department. And then what I would say is leadership and morale at any agency or any business, it's not just one person.
The number of direct reports to me and then another level down on the org chart who organized what I would say is morale boosting exercises to keep everybody's head in the game was also remarkable. First six, eight weeks, every day was a fire drill, but then we were able to settle into an operational environment that I thought was very close to what we had when we were all in person. But what I will say is if we hadn't had a great amount of goodwill among each other, we would not have been able to do that. It was the combination of existing goodwill and great tech support that enabled us to operate. I think a lot of American companies found that.
Josh King:
I want to address one more elephant before we get into the guts of our conversation, Jay. Two days ago, four senators, Democrats Hickenlooper and Warren and Republicans Tillis and Lummis, question Sullivan & Cromwell's capacity as a disinterested party to help investigate the allegations of fraud at FTX based on its prior work for the firm. How should Mr. And Mrs. 401(k) think about the potential conflict of interest?
Jay Clayton:
Look, I'm not directly involved in that matter, but let's just take a step back. Bankruptcy court and the resolution of a bankruptcy matter, the judges and participants in those, what do I say, endeavors, those projects, those searches for the truth, they're actually quite experienced at these types of issues. I'm sure that the court is addressing, whether to the extent there are conflicts, how they can be resolved. And that is part of what bankruptcy judges do on an everyday basis. And look, this is America. The legislature, they're allowed to comment on the courts, but it is the court's job in the first instance.
Josh King:
Given those preliminaries now out of the way, crypto and its regulation has certainly been top of mind here at ICE and across the markets. We had our own experience with the launch of Bakkt back in 2018. But last August you authored an op-ed in The Wall Street Journal. The title of it was The Peculiar Challenges of Crypto Regulation. You wrote, "Regulation of America's public markets is broad and rigorous, while private market access is highly restricted." Why did you decide to wade into crypto?
Jay Clayton:
Well, I wanted to try and explain, and I think it needs explanation, why crypto regulation has proven difficult for our existing regulatory environment. There are a number of reasons why. Let's go with the fact that it started in the retail space and it started globally. The way we regulate financial transactions, whether it's at the consumer level, the investment level or not, is we actually regulate them through intermediaries. We don't sit next to investors and say, "You should buy or sell, or you should ask these questions."
We sit with the people who are selling to them and say, "Look, if you're going to sell, you've got to do it in this way. You've got to provide this much disclosure. You've got to go through these procedures. You got to give the buyers rights." That's how we make sure that the public is protected through intermediaries. Crypto came without those kind of regulated intermediaries, and it came offshore. We didn't have the nodes in the system to affect regulation as we typically do. Now, that doesn't mean that there is a gap in the law. For example, if you are selling securities to the public, as we all know, if you're going to have an IPO listing here at the New York Stock Exchange, you have to file with the SEC.
You have to provide comprehensive disclosure, audited financial statements going back three years. A number of procedural and substantive boxes need to be checked. It's costly. It's very costly. I mean, what's the average size firm that floats on the New York Stock Exchange? It's into the billions of dollars in equity value. If you're trying to finance a project, it's very difficult to raise money from the public unless the project is a big project. The crypto entrepreneurs who came from offshore or watched these things offshore, they kind of blew through that fact. The op-ed goes into why that may have happened and the like, but that's the disconnect and that's why we are where we are.
Josh King:
We are recording this episode as the fallout from the collapse of FTX continues to unfold. One aspect that came to light last week was the firm's targeted outreach to low income and young investors, talking about retail Jay, to deposit their money with them instead of going into traditional banks. You've written in the past about your relationship with your grandparents and how they started you on a Christmas club savings account and a gift of three shares of stock that you finally had to divest as you took the gavel of the SEC chair. How did their love and discipline teach you about Wall Street and how could we ensure that every kid today has a Christmas club account?
Jay Clayton:
Well, I'm a believer that just like you get a social security number, you should get a bank account. We have the technology to provide every child in America with access to a bank account. Because if you have access to a bank account, regulated or not, then you're connected to our economy from a young age and you understand. Getting your first job, you actually have a place to put your salary. If you want to save for something, you have a place to do it. That connection, I think, would enable what I would call as financial literacy to be more easily taught in schools and in other places.
We all know that we learn better when we can touch something. When you're talking to somebody about having a bank account or investing and the only place they're hearing about that is in a textbook, it doesn't work as well. Kids are really smart. You just got to give them an opportunity.
Josh King:
The idea of parents giving their kids allowance through electronic transfer, grandparents giving them birthday presents through electronic transfer, people shoveling snow in the sidewalk, filling up that bank account, I mean, it's so different in terms of when you and I were kids and getting a couple dollars to put in our wallet, but we can do so many things.
Jay Clayton:
You had a jar. You babysat and you put a few dollars in the jar. We have the ability to get people connected early. We should do it.
Josh King:
In addition to the financial lessons, what was life like growing up in the Clayton household? What was your first job? When did you first earn a buck?
Jay Clayton:
I would say lifeguarding. I was a lifeguard at the Jersey Shore, and that was a lot of fun. I remember my first check was $4.13 an hour, which I thought was pretty cool.
Josh King:
Were your parents good disciplinarians about saying, "You saved that. Don't go buy Three Musketeers bars?"
Jay Clayton:
For the most part. For the most part. They were on us to save, pay for books, do things like that. We're not that old, but I will say this, let me get to the cost of higher education. I like to make this point, because I had a good summer job, worked a lot. With that summer job and little odd jobs, I could actually pay half my tuition. If you have a good summer job today, it probably pays twice as much as what I was making, maybe three times. You're not paying half your tuition.
Josh King:
No, you are not.
Jay Clayton:
And that's a big change. You could work the summers hard and get through school without a lot of debt, and I'm just not sure that's true anymore.
Josh King:
Despite the ability to pay half your tuition and overseeing your own thriving stock portfolio through your Christmas club by the time you're 12, you studied engineering at the University of Pennsylvania. That's where you put your tuition money after transferring from Lafayette. What was the initial career plan? How did it evolve?
Jay Clayton:
Look, I like puzzles, problem-solving, and being an engineer, that's what you do, right? Take whatever we're doing today, do it better, more cheaply, faster. You could say what Sprecher did here with ICE was really an engineering project, right?
Josh King:
Yes, exactly.
Jay Clayton:
It's an operations research type project. Those things are a lot of fun. When I got out of college, the entrepreneurial opportunities, it wasn't that long ago in 1988, they weren't like they are today. The idea that you would get a bunch of money from friends and family and go to a garage and try to figure something out. Now, there were some really smart folks who were doing that and we all know who they are now, but that wasn't readily apparent. So then I thought about going off to graduate school and becoming a professor.
One thing led to another. That didn't happen. I bumped my way into law school and ended up at Sullivan & Cromwell. Thought I'd stay 18 months, maybe two years. Ended up liking the job, stayed almost 25.
Josh King:
That time at Sullivan & Cromwell, you represented some of the world's most recognized firms, advised them in some of their most white knuckle moments. There was Bear Stearns sale to JPMorgan Chase, Barclay's purchase of the assets of Lehman Brothers. How did your experience specializing in M&A and capital market offerings like the launch of ICE define the priorities that you set when you became SEC chair?
Jay Clayton:
That 2008 time, anybody who lived through that, and I was fortunate enough to Roger Cohen, people know, asked me to basically carry his bags through the financial crisis, which was an incredible exposure. You learn about things like how much liquidity matters in times of stress, and that having high quality assets matters in times of stress, and that capital matters in times of stress. And that the more you have liquidity and capital, the less likely you are to get into a stress situation that turns into what I would say is a financial crisis. You learn that firsthand.
One of the things that I talk about that I learned very well then, and I hope I do, is that when you are in a situation where the company's viability or something about the company is in question, understand that every statement that you make is going to be tested by the market. We actually just saw this recently in FTX. As FTX was bumping down the road to where it is today, the statements that they were making were immediately tested by the market. That's one of the lessons that I learned that isn't always articulated.
When you're talking and advising companies and thinking about how to handle communicating the stress you're under, know that you will be trusted if the statements that you make are tested and proved to be true.
Josh King:
Talking about some of the statements that you've made, Jay, you served as chair of the SEC for three years and 233 days to be exact. You've long been an advocate for mom-and-pop investors, or as you refer to them in your inaugural speech, Mr. and Mrs. 401(k). Can you explain the role that regulation plays in protecting the interests of smaller investors and how you balanced it with the desire certainly expressed many times during your tenure here by our then President Stacey Cunningham to bring more private companies into the public markets?
Jay Clayton:
Well, the ability of ordinary investors to access non-public market investments is extremely limited.
Josh King:
Certainly.
Jay Clayton:
If you want to provide them with opportunity, you want to provide more public market investments, or figure out a way to give them access to those private markets. Now, let me explain why the public markets are such a good deal for retail investors. You sit side by side with and for the most part get the same deal as the largest institutions, that's pretty remarkable. They do all their work. They do their due diligence with Burt Malkiel, Random Walk Down Wall Street, and whatnot, but you are, to use an economics term, you're freeriding on the work of all these professionals who its job is to truly have price discovery.
We've gotten to the point in this country where you can get that for 10 basis points a year, 15, 20, and maybe you get some active management for 100 basis points, but that's an amazing deal for the retail investor. I feel really good about that. I think the price of that access came down during our tenure. I hope that through competition it continues to come down. Let me just throw out a stat. Let's just say there's $10 trillion of retail money in the market. It's probably more. If you save those people 50 basis points a year, that's $50 billion a year, year after year after year that you're putting into their pockets. That's the kind of thing that motivates the women and men of the SEC, and it's a pretty wonderful thing.
Josh King:
Talking about the magic of compounding for sure. When you were SEC chair back in 2017, what were your initial thoughts of this alternative to being in the equity markets, crypto and digital assets? At the time, did you believe that the US needs to act fast to preserve its advantage in the tokenization of financial infrastructure, which you wrote in that 2021 December op-ed in The Wall Street Journal?
Jay Clayton:
I did. Well, look, two sides to this, right? An incredible technology that... You see people who've been in technology all of their careers say, "You know what? The network effects, the verification effects, the speed that we can achieve compared to today's technology using blockchain or distributed ledger technology is clear. Should we take a look at it," which of course we should take a look at. But then, if you'll note, going back to 2017, I was very concerned that this was getting its traction in the retail market, and that it was getting its transaction in the retail market with promoters who were not subject to US law.
We tried, I think I tried as much as I could, to warn people that this was not the place to be putting their money. If you send your money offshore, there is nothing that we or the DOJ or the State Department or anybody else is really going to be able to do as a practical matter to get it back. Well, kind of proved to be true. We obviously had the ICO cracked down. I thought that the ICOs were IPOs by just another name, and I stand by that. We're on the, are we going to get this technology right or wrong, journey.
Josh King:
Talking about getting the technology right or wrong, you've been a vocal proponent of regulation and crypto, recently co-authoring another op-ed in The Journal with the former chair of the CFTC, Tim Massad, in which you outlined three recommendations for US regulators. Help me understand what are the potential legislative options for regulating crypto, and how have those options changed since the implosion of FTX?
Jay Clayton:
I think one of the things that Tim and I... Tim's a fantastic guy. If people try to put tension between Obama, Trump, Biden, if Tim was a Treasury official, CFTC official in the Obama administration, I think we would agree on 95% of the questions you're going to ask us, because at the core of good regulation is transparency and enforcement of what I would say is the anti-fraud aspects of law. What do we think we should do today? One thing we say in there about legislation is waiting for legislation can be Waiting for Godot, that bandwidth in Washington, attention, those types of things. With the tools that the CFTC, SEC, Fed have now, where should they allocate their resources? We make three recommendations.
One is go to the platforms where there's some debate as to whether they're trading commodities or securities and say, "Look, while we work out that debate, at least do these things." No wash trading. No leverage, custody, segregation. All of the things that you guys here at the NYSE do every single day, put those in place. And you know what? If you can't put them in place, then we know we have a problem." That's number one. Number two, continue with the enforcement. Again, I have no problem saying that virtually every ICO I saw was a securities offering.
And three, again, sort of going back to the fundamentals on stablecoin, which is what I would say is the liquidity in the crypto market, let's have real regulation around what you have to do to call yourself a stablecoin. And if you're not in that box, you're probably an illegal product in at least the jurisdiction of one or two agencies. Those are three things that could be done relatively quick. Now, it's always easy when you're on the outside to comment and say that. When I say relatively quickly, I mean months, not days.
Josh King:
One, two, and three. After the break, we'll talk with the former SEC chair Jay Clayton to dive deeper into the challenges of regulating crypto and the potential options facing the SEC and other regulatory bodies. That's all coming up right after this.
Audio:
Connecting the opportunity is just part of the hustle. Opportunity is using data to create a competitive advantage. It's raising capital to help companies change the world. It's making complicated financial concepts seem simple. Opportunity is making the dream of home ownership a reality. Writing new rules and redefining the game. And driving the world forward to a greener energy future. Opportunity is setting a goal. And charting a course to get there. Sometimes the only thing standing between you and opportunity is someone who can make the connection. At ICE, we connect people to opportunity.
Josh King:
Welcome back. Before the break, Jay Clayton, Senior Policy Advisor of Sullivan & Cromwell and the former chairman of the Securities and Exchange Commission, and I were talking about his beginnings in the legal profession, his transition to the SEC. We touched on crypto regulation and FTX in the first part of the show, but we barely scratch the surface, so we're going to dive a little deeper as we continue. Jay, I mentioned that August 22 op-ed of yours, but let's unpack those thoughts a little bit more, one, two, and three.
Can you discuss the dichotomy between the ability of private industry's ability to adapt quickly and the government's bureaucratic pace as they pertain to financial regulations or lack thereof? You mentioned it's not weeks, it's months, but could it even be years?
Jay Clayton:
Well, you're talking about what I would call is clarifying regulations for new technology, and that can take a while. The notice and comment and rulemaking period can take a while, but you are able to give guidance in the interim, the guidance, informal commentary and the like. I think what most people in this space have tried to do is say, "Let's look at the substance of these transactions and not argue about form."
Like I said, the ICO craze, if you're asking people for money and you say, "I'm going to take your money. I'm going to use it to build out a network. I'm going to use it to build out a product. I'm going to sell it to the public, and you should be able to get a return, either because you're able to use that network and do so in a way that's much cheaper, or you can sell your right to use that network to somebody else, just like you would sell a stock certificate," in substance, that's the sale of equity.
It's the sale of equity in a project. We've always in this country looked at substance over form when it comes to financial regulation. Because the people who wrote the laws in '33 and '34, if you look at the definition of a security, if you look at the definition of an offering, they didn't want people to make form over substance arguments. If you were taking people's money and they were expecting you to make a profit, you were going to be subject to fairly paternalistic regulation.
Josh King:
Substance over form. Let's pivot from what an administrative agency like the SEC would do to what happens on Capitol Hill. There are several bills at play in the Senate right now which take a different approach to the question of whether crypto should be treated and regulated as a security or as a commodity. Senators Lummis, Republican of Wyoming, and Gillibrand, Democrat of New York, have a bill that would divide digital assets into commodities, securities, and ancillary assets.
And under it, crypto issuers would be required to make disclosures to the SEC. Digital asset issuers would be presumed to be a commodity, therefore subject to CFTC regulation. Will these types of bills see enough bipartisan support in the House and Senate to pass into law?
Jay Clayton:
Look, this is an outside commentary. My expectation is that some of the issues that you and I talked about a few minutes ago may be the subject of legislation. For example, what is a stablecoin? That should not be regulated as a security, but rather should be regulated as a bank deposit. What form does that need to take? What kind of reserves need to be in place? That type of issue may be the subject of legislation. How do you custody an asset that is in digital form that is recorded on a distributed ledger in a way that is compliant with the securities laws?
That kind of question may be the subject of legislation. Do I expect that we're going to have a comprehensive new crypto regulator that parallels the CFTC and the SEC? I do not.
Josh King:
You heaped praise on Timothy Massad earlier. Can the work really be shared between these two agencies, the SEC and the CFTC, or does one have to take the lead? There were some news stories during your tenure that maybe the two would merge or another approach.
Jay Clayton:
The rumors of an CFTC-SEC merger occur with every change in administration, but I don't see it happening anytime in the near future. In terms of working together, look, Dodd-Frank required the CFTC and the SEC to work together in a number of areas, particularly swaps around securities and securities indices and the like. I think there really weren't many complaints, whether it was from end users, from legislators, from market observers, that we were duplicating or piling on or leaving gaps. It takes work, but it can be done.
Josh King:
In an interview in the Financial Times, you said that you believe that most digital assets or securities, you mentioned that earlier, and the attempts, I'm going to quote you here, attempts to use this difference in securities and commodities regulation to leave a substantial swath of digital assets unregulated are just absurd. How do these cases that you worked on at the SEC demonstrate this in your opinion? Give us some examples of things that brought that absurdity to light.
Jay Clayton:
Let me say this, there were a number of cases that we brought in that ICO where the argument was that the form of the token was such that it wouldn't be a security because it had some utility. Well, if I take a share of stock for a New York Stock Exchange listed company and I attach a coupon to it that allows me to go to, let's go back to CVS, that gives me a discount at CVS, now that share of stock has some utility. I can go and use that coupon at CVS. It doesn't make it no longer a stock.
I'm not kidding you. People were making the argument that any bit of utility as part of a token, although there was a financial return aspect associated with it, would take it out of the securities law ambit. I think that's absurd. You don't make something less regulated by adding a feature to it.
Josh King:
Another example perhaps, Crypto.com launched a proof of reserves page which offered a snapshot of its reserve holdings. The shortcoming here is that it only shows a moment in time, not the ongoing update of assets. How well do you think this type of transparency works? Is it enough?
Jay Clayton:
For me, if what you want is something akin to an audit, why wouldn't you just have an audit?Isn't that a fair question? One of the things that happens in what I would say is markets areas of our economy that are used day after day is you start to take things for granted. The fact that we have an incredible financial reporting and auditing framework here in the US where... It's people, but it's also systems.
When you have a decent size company, large company, retail investors may not know this, but all of your financial reporting systems are also built so that you can have an audit that you feel very comfortable with. That's part of the architecture of the financial reporting. The fact that we have all that, you might take for granted, but it's an incredible confidence builder. Is it 100% foolproof? No, but it's a lot better than a screenshot.
Josh King:
Just last week, Jay, US banking regulators, the Fed, FDIC, and the Comptroller of the Currency, issued a joint statement writing that the events of 2022 were marked by, I'm going to quote them here, volatility and the exposure of vulnerabilities in the crypto asset sector. The regulators said the risks include fraud and scams among crypto asset sector participants and contagion risks within the crypto asset sector resulting from interconnections among certain crypto asset participants. In your opinion, how great is the risk of contagion to banking organizations?
Jay Clayton:
Well, the risk of contagion to banking organizations as we saw and as it stands is very low. They do not have, as far as I can tell, direct or indirect exposure to fluctuations in value in what we'll call the loosely defined crypto asset market. Have we seen that what I would say is the nodes in the crypto asset market, the global crypto asset market, do they have exposure to volatility and sudden price drops? It's proven that they do.
Josh King:
Jim Cramer weighed in response to their statement and said that he expects the SEC to do a roundup of crypto companies that are not compliant with regulation. Let's hear what you have to say.
Jim Cramer:
Well, I think that there have been a lot of people who thought that the banks would adopt it. Fidelity adopted it. I think these statements are the beginning of what I've been calling for, which is that I think the SEC is going to do a roundup of the ones who are not compliant. They said that. They made this broad statement saying, "Listen, if you do not go along with the rules, we're going to come after you."
Josh King:
Do you agree with what Cramer had to say?
Jay Clayton:
Do I think that we're going to have what I would say is government action that completely pushes this technology outside the financial system? I don't think it's going to go that far. Go back to what we did with what I would say is the ICO crackdown, do I think people are going to look at other aspects of this market and say, "You know what? Let's demonstrate that the traditional securities laws in their substance apply to this form of technology?" No. Yes, I think that's going to happen. I think it's been happening.
Josh King:
Let's talk about institutions waving the white flag. Metropolitan Banking Holding Corporation announced it's going to fully exit the crypto asset related vertical. Silvergate customers have withdrawn over $8 billion of crypto related deposits, forcing the bank to sell assets to cover the cost and maintain its liquidity. Is this just the beginning for these types of crypto-friendly banks?
Jay Clayton:
I really don't know on that. What I would say is I don't have enough look into the detail of how much exposure these banks have to deposits related to what I would say is stablecoins and the like. But what I do want to note here is there's some pretty amazing things that have happened. As we've talked about, I am very much for compliance with law. I don't think that the path to innovation in the financial sector is to evade the law and then have the law catch up through legislation. That's the wrong path. That's the path that Uber took in the taxi cab industry. They were like, "Okay, you know what? Taxi cab law makes zero sense."
Josh King:
Let's see how long we can get away with it.
Jay Clayton:
And then the law will come around to us. That's not the way to do it in the financial industry. When I make that analogy, I note to people, Uber, whether you agree with my characterization or not, the cars weren't worse. They weren't uninsured. They weren't being driven by people who they weren't monitoring. The fundamental protections remained. Some of what has happened in the crypto spaces, let's just blow through the fundamental protections and then people will catch up. It was never the right way to go.
But what has happened is with stablecoin, and let's just say you have a true, well-functioning, well-reserved, audited stablecoin, the ability of people to do dollar based transactions instantaneously around the globe is something we have not had in the past. That's something that makes me sit up and say, "Okay, that technology is really something pretty special."
Josh King:
Crypto witnessed a plunge in trading volumes in 2022, signaling institutional investors are going to continue to be wary of digital assets. Do you see interest from institutional investors returning this year? What's going to take to draw their interest back to this asset class? This was basically the organizing principle of Bakkt that it was going to move from individual and consumer to institutions and we've kind of yet to see it. What's it going to take to get them involved?
Jay Clayton:
Again, I don't prognosticate on institutional take up and the like. One of the interesting things though for me about Bitcoin, if I understand the statistics right, is I think over half the interest in Bitcoin is from outside the United States, and that a lot of that is what looks to be a store of value, and it has had a relatively stable price over this downturn. If you listen to what I'll call them the Bitcoin bulls, they're like, "Hey, it's actually operating the way it should, and therefore, okay, maybe it's here to stay."
Josh King:
The US Attorneys Office for the Western District of Washington, Seattle recently subpoenaed hedge funds in its investigation into Binance and authorities are also investigating Digital Currency Group and its subsidiary Genesis, that's in the news this week. What are your thoughts here and now on how you see that all shaking out?
Jay Clayton:
Let's just keep going back to these fundamental principles. Do we have transparency? Do we have limited leverage? Do we have segregation of customer assets? Do we have all of those things that have become fundamental to how we regulate Binance? If you want to look at any one of these situations and ask yourself how is it going to come out, look at how many of those fundamentals are there and the way we would expect and how many of them are not there. That'll give you a pretty good sense of how much trouble, stress, scrutiny a particular product is going to face.
The other thing in the way we look at regulation of financial products in America is we do protect retail more than institutional. And to the extent that the project that we're talking about has retail people who were harmed by the lack of those protections, that's more on the dark side of the spectrum than on the light side of the spectrum.
Josh King:
As we begin to wrap up, Jay, it appears you and the current SEC Chair Gary Gensler have a similar agenda in terms of crypto regulations, specifically in defining most cryptocurrencies as securities. That's what we've been talking about so far. Let's listen to an excerpt of Nick De of CoinDesk's interview with Gary from last September.
Nick De:
To your point about instilling trust in these markets, you've said on numerous occasions that you believe a lot of crypto trading platforms, which we commonly refer to as crypto exchanges, should be registered as national securities exchanges. Because in your view and in the view of your predecessor Jay Clayton and in the view of I think many other SEC staffers and even lawyers, a lot of cryptocurrencies do resemble securities. What's the next step?
Gary Gensler:
They don't just resemble, they are securities, Nick. They are. They are. I mean, Thurgood Marshall, a great Supreme Court Justice, wrote in an opinion I think it was in the 1970s, ""That Congress painted with a broad brush to protect the public when somebody is raising money from the public and the public anticipates a profit." That's kind of the core.
Josh King:
Any daylight between you and Gary on that?
Jay Clayton:
No. No. I mean, look, we decided that when you are raising money from the public for a project and they had an expectation of a return or a store of value or the like based on your efforts, that we were going to rigorously regulate that transaction. Now, let me say, because there are some areas where there is daylight between. One of them is just how much regulation we are going to put on that public company. I am much closer to the financial reporting is for making investment decisions that are at the core of what we think about in terms of management philosophy, financial reporting, risks to the company, and the like.
There are some who think that we should add even more to that public company reporting burden and ask public company disclosure to do more than we have in the past. I have two issues with that, that I always ask myself, is this really about investors as investing, or is it about a general public policy matter? That's number one. But then number two is we made that decision. It's really expensive to do a public offering. Why are we making it even more expensive? But every time you add something to the public company burden, you raise the bar on how big a company has to be to be public, and therefore you reduce the number of investment opportunities that are available for retail investors.
Do Gary and I have any difference at all on this subject of what is and is not a security? Not at all. Do we have legitimate policy differences on just how much you should use the public reporting process for public policy versus investing? We probably do, but they would be healthy disagreements.
Josh King:
You joined CNBC last week to talk about Sam Bankman-Fried's fraud case and Andrew Ross Sorkin was asking you to address the speed at which the prosecution could move. You answered by citing how far the DOJ has come in just one month. No case is the same, but will the case serve as a prosecution precedent for those to follow?
Jay Clayton:
It is the case of the moment. It's what you talk about on TV. People are interested. It's got all sorts of human interest. But in terms of what I would say is gathering evidence and bringing a case like this to trial, it's pretty clear to me from the outside that the Southern District is doing a very good job of moving a pace. And I expect they'll continue to do so.
Josh King:
It always seems it takes a crisis to bring regulation in to focus something like this. The aftermath of the financial crisis in 2008, we talked about that earlier, inspired new financial regulations. In your recent op-ed, you cite the implosion of FTX, the collapse of TerraUSD stablecoin, and the recent bankruptcy of crypto lenders and hedge funds. What do you think is next?
Jay Clayton:
Wow! Gosh, isn't that enough? Look, I don't know what is next, but I think all of those things together I would say disprove the notion that technology can replace the fundamentals of financial regulation. Don't commingle. Don't have excessive leverage. Don't allow people to be on both sides of a trade. Those types of things, they remain true.
Josh King:
You finally stood down your post at the SEC in December 2020. Now that your government service is in the rear view mirror, how do you look back at the time in Washington, both the stuff you expected and some of those dramas that you couldn't have predicted?
Jay Clayton:
Short answer, would do it again in a heartbeat. I had a terrific team. I met a remarkable team of people who I think... Our objective, with the retail investor in mind, and that doesn't mean that you're not focused on institutions, you're focused on how the institutions are actually affecting or serving the retail investors, but the ability to what I would say is modernize the investment experience and make it more efficient for the retail investor and safer. There's one thing I want to say.
A lot of people think there's a trade-off between investor protection and capital formation. You can actually increase both at the same time. That's a false dichotomy. I think I had the kind of people that worked with me who recognized that, that you could actually pursue both at the same time.
Josh King:
In terms of capital formation and business development, you're now serving as an advisor to a number of organizations, including Electric Capital, Collectable, Fireblocks, and One River Asset Management, recently elected the board of directors of Amex, and have been serving, as I note at the intro, as the non-executive chair of Apollo. How are you hoping to help these companies? Specifically those related crypto and digital assets, what's the biggest challenges that you're seeing now that you're working in the private sector?
Jay Clayton:
Well, it's having exactly this conversation that we just had about the importance of regulation and the fact that regulation is not going to bend to technology. The technology actually has to comply with the regulation better and what does that mean for those companies.
Josh King:
Outside of all these numerous advisory roles, what does a former SEC chairman do to spend their time?
Jay Clayton:
I don't know. I live around the corner. I work around the corner. Like I said, catching up with friends that I was away from for a good three or four years.
Josh King:
Well, it is great to have you back full-time in the neighborhood to be able to walk in these doors of the New York Stock Exchange and have a conversation like this similar to conversations as you mentioned that are going on in boardrooms all across the country. Thank you so much for coming down to 11 Wall Street and joining us Inside the ICE House.
Jay Clayton:
Thank you. Enjoyed it.
Josh King:
That's our conversation for this week. Our guest was Jay Clayton, Senior Policy Advisor and Of Counsel to Sullivan & Cromwell and the former chairman of the Securities and Exchange Commission. If you like what you heard, please rate us on iTunes, so other folks know where to find us. If you've got a comment or a question you'd like one of our experts to tackle on a future show or guests you'd like to have us have on the show like Jay Clayton, email us at [email protected] or tweet at us @icehousepodcast.
Our show is produced by Lauren Sullivan and Jess Hatham, with production assistance from Pete Ash. I'm Josh King, your host, signing off from the library of the New York Stock Exchange. Thanks for listening. Talk to you next week.
Announcer:
Information contained in this podcast was obtained in part from publicly available sources and not independently verified. Neither ICE nor its affiliates make any representations or warranties, expressed or implied, as to the accuracy or completeness of the information, and do not sponsor, approve, or endorse any of the content herein. All of which is presented solely for informational and educational purposes. Nothing herein constitutes an offer to sell, a solicitation of an offer to buy any security, or a recommendation of any security or trading practice. Some portions of the preceding conversation may have been edited for the purpose of length or clarity.
