Speech by SEC Commissioner:
Remarks before the American Bar Association Legislative and Regulatory Subcommittee of the Committee on Banking Law
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
November 11, 2005
Thank you, Martha, for that introduction and for the opportunity to be a part of your Fall Meeting. Let me begin by noting 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.
We owe gratitude for the freedom that we enjoy today to those of you who served in the armed forces. I would like to extend my thanks, on this Veterans Day, for your service to this country. The sacrifices of veterans like you have made it possible for us to enjoy our freedom that is the basis for our prosperity. Veterans have also made it possible for other nations to have the freedom that serves as the foundation for their prosperity. Formerly communist countries are shaking off the remnants of their past and embracing capitalism. Countries in the Middle East that could never have dreamt of democracy are witnessing Afghanistan's and Iraq's transition from dictatorship to democracy.
The simple but eloquent words that the late Corporal Jeffrey Starr of Snohomish, Washington, wrote to be delivered to his girlfriend in case of his death in Iraq deserve to be quoted today:
I don't regret going, everybody dies but few get to do it for something as important as freedom. It may seem confusing why we are in Iraq, it's not to me. I'm here helping these people, so that they can live the way we live. Not [to] have to worry about tyrants or vicious dictators. To do what they want with their lives. To me that is why I died. Others have died for my freedom, now this is my mark.1
The sacrifices of people like Corporal Starr and other veterans, who for more than 300 years have literally laid down their lives for all of the freedoms that we cherish today, have made it possible for the U.S. - and derivatively, most of the rest of the world - to enjoy a burgeoning economy and trade. In the U.S., personal income, home-ownership and productivity are all up; unemployment is down. Our GDP is now more than $12 trillion, and aggregate household net worth is now almost $50 trillion. Our country's economy is truly the envy of the rest of the world.
The SEC, depending on the approach that it takes in carrying out its mission, can help or hinder economic prosperity in the U.S. and -- with the ever-increasing internationalization of the capital markets -- abroad. As you all know, the face of the Commission has changed over the past year. We have a new chairman and Annette Nazareth has left the staff to join the Commission. I am enjoying working with both of my new colleagues and am optimistic about the direction that the Chairman has set for the Commission. Under Chairman Cox's able leadership, I am confident that the SEC will facilitate continuing economic prosperity by strengthening markets and protecting investors.
As we look ahead, we need to be receptive to ideas about how we can improve our approach to regulating the financial markets. We need to have the courage to question even well-entrenched Commission practices. We should welcome constructive criticism from observers outside the Commission, who are often better able to identify areas in need of improvement than those of us on the inside.
Earlier this week, for example, the U.S. Chamber of Commerce announced the formation of a Commission on the Regulation of U.S. Capital Markets in the 21st Century, which is expected to issue modernization recommendations in 2007. And, last month, the Financial Services Roundtable issued a comprehensive set of recommendations for the Commission.2 Underlying those recommendations was one theme that is particularly worthy of the Commission's attention: every Commission action should be preceded by an opportunity for public comment and an honest assessment of costs, including effects on efficiency, competition and capital formation.
During the past couple of years, the Commission has not always fulfilled these essential prerequisites to Commission action. First, we have often been too casual in allowing staff-level decisions to be treated as if they have a Commission imprimatur. As all of you have witnessed first-hand, the Commission has a hard-working and committed staff, but their excellence and hard work are no substitute for accountability and transparency. Second, we have frequently succumbed to using economic analysis as an ex post facto rationale for a decision already taken, instead of as a decision-making tool. In doing so, we have deprived ourselves of the full benefit of resources at our disposal, and we have risked undertaking initiatives that do more harm than good.
The poster child for these flaws in the Commission's process was our mutual fund governance rulemaking. Now, many of your clients already had appointed an independent chairman, which was the most controversial aspect of the rulemaking. Nevertheless, this rulemaking provides a useful illustration of what went wrong with our processes, and how we can improve it under our new leadership.
I have not been reticent about my objections to the substance of the rule as an unprecedented, unnecessary, and, for many shareholders, unwelcome intrusion into matters of corporate governance. But, the process by which the rule was adopted and then readopted and is now being defended by our legal counsel is perhaps even more objectionable than the substance of the rule. Worse, it could have long-lasting adverse ramifications for the integrity that is attributed to the Commission's rulemaking process. This is certainly not, as our legal counsel contends in its most recent brief to the DC Circuit, "an example of good government in the finest traditions of the Commission."3
Last year, over Commissioner Glassman's and my dissent, the Commission voted to require fund boards to be 75% independent and to have independent chairmen. The Commission achieved this through a back-door approach: by imposing new conditions on ten widely relied-upon exemptive rules to effectively mandate a uniform corporate governance structure for all funds. A legal challenge by the U.S. Chamber of Commerce followed.
On June 21, 2005, the U.S. Court of Appeals for the DC Circuit ruled in favor of the Chamber. The Court held that the Commission's rulemaking ran afoul of the Administrative Procedure Act, which requires courts to overturn agency actions that are "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law."4 First, the Court faulted the Commission for its failure to assess the economic implications of its proposed action. The Commission hid behind protestations that it had "no reliable basis" for determining how funds would choose to satisfy the new requirements or for determining the costs that would likely be necessitated by these requirements. Second, the Court held that the Commission impermissibly failed to consider a perfectly plausible disclosure-based alternative to the independent chairman requirement.
The Court's remand, a rare event in the Commission's history, should have given the Commission pause. Instead, the Commission responded to the Court in wholly uncharacteristic, and highly inappropriate, haste. Within hours of learning that a decision had been announced, then-Chairman Donaldson's office announced that the staff had formulated a way to speed through the rule's readoption, and set the item for a public meeting a scant week later. The staff completed a draft release within days. On June 29, a mere eight days after the Court announced its decision (and before it formally issued its mandate to the Commission), the Commission, again in a split vote, readopted the two disputed requirements without change.5
The Court gave the Commission the opportunity to address the deficiencies it identified. Instead, the Commission compounded them, perhaps in reliance upon one commissioner's casual assurances that, "[i]f we are wrong about being fully responsive, the Court will certainly tell us so."6 An unwillingness to treat the appellate court's criticisms with deference, and thus to do nothing more than what was perceived to be the bare minimum necessary to survive further appellate review, permeates the Readopting Release and our counsel's subsequent defense of the readoption.
The decision to go forward in eight days in order to avoid harm to investors embodied a predetermined conclusion about the relative costs and benefits of the rulemaking. The Commission's response to the Court's remand was not the product of deliberation, but rather was the product of a blind and grudgingly-performed ratification of the Commission's prior action. In the words of a former Commissioner engaged in this debate, the Commission treated the Court's instructions on remand as nothing more than a request to "dot I's and cross T's."7
The Court, however, asked for more than a superficial gloss on the existing rulemaking. The Commission was ordered to take a hard look at its prior rulemaking and to fulfill its "statutory obligation to do what it can to apprise itself - and hence the public and the Congress - of the economic consequences of a proposed regulation before it decides whether to adopt the measure."8
Appreciating the difficulty of estimating costs in this area, the Court directed us to do "the best [we] can" to determine the economic implications of the rule.9 Even taking into account the staff's dedication and hard work, it would have taken more than eight days for the Commission to do its best. This is particularly true in light of the admissions in the adopting release and in a post-release staff report to Congress that key costs were "speculative" and that the Commission had "no reliable basis" on which to estimate them.
Implicitly acknowledging that the rulemaking record contained critical gaps regarding costs, the Readopting Release reached beyond the existing record to information that was publicly available at the time of adoption. But to do our best, we could, and should, have embraced the opportunity to assess the costs experienced by funds that had already begun to comply with the fund governance rules. The Investment Company Institute volunteered to assist the Commission with obtaining this information. We should have asked for additional comment to ensure that we got data from a wide range of funds. We had no excuse not to have done so, especially if we followed the Court's directive that we do our best.
The Readopting Release also fell short in its consideration of the disclosure alternative. The Court reminded the Commission that "the Commission - not its counsel and not this court - is charged by Congress with bringing its expertise and its best judgment to bear upon [the] issue" of whether the disclosure alternative would serve investor interests.10 Yet neither the majority nor the staff solicited my views on the disclosure alternative before (or after) circulating a draft that concluded that the disclosure alternative was without merit.
Concern about the lack of deference to the directives of the Court of Appeals was not limited to sitting commissioners. One former chairman, who had originally supported the substance of the Commission's proposed rules,11 and several former commissioners urged us publicly and privately not to break with its time-honored tradition of lawful obedience to judicial mandates.12 Those requests fell on deaf ears.
It is somewhat ironic that the Readopting Release commended the staff for its "usual even-handedness in the treatment of all Commissioners."13 Yet, the General Counsel was less than even-handed in his response to Commissioner Glassman in the public meeting on readoption when she asked about an eleventh hour footnote insertion into the release that instructed the Office of the General Counsel "to take such action as it considers appropriate to respond to any proceedings relating to this rulemaking."14 He responded, "I think it speaks for itself." When she disagreed and asked him what the language meant, he said, "I really can't elaborate."15
Developments in the months since the readoption reveal why elaboration would have been uncomfortable. As it turns out, the unprecedented delegation of authority about which Commissioner Glassman asked has formed the basis for the General Counsel's extraordinary decision to purport to express the Commission's positions without regard for - or solicitation of -- the views of the current Commission. The staff has contented itself to rely on "dead-hand" authority. It has prepared and filed briefs in the name of the Commission without the Commission's advance review, let alone any Commission input.
The General Counsel nevertheless proclaims that seeking the input of the Commission, his one and only client, would run counter to staff precedent, which purportedly does not provide for circulation of briefs to the Commission when the Commission is a named party, even in cases of great consequence to the Commission and the public. Leaving aside that this is inconsistent with my own past experience and that of others, a room full of lawyers should be taken aback by hearing that an attorney would substitute his personal judgment for that of his client. These briefs, filed in the name of the Commission, do not even contain a disclaimer like the one I started out this speech with today - that the views the brief sets forth do not necessarily represent those of the Commission. In fact, because, as far as I know, none of the commissioners has been consulted about the contents of the briefs, it would be a stretch to say that, in this case, these briefs speak for the Commission. After all, this is not a routine defense of a Commission action.
In defending the Commission's legal authority for its hasty readoption, our legal counsel has claimed that the readoption was the product of free and frank deliberation. If the board of any other entity "deliberated" in this rushed, top-down fashion, we would deem it derelict in its responsibilities.
It is not true, as our legal counsel in its brief now suggests, that the whole Commission came to the conclusion that it was imperative for the same five of us that had voted on the original rule to act, and act fast purportedly to protect investors after the remand. Commissioner Glassman and I made clear to former Chairman Donaldson that we did not believe that the matter should be considered so quickly. Also contrary to our legal counsel's representation to the Court, it was not the Commission, but the staff in the Division of Investment Management and General Counsel's Office, that concluded that the court's concerns could be addressed on the basis of the record already before the Commission without further notice and comment.
Our legal counsel in its brief cites "the lengthy concurring and dissenting views … appended to the release" as evidence of "[t]he deliberative nature of the process here, in which all of the Commissioners were fully engaged."16 Dissenting statements were "due" at noon on the day before the meeting and before we had received the draft release that was to be voted on at the meeting. My written dissent, therefore, was completed after the meeting, as was the final Readopting Release.
In defense of the rule, our legal counsel offers a list of former Chairman Donaldson's professional achievements before he arrived at the Commission. As impressive as this list may be, it hardly seems pertinent to a defense of the Commission's actions. Our brief likewise labored hard to explain that the former chairman, like Sisyphus seeing that his rock had rolled down the hill, undertook to push it back up again. The key issue is not the purity of the majority's motives, but the legality of their actions. Because we are a government of laws, not of men, the Court's assessment of whether the readoption comported with the APA is unlikely to turn on the mens rea of the Commissioners who voted for it.
The brief filed by our legal counsel supplements its legal arguments with ex post facto rationales for the readoption. For example, one of the briefs cites an additional supportive survey that was conducted by the Mutual Fund Directors Forum in August. Our legal counsel also argues that the Readopting Release simply made explicit what was implicit in the initial adoption.17 But the proposing release did not mention the disclosure option and the Adopting Release ignored the few commenters who sua sponte raised the possibility of allowing investors to choose among funds based on clear disclosure about the independence of their chairman. In light of the majority's failure to consider the disclosure alternative prior to adoption, it is hard to understand how the pre-adoption rulemaking record can now be relied upon to form the basis for a full and fair discussion of this alternative.
In sum, the fund governance rulemaking demonstrates the Commission's backward approach to rulemaking during the past couple of years. First, we determined what the rule would be. Then we conducted an "analysis" to "demonstrate" that its costs are low and its alternatives inferior. Not even the Court of Appeals seems to be able to convince us to conduct our business differently. It is troubling that such a rulemaking is now being defended, not by the agency, but by its lawyers, all without regard for the views of the current Commission. If the Commission had adopted a meritorious rule under lawful procedures, then the composition of the Commission that adopted it would have been irrelevant. The rule would have been able to weather the inevitable personnel changes at the Commission and stand on its own without the support of the three commissioners that originally voted for it, two of whom have since left the Commission.
The soon-to-be-effective hedge fund registration requirement, to which I also objected, further illustrates the undisciplined approach that we have taken to rulemaking. We have been sued over that rulemaking also. Briefs have been filed, and arguments are scheduled for next month. Again, as with the mutual fund governance rulemaking, to the best of my knowledge, none of the commissioners has been consulted about the contents of the briefs, despite our clear interest in the matter. Given the diverging views on the Commission, I would have at least expected that our legal counsel would solicit his client's views before filing briefs in the case.
In addition, we now are discovering practical problems with the implementation of the rule. We are discovering now that we have neither the resources nor the expertise to oversee all of the potential new registrants, a fact that an honest assessment of the rule could have turned up prior to adoption. In fact, the dissent that Commissioner Glassman and I wrote in the matter, raised exactly these issues. A recent GAO report also questioned the Commission's ability to take on this new task. We are also discovering that the benefits of registration might fall short of our expectations since Form ADV will not yield the type of information that would be needed for meaningful oversight. The consequences of this venture are serious; precious time and attention of our examination staff will be diverted from overseeing the mutual funds and advisers for average investors to overseeing advisers that manage the money of a relatively tiny number of sophisticated investors (or those who have the wherewithal to vet their advisors) -- my estimate is fewer than 200,000, maybe even 100,000. That number should be compared to the more than 90 million shareholders in mutual funds.
The Commission's recent regulatory carelessness is unfortunate, but can be remedied. I also am confident that our new leadership recognizes the problem and will ensure that our future actions are not conducted in such a slipshod manner. I hope that economic analysis will play its appropriate role in helping to shape regulatory policy, rather than being used as a quaint diversion, annoying hindrance, or potential roadblock to be avoided until the last minute.
All of us need to take some time to step back and look at the regulatory actions of the past incredibly busy several years. While you, as practitioners, are dealing with implementation issues, we at the Commission can be looking critically at our new stable of regulations with an eye towards repairing those that are not working as we had hoped. You can help us in this task by periodically looking up from the nitty-gritty implementation issues and advising us on ways that our objectives could be met more effectively.
Now, turning to an issue that is likely on the minds of banking lawyers, I would like to discuss briefly Regulation B. Since the passage of Gramm-Leach-Bliley, we have been trying to figure out how to implement the new functional exceptions from broker-dealer registration. Two months ago, we gave ourselves another year-long extension by extending the exemption for banks from the definition of "broker." Congress expressly said that this statute was not supposed to create undue burdens on business. As I stated when we proposed Regulation B, I want to find the best, simplest, fairest approach that will be consistent with the Gramm-Leach-Bliley statute and with the other statutory obligations that this agency operates under - namely, investor protection, promotion of a competitive marketplace, and equal application of the securities laws. The comment letters that we received, particularly the strongly worded one submitted by the Federal Reserve Board, the FDIC and the Comptroller of the Currency, gave us important issues to think about as we determine how to move forward. Your committee's comment letter correctly noted that "getting Regulation B 'right' is much more important than adopting it quickly or adhering to an artificial deadline."18 As we are assessing our options, additional comments are welcome.
I will close with a word of caution. This is a room full of lawyers, so all the talk recently of the lapses of corporate executives may cheer some up in a bout of Schadenfreude. It is always nice to have company in the doghouse of public opinion. And, keeping them out of the big house is steady work for the lawyers. But attorneys of course need to remember also to work with executives to polish the images of both professions. Highly-prescriptive regulations crafted by bureaucrats who are removed from day-to-day business realities are, needless to say, a less attractive option than ground rules set by those who are playing the game or coaching the players.
The attorney, as coach, helps to establish practices that are within the bounds of the law and grounded in morality and ethics. When you notice a problem, work with your clients to rectify it, as I am sure everyone in this room does. And, if the problem is widespread, work with your colleagues, in forums such as this one, to devise efficient, effective solutions and preventive measures of your own. You will serve your clients better in the long-run if you counsel them in a principled way rather than seeking regulatory solutions that entrench their particular business model and shut competitors out.
Thank you for your attention. I would be happy to answer any questions and would be interested in hearing your perspectives on what the Commission has been doing and the steps that it can take to more effectively carry out our responsibilities.