SEC Chair Gary Gensler On Handling Crypto And The Gamification Of Investing

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Following is the unofficial transcript of a CNBC exclusive interview with SEC Chair Gary Gensler on CNBC's“Squawk on the Street” (M-F, 9AM-11AM ET) today, Wednesday, September 15th. Following are links to video on CNBC.com:

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• 1. SEC Chair Gary Gensler: We're Handling Crypto In The Best Way To Protect Investors
• 2. Gensler: Investors May Not Be Getting The Best Execution
• 3. SEC's Gensler On The Gamification Of Investing

DAVID FABER: With that, let's bring in the SEC Chair, Gary Gensler. Chair Gensler, appreciate you're taking time with us and your willingness to hopefully move through so many of those important topics. And with that, let me start with last week in crypto and this week, you talked about it yesterday in your testimony, in terms of answering questions as to whether some of these tokens should be regulated as securities. Last week, Brian Armstrong, the CEO of Coinbase, had some pretty pointed things to say in a tweet. I'll read the middle one here. He said“they,” and the“they” is you as in the SEC,“refused to tell us why they think it's a security and instead subpoena a bunch of records from us, we comply, demand testimony for our employees, we comply, and then tell us they'll be suing us if we proceed to launch with zero explanation as to why.” Love to get you to respond to that.

GARY GENSLER: Thank you for having me on your show, it's always good to be back. Look, we have a set of investor protection laws in this country a basic bargain that was laid out in the 1930s where Congress wanted to protect the public against fraud and other bad actors. Investors get to decide what to invest in as long as companies make full and fair disclosure. Now, in those laws, there's a very broad definition of what is a security. In fact it has like 35 different sub parts to it. And the reason Congress did that is they really wanted to protect investors against that fraud that can come up in the capital markets. And so, cryptocurrencies has come along. I think the laws are clear, the case law, the Supreme Court's weighed in on this multiple times and that many of these tokens do come under the securities laws and the extent that a platform, a lending platform or a trading platform whether centralized or so called decentralized and I say so called, has securities on it. Our investor protection regime is there to protect the public. I think the public benefits from that and that's what we're trying to do.

FABER: Are you actually though communicating with Coinbase again back to this, you know, it's not often you see a CEO kind of criticize the SEC in the way that Mr. Armstrong chose to. He said,“You know, the SEC responded by telling us the LEN feature that they have is a security. Okay, seems strange how can lending be a security. So, then we ask them to help us understand and share the view. We make an effort to work with them.” And he indicates you have no interest in working with them. Is that true or is he lying?

GENSLER: Let me, let me take it more to the generic if you'd understand why I'm not going to get into any one company or one token. But our, our SEC staff talk to a lot of participants in this market as we do in other markets as well and if they come in, ask a question and I suggest they come in and something is a security then work with us to get registered. Now as it relates to lending products, lending products for a long time have been part of the securities law. In fact, the first word, the first word and there's 30 or 35 things Congress listed in 1930 was note, a note, comma stock, comma bond, and it goes on and on. In 1990, the Supreme Court addressed themselves to what is a note that comes under the securities laws so I think that the law is clear. We do work with and talk to many companies and projects in this space.

JIM CRAMER: Mr. Chairman, it's terrific to have you on the show. Jim Cramer here. There's something that I know that Tim Masson CFTC, you've had that job granted, told me on“Mad Money.” He thinks that Tether is specific which is a stable coin represents actually maybe one of the great threats to the financial markets, talking about how we've seen this movie before, it looks small, subprime, mortgages, derivatives. Do you know anything about what's really in a $60 billion, I don't know, security, asset, whatever that is Tether and isn't that, doesn't that represent systemic risk to the American financial system?

GENSLER: I thought that your interview with Tim was, was quite good. And if I could quote him, Tim said that stablecoins are a bit like the chip at the casino where somebody's going from gaming table to gaming table and you see the $125 billion of stablecoins that are in existence today are intertwined in the crypto lending and crypto trading space. 70%, 80% of all the trading whether it's Bitcoin versus this or that is versus one of these stablecoins as Tim said that chip at the gaming tables that people were trading in and out of and as Chair Powell even raised in, in recent testimony, they do have some attributes that look like money market funds and I think that's what Tim was talking about as well.

CRAMER: Well, Mr. Chairman, one of the things that confused me is Alesia Haas, who is the CFO of Coinbase, suggested that perhaps you don't have much knowledge about this area and she needs, and you need to be educated. When I look at your background, I think that perhaps you have a formative education of crypto, would you agree?

GENSLER: Well I'm learning every day, I learned from the wonderful students and faculty at MIT. I was honored to be a professor there teaching in blockchain and crypto financing and the like but I look forward to further engagement with the companies in this space and the market participants and it's really about how we bring basic investor protection to protect people against fraud manipulation and this is an area that's been rife with fraud and abuse.

FABER: You know, Chairman Gensler, I think we're going to add many of these topics with this question for me, which is okay, when is the SEC actually going to do something? And so, I'll start with, with crypto. When are you going to put into effect some of the things you've been indicating here that you're at least thinking about doing in terms of the regulations for this market?

GENSLER: Well, we're doing it right now even Chair Clayton was doing it before me and the SEC's remarkable career staff we work with our fellow regulators, Commodity Futures Trading Commission, and we both have authorities in the markets and over the markets and to help protect the investors. We brought about six dozen enforcement cases to help protect investors in this space. We encourage the platforms to come in, properly register, work with us if we need to sort of sort through whether it's, you know, some of our, some of our laws written in bricks and mortar time, transfer agents, I know your listeners aren't thinking about that. Custody maybe we have to adjust some things but to work with us and to come inside to help this market. If this market's gonna have any potential, it's not going to long survive outside of that investor protection framework.

FABER: All right, want to move on to another topic that we had indicated of course which is payment for order flow involves Robinhood certainly given how important it is to their business. Yesterday in your testimony, you talked as well about orders competing with other orders. That was about competition and perhaps Citadel's place there since it's very important part of this. One party buying literally half the retail flow in America these market orders you said could actually diminish competition in the marketplace. Chair Gensler, I'd love for you to listen to a response as well though from the Virtu Financial CEO, specifically about you and what he had to say in terms of what he claims as you conflating some issues when it comes to payment for order flow and then get your response.

DOUG CIFU: But he's conflating the issue of payment for order flow and the inherent conflict which has been addressed and dealt with for the last 30 years by the SEC with order routing and price improvement. Two separate issues and the data around price improvement is so overwhelmingly compelling, $11 billion of price improvement in 2020. $11 billion and 0 commission trading in this country. Game, set, match.

FABER: Your response.

GENSLER: Well, let me just address I don't think that the disclosures that are put out really addressed the question about whether people are getting best execution so best execution means best execution. And so we have something in America where nearly half of the trading is going to dark pools and to the wholesalers, one of whom you were just interviewing, wholesalers that dominate and concentrate the market, and even that which is on the so-called lit markets, the New York Stock Exchange and NASDAQ, many of the trades there are not being fully displayed. So this concept of price improvement is against a measuring stick, which is a measuring stick that's not fully reflective of the market, our consolidated tape, our national best bid, best offer so to speak, does not reflect the half and the dark markets. It doesn't even reflect a lot that's on the exchanges. So if you or I make a trade, a market order retail trade, where does it go? 90 plus percent chance it goes to a handful of wholesalers, one of whom you were interviewing, I would say that's a conflict. And the thing that we're trying to do is update our markets for the 2020s. They were last seriously updated in 2005. A lot's changed in those 16 years.

CRAMER: You know, Mr. Chairman, I want to follow up on that. This notion of payment for order flow and I understand what the Virtu fellow said but isn't it true that if brokerages are optimizing their digital engagement practices for their own revenue, that may not be exactly on the same page as what, of giving investors the best returns. So, therefore investors should know ahead of time that they may not be getting the best returns by so-called paying, no commissions.

GENSLER: Jim, I thank you for that. You're absolutely right, so today's data analytics aren't what you and I learned in college. They're very sophisticated and they can optimize for the trading platform or the robo-advisor to maximize their revenues and their data collection. That may well be in conflict with your investor returns when they're trying to use a behavioral prompt to get you to trade more or to move into one of their investment products. Secondly, you mentioned zero commissions. Zero commission does not mean it's free to the retail public. You may not be getting best execution and so that's what our economists, that's what we're looking at very closely to see, can we do better and I think that we can do better than the regime that was laid out 16 years ago.

CARL QUINTANILLA: You know, when we talk about regulation exposure to a number of new platforms and technology not just in financial services, one thing we keep coming back to is the popularity of the platforms creating friction for regulators. Is it any more difficult to regulate something that's popular maybe because the client base does believe it has zero commission?

GENSLER: You raise a good point. Technology has come along and change the nature of finance, suddenly the internet came along and that changed the nature of finance as well. So, these are the challenges we have it makes it an exciting job but at the core what we're trying to do is get competition in the market. I mean it's a, it's a basic thing in America. I'm deeply a markets person and believe in transparent trading and competition, order by order competing, and right now we have large wholesalers buying a bunch of that order flow and so that the retail public, most of your trades are going to a small handful of wholesalers and in fact they've publicly announced, there's a high concentration amongst two or three of them. And that's not the lit markets of New York Stock Exchange or NASDAQ as we know them.

FABER: Mr. Chair, on the, on the subject of gamification we were just looking at shares of AMC, obviously we're talking about Robinhood, I mean they're on college campuses encouraging students to open accounts, I think giving them maybe it's 15 bucks to do so, you know, I know from personal experience, there's a lot of college students who are trading Bitcoin on their phone, trading in any number of these so-called meme stocks. It's unclear how much they really understand about the market so the underlying fundamentals. Is that a concern to you?

GENSLER: Well I think it's, it's, it's a positive that more Americans are, are investing in the market but investing for the long run is different than trading daily or trading hour to hour on an app and I would just say, you can go to investor.gov and see better details on this at the SEC, but that day trading often lowers your returns but it's positive that more people are investing. It's better to invest for the long run than try to day trade or even hourly trade.

CRAMER: Well, Mr. Chair, I have to follow up on this because I believe that some of these apps, let's just say Robinhood, I think they maximize trading and volume and that does not necessarily align with the customers incentives. How do we teach the customer that?

GENSLER: Well I think that we, we certainly need to do all collectively, the media, the SEC and others, all we can do to help educate the public. Ultimately the public gets to decide what they invest in, that's our basic bargain. But also, we have the SEC here to try to protect the public and what we're trying to do in terms of what you just said is if the, if the application, the platform is maximizing and running an algorithm in the background to maximize their revenues, whether it's a robo-advisor or a trading app, that presents a potential conflict right there and that's something that Congress long ago said to the SEC to address those conflicts and disclosure alone may not do it. It may not be good enough to say hey we have a conflict, don't worry. We liked you, too. It's, it's really we have to address those conflicts and try to help the investing public out.

CRAMER: I want to be sure about this and we know that Justice Brandeis said that disclosure is the best disinfectant. You are now saying on air that disclosure may not be enough when it comes to the so-called gamification that some of these organizations have. I think that in many ways Robinhood is no different from DraftKings. If you get $100, it's a touchdown.

GENSLER: We've said this for decades my predecessors, republican and democrat alike, we use the tools and the toolkit that Congress gave us. Congress can change those tools but those tools include disclosure, really important, but we also are cops on the beat, protecting the public when people are defrauded and we do address some conflicts, more specifically around our ruleset, so we have a mix of tools. Disclosure as Justice Brandeis said is a very important piece of it but it's not the only tool.

FABER: Alright. Speaking of disclosure I want to move on to SPACs because yesterday Chair Gensler, you did say you're looking at greater disclosures and looking at their inherent conflicts. I can tell you having followed this market quite closely, there certainly is a misalignment of incentives oftentimes between sponsor and holder of SPAC shares. I can also tell you that when it comes to at least disclosure, recently I've been focused on reporting on redemption rates, we don't know sometimes what percentage of SPAC shares are being redeemed. It's not something that is typically or always reported in a uniform fashion. Let me just start there, is that a concern to you because it would certainly seem to be a material, material information investors should know.

GENSLER: I think that there's a number of areas including, as you say the redemptions, what a special purpose acquisition company is, is basically a blank check company raising sometimes hundreds of millions or even billions of dollars and saying we will go find something in the next two years, bear with us we'll find something. But when we find something there's a redemption and many of the institutional investors and hedge funds that are in there redeem out and the retail public might be left with a small portion of the company. Now why that matters is all of these—

FABER: Yes, you might be left with a very small, very small shareholder base.

GENSLER: Now why that matters is all of these—

FABER: Yeah.

GENSLER: All the fees then fall on them. There's a 20% promote usually in the beginning, there's investment banking and lawyer fees and the like all along the way and often that falls on the remaining retail investors.

FABER: But also a lot less cash is left as you know. You know, they, they, they put projections out initially when they announced the deal for a certain amount of cash that's going to come from the trust and typically from a PIPE and then we're left with cash numbers that are far, far below what they had anticipated. Is that a concern for you at all?

GENSLER: Yes, and you mentioned the private investment and public equity are so-called PIPE investors who come in later and they too sometimes get to buy at a discount. So the discounts they get, the bankers, the lawyers, the accountants and the promote at the beginning is significant costs in the retail public but still in is bearing the bulk of those costs.

CRAMER: Well, Mr. Chairman, to follow up on that, in the case Momentus and Stable Road that you brought, there is just out now fraud and I think it's given people a safe harbor thinking listen if we don't have out now fraud, we can make any projections we want. Out to 20, out to 2027. This is directly for many, many investors, how do we keep the investors from being fooled by phony projections.

GENSLER: So, I've asked staff to make recommendations up to our member commission. We'll put it out to the public, we'll get notice, comment and we'll see if we can finalize something on the issues you've raised. Better disclosure about all the fees, better disclosure as you said with regard to these redemptions, and then you just Jim raised about forecasts and projections and while we in the security space address it elsewhere, I think we need to through our rule writing also take that up here as a commission.

FABER: Now SPAC issuances dropped off significantly. People seem to be getting the message, are you encouraged by that? Are you happy that perhaps there are fewer SPACs being not just taken public but doing deals even though plenty are out there looking for deals?

GENSLER: I think we still have our work cut out for us to put out to notice and comment better disclosure regimes, better regimes, writ large with regard to Special Purpose Acquisition Companies. There's still five to 10 new ones a month, there's 400 that are still looking and shopping for acquisition targets. But whether there's one or there's 400 I think we can do a better job in terms of the disclosure and the, the protections for the retail investor.

FABER: All right, we want to move on to China , we're getting limited time left here.

CRAMER: Oh, actually we're gonna extend the time.

FABER: We are?

CRAMER: Yeah. Right now.

FABER: Has he agreed to that because I don't think he knows about that?

CRAMER: Chairman Gensler wants to answer these questions.

FABER: All right, China—

GENSLER: Jim, I am going to be running into something for work in a handful of minutes but why don't we talk about—

CRAMER: I'll give them a call, sir. This is just too good.

FABER: Alright, well, you know, the VIE structure you've written about it a number of times in fact an op-ed earlier this week in the journal. How much of a concern is it to you? How much of what the SEC is doing should be viewed in light of what the Chinese regulators are doing as well.

GENSLER: So, with regard to China related companies and I said China related because they're not all based there, many, many of these companies are based in the Cayman Islands, we have a number of issues. Number one was a basic bargain that we entered into in a bipartisan way about 20 years ago Paul Sarbanes, Mike Oxley and, and George W. Bush, all work together to say that if you're a public company in the US, your auditor has to be subject to auditing. Basically audit the auditor inspect the auditor. This is about trust in our capital markets. 50 plus jurisdictions have said yup, you can do that, France, Germany, Switzerland and so forth. Two have not, China and Hong Kong. So, Congress weighed in again late last year and said guess what, we will give it three years but if they can't do it, these 200 plus companies that are China related will have to step out of our listed markets and be suspended in trading. Two is because China has said for many years, decades, that foreign ownership is prohibited in technology, internet and other spaces, the lawyers and accounts came up with a structure called variable interest entities, where you actually do not invest in the China company, you invest in the Caymans and that Cayman company has a series of contracts that may or may not be enforceable under China law. And by the way, there might not be even any cash that's flowing from the Chinese operating companies to the Cayman companies and the ownership is still amongst friends, families and other in China. So, we've said, let's take a pause and get better disclosure back to Justice Brandeis, better disclosure about that variable entity, variable interest entity structure, the Cayman Islands' company needs to disclose more about what's going on.

CRAMER: Thank heavens we need that. Now I speak a lot of people about what happened in GameStop. And sir, I get the sense that we both want the millions of people who have come in to be as educated be as good as possible but there is a, there's an angle and the angle is is that three hedge fund members work in contract to smash a short hedge fund, these are, the 5 million Reddit people would say that's legal and perhaps shouldn't be. If the 5 million people decide to smash a hedge fund that short, is that okay? What is within the bounds of what you can do to smash a short seller?

GENSLER: Again, as I said earlier, I'm not going to speak to one specific company or issuer and so forth. But I think that people come into your, your show and they advocate either to buy or sell a security before we had television, people did it on radio and now we have various social media platforms. That's, that's sort of, that's not only free speech but it's part of what makes our capital markets robust that people can disagree and disagree using the medium of the day. But I also think that we do police the markets for fraud and manipulation, for pump and dump schemes and the like and that's, that's the important role of the SEC.

FABER: Want to try and get through all the topics we'd outlined so let me end here with Archegos. It's a long time ago that we learned of this family office, few of us had heard of that owned perhaps as much as what 25%, 30% of Viacom shares and Discovery shares through total return swaps, why haven't you done something to make that less opaque?

GENSLER: So, total return swaps are something that is a broader group called securities based swaps that also includes credit swaps and credit swaps were at the center of the '08 crisis and brought down the big insurance company AIG and others, and then total return swaps were at the heart of not only these events but long term capital management 24 years ago. We have done things at the SEC and we're going to do more. We have going live this November a whole regime that oversees these securities-based swaps and makes more transparent, not only to the regulators but starting next February to the public, the transactions in the security-based swaps . In addition, I've asked staff for recommendations on how we can put out with the thought of Archegos in mind and we can put out aggregate information about the aggregate positions in securities underlying the total return swaps. So, I think we're doing a lot. It's going live in November and next February, we're going to be doing more with regard to aggregate disclosure of these positions.

FABER: All right, and finally given everything we've covered here it's clear the SEC has plenty on its plate. Do you have the resources to actually be effective as a regulator given all the challenges you're facing?

GENSLER: We, we, we are short staffed. It might sound odd to say that in an agency with 4,400 remarkable dedicated staff working remotely during this challenging pandemic. But that's 4% to 5% less than we had just five years ago. We've got an IPO boom, we have a SPAC boom, cryptocurrencies to deal with. We have the issues we talked about earlier about China issues and, and the like, and we have more, our capital markets are $100 plus trillion, about half of that is the stock market, a little over half is the bond market. So I'd like to at least get back to where we were in 2016 and I think we should probably be 5% or 10% larger than that.

FABER: Well, Chair Gensler, we know you got a 9:30 call to get to. We have an opening bell as well. We certainly appreciate you spending so much time with us. Thank you.

CRAMER: Thank you sir.

GENSLER: You all stay well your families and you stay safe in these challenging times.

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