Speech by SEC Commissioner:
Address at the North American Securities Administrators Association Annual Conference
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
October 1, 2007
Thank you, Fred, for those kind words. And I also want to thank Joe for his hospitality. I have been fortunate to know Joe for quite some time as we both have worked for the people of the State of Alabama — Joe as the Director of the Alabama State Securities Commission and me as a longtime aide to Alabama Senator Richard Shelby, the Ranking Member of the Senate Banking Committee. Given that Joe, Senator Shelby, and the Ranking Member of the U.S. House Financial Services Committee Spencer Bachus are all Alabamians, I think it's safe to say that Alabama investors are probably pretty well protected.
But today, I'm pleased to be working with Joe and all of our friends at NASAA on behalf of the nation's investors and markets. NASAA is an important partner to the Commission, and we greatly value our strong and close working relationship; and just to show you how much we value the relationship, half of the Commission is here at the conference.
As you may know, Paul Atkins, the most senior member of the Commission, spent much of yesterday meeting with members of the NASAA board and many conference participants. As the SEC's key liaison to NASAA, he has worked tirelessly to ensure that the Commission maintains its close association with NASAA. And I am so pleased to be able to join him in attending your annual conference. Despite my short time here, I have enjoyed meeting and visiting with so many of our NASAA colleagues. I only wish I were able to stay longer.
Before I go further I must remind you that my comments today are my own and do not necessarily reflect the views of the Commission or my fellow Commissioners.
As you know, the SEC, NASAA, and the member organizations that make up NASAA all share the same basic objectives: we seek to protect investors while assuring that our markets work effectively and efficiently — these objectives go hand-in-hand. This is a vital mission, and to serve our mission we must rely upon careful market oversight, and vigorous enforcement.
As I look at your agenda for this event, I see that you are focused on many of the same issues that have the attention of the Commission: issues such as staying ahead of microcap fraud and its many new iterations; the growing need for investor education and outreach; and the United States' competitiveness in the global marketplace.
Now, perhaps at a pace unparalleled in recent history, capital markets are changing. We're seeing a steady and accelerating emergence of new and increasingly complex products. And markets abroad are growing and strengthening exponentially. Like never before, everyday investors are joining institutional investors in seeking and gaining greater access to investment opportunities and markets abroad. This globalization of our markets, fueled by technological innovation, continues to diminish the relevance of geographical boundaries that have historically defined and dictated our approach to regulation. As regulators, if we are to maintain our effectiveness, we must be nimble in our regulatory approaches, vigilant in our enforcement efforts, and increasingly collaborative. Indeed, this dynamic marketplace challenges us all as regulators.
In the last year, three major studies have called into question U.S. competitiveness. Each concludes that America is losing ground to foreign markets. They suggest that these trends may be caused by foreign markets developing and evolving — no more than a natural growth and maturation in markets abroad. But they also question whether America's regulatory climate dissuades investment in our markets. For example, a report commissioned by Senator Charles Schumer and New York Mayor Michael Bloomberg concludes that our competitiveness concerns derive from needed reform in our immigration policies, legal system, and regulatory approach. And all of the reports urge various suggestions for reform.
In response to these reports, some argue that we must act now, or we will forever lose our competitive edge. Others warn that the concern is overblown, and that any reforms would be a 'rollback' of investor protections and could be catastrophic for investors' interests. I know that many in this room have added their voices to this debate; I encourage you to continue to do so because you bring important views to this national discussion.
For my part, I do not believe this is necessarily a binary choice that requires either rejecting or embracing the conclusions of these reports. On the one hand, the sky is not falling — America's capital markets remain rich, deep, vibrant and attractive; and while we may be losing global market share, there are likely many reasons for this trend, not all of our own making.
On the other hand, doing nothing to analyze and consider these very noteworthy trends would be perhaps the worst thing we could do, and would almost certainly further erode our ability to compete internationally. A runner may not win the race by running faster; but she will surely lose it by standing still.
So this is a debate we should be having, and that we should be taking seriously. And although the emergence of other significant foreign capital markets could be seen as a threat to the central role U.S. markets have historically played in global commerce, it can also be seen as an opportunity for growth and productive change. We can all benefit from competition, whether at home or abroad.
I believe we should always be asking ourselves whether and how we can do better, but this is especially so given the fast-changing and competitive markets we oversee. Do we have the proper emphasis on enforcement? Can state and federal regulators better coordinate to leverage resources and improve legal certainty so that market participants can manage risk? After all, law abiding corporate citizens require predictability.
Does our civil justice system effectively complement our regulatory enforcement efforts? And do our financial reporting rules effectively promote useful and informative disclosures without undue complexity and regulatory burdens? These are questions we should all be asking and trying to answer. And I'm glad that the Commission isn't standing still.
Each of the three competitiveness reports expresses concern that our separate state and federal regulatory systems create uncertainty and complexity which can turn businesses away from our markets. They call for greater communication, coordination and cooperation among regulators. Even if one does not agree with their conclusions, we must recognize that greater cooperation and coordination are critical to leveraging resources. I know that Commissioner Atkins has worked closely with the states and NASAA during his tenure at the Commission, and that Joe and his predecessors at NASAA have also valued the relationship between state and federal regulators. But we can always do better. I promise you, as a Commissioner at the SEC, I will strive to do so.
Whenever I meet with SEC officials in our regions, I always ask what they are doing with other regulators. It's great to hear about a seniors seminar hosted by the SEC and the state of Rhode Island, or an enforcement action in collaboration with Texas, or a coordinated boiler room examination.
With the full backing of the Commission, our staff meets regularly with states and the SROs to share information and coordinate activities. This is critical to maximizing resources, and helps to insure consistency and clarity for market participants. That effort, in turn, fosters investor protection, orderly markets, and the formation of capital.
In response to this changing marketplace, the Commission is doing its part to ensure that American investors and companies have the tools they need to compete. Long before these competitiveness reports, the Commission and the PCAOB embarked on a process to address the undue costs and burdens associated with the implementation of Section 404 of the Sarbanes Oxley Act — the internal controls provisions of the law that have been a lightening rod for criticisms of the U.S. approach to regulation. SOX has a great many virtues and has been important to restoring needed confidence in our markets following the scandals we all know so well. But critics — in particular small business owners — have noted that the costs of 404 as implemented threaten to dramatically outweigh its benefits. This summer, the Commission released management guidance and the PCAOB released a new audit standard, both designed to alter the 404 internal controls audit process from a costly, and often unnecessary, rules-based check-the-box audit, to a principles-based internal controls review. Although in my view the schedule should be modified to allow small business more time to comply with the new standards, we are certainly moving in the right direction. And we are doing so through close collaboration between the SEC and the PCAOB, which benefits everyone.
Further, the Commission has continued down the SEC's 2005 Roadmap toward convergence of international accounting standards. With the ultimate goal of creating a single set of high-quality global accounting standards, the Commission is currently considering eliminating the reconciliation requirement of IFRS to US GAAP.
As global markets continue to expand, investors seek greater and more timely access to high quality financial information, driving a demand for a more common reporting language. The development and acceptance of IFRS around the world has helped foster this drive to convergence of differing accounting systems. And it has questioned the continued effectiveness and value of the U.S. GAAP reconciliation requirement for investors, instead perhaps acting more as an unnecessary cost and disincentive to list in the U.S. for market participants who can now just as readily tap capital around the world.
The comment period recently closed for the Commission's proposal, and I look forward to carefully considering all comments.
The Commission is also actively considering the prospect of developing a mutual recognition framework that would facilitate greater border access for investors and market participants. Recognizing the realities of the market today, the challenge for the Commission will be continuing to strike the right balance between fostering choice for investors, and protecting investors from unknown perils that could lie in far away markets.
For just as surely as U.S. investors seek and demand greater investment opportunities, they also expect high standards of investor protection. This is a significant initiative that promises great benefits for U.S. investors and our markets. And NASAA will have a critical voice in informing the Commission's consideration of these issues.
So I look forward to your input as the Commission moves forward in this area.
The Commission has also recently announced several broader study initiatives to be considered over the coming year. This summer, the Commission formed an advisory panel to look at ways to eliminate unneeded complexity in U.S. financial reporting. The panel has all critical interests represented by distinguished professionals. If successful, the effort should result in recommendations that reduce regulatory burdens while improving disclosures for investors — and I look forward to their findings.
In recent months, the Commission has also been asked to evaluate our private class action system. This summer, several Representatives from the U.S. Congress asked us to consider whether the securities class action system adequately complements our enforcement efforts. And in August, a group of 6 noted professors asked us to explore a purely economic consideration: does the private litigation system achieve an efficient wealth redistribution objective, or are the transactions costs unnecessarily high?
One of the questions raised by the competitiveness reports is whether the uncertainty created by our class action system is chasing capital from our markets. The focus is upon the unpredictability of our system, a system involving fifty different state legal systems and a federal system, where the outcome of a case can sometimes be determined by which law firm files first, and where. The results of these disparate cases are often, not surprisingly, uneven. So it can be hard to discern clear standards of conduct, and the sanctions for violating those standards.
People rightly criticize the Commission when our enforcement efforts are unnecessarily prolonged; but one thing that I think our thoroughness attempts to foster is horizontal equity. While not always possible, I strive for consistent results in our enforcement activities. For if we are consistent, we are predictable. And if we are predictable, market actors can know how to do the right thing, and know what to expect if they fail.
These questions about our civil justice and enforcement efforts do not invite a simplistic response: one need not be either for our class action system or against it; that would invite a false choice. Indeed, these questions are being raised by non-partisan and bi-partisan groups. Instead, these questions call upon us to examine the importance of balance in our system. Early next year, the Commission will hold roundtables to explore these issues, and the public discourse that should follow will be important and valuable.
These are just a few examples of the Commission's efforts to evaluate and reevaluate our rules and practices in service of our mandate to promote efficient and orderly markets and protect investors. As the global market broadens, we must take a broad view of our rules and practices so that America remains competitive.
But we can't focus all of our attention overseas. American markets must remain attractive to American businesses and investors. Our country was built on entrepreneurial spirit. It is often said that small business is the engine of the U.S. economy. We must strive to assure that our capital markets are available to those entrepreneurs and their companies.
For small businesses, this means access to capital; it also means that regulators must guard the markets against those who would corrupt them through schemes and scams designed to divert money from honest enterprises.
As far as access to capital, I have already noted our efforts to scale Section 404 so that small and growing companies which choose our markets are not unnecessarily burdened by mechanical box-checking exercises that do little to protect investors. The Commission is also reviewing other means to improve capital access. This summer, the Commission proposed a number of rules targeted to benefit small businesses. There are the amendments to Rule 144's holding requirements that would shorten the holding period and could improve liquidity and access to capital; I believe that NASAA has some strong views on this proposal and I assure you that, like all comments we receive, I will carefully consider these views. As I have stated before, our collaboration on matters such as these will help to assure a better regulatory environment for investors and businesses alike.
Proposed amendments to our shelf-offering rules could allow smaller companies to take advantage of registration efficiencies currently available to large issuers. And we have proposed rules that would streamline reporting for small businesses. The comment period for each of these proposals recently ended, and I look forward to considering the many thoughtful responses we have received.
Another proposal that is, no doubt, of great interest to this group is our proposal relating to an improved electronic filing system for Form Ds. Such a system could streamline the filing process for businesses seeking to take advantage of Regulation D offerings, and could also help regulators share critical information. I know that NASAA and several states have offered constructive ideas to improve the framework we have proposed. This is certainly one area that requires thorough communication between the Commission and the states, and careful coordination. I hope that the Commission will be able to take up this and the other small business related proposals in the coming months.
As part of its continuing effort to focus on helping small issuers compete and thrive, last week the Commission hosted its annual Forum for Small Business on Capital Formation. Topics included many of the proposals just discussed. It is in these types of interactive fora — roundtables, meetings such your meeting this week, and conversations between and among regulators and market participants — that I think the investing public and the stakeholders are best served.
So the Commission remains focused on the engine that drives our economy: entrepreneurs and small businesses. But as I mentioned a moment ago, in order to foster competitive markets, we must do more than facilitate access to capital and preserve orderly markets; we must ensure that those markets are safe for investors. For if the perils of the marketplace are too great, investors will shy away, and capital will dry up for America's entrepreneurs.
And this is where enforcement programs serve such a critical role. Our enforcement work is important, exciting, and often high-profile. Every day in cities around the world, enforcement cases make headlines. Complicated, big-dollar cases involving well-known managers and public companies are extremely important for our markets and investors in those markets in that they send the message to would-be wrongdoers that crime doesn't pay; and they remind investors that the regulators are on the beat — looking out for them.
But while the big famous cases are important, and even fun to work on, the not-so-notorious cases matter just as much — if not more — because they help ensure that investors will continue to feel secure investing in our capital markets and in the small companies that grow within them. So we, the enforcers, must continue to pursue the pump-and-dump schemes, affinity frauds, unregistered offerings, boiler room scams, ponzi schemes, internet intrusions, and all of the old and new iterations of these often microcap frauds that divert money from good companies that need it to grow.
I was privileged to speak last month at an enforcement conference in Fort Worth, and I focused my remarks on pursuing these types of cases because I think that rooting them out is so very important, but is often under appreciated. So at the risk of repeating myself . . . and perhaps driving Denny Crawford out of the room — she was in Fort Worth — I'd like to tell you why I think we must always keep focus on the cases that, quite frankly, don't always make headlines.
They've been around in one form or another for ages, and they aren't going away. Such frauds target and exploit retail investors — everyday people who depend on transparent and honest markets for securing their nest eggs. These cases are the bread and butter of what you do; they represent a constant presence in our markets. They deserve your energy and attention, and you deserve credit for vigorously pursuing them.
It was over 150 years ago that PT Barnum proclaimed that "There's a sucker born every day." Some say that Barnum finished the sentence with "and two to take 'em." Barnum recognized that there's no shortage of people to exploit, and certainly no shortage of people willing to do the exploiting.
A few decades after Barnum uttered those famous words, an Italian named Charles Ponzi made his way to Boston. Ponzi wasn't the first to exploit investors with his fragile scheme — he was just the best known at the time.
And still, almost 100 years after Ponzi first schemed, despite the enactment of several major laws, the creation of the SEC, the hiring and training of thousands of investigators and prosecutors, and the proliferation of investor education and alerts, Ponzi's scheme survives.
Perhaps the internet or other new technologies have made it possible to disguise these schemes or employ ever more enticing sales pitches; perhaps it's the greater access to the marketplace brought about by the internet and it's low barriers to entry for those with a sinister idea and a laptop; or perhaps it's just human nature, as Barnum suggested, and we'll just never learn.
Whatever the case, as legislators, regulators and marketplaces endeavor to improve access to capital for entrepreneurs, we must also remain ever vigilant to the new threats posed by this easy access to the marketplace.
The modern fraudster repackages old frauds in enticing new ways: "foreign exchange trading," real estate investment contracts, or high-yield, tax free prime bank offerings. Often, fraudsters use high-pressure sales tactics to push these exotic investments on seniors or other unsuspecting investors. Indeed, the SEC's office of Investor Education and Awareness received almost fifteen hundred boiler room complaints last year.
I know that NASAA's members are responsive to new threats to retail investors and that you are keenly focused on the traps that await retail investors; I'm also proud of the record of the Commission in this regard, and I want to highlight some of our initiatives.
Pump-and-dump schemes have been around for years; earlier iterations relied on word of mouth. Indeed, one of the earliest reported pump and dump schemes involved the run up of the South Sea Company stock in the early 1700s.
While management was singing the glories of the South Sea Company's monopoly over trade routes to the New World and the huge profits it would produce, management was issuing and dumping its own stock into an inflated market. More recently, telemarketers and blast-faxers got in on the pump and dump game, urging investors to jump at the chance to buy sometimes worthless stock. And the modern day scam, brought to us by the internet, uses financial spam: cheap and anonymous mass mailings of fraudulent inducements to buy worthless stock. Not only do these market manipulations hurt investors, they take critical dollars from honest businesses and pervert the reliability of our markets.
Several months ago the Commission announced an effort to step-up trading suspensions in 35 stocks that involved fraudulent emails hyping stocks with promises like "Ready to Explode," or "Ride the Bull." The sweep has been immensely successful in publicizing these spam scams and took 35 bogus stocks out of circulation.
As usual, the Commission did not act alone. Just as we often collaborate with many of our state counterparts, we worked closely with the NASD and Canadian securities authorities to bring about these trading suspensions in this massive sweep. Today, the markets have 35 fewer scam stocks. Our only failure in this effort was in the name, "Operation Spamalot." It's a catchy name, which was the point. But it caught the attention of Monty Python's Spamalot, who also thought it was a catchy name; hence, "Monty Python's Spamalot." They then kindly asked us to consider a new name for our sweep, which we obligingly did.
An excellent example of enforcement efforts protecting markets for small businesses and investors was announced just last month. Working with the Department of Justice, the FBI, the Postal Service, and FINRA, the Commission broke up a massive market manipulation fraud that hurt countless companies and investors. Michael Paloma, Lawrence Kaplan and others convinced several cash-strapped, honest small business owners that they could help them raise capital by taking them public. These entrepreneurs, unskilled in the complexities of public offerings, turned over company stock to Paloma, Kaplan and their fictitious companies. After using wash sales, blast faxes and spam emails to create an inflated market for the stock, Paloma and his cronies dumped the stock and walked away with hundreds of thousands of dollars. The companies got next to nothing — companies like Courtside Products, Inc., a sports bag company founded by Lola Emter of Spokane, Washington; and Latin Heat Entertainment, a company that publishes a newsletter about Latin entertainers founded by Bel Hernandez of West Covina, California; and XTreme Technologies, a telecom consulting company also from Spokane, and founded by Michael Burk. The case is extremely important for protecting investors and protecting the marketplace for legitimate companies and honest business people seeking to raise capital; not only are these perpetrators likely headed to jail, other participants in the fraud should get snared.
As a convenient side effect of our stepped-up efforts, I am pleased to note that a recent report credits the Commission with a 30% drop in financial-related spam — that unwelcome email that clogs up our in-boxes. That's not just good news for our markets, it's great news for our sanity!
Speaking of manipulations and shell companies, several years ago the Commission's Enforcement Division started looking for fast and efficient ways to interrupt the use of shell companies by stock manipulators seeking to defraud investors. Because many such shell companies were also delinquent in their registrations with the Commission — depriving investors of important financial information — the Commission created our "Delinquent Filer Program Branch" to allow for swift trading suspensions of these unregistered shell companies.
Since this program was started in 2004, the Delinquent Filings Branch has obtained over 300 revocations and almost 200 trading suspensions. This program doesn't receive a lot of press, but the three attorneys who run it do tremendous good for investors: the program either forces registration or it pulls delinquent companies out of the public markets altogether. Either way, investors win, and so do the honest companies competing for capital.
Our internet enforcement group was among the first to discover a new trend in internet-based fraud that has been dubbed the "intrusion" cases. In these cases the perpetrator, sometimes affiliated with a foreign crime syndicate, hacks into an online brokerage account and places purchase orders for large blocks of relatively obscure or lightly traded stocks. The perpetrator then sells this same stock in his own account, quickly posting thousands of dollars in paper gains. The owner of the intruded account is left with a depleted bank account and shares of worthless stock.
We have been working with the online brokerage firms to be proactive; hopefully, investors, brokerage houses, and the Commission are all getting ahead of this crime through education, enforcement, and improved security awareness. Good news for our capital markets.
I'm pleased to see that your conference agenda focuses on internet and microcap fraud; and it's great to see you are also focused on investor education. While our collective enforcement efforts are critical to safeguarding markets, education is an important shield. Resources are far too scarce to confront every fraud or abuse that threatens investors. So our efforts must be complemented by energetic investor education and awareness; and vigilant, discriminating investors.
I see no better way to leverage our resources than by helping investors help protect themselves. These coordinated efforts are fortifying investors, thwarting would-be fraudsters, and ensuring that our markets attract capital.
We've got a full plate right now at the Commission, and I hope that I've given you some insights into what we're doing, and where we're going. We're focused on our tripartite mission: protecting investors, facilitating capital formation, and ensuring fair, efficient, and orderly markets. In the ever-expanding global marketplace, serving this mission means being nimble, vigilant, and collaborating as regulators.
Your role — NASAA and all of the state and provincial authorities attending this terrific conference — is critical. I know that you will strive to keep our markets deep, vibrant and secure, so that America remains a competitive force. I urge you to continue to press your historically active enforcement programs, but also to be open to concerns about America's place in the global marketplace. We can do both. This is a fair debate; regulators should listen carefully and engage actively. I believe that if we do so, our markets and investors will be better for it.
Thank you for the work that you do, and for allowing me to speak with you today.