Speech by SEC Chairman:
Address to the 2007 Corporate Counsel Institute
Chairman Christopher Cox
U.S. Securities and Exchange Commission
Georgetown Law Center
March 8, 2007
Thank you for that very kind introduction, and thanks especially to Dean Alex Aleinikoff, Program Chair Marc Gary, and Program Co-Chairs Allen Gross and Stephen Paige.
I couldn't be happier to be here this morning to speak to the Corporate Counsel Institute, because you are at the forefront of reshaping the rapidly changing landscape of the relationship between companies and their shareholders. You’re destined to play a vital role in the implementation of every one of the Commission's new disclosure initiatives in this area.
This morning I'll mention just two topics in this connection. First, the recent changes we've been making in the way that companies disclose information and interact with their shareholders — and the opportunities that you have, as inside counsel, to get ahead of these changes and lead. Second, the responsibilities of counsel, including each of you practicing in the securities area, that we have had reason to address recently.
The disclosure changes I'm talking about are significant. They're destined to remake the very nature of communications between companies and investors. Whether in periodic reports or proxy solicitations or any other investor communication, we're trying to simplify things to make our disclosure more accessible and more useful to investors.
It's fitting that we're gathered at a law school, because it reminds of us how bewildered we all once were when we first heard the jargon and cant of the lawyer. Back when the deep structure of our minds was not influenced by the densely reticulated vocabulary of legalese, we could relate to the experiences of today’s investors trying to make sense of their proxy statements. And for me, the environment here at Georgetown brings back other memories — of my time in the classroom as a teacher, a quarter century ago, teaching federal income tax. The students were bright young men and women, eager to learn. My job was to get across the important concepts of federal taxation without getting lost in the minutiae and the jargon.
I'll never forget my experience grading the students' final exams. There were two cases on the final - two business situations nefariously constructed to contain every tax problem known to man. The exam lasted four hours. Naturally, each of the students filled up multiple blue books. All, that is, except one. I can't tell you how excited I was when I picked up this student's single blue book. I was intrigued to find out what this model of concision could possibly look like. And then, when I opened the cover, I discovered that he'd written on just the first page of the one blue book. Here is what he wrote:
"Dear Professor Cox: What I have learned in your course is that federal income tax is extraordinarily complicated. And when I go into business, I'll be sure to hire someone who knows what he's doing in this area."
I'm reasonably certain that this fellow ended up with a career in improv, rather than tax accounting. Either that or he went to work for Enron. And much as I appreciated the wry humor, I didn't have too much remorse about flunking him.
But you have to admit, that student had a point. The arduous process of unraveling the man-made complexities that are too often the hallmark of government rules and regulations isn't just hard work. It's entirely unnecessary. That's why, from the forms issuers must file, to the accounting standards they use, the SEC is waging an all-out war on complexity.
Just four months after I became Chairman, the Commission put a wide-ranging package of new rules into effect to simplify the U.S. public offering process. We broadened the scope of permissible communications both before and during an offering. We liberalized the rules for shelf registration statements, and completely eliminated the need to physically deliver final prospectuses in almost all cases. A new category of well-known seasoned issuers can now benefit from automatic shelf registration procedures — without having to worry about potential staff review.
In just three weeks, our new e-proxy rules will go into effect, further advancing our goal of tapping the enormous power of technology and the Internet to simplify and improve disclosure. We're going to be relentless in seeing to it that the language in which both regulation and disclosure are written is plain English.
Since this is a gathering of lawyers, it goes without saying: you're all multilingual.
Everyone here speaks Legalese. But even so, I'd be willing to bet you'd appreciate a good John Grisham novel more than a big fat 10-K, any day of the week. So let me ask you a question. Take off your lawyer hat, and put on your investor hat — the one you wear when you figure out what to do with your 401(k), your IRA, your 527 plan, or your lifetime savings. When you get that prospectus or that proxy statement in the mail — do you immediately plunk down in a comfortable chair and read it? How many people here actually read all of the stuff that comes in the mail courtesy of the SEC? [Laughter]
O.K. — and tell the truth now — how many of you throw it away?
Just as I thought.
Well, it goes without saying, that's a sad irony. Because the SEC is the investor's advocate, and if you’re an investor, you are our customer. Any enterprise has to be concerned if the customers are throwing away the products.
It's our aim to break down all the legalese and the jargon, the dense cover-your-assets boilerplate that reads more like the insurance policy it is than the helpful guide to investors that it's meant to be. And since lawyers continue to advise their clients to include more rather than less, and by all means to keep repeating the litigation-tested boilerplate, the best way to simplify things for investors is to give them new tools to cut through the fog.
The Internet and your computer are made for that. By putting proxies and 10Ks in searchable form, and by moving to a system of interactive data that lets you reorganize and collate and compare information at the touch of a button, we're going far beyond merely reproducing the paper documents in electronic form.
Interactive data, which will give every number in a prospectus or proxy statement a life of its own, will vastly improve the quality of analysis that's possible for investors and their intermediaries. It will make understanding the most important information about a company much easier. Interactive data will permit the nearly instantaneous analysis and comparison of broad ranges of data, which in turn will change the very nature of disclosure — and ultimately of investing itself.
It's because of the potential that interactive data holds to give investors and analysts remarkable new insights into the disclosures we already mandate that the SEC has recently committed $54 million to convert all of our filings, and the entire EDGAR system, to this new interactive format. We are already accepting periodic reports to the SEC in this new interactive data format, and some 50 major public companies are using it. You should be using it, too. We're learning every day that interactive data is a cost saver for issuers, and a godsend for users. So I encourage you and the companies you represent to become leaders in this new investor-friendly way of reporting.
It's very likely that the data tags for the companies you represent are already available. The XBRL codes — that stands for eXtensible Business Reporting Language — are already written for most industries. By September, XBRL-US — the private sector organization that is responsible for interactive data in the United States — will have completed all the data tags for every industry. And they are making it available to the world for free. This is an entirely open-source project, not only here in America, but around the world in more than 100 countries.
The parent of FASB, the Financial Accounting Foundation, is contributing $3 million to this project. The SEC is contributing over $6 million. Several accounting firms and others are also contributing substantial monies to support XBRL US in getting this job done — and I want to publicly thank them all.
Just as our efforts to encourage companies to make their disclosures in plain English are designed to help the retail investors, this initiative is using the power of technology to help investors by getting more high quality information out of the same basic financial data. A good example of how this can work is the new executive compensation disclosure that most of you are familiar with. In the past, this disclosure has been among the most complicated, and it's provided investors with some of the biggest challenges they've faced in analyzing and comparing data. The new compensation disclosure is making this info, at long last, more accessible, by distilling all of the various forms of compensation into one number.
But already we're seeing examples of overlawyering that are leading to 30- and 40-page long executive compensation sections in proxy statements. We’re seeing companies including columns in the summary compensation tables even when there's nothing to report in those columns. This kind of slavish adherence to boilerplate disclosure is what we're trying to stamp out.
So it's fitting that we're gathered here this morning on Oliver Wendell Holmes's birthday.
After all, Justice Holmes wrote some of the most important decisions in some of the most complex areas of our jurisprudence. And he did it in famously pithy, short opinions that were often no more than a page or two in length.
He also had a mustache just like Mark Twain, who you will recall famously apologized about one of his own pieces of correspondence by saying, "I'm sorry this letter is so long, but I did not have time to make it shorter." Twain also classically defined a classic as something that everybody praises and nobody has read. Our object in overhauling SEC disclosure for the benefit of investors is that lawyers stop writing lengthy classics that no one wants to read and start writing like Holmes. We want to replace boilerplate with potboilers.
After all, if one of America's greatest jurists can cover great legal theories in one page of clean prose with no jargon, why can't a proxy statement tell a reader what she needs to know about the boss's pay in the same way?
So while we're giving people some grace in getting used to the new rules, the plain English part of executive compensation will be increasingly strictly enforced in the coming year. Meanwhile, this year, we're going to let interactive data do some of the simplification for us. Even before interactive data becomes the norm for all reporting companies, we're going to tag the executive compensation data for you using XBRL. And we're going to put an interactive data web tool on the SEC's website, to let users slice and dice the executive compensation data any way they like — or do industry comparisons, or even do analyses of particular forms of compensation, such as stock options. We're going to do this for at least several hundred of the largest public companies in America — and we expect to have it available in June.
The truth is, investors — and their representatives on the compensation committees of boards of directors — have a right to this information. And they have a right get it in a form they can really use.
Before I leave the topic of executive compensation, let me offer a word about the new Compensation Discussion and Analysis section. This new opportunity for a company to detail the objectives of its compensation program is what good disclosure is all about — and it's where inside counsel can play a vital role. The narrative in the CD&A should provide a qualitative look at the company's executive compensation policies, and shed light on the quantitative tabular data. This is your chance to plainly tell the company's compensation story. I urge you to take the opportunity and make the most of it.
The truth is, as the SEC moves to strengthen the hand of investors in their relationships with the companies they own, your actions — the choices you make — will determine how successful these reforms will be. From the disclosures you make, to the structure of your boards of directors, to the way you respond to investor concerns and the way you solicit proxies, your implementation of our regulations is the fulcrum upon which the entire effort rests. It is only through your efforts that we'll be successful in protecting the interests of investors. Only through your efforts can we raise the standards for the protection of market participants, while at the same time making those markets more efficient.
This is not by any means aggrandizement or embellishment of the role of lawyers.
Long before Section 307 of Sarbanes-Oxley required the Commission to set minimum standards of professional conduct for lawyers, for at least five centuries, it has been recognized that lawyers are the indispensable guardians of the rule of law. Every lawyer — whether she was an engineering major in college, or a specialist in 16th English literature — knows that when Dick the Butcher said “The first thing we do, let's kill all the lawyers” in Shakespeare's King Henry VI, Part 2, he was talking about how to execute his plot to overthrow the government. To Dick the Butcher, just as to Jack the Ripper, or to this year's most egregious securities fraudster, getting rid of the lawyers would be an extremely useful step in getting away with murder.
Just as Shakespeare's audiences recognized it, so do we — and in the securities realm, lawyers are what today we call crucial gatekeepers responsible for safeguarding shareholders' interests by advising companies on disclosure standards and all of the requirements of our securities laws. It's because of this key role that you play that the SEC views you as important partners in our mission to protect investors. Your responsibility in this area wasn't created by Section 307 of Sarbanes-Oxley, although that provision of law now underscores it. The requirement of highly professional conduct affects all of the work you do and have always done.
For example, if you as corporate counsel find evidence of material violations of federal securities laws or breaches of fiduciary duty, then depending on the response you get from your supervisor or client you are required to "report up the ladder" to senior management and, if necessary, the board of directors. It's because the roles of gatekeeper and watchdog come with a great deal of responsibility that, when professionals — lawyers or accountants — fail to live up to their responsibility, the Commission will bring enforcement actions.
Just yesterday, the SEC won a jury verdict in San Diego on all counts in our case against Gateway for manipulating earnings. It’s a case that shows the Commission’s commitment to holding accounting professionals responsible.
And not surprisingly, we have been looking just as carefully at the role of lawyers in the stock option backdating scandals. The misconduct in these cases, which requires certain access to records, as well as authority to grant options, raises the question -- where were the lawyers? Where were the gatekeepers? And unfortunately, as the Commission's recent actions against individuals at Comverse, Monster Worldwide and McAfee have shown, the answer is quite troubling.
Last August, we brought charges against three former senior executives of Comverse Technology, including the company's former General Counsel. The facts in Comverse read like a Grisham novel. We alleged that high-paid corporate executives engaged in a decade-long fraudulent scheme. By backdating undisclosed in-the-money options to themselves and to others, they gave themselves strike prices that coincided with historic lows. We alleged that to further the scheme, the company's inside counsel falsified company records to make it appear that a board committee approved the option grants on the falsified grant dates. The former executives collectively made millions of dollars by exercising the illegally backdated options and then selling their Comverse shares. The General Counsel ultimately settled with the Commission, agreeing to pay over $3 million in penalties, disgorgement, and prejudgment interest. He was also hit with a permanent officer-and-director bar, and suspension as an attorney before the Commission.
The story at Monster Worldwide wasn't any better. Last month, we sued the former General Counsel for his role in another multi-year scheme. The General Counsel, we alleged, secretly backdated stock options to thousands of Monster officers, directors and employees, including himself. He falsified documents to make it appear as if the company had actually granted options on dates that in reality had been selected after the fact. By looking backward, he could find a date when the stock price was low.
In the McAfee backdating case, we also sued the former General Counsel. We alleged that he wrongfully re-priced his own grants, as well as those awarded to others — all in order to secretly increase their value. The General Counsel concealed his fraudulent re-pricing by filing false stock ownership reports with the SEC. In addition, in his capacity as Secretary of the Compensation Committee at McAfee, the General Counsel allegedly falsified the minutes of committee meetings, and directed the company to issue a 420,000 share option grant to McAfee's chief executive after the date that the commission had expressly directed.
It isn't just in the backdating cases that we see lawyers failing to live up to their responsibilities. Last Thursday, in a case that recalls Oliver Stone's Wall Street, we charged 14 defendants in a brazen insider trading scheme using information stolen from UBS Securities and Morgan Stanley. We alleged that eight Wall Street professionals, including a Morgan Stanley attorney, participated in the scheme, which netted more than $15 million in illegal insider trading profits on thousands of trades. This, too, is a tragic tale of a gatekeeper gone bad. The complaint charges that the attorney, who ironically worked in Morgan Stanley's compliance department, illegally passed on material, nonpublic information she stole from Morgan Stanley in exchange for sharing in the illicit trading profits.
There is a recent decision of the D.C. Circuit in one of our cases that I also want to draw to your attention. In SEC v. Weiss, the D.C. Circuit upheld Commission sanctions against bond counsel to the school district in Lawrence County, Pennsylvania. The court said that the lawyer violated the securities laws when he gave the school district an unqualified opinion on the tax-exempt status of a proposed municipal bond transaction, even though he had no reasonable basis for doing so — and even though he'd conducted no investigation of the underlying facts on which the opinion relied.
It is important to emphasize that neither this case nor any of the actions we have brought against lawyers have been for giving bad advice. Rather, our actions against lawyers have focused on the lawyer's actual conduct.
The good news for all of you here is that while the number of enforcement actions against lawyers has increased over the past several years, these actions still are relatively infrequent. And because we rely daily on corporate counsel to help us get to the right answer in so many areas of our responsibilities, I want to re emphasize that we view lawyers as critical partners in our mission.
Indeed, the great majority of the roughly 160 backdating investigations demonstrate this very point. A significant number of these cases were brought to our attention by self reporting, as the result of sound legal counsel. In most of these cases the companies have undertaken extensive internal investigations — again as the result of wise counsel. In our experience, the vast majority of corporate counsels uphold their legal, ethical and fiduciary responsibilities to investors. They are worthy gatekeepers and faithful watchdogs.
Lawyers – including every one of you here this morning — have a vitally important role in ensuring that America's markets are honest, and in bolstering investor confidence in our entire system. In every transaction you handle, every governance problem you tackle, and every shareholder communication you write, keep in mind that America's investors are depending on you.
Here at Georgetown, they like to talk about vocations. And you don't have to be a Catholic to appreciate the importance of acknowledging a duty to help others in everything we undertake in our daily lives. There's a real nobility in contributing as a professional to the services not only of millions of average investors, but also the health and vitality of our nation's capital markets — the richest, deepest, and most liquid in the history of the world.
The importance of our capital markets — and hence, what each of you do every day — to the prosperity of our nation can't be overstated. Everyone in this room has a huge stake in that relationship. Our capital markets are the engine that continues to power our economy in the creation of millions of new jobs, and they're the source of a way forward for every young American thinking of going to college. They hold the retirement savings of our parents, and indeed, every one of us. They're the well our nation will tap to support the innovations in health care that will cure cancer, and conquer diabetes. It’s worth doing everything we can to keep our capital markets working well, and to make them always better. As lawyers, and as securities professionals who are critical to the process of capital formation, every one of you is a contributor to our nation's success.
Thank you, each of you, for pursuing a vocation in our capital formation process — and for your work, your ideas, and your integrity. We at the SEC are doing our part to meet your needs as practitioners, and to fulfill our statutory mandate to protect investors and promote capital formation. And we're proud to be your partners.