Speech by SEC Commissioner:
Remarks Before the SEC Speaks Conference:
The Light at the End of the Tunnel – What's Next?
Commissioner Cynthia A. Glassman
U.S. Securities and Exchange Commission
March 3, 2006
Thank you, Linda, for your introduction. It is a pleasure to be speaking to this group once again. And—with 15 minutes allotted— I have 50% more time than in previous years! To keep our new general counsel happy, let me begin by reciting the Commission's standard disclaimer that the views I express today are my own, and do not necessarily reflect the views of the Commission or its staff.
My theme for this year is "what's next?" - as we are finally, I hope, seeing the light at the end of the tunnel. As we emerge from a period in which our rulemaking agenda had to be reactive to external events, notably the corporate accounting scandals and the mutual fund market timing and late trading abuses, we now have the opportunity to step back, take a deep breath, and think about what proactive steps we can take to carry out our mission.
One major category that we can now focus on is new and/or improved disclosures. We need to make sure our disclosures are clear, timely, and getting the message across. I'd like to discuss a few of our initiatives in this area that are already underway at various stages.
- We have proposed changes to our rules on executive and director compensation disclosure, which would revise the current tabular disclosure and require a new, plain English, Compensation Discussion and Analysis. Significantly, the proposed rules would require disclosure of total compensation for each of the named executive officers and directors, and possibly three other highly compensated non-executives (who would not have to be named). As part of total compensation, options and pension benefits would be valued. The comment period is open, and I invite public input to help us evaluate whether our proposed rules require some modification or fine tuning, including whether all of the components of the total are valued appropriately.
- In January 2004, the Commission proposed the use of a point of sale disclosure form and an updated confirmation form to enhance the information that broker-dealers give their customers when selling mutual funds, college savings plans and variable annuities. In my view, before they make a purchase, investors deserve full and clear disclosure of all the fees and costs that come out of their pockets, either directly or indirectly, to pay for all the activities related to the operation and sale of these products, including whether a broker's recommendation benefits the broker.
I strongly encouraged our use of investor focus groups to obtain a better sense of the information that would be most helpful to investors, a step that has resulted in much improved forms. Now the challenge is to achieve a final rule that is cost effective in accomplishing its objective. I would like to see us go back out for comment soon in order to inform our judgment on how best to balance the costs and benefits.
- An even more far-reaching initiative is mutual fund prospectus reform. As I have said before, I believe we need to conduct a top-to-bottom, full scale review of the mutual fund disclosure regime. We require that investors receive a mutual fund's statutory prospectus but, given its format and the sheer volume of information, I question whether the prospectus is helpful for many individuals.
Starting with a blank sheet of paper, we should identify the most meaningful and helpful disclosures to investors and the best method for making these disclosure available. I am pleased that such an initiative is underway, and I hope we will obtain actual investor input through focus groups and other means in crafting an updated mutual fund disclosure regime.
- Another promising Commission initiative is our voluntary pilot program for submission of filings in Extensible Business Reporting Language, or XBRL. XBRL is an interactive data format that enables filers to "tag" items in their submissions so investors can more easily extract and analyze the underlying tagged data. Investors can use the tagged data like Lego building blocks – they can construct meaningful financial ratios and comparable company data just as Lego blocks can be used to build different structures. As a result, the information disclosed in required financial reporting would be more useful for analytical and comparative purposes. I enthusiastically encourage participation in the pilot program and commend Chairman Cox for this cutting-edge initiative.
In addition to re-thinking disclosures, we should review our existing rules – old and new – to see if they are accomplishing their objectives, doing so efficiently and effectively, and without serious unintended consequences. For old rules, this is particularly important in light of the major demographic shifts, product developments, and technological changes that have taken place since many rules were promulgated. For newer rules, I believe we should always monitor their implementation within a reasonable time period to learn whether they are working as expected or need to be refined or revised. We need to make sure that our rules provide real solutions to real problems. This means good ex ante and ex post analysis. For you non-economists in the audience, this means we should take a more formalized analytical and empirical approach both before proposing a rule and after implementing it. This was an initiative that I discussed with then-Chairman Harvey Pitt and that I had hoped to undertake on a broad scale when I joined the Commission, but was preempted by other priorities. Three Chairmen later (including my own stint as Acting Chairman), I am still hopeful that this initiative will be undertaken.
I'll point out just three of the older requirements that could use a fresh look, although I have no doubt there are many more.
- First are the rules pertaining to private offerings. Among other questions, I think we need to ask if the current thresholds, definitions, restrictions and rules make sense given the attributes of today's capital markets. For example, offerings and sales of securities to "accredited investors" in certain types of offerings are exempted from Securities Act registration. Natural persons with a net worth (either individually or jointly with a spouse) in excess of $1 million (including equity in their home), or persons with an individual income in excess of $200,000 or a joint income in excess of $300,000 for the past two years are included as accredited investors. The only unaccredited investors in this audience are probably people who work at the SEC. The Commission has not changed the definition since the 1980s. Should the accredited investor thresholds be higher? Indeed, this was an issue that Commissioner Atkins and I discussed in our dissent to the Commission's rule requiring hedge fund advisers to register with the Commission.
- Second, we may want to consider whether the number of record holders should be the main criterion that determines whether or not a company is public. The current registration and deregistration statutes and rules are premised on the number of record holders rather than total shareholders. For shares held in street name, the record holder is the broker, not the beneficial shareholder. Forty years ago, when the current rules were adopted, less than 25% of public company shares were held in street name. Now, 85% of public company shares are held in street name. Thus, a company with many total shareholders, but few holders of record may not have to report, whereas another company with fewer total shareholders, but more record holders may have to report. This anomaly suggests to me that we need to consider whether these requirements should be premised on different criteria. I know that the Advisory Committee on Smaller Public Companies is looking at these and other issues, and I await its final report.
- The third area involves investment advisers and broker-dealers. When we adopted the IA/BD rule last year, permitting fee-based brokerage accounts without requiring investment adviser registration, there was consensus on the Commission on the need for additional attention to some of the broader issues that had come up during the rulemaking. Specifically, we called for a study to focus on the extent of customer confusion and how best to deal with its impact. Therefore, I am very pleased with the Chairman's announcement this morning that we will be going forward with the study. We need to look at ways to address potential investor confusion and to consider whether it any longer makes sense to have two different regulatory regimes for investment professionals who offer similar services.
Some of the newer rules that I think we need to reassess, especially from the perspective of unintended consequences, include Sarbanes-Oxley 404, the mutual fund proxy vote, and hedge fund adviser registration.
- Regarding SOX Section 404, criticism persists regarding the high costs and burdens of complying with Section 404 and the PCAOB's Auditing Standard No. 2. Despite the issuance of additional guidance and extension of the compliance deadline, it does not appear to me that effective and efficient implementation of 404 is on track. As I have said numerous times, my concern is that the implementation has been misfocused, shifting what was meant to be a risk-based management focus to a check-the-box audit exercise. I am pleased, however, that we and the PCAOB are continuing to evaluate implementation and in fact will conduct another Roundtable in May, this time to discuss and evaluate year two of Section 404 compliance. I look forward to recommendations to get 404 implementation on track to achieve its purpose of making sure management has its arms around its internal controls to provide accurate financial reports.
- In 2003, we adopted two proxy voting rules. The first addressed an investment adviser's fiduciary obligations to clients when the adviser has authority to vote their proxies. The second obligated mutual funds to disclose how they voted proxies for portfolio securities. Regarding the latter, our release specifically stated, at my request, that the Commission expected the staff to monitor the effects of disclosure and report back on the operation of the rules and whether there have been unintended consequences as a result of disclosure. I have been working closely with our staff on framing this review. One issue I have been particularly concerned about is whether one unintended consequence has been that funds are delegating to a third party not only the mechanical voting of their proxies, but the substantive determination as well. I welcome your comments on this issue and on any other effects of public disclosure of funds' proxy voting.
- Some of the unintended consequences of our hedge fund adviser registration rule were apparent to me even before it was adopted, including some longer lockups, decreased liquidity, fewer investment choices for U.S. investors and more retailization. Further, as I said at the time, the rule may not be a particularly effective way to combat fraud at hedge funds and their advisors. Throughout this process, I have consistently noted that we need to better understand the hedge-fund world. The silver lining of having adopted this rule is that now we are working to identify what information would be useful to better understand hedge fund issues and see red flags – a step I had urged early on in the rule proposal process.
Finally, we cannot let up on our efforts to educate investors. Given that the fundamental principle underpinning all of our securities laws is disclosure, it is imperative that we do all that we can to make sure that investors have the information they need to make informed investment decisions. In previous years, I have discussed a number of investor education initiatives. This year, I would like to update the list.
- In the aftermath of our enforcement action against First Command for selling unsuitable products to military personnel, we have targeted additional resources towards investor education for the military. Our Office of Investor Education and Assistance has published articles on investing wisely and avoiding scams in Military Money magazine, has coordinated with librarians on military installations to distribute our educational pamphlets, and has participated in investing workshops on military bases across the country. Two weeks ago, we joined forces with the NASD Investor Education Foundation in the launch of a major financial education campaign that provides information and tools to help service members and their families make wise investment choices. In addition, we recently launched a special page for military personnel and their families in the Investor Information section of the SEC's website.
- Operating on the theory that financial fraud all too often follows natural disasters, we launched a Katrina-related "fake scam site" at GrowthVenture.com. Like our other fake scam sites, Growth Venture purports to be a "can't miss" investment, but if you click to invest, you'll get a stern warning from us, the FBI, U.S. Postal Service, and NASD.
- Our new "Just for Teachers" page on our website – which we unveiled at the beginning of the school year – has been a great success. Tens of thousands of teachers have requested our "Teacher Care Package," a collection of materials on 403(b) plans, asset allocation and diversification, and investing wisely.
- We have undertaken a host of other initiatives as well. In particular, at a time when concern about identity theft is on the rise, we have issued an investor alert on protecting online brokerage accounts and have partnered with the federal agencies that operate the new OnGuardOnline.gov website. We are also working on several new Investor Alerts that range from "auto-surfing" – which purports to pay money for nothing – to ultra-short term bond funds that, in many cases, have been marketed as being as "safe as a CD," but are not.
Lastly, I continue to try to interest producers to use our story lines in mainstream television. I have actually had some conversations with producers. As they say in the T.V. business – stay tuned. Thank you.