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U.S. Securities and Exchange Commission

Speech by SEC Chairman:
Opening Statement at Open Commission Meeting


Chairman William H. Donaldson

U.S. Securities and Exchange Commission

Washington, D.C.
December 17, 2003

Good morning.

As our first item of business today, we have before us a recommendation to approve a proposal of the New York Stock Exchange that would significantly revise the way the Exchange is governed. The importance of the role of the NYSE in our equity markets goes without saying: it is the largest equity market in the world; it regulates the nation's largest securities firms; and it is the arbiter of corporate governance standards for many of the nation's largest corporations. The NYSE's substantial role, as a marketplace and as a regulator, makes it imperative that the Exchange's own governance structure be a model of good governance practices.

As we are all aware, a series of recent, widely-publicized events were the catalyst for reassessing the NYSE's governance. Without detailing the events that have brought us to this point, I will say that the NYSE's governance structure allowed too great a consolidation of executive authority in the Chairman and CEO, with unfortunate results.

That said, I believe the Exchange, under the leadership of its Interim Chairman John Reed, has made a strong — and speedy — effort to address the governance problems it has faced. In my view, the proposed changes to the NYSE Constitution represent a significant step forward in meaningful reform of the NYSE's governance structure and the transparency of its governance processes. These reforms are designed to strengthen the independence of the NYSE Board and key committees, and better insulate the NYSE's regulatory function from its market operations.

The proposal includes the creation of a new, smaller Board of Directors that is independent of members, member organizations, and listed companies, and includes only one officer of the Exchange — the CEO — who would not participate in executive sessions. Key committees — on Nominations, Compensation, Audit, and Regulatory Oversight — would all be composed of independent directors and have responsibilities articulated in the Exchange's Revised Constitution.

The proposal also would create an autonomous regulatory office, headed by a Chief Regulatory Officer, who reports directly to a committee of the Board that is composed totally of independent directors. This Board committee would be responsible for ensuring the effectiveness, vigor, and professionalism of the NYSE's regulatory program. The committee would determine the budget, regulatory plan, and staffing of the regulatory office, assess the NYSE's regulatory performance, and recommend compensation and regulatory actions to the Board.

In addition, the proposal calls for a Board of Executives, composed of representatives drawn from various defined constituencies of the Exchange, including retail broker-dealers, specialists, floor brokers, lessor members, institutional investors, and listed companies.

There are questions about whether the NYSE proposal goes far enough in separating the self-regulatory function from the marketplace. Historically, self-regulation has had both benefits and weaknesses. The principle of self-regulation is based on the notion that regulation can best be done as close as possible to the regulated activity. When we see problems with self-regulation, they are often the result of the inherent tension between a SRO's role as a regulator and as the operator of a market, and between its role as a regulator and as a membership organization. Two key factors in addressing these conflicts are the independence of the SRO board from the interests of specific members, or even specific users, of the SRO's market; and the independence of the regulatory function of the SRO from the self-interest of the members or the business interest of the market itself.

I believe that the independence of the regulatory function can be accomplished through a range of alternatives along a spectrum. The appropriate regulatory structure for one SRO may not be appropriate for others, given their different membership, sizes, and regulatory responsibilities. For all SROs, however, the challenge is to develop governance structures that help assure SRO regulatory programs that are effective, yet insulated from any undue influence from potentially conflicting business or member pressures. Moreover, it is crucial that SROs have governance structures in place that assure objective decision-making by the SROs' governing bodies. I believe that the NYSE proposal, which has the regulatory function reporting solely to Board members who are independent of the market, meaningfully insulates the regulatory function. In my view, the proposal also effectively addresses concerns about board objectivity and freedom from undue influence.

There can be little doubt the NYSE proposal is far-reaching both in its purpose and scope and, in my opinion, the reforms proposed should be given a chance to work. If the Commission approves the proposal, the NYSE faces a significant task ahead as it moves to incorporate those reforms into its governance structure and address the many issues which have arisen in the recent past. The Commission must be especially diligent in assuring that the proposed reforms achieve their intended results.

On the broader stage of U.S. market structure, early next year the Commission will review recommendations and present plans for public comment for revisions in overall structure, as well as conduct an assessment of those elements of the NYSE proposal that might properly be applied to the governance structure of other SROs. In the slightly longer term, the Commission will take the results of these reviews and assess whether we have achieved the right checks and balances in our SRO regulatory structure market-wide.

In addition, I note that the NYSE proposal includes the flexibility to permit the positions of Chairman and CEO to be held by the same person, or by two different people. Given the unfortunate experience of the recent past, however, I believe it is highly preferable — and I have expressed this opinion to the Exchange — that the positions of Chairman and CEO be held by two different people, at least in the near term. I am pleased to announce that interim Chairman Reed has informed me that he and his Board intend, if and when the Commission approves the proposal before us, to have the positions of Chairman and CEO separated. In this way, the NYSE should be in a better position to protect against the concentration of too much executive authority in one individual. Again, I commend the Exchange for submitting such a far-reaching proposal. I look forward to seeking ways to facilitate the public debate on issues of SRO governance with all parties concerned.


The remainder of today's meeting will be devoted to the critical initiatives already underway at the Commission aimed at protecting mutual fund investors and ensuring that they have better and more thorough information at their disposal through which to make sound investment decisions.

This is the second meeting in a series. At the first of these meetings, held on December 3, we approved a package of rules and rule proposals to combat late trading, market timing, and selective disclosure abuses, as well as requirements that all funds and advisers have comprehensive compliance policies and procedures and chief compliance officers.

Today, we will consider recommendations from the Division of Investment Management that stand to provide mutual fund investors with more information about mutual fund sales load breakpoints and fund transaction costs.

I fundamentally believe that greater disclosure and transparency of the fees that mutual fund investors are charged, is key to not only protecting investors, but to ensuring that they have the information necessary to make informed investment decisions that best suit their own financial interests. I do not, however, think the government should serve as a fee setter in enforcement actions or otherwise. I strongly believe that any monetary benefits of a settlement in a law enforcement case should go to benefit the victims. Investors should be fully informed about the fees they are being charged and how they relate to the investor's objectives and competitive alternative opportunities. Through the rule setting process — indeed in actions we are considering today -- we are moving to improve the transparency of fees for all mutual fund investors. Before I detail the action that the Commission will consider today, let me first review our timeline for action on the mutual fund front:

On January 14, we will consider a proposal for a new mutual fund confirmation statement that would spell out expressly the sales loads and other charges that investors incur when they purchase mutual funds, as well as the compensation of the selling brokers. We will also consider the issue of how rule 12b-1 applies to funds' use of brokerage commissions to facilitate distribution of fund shares, and a package of recommendations to enhance mutual fund governance, including proposals -

  • To require that fund boards of directors be led by an independent chairman;
  • To increase, from a majority to three-fourths, the proportion of fund directors that must be independent;
  • To provide independent directors with authority to retain staff;
  • To require fund boards of directors to perform an annual self-evaluation of their effectiveness, including consideration of the number of funds they oversee and the board's committee structure; and
  • To require fund boards to focus on and preserve documents and information that directors use to determine the reasonableness of fees relative to performance, quality of service and stated objectives.

Finally, in February, the Commission will consider a final rule to require funds to disclose semi-annually the dollar amount of fees and expenses that their shareholders pay. We also will consider additional proposals to combat market timing abuses, including a proposal that would require mutual funds to impose a mandatory redemption fee on market timers, any recommendations from the NASD's Omnibus Account Task Force, as well as a proposal to require portfolio managers to report their personal trading in the mutual funds they manage. As I have said before, every mutual fund investor should expect, and is entitled to, honest and industrious fiduciaries who sensibly put their money to work for them in our capital markets. Investors also deserve a brokerage and mutual fund industry built on fundamentally fair and ethical legal principles. I firmly believe that the protections embodied in this comprehensive package of reforms will begin to address these concerns, and will go a long way toward restoring investor confidence in these important investment vehicles.

Now — turning to the items on today's agenda — the first is a recommendation from the Division of Investment Management that would amend the prospectus requirements for mutual funds in order to provide enhanced disclosure about breakpoint discounts on front-end sales loads.

Late last year, routine examinations uncovered "red flags" which raised concern about whether mutual fund investors were receiving breakpoint discounts they were due. The Commission and the NASD, along with the New York Stock Exchange, initiated an examination sweep of 43 broker-dealers to evaluate this problem. The findings were troubling and laid the foundation for a number of ongoing enforcement proceedings. In addition, at the request of the SEC, the NASD, SIA, and ICI formed a joint task force to recommend ways in which the mutual fund and broker-dealer industries could prevent breakpoint problems in the future.

Today's proposal is designed to implement two of the task force's recommendations, by making the terms of a fund's breakpoint discounts clearer to both fund investors and fund intermediaries. The Commission is monitoring the implementation of the task force's remaining recommendations.

Concept Release on Disclosure of Transact Costs

The final item that we will be considering today is a recommendation from the Division of Investment Management that the Commission issue a concept release on disclosure of mutual fund transaction costs.

Transaction costs are the costs mutual funds bear when they implement their trading strategies. Some costs, such as commissions, are explicit and easy to quantify, others, such as market impact, are implicit and more difficult to quantify. These costs can be significant relative to a fund's overall expenses, and understanding them can be crucial to a person who is trying to make an investment decision. Two funds can have identical investment policies, advisory fees, and sales charges, but their shareholders can see widely different investment results, if the funds' transaction costs differ significantly.

Of course, stating a problem and solving it are two entirely different matters. I see this concept release as a good first step as we work toward formulating a reliable and useful yardstick for measuring transaction costs.

I am glad to see that we are also asking for comment on issues relevant to the review of transaction costs by fund boards. Fund brokerage commissions must be used in a manner that benefits fund investors, but fund managers can have conflicting interests with respect to their role in allocating fund brokerage. Effective disclosure to fund investors and vigilant oversight by fund boards are critical to ensuring that brokerage payments are not being put to use other than for the benefit of the fund.



Modified: 12/17/2003