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Speech by SEC Chairman:
Moving Forward: The Next Phase in Financial Regulatory Reform


Chairman Mary L. Schapiro

U.S. Securities and Exchange Commission

Center for Capital Markets Competitiveness, U.S. Chamber of Commerce
Washington, D.C.
July 27, 2010

Good morning. Thank you for having me here today.

The past couple of years have been very trying for our markets and our economy. And the path forward still poses significant challenges. But to be fully successful in meeting those challenges, it will require broad engagement—that means business, regulators, consumers and investors alike.

A key part of that challenge will be continuing to strengthen and improve our capital markets.

At the SEC, we routinely hear from investors with concerns and ideas for doing just that. We hear how investors—large and small—are worried about the structure of today's market, concerned that they are at a disadvantage to the relative handful of sophisticated traders and market intermediaries with unfair access and built-in advantages. We hear about increased volatility and instability. These are issues the SEC has been addressing.

But, we also hear how investors are harmed by opacity and excessive complexity in over-the-counter derivatives and structured products, subjected to hidden costs or to risks that were not clearly and fully explained.

We hear their concerns about the confusing nature of their relationship with financial advisers. And, we hear their desire that regulators learn the lessons of the recent past and take all necessary steps to avoid another crisis.

These concerns must be addressed to fully modernize our system and ensure that our markets continue to foster capital formation and serve as an efficient engine for turning savings into jobs and economic growth. And, I believe that the recently-enacted regulatory modernization legislation goes a long way to addressing them.

This law creates a new, more effective regulatory structure, fills a host of regulatory gaps, brings greater public transparency and market accountability to the financial system and gives investors important protections and greater input into corporate governance.

I believe the Act, especially when fully implemented, will bring us closer to a goal we all share: namely, more stable financial markets that better protect investors and facilitate the capital formation on which our workers, investors, companies and economic growth rely.

I know that there are some differences of opinion about the legislation, but I am here today to ask for your input in good faith as we implement a number of vitally important changes.

It has not even been a week since the President signed the Wall Street Reform and Consumer Protection Act, but—at the SEC—we are already working to fully implement it.

Over the next year the SEC is looking at a demanding schedule. The law calls on us to produce dozens of studies and rulemakings. But just as important, the law provides us with new data and new authority that will enable us to be an even more effective securities markets regulator—not just next year, but for many years to come.

As you know, during the past 18 months, in addition to addressing a number of longstanding gaps in regulation, we've worked to strengthen the SEC at every level and are hitting the ground running on financial regulatory reform.

But, clearly, our efforts alone cannot bring optimal results. We recognize that the process of establishing regulations works best when all stakeholders are engaged and contribute their combined talents and experiences.

In doing so, though, we must move forward. The regulatory process is not designed to re-debate issues that Congress has resolved.

Rather, investors, leaders of small and large businesses, academics and others who identify issues, and who offer ideas and alternatives, can help us create a regulatory structure that supports our shared goals over the long term.

As many of you know, the SEC generally seeks public comments on its proposed rules. But, because of the significant rulemaking envisioned under the Act, we are expanding our process beyond what is legally required.

The idea is to offer maximum opportunity for public comment and to provide greater transparency. We are inviting public comment even before the various rules are proposed and before the official comment periods have begun.

As part of this process, we have created a series of e-mail inboxes—that can be accessed at www.sec.gov—so that anyone interested can easily weigh in. These mailboxes are organized by topic and have been deployed in tranches, starting with those rules that have the shortest time frame for implementation.

If, for example, you are interested in capital and margin in OTC derivatives rules, you can just go to that mailbox to provide your preliminary comments.

Also, while we want and need input, we also recognize that there is significant interest in how we obtain it. I believe that an open process maximizes public confidence in the rules that are proposed and ultimately adopted—as well as in the studies that are released.

At the same time, we need to have a process that does not stifle communication of important information from the public. To address all of these issues, we have instructed the staff to follow a few best practices:

  • First, our staff will try to meet with any interested parties who seek to meet with us. When the number of requests exceeds availability, the staff will seek out parties with varying viewpoints. Our staff may have to limit the number of meetings with similarly situated parties and certainly it will limit multiple meetings with the same party. The goal in these instances will be to hear all varying viewpoints. If need be, we will reach out to solicit views from those whose interests are affected, but who do not appear to be fully represented by the developing record.

  • Second, the staff will ask persons who request meetings to provide, prior to the meeting, an agenda of intended topics for discussion. After the meeting, the agenda will be filed in the public e-mail file.

  • Third, meeting participants will be encouraged to submit written comments to this same public file, so that all interested parties have the opportunity to review and consider the views expressed.

  • Fourth, I expect we will hold public hearings on selected topics.

We are determined to do this right, and we are determined to get this right.

After all, there are many topics on our plate that our rules will need to address—five of which I'd like to discuss:

Regulatory Reform

OTC Derivatives: First, among the key provisions of the bill are those that will bring essential oversight to the over-the-counter derivatives market. Working with other regulators and the CFTC in particular, we will be writing rules that address, among other issues, capital and margin requirements; mandatory clearing; the operation of execution facilities and data repositories; business conduct standards for swap dealers; and public transparency for transactional information.

To prevent gaps, regulatory arbitrage and confusion, the CFTC and SEC will engage in joint rulemaking regarding issues including the definition of key terms—like "swap," "security-based swap," and "mixed swap". In addition, we will collaborate closely on the other required rulemakings under the Act. In fact, we already have started these efforts.

Under the legislation, primary jurisdiction over swaps is divided between our agencies. The SEC has primary jurisdiction over security-based swaps. And the CFTC has primary jurisdiction over other swaps, such as energy swaps, interest rate swaps and swaps based on broad indices, like the S&P 500.

Joint rulemaking regarding key definitions will help to ensure regulatory consistency and comparability.

Further, the new law establishes important mechanisms for ensuring that new derivative products are appropriately regulated, even if they don't fit into a traditional SEC or CFTC "box". It creates an expedited procedure for determining the status of a new product.

This is a major series of rulemakings that will be enormously important to reducing systemic risk and strengthening our markets.

Fiduciary Duty: A second portion of the Act mandates that we study the effectiveness of existing standards of care for broker-dealers and investment advisers. As an example of how rapidly we're moving to meet the mandates of the Act, we have today issued our formal request for public comment on standards of care, and are anticipating a significant response.

As it stands now, investors who turn to a financial professional often do not realize there's a difference between a broker and an adviser—and that the investor can be treated differently based on who they're getting their investment advice from.

In particular, an investment adviser is held to a "fiduciary standard" meaning they must put the interest of their clients before their own. Whereas a broker-dealer has to observe standards which include an obligation to make recommendations that are "suitable" for their clients.

In addition, quite different regulatory regimes surround the same activity for the two different registration categories. Until now, duty to the customer has flowed from the perspective and legal regimes of the adviser or broker, not from the perspective of the investor we are seeking to protect.

At the completion of this study, we will have the authority to write rules that would create a uniform standard of conduct for professionals who provide personalized investment advice to retail customers. And, the new law requires that this standard be "no less stringent" than the standard applicable to investment advisers.

I have advocated such a uniform fiduciary standard and I am pleased the legislation provides us with the rulemaking authority necessary to implement it.

Comments that recognize the primary and central importance of investor protection, but offer suggestions on implementing fair and flexible regulation, will help us craft rules that increase investor confidence while preserving brokers' ability to offer a full spectrum of services.

Hedge Funds: A third major provision of the Act requires advisers to hedge funds and other private funds to register with the SEC. These funds have flown under the regulatory radar for far too long. The lack of a comprehensive database for private funds has made it virtually impossible to monitor them for systemic risk and investor protection concerns.

The Act eliminates the so-called "15 client" rule which allows advisers to avoid registration while managing substantial amounts of assets on behalf of a large number of ultimate investors. It also authorizes the Commission to require registered advisers to maintain records of—and file reports regarding—the private funds they advise.

We have been working closely with the FSA on hedge fund reporting requirements and expect to leverage this work in our rulemaking.

Corporate Disclosure: A fourth category focuses on expanding corporate disclosures. And, as a result, we will be adopting many rules in this area—especially in the area of executive compensation.

Advisory say-on-pay votes will be required at all companies at least once every three years. Shareholders will have a similar say on golden parachutes that provide payments to executives in the wake of mergers, acquisitions and major asset transactions.

Companies will be required to calculate and disclose the median total compensation of all employees and the ratio of CEO compensation to that of employees. The relationship between senior executives' compensation and the company's financial performance will also be calculated and graphed for shareholders' information.

Companies will also have to disclose whether employees or directors are permitted to hedge against a decrease in value of options granted as part of their compensation.

We will also be writing rules on new standards of independence for compensation committees and for conflict of interest standards that boards must observe when retaining compensation consultants.

In addition, companies will be required to develop "clawback" policies for reclaiming incentive-based compensation from current and former executive officers after a material financial restatement.

And rules governing when brokers can vote proxies without instruction from beneficial holders will be revised further so brokers cannot vote on compensation matters—like the new say-on-pay requirement—or other significant matters that the Commission determines by rule.

These areas are quite complex, and we expect public comments from those "in the trenches" of corporate disclosure to be particularly valuable.

Other key provisions of the Act also confirm the Commission's authority to adopt rules that facilitate shareholders' ability to nominate director candidates. As you know, our proposal on this subject has been out for some time. I am committed to bringing a final rule to the Commission for consideration so that rules will generally be in effect in time for the 2011 proxy season.

I'm also committed to following up on public comments we receive following the issuance of our "concept release" on proxy plumbing about two weeks ago.

As you know, we asked many hard questions in that release about such hot button topics as the appropriate regulatory response to the significant role played by proxy advisory firms, the fees paid by companies to proxy service providers and the constraints under our current OBO/NOBO system on companies' ability to communicate with their stockholders. While we will be busy with regulatory reform rulemaking, we can, and will, make the time to address these critical issues.

Credit Rating Agencies: Finally, the Act will permit us to move further on the credit rating agency front. It was, after all, an over-reliance on credit rating agencies that contributed significantly to the explosive growth—and then violent contraction—of the securitization market. One government report indicates that 93 percent of the AAA-rated subprime mortgage backed securities issued in 2006 are now rated at junk-bond level or are in default.

At the Commission, we have acted diligently since obtaining authority in September, 2006 to implement an oversight program for credit rating agencies that operate as nationally recognized statistical rating organizations, or NRSROs.

But the Act significantly expands the original 2006 legislation, giving the SEC the authority to address internal controls and procedures. And it imposes rulemaking mandates in areas including disclosure, controls around the ratings process, conflicts of interest and analyst training.

For example, the new legislation enhances the transparency and consistency of credit ratings by requiring that the procedures and methodologies used be included with ratings, and that each rating be accompanied by a form disclosing a full range of qualitative and quantitative information.

In addition, we will adopt rules requiring NRSROs to submit an annual report to the Commission in which the firm's CEO or equivalent officer attests to the effectiveness of the firm's internal controls governing adherence to its policies, procedures and methodologies.

We also will continue to address conflicts of interest. This legislation requires the Commission to adopt rules preventing sales and marketing considerations from influencing credit ratings. And it enhances the Commission's authority to suspend or revoke the NRSRO status of a rating agency when conflicts of interest influence a credit rating.

Finally, the Commission will be charged with studying the feasibility of creating a public or private entity which would establish a system for assigning ratings of structured finance products in a manner that prevents the product's issuer, sponsor, or underwriter from selecting the NRSRO.

Given the performance of highly-rated structured finance product offerings in recent years, addressing this issue is of particular interest and importance. We look forward to hearing your thoughts as we determine how to reduce conflicts that might skew ratings and mislead investors.

This is not, by any means, all the areas in which the SEC will be engaged in rulemaking and studies over the next 18 months, but they are significant undertakings that will occupy much of our time and attention. As the study and rulemaking processes move forward, I believe that interests we all share will be served by constructive and pragmatic participation by all those affected.

* * *

The long-term success of our economy requires fair and efficient capital markets.

I believe, together, the agenda we've undertaken, and the one we are embarking on is the next step in further strengthening those markets for the future.

Thank you.


Modified: 07/27/2010