A Renewed Focus on SEC Priorities
Commissioner Daniel M. Gallagher
AICPA/SIFMA Financial Management Society Conference on the Securities Industry
Oct. 25, 2013
Thank you, Paul [Lameo].
I'd like to take on the subject of SEC priorities today — the priorities themselves, but also the need for the Commission to establish and follow a list of priorities, created by reference to articulated criteria, to determine and drive what we do. The alternative is to follow the prevailing political winds or the policy fashion of the moment — which have, unfortunately, guided our priorities over the past few years. Congressional mandates don’t make the process of setting our priorities any easier - the SEC’s one hundred Dodd-Frank rulemaking assignments, spread across more than two thousand pages of legislation, expand our docket exponentially and raise difficult questions of where to begin and which of our higher priorities to push aside in order to tackle those mandates.
Establishing priorities is about making sure that we spend our time and resources addressing the most pressing and important items on our agenda, remaining cognizant of the fact that deciding which potential agenda items to pursue also entails deciding what not to do and what to defer. Let’s be honest: some things simply matter more than others — and even if everything were equally important, we couldn’t do everything at once. And, to be frank, some things simply shouldn't matter at all, and we simply shouldn’t waste our time on them.
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Fortunately, in setting our priorities we need not start from scratch. The SEC is tasked with a clear and longstanding mission. Our threefold mission, in short, is to facilitate capital formation, maintain fair, orderly, and efficient capital markets, and protect investors.
Although the investor protection element of our mandate seems to get most of the attention, the three components of the SEC’s mission are tightly intertwined and should never be disassociated. In fact, when you think about it, they cannot be. Without fair and efficient capital markets promoting capital formation, there would be no investors to protect - unless, as has sometimes seemed to be the case in recent years, our regulation has become a matter of protecting investors from risk by denying them opportunity. This is especially problematic in a zero percent interest rate environment in which investors are seeking opportunities to earn a return on their investments.
So let’s be clear: the SEC has three overriding mandates against which everything we do or are asked to do must be measured. Of course, in practice, it’s not quite that simple. Markets have multiplied and morphed, while investment products and the manner in which they are traded have become extraordinarily complex.
Perhaps the most conspicuous complication in fulfilling our threefold mission is the thick overlay of recent congressional mandates that, given our necessarily limited capacity, compete for our attention. I've already referenced - as I often do - the Dodd-Frank Act's complicated, convoluted, and sometimes crippling new mandates. Alongside those, the JOBS Act’s handful of rulemaking mandates seem almost poetically focused and concise.
What gets lost too often in discussions of the Commission’s agenda is what I like to call the SEC’s basic “blocking and tackling,” the fundamentals of our regulatory mission stemming from our threefold statutory mission. Fellow football fans understand the importance of successfully executing the fundamentals day-in and day-out. Fail at those and risk losing, whether the opponent is the Giants, the Jets, or jumbo RMBS.
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All that said — and this is the real point — we can’t do everything, at least not all at once. There are other practical constraints which may seem obvious, but their considerable implications underscore the critical importance of sticking to our priorities. We are constantly working on a steady diet of rulemaking proposals and considering a never ending stream of enforcement recommendations. Despite our able and dedicated agency staff, there is only so much we can manage at any given time.
It is, as I noted in a speech on this topic over a year ago, “all about priorities and relative priorities.” So how are we doing? Well, in that speech I took a step back and asked the same question. I wondered whether the SEC was spending its time as it should and whether the priorities reflected in the SEC’s rulemaking agenda stemmed from an expert appreciation of then-current market conditions and the most pressing problems they raised. I asked whether they reflected the SEC’s proper situation in the regulatory constellation and reflected the application of an understood set of criteria or standards. Finally, I urged consideration of the extent to which our priorities were, in fact, driven by other agencies’ policy preferences or institutional mandates rather than our own.
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Those questions remain timely and valid. I last posed them soon after a bare majority of the Commission had voted to adopt rules implementing Dodd-Frank disclosure mandates for conflict minerals and resource extraction payments. Since that time, both rules have been challenged in the courts. One was rightfully vacated, while the other was sustained pending the D.C. Circuit’s decision on appeal. They have continued, in short, to take their toll in terms of Commission staff time and attention, to say nothing of their present effect on affected issuers.
So should promulgating those two sociopolitical rules have been among our top implementation priorities, given the roughly 100 mandates Congress lavished on the SEC in the Dodd-Frank Act, theJOBS Act mandates, and our blocking and tackling needs? Or, put another way, exactly which aspects of our conflict minerals and extractive resources rules had anything at all to do with “fostering fair and efficient capital markets, promoting capital formation” or “protecting investors”? The answer is nothing. Nor, to be clear, did they have anything at all to do with the financial crisis, which Dodd-Frank was ostensibly designed to address. They were certainly mandates, but should never have been priorities.
Should they have taken precedence, in terms of Commission and staff time and attention, over, for example, the removal of credit ratings pursuant to Dodd-Frank’s Section 939A mandate? Overreliance on credit ratings was, after all, at the heart of the collapse of securitized products that played a key role in the financial crisis. And, as I pointed out over a year ago, “the Commission has been analyzing the removal of rating agency references since former Chairman Cox and the Commission proposed removing them in 2008,” even before the collapse of Lehman and the onset of the financial crisis? Chairman Cox and the Commission were right at the time, and it’s disheartening to think it took the crisis to prove it. And I am also sad to report that no progress has been made on Section 939A since I made this point last year.
And as for regulatory distractions along the lines of our conflict minerals and extractive resources rulemaking adventures, there are other, more recent examples of misprioritization. For example, just last month a bare majority of the Commission proposed — over my vigorous objections and those of my colleague Mike Piwowar — rules to implement a Dodd-Frank requirement that issuers disclose, in their filings, the ratio of their CEO’s “total compensation” to that of their median employee worldwide — including part-time, seasonal, and temporary employees. That provision didn’t find its way into Dodd-Frank in order to foster fair and efficient capital markets or promote capital formation. And it surely does nothing at all to protect investors. In fact, it absolutely guarantees injury to their financial interests by imposing significant costs on the companies in which they have invested.
In no sense did the pay ratio provision address any aspect of the financial crisis, and, unlike other non-germane mandates in Dodd-Frank, it did not even purport to address a humanitarian crisis. Nor did Congress impose any deadline by which the SEC was to act. So why was the “pay ratio” mandate in Dodd-Frank and why was it so high on the SEC agenda? Whatever may be the answer, it has nothing at all to do with our threefold mandate.
This kind of misprioritization carries other costs as well. Over the past several years, the Commission has gone from being ranked as one of the best places to work in the federal government to one of the worst, bottoming out in last year’s survey at 19th out of 22 mid-sized agencies. There are many reasons for this morale problem, but undoubtedly a main cause is the impact of years of carrying out mandates unresponsive to the financial crisis under unrealistic, arbitrary deadlines. The Commission staff is filled with intelligent, motivated workers — exactly the type that chafe the most when forced to put aside vital market reforms that they have identified in overseeing various programs to meet congressional deadlines to work on rulemakings that are, at best, tangential to the SEC’s mission.
Furthermore, the more we are forced to divert our limited time and resources to non-core issues, the more we risk being marginalized by bigger, less distracted regulators. The Fed, for example, has proposed rules under Dodd-Frank Section 165 that would severely undercut our regulatory authority over broker-dealer subsidiaries of foreign banks. Regulators, like nature, abhor a vacuum, and when the nation’s securities regulator is too busy focusing on conflict minerals, extractive resources, and pay ratios to exercise its discretion to address the most pressing matters, we shouldn’t be surprised at all to see other agencies move in.
And that brings us to the heart of the matter. Of all the things we might have done — mandate or no mandate — what should we have done, and what should we be doing? And by what criteria would I prioritize those tasks above all other potential tasks and rulewriting initiatives? Let me outline a framework by which I believe the Commission’s priorities should be set.
First, is the potential action clearly important in order to fulfill some aspect of the Commission’s threefold mission? That’s the sine qua non of taking action, situating the task within our mission and competence.
Second, is the task relatively more pressing than other tasks that also meet those criteria? Would it, for example, have a direct, positive economic benefit — as would prompt and proper implementation of several of our JOBS Act mandates?
Third, does it address one or more causes of the financial crisis — or anticipate and seek to address factors that could lead to a future crisis we should be eager to avoid? That’s the question of its relative importance — it puts the task into its temporal and substantive context.
Fourth, what is the trade-off? What must we, by engaging in this activity now, leave undone for the present? And here, it is critical to include the SEC’s routine “blocking and tackling” assignments, not just newly imposed congressional mandates.
Fifth, does the Commission have the requisite expertise to complete the task efficiently and effectively? If not, I would take another look at our initial question — whether the task in question is really within the SEC’s threefold mission.
Finally, can the Commission fulfill its objective in a cost-effective manner or, to put it more simply, do the benefits outweigh the costs?
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So, it’s fair for you to wonder what would make my list — and whether you should expect to see any of these priorities on the Commission’s rulemaking agenda any time soon. I’d propose the following, which clearly meet the criteria I’ve outlined.
I’ll begin with credit agency reference removal as required by Dodd-Frank Section 939A — including those for net capital requirements, shelf eligibility, and money market funds. During the financial crisis, bundles of securitized subprime mortgages were, disastrously, bequeathed triple-A credit ratings, and regulators, investors, and other market participants relied on these ratings to their great detriment. Hence Section 939A of Dodd-Frank, which required us and our fellow federal regulators to remove credit references from our rulebooks, and thereby eliminate the regulatory incentive to rely blindly on them. I don't often speak positively of Dodd-Frank requirements - how could I? But 939A’s well-targeted, crisis-related fix should have been completed years ago, and should now be among our highest priorities.
Another key priority should be the commencement of a comprehensive market structure review. As I’ve noted in the past, our securities markets and trading practices did not develop in a vacuum but instead have been shaped by our rules. It is long past time to conduct a serious, thorough, holistic review of our current market structure with no “sacred cows,” and I was very pleased earlier this month to hear Chair White express her agreement that we need to rethink our assumptions in that manner. The fundamental question, on which a large portion of our economic well-being turns, is whether a combination of legislative regulatory actions taken in other times and economic contexts has induced unintended and potentially harmful market practices and trading behavior in response. Should we find problems, we would turn to the equally serious question of how best to address them.
Proxy advisory reform should also be a Commission priority. We need to take a very close look at how we have allowed a tiny oligarchy of proxy advisory firms to wield disproportionate influence on proxy questions in corporations nationwide. We have, indeed, permitted institutional investors to outsource their fiduciary responsibilities to these unaccountable third parties, who often have serious undisclosed conflicts of interest. In my view, this issue goes to the heart of corporate governance and is of fundamental importance. And just last month, the Canadian Securities Administrators announced that they intend to publish early next year a proposed approach to addressing issues with proxy advisors. Similarly, the Europeans have been actively pursuing oversight. Action on this issue on the part of the Commission is long overdue, and the SEC should not lead from behind.
We should prioritize the responsible implementation of Title IV of the JOBS Act, often referred to as “Regulation A+.” Our Regulation A exemption from registration is meant to provide a helpful step in the capital formation process along the road to a possible initial public offering. It is, nevertheless, seldom used — only twice last year, for example. While there are several explanations for its unpopularity, the standard view is that the current offering limit is too low to make its use worthwhile today. Other exemptions have served as preferable ways to raise capital. But Reg A has another feature — it offers an investment opportunity to ordinary retail investors, not just to the affluent like so many of our rules. I believe we need to implement the JOBS Act's provisions and do what is necessary to fix Reg A, so that it becomes a practical and useful way of promoting capital formation and, in turn, job creation.
Another important area of focus for the Commission should be fixed income regulatory reform. Commission staff estimates that in 2012, the corporate bond market was comprised of $10.8 trillion in outstanding debt, with a retail participation rate of approximately 48 percent. The municipal securities market was $3.7 trillion, with an approximately 75 percent retail participation rate and fully 45 percent held directly by retail investors. Despite the tremendous size of these markets, until recently, the Commission had no more than a handful of staff handling fixed income issues — indeed, when I served as Deputy Director of the Division of Trading and Markets, a grand total of two individuals covered munis. In one of the few provisions of the Dodd-Frank Act that make sense, Congress directed the Commission to establish an Office of Municipal Securities. This is an excellent first step, but it’s only a first step — the Commission needs to build upon this foundation and commit the resources necessary to develop expertise in the fixed income field to match our knowledge and experience in the equities markets.
I’ll conclude my list of priorities by emphasizing the need for disclosure reform more generally. This one can get a somewhat different reaction depending on whether I’m speaking to a roomful of lawyers or to corporate officers and directors. The accretion of decades of complex disclosure rules has generated a vast pile of disclosure requirements, both periodic and occasional, and numerous equally complex forms. That keeps many legal specialists gainfully employed, and noncompliance with disclosure requirements is the basis for much of our enforcement activity and, of course, fodder to the ever-present plaintiff’s bar. But today's disclosures are not written in a manner designed to communicate with average retail investors — or even with sophisticated investors. Rather, disclosure drafting efforts are aimed at avoiding any claim that they have failed to meet regulatory requirements — that is, to avoid securities strike suits and enforcement actions. In other words, disclosure has become an elaborate and expensive formality which is further complicated by politically motivated disclosure requirements like those I mentioned earlier. The byproduct is such a welter of impenetrable information that what is truly material is buried in a sea of legalistic subtleties — as my friend and former colleague Troy Paredes phrased it in a speech earlier this year, “information overload.“ This sort of disclosure is a form of non-disclosure — and shareholders bear the full brunt of its costs. We need to begin a comprehensive evaluation of our disclosure system and whether it is, in practice, as effective as it should be in providing truly material information to the investing public.
Lately we have begun to see some hopeful signs. I expect, for example, that the Commission will begin work on implementing the bulk of the JOBS Act’s mandates soon and that we start the final push towards removing all references to credit ratings from our rules by year’s end. Better late than never.
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Finally, having spelled out both my criteria and the resulting priorities, it is fair to mention a couple of items that would certainly not make my list. Mandated disclosure by issuers of non-material “political” contributions would not fit anywhere on my list. Simply stated, either the payments are material — in which case they must be disclosed anyway — or they are not. But requiring disclosure of all corporate political contributions adds a pile of inherently non-material information to the mountain of disclosure already mandated at considerable cost. Similarly, and for the same reason, we should not have taken it up as a priority in the first place, rewriting the Section 1504 “extractive industries” payment rule stricken by the courts should be very low on our to-do list.
Establishing our rulemaking priorities entails deciding how not to expend our time and expert resources. And American taxpayers should expect no less of us.
In summary, fulfilling our threefold mandate and considering the ramifications of what we do on “efficiency, competition, and capital formation,” means that we must, and in this order, study, consider, prioritize in proper context, and then act as appropriate.
Let me add, finally, that you can help. It is critically important that the Commission avoid setting its priorities in a vacuum, irrespective of investor and industry needs. There is an inevitable degree to which the Commission is insulated, if not actually isolated, from the world it regulates. Some of that is deliberate. It enables us to maintain critical distance — the space within which to exercise independent policy judgment — and to avoid “regulatory capture.” But that distance carries a danger that our agenda and our actions may be mistargeted, imprecise, or inadequately informed.
 Commissioner Daniel M. Gallagher, “SEC Priorities in Perspective” (Sept. 24, 2012), available at http://www.sec.gov/News/Speech/Detail/Speech/1365171491262.
 Chair Mary Jo White, “Focusing on Fundamentals: The Path to Address Equity Market Structure” (Oct. 2, 2012), available at http://www.sec.gov/News/Speech/Detail/Speech/1370539857459.
 “CAS Notice 25-301, Update on CSA Consultation Paper 25-401, Potential Regulation of Proxy Advisory Firms”, September 19, 2013, available at http://www.osc.gov.on.ca/documents/en/Securities-Category2/csa_20130919_25-301_update-25-301.pdf.
 “ESMA recommends EU Code of Conduct for proxy advisor industry”, February 19, 2013, available at http://www.esma.europa.eu/news/ESMA-recommends-EU-Code-Conduct-proxy-advisor-industry; see “Final Report: Feedback statement on the consultation regarding the role of the proxy advisory industry”, European Securities and Markets Authority, February 19, 2013, available at http://www.esma.europa.eu/system/files/2013-84.pdf.
 Commissioner Troy A. Paredes, “Remarks at The SEC Speaks in 2013” (Feb. 22, 2013), available at http://www.sec.gov/news/speech/2013/spch022213tap.htm.