Speech by SEC Commissioner:
Remarks Before the SEC/NASAA 19(d) Conference
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
May 8, 2007
Good afternoon. Thank you, Joe [Borg], for that kind introduction and congratulations on your second term as president of NASAA. This conference provides an opportunity to discuss issues of mutual concern with not only our state and SRO counterparts, but also from our neighboring countries of Canada and Mexico. My comments today reflect my own thoughts and not necessarily those of the Commission.
On this date in 1914, several producers organized the Paramount Pictures Company to engage in the new business of film distribution. In an era without television, the internet, and in which literacy rates were far lower, the movie business would become an important source of entertainment and news for millions of Americans.
Over the decades, Paramount Pictures has released many notable films, including one that involved Wall Street, greed, and inside information: Trading Places with Dan Aykroyd and Eddie Murphy.1 But since that film involved commodities trading, I don’t think I have jurisdiction to discuss it.
Instead, I will open my remarks with another Paramount film: Ferris Bueller’s Day Off (1986). Why Ferris Bueller, you may ask? It is due to that scene with Ben Stein as the economics school teacher discussing the Laffer curve. Perhaps best known as an actor and game show host, Ben Stein — a native Washingtonian — is, among other things, a noted law professor, economist and personal finance writer.
So what is the Laffer curve? Anyone? Anyone? As described by Arthur Laffer, the Laffer curve postulates that there is an optimal tax rate to maximize government revenues. At one extreme, a zero tax rate would result in zero revenue. Similarly, a 100% tax rate would also produce zero revenue, because a rational person would no longer engage in taxable activity. Therefore, the optimal rate can be found somewhere on a theoretical curve between these two points.
A similar analogy can be made for the capital markets and government regulation. The absence of any regulation may result in a loss of confidence by participants — resulting in few, if any, market transactions. On the other hand, if high and burdensome regulatory costs are imposed, then rational participants may decline to participate in the market at all.
Without an active and accessible capital market, economic growth, innovation, and jobs creation would be less than optimal. While alternative sources of capital exist, such as bank loans and private equity, the public capital markets ought to remain the preferred choice due to its efficiency and liquidity.
Like the Laffer curve, the optimal regulatory structure will achieve the greatest amount of market benefits relative to the regulatory costs. This thinking is guiding our efforts to reform Section 404 of the Sarbanes-Oxley Act, which requires management to assess their internal controls and requires outside auditors to report on management’s evaluation. To date, the implementation of Section 404 has been far more costly than anyone imagined. A large part of this cost can be attributed to the “check the box” atmosphere created by Audit Standard No. 2, which downplayed certain principles, such as materiality and professional judgment. We must keep in mind that it is investors — not companies — who ultimately pay the bill for Section 404 compliance costs.
Some critics have called for a repeal of Section 404, while others have asked that smaller companies be exempt. Recently, Chairman Cox testified before the Senate Committee on Small Business and Entrepreneurship and stated that there is no need to amend Sarbanes-Oxley or carve out any exemptions to Section 404 at this time and assuming that we and the PCAOB can take appropriate action. I am in complete agreement.
Significant errors were made in the initial roll-out of Section 404 and AS 2, but we have all of the tools needed to fix Section 404 through our own rules and our oversight of the Public Company Accounting Oversight Board. We have proposed our own management guidance and the Board has proposed a new audit standard, AS 5, to replace AS 2. Both of which will be considered for approval soon. This time, I hope we get it right. AS 5 must provide the necessary protection for accurate financial disclosure, but not be unnecessarily costly and burdensome — especially for smaller companies — and, if necessary, the Commission must exercise its authority over the Board to strike the right balance.
One of the more interesting issues being discussed in Washington is shareholder rights. Yesterday, the Commission held a roundtable on the role of the federal proxy rules and state corporate law. In Congress, legislation is being considered to mandate advisory shareholder votes on executive compensation.
I look forward to the ensuing discussion on the appropriate role of the Commission and the federal government in corporate governance. Although the Supreme Court recognized the primacy of state law for governing internal corporate affairs in CTS Corporation v. Dynamics Corporation of America2 back in 1987, the Congress would be within its interstate commerce power to regulate corporate governance for publicly-traded companies — just as it did with a few specific corporate governance provisions of Sarbanes-Oxley.
Many advocates of greater shareholder rights have argued that the federal government needs to take action, because the states have been unwilling or unable to make such changes themselves. Although preemption may be too strong of a word to describe such proposals, I think that is exactly what proponents of proxy access and advisory votes on executive pay have in their mind. They would create a structure such that, to the extent state corporate law fails to provide certain rights, federal standards will apply. The chairman has promised action by early summer, so it will be interesting to see how the debate over the appropriate balance between federal and state interests plays out.
A few weeks ago at another conference, I spoke about renewing our efforts at “regulatory convergence” among the Commission, the states, and the SROs. This was in response to recommendations contained in the various competitiveness reports released during the past six months. I do not view these recommendations as anything new. Congress clearly expressed its policy preference in Section 19(d) of the Securities Act when it stated that the federal government and the states should seek to maximize “uniformity in Federal and State regulatory standards” and minimize “interference with the business of capital formation.” Section 608 of the Uniform Securities Act of 2002 contains similar language.
The states play a key role in enforcing the securities laws. Collectively, the states have a presence throughout the country that cannot be matched by the Commission. We have made significant progress in coordinating our enforcement efforts over the past few years. To facilitate coordination, an SEC regional director has been assigned to serve as a liaison for each state and is responsible for connecting that state with appropriate Commission resources.
It is imperative that we work together to maintain an optimal regulatory structure. In my mind, “regulatory convergence” means that we must all be working from the same standards, particularly with respect to disclosure in offering documents. Sometimes, determining the correct standard is a tricky exercise, so we must collaborate to find the right solution.
In order to promote uniformity, the National Securities Markets Improvement Act gave the Commission sole responsibility for setting disclosure standards for covered securities and regulatory policy for broker-dealers and federal-covered investment advisers. But this does not mean that the states should not be involved in formulating disclosure standards and regulatory policy. The Commission has a responsibility to consider and to act upon the concerns of the states in a prompt manner.
I particularly appreciate NASAA’s involvement during the Commission’s adoption of amendments to Securities Act Rule 146, giving covered security status to the Nasdaq Capital Market under NSMIA. NASAA’s efforts helped focus attention on clarifying policies on listing and maintenance standards, which are important to investor protection.
As Commissioner, I have always been greatly concerned when it appears that a new standard, interpretation, or policy is being established through enforcement action. This is particularly disconcerting if the alleged misconduct is part of a generally accepted industry practice. I have not been hesitant to criticize such enforcement actions, regardless of whether they are being carried out by the Commission’s own staff or the states. My criticism should not be mistaken for a lack of concern about the underlying problem. But as a matter of due process, where the appropriateness of certain disclosure or conduct is ambiguous, the better course should be to work cooperatively and issue appropriate guidance to address the situation.
There are many other issues that the Commission is currently addressing: the “roadmap” for international financial reporting standards, e-proxy, hedge fund regulation, private offering reform, executive compensation disclosure, XBRL, ratings agency registration, finders and private placement broker-dealers, stock options backdating, abusive short sales, issuer corporate penalties, the propriety of awarding cooperation credit for waivers of attorney-client privilege, auditor liability caps, foreign trading screens, mutual recognition, and municipal bond offering disclosure.
That’s a pretty long list. As Ferris Bueller said, “Life moves pretty fast. If you don't stop and look around once in awhile, you could miss it.” I hope we can stop and look around at some of these issues later today. Thanks and enjoy the rest of the conference.
1 Other famous films focusing on the securities industry have been produced by other studios, such as Wall Street (1987) by 20th Century Fox and Boiler Room (2000) by New Line Cinema. Sadly, it turns out that the film Disclosure (1994) by Warner Brothers did not in fact center on securities offering documents.
2 481 U.S. 69, 89-90 (1987).