Statement at Open Meeting on Security-based Swap Rules Under Title VII and on Pay Ratio Disclosure Rule
Chair Mary Jo White
Aug. 5, 2015
Good morning. This is an open meeting of the U.S. Securities and Exchange Commission on August 5, 2015, under the Government in the Sunshine Act.
The Commission will today consider three rulemakings, including recommendations from the staff to finalize two mandates of the Dodd-Frank Act – the dealer registration requirements for security-based swap dealers and major security-based swap participants under Title VII and the requirement to disclose a pay ratio under Section 953. The Commission will also consider, in connection with the registration requirements, a third staff recommendation to propose a rule of practice providing a procedure for processing applications from security-based swap entities to deal with individuals and entities subject to statutory disqualifications.
We will start today with the two recommendations from the Division of Trading and Markets regarding security-based swap entities. We will discuss these recommendations together, but vote on them separately. Then, we will consider and vote on the third recommendation, which is from the Division of Corporation Finance, to implement the statutory pay ratio mandate.
Registration Requirements for Security-Based Swap Entities
We will begin with derivatives. Following the financial crisis, Title VII of the Dodd Frank Act established an entirely new regulatory framework for the over‑the‑counter derivatives market, with the Commission given the mandate to regulate and oversee security-based swaps, a global market with now over $11 trillion in contracts outstanding. Fully implementing this mandate has been a key priority for the Commission. Early in my tenure as Chair, the Commission issued the last core proposals under Title VII, including a comprehensive approach to cross‑border issues and extensive recordkeeping requirements, and re-opened the comment periods for the outstanding proposals. Since then, the Commission has adopted the foundational rules defining the scope of our regulatory regime and finalized the framework for the data repositories that will collect, report, and disseminate critical market data.
Today’s rules begin the next major phase of finalizing our rules under Title VII: the regulation of the dealers and other market participants who occupy a critical role in this over‑the‑counter market. Virtually every security-based swap transaction involves a dealer whose counterparties rely on them to provide liquidity when needed; to assist them in structuring transactions that meet their business needs; to provide access to clearinghouses; and to remain financially viable throughout the sometimes long life of a derivatives contract. In the coming months, I expect the Commission to finalize the full series of regulations for dealers, including controls on how they conduct business with counterparties and how they preserve their financial integrity with capital and margin.
The first recommendation before us today establishes a thorough process for security-based swap dealers to register with the Commission. Registration of these dealers with the Commission is the fundamental tool by which the Commission obtains the comprehensive information necessary to regulate dealers and supervise their business operations.
Under the recommended process, a registered security-based swap dealer will submit – and will be required to update – extensive information about its business activities, structure, and background, as well as information about its control affiliates. As is true for broker-dealers and our other existing registrant classes, this information will be the core of our ongoing oversight program – and newly registered dealers will be immediately subject to our examination and inspection authority.
But filling out detailed forms is obviously not enough. The rules would also require that dealers undertake due diligence to help ensure that they have put in place a framework to enable them to operate in compliance with the federal securities laws. The required due diligence, which must be documented, will be the basis of a certification by a senior officer of the dealer at the time of registration that he or she has reasonably determined that the dealer has developed and implemented written policies and procedures reasonably designed to prevent violations of the federal securities laws.
In addition, under the final rule, a dealer will need to conduct an investigation of its associated persons, including performing background checks and soliciting questionnaires from employees, regarding whether they have been subject to certain adverse legal actions that have resulted in their statutory disqualification under the federal securities laws. The results of this diligence will be the basis of a second, separate certification by the dealer’s Chief Compliance Officer that no such persons are involved in effecting the dealer’s security-based swap transactions, further promoting the protection of investors and the integrity of the security-based swap market.
The second certification requirement flows from a unique and very broad provision of the new statutory regime for security-based swaps – absent Commission action by rule or order, a dealer is prohibited from having any associated person who is subject to a statutory disqualification involved in effecting its security-based swap transactions – activity that can cover everything from sales to pricing services to cash and collateral management. And it applies to a very wide range of prescribed statutory disqualifications, which go far beyond Commission enforcement actions or criminal misconduct. This prohibition applies even though the dealer itself has not violated any law, and it would apply whether the associated person is a natural person or an entity.
The statute does, however, provide the Commission with explicit authority to tailor this broad prohibition. In determining how to use this authority, we should strive for an approach that is consistent with the goal of the prohibition, but that does not unnecessarily harm the counterparties of the dealer or hinder the broader operation of the security-based swap market that exists today – and that will exist after our final rules are implemented. Today’s recommendations endeavor to strike a careful and reasonable balance in using that authority.
First, in recognition of the challenges associated with imposing new regulations on an existing market, the recommendation permits a dealer, at the time it registers with the Commission, to continue to associate with entities that are subject to a statutory disqualification that occurred prior to the compliance date of the registration rules. The dealer will need to disclose such entities in its registration.
Second, for all other cases, the staff’s other recommendation in this area proposes a rule of practice – based on our existing rules – that would establish a transparent, efficient, and comprehensive process for the Commission to consider expeditiously whether it is in the public interest to permit the dealer to associate with the disqualified person. This process should enable the Commission to consider the facts and circumstances of each situation while providing market participants certainty about their potential business arrangements in a timely manner.
As the detailed questions posed in the proposing release reflect, there are a number of issues that we are considering where I am very keen to receive comments and, where possible, empirical data. These issues include:
- Whether we should apply the general prohibition on association to disqualified natural persons only and not entities, as the CFTC does in its swap rules. Our proposal contemplates covering both.
- Whether we should provide any temporary relief from the prohibition on association with disqualified entities, as the proposal contemplates, to avoid abrupt disruptions in ongoing business.
- And whether the period of time for such temporary relief is appropriately set at 180 days, as the proposal contemplates, instead of a longer or shorter period.
Another important issue for comment is the appropriate level of comity for the work and perspective of other regulators concerning their own registrants. The recommendation provides that, where the Commission itself has not separately barred or suspended the associated person, a separate application to the Commission would not need to be made if the CFTC, National Futures Association, or an SRO regulated by the Commission has already specifically examined the facts and circumstances giving rise to the statutory disqualification and made an affirmative finding that association is permissible.
This proposed process would avoid anomalous results and leverage Commission resources by taking into account determinations made by other regulators with respect to persons squarely within their jurisdiction. I am very interested in comments from all market participants on the potential benefits and risks of the proposed approach, including views on whether the Commission should itself process all applications for continued association with a disqualified party.
It is our objective that the final process for dealing with the disqualifications of associated persons be both transparent and efficient, while implementing the statutory prohibition in a manner that provides strong investor protections and avoids unnecessary disruptions for counterparties and the market.
Before I ask Gary Goldsholle, the Deputy Director of the Division of Trading and Markets, to discuss the two recommendations, I would like to thank Steve Luparello, our Director of Trading and Markets and Gary, as well as their counsels, Malou Huth and Carl Emigholz, for their leadership in this rulemaking.
I would also like to especially commend the core rulemaking team for all their hard and exceptional work. From the Division of Trading and Markets: Heather Seidel, Paula Jenson, Joseph Furey, Joanne Rutkowski, Bonnie Gauch, Natasha Vij Greiner, and Jonathan Shapiro from the Division of Trading and Markets, and from the Division of Economic and Risk Analysis, Jennifer Marietta-Westberg, Vanessa Countryman, Adam Yonce and Diana Knyazeva.
Many thanks as well to Meridith Mitchell, Lori Price, Robert Teply, Janice Mitnick and Maureen Johansen from the Office of General Counsel, for their invaluable assistance in developing and refining both recommendations.
In addition, I would like to thank many other staff throughout the agency for their contributions, including Amy Starr, Paul Dudek and Andrew Schoeffler from the Division of Corporation Finance; Charlotte Buford, Kerry Knowles and Ken Hall from the Division of Enforcement; Sara Crovitz and Michael Didiuk from the Division of Investment Management; Carrie O’Brien from the Office of Compliance Inspections and Examinations; Eric Pan, Katherine Martin and Kathleen Hutchinson from the Office of International Affairs; and Brian Bussey, Carol McGee, Richard Gabbert, Joshua Kans and Andrew Bernstein from the Division of Trading and Markets.
Finally, I would like to express my gratitude to my fellow Commissioners and all of our counsels for their very hard work and comments on these and related Title VII rules over these past months.
The third item on the agenda today is the consideration of final rules to implement Section 953(b) of the Dodd-Frank Act – the provision requiring companies to compute and disclose the ratio of the chief executive officer’s annual total compensation to the annual total compensation of the company’s median employee.
To say that the views on the pay ratio disclosure requirement are divided is an obvious understatement. Since it was mandated by Congress, the pay ratio rule has been controversial, spurring a contentious and, at times, heated dialogue. The Commission has received more than 287,400 comment letters, including over 1,500 unique letters, with some asserting the importance of the rule to shareholders as they consider the issue of appropriate CEO compensation and investment decisions, and others asserting that the rule has no benefits and will needlessly cause issuers to incur significant costs.
These differences in views were evident at the time the Commission voted to propose the pay ratio rule. That the Commission was even considering the rule proposal was, for example, criticized as contrary to our mission. We may hear similar thoughts today.
From my perspective, one of our important affirmative responsibilities, among many others, is to implement the mandates of Congress – and to do so in a way that is as cost-effective as feasible and that best advances our mission. That this particular mandate and others under the Dodd-Frank Act or the JOBS Act do not provide a specific deadline for their adoption does not diminish the agency’s obligation to act. It is the law, and we are required to carry it out, just as we did in March when we adopted Regulation A+ under the JOBS Act.
Here, the staff is recommending that the Commission adopt a carefully considered and calibrated pay ratio disclosure rule that carries out a statutory mandate that the Commission was given. The pay ratio disclosure will provide shareholders with additional company-specific information that they can use when considering a company’s executive compensation practices, an important area of corporate governance on which shareholders now have an advisory vote. A number of commenters noted that the pay ratio disclosure will be important to them as they exercise their say-on-pay votes.
While there is no doubt that this information comes with a cost, the final rule recommended by the staff provides companies with substantial flexibility in determining the pay ratio, while remaining true to the statutory requirements. As did the proposal, the final rule provides companies with substantial discretion to use estimates and sampling as a means to determine the median employee and the employee’s compensation. As required by the JOBS Act, the final rule excludes emerging growth companies. Smaller reporting companies, foreign private issuers, registered investment companies and registrants filing under the U.S.-Canadian Multijurisdictional Disclosure System would also be excluded, as they were in the proposal.
The staff is also recommending additional accommodations in the final rule, including: an exemption for situations when foreign data privacy laws would prevent companies from being able to process or obtain the necessary compensation information to calculate the ratio; an ability to exclude up to 5% of non-U.S. employees when determining the median employee; and allowing companies to use cost-of-living adjustments when determining the median employee and calculating the employee’s total compensation, in order to achieve a more meaningful reflection of the compensation of employees as compared to the chief executive.
The staff’s recommendations for the final rule would also allow companies to choose any date during the last three months of a company’s fiscal year to determine the median employee and, to further reduce costs, would permit companies to use the same median employee for three years unless there has been a change in the employee population or employee compensation arrangements that the company reasonably believes would result in a significant change in the pay ratio disclosure.
These are good and reasonable changes that should reduce costs for many companies while adhering to the statutory requirements.
I want to commend the staff for all of their exceptional and extensive work to craft a reasonable rule that is both flexible and faithful to the terms and objective of the statute. Once again, the SEC staff has demonstrated their expertise, thoughtfulness and clear-eyed analysis as they formulated this recommendation for our consideration.
Specifically, I would like to thank Director Keith Higgins, Betsy Murphy, Felicia Kung, John Fieldsend, Shehzad Niazi, Raquel Fox, Sylvia Pilkerton, and Brandon Riemersma in the Division of Corporation Finance; Annie Small, Rich Levine, Bryant Morris, Dorothy McCuaig, Brooks Shirey, and Sara Prins in the Office of the General Counsel; Mark Flannery, Scott Bauguess, Vanessa Countryman, Simona Mola Yost, Anzhela Knyazeva, Vladmir Ivanov, Peter Iliev, and Wei Liu in the Division of Economic and Risk Analysis; and Michael Pawluk and Matt DeLesDernier in the Division of Investment Management.
 While these remarks generally focus on security-based swap dealers, the registration process and requirements are similar for major security-based swap participants.