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Speech by SEC Chairman: Remarks at the Practising Law Institute’s SEC Speaks

Chairman Mary L. Schapiro

U.S. Securities and Exchange Commission

Washington D.C.

Feb. 24, 2012

Good morning. Thank you so much for that kind introduction, Rob.

It is a pleasure to be here. I look forward to this conference every year as an opportunity to give a “State of the SEC” exposition – reviewing our recent activities and how we have evolved and how the changes we’ve made will benefit the markets we regulate and the investors we protect.

Twenty years ago when I first served as an SEC commissioner, the financial world was a very different place. The Dow was inching towards the 3000 mark. Derivatives were barely a blip on the radar. A portable Macintosh weighed 16 pounds. And all you could do on a cell phone was talk.

For most SEC staff, the biggest market disruption in living memory was the “Black Monday” crash of 1987 – a near-cataclysmic experience to be sure, but one that paled in comparison to the crisis of 2008.

So, when President Obama asked me to return and serve as Chairman, I knew the agency would be challenged on a level at which no SEC had ever been challenged before:

  • Challenged to restore confidence in markets that had nearly self-destructed.
  • Challenged to address risks that could jump from market to market like wildfire, incinerating each in turn.
  • Challenged to bring a pre-crisis mindset into a post crisis-era.
  • Challenged to prove that the agency could and would step up to play its role, aggressively and effectively.

Given the scope of the financial crisis and the fallout from the Madoff scandal, it was no surprise that some were calling for the agency to be disbanded.

But, the investing public and policymakers understood the importance of our mission – to protect investors and ensure the integrity of our markets.

And the men and women of the SEC were eager to meet these challenges head on.

That was no surprise to me. From my earlier years with the SEC, I knew well that the individuals who serve are a dedicated and talented team, able and eager to rise to the occasion. I knew we’d come through – and I am pleased by how far we have come.

And, so I would ask anyone who currently works – or has previously worked – at the SEC to stand and be recognized.

Thank you.

Our commitment to evolve helped to drive a consensus, inside and outside the SEC, that the better solution was not to shutter the agency, but to strengthen it – to demand more aggressive and efficient action from us, and for us to embrace needed reforms and better adjust to the new world in which we were operating.

And that’s what the SEC’s leadership team set out to do.

  • We redesigned the SEC, investing in technology and human capital, and significantly improving operations.
  • We put in place a new operating strategy, rooted in an entrepreneurial attitude and a collaborative approach.
  • We immediately began to execute on an agenda that would better protect investors and reduce the chances of another systemic shockwave.

I knew, as we found our footing after the financial crisis and began to implement this strategy, that every move would be watched by many eyes. What I didn’t realize was that the SEC’s energetic response to the challenges we faced would lift the agency’s profile to heights rarely seen since the days of Joe Kennedy and The New Deal.

I welcome the attention. It gives rise to needed debate about important issues and challenges us to be our best. But, I sometimes worry that the tendency of observers to focus on individual rules or discrete actions distracts them from the big picture. What the agency has accomplished is greater than the sum of the rules we’ve adopted and the cases we’ve brought: we have fundamentally changed the agency in ways that will allow us to carry out our mission more effectively than ever in the 21st Century.

And it’s not just that we’ve accomplished a great deal over the last three years. It’s that we’re now fundamentally better equipped to perform at an even higher level in the years to come.

Redesigning the SEC

Investing for Continued Success

A first priority was to make better use of SEC resources, carefully investing overdue budget increases in people and technology and improving management in ways that allowed us to make the most of our funds.

When I returned to the SEC, I saw how much the staff was being asked to do, and how little they were being given to do it.

Although the agency experienced a brief period of funding growth following Sarbanes-Oxley, the budget failed to keep up with inflation in the years leading up to the financial crisis. Despite continued growth in the markets, the number of employees actually fell. And with oversight, examination and enforcement staff stretched to the limit, operations and IT needs were put on the back burner – investments in new IT fell by half.

During my term, we have been fortunate to experience a modest funding turnaround – increases that we were determined to invest strategically. We wanted not just to grow, but to grow more efficient as well – growing in ways that would expand capacity faster than the budget numbers were rising.

  • We broadened our hiring approach, searching for recruits with financial industry backgrounds and specialized experience. We now have traders, asset managers, academics and quants on staff in addition to attorneys, economists and accountants, giving us a correspondingly greater insight into the technologies and practices that drive today’s financial markets.
  • We increased the training budget to more than double what it was in 2009, helping staff to keep pace with the changes in the market.
  • We significantly upgraded our case management system. Overworked attorneys and paralegals can now take advantage of vastly improved research capabilities – and we are deploying an agency-wide eDiscovery tool that will expand our ability to parse evidence and drill down on key subjects.
  • Perhaps our most reported IT investment has been our new system for handling the thousands of tips, complaints and referrals we receive each year. And an ongoing series of upgrades is allowing us to better triage the information we receive as well as compare the data more effectively – opening new investigations, routing tips to existing investigations or discovering emerging trends that need to be watched.

Managing Effectively

Together with wise investments, we also have been finding ways to improve agency operations.

  • Within the various divisions and offices, we’ve created “managing executive” positions to handle important support areas, freeing legal, examination and other professionals to focus their skills on mission-critical work.
  • We are outsourcing responsibilities like leasing and financial management reporting to other agencies, focusing on core strengths and deploying people and resources accordingly.
  • And we’re implementing a number of management recommendations resulting from the Dodd-Frank mandated study of agency operations.

After three years of intense effort, the SEC is simply a sounder agency on a fundamental level, deploying people and technology more effectively and maximizing the impact of our limited resources. It’s all part of an effort to be more effective for years to come. But it should not suggest in any way that our work is done.

Instilling Entrepreneurial Leadership

Parallel to our investments in people and tools, we began to put in place a new approach. We wanted to be more entrepreneurial – moving to diminish or head off threats within the markets, trusting our teams to recognize these threats and move rapidly without the need for top-down guidance in every case.

This approach has flourished, and while we don’t have time to discuss every office and division, I’d like to offer a few as examples of how it is improving our efforts.

Corporation Finance

One place to look is the Division of Corporation Finance, which is run by SEC Speaks co-Chair Meredith Cross, and which has been particularly aggressive in enhancing its structure and focus.

In the last year, Corp Fin established new groups to concentrate closely on three systemically critical facets of the financial world: the largest financial institutions, structured finance products, and capital markets trends. These offices will help ensure that investors have clear information about items that could – without the sunlight of disclosure – turn into malignant trends or dangerous practices.

In addition, Corp Fin’s disclosure teams have been proactive in targeting specific disclosure issues which have potentially significant consequences.

  • They’ve prompted companies to provide critical information about the potential financial impact of repatriating cash held overseas.
  • They’ve raised questions about whether companies are properly disclosing their litigation contingencies.
  • And they’ve worked with our enforcement, accounting and international units to combat an uptick in problems with reverse mergers by stepping up scrutiny of related filings.

Corp Fin also is taking a lead in providing companies guidance on how existing disclosure rules apply to emerging and fast-changing market realities, issuing guidance – where possible – before inadequate or outdated disclosure practices harm investors.

The staff issued guidance regarding the way financial services firms should disclose their exposure to European sovereign debt in time for these firms to use it when they prepare their annual reports – helping to provide investors with adequate, granular financial information even as the situation remains fluid.

And the staff issued guidance regarding companies’ obligations to disclose material cyber-security risks and attacks – clearly an area of growing concern to investors. Additionally, in reviewing the most recent wave of IPOs, Corp Fin quickly stopped problematic revenue recognition practices. And they halted the use of misleading non-GAAP measures before these practices – prevalent during the tech bubble of the 90s – could take root again.

Similarly, disclosure teams acted swiftly when the right of investors to have their day in court was threatened – by objecting to a mandatory arbitration provision that was included in governing documents connected with a company’s IPO.

The results of these changes aren’t always eye-catching. But we are convinced that increased focus on systemically significant market sectors is a necessary shift in a post-crisis world. We know that our proactive efforts to provide guidance have proved helpful to many companies as they grapple with disclosure issues. And we believe, based on our own review of disclosure statements, that investors are getting information that is both more complete and more relevant than in the past.

Office of Compliance Inspections and Examinations (OCIE)

Perhaps the areas in which changes in organization and approach have been most apparent are in our examination and enforcement units.

In both, new leadership has managed significant organizational changes and – just as important – encouraged an aggressive and proactive approach.

Over the last two years, OCIE has put in place a new National Examination Program. The program has brought changes in the way examination teams are assembled – OCIE now precisely matches examiners’ skills with the unique challenges each examination offers. Examination materials are now standardized.

And working with the Division of Risk, Strategy and Financial Innovation, this national exam program greatly expands the use of risk-based targeting.

Better targeting and more effective examinations are paying off. Over the last two years, 42 percent of exams have identified significant findings – up by a third since 2009. And over that same period, the percentage of exams resulting in referrals to Enforcement has risen by half, from 10 percent to 15 percent.

One such referral involved a fund which had come into our sights through our risk-based targeting efforts.

During the resulting examination, the fund admitted to an error in its trading algorithm, which it had previously failed to report – a failure that cost investors more than $200 million. Thanks to the work of the exam team and enforcement staff, the fund agreed to a settlement – returning the money to wronged investors almost before they knew they had been wronged and paying a $25 million penalty.

Division of Enforcement

Meanwhile, the Enforcement Division – led by today’s other co-Chair Rob Khuzami –revamped its operations, putting additional talented attorneys back on the front lines, creating specialized units, and streamlining procedures.

Those reforms are already producing record results. I won’t steal all of Rob’s thunder, but last year the SEC brought a record 735 enforcement actions, including some of the most complex cases we’ve ever worked on. And we obtained orders for $2.8 billion in penalties and disgorgements. What’s most satisfying is that last year we returned more than $2 billion to wronged investors. If Congress agrees with my request to raise the caps on what we can obtain, we would have the ability in appropriate cases to return even larger sums to wronged investors.

In the area of financial crisis-related cases, we filed charges against nearly 100 individuals and entities – actions against Goldman Sachs, Citigroup, J.P. Morgan and top executives at Countrywide, Fannie Mae and Freddie Mac. And more than half of the individuals charged were CEOs, CFOs or other senior officers.

It should come as no surprise that there are more actions to come.

This division also realized significant gains from its Aberrational Performance Inquiry – another collaborative effort with Risk Fin and OCIE which uses quantitative analytics to search for hedge fund advisers whose claimed returns are unusual enough to raise a red flag.

In December, as a result of one of the aberrational performance sweeps, we charged four hedge fund advisers for inflating returns, overvaluing assets and other actions that materially misled and harmed investors.

OCIE, RiskFin, and Enforcement are working together through different analytic initiatives to target various types of misconduct. These initiatives are particularly important to the SEC’s efforts to detect fraud before complaints are received.

And one can draw direct lines between Enforcement’s earlier restructuring and its current results.

For instance, one unit created during the reorganization – the Asset Management Unit – took the time to survey a group of firms that were actively communicating through social media. In the process, they learned about the various approaches firms were using – getting a sense of those that were legitimate and those that might not be.

Shortly thereafter, a staff member who was familiar with the survey noticed something irregular in the operation of an Illinois-based investment adviser.

In short order, the ensuing investigation uncovered the fact that the adviser was offering more than $500 billion in fictitious securities through various social media websites, garnering significant attention from multiple potential buyers.

Again, the agency acted before investors were harmed by suing the adviser last month and effectively halting the fraud.

But rather than just stopping there, Enforcement teamed up with OCIE, the Investment Management division and our Investor Education office. And on the same day that we shut down the fraud, we released two publications – one that will help investors recognize, avoid, and report similar scams, and another one that will help investment advisers keep their communications in compliance.

It’s hard to quantify the results of efforts like these – to know how much savings won’t be poured into fraudulent offerings or what tips might arise from the publications we’ve released. But we think this is important and that this aggressive and coordinated approach is yielding superior results across the agency – and will continue to do so going forward.

Recommitting to our Investor Protection Mission

Yet another priority in recent years has been rededicating ourselves to our investor protection mission – an important task if we were to bolster the confidence so necessary for our markets to thrive.

That meant strengthening the regulatory structure and pulling back the veil that covered portions of our financial system.

That is why – even before Dodd-Frank – we set out to address the resiliency of money market funds, insist upon more meaningful information regarding municipal securities and require more information from investment advisers, among other initiatives.

The Dodd-Frank Act

With the passage of Dodd-Frank our responsibilities expanded dramatically. And I am proud of the across-the-board progress we are making against these mandates. Of the more than 90 mandatory rulemaking provisions, the SEC has proposed or adopted rules for more than three quarters of them, not to mention a number of the rules stemming from the dozens of other provisions that give the SEC discretionary rulemaking authority.

And we already have completed 12 studies called for by Congress.

We could talk for hours about Dodd-Frank, but let me just touch on a few highlights.

  • In the area of corporate governance, we have finalized rules concerning shareholder approval of executive compensation and "golden parachute" arrangements.
  • Led by the Division of Investment Management, we have adopted new rules that have already resulted in approximately 1,200 hedge fund and other private fund advisers registering with the SEC. It’s a process by which they agree to abide by SEC rules and provide critical systemic risk information that can give regulators better insight into their practices.
  • And we have established a whistleblower program that is already providing the agency with hundreds of higher-quality tips, helping us to avoid investigatory dead-ends and – at the same time – prodding companies to enhance their internal compliance programs.

In another area, response to the meltdown of the mortgage-backed securities market, the SEC has proposed rules that will protect investors by:

  • Increasing dramatically investors’ visibility into the assets underlying all types of asset backed securities.
  • Requiring securitizers – in conjunction with our banking colleagues – to keep skin in the game, giving them an incentive to double-check originators’ underwriting practices.
  • Changing the practices of the rating agencies whose gross mis-ratings of billions of dollars of mortgage-backed securities were kerosene on kindling.

OTC Derivatives

Next up will be the final proposals to essentially build, from the ground up, a new regulatory regime for over-the-counter derivatives.

The over-the-counter structure of the derivatives market has long presented a risk to the financial system. In October 1993, I addressed a Symposium for the Foundation for Research in International Banking and Finance about the potential problems. At that time I said “nothing will interrupt the progress of the derivatives market more abruptly than a financial crisis that is perceived to be caused or exacerbated by unregulated activity in those markets.”

Back then, of course, the notional value of interest rate and currency swaps was $4.7 trillion, which seemed like an extraordinary figure.

I was concerned that this potentially useful financial innovation might present significant systemic risk for various reasons, including: the opacity of the derivatives market; weak or non-existent capital, margin and clearing and settlement requirements; and the concentration of derivative transactions among a relatively small number of institutions.

While others shared these concerns, in 2000, Congress specifically excluded most derivatives transactions from regulation. And by mid-2008, as the repercussions of the mortgage-backed securities market’s collapse were echoing throughout the financial system, the notional value of the derivatives market had increased more than a hundred-fold, and was approaching $700 trillion.

Title VII of Dodd-Frank addresses challenges in the OTC derivative market underscored by the events of 2008, by bringing the derivatives market into the daylight.

The SEC is working with the CFTC to write rules that strengthen the stability of our financial system by:

  • Increasing centralized clearing of swaps and ensuring that capital and margin requirements reflect the true risks of these products.
  • Improving transparency to regulators and to the public by shedding light on opaque exposures and assisting in developing more robust price discovery mechanisms.
  • Increasing investor protection by enhancing security-based swap transaction disclosure, mitigating conflicts of interest, and improving our ability to police these markets.

Next Steps on Implementing Title VII

It is my hope that, in the near term, we will complete the last remaining proposals regarding capital, margin, segregation and recordkeeping requirements.

But, we are already beginning to transition to the adoption phase. As a first step, I expect the Commission to soon finalize rules that further define who will be covered by the new derivatives regulatory regime and, next, what will constitute a security-based swap.

Finalizing these definitions will be a foundational step, defining the scope of the new regulatory regime and letting market participants know whether their current activities will subject them to the substantive requirements we will be adopting in the coming year.

Beyond this, the Commission staff is continuing to develop a plan for how the rules will be put into effect. The plan should establish an appropriate timeline and sequence for implementation and avoid a disruptive and costly “big bang” approach.

And at all stages of implementation, those subject to the new regulatory requirements will be given adequate time to comply.

International Application of Title VII

While some issues are stand-alone concerns, certain issues cut across the entirety of our implementation of Title VII. Among the most important, given the global nature of the derivatives market, is the international impact of our rules.

We are working hard to coordinate with our foreign counterparts to help achieve consistency among approaches to derivatives regulation. There has been significant progress on the international level.

Our cross-border approach must strike a balance between sufficient domestic regulatory oversight and the realities of the global market. A “one-size-fits-all” approach is neither feasible nor desirable.

In the near term, the Commission intends to address the most salient international issues in a single proposal. This will give interested parties an opportunity to consider, as an integrated whole, our approach to cross-border transactions and the registration and regulation of foreign entities engaged in such transactions with U.S. parties.

Money Market Funds

Despite the breadth of Dodd-Frank, there are other gaps in the regulatory system that threaten investors that we are working to address.

One high-profile area of interest is money market funds. As you know, when the Reserve Primary Fund broke the buck in 2008, it set off a run so serious that the federal government was forced to step in and guarantee the multi-trillion dollar industry.

It was a shock that reverberated across the market and compelled us to take action. And so, two years ago, we adopted regulations making the mix of investments these funds can hold more liquid and less risky. But, at the time, I said we needed to do more.

That is because money market funds remain susceptible to runs and to a sudden deterioration in quality of holdings. We need to move forward with some concrete ideas to address these structural risks.

We’ve spent lots of time and outreach reviewing many possible approaches. There are two serious options we are considering for addressing the core structural weakness: first, float the net asset value; and second, impose capital requirements, combined with limitations or fees on redemptions.

It’s hard to miss the hue and cry being raised by the industry against either of these approaches.

But the fact is investors have been given a false sense of security by money market fund sponsor support and the one-time Treasury guarantee. Funds remain vulnerable to the reality that a single money market fund breaking of the buck could trigger a broad and destabilizing run.

Should that happen, the government will not have the tools it had in 2008. Then, Treasury used the Exchange Stabilization Fund to stop the run. But Congress eliminated that option when it passed TARP legislation. Today, the money-market fund industry and, by extension, the short-term credit market, is working without a net.

To the extent that there’s a deadline, it’s the pressure that we should feel from living on borrowed time. We’ve been incredibly deliberate about this. The President’s Working Group report on reform options was issued in October 2010. We’ve had extensive public comment. And we held a roundtable with the Financial Stability Oversight Council on money market funds and systemic risk last May.

Consolidated Audit Trail

Finally, we’re working to improve the SEC’s capacity to regulate and investigate. And so another major initiative is the consolidated audit trail.

Standardizing reporting across trading platforms would seem to be an obvious move, serving investors on two levels: aiding in the investigation of suspicious trading activities, insider trading, or market manipulation and allowing more rapid and accurate reconstruction of unusual market events.

The complexity of the undertaking, however, has necessitated a detailed and extended rulemaking process, including a thoughtful review of the many comments received since we first proposed the system’s creation. The contours of the regulation are being finalized and will be considered by the full Commission. But, regardless of the details, the broader result must be a mechanism that gives the agency the ability to rapidly reconstruct trading – something that doesn’t exist today.

In addition, while the initial proposal will be for an audit trail tracking orders and trades in the equity markets, I believe that the system should eventually be expanded to include fixed income, futures and other markets.

It is important that we get a structure in place sooner rather than later so that the heavy lifting of working through the technical nuances of the system can begin. We expect to adopt a final rule in the months ahead. After that, I anticipate that the exchanges and FINRA will be required to submit a detailed blueprint, which in turn would be subject to public comment and a separate Commission approval.


I’m proud to have the opportunity to work at the SEC during an exceedingly productive period in its history.

The SEC has accomplished much and we are on the verge of further critically important rulemakings that will strengthen the structure of the financial markets and enhance the agency’s ability to oversee those markets and pursue investors’ interests.

However, just as important as the cumulative effect of these accomplishments, are improvements in the culture, management, approach and attitude of the agency as an institution and the staff who make it work – improvements that all regulatory agencies should undergo – and that will allow the SEC to continue to function at a high level in the years ahead.

No one can predict what challenges will arise, what new threats to market stability will emerge, what fraudsters and manipulators will try down the road. But whatever does happen, the SEC is now materially better able to enforce the law and to identify and manage threats.

The burst of activity isn’t just a result of circumstances – a reaction to the financial crisis. It’s an indication that the SEC is evolving in step with the rapidly changing markets.

It has been a busy time. But there are a lot proud people who – even as we finish what is on our plates today – are looking ahead to an equally productive future.

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Modified: July 28, 2014