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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks at the PLI Conference on International Securities Markets 2003


Annette L. Nazareth

Director, Division of Market Regulation
U.S. Securities and Exchange Commission

New York City
May 9, 2003

Good morning. It is a pleasure to participate once again in this conference, and to share some thoughts on current developments in market regulation. Before I begin, however, I must remind you that my remarks represent my own views, and not necessarily those of the Commission or my colleagues on the staff. 1

As we've all come to realize in recent years, the globalization of the securities markets presents a series of challenges and opportunities, for the industry and regulators alike. For those of us in the regulatory community, there are more frequent opportunities to interact with our foreign counterparts, and learn from their experiences with a variety of approaches to securities regulation. At the same time, the acceleration of cross-border activity presents challenges for regulators, as we strive to reconcile our individual statutory mandates with the desire to rationalize the cross-border regulatory framework, so we can all more fully reap the benefits of global financial markets. I am confident that, over time, we will see a convergence of principles worldwide, so that much of the regulatory tension we've experienced in recent years gradually will dissipate. In the meantime, as the Commission addresses the wide range of important regulatory issues that have arisen in the U.S. financial markets, it frequently must grapple with the complex cross-border aspects of its actions.

I. Sarbanes-Oxley Implementation

One high-profile area where these issues recently have arisen is in connection with the implementation of the Sarbanes-Oxley Act. Shortly after I addressed this group last year, Congress passed the Sarbanes-Oxley Act in response to serious corporate abuses and accounting fraud. Among other things, that law has given securities regulators in the U.S. an opportunity to influence corporate governance in a way that could not have been envisioned just a few short years ago. Corporate governance traditionally had been a matter relegated to state law, with minimal involvement at the federal level. Sarbanes-Oxley, in effect, "federalized" some important aspects of corporate law, at least for listed companies. And, in some cases, the application of Sarbanes-Oxley extended well beyond our borders. While this has created challenges for the Commission and our foreign counterparts, it also has led to numerous opportunities to work on the convergence of regulatory principles, with the ultimate goal of creating a global marketplace of the highest quality. Over the past year, we've been pursuing these convergence efforts bilaterally, as well as through various groups, such as IOSCO, the Joint Forum, and the Financial Stability Forum.

The manner in which the Commission has been implementing the Sarbanes-Oxley Act, and dealing with some of its international implications, is consistent with the approach the Commission historically has taken to these matters. That is, in considering how to manage the effects of globalization on U.S. markets, the Commission carefully balances investor protection and market integrity concerns, with the goal of promoting less costly and more efficient access by U.S. investors to foreign markets. In so doing, the Commission seeks the views of its regulatory counterparts around the world, as well as the private sector, and strives to avoid unnecessary burdens on non-U.S. entities. Ultimately, however, the Commission cannot compromise the fundamental principles of investor protection and market integrity, or the promotion of high regulatory standards.

A good example of this approach in the Sarbanes-Oxley context was the Commission's recent adoption of rules directing the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with the audit committee requirements established by the Sarbanes-Oxley Act. I expect Alan Beller discussed these rules in some detail yesterday. However, it is worth emphasizing that, although the new rules will apply to both domestic and foreign listed issuers, based on significant input from and dialogue with foreign regulators and foreign issuers and their advisers, several provisions, applicable only to foreign private issuers, have been included that seek to address the special circumstances of particular foreign jurisdictions, such as: allowing non-management employees to serve as audit committee members; allowing shareholders to select or ratify the selection of auditors; allowing alterative structures such as boards of auditors to perform auditor oversight functions; and addressing the issue of foreign government shareholder representation on audit committees.

The Commission demonstrated similar flexibility when it adopted rules implementing the provisions of Sarbanes-Oxley that prescribe minimum standards of professional conduct for attorneys practicing before the Commission. Specifically, the rules exclude "non-appearing foreign attorneys" who, among other things, conduct activities before the Commission that are only incidental to a foreign law practice or in consultation with U.S. counsel.

Indeed, the Commission is interested in finding "common ground" between the U.S. and non-U.S. approaches to issues such as these. Since the passage of the Sarbanes-Oxley Act, the Commission has hosted two roundtables on the application of that legislation to non-U.S. issuers. Commission representatives also have met with numerous foreign delegations and European securities regulators. We believe this interactive process is working, and that the active participation of foreign commenters in our rulemaking process plays a key role in helping the Commission understand the particular needs of non-U.S. issuers. Merely because our approaches are different does not mean that they cannot work together effectively.

With these general principles in mind, I would like to focus on two areas where my Division — the Division of Market Regulation — has been devoting substantial resources as a result of the Sarbanes-Oxley Act: (1) analyst conflicts of interest; and (2) credit rating agencies.

A. Analyst Conflicts of Interest

In order to improve the objectivity, reliability and usefulness of information that analysts provide to investors, the Sarbanes-Oxley Act requires that the Commission or the self-regulatory organizations ("SROs") adopt rules to address conflicts of interest that can arise when analysts recommend securities in research reports and public appearances. These rules are to include safeguards such as blackout periods during which a broker-dealer who has participated in a security underwriting cannot publish a research report related to that security. Sarbanes-Oxley also calls for enhanced disclosure of conflicts of interest, including the extent to which an analyst has an investment in the issuer's securities or has received compensation from the issuer.

These Sarbanes-Oxley rulemaking requirements complemented work already underway by the Commission and SROs to address potential analyst conflicts of interest. In May 2002, for example, the Commission approved rule changes by the NASD and NYSE designed to lessen analysts' conflicts and improve disclosure. Among other things, these rules prohibit analysts from offering or threatening to withhold a favorable research rating or specific price target to induce investment banking business. They also prohibit analysts from being supervised by the investment banking department, and bar securities firms from tying an analyst's compensation to specific investment banking transactions. In addition, these rules bar analysts from trading securities of companies they follow during certain "blackout periods" surrounding the issuance of a research report, and require securities firms to disclose in a research report if it received any investment banking compensation from the subject company in the past 12 months. Furthermore, they require analysts, and, in some cases, securities firms, to disclose whether they own shares of recommended companies, and require securities firms to disclose in research reports the percentage of all the ratings they have assigned to the "buy," "hold," and "sell" categories, as well as historical performance information. And finally, the rules require analysts to disclose during public appearances if they or their firms have a position in the stock and whether the subject company is an investment banking client of the firm.

The Commission is working with the NASD and NYSE on further SRO rule changes designed to meet the remaining requirements imposed by Sarbanes-Oxley with respect to analyst conflicts. This rulemaking must be completed by late July of this year, and we expect the final set of rules to be published for public comment shortly.

I also should say a few words about the global settlement relating to research analyst conflicts of interest that the Commission and other regulators announced late last month. As you undoubtedly have heard, last week, the Commission, the New York Attorney General, the NASD, the NYSE, and state securities regulators announced that enforcement actions against ten of the nation's top investment firms had been completed, thereby finalizing the global settlement in principle reached and announced by the regulators last December. Under the terms of the agreement, each of the ten firms will physically separate their research and investment banking departments to prevent the flow of information between the two groups. Also, the firms' senior management will determine the research department's budget without input from investment banking and without regard to specific revenues derived from investment banking; and research analysts' compensation will no longer be based, directly or indirectly, on investment banking revenues or input from investment banking personnel, and investment bankers will have no role in evaluating analysts' job performance. Research analysts will be prohibited from participating in pitches and roadshows; and firms will be obligated to furnish independent research to its customers for a five-year period. I am also sure you have read that ten firms will pay a total of $875 million in penalties and disgorgement.

Again, the issue of analyst conflicts of interest is not unique to the United States. The international community has taken great interest in developing different approaches to address conflicts of interest in a manner particularly suited to domestic circumstances. We can learn from one another, and the Commission has been active in an IOSCO Task Force — chaired by Commissioner Campos — that was formed to review the different regulatory responses to the analyst conflicts issue. Among other things, that Task Force is now examining the possibility of developing high-level principles that may guide regulators across the globe.

B. Credit Rating Agencies

The Sarbanes-Oxley Act also required the Commission to study the role and function of credit rating agencies in the operation of the securities markets. Among other things, Congress was concerned with the performance of the rating agencies in connection with recent high-profile corporate failures — for example, rating Enron as a good credit risk until just four days before that company declared bankruptcy.

The study called for by the Sarbanes-Oxley Act coincided with a review of credit rating agencies already underway at the Commission. In recent years, the Commission has pursued several approaches, both formal and informal, to conduct a thorough and meaningful study of the use of credit ratings in the federal securities laws, the process of determining which credit ratings should be used for regulatory purposes, and the level of oversight to apply to recognized rating agencies. Commission efforts included informal discussions with credit rating agencies and market participants, formal examinations of each of the rating agencies recognized for regulatory purposes — known as "nationally-recognized statistical rating organizations" or "NRSROs" — and public hearings that offered a broad cross-section of market participants the opportunity to communicate their views on credit rating agencies and their role in the capital markets. At those public hearings, we particularly appreciated having a representative of the U.K. Financial Services Authority share her views — from an international perspective — on the many complex issues associated with credit rating agencies.

The Commission submitted a Report on its study of credit rating agencies to Congress this past January. The Report identified a number of important substantive issues relating to credit rating agencies that the Commission would be exploring in more depth, including the following: (1) improved information flow in the credit rating process; (2) potential conflicts of interest; (3) alleged anticompetitive or unfair practices by NRSROs; (4) potential regulatory barriers to entry into the credit rating business; and (5) ongoing regulatory oversight of credit rating agencies. I expect the Commission to issue a Concept Release seeking public comment on these matters shortly. Among other things, the Concept Release would ask a wide range of questions regarding possible approaches the Commission could develop to address various concerns regarding credit rating agencies.

We recognize that there has been substantial interest in the international community regarding credit rating agencies. We hope to elicit widespread comment from the international community on the Commission's forthcoming Concept Release. In addition, the Commission is active in an IOSCO Task Force — again chaired by Commissioner Campos — created to develop broad principles relating to credit rating agencies. Finally, I should note that the Financial Stability Forum intends to sponsor a forum for its members on credit rating agencies this summer, at which Commission staff intends to participate.

II. Other International Issues

Moving beyond Sarbanes-Oxley, I would like to use the remainder of my time to update you on two other issues of international interest: (1) the European Commission's Directive on Financial Conglomerates; and (2) foreign market access.

A. Financial Conglomerates Directive

The European Commission's Directive on the Supervision of Financial Conglomerates was finalized in December 2002. It will become effective at the beginning of a financial conglomerate's (or financial holding company's) 2005 fiscal year, and poses potential concerns for U.S. registered broker-dealers that have affiliates within the European Union.

The Directive is intended to establish minimum group-wide supervision for "financial conglomerates" and "mixed financial holding companies" doing business in the European Union (EU). However, even if an EU-based credit institution is not deemed to be part of a financial conglomerate — for example, where the holding company does not have a significant insurance business — if the parent entity is a credit institution or a financial holding company, the head office of which is outside of the EU, then the Directive may apply. In such a case, EU "competent authorities" must verify (1) that the foreign parent is subject to "consolidated supervision by a third-country competent authority," and (2) that such supervision is "equivalent to that governed by the principles set forth in [the Directive]." If an equivalence finding is not made, this could lead to the imposition of quantitative and qualitative requirements at the holding company level, which would be applied by an EU member state's home regulator designated as the "coordinator." For example, credit institutions in the EU that have non-EU holding companies could be subject to higher capital and risk control requirements, or be required to create an EU sub-holding company.

We have had several meetings and an ongoing dialogue with our EU counterparts regarding the manner in which U.S. regulation of securities firms satisfies the EU directive by providing "equivalent" consolidated supervision through our Risk Assessment Program. We have also advised the Europeans that the establishment of Investment Bank Holding Companies subject to Commission oversight, which is authorized under the Gramm-Leach-Bliley Act, would formalize this existing program. We will continue our dialogue with the Europeans on this issue, and are confident that, through a mutual process of "listening and learning," our European colleagues will be persuaded that U.S. firms satisfy the Directive, by virtue of the Commission's regulatory regime.

B. Foreign Market Access

Finally, I would like to say a few words about the foreign market access issue. That issue, as you probably know, involves whether the Commission should permit foreign exchanges to access the U.S. market directly — in other words, place their screens in the U.S. and have U.S. members — without complying with U.S. registration requirements. Currently, foreign exchanges seeking to operate in the U.S. are subject to the same standards as U.S. exchanges: both the exchanges themselves and the securities traded on them must be registered with the Commission, absent compliance with an available exemption. Full compliance with U.S. exchange registration requirements, however, raises difficult business issues for foreign exchanges and the issuers of securities traded on them.

In addressing this difficult issue, the Commission must carefully balance its desire to promote cheaper and more efficient access by U.S. investors to foreign markets, against concerns fundamental to Commission's mandate that are addressed by the registration of exchanges and securities — namely protecting investors and preserving market integrity. Another significant consideration is ensuring that U.S. and foreign markets compete in the United States on a level playing field. The Commission must consider how to ensure a fair and competitive environment for all exchanges.

Commission staff has made significant progress developing a proposal to address the foreign market access issue. In so doing, we have sought to carefully balance the underlying fundamental policy considerations in a consistent, apolitical manner. We hope to be in a position to formally present our proposal to the Commission for their consideration in the near future. While it would be premature to divulge details of this staff-level effort, I believe it's fair to say that the focus of our proposed regulatory relief is on foreign exchanges that limit their U.S. activities to offering foreign securities to sophisticated U.S. investors.

We have been meeting regularly with representatives of the EU to discuss the foreign market access issue and other matters of mutual interest, including all of those I have mentioned this morning. We believe this dialogue is essential to permit the most effective and informed policymaking both in the U.S. and Europe, and look forward to continued progress on these issues.


In closing, I think it is important to acknowledge the tremendous strides that have been made to facilitate the concerns of firms and regulators regarding cross-border issues. Sarbanes-Oxley is the latest of a number of important events that have moved the world's regulators closer. Indeed, negative historical events, in our case severe corporate abuse and accounting fraud, provided new impetus for both important regulatory reforms, and the building of stronger bridges of cooperation and mutual learning. Our active participation in the work of IOSCO in the areas of credit rating agencies and analyst conflicts of interest is evidence of the fact that events here in the U.S. have moved regulators around the globe to work more closely together. We must be respectful of each other's laws and practices, but we must also move forward together in advancing the cause of investor protection, market integrity, high standards and global access.

Thank you.


1 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or the author's colleagues on the staff of the Commission.



Modified: 05/27/2003