Speech by SEC Commissioner:
Remarks at Nippon Keidanren (Japan Federation of Economic Organizations)
Commissioner Roel C. Campos
U.S. Securities and Exchange Commission
June 21, 2005
It is a great pleasure to be here today. A special thanks to my host the Keidanren for their kind invitation. I am truly honored to be here in Japan speaking before a group of distinguished market participants, securities regulators, and other government officials. The United States and Japan share a special relationship, and, in this time of economic and financial market challenges, I believe that dialogue and the exchange of ideas among our industries and our governments is especially vital. So again, thank you for this opportunity.
Before going any further, I must issue the standard SEC disclaimer that the views I express here are my own do not necessarily represent those of the Commission or its staff.
The last three years have been an incredibly tumultuous time for the world's financial markets and, consequently, an extraordinarily active time for the world's securities regulators. For the US SEC, this period may well be remembered as one of the most productive and consequential in its history since its founding in 1934.
As we have worked to address corporate malfeasance and the mutual fund crisis and to restore investor confidence, we have learned many things. One of the most important is that, while our regulations are national, their effects are global. Our world is interconnected like never before -- our countries share investors and market participants; we face similar problems and crises; and we share solutions.
By shared solutions, I do not mean to suggest that we have all discovered one "right" answer. Rather, securities regulators around the world recognize the importance of ongoing dialogue on regulatory, market oversight and enforcement issues. Although we may not take identical approaches to common regulatory concerns, I believe that regulators and policy makers in the United States and Japan share important investor protection and market integrity goals, and that there is much we can learn from each other. Moreover, through ongoing bilateral and multilateral dialogues, we can identify and discuss regulatory risks present in our respective securities markets and, where appropriate, work towards regulatory convergence.
I would like to begin today's remarks by taking a journey back a few years to the enactment of the Sarbanes-Oxley Act. Implementation of corporate governance and other reforms under this Act is a wonderful illustration of the value of constructive dialogue among the word's securities regulators. I will then move on to more recent domestic reforms, including a set of major reforms to the regulatory apparatus governing US equity markets. Finally, I will look to international issues taking center stage, including the convergence of International Financial Reporting Standards.
THE PAST: THE SARBANES-OXLEY ACT
Although passage of the Sarbanes-Oxley Act was prompted by accounting scandals and corporate governance failures in the United States, the underlying issues it was intended to address are universal. For example, one of its principal aims was to improve executive responsibility, or what is called the "tone at the top" through corporate governance reform.
Achieving effective, strong corporate governance is not a simple task. It is an intricate balancing act pitting the efficiencies of centralized professional management and diffuse public ownership against the potential for abuse, greed and conflicts of interest on the part of management. Different jurisdictions have attempted to address this balance in different ways -- through bifurcation of management and supervisory boards, by separating the roles of CEO and board chairman, and by attempting to align the interests of managers, directors and shareholders through share based compensation plans. While there is no one foolproof approach, it was imperative that investors globally be aware of the steps being taken by government and industry to respond to corporate failures and reduce the likelihood of it happening again. To this end, the Sarbanes-Oxley Act mandated certain corporate governance reforms recognizing that effective oversight of the financial reporting process is fundamental to preserving the integrity of US markets.
The Act is also a prime example of how national legislation intended to address a domestic issue can have direct effects on foreign companies. Indeed, one of the greatest challenges that the SEC faced in implementing the Act was to fulfill our Congressional mandate, while not running afoul of foreign laws and regulatory schemes. After all, the SEC has long recognized the contribution of foreign market participants, including Japanese companies, to the creativity, strength and vibrancy of our capital markets. Currently, 31 Japanese companies are listed on US markets, 19 of those on the New York Stock Exchange. This makes Japan the country with the third largest number of foreign issuers on the NYSE and the seventh largest overall.
I believe that, as evidenced by SEC rulemakings in the wake of the Act, we have worked hard to strike this balance and afford accommodations to foreign firms to avoid conflicts of law and where consistent with the letter and spirit of the Act. Dialogue with our foreign counterparts, including bilateral meetings and opportunities such as this today, was critical to the process. In particular, Japanese regulators and industry -- including the Ministry of Finance, the Financial Services Agency, and Japan's Business Federation and Corporate Auditor's Association -- provided valuable input.
I would like to take a moment to highlight two areas where input from the foreign community proved particularly valuable: audit committee and internal control requirements.
Section 301: Audit Committee
- The audit committee rules, in particular, generated a great deal of concern among the foreign community, including Japanese commenters, due to potential conflicts with foreign laws and requirements.
- To address these concerns, the SEC has accepted different mechanisms under other countries' laws designed to assure the "independence" of the board of directors. For example, under German law, labor representatives of the company serve on audit committees. In the United States, employees are not considered independent since they typically report to management. However, in Germany, labor unions are very strong and we recognized that these labor representatives were quite effectively independent of management and, thus, the German audit committee model was deemed to satisfy the Act. Japan's Statutory Board of Auditors was held to satisfy the Sarbanes-Oxley requirements for similar reasons.
- These accommodations avoided conflict with foreign laws while still preserving the intended result of the Act to ensure that those with oversight responsibility for a company's outsider auditors be independent of management.
Section 404: Internal Controls
- As I am sure you are aware, Section 404 of the Sarbanes-Oxley Act and the Commission's related implementing rules require issuers to include in its annual report filed with the Commission a statement of management's responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting, as well as an assessment of the effectiveness of those controls. Section 404 also directed that the independent accounting firm that audits the company's financial statements report on management's assessment and the effectiveness of the company's controls, in accordance with standards to be established by the Public Company Accounting Oversight Board.
- We recognize that Section 404 and the related rules have significant costs, although I believe that the benefits far outweigh these costs. Indeed, I believe that there is an added benefit of lower cost of capital when there is sufficient trust in the integrity of financial statements. A more rigorous internal control framework helps provide that.
- We also recognize that many foreign private issuers are facing regulatory and reporting challenges in addition to internal control reporting. Accordingly, the Commission recently extended the deadline for compliance with the internal control over financial reporting requirements for foreign issuers to their first fiscal year ending on or after July 15, 2006. This is a one-year extension from the previously established July 15, 2005 compliance date.
- This additional time will afford foreign private issuers an opportunity to benefit from additional guidance gleaned from the experience of US issuers as well work through their own domestic issues, including, in some cases, conversion to International Financial Reporting Standards.
The reforms in the United States were prompted by the sense that the scandals of the last few years threatened to undermine the faith investors have in the integrity of our markets. Investors must have faith, when they buy shares in a company or purchase its debt securities, that they are getting what they are promised. They must have faith that the company's financial statements accurately reflect the company's financial situation. If they do not have this faith, they will not part with their money so easily. They will insist on a premium for their investment. And this means the cost of capital will increase for companies, who will then have less capital to invest in research and development, hire new workers, and build new factories.
The faith of investors is not blind. The problem may be just a few "bad apples" among thousands of issuers, but if investors cannot tell the good from the bad, they will begin to assume the worst until proven otherwise.
I believe that the willingness to act to safeguard this confidence is the reason that the US capital markets have been so successful. Since the 1930s, when the US Congress passed the first federal securities laws and created the Securities and Exchange Commission, the US has required some of the most extensive financial disclosures, backed up by one of the strictest enforcement regimes, of any jurisdiction in the world. The result is that the average person in the United States who saves money doesn't feel that the only realistic investment opportunity is a government-insured savings account in a bank. Educated investors recognize that investing in the stock market entails risks that do not exist with a savings account. However, the US Government has worked hard to make sure that that person does not have reason to think that investing in the stock market is to the disadvantage of the little guy.
I believe it is these same laws, regulations and enforcement activities that make the US capital market attractive to domestic as well as foreign investors -- even today, when the dollar is declining against other currencies.
THE PRESENT: CURRENT REGULATORY ISSUES
Let me know turn to the present and reflect on the Commission's more recent activity.
You will note that the principal reforms contained in the Sarbanes-Oxley Act aimed at improving the performance of and restoring confidence in the accounting profession, providing new tools to enforce the securities laws, and improving public companies' disclosure and financial reporting practices. But this is not enough if the securities of public companies are traded in a marketplace where the interests of intermediaries are given precedence. For that reason, we have also worked to make sure that, in the exchanges and markets themselves, investor interests come before the interests of their agents and intermediaries. As with our efforts to enhance investor protection with respect to particular securities, our rulemakings and enforcement actions reaffirm this basic principle.
Our recent activity was also motivated by the need to face the regulatory challenges arising from the fact that globalization and technological advances have dramatically changed the regulatory landscape since the SEC's creation more than 70 years ago. We want to continue to foster a marketplace that facilitates business access, creativity and innovation, while always being mindful of important investor protection concerns. I believe this is an objective we share.
Securities Act Reform
- One of the issues that the Commission will soon consider is reform of the Securities Act of 1933, the beginning point for federal securities regulation in the United States.
- The securities markets today are more robust and more dynamic that the writers of the Securities Act could have imagined. This month, the Commission will vote on whether to adopt modifications to the registration, communications, and offering processes under the Securities Act of 1933. The proposals address communications related to registered securities offerings, delivery of information to investors, and registration and other procedures in the offering and capital formation process.
- These changes reflect the fact that the Commission's rules governing the offering process were first developed more than 72 years ago. At that time, the Internet was unimagined and most offerings were "plain vanilla" stocks and bonds. Today's offerings often are more complicated and investors receive information about offerings from a variety of sources, including newspapers, television, the Internet and more.
- The proposed rules are designed to bring the rules governing the offering process up to date to accommodate the current market and the needs of today's investors.
National Market System
- The SEC has also passed Regulation NMS, which represents the first half of proposed changes to the US national market structure. Among other things, Reg NMS imposes a "trade-through" rule on all markets and exchanges in the United States. This rule is designed to ensure that when an investor sends an order to a trading center, the order will be filled at the best price then immediately available anywhere in the national market system.
- Among its benefits, this rule should protect individual investors who may not be able to monitor the order-routing decisions of their intermediaries, whose decisions could be affected by factors such as payment for order flow. In addition, the rule promotes fair and non-discriminatory access to, and the fairness and accuracy of, quotations displayed by US trading centers.
Future of Self-regulation
- The second part of the SEC's review of the national market structure was a proposal for new rules and changes to existing rules regarding the governance, administration, transparency and ownership of self-regulatory organizations ("SROs"), and the periodic reporting of information by these SROs regarding their regulatory programs.
- First, the proposals would impose new governance standards on national securities exchanges and registered securities associations regarding independence of board members, including a new definition of independence. The proposals also would require exchanges and associations to establish policies and procedures to maintain a separation between their regulatory functions and their market operations and other commercial interests, and require that funds received from regulatory fines, fees, and penalties be used for regulatory purposes.
- Further, the proposals would require national securities exchanges and registered securities associations to prohibit any member that is a broker or dealer from owning and voting more than 20% of the ownership interest in the exchange or the association, or a facility of the exchange or association.
- In addition, the Commission proposes to require that these SROs file with the Commission and publicly disclose enhanced information relating to their governance, regulatory programs, finances, ownership structure, and other matters.
- The Commission also proposes to require national securities exchanges and registered securities associations to file with the Commission, in an electronic format, quarterly and annual reports on particular aspects of their regulatory programs.
- We hope that the result of these US reforms will be greater transparency for investors, the elimination of outdated requirements for issuers, and a more robust governance framework for SROs.
Let me now turn to international issues facing securities regulators around the world. I believe that resolution of these issues is critical to fostering a global environment where multinational business can thrive, absent unnecessarily burdensome or duplicative regulation, and where investors globally can have access to comparable high quality information on which to base their investment decisions. While I do not foresee a time where national securities laws cease to exist, I do hope for a time where such regulation reflects an international consensus and, where appropriate, a converged approach.
Globalization and Convergence of Financial Reporting Standards
- For many years there has been a dedicated group of practitioners, standard setters, business leaders and others who have worked to establish a single set of globally accepted accounting standards for the benefit of the capital markets. Specifically, since 2001, the London-based International Accounting Standards Board (IASB) has worked to improve the body of International Financial Reporting Standards (IFRS).
- As the IASB has progressed in developing a set of global accounting standards, many national accounting standard setters -- including the US Financial Accounting Standards Board (FASB) -- have adopted programs that designed to result in the convergence of the provisions of their national accounting standards with IFRS. The SEC staff has closely monitored the work of the IASB and has been supportive of the ongoing work between it and the FASB to meld the provisions of US accounting standards and IFRS.
- Most recently, SEC staff unveiled a "roadmap" of the steps needed to possibly eliminate the US requirement that financial statements prepared under IFRS be reconciled to US standards in the financial disclosures of foreign companies selling shares in the United States. This is an extremely important milestone as it represents a potential departure from the Commission's historical stance that financial statements not using US GAAP must be reconciled to US GAAP.
- In this roadmap, SEC staff states that eliminating the reconciliation requirement will first involve, among other things, a detailed analysis of the faithfulness and consistency of the application and interpretation of IFRS in financial statements across companies and jurisdictions, combined with continued progress in the convergence work now being conducted by the IASB and FASB.
- SEC staff is also working closely with foreign regulators through the International Organization of Securities Commissions or IOSCO in an attempt to ensure that an effective infrastructure for consistent interpretation and enforcement of IFRS is in place. This will be critical for investors to realize the full benefits of convergence.
- We also look forward to working on a bilateral basis with regulators in Japan and around the world to find solutions to problems and issues that affect the financial reporting and auditing of foreign private issuers who seek to list here in the US markets.
Credit Rating Agencies
The development of a code of conduct for credit rating agencies is another notable international effort, in which the SEC has been actively involved.
- After the failure of credit rating agencies to detect the problems at several large companies such as Enron, Worldcom, and Parmalat, the role of credit rating agencies came under great scrutiny. IOSCO undertook to analyze the activities of credit rating agencies.
- Building on this work, in December 2004, IOSCO published "Fundamentals of a Code of Conduct for Credit Rating Agencies." The Code describes measures recommended for inclusion in the codes of conducts of individual credit rating agencies. The Code is meant to address, among other things, the quality and integrity of rating processes and potential conflicts of interest facing rating agencies.
- The five US designated credit rating agencies have expressed a willingness to abide by this code.
Cross Border Enforcement
I would be remiss if I did not take my final moments today to address cross border enforcement.
- Quite simply, efforts to converge regulatory approaches to any degree will be meaningless unless transparent, consistent and robust mechanisms for enforcement exist.
- Clearly, the globalization of fraud is a critical issue for every securities regulator. However, it is also important for public companies around the world because illegal activity occurring anywhere in the world can target domestic investors and impact investor confidence across jurisdictions. This in turn affects capital formation globally. Indeed, investors must have confidence that should wrongdoing in the financial markets occur, it will be quickly detected, investigated and prosecuted by the relevant authority or authorities and that every effort will be made to return ill-gotten gains to defrauded investors. Without this confidence, investors quite simply will leave the capital markets in favor of perceived "safer" alternatives.
- An increasingly important component of domestic enforcement regimes is the ability of securities regulators to provide, as well as receive, international assistance. Indeed, the internationalization of the world's securities markets and the increased frequency of cross-border trading activity have made reliance on domestic powers alone insufficient. Strong international cooperation is vital to the quick, thorough and accurate resolution of international enforcement investigations.
- Today, over 100 jurisdictions, who are members of IOSCO, recognize that their securities regulators should have comprehensive inspection, investigative, surveillance and enforcement powers. Every IOSCO member also recognizes that all securities regulators should have the authority to obtain and share public and non-public information with their foreign counterparts.
- Each year, more and more of the world's securities regulators are moving to implement the legal tools necessary so that they can enter into multilateral or bilateral frameworks that serve to facilitate information sharing among the world's securities regulators, such as, most notably, IOSCO's Multilateral Memorandum of Understanding. We believe these efforts are critical to our shared goal of ensuring that fraudsters cannot use borders as a way to escape detection and prosecution of domestic securities laws.
- We look forward to continuing to work closely with Japan's FSA (Financial Services Agency) and SESC (Securities and Exchange Surveillance Commission) in providing the assistance necessary to combat cross-border securities fraud.
Let me conclude today by reiterating our recognition of the valuable contributions that foreign issuers, particularly those from Japan, have made to our markets. Creativity and innovation in the US capital markets has certainly been enhanced due to the diversity of market participants. For this reason and others, we will continue to be mindful of the impact that our domestic regulations have on all issuers, foreign as well as domestic.
Today's capital markets are truly seamless. This brings with it many advantages. Cross-border diversification and technological advances have provided companies with new sources of capital and individuals with new investment opportunities. However, equally clear, are the potential dangers. Indeed, the global marketplace is one where fraudsters are virtually unconstrained by borders. Moreover, as I hope I have illustrated today, we share common regulatory concerns as well as goals, namely to protect investors, to strengthen market integrity, and to facilitate capital formation and growth. In this environment, it is especially critical that regulators and policy makers in the United States and Japan, along with valuable input from our industries, work as partners in addressing important securities regulatory, oversight and enforcement issues.
To this end, we greatly value the willingness of Japan's FSA to participate with us in dialogues on important regulatory issues, in both bilateral and multilateral contexts. By sitting across the table from one another, we can truly see the multitude of issues and concerns we share and address those issues through a spirit of cooperation.
As we move down the path of globalization and convergence, we look forward to working with you to meet our shared goals of thriving capital markets, investor protection, and investor confidence. Thank you for your time.