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U.S. Securities and Exchange Commission

Speech by SEC Chairman:
Address before the New York Financial Writers’ Association Annual Awards Dinner


Chairman Mary L. Schapiro

U.S. Securities and Exchange Commission

New York, N.Y.
June 18, 2009

Thank you Myron [Kandel] for that kind introduction and for inviting me to speak here tonight.

I am so pleased to see so many of you here tonight. I can imagine that it’s a very interesting and exciting time to be a financial reporter. Between the economic crisis and regulatory reform efforts, investors — let alone all Americans — are thirsting for information. And, they are turning to you to help make sense of it all. At the same time, I know you’re all doing your part to keep market participants — and dare I say market regulators — on their toes. All of which helps keep our system honest and transparent.

It is for that reason I want to especially acknowledge the N.Y. Financial Writers Association and your President Josh Friedlander. Through the college scholarships your organization awards, you encourage some of the best and brightest to pursue a career in financial journalism.

Of course, I also want to extend my personal congratulations to Allan Sloan of Fortune magazine as this year’s Elliott Bell Award recipient. His tremendous long-term commitment to the profession is an example for all scholarship recipients to follow.

As you know, the past year has been quite demanding for folks in your profession — and this week no different.

Just yesterday, President Obama unveiled his plan to build the foundation for a stronger and safer financial system. And, earlier today Secretary Geithner appeared before the Senate Banking Committee to provide more detail on the reforms that the Administration is proposing.

The plan makes real progress in helping to fill gaps in our financial regulatory framework that became apparent in the wake of the financial crisis. Although the SEC is just one part of that landscape, the proposals laid out in the Administration’s white paper go a long way to strengthening the SEC and improving investor protection in the process.

The plan is sweeping. It seeks to create a systemic risk regulator to help reduce the likelihood of a systemic shock; an oversight council so that all aspects of financial markets regulation can be taken into account and so that there are a diversity of viewpoints; and a financial consumer protection agency that will properly look after the interests of those who purchase credit products.

It also seeks legislation to regulate hedge fund managers, credit default swaps and other inadequately regulated areas so that there are certain basic safeguards in place for investors.

I believe the Administration’s plan charts the right course for investors and the capital markets.

While many of the proposals will require legislative activity, the white paper acknowledges that there are several areas where the SEC can act — and already is acting. Indeed, those of you who cover the SEC undoubtedly have noticed that we’ve been quite busy in the past five months.

In that short time:

  • We’ve proposed rules to better protect investor assets under custody or control of investment advisers.
  • We’ve proposed rules to facilitate the ability of shareholders to nominate corporate directors.
  • We’ve proposed rules to restrict short selling in declining markets.

In addition, we’ve streamlined our enforcement procedures, filed the first major enforcement actions arising out of the financial crisis, begun to hire professionals with new skill sets, and brought on new senior personnel throughout the agency.

Tonight, however, I would like to focus on four areas that will have a significant impact on individual investors and the readers of the financial press — they include target date funds, municipal securities, fiduciary duties and dark pools.

These are four areas where I believe the SEC has a particular responsibility to ensure that the markets work for individual investors, not just for institutions and professionals.

Target Date Funds

First — is target date funds, in which millions of Americans invest either directly through mutual fund investments or, perhaps unwittingly, through their 401(k) plans.

These funds as well as other similar investment options are investment products that allocate their investments among various asset classes (often a mix of equities, fixed income securities, and cash equivalents). They then automatically shift that allocation to more conservative investments as the “target” date approaches.

Unfortunately, while many target date funds may share the same date, they can be difficult for investors to evaluate and compare. That’s because funds with the same “target date” in their names can be structured, and thus perform, very differently.

Take for instance the 31 funds with a 2010 target date. The average loss in 2008 for these funds was almost 25 percent. But, their returns varied dramatically, ranging from about minus 4 (3.6) percent to minus 41 percent.

While there are several reasons for such variations, these results are due at least in part to the differences in the way the funds are allocated to various asset classes.

For example, based on recent data from Morningstar, the equity allocations of target date funds with “2010” in their names ranged between 21% and 79% of assets. For “2040” funds, the equity allocation ranges between 67% and 100% of assets.

This dispersion of equity allocation in target date funds with the same target dates is surprising to many, especially to retail investors who rely on them precisely for their simplicity and ease of use.

To flush out these issues, earlier today we held a joint hearing with the Department of Labor to discuss these target date funds.

It is essential that we evaluate the information shared and the lessons learned from today’s joint hearing. We must focus on how best to address target date fund issues in a way that benefits the investors who have entrusted these funds with $182 billion. At the same time, we must remember the countless investors who will turn to target date funds in the future to invest for retirement and education needs. As the popularity of target date funds continues to grow, it is important that our regulations are appropriately tailored to address the interests of investors who are relying on target date funds to invest for their lifetime goals.

There is much to follow up on in the wake of today’s joint hearing on target date funds. One issue I have asked our staff to examine closely is whether the use of a particular target date in a fund’s name is materially deceptive or misleading and should be prohibited.

We also will consider, in the alternative, whether the SEC rule governing a fund’s name should be revised to require clarification when a particular target date is used. Finally, we will engage in a re-consideration of our disclosure requirements to determine whether improvements can be made to enhance investor understanding of target date funds.

Municipal Securities

A second issue that is high on the SEC’s agenda is municipal securities. I expect to ask the Commission to take the steps available to us to help ensure that investors in municipal securities receive improved quality, quantity and timeliness of information about those investments.

Municipal securities represent an important market, and one with a sizable level of retail investor participation. At the end of 2008, individual investors held approximately 36 percent of outstanding municipal securities directly and up to another 36 percent indirectly through mutual funds and closed end funds.

There also is substantial trading volume in the municipal securities market — almost $5.5 trillion of long and short term municipal securities were traded in 2008 in nearly 11 million transactions. With nearly 50,000 state and local issuers, it is an extraordinarily diverse market. And despite their reputation for safety, municipal securities can and do default. In 2008, 140 municipal issuers defaulted on $7.6 billion in bonds.

Despite the tremendous importance of these markets and the broad retail participation, the information available to municipal securities investors is lacking, compared to the information available to investors in public corporations. I plan to ask the Commission to take actions within our authority to improve disclosure to municipal securities investors, and I plan to request Congress’ assistance to more fundamentally address municipal security disclosure, given the current restrictions on the Commission’s authority to do so.

Fiduciary Duty for Professionals Who Give Personalized Investment Advice About Securities

A third area that we are focused on involves the standards of conduct applicable to broker-dealers and investment advisers that provide financial services to retail investors. This is an area that was specifically noted in the white paper issued by the Administration this week.

The market gyrations of 2008 and the first half of 2009 have befuddled even the most seasoned of investors, let alone Mom and Pop seeking to plan for retirement and invest for their children’s educations. Increasingly these Mom and Pop investors are turning to financial intermediaries to help them navigate the sometimes treacherous securities markets.

More and more, Americans are feeling overwhelmed by the complexity and volatility of our markets. They are looking for assistance with their securities investments, but at times that assistance adds a host of new complexities.

I am speaking of what some refer to as the broker-dealer and investment adviser divide. But it is hardly a divide. In fact rather than growing farther apart, the two industries are merging to the point of, in some cases, relative indistinguishability. And this is certainly evident from the retail investor’s perspective.

When a retail investor turns to a financial professional for investment advice or assistance in accessing the securities markets, there is an array of choices. There are broker-dealers, investment advisers, financial advisors, financial consultants and financial planners to name just a few.

When assessing these financial service providers, there is a commonality of names in certain cases — and an apparent commonality of function and services provided.

However, the types of financial service providers I just mentioned are subject to very different regulatory regimes. And the standards of conduct and legal duties owed to investors under those regimes are not consistent.

I believe that, when investors receive similar services from similar financial service providers, they should be subject to the same standard of conduct — regardless of the label applied to that financial service provider. I therefore believe that all financial service providers that provide personalized investment advice about securities should owe a fiduciary duty to their customers or clients.

The fiduciary duty means that the financial service provider must at all times act in the best interest of customers or clients. In addition, a fiduciary must avoid conflicts of interest that impair its capacity to act for the benefit of its customers or clients. And if such conflicts cannot be avoided, a fiduciary must provide full and fair disclosure of the conflicts and obtain informed consent to the conflict.

A fiduciary owes its customers and clients more than mere honesty and good faith alone. A fiduciary must put its clients’ and customers’ interests before its own, absent disclosure of, and consent to, conflicts of interest.

While I believe that a consistent fiduciary standard of conduct should be applied to all financial professionals providing personalized investment advice, I also understand that the fiduciary standard is not a panacea to deter all fraud against individual investors.

Unfortunately, malevolent behavior still occurs, even by those who owe a fiduciary obligation to their clients. Since I became Chairman, the SEC has brought 26 actions against Ponzi or Ponzi-like schemes, which on average is more than one action per week. Roughly one-third of those actions involved investment advisers that were subject to the fiduciary standard of care. Thus, we cannot build an effective regulatory regime around the fiduciary standard of conduct alone.

That is why more needs to be done to effectively harmonize our regulatory structure for broker-dealers and investment advisers and meaningfully protect investors. If both broker-dealers and investment advisers are providing virtually identical services to retail investors, then the regulatory regimes that govern those activities should be virtually identical as well.

Investors are not well-served by a confusing array of varying disclosure, liability, recordkeeping and conflict management requirements.

Indeed in a 2008 report on “Investor and Industry Perspectives on Investment Advisers and Broker-Dealers” conducted by the RAND Corporation, the authors concluded that many survey participants “did not understand key distinctions between investment advisers and broker-dealers — their duties, the titles they use, the firms for which they work, or the services they offer.”

The primary laws governing the activities of broker-dealers and investment advisers were written in 1934 and 1940, when retail investment in our securities markets was quite limited compared to the nearly 50 percent of U.S. households invested in the markets today. It is time that the regulatory regime for financial service providers reflects 21st century realities, rather than 1930s-era distinctions that are no longer relevant in today’s market place. I am very pleased that the Administration has raised this issue in its regulatory reform plan.

Dark Pools

Fourth and finally, the Commission also has to be vigilant in looking around the corner for emerging risks to investors and markets. To this end, I have directed Commission staff to investigate ways the Commission can best bring light to an area of the market known as dark pools. Dark pools can be defined in various ways, but generally refer to automated trading systems that do not display quotes in the public quote stream.

We have heard concerns from market participants that the lack of post-trade transparency by dark pools makes it difficult, if not impossible, for the public to assess dark pool trading and to identify pools that are most active in particular stocks. This lack of transparency has the potential to undermine public confidence in the equity markets, particularly if the volume of trading activity in dark pools increases substantially. For example, the lack of reliable information can prompt speculation and suspicion about the basis for market fluctuations.

Another area of concern posed by dark pools centers on the use of pre-trade messages to indicate the availability of liquidity. Although dark pools currently do not submit quotes to the public quote stream, many dark pools nevertheless transmit pre-trade messages with information about actionable orders as part of “indications-of-interest,” or “IOIs.”

As a practical matter these messages generally are similar to public quotes except that their pricing is implicitly set at the National Best Bid and Offer or better instead of being explicit.

Dark pools that use these messages typically transmit them to networks of selected market participants. As a result, there is the danger that significant private markets may develop that exclude public investors. These private markets could wind up representing a significant volume of trading based on valuable information on actionable orders to which the public does not have fair access.

A further concern about dark pools is that they potentially could impair the public price discovery function if they diverted a significant amount of valuable marketable order flow away from the “lit” markets — the exchanges and ECNs that display quotes in the public quote stream.

Indeed, it is ironic that dark pools rely primarily on the price discovery provided by the public markets to run their trading mechanisms, yet if dark pool volume were to continue to expand indefinitely, their success could threaten the very price discovery function on which their existence depends.

Given the emerging risks posed by dark pools, the Commission will be taking a serious look at what regulatory actions may be warranted in order to respond to the potential investor protection and market integrity concerns raised by dark pools.


In addition to focusing on target date funds, municipal securities, fiduciary duties and dark pools, there is even more to do. Next week, the SEC is considering proposals to strengthen money market fund oversight. In addition, I have asked the staff to revisit a 1999 proposal to address harmful pay-to-play practices related to public pension plans.

And, I have announced a comprehensive review of rule 12b-1, which permits mutual fund assets to be used to compensate broker-dealers and other intermediaries. Our focus on reforming for the benefit of individual investors will continue unabated for as long as I am Chairman of the SEC.

Even though we are meeting in New York tonight, I know that many of you will also be looking to Washington, and the Congress in particular, as the discussion of financial regulatory reform continues. As we consider regulatory reform, it is essential that the SEC remain true to our investor protection mandate. Investor protection is a core competency of the SEC and is the fundamental driver of our regulatory decisions and enforcement activity.

It is fair that we be judged by our actions, not by our words. And the SEC’s investor protection regulatory agenda, as well as our renewed commitment to a meaningful enforcement program, will — I hope — restore investor confidence.

We must re-make the agency into the kind of nimble, effective and rigorous regulator that American investors deserve in the 21st century. And, of course, one that continues to pursue investor-oriented activities for the financial press to cover.

Thank you.



Modified: 06/19/2009