On a cold and cloudy morning in the spring of 2021, a new sheriff rides into town. Following his appointment as the head of the US Securities and Exchange Commission (SEC) two and a half years ago Gary Gensler quickly made it clear that he plans to take a tough stance on regulatory violations. Under Gensler's leadership, the agency places investor protection at the top of its agenda and begins to initiate enforcement actions at a record pace. In the fiscal year 2022, the SEC imposed fines totaling $6.44 billion, by far the highest level ever.

However, Gensler doesn't stop at post hoc sanctions against financial service providers and large investors. Instead, the 65-year-old takes aim at entire market segments and industries with extensive new regulations, including stock trading, money market funds, hedge funds, private equity firms, and notably, the digital assets sector.

According to a compilation by the research organization Committee on Capital Markets Regulation, between Gensler's appointment on April 17, 2021, and August 15 of the current year, the SEC proposed 47 regulatory initiatives that significantly impact market participants, adopting 22 of them. None of the three previous heads of the SEC since Mary Schapiro, who led the agency from 2009 to 2012 and oversaw its response to the financial crisis, have achieved such numbers.

Nevertheless, it has become evident that the more firepower the Wall Street sheriff deploys, the more often he misses his mark. Gensler faces a recent setback for his confrontational regulatory strategy at the end of August when a US appeals court overturned the SEC's rejection of a spot-market-based Bitcoin ETF proposal by the investment company Grayscale. The SEC had criticized the listing plans in June 2022, citing insufficient safeguards against fraud and market manipulation. Grayscale subsequently filed a lawsuit.

In the meantime, the agency has rejected over 30 applications for similar index funds' approval, consistently citing the spot market's low liquidity, high volatility, and susceptibility to manipulation. All these decisions are now in jeopardy following the Grayscale case. The judges describe the SEC's actions as "arbitrary and capricious," referring to a rare moment of leniency from the otherwise steely sheriff of Wall Street.

In October 2021, the SEC did approve futures-based Bitcoin index funds. In the US financial market, the legal principle dictates that similar products should be regulated congruently. The judges concur with this principle, arguing that the SEC has not satisfactorily explained why it treats spot ETFs differently from futures vehicles. Grayscale emphasizes that the exchange rates used for Bitcoin futures contracts are directly based on data from cryptocurrency exchanges. Therefore, volatility and manipulation attempts in the spot market also affect futures exchanges. The rationale for providing a higher level of investor protection in the futures market thus remains unclear.

While the SEC can request a new hearing, legal experts suggest that it will be compelled to reevaluate Grayscale's application following the court's ruling. Furthermore, the SEC was expected to make decisions on the registration of several spot Bitcoin ETFs, including those from major asset managers like Blackrock, within a few days. These decisions have now been postponed.

The recent misfire is emblematic of the problems that have arisen in other market segments as well. According to investor protection advocates, the SEC may have lofty goals but undermines its position by enacting overly ambitious or impulsive rules, subsequently being forced to backtrack or make extensive compromises. This was evident in the regulatory changes introduced at the end of August concerning private equity and hedge fFunds.

Under the new rules, hedge funds and private equity firms must now provide investors with quarterly updates on fee structures, expense developments, and performance. Additionally, fund advisers are obligated to subject every private fund in their offering to an annual audit. The SEC also aims to prevent the unequal treatment of investors by restricting the use of "side letters." Previously, providers of private funds could make side agreements with large investors to offer them more favorable terms, including greater information access and greater flexibility in redeeming fund shares.

In the future, such side agreements should no longer be possible if they result in "material adverse effects" for other investors. This formulation by the SEC is an example of how the regulator has softened the rule framework compared to the version proposed in 2022. To avoid renegotiating agreements for existing funds, fund providers will also be able to adopt many previously established arrangements.

Original plans, which would have prohibited fund managers from charging fees for services not yet provided, are absent from the final version of the rule framework. Investments by alternative managers in Collateralized Loan Obligations (CLOs), which pool a variety of loans, are also exempt from the new disclosure requirements.

A reform of stock trading initiated in 2022 is also at risk of being implemented only in a weakened form due to resistance from brokers and trading service providers. Market participants are concerned about the introduction of single-order auctions, through which the SEC seeks to restrict the practice of Payment for Order Flow (PFOF). Under this practice, brokers receive flat fees for routing orders to trading service providers. Gensler argues that brokers may be tempted to route individual orders based on the size of these flat fees, potentially compromising order execution quality.

Critics of Gensler's regulatory plan fear that the introduction of single-order auctions could make it less attractive for trading service providers to participate in the execution of illiquid stocks compared to the current PFOF system. Consequently, price discovery in such auctions may become less efficient. Moreover, brokers would lose income from PFOF, which they would need to recoup from retail investors elsewhere. While the regulatory plan includes numerous other provisions aimed at ensuring fairer order execution, opposition from brokers and trading service providers is primarily driven by the SEC's proposed limitation of PFOF, a key source of revenue for them.

Gensler's overambition is also indirectly expressed in the Committee on Capital Markets Regulation's record on SEC chiefs. This balance sheet excludes final rules resulting from reform proposals by previous officeholders, as well as decisions on internal agency matters and cases in which the SEC is a junior partner. However, when these are included, Gensler's track record for implementing regulatory proposals appears significantly lower than that of any of his four immediate predecessors.

These failures are now subjecting the SEC chief to political pressure. Only a small portion of his projects are mandated by the US Congress. At the same time, the SEC has requested a budget of $2.436 billion for the fiscal year 2024 due to increasing workloads, which is $265 million above the current level. This has drawn criticism from members of the US House of Representatives, who argue that the SEC serves as a prime example of bloated budgets within the government apparatus. After years of budget increases, they believe the SEC is no longer adequately reflecting on its approach. For the sheriff of Wall Street, it is now time to aim more precisely.