Speech by SEC Chairman:
'The Hunters and the Stag': Why National Securities Regulators Must Collaborate In the Era of Global Investing
Chairman Christopher Cox
U.S. Securities and Exchange Commission
Keynote Address to the International Organization of Securities Commissioners
Technical Committee Conference
November 16, 2006
Good morning, and thank you for that kind introduction. This is an excellent opportunity to congratulate the UK Financial Services Authority for hosting this conference. We all owe the FSA - and in particular Callum McCarthy, John Tiner, and their outstanding team - a deep debt of gratitude for their leadership in bringing forward regulatory issues that are of truly international importance and that affect every one of our markets.
The challenges that the world's securities regulators now face, as our global securities markets become more integrated each day, may sometimes seem to us to be entirely new. But of course there has really never been a time when capital markets weren't global. One need only recall the world's first public company, the Dutch East India Company, which drew its investors from all over Europe, and spread its activities around the globe from Asia to South America.
For over 400 years, globalization and transnational investment have been powerful forces bringing nations together. These forces arise from the very nature of trade itself. And so it behooves us as regulators to pay attention - and if at all possible, to stay ahead of the curve. That's because while globalization isn't new, the speed at which the world is shrinking certainly is.
Today, financial transactions are crossing national boundaries faster than ever before. More and more, public companies are raising capital beyond their home markets. Investors increasingly are trading in other countries besides their own. Without question these are exciting times, and in this respect they're unparalleled in the history of the world. With a quick conference call over a wireless network to colleagues half a world away, or simply by pressing "Enter" on a computer keyboard, anyone in any country can cause money and information to travel at the speed of light, and make decisions that are carried out immediately overseas.
To give just one example of what this means in securities markets: According to the U.S. Federal Reserve, over the last decade the total holdings of foreign investors in U.S. equities grew from just over $500 billion in 1994 to more than $2 trillion in 2004. And that doesn't even count the U.S. mutual fund holdings of foreign investors. During that same period, the holdings of U.S. investors in equities in other countries grew from less than $800 billion to over $2.5 trillion. And again, that doesn't even count what Americans owned in the way of non-U.S. mutual funds.
So it should come as no surprise, at a time when investors are already able to quickly and easily buy and sell securities almost anywhere on the planet, that the world's exchanges are now beginning to combine their operations in order to more closely integrate the world's capital markets.
The question for this conference as we're gathered here this morning is what this integration of world's capital markets means to us as regulators. And the starting point for our analysis has to be the immediate recognition that in a world where companies and investors can easily choose where to buy and sell, every nation is going to face new challenges to its ability to impose and enforce securities regulations. After all, if companies and investors find the rules within a particular jurisdiction too restrictive, technology makes it easy for them to find another jurisdiction more to their liking.
And so we must then ask ourselves: Does this mean we have to concede that the whole idea of investor protection has outlived its usefulness? And the answer is, absolutely not. In fact, just the opposite is true: National securities regulators are more relevant, and more needed, in the face of globalization than ever before. That's so for two very important reasons.
First, along with the undisputed benefits of global markets, come greater risks - particularly to unsophisticated investors. Those risks from cross-border trading take the form of new opportunities for fraud, the greater exposure to unethical trading practices, and higher susceptibility to market manipulation.
The second reason is obvious: there is no other national or international body that has both the legal mandate and the legal authority to protect investors and promote capital formation. National regulators have no choice but to wade into this fray.
So the challenge we face is figuring out how to protect investors and promote capital formation in an environment where capital, market actors, and fraudsters are all completely mobile.
In the nineteenth century, Max Weber defined the state as a community that claims a monopoly on the legitimate use of force within a given territory. That celebrated definition has been neatly captured in the schoolchild's aphorism: if you play in my yard, you play by my rules. But in the information age, which Weber did not live to see, things aren't so simple. Technology has made it possible for fraudsters and criminals anywhere in the world to play in whatever yard they wish, even though they're physically located across an ocean or on the other side of the planet. And the swindlers know that the regulators responsible for enforcing the rules can't pursue them outside the yard, let alone to the ends of the earth, because the regulator's power stops at its borders.
Each of us is keenly aware of the very real geographic limits on our individual jurisdictions. So solving this growing problem is necessarily beyond the ability of any individual regulator. We have no choice but to cooperate. Yet at the very time that the globalization of our markets and this looming problem of fraud without borders are driving us inexorably to greater cooperation, there's an opposite force at work pulling hard in the other direction. That is the temptation for regulators to relax their standards to attract investors and issuers, at the expense of the other jurisdictions - with the result that the overall standard of regulatory quality suffers.
You might think of it as Rousseau's dilemma.
Two centuries ago, the philosopher Jean Jacques Rousseau described the very challenge we're facing as securities regulators today. Rousseau tells the story of five hunters who come together in a forest, at a time when each one of them is desperate with hunger. If they can kill a stag, it will provide enough to save all of them. But they will all have to cooperate in order to trap it.
It's also the case, however, that the hunger of any one of them will be satisfied by a hare. And sure enough, just as the hunters are about to succeed in trapping the stag, a hare comes within reach of one of the hunters, and he grabs it. But by grabbing the hare and satisfying his own hunger, the hunter permits the stag to escape - and the others go hungry.
The moral of Rousseau's parable has been stated in many ways. Perhaps the most stark formulation is that "we must cooperate or perish." For our purposes as securities regulators, the more subtle and useful interpretation is that unless we cooperate, we won't achieve our highest aspirations for investor protection, orderly markets, and healthy capital formation.
Cooperation doesn't mean that we should harmonize our regulations at levels that cost investors far more than they could hope to gain by way of better protection. Rather, we should seek the appropriate level of regulation that balances the costs to investors against the benefits they might receive. In some cases we'll need to work with our counterpart regulators to heighten regulation on a multinational basis. In other cases we'll need to tailor our approach where the experience of many nations has shown a more effective way to measured and workable solutions.
We at the SEC are grateful for the reactions of our counterpart regulators around the world to our implementation of the 2002 Sarbanes-Oxley law. And we've benefited greatly from your sharing your own experience in related areas, particularly with respect to the requirement that companies assess their internal controls over financial reporting.
In the weeks ahead, the U.S. will unveil significant changes to the implementation of section 404 of Sarbanes-Oxley that are designed to make it more useful for investors. Those changes will be aimed at ensuring that the internal control audit is top down, risk based, and focused on what truly matters to the integrity of a company's financial statements. They will provide guidance for both companies and their auditors to permit common sense reliance on past work, and on the work of others.
The overarching objective of these significant changes will be to reduce the cost to investors while increasing the benefits in terms of investor protection. This is an objective that I know is shared by everyone in this room. In this regard, I can't praise enough the work that IOSCO has done to identify best practices, and to establish principles for securities regulation. IOSCO's long and successful history of promoting high-quality regulation that fosters just, efficient, and sound markets has been invaluable in creating an international setting in which we can share information and collaborate on issues of common concern - including specifically such questions as the best way to conduct internal control audits.
In expressing our gratitude for the work of IOSCO, we owe the highest praise to Jane Diplock, chair of the Executive Committee; Michel Prada, chair of the Technical Committee; and Meleveetil Damodaran, chair of the Emerging Markets Committee. Thank you, each of you, for your leadership in solidifying the foundation on which our collaborative endeavors rest.
IOSCO's Objectives and Principles for Securities have set high standards for IOSCO members, and that has had a dramatic and positive effect on cross-border trading. At the same time, the Principles haven't called for identical regulation among IOSCO members, but rather have recognized that there is "no single correct approach to a regulatory issue."
We all benefit from this international process of observing what works, and learning from what doesn't. In 1932, U.S. Supreme Court Justice Louis Brandeis wrote that "one of the happy accidents" of a system of multiple jurisdictions is that "a single courageous state may, if its citizens choose, serve as a laboratory, and try novel social and economic experiments." Some of the experiments in regulation that we have witnessed around the world seem to have worked. Others have failed. So long as our experiments are aimed at providing high-quality investor protection, we all stand to gain. But if our experiments are guided by the desire to beggar our neighbors, we will all surely lose.
So allow me, at this point, to advance a proposal. The way for each of us, as national regulators, to maintain robust investor protections while building healthy international markets is first, to adopt strong regulatory regimes at home that are cost-justified; and second, to cooperate with our fellow securities regulators abroad to implement agreed-upon regulatory objectives on a global level. We've got to constantly re-examine our regulatory systems from top to bottom, and capitalize on every opportunity for mutual improvement. And we must also continually reassess the costs and benefits of our regulations as they are actually applied.
Regulators don't have the luxury of trying to make things work in theory. We have to make things work in practice. I'm convinced that there is no better way of doing this than by working together -- here at this conference, and throughout the year at other IOSCO gatherings and international fora. Together, we can raise the standards for the protection of trading and investment across all of the world's capital markets, while at same time making those markets more efficient. Without a doubt, the future of our global economy depends upon it.
And so, to every one of the participants here today, thank you for what you do year in and year out to keep our markets free, fair, and competitive. We look forward to continuing to work with you. Every one of us at the SEC is proud to be your partner.