Speech by SEC Commissioner:
Remarks before the Deutsches Aktieninstitut New Year's Reception
Paul S. Atkins
U.S. Securities and Exchange Commission
January 27, 2005
Thank you very much, Professor von Rosen, Herr Kley, Your Royal Highness, Honored Guests, ladies and gentlemen.
It is a privilege to be here today among friends and allies to discuss ways in which we can work together on a wide range of issues that affect us all, regardless of which side of the Atlantic we are on. We no longer live in the days when issues relating to securities regulation can be neatly confined within the borders of one nation. We therefore owe it to one another to discuss these issues frankly and to craft solutions that recognize that we can have an integrated, global marketplace for capital and goods without imposing a single set of uniform rules on all the participants in that marketplace. Let me start by saying that the views that I express here are my own and do not necessarily represent those of the Securities and Exchange Commission or my fellow commissioners.
As that disclaimer suggests, I am one member of the five-member Securities and Exchange Commission, all of whom are appointed by the President and confirmed by the Senate. The SEC is an "independent agency," which means that it performs a mix of executive, legislative and judicial functions. The SEC has civil (not criminal) enforcement powers against people who violate the securities laws and our rules; it has power to write rules pursuant to statute; and it acts like an appellate court in reviewing appeals from sanctions that the stock exchanges and the professional organization of brokers levy against their members. Of course, I realize that because of the unusual amount of rulemaking and high-profile enforcement actions we have conducted during the past several years, you might already be more familiar with the SEC than you would like to be. Today, I would like to address the need in the new post-Sarbanes-Oxley world for the SEC to cooperate with its counterparts in other countries and to regulate with an appreciation for the differences among issuers, whether those differences be based on corporate culture or national culture.
II. The Need for Cooperation
The actions of U.S. corporations have global ramifications. Revelations of corporate wrongdoings serious enough to shake the foundations of seemingly unshakable American corporations have raised the level of anxiety of market participants all over the world. But, just as the problems reverberate globally, so too the solutions or attempted solutions, whether regulatory or self-imposed, have global outworkings.
The economic prospects of countries on both sides of the Atlantic will be stronger if we work together to ensure that these regulations are enhancing, not inhibiting, worldwide economic integration. I am committed to ensuring that the voices of all affected parties, not only U.S. interests, are part of the debate that shapes American regulations. Regulatory changes that serve only to scare foreign issuers into turning their backs on the U.S. markets do not benefit anyone.
III. The Push for Regulation
As an initial matter, I fear that you might be stunned at the sheer volume of new regulations that has been emanating from across the ocean. I cannot deny the frenetic pace or the significance of the SEC's regulatory initiatives since the passage of the Sarbanes-Oxley Act in July 2002. The SEC has been active in numerous other areas as well, particularly in the mutual fund area, which has been plagued by scandals of its own. Simply put, some businesses lost their ethical compass, and the shadow of those few has fallen across the rest.
Regulatory soul-searching is typical in periods of financial turmoil and usually leads politicians and regulators to conclude that, by ratcheting up the level of regulation, future problems can be averted. In fact, the SEC was born out of just such a rush to regulation following the 1929 market crash, which came after an economic boom period, complete with a stock market bubble. In the 1930s, the government attempted to pull the country out of the depression by continued intervention, which included everything from price controls to an anti-free market domestic regulatory policy. These policies, most economists today would agree, were failures.
Now, with the implementation of Sarbanes-Oxley, the U.S. government has completed the largest regulatory initiative since that time. History teaches us time and again that rarely do regulators seriously question, much less analyze, whether the prior regulatory framework was partly to blame for any or all of the problems. The regulatory response to the corporate scandals of the last several years has not been any different in this regard. We regulators do not ask whether we have done anything wrong, but instead what more we need to do. Market forces are painted as villains against whom only regulators stand a chance.
Corporations, however, must themselves do some soul-searching. Private firms lay the groundwork for regulatory solutions when they fail to uphold their own end of simple business ethics through voluntarily-implemented, effective compliance programs. A corporation that focuses on ensuring the long-term success of its business is more likely to implement strict internal controls than one that is primarily concerned with achieving short-term targets. The culture of a firm is determined by the tone set by its executives, the firm's organizational structure, compensation incentives, and the degree of oversight activity by gatekeepers such as directors, auditors, and attorneys. A CEO's tolerance or lack of tolerance of ethical misdeeds and a CEO's philosophy of business conveys a great deal throughout the organization. An informed, inquisitive, and well-rounded board of directors serves an important role in monitoring the corporation and management on behalf of stockholders for whose benefit the corporation ultimately exists.
IV. The Need for Reconsideration
Now that we have made it through the Sarbanes-Oxley implementation and our other rulemaking activity seems to be slowing down, I am looking forward to a period during which we can take a hard look at those changes. We must determine whether the measures that we have implemented serve their intended purpose of protecting investors and at what cost. We must be particularly vigilant because the SEC, in implementing Sarbanes-Oxley and in other recent regulatory actions, has in some ways stepped outside its traditional sphere of regulatory activity, and, as a result, has come into conflict with other established regulatory frameworks both in the U.S. and abroad. We must identify where these conflicts exist and need to work with our foreign counterparts and market participants to do so.
Maintaining the Balance
Underlying all my other concerns is a basic philosophical one, namely we must not allow the American economy to be unduly encumbered by a web of regulations. Recently, the Wall Street Journal and the Heritage Foundation, an American think tank, released their annual "Index of Economic Freedom." For the first time in the decade-long history of the index, the U.S. is no longer among the top ten "most free" countries. Although it is wonderful to see other countries becoming more free, I do not like to see the U.S. losing its reputation for being a great place to do business. We cannot allow "Standort Amerika" to lose its appeal. President Bush said it very well earlier this month when he reminded us that "it's very important not to get [the system] out of balance when it comes to [ ] government reach."
As a result of the increasingly high-profile nature of securities regulation and the fact that securities regulatory issues are not neatly confined to one particular jurisdiction, regulators in multiple jurisdictions increasingly regulate or prosecute in response to the same set of facts. In the U.S., for example, a firm that negotiates a settlement with the SEC might also face actions by one or more state attorneys general who elect not to work with us. As a multinational corporation, Royal Dutch Shell was recently sanctioned both by Britain's FSA and the SEC. Royal Ahold faces a similar prospect. Companies doing business in the United States are justified in fearing actions by multiple regulators. In the E.U., similar concerns about overlapping regulatory schemes are arising and doubtless will continue to crop up.
The SEC is committed to working with its international counterparts to apportion the regulatory responsibility in a reasonable manner. The sweeping reach of Sarbanes-Oxley, however, legitimately has caused non-U.S. issuers to worry that the SEC is unnecessarily treading on regulatory territory already within the sights of local regulators. Only through cooperation and deference to other regulators can we ensure that this does not happen. It is important to remember, however, that different regulatory frameworks do and should continue to exist side-by-side so that we can see which is the most effective at facilitating a free and fair marketplace.
Regulation of Corporate Governance
We must continue to ensure that issuers, whether domestic or foreign, are not constrained to adhere to a single, predetermined corporate governance model. The SEC's recent decision, taken on a 3-2 vote, to require that all mutual funds have independent chairmen and boards made up of at least 75% independent directors, sends a signal that a one-size-fits-all mandate is appropriate in the corporate governance context. Let me be clear that I believe that a non-executive Chairman of the Board, a model common in British corporations at least, can be appropriate under certain circumstances. Those circumstances, however, must be determined by that corporation's shareholders and their representatives, who are much closer to the facts of a particular company than are bureaucrats in Washington, D.C. or Brussels.
Historically, in the U.S., the States have had responsibility for corporate governance matters, and the stock exchanges have included certain corporate governance standards among their listing requirements. Although Sarbanes-Oxley has federalized corporate governance issues to some extent, we must continue to acknowledge that a variety of approaches to corporate governance is acceptable. We must be particularly sensitive to the concerns of foreign issuers, many of whom because of local custom and regulation employ significantly different corporate governance models than are typical in the U.S. Of course, all of us, whether European, Asian or American, have much experimentation to do. Investor-driven decisions are the proper instigation for that experimentation, not government fiat.
My concerns in this area are somewhat attenuated by the fact that the Sarbanes-Oxley Act, to a large extent, requires corporations to disclose aspects of their governance models and then lets the market decide what value to give to different models. In this way, the American approach is consistent with that of the European Commission, which similarly has concluded that Member States need room for experimentation.
Regulation of Corporate Gatekeepers
Now that Sarbanes-Oxley has strengthened the hand of federal regulators in overseeing corporate gatekeepers such as directors, attorneys, accountants, and audit personnel, I worry about the form that oversight will take. The SEC understandably is interested in ensuring that these gatekeepers play an active role in shaping business decisions. My concern is that, frustrated by a few instances of incompetence or venality, we might devise our own overly-technical prescriptions for gatekeeper conduct. These technical prescriptions could dissuade talented professionals from serving in a gatekeeper capacity for public corporations.
The Act requires foreign public accounting firms that audit SEC-registered issuers, including non-U.S. issuers, to register with and be subject to the oversight of the Public Company Accounting Oversight Board. I hope that we can minimize instances in which this oversight leads to conflicts between local laws governing auditors and the requirements imposed by Accounting Board. Germany recently decided to form its own version of the Accounting Board. Other such bodies in other countries will ease the work of the Accounting Board and the difficulties that it would face in reviewing foreign auditors. More generally, the SEC must use its oversight powers to ensure that the Accounting Board, which is a non-governmental, nonprofit corporation, is ultimately accountable to the taxpayers.
Scaring Foreign Issuers Away
Neither the Sarbanes-Oxley Act nor implementing rules should dissuade a foreign company from considering a U.S. listing, yet there are some signs that this might be happening. As of the end of 2003, over 1,200 non-U.S. corporations from 57 countries filed reports with the SEC. This number is three times the number of non-U.S. corporations that filed reports in 1990, but is down nearly 100 from a year before. The number of issuers from Germany fell from 28 to 24 in the same time period.
I do not know whether these declining numbers are attributable to Sarbanes-Oxley, but anecdotal evidence suggests that our new regulations might be just what it takes to make issuers look for capital sources outside of the United States. Recently, a number of corporations in deciding not to list in the U.S. have suggested that Sarbanes-Oxley regulations were a deciding factor. The press is also full of stories that Sarbanes-Oxley encourages some non-U.S. listed companies to contemplate shedding their American listings. As you know all too well, however, delisting can be a complicated and costly process for foreign issuers.
These rumblings about the costs of compliance outweighing the benefits of being listed in the U.S. cause me great concern. Foreign listings not only benefit U.S. investors in the form of greater investment choices and diversification, but also provide foreign issuers with access to the U.S. capital markets and greater potential for making acquisitions in the U.S. If there are additional accommodations the SEC can make for non-U.S. issuers without undermining the objectives of Sarbanes-Oxley, we should do so.
Currently, complaints about cost are largely focused on Section 404 of Sarbanes-Oxley, which requires management to complete an annual internal control report and requires the company's auditor to attest to, and report on, management's assessment. These rules are separate requirements from the CEO and CFO certifications, which themselves imposed significant costs on issuers. The Section 404 rules establish accountability of management for the integrity of financial information and allow the market to distinguish between companies based on the quality of their internal controls.
Because these rules can require significant internal changes, the SEC has been flexible with respect to its implementation. We provided non-U.S. issuers with an extended compliance date and last November extended the compliance date for certain U.S. issuers. Management must base its evaluation of the effectiveness of the company's internal controls on a suitable, recognized control framework that is established by a body or group that has followed due-process procedures. We did not mandate the use of any particular framework, nor did we preclude corporations from looking outside the U.S. for a suitable framework.
Despite our flexibility, Section 404 compliance has caused firms a number of problems, some of which are unrelated to the quality of internal controls at those firms. We have already had to defer one compliance deadline in part because accounting firms are so backlogged. I hear that auditors' small clients are given less priority than completing 404 audits for larger clients. Because the requirement is so new, the auditors tend to be extremely cautious, which could result in the improper tainting of a significant number of companies without internal control problems. These events serve to heighten my concern that one of the primary effects of Section 404 is to generate a lot of lucrative new business for auditing and law firms without a correspondingly large benefit in the form of meaningful information for investors. I remain hopeful, however, that the burdens associated with Section 404 will diminish as corporations and auditors become more comfortable with our expectations.
One other cost that the non-U.S. corporate community has raised with me is the tremendous cost of litigation. Many within the U.S. are likewise calling for litigation reform. Less than a month ago, the President, noting the ramifications for the U.S. economy of frivolous litigation, renewed his call for Congress to enact litigation reform. As we impose more and more disclosure obligations, we need to be mindful that these disclosures might someday form the basis for litigation. It is incumbent upon us to give clear guidance about what companies must disclose so that they are not subjected to retroactively-imposed disclosure obligations through enforcement actions and private litigation.
Finally, I am concerned about the complacency of corporations. To what extent have corporations that are already committed to compliance willing to submit to additional governmental incursions as a form of penance for the well-publicized misdeeds of other corporations? Such complacency on the part of corporations might serve simply to confirm the view of many that regulatory solutions are an appropriate way of solving financial crises. Lawmakers cannot be faulted for missing important issues if they were not brought to their attention as they were drafting the statute.
Now that Sarbanes-Oxley is in place, some corporate executives still speak as if the costly measures that they must comply with are akin to medicine that is hard to swallow, but life-saving. I too am encouraged by the stories that I have heard from numerous corporate officials who tell me that Sarbanes-Oxley has had salutary effects at their firms, such as heightening regard for compliance issues through the entire ranks of the company and strengthening the internal controls. That said, it is not helpful for those affected by the rules to take the bitter pill we offer if there is an alternative that is both equally or more effective, and more palatable.
Moreover, to the extent that you think changes in your corporation or industry are necessary, do not wait for a regulator to tell you to make them. I would encourage you to work with your colleagues to design efficient, effective solutions and preventive measures of your own. As a supporter of the free market, it distresses me when business people do not react to perceived problems using a principle-based approach to guide the conduct of their organization and the industry. Too often, however, it seems that some corporations might prefer to manipulate regulatory solutions so that they enshrine a solution that works well for them, but not for their competitors.
V. Encouraging Signs
Although perhaps imperfect, Congress intended the Sarbanes-Oxley reforms to address the ways in which the system has failed to protect the individual investor and to eliminate the systemic weaknesses that created misrepresentations and skewed the transparency in the market. Broadly speaking, Sarbanes-Oxley reflects goals shared by Europeans and Americans with respect to strengthening corporate governance. Sarbanes-Oxley's promotion of independent audit committees, for example, confirmed a global trend toward setting up such audit committees.
There have also been some successes at a more technical level. The SEC sought and received comments from a wide variety of commenters, including the corporate community, as part of the process of adopting the rules. The SEC has hosted interactive roundtables on the application of the Act to non-U.S. issuers. We have met with foreign delegations and European securities regulators and non-U.S. issuers. Input from these meetings and from non-U.S. commenters led us to make a number of accommodations. For example, we have made changes to allow certain individuals who might not qualify as independent under our definition, to serve as members of a company's audit or supervisory board. This accommodation recognizes, among other things, the German Mitbestimmung requirement pursuant to which non-management employees serve as members of a company's audit or supervisory board. We also allowed shareholders to select or ratify the selection of auditors and allowed the development of alternative structures such as boards of auditors to perform auditor oversight functions where such structures are provided for under local law.
VI. Call to Action
The SEC is legally bound to give people fair notice of what rules the SEC plans to adopt and an opportunity to send to us comments on and objections to those rules. We are required by law to take those comments into account and explain why we accept or reject those objections. This is an obligation that we take seriously. I hope that you will also take it seriously.
During this consultation process, the SEC looks to non-U.S. issuers for information and insights that are not otherwise readily available to us. I am a frequent critic of government mandates imposed without prior empirical inquiry, but, to be fair, information that would assist regulators in understanding the potential effects of their actions is often not presented to them. By representing your own interests effectively, you also protect U.S. investors who want to have the option of investing in non-U.S. issuers. You must remind us from time to time of a lesson that we are all too eager to forget, namely that we as regulators have limitations. Once the regulations are finalized, you must continue to share with us your practical experiences and frustrations in complying with those regulations.
Moreover, there are always new issues on which to comment. At the end of last year, for example, we proposed rules that would modernize the registration, communications, and offering processes under the Securities Act of 1933 by eliminating unnecessary and outmoded restrictions on offerings. These changes would facilitate access to capital. The proposals also would continue our long-term efforts toward integrating disclosure and processes under the Securities Act and the Securities Exchange Act of 1934. The comment period for these proposals ends just a few days from now, but we are always eager to hear the perspective of non-U.S. issuers.
Some of you might be following the current debate in the U.S. about whether and how to restructure the national market system, the so-called "Regulation NMS" proposal. The call for market structure reform, which began before I joined the SEC over two years ago, has taken an unpleasant turn towards technical tinkering with the pricing mechanism employed by our markets. I supported the initial concept of providing for regulatory certainty, removing barriers to competition, and leveling the playing field between market participants and market centers, but I cannot support government intrusion into the marketplace, and specifically, into the pricing of securities. I fully support market transparency, but the proposed trade-through rule outlined in regulation NMS is not a disclosure rule or a transparent form of regulation. Vibrant capital markets in the U.S. benefit investors and issuers throughout the world, so your voices are important on this issue as well as the ones that more directly affect your day-to-day regulatory obligations.
With your assistance, we can work to address some of your persistent concerns about recent regulatory reforms. We can also work to shape future regulatory initiatives so that they fulfill their intended function of protecting investors without imposing unnecessary burdens on you and your counterparts all over the world. You and your national and EU regulators can help us to avoid imposing conflicting regulatory burdens on you. I am confident that international cooperation in these regulatory matters will benefit all of us in the long run.